Trader Views March 27th 2020

Trader Views March 27th 2020

European and U.S. stock futures are under pressure after three days of strong performance in the cash market. A quarter-end portfolio rebalancing lift to equities and a pricing in of a short duration of economic weakness on stimulus measures appear to be contributing to the gains. Any delay to the signage of the U.S. fiscal bill today could curb enthusiasm while a lack of progress from EU leaders to agree to a containment strategy could weigh on risk appetite heading into the weekend.

Here’s what to watch for today:

  • Less confident. February consumer confidence data for France and Italy are expected to show sharp drops to late 2018 and 2015 levels, respectively. But periphery bond yields are likely to tumble further with the ECB abandoning limits under its 750B-euro PEPP
  • Waiting mode. The dollar is tumbling as the liquidity squeeze is loosening. Any delay to the anticipated signing of the U.S. stimulus bill today could damper sentiment and boost the dollar. But the passage would mean that details of the Fed’s Main Street Business Lending Program are forthcoming. Core PCE inflation, consumption and income are likely to remain in the background
  • Rating woes. The Mexican peso is leading EM FX gains against the greenback this week despite rating agency S&P downgrading the country to BBB, two levels above junk
  • And more. The rating decision for South Africa is expected from Moody’s today and while risks of a downgrade are high given the fiscal outlook, the agency could hold until November and knee-jerk moves in USD/ZAR are likely to fade with Covid-19 guiding sentiment
  • Rate cuts. The RBI surprised with a rate cut overnight and the Colombian central bank looks poised to follow today. Median consensus is for a 50bps move despite inflation at the high end of its 2-4% target range and the peso near all-time recorded lows

Here are the highlights from the Asia session:

Asia stocks rose as investors mostly waited for the U.S. House to pass the American rescue bill. The MXAP index advanced about 1.8%, climbing for a fourth day. Shares gained in Japan, China, Hong Kong and Korea. S&P 500 futures dropped more than 1% as U.S. virus cases overtook China’s.

The yen advanced around 1%. The pound, euro and Aussie dollar also gained. The Mexican peso fell about 1% after S&P downgraded the nation. Treasury 10-year yields fell 4bps to 0.81%. Yield curves narrowed in Japan and Australiaafter blowing out last week. Gold slipped while WTI crude advanced.

Key Headlines:

  • Global Deaths at 24,000; U.S. Cases Surpass China
  • India’s central bank cuts repo rate by 75 bps
  • Mexico Downgraded to BBB by S&P on Virus, Oil Price Shocks
  • Tokyo March Core Consumer Prices Rise 0.4% Y/y; Est. +0.4%
  • Chinese Industrial Firms See Profits Slump on Virus Impact
  • Indian Markets Rally on Hopes RBI May Announce Policy Steps

Question of the Day: Will the Coming Debt Deluge Send Yields Up?
The U.S. will have to pay for all the stimulus by issuing more bonds. Treasury Secretary Mnuchin says the government will be selling a lot of 30-yearsecurities and doing a lot of long-term financing. The U.S. marketable debt is already up to a record $16.9 trillion. Record-low yields won’t help attract investors. And there are now rumblings about a second stimulus package if the first one isn’t enough. In theory, all this government borrowing and spending should be inflationary.

Or will demand for safety overshadow the size of the national debt? The growing supply never seems to send yields up. They just keep falling. Are the bond vigilantes dead, or are they about to rise up in force?
What’s your opinion? Please send your insights to info@traderinput.com.

Chatrooms highlights include:
King Dollar‘s retreat; more policy move from China? HKD up against strong end; ratings downdrift for credit markets; U.S. REITs say relief rally at risk; fortunes of property bonds

U.S. Dealers Will help Push Yields Down While Central Banks Sell

Treasury yields can keep falling as primary dealers load up on U.S. debt. The latest Fed data show dealer holdings of long-term bonds squeezed to a new record. The total held by Wall Street’s biggest banks is approaching an all-time high. These purchases have corresponded nicely with the decline in Treasury rates over about the past month.

Foreign central banks keep dumping Treasuries, and that’s something of a warning sign. They probably need to raise money to support their own economies. That hasn’t gotten in the way of the bond rally, so far. But the U.S. has relied on overseas lenders to buy its debt for years. Just as it prepares to ramp up borrowing to pay for all the stimulus, reduced foreign demand could eventually make it tougher to sell the new debt.

Japanese Bonds Heavy as Collateral Premium Unwound

Japanese government bonds are a bit heavy Friday, as the market’s plumbing starts to shake clear some of the clogging caused by the turmoil that struck earlier in the week and sent collateral premiums on JGBs skyrocketing.

Japanese banks have taken down well over $150b from Fed swap lines, and JGBs needed to be put down as collateral. With market-based funding costs rising, banks and dealers wanted to hold onto JGBs.

In turn, the debt has become expensive to borrow, with tom/next repo rates hitting records earlier this month. Another sign was the limited appetite to sell into BOJ buying operations with the 5-10y buyback seeing lowest offers on record on Monday.

This is all unwinding now. Yen basis has tightened 50bps this week as foreign banks are now swimming in cheap dollars. FX funding markets have eased considerably — yen-funders are now able to borrow dollars well under 2%.

Stocks Should Be Worried If Dollar Weakness Was Key Driver

Month-end portfolio re-balancing is likely to result in a strong flow of dollar buying and that may be bad news for stocks.

The S&P 500 just had its best three days since 1933. Robert Burgess makes a reasonable argument that recent dollar weakness has played a large part in that rapid rebound. That’s a concern though, since the dollar is likely to have at least one more leg of strength in the coming days as real money funds will have to buy dollar assets to re-balance after this month’s large U.S. equity losses.