Wednesday, March 29, 2023

Uncertainly Bristles Amid The COVID Fog


Investor uncertainty is bristling ahead of an expected choppy period in terms of headline risk, where perhaps the most horrifying trouble of all is that the second wave of the coronavirus could trigger more intense lockdown fears. Still, the allure of the US stimulus deal is keeping the S&P dream alive.

How do you want to slice the short Euro trade?

dropped back to support at 1.17 as the news flow on COVID-19 highlighted additional headwinds’ risk to growth, which will  complicate life further for the ECB as it battles to prevent inflation expectations from becoming de-anchored

While a Brexit Deal felicitates a positive currency risk signal, I think the market will be more apt to consistently, at least until Europe’s COVID curve flattens, pivot to the downside risks to Eurozone activity, which is rising sharply after the announcement of a six-week curfew in Paris and eight other large French cities from Saturday. 

Although the government announced a further EUR1 bn in compensation to employers, damaging and long-lasting structural economic headwinds are building. In Spain, Catalonia became the first state to announce stricter measures since the first lockdown earlier this year by closing bars and restaurants for two weeks.

Risk sentiment captured by the Eurozone’s government bond markets points to increased risk aversion. The BTP spread is up 9bp this week to 130bp, while the Bund yield has fallen to levels last traded in mid-March (-0.61%). Meanwhile, inflation expectations are waning.

The EUR 5y5y inflation swap is down ~17bp from Aug. 11 highs. By contrast, US inflation expectations are within 1bp of the high of the last 16 months.

Also, the is being undermined on the cross as traders sell and buy dip on expectations of the Brexit deal. 

But ultimately, in this type of environment, I would expect downside activity to accelerate. 

Or traders could make life easy and load up short , which  encapsulates  the risk-off panacea succinctly despite Tokyo retail heavily on the reversion bid down to 104.50

Oil markets

The fall in mid-morning Asia is being chalked up to a decline in US oil exports and the omnipresent escalating coronavirus restrictions, which have cast a pall over the large draw in US crude inventories.

In a week dominated by virus headlines, global oil benchmark prices remained firmly anchored around the $40/bbl price point even as Covid-19 cases climbed again in the US and Europe ahead of what public officials have warned could be a winter of discontent.

Once again, China proved to be a colossal buyer of oil at $40/bbl, encouraged by the stronger RMB as the has entered a massive bull channel, and is on a max downtrend.

Reflective of these competing narratives, we are pretty much mired in a bit of a range trade mentality.

Currency Trading Update

Cross-asset positioning for a Biden presidency and a Democratic sweep of Congress is starting to fade. Flat US equities, a stronger USD, and a bull flattening in the UST curve this week suggest a hiatus in pro-reflation trades.

Consistent with these moves, a ‘blue wave’ is priced at 58% in prediction markets (source: PredictIt), having hit a high of 62% on Oct. 2, an outcome that was priced at 50% on Sept. 29. USD selling is stalling with EM currencies outside North Asia (CNH, KRW, TWD) lacking upside momentum, while G10 commodity currencies (e.g., NOK, AUD, NZD) are on the back foot.

A ‘blue wave’ with fiscal stimulus to the order of $3.4 trn originally proposed by the Democrats would have a pronounced bear steepening impact on the UST curve. Progress towards improving the US economy’s supply-side via infrastructure spending would encourage broad-based short USD strategies on higher commodity prices and expectations that the Fed would allow the economy to ‘run hot’ and leave policy unchanged. However, there are two potential setbacks to this setup.

First, a contest election or split Congress would undermine fiscal reflation trades (e.g., long steepeners, long EM FX, long commodities). This dynamic is likely inhibiting more broad-based USD selling.

Second, inconsistent Fed communication suggests Vice Chair Clarida is not on Chair Powell’s ultra-accommodative page. Clarida’s comments this week on the brevity of the US recession this year is indicative of a central banker who views the hurdle towards greater balance-sheet expansion, for example, as being high. That suggests the UST curve steepening may not elicit Fed intervention to calm the move and could discourage broad-based  USD selling vs. high-yielding EM FX.

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