Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Stimulus Spurs Record Gains
Summary: US stocks had a record setting session overnight and that positive sentiment has flowed through to the Asian session. The USD continues its retracement allowing a breather for Asian currencies, the AUD in particular liking the return of risk appetite and dollar pullback.
Stocks in Asia have continued Wall Street’s record setting rally spurred by the unprecedented whatever it takes backstop from the Fed, anticipation of the $2trn US fiscal stimulus package and short covering. Calls from President Trump that he aims to have the US economy open again by Easter despite medical advice to the contrary, potentially adding to risk appetite. Although we question how likely this will be given the rapidly accelerating case count in the US. The NYC Major De Blasio’s more candid declaration that an improvement in NYC is months away, not weeks and that April will be worse than March for the city is likely a more fair representation.
In a quiet session relative to the prior week, Asian indices are higher across the board, but the gains are muted relative to the overnight session and fading into the afternoon as US futures have declined into negative territory and remain under pressure.
The COVID-19 containment measures have also been stepped up across the region, Australia extending the shutdown of non-essential services, banning overseas travel and New Zealand declaring a state of emergency and nationwide isolation.
Congress are still stalling on the rescue package bill and the latest is that Mnuchin and Schumer remain in negotiations, but a deal is “very very close” according to Mark Meadows.
Despite US futures remaining under pressure for most of the Asian session, some tentative signs of reduced stress are appearing. Both HY and IG spreads tightened overnight for the first time since March 4th. The dollar is weakening as the global funding short squeeze abates somewhat after the record liquidity injections and expansion of swap lines. Although it is still too early to sound the “all clear” on this front. The AUD has continued its gains against the USD in today’s session, but as John Hardy notes, the tactical bull-bear line around 0.6000 is proving tough to break. However if risk remains buoyant and broad based dollar strength continues to pull back, the Aussie being highly leveraged to risk sentiment should be able to extend gains.
It is important to remember that a bear market does not preclude rallies. In fact, the biggest rallies are typically seen in bear markets. The big swings and erratic price action is exacerbated by the present high volatility regime and strained liquidity conditions. This as panic deleveraging and forced selling on the downside, is countered by short covering, bargain hunting and policy action hopes on the upside. With VIX remaining significantly above the long-term equilibrium, alarm bells are still sounding and traders should be wary of relief rallies. We are in unchartered territory, both as it relates to the global health crisis sparked by the COVID-19 pandemic and therefore by default market conditions.
US and European PMIs released overnight have provided a window into what is yet to come as the sudden collapse in economic activity is played out in hard data. Despite the bounce in risk sentiment a wave of second-order panic remains likely and capital preservation should remain a priority.
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