Markets in turmoil as a deep global recession comes into play. Global equities plunge, even as Fed begins QE4. Wide ranges in USTs and currencies. Demand for USD liquidity sees USD soar

Financial markets are in turmoil, as containment measures to stop the spread of COVID-19 look increasingly likely to send the global economy into a deep recession and potentially trigger a credit crisis. Record double-digit falls in European equity markets have been seen, with the tweaks in ECB policy only confirming that the toolbox is largely empty, and US equities are down over 7%, even with a surprise liquidity announcement by the Fed. Falls in global rates have been limited by offsetting selling pressure in a demand for cash, while the USD has soared on increased demand for USD liquidity. The NZD and AUD have seen falls to below 0.61 and 0.63 respectively, since recovered somewhat.

Markets, already under pressure, took a turn for the worse after President Trump addressed the nation during the NZ trading session. The market was hoping for a circuit breaker to offer a modicum of confidence about the outlook, but that wasn’t delivered.  In a drastic move, President Trump said that he would suspend all travel from Europe (excluding the UK) to the US for the next 30 days (later revealed as meaning non-resident US folk), another containment measure that will add to the deeply negative economic impacts from COVID-19 being felt around the world. Other policy measures announced were pretty underwhelming and disappointed the market. Rather than tell the nation he wanted to see people wash their hands more thoroughly, the market was looking for a bipartisan policy prescription that will help prop the economy up through this difficult time.

Overnight, attention turned to the ECB to see how it might help prop up the euro area economy, and again the market was underwhelmed. The ECB’s toolkit is nearly empty and that was evident with the series of fresh policy measures announced that won’t do much to promote growth. The Bank decided that cutting its deposit rate lower from its minus 0.5% rate would do more harm than good, a move that had sympathy with many, even if the market had come to expect another token 10bps cut. Additional targeted long-term loans at favourable rates will be available to banks to support lending to businesses. Furthermore, an extra £120bn of asset purchases as part of its QE programme and a temporary cut to banks’ capital requirements were all part of the new policy package. All this will mean nothing much to the economy if there aren’t willing borrowers, a fair assumption as the economy heads into recession. Not surprisingly, ECB President Lagarde urged governments to form ”an ambitious and coordinated fiscal policy response” to match the ECB’s new injection of liquidity. That has been the right policy prescription for years and hasn’t happened so far, so the market rightly took the pessimistic view that nothing much will change.

Bloomberg reports that German Chancellor Merkel’s government is prepared to abandon its long-standing balanced budget policy given the “exceptional circumstances” under the constitutional debt brake that allows for additional borrowing, although no official announcement has been made.

Just some of the new containment measures to stop the spread of COVID-19 included Italy’s government ordering almost every shop to close (the exceptions being pharmacies and grocery stores), India suspending most visas, Ireland closing schools and the cancellation of NBA games until further notice.

Economic data releases remained of little interest, with the recovery in euro area industrial production pre-dating the spread of COVID-19, while US core PPI inflation looked to be heading lower ahead of the economic shock. Timelier weekly initial jobless claims figures still show no sign of increasing layoffs, but it only seems matter of time, and the first response of firms is a hiring freeze before layoffs, as has been evident in the JOLTS data.

Turning to the markets, European equities fell by a record amount, with the Euro Stoxx 600 index down 11½%.  Circuit breakers were again in action in the US market after the S&P500 fell by 7.5% in early trading. After re-opening, the index has been down as much as 8.7%.

Safe haven assets aren’t showing as much strength as one might expect with such a low level of risk appetite, and this is being put down to some liquidation to raise cash.  Indeed, the gold price was down over 4% to USD1560 per oz, as investors sought to raise cash. US corporates are increasingly drawing on their banks’ credit facilities to raise cash and support them through difficult economic times, creating a wave of demand for liquidity. The US 10-year Treasury yield has traded a 0.63%-0.84% range, with JP Morgan reporting liquidity conditions (market depth) at their worst since the GFC.

The US Fed surprised the market in announcing 3-month repo facilities of $500bn over the rest of the month and expanding Treasury purchases beyond bills. This move is “to address temporary disruptions in Treasury financing markets”. This announcement had a positive impact on market sentiment, although the impact of that has already faded somewhat. US Fed Funds futures basically suggest that the Fed will move rates down to zero in one hit by next week, taking the range down to 0-0.25%, with around 90bps of easing priced.

In the euro area, rates are higher across all countries apart from Germany, highlighting the flight to quality. France 10-year rates are up 19bps, while Italy is up 59bps, not helped by Lagarde’s comment that “the ECB is not here to close bond spreads”.

Turning to currency markets, during times of crisis demand for USD funding in general soars and that has been evident, with a strong broadly based gain in the USD. There have been some wild currency swings overnight, with funding pressures at their heart.  The NZD fell as much as 2.8% to 0.6092, before the US Fed announcement saw it recover to just below 0.62. The AUD got down to 0.6266 before recovering nearly a cent. This week we have been surprised by the resilience of the NZD in response to evaporating risk sentiment. Our global recession playbook has the NZD falling a lot further (down to mid- to-high 0.50s level) and that recession risk has been rising by the day.

Strong demand for USDs has seen JPY lose its preeminent safe haven status, at least for the day anyway. USD/JPY got down to 103.09 soon after Trump’s address, and gained to as much as 106 overnight. EUR and GBP have also traded wide ranges in the order of 3-4 big figures, and both succumbing to USD strength.

NZD crosses haven’t been as volatile. In overnight trading, the NZD is flat to higher on all the key crosses apart from CAD. NZD/AUD has stretched up through 0.97 with the “terms of trade” effect dominating, as oil prices come under pressure. The Australian government’s fiscal easing announced yesterday (worth a temporary 0.9% of GDP) was a welcome development, but largely ignored by the market.

In a race to zero, the pressure will be on the RBNZ to deliver a substantial rate cut. The OIS market is priced at 0.55%, suggesting increased conviction of a 50bps cut in two weeks than a more timid 25bps cut. Yield curve steepening was the order of a day, consistent with the steeper curves seen elsewhere. The 2-year swap rate fell by 4bps to 0.73%, while the 10-year rate rose by 3bps to 1.07%.

On a final note, these volatile times are not likely to go away in a hurry.  It is a good time to stress-test business models. Would your business cope with an 80% drop in demand over the next month or two?  Are the necessary banking facilities in place to see you through these potentially bad times? How would your mark-to-market look if the NZD fell to USD0.55, and how about if that happened over the next week or two?