19-Mar-2020

1) US Dollar Rallies On Fund, CP Liquidation, Equities Fall Despite Extra ECB, RBA Intervention
2) GBP/USD Bears Take a Breather after the Overnight Crash
3) ECB Research: Emergency Meeting – All In With EUR750bn Package

1) US Dollar Rallies On Fund, CP Liquidation, Equities Fall Despite Extra ECB, RBA Intervention

The world is on the verge of a severe economic depression, and unfortunately, without having fully recovered from the 2008 financial crisis.

Factories around Europe slow down or halt production in an effort to contain further contagion of the coronavirus, or because employees start being tested positive for coronavirus.

The pandemic continues shaking small, medium, and international size businesses, the first two being on the brink of severe financial difficulties as a result of several weeks long shutdowns.

More globally, there is an increasingly restricted goods and people circulation across globe. Airline companies are perhaps the most hit by the coronavirus-led crisis. US government rejected the airline companies’ demand for $30 billion in grants but proposed a $50-billion loan package to help them survive the crisis. Schengen countries closed their borders, as US and Canada agreed to stop all non-essential traffic between the two countries.

The European Central Bank (ECB) announced a fresh 750-billion-euro worth bond and private securities purchases package, while the Reserve Bank of Australia (RBA) cut its policy rate to the fresh historical low of 0.25%.

Alas, equities’ race to the bottom continues at full speed.

The S&P500 lost up to 10% on Wednesday, before a late session rebound trimmed losses into the close. But US futures continued their journey south after the bell, as Asian stocks remained heavily offered.

WTI crude tanked to $20 a barrel, before rebounding near 12% to $24 in Asia.

FTSE futures (-1.16%) hint at another round of sell-off at today’s trading session. British energy stocks will likely remain on the chopping block, after having shred 50% to 60% of their value since the beginning of this year.

And despite heavy losses, we do not rule out the possibility of a deeper bear market. Gone is the view that the monetary and fiscal stimulus would help bettering the investor mood.

Looking at data, inflation in Japan slowed to a four-month low in February, and the worst is yet to come.

The Euro area inflation figures, on the other hand, were left unrevised during the same month, though the sharp decline in oil prices point at the possibility of a dramatic decline in consumer prices starting from March. JP Morgan expects 0% inflation in the second quarter of 2020.

Curiously, the Australian jobless rate improved from 5.3% to 5.1% in February and Japan’s all industries activity index jumped to 0.8% in March versus 0.3% expected by analysts and -0.1% printed a month earlier. Yet, the better-than-expected data couldn’t enchant investors much.

Due today, the Philly Fed manufacturing index, which recorded a surprise peak at 36.7 in February, could fall to 10.0 according to a consensus of analyst expectations. We believe there is room for disappointment, a negative read would not be a shocker.

The US dollar index extends gains past the 101 level, as a result of a sudden rush to the greenback. The rally that started by the end of last week is believed to be driven by a combination of fund liquidation and a breakdown in US commercial paper (CP) markets – when the yield on 30-day CP shot up to 3.2% from 1.6% as investors lost confidence in these short-term unsecured debt instrument and opted for a quick winding up, oddly weeks after the sell-off in equities started. Moving forward, the US dollar rally should cool off with the Fed’s intervention through direct CP purchases, but forced or desired portfolio liquidations will likely continue feeding into the US dollar.

In Switzerland, the Swiss National Bank (SNB) will decide whether to cut interest rates at today’s monetary policy meeting. While interest rate futures price in a 14-basis-point cut over the next twelve months, we believe that the SNB will hold fire today, in the same way than the European Central Bank (ECB) and the Bank of Japan (BoJ) which also run on negative interest rates. But both the ECB and the BoJ opted for alternative measures such as increased asset purchases, targeted loans, and even loans backed by debt in the case of Japan to support their virus-infected economies.

On top of the looming economic recession, the strong franc continues being a severe headache for Swiss policymakers, but the SNB cannot intervene directly via the FX market as the US put Switzerland on its watchlist of currency manipulators. So, as a last resort, it is possible that the SNB announces new policy measures to fight against the strong franc, such as balance sheet expansion, cheap loans, etc.

2) GBP/USD Bears Take a Breather after the Overnight Crash

The GBP/USD pair prolonged its recent sharp retracement slide and remained under some intense selling pressure on Wednesday amid some aggressive US dollar buying. Despite the Fed’s latest moves to pump billions of dollars into the financial system, investors have been selling almost everything amid nervousness over the economic fallout from the coronavirus pandemic. The rush to hoard cash was further evident from a selloff in the US Treasuries, which lifted the yields sharply higher and provided a strong boost to the USD’s status as the global reserve currency.

On the other hand, the British pound failed to gain any respite from the UK government’s £330 billion stimulus package announced on Tuesday, rather continued to be weighed down by Britain’s late move to discourage mass gathering and controversial measures on combating the coronavirus pandemic. The combination of negative factors led to a steep intraday crash of nearly 700 pips and dragged the pair to its lowest level since 1985. The downward momentum took along some heavy stops placed near the lower end of a two-week-old descending trend-channel, which further aggravated the bearish pressure.

The pair nosedived to mid-1.1400s, albeit managed to stage a modest recovery amid extremely oversold conditions on short/medium-term charts. The pair finally settled around 125 pips off daily swing lows but failed to capitalize on the move and met with some fresh supply during the Asian session on Thursday. The brutal selloff across the global equity markets remained unabated, which continued underpinning the greenback’s perceived safe-haven demand and exerted some fresh pressure around the major. In absence of any major market-moving economic releases, the incoming coronavirus-related headlines might continue to infuse volatility in the FX market, leaving the pair at the mercy of the broader market risk sentiment and the USD price dynamics.

The overnight break below a short-term descending trend-channel confirmed a near-term bearish breakdown and sets the stage for an extension of the recent bearish trend. This coupled with the pair’s inability to build on the overnight rebound adds credence to the negative outlook. However, extremely oversold conditions warrant some caution before positioning for any further depreciating move. Hence, it will be prudent to wait for some near-term consolidation or a modest recovery before placing any fresh bearish bets.

3) ECB Research: Emergency Meeting – All In With EUR750bn Package

Last night, the ECB held an emergency meeting in response to COVID-19 and the financial market fragmentation, which was led in particular by Italian and Greek yields.

ECB went all in with a Pandemic Emergency Purchase Programme (PEPP) with an overall envelope of EUR750bn, to be done in all asset classes under the APP. The EUR750bn will be implemented until end 2020 in a flexible manner. The EUR750bn comes on top of the normal APP and the EUR120bn envelope decided last week.

ECB stands ready to adjust the self-imposed (ISIN) limits. Non-financial commercial paper is included in the PEPP.

We believe this will act as a circuit breaker in fixed income markets and lead to extremely sharp spread tightening and decline in credit risk.

With the current credit widening and particularly Italian surge in yields in recent days, a forceful response from the ECB to act as a circuit breaker was needed. Yesterday, we changed our call to include a step up its QE, ISIN limits, and even more deviation from the capital key with a total envelope of at least EUR500bn, see ECB Research – Action needed urgently. This happened last night.

The ECB launched a new purchase programme to contain the severe repercussions of the spread of COVID-19 spread and the malfunctioning of markets in recent days – most notably in Italy and Greece. The PEPP envelope is very large but also has a sufficiently bold level of EUR750bn purchases by the end of the year and will be conducted in all asset classes under the APP. Furthermore, the PEPP will be implemented in a ‘flexible manner’, which allows purchases to focus on the most distressed parts at the current time.

Part of the strong signal is also that Greece will be included in the PEPP, which so far hasn’t been part of the APP. It is a very strong signal to send that it includes non-investment grade bonds in its purchases.

On the more technical side, but importantly, the ISIN limits, which are deemed to be broken on the back of the increased purchases, will be reassessed to the ‘extent necessary to make its action proportionate to the risks that we face’.

The ECB decided to ‘expand the range of eligible assets under the corporate sector purchase programme (CSPP) to non-financial commercial paper, making all commercial paper of sufficient credit quality eligible for purchase under CSPP’. Similar to the Fed’s and BoE’s decision, this is welcomed in a distressed market in this turmoil. Also, the ECB eased ‘the collateral standards by adjusting the main risk parameters of the collateral framework’.