Macro News
Global: The past few weeks were marked by radical changes in monetary policy conducted by central banks around the world. The Fed, which has already cut its benchmark rate by 150bps into 0 percent, announced an open-ended QE that will include purchases of corporate bonds and loans in the primary and secondary markets as well as muni bonds following the recent collapse in the muni market (muni ETF MUB fell by over 15% in the past two weeks), and announced the reintroduction of TALF (Term Asset-Backed Securities Loan Facility) in order to support lending to households, consumers and small businesses by lending to holders of ABS collateralized by new loans.
Hence, in order to bring back confidence in the market and limit downside risk on all asset classes that have been on a constant freefall in the past 4 weeks, the Fed will purchase $125bn of securities every single day ($50bn of US Treasuries and $25bn of MBS), which would amount to $625bn in purchases per week, $25bn more than its post-crisis QE2 program run from November 2010 to June 2011. As the Fed Funds rate in the US has reached the zero bound, conducting this large asset-purchase program will lower the shadow rate, which has switched back to zero in October 2015. As economists are now expecting the r-star to dramatically fall in all the economies due to the global shutdown, running aggressive unconventional monetary policies in a ZIRP/NIRP world will push the shadow rate below r-star and therefore stimulate the whole economy. According to academics’ calculations, $250bn of asset purchases correspond to a 25bps cut in the benchmark rate. As the Fed’s balance sheet is expected to increase by $1 trillion by Friday (27th) since the start of QE on March 13th, this implies that the shadow rate in the US will stand at -1% by the end of the week.
The economic consequences of Covid-19 are expected to be catastrophic for the coming quarters; for instance, St. Louis Fed President Bullard recently said that the unemployed rate could reach 30 percent in Q2 with a 50 percent contraction in GDP amid the country’s shutdown, resulting in a $2.5tr loss in income. This leaves no other options for governments than bailing out the whole system with the help of central banks. This process is known as MMT (Modern Monetary Theory), a macroeconomic theory under which country’s budget deficits do not matter unless they cause inflation and are entirely financed by central banks. In the euro area, Covid-19 will clearly mark the end of the 3-percent deficit limit imposed by the SGP as no governments will accept a 30 to 40 percent unemployment rate. Hence, this massive increase in liquidity could generate another rally in the oldest and ultimate safe haven: gold.
Figure 1
Source: Eikon Reuters
US Treasuries Net Specs
As expected, the amount of interest in shorting US Treasuries has significantly decreased in the past month amid a sharp fall in US interest rates. Net short specs have decreased by 542K to 632K contracts in the week ending March 17th and are nearly flat for the 2Y and 5Y contracts.
Figure 2
Source: CFTC
FX Positioning
EUR/USD: The strength of the US dollar in the past two weeks brought EUR/USD back to a 2-year low at nearly 1.06 in the end of last week. The pair currently stands a few figures away from its crucial support of 1.0340 reached in the beginning of January 2017. Drastic deterioration in fundamentals in the euro area will deprive the euro from rising against the greenback. Therefore, we think that any bull consolidation could be seen as a good opportunity to short the pair.
Figure 3
Source: Eikon Reuters
EUR/GBP: Cable has been the currency on fire in this highly volatile period; the British pound depreciated against most of the major currencies and EUR/GBP is currently trading at the high of its 3-year range at around 0.93. Next resistance on the pair stands at 0.98, which was a level tested during the Financial Crisis. Even though we would avoid buying the dip on GBP, we still think EUR/GBP could experience a short-term (bear) consolidation in the short term. We went short at 0.9270 with a stop at 0.9420 with a target at 0.90.
Figure 4
Source: Eikon Reuters
USD/JPY: We also saw impressive moves on the yen in the past month; USD/JPY dropped from 111 to 101 back to 111, which represents its 38.2% Fibo retracement of the 99.60–118.70 range. Massive injections from the Fed could ease investors’ concern on the global USD shortage story and therefore, reduce FX volatility this week. We are slightly bearish on the USD this week, with a low to medium conviction level. Hence, we went short USD/JPY at current levels 110.40 with a very tight stop at 111.20 and a first target at 109.
Figure 5
Source: Eikon Reuters
Gold (GLD): We do think gold could perform well in the coming weeks in this current environment. Hence, the sharp consolidation we saw in the past 2 weeks offer a good opportunity to buy the dip for MT investors.
Chart Of The Week
There is no question that the constant growing uncertainty amid Covid-19 and the country’s shutdown periods have generated one of the biggest selloffs in all asset classes in the history of finance. This chart shows us all the equity bear markets in the past 100 years. With the massive liquidity injections of central banks, investors have been questioning themselves if it is a good time to step in and buy the dip in markets. There is no doubt that a lot of assets look cheap at current valuations; however, we are still very cautious as markets could take a while to digest the current deleveraging. The chart shows that the 35-percent drawdown in the S&P 500 in the past month was the second quickest one in the index’s history (US equities were down 34% in 11 days during the October crash in 1987), but also shows that bear markets can last for a while – the longest one was 700 business days after the 1929 crash and the index was down nearly 90 percent from peak to trough.
Figure 6
Source: Eikon Reuters, RR Calculations
