In hindsight, Monday on Wall Street will probably be seen as either “peak COVID-19 panic” or the beginning of something far more serious, both for markets and humanity in general.
I’m leaning towards the former, in part because, as I was compelled to remind some folks over the weekend, one cannot hedge the apocalypse – or at least not if you’re using the term “apocalypse” any semblance of literally.
Among the endless market notables, the entire German curve turned negative again on Monday, as 30-year yields fell below zero for the first time since October.
In a short Op-Ed for Bloomberg, Narayana Kocherlakota called for an immediate, inter-meeting 25bps rate cut. To wit, from what amounts to an SOS:
The Fed’s rate-setting Federal Open Market Committee holds its next meeting on March 17-18. I don’t think that the FOMC should wait that long to deal with this clear and pressing danger. I would urge an immediate cut of at least 25 basis points and arguably 50 basis points. That’s a cheap insurance policy for the economy that the Fed shouldn’t pass up.
Gold has gone parabolic. “It’s tempting to look at gold and wonder what is the price point that starts to bring jewelry out of the drawer to be melted down”, Bloomberg’s Richard Breslow mused. “As a wild guess, something close to $1,800/oz might start to pique some interest”.
(Melted down into what, though? Maybe magic bullets for the werewolves that will roam the desolate, windswept prairies once COVID-19 has run its course on humankind. Or is that silver bullets?)
The irony for the long-end of the US curve is that there are still plenty of good, non-apocalyptic arguments for staying bullish, not the least of which are the myriad structural factors (demographic and otherwise) that are likely to weigh on inflation for the foreseeable future.
Without a fiscal push credible enough to force a secular rethink among market participants, it’s not clear where the bottom is for US yields, especially in an environment where virtually no other haven asset offers any yield.
Remember, if the virus weighs disproportionately on ex-US economies, the growth disparity will exacerbate dollar strength, which, in turn, could further imperil the Fed’s efforts to bring inflation to target. Kocherlakota mentions this dynamic in his Op-Ed. “Such a global economic slowdown would likely lead to continued upward pressure on the US dollar, which would drive inflation even further below the Federal Reserve’s 2% target in the next couple of years”, he writes.
“Global investors continue to demand US assets [and] absent a more dovish Fed, there is little reason to anticipate any change to this trend, and hence for growing downward pressure on US inflation from the strong dollar”, Deutsche Bank’s Stuart Sparks, who has written extensively on this dynamic, says, in his latest note.
The market is now priced for two Fed cuts in 2020. June is fully priced. TD has now exited a long January 2021 fed funds trade after it closed in on their target amid escalating expectations of policy easing, although they acknowledge it could run further still in light of deteriorating sentiment.
Meanwhile, the 2s10s is inside of 12bps.
“Pandemic panic is spurring high demand for Treasurys that could take the 10-year yield well beyond the 1.32% record low that was made in the summer of 2016”, Oanda’s Edward Moya wrote Monday morning, on the way to noting that “if US stocks hit correction territory and the 10-year Treasury yield falls well below the 1.318% level, we could see the dollar have one last major run”.
For her part, SocGen’s Subadra Rajappa (who, you might recall, came into 2020 forecasting 10-year US yields would drop to 1.20%), said Friday that despite the recent bond rally, “the risks are skewed towards lower yields for at least four reasons. To wit (heavily abridged from her full take):
- Although recent data in the US have been generally positive, it is still too soon to gauge the impact of the coronavirus on global economies
- Demand dynamics are likely to favour US bonds and dollar assets. Recent Japanese flow data show a surge in demand for foreign bonds from Japanese investors. Hedging costs for foreign investors to buy Treasurys have also declined recently making it more attractive for foreign investors
- Receiver skews suggest potential for lower yields
- Convexity receiving need could amplify a further rate rally and tighten spreads
Coming full circle, Monday feels like a watershed moment any way you cut it. Opinions vary on whether this is the beginning of the end or just another dip to be bought, not just by retail investors acting on their Pavlovian instincts, but also by corporates, who have provided a real-life plunge protection bid during some of the market’s more dramatic routs over the past several years.
On Sunday evening, when it became apparent that things were likely to get dicey on the first day of the new week, JonesTrading’s Mike O’Rourke sent out a quick note which contained a few quotes from a previous missive. “The flows, liquidity and policy driven environment… has impaired the market’s pricing mechanism and nearly eliminated price discovery”, he wrote, on January 27, adding that “the discounting nature of markets has been replaced with delayed reactions to real developments”.
On Monday, we witnessed that “delayed reaction”.
The question now, is whether it will trigger the type of chain reaction, wherein the very same flows-liquidity feedback loop which drives markets inexorably higher in good times, pushes things dramatically lower when volatility picks up.