October 28, 2021

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Entering the Covid19 Rabbit Hole

For a while last week, it felt like a stroll through Wonderland with the Federal Reserve Board “all in” and world leaders dropping nearly $5 trillion fiscal stimuli in the markets lap. All amid sugar-coated promises, this would be the deepest yet shortest recession in modern-day financial history. But with Coronavirus cases in the US rising exponentially with lethality projection rates soaring and secondary cluster fears gripping Asia and Europe causing county-wide lockdowns, it certainly feels we’re nudging ever so closer to falling down the Covid19 Rabbit Hole with reports that the US death counts could reach 200,000

Global cases increased by 26% since Friday (now 713,000), led by the US 136,888 total cases (48% growth). Less well known is where the virus building now:

  • Turkey 147%, Portugal 43%, Belgium 47% all had significant growth over the weekend
  • Australia, New Zealand, Canada >60% growth over the past three days
  • Chile, Argentina >75% growth

Now policy responses read like a playbook: cut rates to zero, purchase a more comprehensive array of assets than ever before, pump fiscal spending with little regard to debt sustainability. Suggesting we are nearing policy fatigue where it becomes less effective, and as the surprise element diminishes, no one cares.

So, while policy responses in the US and Europe have been spectacular, allowing for markets to rebound last week. But the coronavirus keeps spreading globally, deepening fears of the economic and financial impact across countries. More market turmoil likely lies ahead.

If you’ve spent any time ocean fishing, you’re probably aware of the term “sucker hole, “a colloquial term referring to a short spate of good weaker that “suckers” sailor into leaving port just in time for a storm to resume at full force. Well, that’s what last week’s market felt like as now we are about to enter a vortex of bad earnings, bad economic data, and bankruptcies. Indeed, last week’s animal spirits will be severely tested.

Oil and copper did not rally; the Vix isn’t pulling back despite the S&P 500 10% higher last week.

With no visibility on the end of lockdown,the world is becoming increasingly branched, with business people wanting a quick reopen thinking the solution to a problem produces a worse net result than the problem itself. And scientists pleading for caution as we don’t want to overrun the hospitals and potentially deal with multiple rolling lockdowns. And possibly triggering the ultimate policy destabilizing moment that no one wants to see as the President (emphasizing business priorities) and Governors (highlighting science priorities) lock horns. Fortunately, the President says he is extending virus guideline to April 30.

Oil prices 

The primary narrative 

The spread of Covid-19 and the impact on oil demand will continue to pressure oil prices. And the virus headcount numbers out of New York City are providing those especially poor optics this morning.

Oil prices have softened in the aftermath of the US package hoopla and suggesting the direction of travel skews lower as markets anticipate a 2Q that will inevitably see a large build in inventories as demand echoes the shutting down of major global economies.

Storage facilities 

There is a relatively wide range of estimates on how much global crude storage capacity remains and on how quickly that capacity is filling.

However, when the storage capacity is filled, we should probably expect a response from Saudi Arabia, Russia, and other essential oil producers. On the other, the longer their response takes, the higher the risk of another steep decline in oil prices.

While WTI seems settled in the low 20$ as a baseline for now, however, it’s tough to rule out a drop into the teens or lower if Saudi Arabia and Russia stay the course.

Only then would the cash cost accelerate shut-ins and ultimately lead to a price rebound, but it would make for a horrible year for a good chunk of the world who are oil price takers.


On the supply side, which I think is less relevant today but a factor none the less. US Oil companies seem to be reacting more quickly this time than they did in the previous downturn. Energy firms cut the most oil rigs since April 2015, removing platforms for a second week in a row as a coronavirus-related slump in fuel demand has forced massive reduction in investment by oil and gas companies.

Drillers cut 40 oil rigs in the week to March 27, bringing down the total count to 624, the lowest since March 2017, energy services firm Baker Hughes Co. said in its weekly report.

False hope

Is there light at the end of the tunnel as several sources are reporting that refiners in the US and Europe are not buying Saudi Arabia’s crude, despite the steep discounts being offered as part of Saudi efforts to pressure Russia and other global producers.

Excess supply was brewing even before the Saudi – Russia falling out & long before the collapse in oil demand. Indeed, this the most significant mismatch between supply and demand in modern history, suggesting that these aggravating factors will l limit any price recovery even with a truce.

Gold Markets 

A shift back to ‘risk-off’ sentiment did little to support gold as the thought of distressed sales is still too fresh in trader minds. So, the market remained in tight ranges on Friday were all three sessions bore witness to profit-taking after steep gains last week. But US weakness helped to temper profit taking price declines.

But gold should shine through as risk sentiment weakens this time around. For the most part, the immediate need for equity margin call selling has already been done, suggesting there is no apparent reason to sell gold in this environment other than to book profits.

In both 2008 and 2020, gold has briefly been caught in the mix, where good trades were being liquidated in distressed markets. But last week there were clear signs the market is warming up the idea of central banks monetizing debt and leaving considerable excess liquidity in the banking system. But the key differentiator in 2020 is that QE is financing helicopter drop into households around the world. And interestingly enough, QE is even being discussed in ASEAN markets even when interest rates are far from zero, which could be the harbinger for a new form of debt monetization policy around the globe.

Currency markets

GFXC Issues Statement on FX Market Conditions

The Global FX committee (made up of banks and other stakeholders) has issued a statement (unprecedented as far as I can tell). Effectively it just says – “be careful this is going to be a big and busy month end” in slightly more technical language.

GFXC Issues Statement on FX Market Conditions

Dollar liquidity 

The dollar liquidity crisis appears over. It has taken more than $30 trillion in annualized bond purchases from the Fed, among others, but the dollar crunch now appears under control. US real yields have dropped almost 100bps in a few days, and cross-currency basis has normalized. So, with policy rates converging to zero, traders are now looking to take the Asia “virus divergence” trade global. In other words, bet on those economies that will see the virus pass quicker and return to some type of economic normalcy.

Markets may be able to look through some pretty horrible economic data—like the non-reaction to the historic spike in US jobless claims last week—but will likely be sensitive to the news on the duration of shutdowns and any signs of second-round effects extending travel alerts and lockdown measure.

Last week the Dollar pulled back as risk assets rebounded, but our best guess, as that all most of us are flying on, is that the epic USD rally is not quite over. But moth end flow will complicate matters, but with US equities in the tank, it’s unlikely we will see USD demand from rebalancing flows kick in today.

The Ringgit

The Ringgit will remain defensive due to secondary cluster fears, the negative economic effect of the MCO, and the prospect of lower oil prices, which reduces the supply of petrodollars, which is a crucial stabilizer for the Ringgit.

This article was originally posted on FX Empire


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