Morning Brief – Loose footing

Loose footing

Equity markets have been a good barometer of the risk associated with the Coronavirus. Thanks to numerous developed markets and indices being ‘late-cycle’ they are proving to be particularly sensitive to exogenous risk; more valuable in my opinion than many purpose-built indices. In the UK yesterday, the FTSE100 kicked off to a good start. The daily high was reached within minutes as short sellers took some profit from the near-thousand point sell-off. Sentiment waned into lunchtime before rebounding in afternoon trade to close 1% up. European equity markets this morning have continued yesterday’s rally so far.

Markets in the US performed even better yesterday with the tech-heavy Nasdaq up nearly 5%. The complexion of the recovery, one that has benefitted internationally orientated firms with complex supply chains can be taken either as a meaningful improvement in risk or a correction in last week’s severe over-pricing. Time will tell. For now, the OECD has revised this year’s global growth forecast from 2.9% to 2.4% with warnings of a further tumble to 1.5% should the infection become more widespread and intense. In markets, research teams are entertaining the idea of the first quarterly contraction in global growth since the 2008 financial crisis. The fragility of yesterday’s rally and the dynamics that these episodes produce in financial markets should not be underestimated therefore.

In foreign exchange markets there have been upsets to three key safe havens: Gold; JPY and USD.

Gold: despite risk climbing and equities tumbling the price of gold has taken a sudden and severe fall at the end of last week. The reason for the sell-off has been blamed on forced selling by investors who, long in riskier products including equities, had to liquidate gold holdings to meet margin calls in other markets. That has been the story for now but I’m not convinced. Look out for more gold vulnerabilities in the future.

JPY: the safehaven. Safer than houses! Probably. The Yen has lost a lot of value despite risk ratcheting up to extreme levels across markets. But it’s not as bizarre as it seems. As has been said here before, partially by legacy and partially thanks to the ultra-consistent monetary and fiscal policies in the nation, the Yen is a long-standing asset that markets flood to first in a storm. Not this time. The reason for yesterday’s sell-off in the Yen was a promise by the Bank of Japan to, “provide ample liquidity and ensure stability in financial markets”. In conjunction with additional threats to domestic growth, the Yen has lost some of its pulling power.

USD: The (relatively) high yielding US currency had attracted strong flows for the last few years particularly as a reaction to risk. In reaction to the equity market sell-off and exacerbation in risk markets have begun to anticipate the Fed to step-in. It’s ‘central bank to the rescue’ time again which has created expectations that the reward for holding the dollar will fall as the Federal Reserve’s easing cycle continues. This has undermined the dynamics that have benefitted the Dollar (particularly when compared to the Euro) and cash has flowed from the Dollar in the past week despite increased risk.

As with most of the last decade, the legacy of the recovery in the financial crisis is dictating global trading conditions. With central banks full to the brim with debt, someone, somewhere is going to start talking about the next financial crisis…

Discussion and Analysis by Charles Porter

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