As the Dow plunged 1,000+ points on Monday, erasing its 2020 gain in the process, Goldman threw in the towel on their Q1 GDP forecast, slashing their outlook to 1.2% from 1.4%.
It’s indicative of a slow, begrudging recognition of reality, and you can expect more of the same across desks over the next two weeks, even if the news flow around the epidemic improves. After all, some of the economic damage is already done. It’s just a matter of waiting for it to show up in the data.
Of course, in times like these, one has to immediately question whether things have overshot. I touched on that early Monday in “Werewolves, Emergency Rate Cuts And Peak COVID-19 Panic“. A quick look at recent history suggests the current pullback is still just a blip on the proverbial radar screen – at least in terms of US equities.
“In December we cautioned that a 5-10% market pullback in 1H20 was possible as volatility was low, expectations were high, and Fed accommodation had repriced risk beyond the fundamentals”, Wells Fargo’s Chris Harvey said, adding that “Friday appears to [have been] the beginning of that selloff”.
The bank says it isn’t seeing panic selling on its equities desk, but Harvey goes on to note that “conversations with Rates players indicate the focus is on convexity hedging and the worry is yield movements have the potential to be very fluid”.
Indeed they do. And this is just a continuation of the discussion from last week. It’s difficult to decipher exactly what you’re seeing in rates during moments like these, when hedging flows have the potential to magnify moves.
Read more: Bond Rally Has That August Feel, As Macro Scare And Hedging Flows Collide
The speed of the decline in yields has now matched the August extremes. The 21-day Z-score is nearly -3.
“While yield levels are not favorable, US Treasurys are clearly the optimal choice as safe haven protection [given that] JPY may no longer function as a safe haven asset”, BofA’s Carol Zhang said Friday, underscoring one of last week’s most compelling storylines.
“That 10- year yields were able to easily drop through 1.427% (the 2019 trough) speaks to the conviction of the flight-to-quality flow, and that it occurred when Japanese markets were closed for a holiday is even more telling”, BMO’s Jon Hill, Ian Lyngen, and Ben Jeffery wrote Monday, adding that “when cooler heads prevail, current valuations appear out of step with fundamentals [as] the 1- year yield, nine years from now, is 1.61%… almost exactly as extended as we saw during the peak of the rally back in August 2019”.
For those who want a simpler version of this, stripped of any and all nuance, just note that TLT has already matched 2019’s return in just the first two months of 2020.
Another couple of sessions like Monday, and the Fed will likely have to consider how to convey to markets that what’s happening with the virus constitutes grounds for the kind of “material reassessment” that Jerome Powell has made clear would be required to put imminent rate cuts on the table.
Any such shift wouldn’t necessarily be designed to bail out equities, but rather to bail out the curve and short circuit the current situation, which seems almost “rigged” to produce a grinding bull flattener.
“We continue to argue that curve ‘should’ steepen [where] the ‘should’ is normative in the sense that the Fed should act to nudge inflation higher”, Deutsche Bank said Friday, on the way to reinforcing the reality that “the clear free variable to mitigate dollar strength is the level of short rates”. Little wonder, then, that the market continues to press rate cut bets.
Bloomberg’s Brian Chappatta is excited. “OK. It’s official. I’m on ‘four decimal watch'”, he quipped Monday. “10-year Treasury yield currently at session low of 1.3521% All-time low is 1.318%”.
