A memorable phrase is cropping up in market conversations, illustrating how fear currently supersedes greed. The phrase “whatever it takes” was coined by Mario Draghi when, as president of the European Central Bank, he sent a powerful signal of support for the euro in 2012.
After a rough late afternoon in New York on Thursday, with the S&P 500 dropping 4.4 per cent and suffering its worst one-day slide since August of 2011, and European equities also entering correction territory, Eric Robertson at Standard Chartered borrows the expression to sum up the prevailing mood:
“We believe that market volatility and uncertainty about global growth are bringing us ever closer to a co-ordinated, ‘whatever it takes’ moment from global policymakers.”
In the past week, global equities have sunk to four-month lows and with US long-dated Treasury yields hitting fresh all-time lows on Thursday, the need for a circuit breaker is growing. Wall Street is on course for its worst week since the financial crisis in 2008.
True, the speed of recent declines in equities and Treasury yield suggests there are grounds for a bounce and while a market respite is welcome it won’t stem calls for stronger official action. The doubly whammy of a potential supply-and-demand shock against a backdrop of already low central banks borrowing rates, mean governments will have to look at measures beyond rate cuts.
Earlier on Thursday Sir Jon Cunliffe, deputy governor of the Bank of England, told economists at the Barclays International Monetary Policy Forum in London that if the coronavirus proved to be “a pure supply shock there is not much we [monetary policy] can do about it”.
That came after the Bank of Korea passed on easing policy, when a cut to a record-low borrowing rate to 1 per cent had been expected. Lee Ju-yeol, the BoK governor, explained:
“For now, selectively deploying micro-policies to service sectors and other vulnerable industries would be a more effective set of responses than adjusting the (policy) rate.”
As for the European Central Bank, its public face was stoical. Meanwhile, in France the country faced an “imminent epidemic” of the coronavirus, according to President Emmanuel Macron.
The US Federal Reserve is seen as having more scope to cut rates than many of its peers, a view that has made US Treasuries the global haven of choice. The relatively higher yields of Treasuries versus other leading bond markets provides skittish investors with scope for price appreciation that helps offset losses for their equity and credit exposures. So far this year the Bloomberg Barclays index of 20+ year Treasury debt has generated a total return of 11.7 per cent (and is up 29 per cent over the past 12 months).
The bond market is currently pushing hard for easing by the Fed, with the policy-sensitive two-year yield not far from 1 per cent. Versus the effective fed funds rate of 1.58 per cent, the two-year yield has fallen below the overnight rate by a margin last seen in September.
Some argue the Fed should wait to assess matters, a point made by Richard Clarida, the vice-chair of the central bank during a speech on Tuesday. Making an informed judgment about the full impact of the coronavirus on the global economy is impossible at this juncture, but given such uncertainty markets are pricing in more of a downside scenario, as Wednesday’s note highlighted.
Ian Lyngen at BMO Capital Markets makes a valid point about preserving monetary ammunition for now:
“The prospects are quickly building for global central banks to foam the proverbial runway in hopes of a softer landing than might otherwise occur. That said, there is an argument that the effectiveness of a rate cut or two in combating the outbreak isn’t worth using up the ammunition which will eventually be required to address a ‘real’ downturn in the domestic economy.”
But in a highly financialised economy, where the hefty balance sheets of central banks already play a significant role, the Fed will bow to the market if risk assets continue taking the elevator down. Market turmoil does feed into the broader economy, so keep an eye on credit stress, particularly given how US high-yield risk premiums have climbed sharply in recent days.
As shown below, this measure has climbed to levels witnessed in August before equities began their previous rebound. A rise towards the area seen in late-2018 and into early 2019 only runs the risk of fanning a deeper sell-off in equities.
Fred Cleary at Pegasus Capital makes this point about the importance of credit when the economy faces a potential supply-and-demand hit:
“Our primary concern remains the credit markets and debt rollovers that need to take place over the next 3-6 months, especially if cash positions at more highly geared companies become impaired due to unexpected/acute revenue shortfalls.”
Fred calculates $200bn of maturing debt in the most exposed sectors, consumer discretionary ($80bn) and industrials ($119bn), is due before the start of June. He adds:
“The amount of refinancing required is obviously unknown, but this should be front and centre for public officials looking at prudential intervention if ultimately required. Using a Tarp-type facility [created in 2008] to assist in debt rollover for domestic borrowers should at least be readied.”
The credit market is hardly prepared for this outlook on US corporate earnings from Goldman Sachs. The bank revised lower its baseline earnings-per-share estimate for the S&P 500 to $165 this year, down from $174 previously — representing no growth in earnings for 2020. But Wall Street analysts forecast earnings growth of about 7.7 per cent this year, according to data provider FactSet.
Shweta Singh and Charles Dumas at TS Lombard make this point about the dislocations to global value chains (GVCs) intensifying from here:
“GVCs are highly finance-intensive, raising the spectre of defaults in the event of prolonged disruptions. Emerging markets in particular are heavy dollar borrowers, exposing them to major FX mismatches. These risks have mounted because cross-border payments and FX deals within sprawling supply chains are increasingly complex.”
There is also the damage looming from two-year Treasury yields spending an extended period below the fed funds rate:
“A prolonged inversion of the fed-funds/2-year note spread damages credit creation by making loans less profitable for banks. This spread has been negative for just over a month now. If it stays inverted for a few more months, US banks could tighten credit conditions. The cost of offshore dollars (via FX swaps, for instance) would also rise, intensifying any credit problems in supply chains.”
Now that the S&P 500 is below 3,000 points and has sliced through its 200-day moving average of 3,046, anxiety is very high. The late-afternoon selling could well mark a moment of capitulation that results in a near-term bottom for now. Earlier on Thursday, the 10-year yield touched 1.25 per cent, and that area held as resistance and in spite of Wall Street’s brutal last hour of trading.
With the exception of late-2018 and the China growth scare of 2015 into 2016, the S&P has rebounded in good fashion after breaking the 200-day MA in recent years.
As BMO Capital Markets observe:
“For several years, this threshold was generally a solid buy signal, and as a result dip-buying willingness here will be closely watched as a potential inflection point. If stocks continue to fall, rates will be dragged lower, and the conversation in the Treasury market will move to whether we’ll see 1% 10s before the March Federal Open Market Committee [meeting].”
Let’s see how markets navigate the final trading day of February.
Quick Hits — What’s on the markets radar
For President Donald Trump, the stakes in an election year are intensifying given how a buoyant stock market has long been cast as a stamp of success by the White House. The clamour for US central bank action is getting louder. Kevin Warsh, a former Federal Reserve official, penned an op-ed in the Wall Street Journal that didn’t pull any punches:
“Fed leaders call the current, ostensibly low level of inflation the greatest challenge for this generation of monetary policymakers. I disagree. An exogenous, uncertain, global economic shock is a far bigger and more pressing challenge. And a far more compelling rationale for policy action.”
Mr Warsh has been a critic of the central bank for some time, particularly when it tightened policy in late-2018, a period of intense market turmoil. He is also considered a frontrunner for replacing Jay Powell as the next Fed chair in the event that Mr Trump secures a second presidential term.
In currency action, the euro has climbed two cents versus the dollar over the past week, hitting $1.10. This reflects the unwinding of carry trades based on borrowing in euros to buy higher-yielding assets. Emerging market currencies are still sliding, while commodity prices are also suffering from a general exit from growth-sensitive assets.
Another sign of risk aversion within Europe is the rise in sovereign bond yields for the likes of Portugal, Spain, Italy and Greece on Thursday. Not all government bonds are deemed havens, even when the ECB is a buyer.
A weaker tone beneath the surface was evident for the US economy during the final quarter of 2019. A revised Q4 growth figure of 2.1 per cent suggests a moderate pace of expansion before the outbreak of the coronavirus. But there are grounds for taking a less sunnier view from here. Oxford Economics notes:
“Nearly three-quarters of the GDP advance came from a temporary collapse in imports, while business investment contracted sharply and consumers spent more cautiously. The most recent three quarters mark the economy’s worst performance since the 2016 slump.”