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Market Resilience Reigns Supreme

Stephen Innes

Market resilience to coronavirus developments has been tested over the past 24 hours as reported cases of the virus in Hubei spiked almost 50% after the provincial government there began counting cases confirmed by imaging scans in addition to the existing test kit methodology. Even with that, the market impact was little more than a pause in the general bullish upward trend rather than risk-off.

The critical question today will be whether the near 10-fold spike in new virus cases reported yesterday proves to be a one-off. And while there remain some concerns about Chinas transparency with regards to the methodology for counting people with infections. But there is ample evidence to calm markets that the jump is merely a fossil of the reporting — not a sign that the outbreak is spreading faster or farther. All of this suggests that the market base case remains unchanged that the Covid-19 will be primarily contained by end-March, though occasional outbreaks may continue to be reported in April.

And confirming the market recovery Oil prices, which are a crucial bellwether for Covid-19 investor risk sentimentalso managed to lift 0.5% despite the International Energy Agency suggesting oil demand is likely to grow at the weakest pace since 2011 this year due to the coronavirus. Indeed, the IEA expects to see an outright decline in demand in Q1-20, the first “in more than ten years”.

US jobless claims fell more than expected. And given this high-frequency data series is one of the best real-time indicators of recessionary pressure, the key here is the data is not sending any worrying signals about the health of the US economy and labor market.

Markets have shrugged off a surge in the number of coronavirus cases in Hubei, and investors are back in stock buying frame of mind. It seems there’s a definite thematic playing out. Coronavirus has caused investors to be underweight, or at least not get involved in this rally. But low rates are keeping the juice in the market led by defensives, and the harmful data that is expected is now so well-flagged that it has become irrelevant.

Sure, there’s a lot of “hee and haw” that leadership is very defensive and narrow around US tech. But countering this closed-minded view is that earnings have been hitting expectations across the board; US data remains exceptional, so there is a strong rationale to stay long beyond the easy money argument.

Oil markets

Oil put in a positive performance for the day, reinforcing the view that oil markets have already priced in much of the coronavirus-driven lousy news. Barring an acceleration of new infections, the markets should remain relatively supported until we get the “first look data” surrounding supply chains and demand contraction knock-on effect in China as a result of the virus transmission

But keeping the lid on prices, OPEC had hoped to announce additional production cuts of 600,000 BPD. Still, with Russia’s refusal to participate, no action is anticipated before OPEC’s next meeting in March. And of course, the stream of gloomy revised demand outlook by key market monitoring agencies does little to help the oil markets bullish cause.

Gold Markets

Gold benefitted from a resurgence in investor risk aversion. The catalyst remains COVID-19 headlines.

Although gold rallied on fresh COVID-19 concerns, risk appetite lately tends to rebound quickly. So, unless there is new negative news to prompt a renewed deterioration in risk-on equity demand, this could limit gold’s top side ambitions.

For now, policymakers have been content to cite the downside risks to growth from COVID-19, but have argued it is too early to say what the scale of the impact might be and is not providing enough dovish impulse to push gold to the vital $1600 /oz, But the strong USD and a distinct air that risk-on investor sentiment will increase are enough to put a cap on gold.

Investors’ sanguine reaction to the economic fallout from the coronavirus will be tested in the coming weeks. If the economic data comes out weaker than expected, you will be happy to have included gold as a quality asset class in your portfolio. In these uncertain times, gold should remain prime quality asset purchases as a hedge against a stock market correction.

Currency Markets

USD Dollar 

US Retail Sales is going to be essential for the FX market, and while intraday ranges have been relatively tight, they could even be narrower today as the market might sit on their hands. But if there a trade to be had, it could be through short-term tactical plays vs. a weaker Retail sales print. Although I don’t have an absolute reason to fade the core number +0.3%, some may view the estimated headline print a bit optimistic, given global growth uncreates. But one thing that I have learned after decades in the FX game is never to speculate against the resilience of the US consumer even through hell or high water.

Asia FX

The relatively indifferent FX reaction to the Hubei news suggests that investors continue to continue to look through the economic impact.

The USD has been enduringly bid d, although FX vols are only slightly higher. The downtrend in USDCNH since September 2019 remains intact, 12-month forward points narrowed further, and an ongoing sell-off in risk reversals over the past week suggests a more limited demand for protection against a CNH sell-off as the PBoC is offering up a convincing backstop.

Overall the somewhat muted reaction may be attributable to the fact that the number of new cases outside China has failed to rise. However, investors’ sanguine response to the economic fallout from the coronavirus will be tested in the coming weeks, so at this stage of the game, Asia FX investors don’t want to run to far ahead of the economic realities. Hence, they remain cautious about adding more currency risk before assessing the depth of the economic fallout.

There are three main channels for this fallout. 

One is the tourism channel. The impact is easily quantifiable, and the initial reaction of the markets has been most punitive for the more vulnerable economies on this metric – THB and SGD. What’s harder to assess is the damage via the other two channels – supply chains and demand contraction, and for this, we need to see the empirical data. For that impulse, the release of Korea 20-day exports (Feb 21) is essential.

The Malaysian Ringgit 

The US equity markets are getting encouraged by easy money around the Fed repo remedies, and the S&P 500 bounces as not driven by growth rebound. Hence, without an impressive rebound in China data and or global growth, there is no positive risk knock-on effect from US markets as Asia currencies remain out of favor given the gloomy local economic outlook. Eventually, buying into a post-coronavirus manufacturing rebound will make sense. Still, it’s a bit early to start front running that trade versus the strong USD, so the Ringgit continues to trade defensively.

G-10 Currency 

The Euro 

Investors continue to ‘look through’ the economic impact of coronavirus, ostensibly driving EUR weakness via long carry positions.

But if the recent EURUSD weakness reflects downside risks to global growth from China, rather than a hunt for carry, then the EM currencies which have held up well so far could weaken abruptly if China data comes out worse than expected. For EURUSD itself, global growth concerns could overwhelm any short-covering of long EM carry positions. That, in turn, could drive further weakness in EURUSD and return EURUSD-ADXY correlations to pre-summer 2019 levels.

Again, it’s the “lose-lose” situation for the Euro that we suggested at the start of the year.

The Pound 

Following news of UK Finance Minister Sajid Javid’s resignation, as reported by The Sun newspaper, judging by press reports, it would seem that the UK prime minister wants complete integration of Downing Street and the Treasury.

The pound is rallying as closer integration between “No 10, “and the Treasury would almost certainly mean a loosening of fiscal rules and higher budgetary spending than under Sajid Javid.

 

This article was originally posted on FX Empire

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