Market reaction moving from “disorderly” to “panic”
MAR. 09, 2020
The risk-off environment shifted abruptly over the weekend from disorganized to panic as discussions between OPEC and Russia collapsed and a price war emerged, creating the first major ripple effect of the coronavirus outbreak. Equity markets were volatile but relatively little changed last week, though this week has signs of being a washout of risk assets.
Oil prices collapsed on Monday in reaction to the Saudis slashing their official crude selling prices for April and announcing plans for supply expansion, reversing previous efforts to support prices as demand fell. WTI crude fell more than 30% at its open before modestly recovering, a loss not seen since the first Gulf War. Prices have been cut in half since early January, with concerns over the contagion to the high yield market, with the oil patch accounting for nearly 12% of the domestic high yield index.
Interest rates have cratered, with the entire Treasury yield curve below 1%, and the 10-year yield below 0.50%. The emergency FOMC rate cut of 0.50% last week feels like a distant memory, as markets have priced in aggressive additional stimulus. The Fed Futures curve now embeds 100% chance of at least 0.75% in additional cuts at next week’s meeting, with a 85% chance that it is 1.00% effectively 0%. The risk-off environment and falling commodity prices provide a disinflationary environment that provides cover for the Fed to be more aggressive, though given the nature of the panic, it is difficult to see how lower rates will stimulate in the near term. While not tangibly measurable, there is also an expectation of additional stimulus through any combination of quantitative easing, regulatory relief or fiscal spending. The Trump administration is drafting measures to aid the economy including paid sick leave and aid to affected industries.
Reported coronavirus cases have now topped 110k globally with deaths at more than 3,800. Domestically, more states have declared emergencies, major events have been cancelled and companies have implemented contingency plans, impacting the economy.
The current fundamental backdrop looks encouraging, though the uncertainties disallow investors to trust the current data, instead focusing on a murky forward-looking picture. The S&P 500 will open Monday with a forward multiple of roughly 15x, below the long-term average, though there is low confidence in the outlook for earnings. The Atlanta Fed’s GDP Now forecasts first-quarter GDP growth of 3.1% following encouraging reports on employment and ISM.
Global liquidity metrics will be critical to watch in the period of dislocation. The TED Spread (measure of spread banks charge each other) was an early-warning indicator during the Financial Crisis, and spiked to a two-year high on Monday. Last week saw the third-largest outflows on record for high yield bond funds. The Bloomberg Financial Conditions Index has deteriorated, while the CNN Fear & Gread Index is nearing a record “extreme fear” reading.
What to Watch
All eyes will be on the Fed this week in advance of the FOMC meeting on March 18. Vice-Chair Clarida gives a speech on the economy and policy outlook on Monday. Economic data is highlighted by NFIB Small Business Index on Tuesday, CPI on Wednesday, PPI on Thursday, and consumer sentiment on Friday.
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