ASIA OPEN: A POLICY OF TRUTH MOMENT
MARKETS
While everyday folks were "weekending," market enthusiasts took to Twitter en masse to express their M & A opinions of the book closing on Credit Suisse after a storied but at times sullied 167-year run. And even though the speed at which things went pear-shaped was genuinely remarkable, for now, investors concede that the current marriage agreement between the two Swiss rivals was the best alternative amid several horrible options; hence the market has avoided the dreaded worst-case gap-down scenario at the Monday open.
Following last week's extraordinary price action in US bonds, investors are waiting to see where the dust settles on the banking saga before making any bold moves; although not too unexpected, gold has lost some of its mojos despite the dollar opening up a bit weaker.
In US equity markets, traders have primarily treated the recent events as a surgical strike on a specific contingency of stocks. And when coupled with the additional fact that implied volatility is nearly unchanged from where it was marked before this storm hit, the pattern suggests the market has chiefly compartmentalized the stresses in the US banking sector.
Still, it's a bit remarkable that US stocks have held up amid the excessive volatility in rates, not to mention the inconvenient truth that central banks are in a very different position today than they were during past financial shocks. With that on the table, I will note that we're only 7 trading days into a new chapter, and it's an evolving story of uncertainty. Hence market stress as a function of uncertainty will likely continue to weigh on broader sentiment in the near term.
In a tactical context, however, equity market price action determines sentiment and narrative. Given the velocity of the moves in rates the past few weeks, sending an overt recession signal, most folks in the levered community were exceptionally negative on equity risk (anecdotal observation). Still, when taken together with the genuinely stunning drop in front-end yields, there was kindling for the type of short-term, counter-sentiment rally that we saw at times last week. I'm not saying this is a recipe for lasting strength --but in a post-pandemic environment, stocks tend to do better in falling rates environment.
FOREX
Much of the FX market impact of the "dovish Fed shock "is because the Fed is back adding dollars into the global system; hence the apparent signs of financial stress hiding in plain sight are unequivocally USD negative. Still, the EUR is getting held back by the complexity of European banking issues as traders try to understand if other Euro banks will start circling the drains.
JPY moves are currently dominated by broad market sentiment. Still, the rally could get further fuelled as the distribution of risks appears to have shifted more clearly in favour of the Yen, given the current level of rates and more significant downside risk to growth. The markets have entered a phase where growth expectations could more easily dominate policy shocks, at least in the near term. If that proves accurate, the negative equity-bond correlation favours JPY as equities, and real yields fall together.
And, of course, if the Fed decides to pause this week, it should also be supportive for JPY, mainly if the market interprets a pause as an indication that the Fed expects more bad news ahead; in that case, JPY long would be the preferred expression.
ASIA FX
The PBOC announced a 25bp RRR cut, which was surprising given the large MLF operation a few days earlier. Traders have initially interpreted the move as the PBoC perhaps being a little extra generous on liquidity management amid significant banking stress overseas.
FOMC
The policy of truth has arrived for the FED with the market in crisis mode.
Indeed, what a difference a week makes; the FOMC enters this Wednesday's meeting amidst historically high volatility in the front end of the rates curve, which is moving at warp speed. And despite a lot more ground to cover on the inflation front, the market is expecting 25 bp at most as financial conditions will most certainly be a cause and effect of the recent stresses in US regional banks and will then do a good chunk of the Fed heavy lifting.
