There was a time when the equity market would have absolutely embraced the promises and/or deliveries of easing by the Fed as an unambiguous bullish sign. Not that long ago, the market was also used to build long carry trade structures to exploit how cheap it was to borrow funding currencies only to park that capital in a higher-yielding fiat. Well, if by paradigm shift we understand a fundamental change in approach or underlying assumptions, we are right in the middle of one as the COVID-19 global crisis shakes the grounds of what once worked and no longer appears to cut it (pun intended). Lots to go through today, so keep reading...
Quick Take
Anyway we slice it, there is little room for ambiguity, the Forex market is well and truly alive with very healthy levels of volatility the new norm. With the Fed going above and beyond to avoid being schooled by the markets again, it resorted to a surprising 50bp rate cut as part of an emergency meeting, which was the first one since the 2008 global financial crisis, and speaks volumes of how rapid the economic prospects have deteriorated. And they may not even be done as more rate cuts may follow ahead of the March 18th FOMC. A return to Fed’s unconventional tools (QE) may not be such a distant prospect after all.
The rate at which old dominant thematic such as be long carry trades (short EUR, CHF, JPY) or buy stocks on expectations of more easy money flooding in are no longer cutting it for investors. This is leading to a serious re-assessment of certain paradigms, and so far, these uncertain times have opened up an enormous gap in performance between funding currencies and the rest. The spike in the VIX, the break sub 1% in US 10-year Treasury yields, the selling of equities, it’s all contributing to higher volatility in Forex as ‘true risk-off’ + elevated VIX is a receipt for disaster.
Amid this turmoil in the markets, the Aussie’s strength may have some scratching their heads, although I do hope it’s not by those reading my daily edge as I did warn that based on G8 FX aggregated flows, the Aussie valuation was way out of whack and that a correction was due, which happened to occur on the aftermath of the RBA rate cut. Yep, that was the trigger event for long-held shorts to close positions as the outcome had been fully priced in. Today is the turn by the BOC to meet market expectations with a 25bp cut or like the Fed, look to exceed them with a 50bp, even if the result they may have wanted (boost equities) never eventuated.
Narratives In Financial Markets
* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Twitter, Institutional Bank Research reports.
The Fed unexpectedly cut rates by 50bp: The Fed, in the context of an emergency meeting (first since the 2008 GFC), reduced the interest rates by 50 basis points. As part of the press conference by Powell, his COVID-19 assessment was rather bleak, leading to an eventual reversal in US equities after the initial rate cut-induced gains. The Dow was the index most punished with a fall of nearly 5%. Meanwhile, the US 10Y Treasury is now yielding sub 1%, a fresh record low.
More to come at the March 18 FOMC? In Powell’s Q&A presser, his stance remains rather ambiguous, not giving away what’s coming next. “We do like our current policy stance, it's appropriate but prepared based on flow of events.” His comments don’t make it any clearer as to whether or not the Fed will follow up with more cuts, even if the market is pricing in further easing at this month’s March 18 meeting. Powell did not close the door to further easing in a few weeks after noting that “In the weeks and months ahead we will continue to closely monitor developments.”
A return to Fed’s unconventional tools? That March 18 meeting by the Fed in just 2 week will be key. Why? Because it will be faced with either utilizing the full extent of its conventional tools to stimulate the economy before talk of further QE settles in or worse yet, underwhelming investors’ expectations, which may see further carnage in the stock market. The market is telling us, by pricing further cuts, that once the effective lower-bound in rates is established, expanding the balance sheet is up next.
Limitations to what Fed can do against COVID-19: Besides, the Fed Chair also recognized that the Fed is rather impotent and doesn’t have at its disposal all the tools necessary to deal with the negative impact from COVID-19, “We do recognize a rate cut will not reduce the rate of infection, it won’t fix a broken supply chain. We get that. But we do believe that our action will provide a meaningful boost to the economy.”
Official Fed statement: “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent. The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.”
Fed’s Mester hints more cuts could be in store: Cleveland Fed President Loretta Mester, at a speech in the UK, also implied that more rate cuts could be in store as she warned of a slowdown for at least half a year if no longer. “The underlying fundamentals of the U.S. economy remain strong, but the coronavirus will weigh on U.S. growth at least during the first half of the year, with a pullback in spending by households and businesses, with a supply shock that could evolve into demand shock,” Mester said.
USD, CAD sold as carry trade unwind stays the course: The immediate reaction post Fed rate cut was to sell the US Dollar as the market keeps waving ‘goodbye’ to carry trade long structures amid the ‘true risk off’, where the carnage in US yields won’t abate, alongside another considerable spike in the VIX, also keeping FX volatility at fairly elevated levels. The Euro, the Swiss Franc and the Yen continue to be outperforming, alongside a rare episode of AUD strength as well, while the market, on the flip side, finds it’s the turn to build shorts on the Canadian Dollar too, with the BOC set to lower rates next later today.
G7 statement underwhelms: While the Fed went above and beyond, the official statement by G7 Finance and Central Banks as part of an extraordinary meeting failed to live up to the expectations with no concrete measures announced. The statement read: “Given the potential impacts of COVID-19 on global growth, we reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks. Alongside strengthening efforts to expand health services, G7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase…”
BOC policy meeting up next, rate cut done deal: With regards to the Bank of Canada interest rate decision, the market sees a 25 basis point cut as baked in the cake with the chance of a 50bp cut to replicate the Fed at 64%. There are further cuts priced in for later in the year as well. With the coronavirus outbreak to be a major drag on both the global and Canadian economies this year, the BOC is forced to act. The Economics Team at ING does a great job contextualizing this event risk in their preview.
AUD appreciates despite RBA cuts rates by 25bp: The movement in the Aussie overnight, the strongest currency notwithstanding the RBA easing, has prompted the usual bewilderment as to how that’s the outcome eventuating. The lesson here is that when a market has fully priced in a rate cut ahead of the actual announcement, unless the Central Bank over-delivers, many times over the initial sell-side pressure on the Aussie will serve well the purpose of closing long-held short inventory in the Aussie, as what we saw on Tuesday. Expect the next RBA meeting on April 7th to see another rate cut, which means the doors get wide open to start the discussions about introducing QE in Australia via the RBA buying Aussie government bonds.
RBA statement hints more cuts possible: The statement prepared by Governor Lowe read: “The global outbreak of the coronavirus is expected to delay progress in Australia towards full employment and the inflation target. The Board, therefore, judged that it was appropriate to ease monetary policy further to provide additional support to employment and economic activity. It will continue to monitor developments closely and to assess the implications of the coronavirus for the economy. The Board is prepared to ease monetary policy further…”
Where are we at in the COVID-19 situation? The latest developments in the virus saga saw the CDC report 60 confirmed cases of coronavirus in the US, with 4 more deaths bringing the total to 6 deaths, all in Washington state. In an interview yesterday with Bloomberg, Dr Anthony Fauci, the director of the National Institute of Allergy and Infectious Diseases, said coronavirus was at "pandemic" levels. Meanwhile, most of the most severe outbreaks of COVID-19 outside China remain in South Korea, Iran and Italy. In the latter, the coronavirus case numbers have continued to soar to over 2,500, with the number of deaths now at 79 from 52 the prior day.
First time COVID-19 claims more deaths outside China: In yet another sign that the virus has truly gone global, Tuesday was the first time that the majority of coronavirus deaths reported came outside China since the outbreak began.
Insights Into Forex Flows
Notwithstanding the unwind of carry trades as FX volatility keeps picking up, it’s my technically-inspired observation that the EUR is going to face a bumpier road ahead.
The case I made yesterday for the EUR to start slowing down its fast and furious appreciation remains true as we’ve reached what’s usually an inflection point in any chart.
I am referring to the 100% measured movement that got hit last week, a location in the chart that suggests the Euro valuation is out of whack in this daily time window?
Meanwhile, the GBP index continues to hold at a macro level of support. As the chart below reveals, this level has proven to be a solid area to initiate buy-side campaigns in the GBP ever since early Nov last year and the land in the sand drawn by the market.
Granted, the tiny bullish candle printed at this support in the last 24h is far from conclusive, but at least it shows that the market remains adamant to let this level go without a fight. Should the market break into lower levels, be mindful that it will be headed straight into its 100% proj target, so be aware that most of the move may be done by then.
The US Dollar index has been the big mover overnight, as the aggregated flows depict a deteriorating picture even if judging by the structure of the daily, not all is lost yet.
The index has hit a pocket of demand at the previous swing low, with a minor rejection so far ensuing, although is not looking convincing amid the negative fundamental backdrop as the Fed goes aggressive with a 50bp rate cut to meet the market’s demands for easing measures.
Leaving aside the fundamentals for a moment, this remains a cheap valuation, technically speaking, for traders to consider long positions in the currency, no doubt about that.
The CAD index sold off hard ahead of tonight’s BOC policy meeting as the market appears to be front-running the decision by the Central Bank with expectations high for a 25 or 50bp rate cut.
Given the impulsive drop in the currency, there is a real chance that the currency may finally see the breakout of what’s arguably been the key level of support this year.
If this scenario ends up materializing, look for the next support where my lines are drawn - reactionary in the past -, selected based on the aggregated flows seen.
The JPY index, with the risk-off tone settling back in, has found renewed willing buyers off a key area of support in the chart with multiple interactions as marked below.
The Yen, amid the ongoing bullish momentum, is now confined in a broad area between an overhead resistance in response to last year’s supply imbalance origin and the tested support.
Yesterday I made a case for AUD shorts to start bailing out of long-held positions before a fresh cyclical bearish bias settles in, which is certainly very unlikely to occur when the recent sharp declines in the currency have led complete a 100% proj target move.
Along these lines, I did suggest that markets such as EUR/AUD would be facing further downside pressure as the rubber band was at a point of maximum tension at these levels.
So far, a short-term campaign to buy the Aussie is underway as the market starts a process of auctioning the currency higher until the next pockets of supply imbalances are found. The first projected area for sellers to step in doesn’t come until the marked resistance in the chart below.
The NZD has reacted as one may have expected off its first resistance line, with a sizeable pin bar as a result of the ongoing sell--side campaign that shows no signs of abating for now.
When it comes to the CHF index, this is another currency that remains very pricey to consider longs, very much as in the case of the Euro. It’s very hard to justify further buys on this currency unless there is a pullback towards more technically valuable areas.
That said, unlike the Euro, the Franc shows a greater level of buy side commitment, as reflected by the fact that the currency has been able to hold marginally above its 100% proj target.
Important Footnotes
- Market structure: Markets evolve in cycles followed by a period of distribution and/or accumulation.
- Horizontal Support/Resistance: Unlike levels of dynamic support or resistance or more subjective measurements such as Fibonacci retracements, pivot points, trendlines, or other forms of reactive areas, the horizontal lines of support and resistance are universal concepts used by the majority of market participants. It, therefore, makes the areas the most widely followed and relevant to monitor.
- Fundamentals: It’s important to highlight that the daily market outlook provided in this report is subject to the impact of the fundamental news. Any unexpected news may cause the price to behave erratically in the short term.
- Projection Targets: The usefulness of the 100% projection resides in the symmetry and harmonic relationships of market cycles. By drawing a 100% projection, you can anticipate the area in the chart where some type of pause and potential reversals in price is likely to occur, due to 1. The side in control of the cycle takes profits 2. Counter-trend positions are added by contrarian players 3. These are price points where limit orders are set by market-makers.