Good Morning.. It was a wild ride in GBP yesterday but we are breaking higher now and I think this may extend but in these volatile days, I am bringing the stop up to the entry point so we have a free look at this. I do have a few concerns over the USD funding space still as spreads remain doggedly wide suggesting some stress still. Stocks took off in Asia as a deal was agreed in the Senate but there are no details. But with the Fed unleashing $4trln and the Government spending $2trln, this is huge. But beware chasing stocks up here as the credit space will take time to heal. Having said that, I do hear Pension fund rebalancing into quarter end may see a huge demand for equities. Gold is looking tired and margins are being increased which may impact for a while. We may get a better chance to buy lower. Overall the USD is lower but EUR is struggling and for good reason in my view, as it faces some real headwinds. I think the unwind in GBP TWI could continue and this may keep the EUR pressure on. Markets are ill-liquid and prone to wild swings and spreads are widening. Holding trades is not easy so trade accordingly. German IFO will be a stinker but we know that so data still seems rather irrelevant. Until the credit space is fixed and spreads contract, we still have some real risks to consider and none more so than the US becoming the epicentre of this virus.

Keep the Faith..

Data.. All Times GMT

09:00.. Germany IFO business Climate March Cons: 87.7 Prev: 96

Germany IFO business Expectations March Cons: 81.9 Pev: 93.2

Germany IFO Current assessment March Cons: 93.6 Prev: 99.0

12:30.. US Core Durable goods mom Feb Cons: -0.4% Prev: 0.8%

US Durable goods mom Feb Cons: -0.8% Prev: -0.2%

Details 25/03/20

Stocks surge as a deal is struck in the US. The USD swings wildly as stress still seen in funding:

Hope that Congress would finally ditch the politics and come up with an agreement on a fiscal package were realised late last night but details were sketchy at best but something close to $2trln is on the way in some form it seems. The hope and then realisation, saw stocks surge in the US yesterday and to be honest, the dual impact of this and the massive stimulus from the Fed may have an impression that could last some time. The Nikkei rallied over 7%, Kospi over 4% last night with HK and China over 2.5%. But still, with all this hope and the stock market rally, funding markets still showed some stress with the FRA-OIS spread widening yet again yesterday. This saw the USD whipsaw around like crazy and Cable was particularly volatile. We traded as high as 1.1799 before retracing and the swings made it hard to hold on to positions but for now, I am sticking to the higher Cable trade and it busted through 1.1800 last night and could be on its way to 1.2000 now. What I will do in these volatile and unpredictable markets is raise my stop to the entry level at 1.1675 so we have a free look at this. The Pound’s TWI had been slammed recently but recoveries can be huge.

EURGBP is back down at .9150 and I can see this lower still as to my mind the EU is still facing significant headwinds. To put it bluntly, there is nothing monetary policy could do now for the Italian situation. Italy is a paramount example of a capital-consuming economy, where the investment level has plummeted and labour productivity stagnates. They are never out of recession for any length of time; it is a fundamentally broken economy. Italy is like Japan as they both face demographics which have now caught up with them.

I still feel the Fed actions will start to erode the demand in the USD now but to be honest the stress in the USD funding market is beginning to feel like a loss of faith in the whole system, so we need to keep things tight. But the swap lines should make USDs more attainable. Gold made a dramatic recovery and more than even I expected in one day with a high around $1633, rising well over $100. I see this extending higher still.

The unprecedented scramble for physical metal coupled with continued liquidations among leveraged shorts, while refiners remains offline, appears to be fracturing the gold market from within. We may get some consolidation after such a steep and rapid move but I think dips may still attract.

Again I think the Fed actions are responsible and the margin calls are all done in gold. With a supply shortage too, this could extend still. As well as being seen as a hedge against all kinds of market volatility, gold is viewed by many investors as a way to protect themselves from the debasement of currencies and also inflation. The debasement of the USD and others is now a reality (more on inflation later). The situation with gold resembles 2008, when gold also failed to act as safe-haven asset initially, falling by around 20% due to dollar strength and a run into cash. In 2008, the turning point was the announcement of $600bn QE in November, following which gold began to climb despite further weakness in equities and commodities. Gold showed real resilience yesterday as the USD swung around.

Over and above all this, we still have issues lurking in the credit space and investors piling back into stocks need to realise this. Regulators forced bank lenders to change but in doing so pushed lending to non-bank entities which are not so well regulated or covered by regulatory protection. While the banks — designated as systemically important — repaired and tidied up their balance sheets, asset managers, hedge funds and others stepped into the gap, providing credit to the non-financial economy. Investor money flowed in, searching for yield. On top of this we have the energy and travel sector in bits and many sit in the junk space at the bottom of the credit pile and some may not make it. I think some loans are looking very likely to default and there lies the next risk. The COVID-19 virus is going to have an especially severe impact on Commercial Mortgage Backed Securities (CMBS), bonds that are backed by mortgages on non-residential properties. According to data from DBRS Viewpoint, more than half of the mortgages in CMBS deals are on offices, hotels and retail buildings – three categories being especially hit hard by shelter-in-place orders. We may be entering a new normal of increased telecommuting, reduced travel and more online shopping and if so, thousands of office buildings, hotels and malls may default.

This potential default wave will first expose the folly of poorly structured, over-rated CMBS deals. On the ratings side, the problems began on March 20 when Standard and Poor’s finally got around to downgrading 60 bonds in 15 deals with concentrated retail exposure. Rating agencies have a massive conflict of interest and are usually late to act and conservative. A dozen years after the financial crisis, rating agencies remain a weak link in the financial system. We don’t know when the next financial storm will occur or what it might look like, but overrated commercial mortgages are clearly a vulnerability. But the Fed is helping now with all sorts of facilities to stop anything from breaking. I would, however, have preferred to see the stress removed after such moves from the Fed but it seems we are not out of the woods just yet. This euphoria may not last or the stock market may yet have another sting in its tail. Last night in Japan, we saw the Japanese repo rates hit a record as demand for the USD means dealers are pledging JGBs in $ swaps for collateral and the FRA-OIS is out a tad again this morning.

An index tracking US Business Development Companies, listing lenders to small businesses, has halved since February. Many Real Estate Investment Trusts, which have relied on the short-term money markets to boost dividend pay-outs, are also being pummelled. Money market mutual funds invested in corporate debt have been hit by disruptive mass redemptions, while Junk bond exchange traded funds have traded at often large discounts to their underlying assets. There is still pain out there despite the big jump in stocks yesterday. There are still systemic risks from the shadow banks but they are different. The worry now is that the flow of credit to the non-financial economy stops. That would be a huge issue but the Fed action should have sorted this issue out but again, it seems there is some mistrust in the functioning of the system itself; is something broken that the Fed cannot fix?

I hope not and it was good to see a day where stocks rallied and bonds fell; getting back to some normality. There was also a fair bit of front running the Fed in a few bond markets and ETFs. The rush into investment-grade bonds picked up after the Fed said it will step into the market, with the world’s largest credit ETF seeing the second-biggest inflows in its 18-year history. To wit: the $30.3 billion Investment Grade Corporate Bond ETF, the LQD, posted its second biggest ever inflow of $1.06 billion on Monday, as traders piled into LQD ahead of the Fed. Monday’s one-day inflow was just shy of its record one-day intake of $1.09 billion in 2016. US 10yr yields were back up at 0.83% into the close in NY. It would be nice to think a base is in now for stocks but I fear that the US is about to become the epicentre of this outbreak. We may have only seen the first leg of a credit squeeze which could yet morph into a full-blown credit crisis so be wary of chasing things up here in stocks. Having said that, quarter end demand for equities is said to be huge.

Right now we have seen the Fed buying bonds and it seems Pension funds are buying or about to buy stocks as quarter end rebalancing is expected to see huge demand for equities into month end. This is a potent force and the Congress deal could be the icing on the cake. But it is hard to suggest right now that the USD shortages and the credit space are fixed. They possibly should be but the evidence is not apparent yet. Gold has outperformed other safe haven assets like the Japanese Yen or Swiss Franc, a trend Goldman sees continuing as long as uncertainty around the full impact of COVID-19 remains, which will be the case for a long time if Trump insists on reopening the US early and is also why gold is currently the best performing asset class YTD, a once in a decade event, as the last time this happened was back in 2010.

Are share buybacks toast; they have been a massive prop for stock markets. Share buybacks by companies in the S&P 500 Index in the fourth quarter 2019, before the Coronavirus was even a factor, fell 18% from a year earlier, to $181.6 billion, after falling 13% and 14% year-over-year in the prior two quarters, from the blistering tax-cut records set in 2018, according to S&P Dow Jones Indices. For the full year, buybacks fell 9.6% from the tax-cut record in 2018, to $729 billion in 2019, the second highest annual total ever. The Fed is putting restrictions on any firms needing Fed help and many will hoard cash now for a while, so the market is losing a massive prop now.

Since the beginning of 2012, these companies have bought back $4.6 trillion of their own shares. To provide a comparison of how big this number really is: It blows past the magnitude of Germany’s annual GDP. Just a thought.

Now for something to consider when all this fear subsides. It is rather macro; and I fully realise that the idea of inflation right now seems ridiculous. But the monetary and fiscal responses are massive and seem similar to what was used against what was a demand shock in 2008. This crisis, however, emanated from a supply shock that has spilled into demand. This throws up an interesting future development once all this is behind us, which could be only a couple or three months from now. My macro point is; if the governments try to keep spending at levels before lockdowns began (helicopter money etc), while at the same time keeping lockdowns in place, there will be simply more money chasing after significantly fewer goods and services due to the supply shock. The result of this will be inflation, and a lot of it. Just a thought as the dual impacts of massive monetary and fiscal stimulus are about to be unleashed across the globe. Who will have any spare cash to buy all the debt? Oh yes; the central banks. What a world. Maybe in the long run, we would be better off with a massive reset and start gain with a cleaner sheet. Alas, that will be fought tooth and nail.

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Strategy:

Macro:.

Short EUR @ 1.0932 with a stop at entry.. Taken profits at 1.0778

Long Cable as of yesterday at 1.1675.. Stop at entry level…

Long US 10yr yields @ 0.835% (short USTs)

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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