Licking Yesterday’s Wounds Today

Overview:  The nearly three-month rally in risk assets ended with high drama and a stomach-churning almost 6% slide in the S&P 500 yesterday. Follow-through selling was seen in the Asia Pacific region, but most markets recovered from their lows, and although losses were still recorded, the downside momentum seemed broken. The same holds true for Europe.  Bourses opened lower but by mid-morning had moved higher (~1.4%) and US shares are trading firmer (~2%). The MSCI Asia Pacific Index snapped a two-week advance that saw it rise 9.5% and is off around 3% this week. The Dow Jones Stoxx 600 rose around 13.75% over the past two weeks, and even with today’s gains that snap a four-day slide, it is off about 5.3% this week.  The S&P 500 is nursing a 6% weekly loss coming into today’s session.  It rose a little more than 11% over the past three weeks.  Bond markets are subdued today.  Yields are mostly narrowly mixed.  The US 10-year benchmark yield is hovering around 70 bp, an almost 17 bp decline on the week.  The benchmark German Bund yield is off 10 bp, and peripheral spreads widened this week.  The dollar’s safe-haven gains yesterday are being pared today.  The yen and Swiss franc are also slipping after yesterday’s gains.  Many emerging market currencies in Asia did not recover today, but the Mexican peso and South African rand are leading the broader move higher.  The JP Morgan Emerging Market Currency Index is up about 0.4% today to retrace about a third of yesterday’s drop.  Gold is firm (~$1735) in the upper end of its range.  July crude initially extended its slide since poking above $40 on Monday.  It fell to about $34.50 earlier today before recovering to trade a little above $36 in the European morning.  

Asia Pacific

Japan revised its April industrial production loss to a 9.8% slide on the month, compared with the initial estimate of a 9.1% decline. There was little market reaction. The BOJ meets next week, and it is not expected to take fresh initiatives. That said, BOJ Governor Kuroda has hinted that the corporate sector may need more support.  The BOJ has tripled the amount of corporate bonds and commercial paper it purchases. There is some talk that the BOJ could make loans with negative interest rates as the ECB does (and will do so in a big way next week).  

The dollar held yesterday’s low just below JPY106.60 today and is recovering. There is an option for about $445 mln at JPY107.35 that expires today.  A close above JPY107.85 area would be constructive.  Follow-through selling pushed the Australian dollar to $0.6800, from where it bounced back above $0.6900 in early European turnover, but appears to be stalling.  The $0.6930 area corresponds to the middle of this week’s range.   It rose about 4.5% last week and near $0.6900 it is giving back about 1% this week.  The PBOC set the dollar’s reference rate at CNY7.0865, seemingly to try to temper its surge.  The bank models suggest a fix above CNY7.09.  Net-net both the onshore and offshore yuan were little changed on the week (less than 0.1%).  Meanwhile, the Hong Kong Monetary Authority appears to be continuing its defense of the band.  Separately, the central bank of Indonesia announced it would intervene in the spot, NDF, and local bond market.  The rupiah has risen more than 16% here in Q2 and appears to have turned this week.  Intervention in the direction of the market is often more effective than fighting it.  


The UK’s output dropped 20.4% in April after a 5.8% contraction in March.  It was a bit worse than economists expected. Services contracted by 19%, manufacturing by more than 24%, and construction by 40%.  Economic output was at 2002 levels.  The only bright spot, some may find, is that the trade deficit narrowed.  The Bank of England meets next week and is widely expected to increase its bond purchases.  

The UK has indicated it will maintain a light touch customs requirement next year but is set to confirm it has no intention to seek an extension of the transition period.  The latest round of trade talks ended last week with little progress.  The pace of negotiations will be increased, and a meeting between Prime Minister Johnson and EU’s von der Leyen may help reinvigorate the talks.  

The eurozone’s industrial output fell 17.1% in April after an 11.3% decline in March.  The April drop was smaller than expected and may have something to do with seasonal adjustments.  Note the national figures.  Germany reported a 17.9% decline, and Italy’s industrial output fell 19.1%.  French industrial production contracted 20% and Spain’s by nearly 22%.   The two EMU highlights for next week are the ECB’s TLTRO with can provide loans for a little as minus 100 bp, and the EU Summit to discuss the 750 bln euro Recovery Fund.  

The euro eased to almost $1.1275 in Asia before recovering to $1.1340.  However, the market appears to be waiting for US leadership now.  Initial support is seen around $1.1300, and there is an option for almost 610 mln euros at $1.1310 that expires today.  The euro has declined in one session this week and in each of the past two.  It closed near $1.1290 last week.  A gain this week would be the fourth in a row, the longest in more than two years.  For its part, sterling fell to about $1.2545 earlier today before finding a bid that lifted it a cent by late morning turnover in the UK.  Yesterday’s 1.1% slide snapped a 10-day advance that saw it rise by around four cents.  Resistance is seen in the band between $1.2650 and $1.2680.  


The US reports import/export prices, University of Michigan’s preliminary June reading, and the Baker Hughes rig count.  These are not typically market-moving reports even in the best of times.  Investors are more focused on what appears to be a resurgence in Covid cases, and Houston is reportedly considering reimposing stay-in-place orders.   Canada and Mexico do not have market-moving economic reports either.  

The Federal Reserve’s balance sheet rose by $3.7 bln last week, its smallest increase since the crisis began.  About a third of the increase was accounted for by the $1.2 bln purchases of the corporate bond ETFs.  Yesterday, during the equity carnage, the Fed announced adjustments to its repo operations starting next week.  The overnight repo will be conducted at a minimum of five basis points over the interest on reserves, and the one-week repo will be at a minimum of 10 bp on top of interest on reserves.  The Fed cited better functioning markets for its decision.  

Central banks had sold about $155 bln of Treasuries out of the custody holdings maintained at the Fed during the peak of the panic in March and April.  Last week, they bought $17.5 bln back to bring their nine-week buying spree to roughly $97 bln.   There are at least two takeaways.  First, the divestment was tactical, not strategic.  Second, the replenishing of reserves requires selling their own currency to buy dollars, hence what appears to be stepped up intervention. 

The US dollar reached almost CAD1.3315 in the middle of the week, its lowest level since early March.  Yesterday’s sharp recovery was extended to about CAD1.3665 today before it pulled back, reaching CAD1.3530 in Europe.  There is an option for roughly $540 mln at CAD1.35, which could be in play before expiring later today.   That also corresponds to the midpoint of this week’s range. Below there, the next target is near CAD1.3450.  The greenback had been carving out a shelf a little below MXN21.50 before surging to almost MXN22.80 yesterday and MXN22.95 earlier today.  However, it has come back offered.  The initial corrective target is near MXN22.38 and then MXN22.20.  While the peso’s 1.4% decline so far this month is the largest among emerging markets currency, the Brazilian real’s 7.25% gain is the most.  However, Brazil was closed for a national holiday yesterday and missed the drama.  A little catch-up today ought not to surprise.


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