Friday, 6th of March 2020
“Most investors want to do today what they should have done yesterday.”
– Larry Summers
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It has been another busy week in markets, though at least we have seen moves in both directions this time. Indeed, Monday and Wednesday were the best days for the S&P since 2018’s boxing day bounce, while Tuesday and Thursday (and looking to be Friday) saw drops in excess of 2%. We have to go back to the US’ credit rating cut in 2011 to find the last week where markets moved 2%+ every day. Bond yields have been more one directional, with the US 10Y blowing through the 1% mark and fast approaching 0.7%, now down an entire percentage point over the last 3 months… FX markets were no less volatile – the USD weakened against both the JPY and CHF as both currencies played their usual role as safe havens, but advanced against most EM currencies, as well as against the AUD and NZD. There was a notable weakness of the USD against the EUR, which was clearly not due to EUR strength but instead due to carry trades unwinding. This environment has been driven by a heady combination of the Fed, US politics, and the coronavirus outbreak.
The first thing to address happened on Tuesday, when the Fed announced an emergency 50bps cut to its policy rate in order to combat the “evolving risks to economic activity” posed by the coronavirus. To give some context on this, previous events that have triggered emergency cuts from the Fed have included 9/11, the sub-prime mortgage crisis in 2007, and the collapse of Lehman Brothers in 2008. The market’s opinion on the cut was not obvious, initially rallying after the news but then quickly reversing direction and finishing the day down nearly 3%. We share the market’s feelings to some extent. In all previous emergency cuts, the Fed was reactive, responding to some sequence of events that was materially impacting the wellbeing of the economy. However, the Fed itself pointed out that “the fundamentals of the US economy remain strong” at this time, something further highlighted by the strong employment numbers released today. While proactivity is certainly no bad thing with regards to monetary policy, we do doubt the effectiveness that it will have in counteracting something that is very much not financial in nature. Lower borrowing rates will not cure coronavirus, nor will they encourage consumers fearful of contagion out of their homes or repair fractured supply-chains. The market was only 4-5% down from all-time highs when this cut came through and we worry that when the impact of coronavirus does become more apparent in the economic data and earnings reports – which we believe it will – then the Fed’s rainy-day ammunition will be gone. The bond market is already painting a pretty bleak picture, pricing in another 50bps cut at the Fed’s March meeting, which would leave the Fed’s target policy range at 0.5-0.75%. 0% no longer feels too far off. What will be left when the next black swan comes knocking? With rates heading lower and uncertainty on the rise, gold has once again played its role as a safe haven, up +5.5% MTD (as of writing).
The backdrop to the rate cut was the continued spread of the coronavirus, particularly throughout Europe. There are now over 3,800 cases in Italy with nearly 150 deaths, which has prompted the government to close down its schools and universities for 10 days in an attempt to contain it. Cases in France are now over 500, while we have also just had the first fatality in the UK and 25 cases in the city of London itself – HSBC has been forced to evacuate its offices in Canary Wharf after one of their workers tested positive. It is still spreading outside of Europe as well, with an explosion of cases in Iran and a growing number in the US – 53 have been reported in California alone. While new cases in China are slowing down, the global count is fast approaching 100,000. This is clearly an unprecedented situation but with the WHO urging nations to “pull out all the stops”, we expect both governments and businesses across Europe and the world to start taking increasingly serious measures.
The results of Super Tuesday, with a third of available delegates up for grabs in the Democratic primaries, were much more positive for markets and provided some much-needed relief. Reviving a campaign that looked all but dead beforehand, Biden won 10 out of the 14 states on offer, claiming comprehensive victories in Texas and across the South. Although Sanders did manage a crucial victory in California, the results have catapulted Biden into the lead. Following disappointing performances from Bloomberg – who has become rather infamous for spending $500mn on his failed campaign – and Warren, both have dropped out and the Democratic candidacy has very much become a two-horse race. While we find it unlikely that any Democrat poses a serious threat to Trump, Biden is a much more market-friendly alternative to Sanders and a Biden candidacy would be one less tail risk to a market already full-to-the-brim with them. As such, this result completed the job that Powell and the Fed could not, causing a strong rally in equities on Wednesday. US healthcare stocks were particularly relieved, up nearly 6%. Nonetheless, we are still less than half way through the full process and every primary could throw up something new. 10 states, including Michigan and Florida, will be up for contention over the next two weeks with an important debate sandwiched between the two. We have seen the impact that a weak debate can have on a campaign, so we will keep our eyes glued to the results. In this very uncertain world, we continue to be rather defensive in our positioning.
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