Monday Meltdown

Overview: Equities plunged, and yields sank as the coronavirus threatens a global recession. The oil price war signaled by Saudi Arabia and Russia aggravates the desperate situation. Equities markets in the Asia Pacific region slumped 3-7%. The Shanghai Composite was fell 3%. The Nikkei was off by 5%, and Australia was hit among the hardest with a 7.3% loss. Europe’s Dow Jones Stoxx 600 gapped lower and had not reached a bottom in the morning session, and is off nearly 5.7% as this is written. US indices are hitting their opening limits (5% for the S&P 500). Benchmark yields are collapsing. The US 10-year yield is off roughly 30 bp to below 0.50%. The 30-year yield is below 1%. The German 10-year is at a new record low around minus 85 bp, while the 10-year UK Gilt yield has been more than halved to below 10 bp. Peripheral European bonds continue to trade like risk assets, and the yields are rising with the 10-year Italian yield jumping more than 20 bp. The yen has soared and is up roughly 2.5% in late European morning turnover. The US dollar is mixed. It is firmer against the dollar-bloc currencies and the Norwegian krone. The greenback is stronger against most of the emerging market currencies, and the 5.9% loss of the Mexican peso stands out. The peso is seen as an oil play and a proxy for other emerging market currencies that are less liquid or accessible and is also a victim of unwindings of carry-trades. The Chinese yuan is off about 0.2% against the dollar. Gold had initially jumped above $1700 but has reversed lower toward $1657 before finding new bids.  It is now little changed on the day (~$1674). After falling 10% before the weekend, April WTI is off another 21% today around $32.50 after trading as low as $27.35 a barrel

Asia Pacific

In the coming days, the Japanese government is likely to announce a new facility to lend money to small and medium-sized businesses that have been hit by the coronavirus crisis. Japan Finance Corp may be spearheading the effort. Note that in the final look at Q4 19 GDP, Japan reported its economy contracted at a 7.1% annualized rate rather than the 6.3% decline initially reported. Australia may unveil an A$10 bln (~$6.6 bln) aid package as soon as tomorrow.  

In discussions of the global supply chains, the iPhone and autos capture imaginations, but the reliance on China (and India) for pharmaceuticals is extreme and under-appreciated. The US, for example, gets more than 90% of its antibiotics from China, according to authors Janardan Prasad Singh and Rosemary Gibson in China RX, and Hubei, the ground zero of the coronavirus, is one of the largest concentrations in the PRC. India accounts for about 20% of the world’s generic drug supply and relies on China for almost 2/3 of the chemical compounds it needs to make them. The lockdown in Hubei is threatening the availability of some 450 drug ingredients. Indian companies were thought to have 2-3 months of inventory, according to reports. The lower end of the timeframe is being approached. India announced it is restricting the export of some drug ingredients.

The dollar had briefly dipped below JPY105 before the weekend and fell to almost JPY101.55 today before finding a modicum of support in Tokyo morning and has been mostly trading between JPY102 and JPY103. Japanese official concern about exchange rates is elevated below JPY105. The bar to material intervention is high, but verbal intervention should be expected. The dollar last traded below JPY100 in 2016. One-month implied vol had been near 4% in late February is now quoted above 18%. The Australian dollar was marked down to about $0.6315 after finishing last week near $0.6635.  It has snapped back to trade around $0.6600 in the European morning.  


In the eurozone, some expect the ECB to announce such a facility at this week’s meeting that would provide incentives for banks to lend to SMEs. Germany announced an underwhelming 12.4 bln euro industry support effort for the 2021-2024 period.  It will also ease the short-term work rules, which may also help industry cope. Separately, Germany reported industrial output jumped 3% in January, nearly double the gain economists forecast. Moreover, December’s decline of 3.5% was revised to still stark a 2.2% drop. Germany also reported flat exports in January and a 0.5% increase in imports.  

Germany, France, and the Czech Republic have imposed export controls on medical gear to avoid domestic shortages.  Protective equipment, such as faces masks are in short supply. Some see these measures as additional evidence of the failure of the European project. But this is a harsh judgment and not particularly insightful. This is often the way “Europe” works. States move quickly, like the French digital tax, which often provides incentives to find an EU-wide solution. The national bans could be lifted if Brussels banned the export of such medical gear out of the EU. 

The EC had granted Italy’s request to book spending by 7.5 bln euros (nearly as much as the US earmarked last week) to address the impact of Covid-19. The EC noted that one-off measures will not be considered when calculating the key deficit indicators, including the structural budget position. Despite the firm rules, the EC has often shown great flexibility in the application. The issue of sovereignty is one of the issues that separate the right and left in Europe. Many on the right see the European Union itself as well as the monetary union as encroaching on national sovereignty. Many on the left see sovereignty is shared through bodies in which nations are represented, such as the EC itself and the ECB, as well as numerous other institutions. Italy’s former Prime Minister, Gentiloni, is the European Economic Commissioner, whose team is responsible for ruling on fiscal issues.

The euro settled at the end of last week a little below $1.13 and advanced to almost $1.15 in Asia. It has eased back toward the pre-weekend high near $1.1350 in the European morning. The next important retracement objective is seen around $1.1650. One-month implied volatility was around 6% in the middle of last week and is now cited near 10.5%. Sterling reached $1.32 for the first time since the start of February. It eased back to around $1.3120 in the European morning. One-month implied vol is near 9.2%. It was near 6.5% in the middle of last week.   


The White House is said to be putting together a stronger fiscal response, and the market is expecting the Federal Reserve to not wait for next week and deliver another emergency rate cut as early as today. With an implied yield of about 91 bp, the March fed funds futures contract would imply a 50 bp cut next week. The implied yield now is near 72 bp. The December contract is about 10.5 bp, suggested the year-end target range of 0-25 bp. There is also concern about access to dollar funding as the LIBOR/OIS spread widens, and during the Great Financial Crisis, the Fed launched swap lines with many centers and made some permanent. Participants will watch the take-up. 

The Saudis are have slashed oil prices for April shipments by $4-$6 for shipments to Asia and by $7 a barrel for US deliveries. They are expected to boost output sharply as well. See our overview published yesterday. Light sweet crude for April delivery closed last week near $41.30 and opened today below $32.90. It fell to around $27.35 before recovering and is now approximately $33.50. The huge gap, which appears on the weekly bar charts, extends to a little above $41.00.  

The US dollar was straddling the CAD1.34 area at the end of last week and surged to about CAD1.3765 on a combination of the powerful risk-off thrust and the collapse in oil prices. The greenback drifted lower since the middle of the Asian session and eased to around CAD1.3570 in the European morning, which is about the middle of the two-day range. The US dollar spiked to MXN21.90 in Asia. It has not been below MXN20.95 since the high was set. The record high was set in January 2017 near MXN22.04. 


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