Capital Markets Stabilizing

Official actions have succeeded in stabilizing the capital markets, even as much of the world's economy remains locked down, and the hardships faced by households and businesses intensify.  In the middle part of last month, the markets were as dysfunctional as they have ever been.  Volatility remains elevated but normalizing.  The much-watched volatility of the S&P 500 (VIX) peaked near 85% on March 18 and finished last week below 42%.  In the three months through January, it averaged about 13.5%.  The same is generally true for bond and currency volatility:  The market disruption peaked and has been steadily declining without yet returning to status quo ante levels.

When the VIX reached 85%, and MOVE (an index that tracks the implied volatility of the Treasury market) reached nearly 165%, a full-fledged panic was underway. Many questions crisis, including duration, breadth, and magnitude, are still unanswerable.  Investors have concluded two things it appears.  First, that the crisis is finite.  Second, official most countries are taking measures to ameliorate the financial and economic dislocations.  Moreover, the official responses are far from complete, and multilateral institutions, including the World Bank and IMF, are likely to have significant roles.   In effect, the market had discounted left-hand tail-risk and has since taken into account official action and estimates worst-case scenarios will likely be avoided.

Here is a look at the price action:

Dollar Index:  For the fourth week, the Dollar Index alternated between gains and losses.  Last week it fell by about 1.2%.  It finished the week at an eight-day low a little below 99.40.  The recovery off the low in late March (~98.25) stalled near 101.00 and decline in recent days retraced (61.8%) of the last bounce near 99.30.  There is additional support in the 98.80-98.90.  The momentum indicators are heading lower, and the 200-day moving average is around 98.15.  A break of the 97.80 area could have important technical implications. 

Euro:  The euro bottomed on March 23, near $1.0635.  The S&P 500, used a barometer of risk, bottomed the same day.  It rose to around $1.1165 before the end of the month, and although it looked bullish, it set back to about $1.0770 to start last week.  The euro recovered to around $1.0950 to end the week about 1.25% higher.  The MACD and Slow Stochastics appear to be turning higher.  The five-day moving average looks poised to cross above the 20-day moving average for the first time since March 18.  Three-month implied volatility has fallen to a one-month low near 7.6%. after peaking on March 19, near 14%.

Japanese Yen: The dollar traded between about JPY108.35 and JPY109.40 to start last week and spent most of the week, trading quietly if choppily within that range.  It slipped to nearly JPY108.20 on April 9 and finished the week near its lows.  The 200-day moving average is about JPY108.35.  The momentum indicators do not appear to be generating a useful signal.  The dollar was trading comfortably below JPY108 and JPY110 before the crisis.  Three-month implied volatility is near 8.5%, the lowest level since early March.  It peaked on March 12, a little above 19%.

British Pound:   Sterling is knocking on $1.25.  After spiking to almost $1.14 on March 20, it has clawed its way higher.  It stalled near $1.25 at the end of March and backed off to almost $1.2165 on April 7 before launching another run at the highs.  A break would target the 200-day moving average (~$1.2655) and the (61.8%) retracement objective just above $1.2700.  The MACD is trending higher, but the Slow Stochastic has begun leveling off.  A break of the $1.2150 area would negate the constructive tone. 

Canadian Dollar:  The US dollar finished last week near the lower end of a two-week range near CAD1.3965.  The nearly 1.7% decline gave back in full the previous week's gains.  The momentum indicators are heading lower, but the Slow Stochastic is getting stretched.  We often see the Canadian dollar driven by three forces commodities (oil as proxy), risk (S&P proxy), and interest rate differentials (two-year rate differentials proxy).  Last week the rate differential was practically unchanged with about a 17 bp premium for Canada over the US.  Oil prices tumbled, with the May WTI contract off almost 20% (~$5.6 a barrel) after spiked nearly 32% the previous on hopes of a deal to cut output.  However, risk appetites recovered, and the equities around the world rallied, with a 12% rally in the S&P 500.  The CAD1.3800 area corresponds to the halfway point of this year's range.  A break could target CAD1.36. 

Australian Dollar: The Australian dollar was the second strongest currency in the world last week.  Its nearly 6% gain trailed only the Mexican's peso 7% rally and is off about 9.6% year-to-date.  The Australian dollar has been moving in streaks.  It fell for eight consecutive sessions from March 9 through March 19.  It then advanced for seven sessions from March 20 through March 30.  It then fell for four sessions before rising every session last week.  It took out the high from the end of March near $0.6200 to reach almost $0.6370 ahead of the weekend.  The momentum indicators are trending up, and the Slow Stochastic is getting stretched.  While the $0.6270 area marks the (50%) retracement objective, the (61.8%) objective near $0.6450.

Mexican Peso:  The dollar set new record highs against the peso to start the week (~MXN25.7850) and finished the week at its lowest level this month (~MXN23.38).  Neither the MACD nor the Slow Stochastics confirmed the new high, setting up a bearish divergence.  A break of the MXN22.40 area would be a bearish technical signal and warn of losses toward MXN21.30.  The five-day moving average is set to fall through the 20-day moving average at the start of the week ahead for the first time in nearly two months.  Note that the cost of insuring against a sovereign default (five-years, US dollars) is near 227 bp.  This is three times more than prevailed as recently as February 21.  The price peaked on March 23, a little below 300 bp. 

Chinese Yuan: The dollar fell almost 1% against the yuan last week, its biggest decline since last June.  It broke the lower end of its recent range (~CNY7.05) ahead of the weekend, and the question is whether it is sustained.  At the start of April, it briefly poked above the CNY7.1250 area, but it quickly was pushed back into the range.  The dollar's broad movement may be key.  Year-to-date, the yuan is among the strongest currencies, only losing 1% against the greenback.  In terms of exchange rates, it is lost competitiveness to most of the Asian currencies and other reserve currencies. 

Gold:  The precious metal finished the week a stone's throw from the multiyear high set on March 9, near $1703.40.  It rose roughly 4.7% or $76 to close at $1696.65.  The technical indicators are getting stretched.  Gold continues to be positively correlated with the S&P 500.  It is not that the correlation is strong, the sign may be more revealing.  Some levered accounts are buying gold and the S&P 500.  Above $1700, there is little to stand in the way of a move toward $1800.  Last week's low near $1640 needs to contain downticks, or the upside momentum will be lost. 

Oil: May WTI posted an outside down day when OPEC+ announced their deal.  A 10-11 mln barrel per day cut was understood to be around a third of the surplus output anticipated in Q2. On top of that, Mexico refused to participate by reducing production by 400k bpd. It offered 100k bpd cut instead. Saudi Arabia's Aramco, which has postponed a couple of times the setting of the May's "official selling price" (OSP) and it is now expected on April 13.  While the markets were closed for Good Friday, the G20 met and did not even commit to an output cut besides what the markets were already imposing. At Mexico's request, President Trump appeared to commit the US to cut 250k bpd for it.  The author of The Art of the Deal claimed without acknowledgment from Mexican officials, that in exchange, Mexico would do the US a favor at some point when and how it chose. Nor is it clear how Trump intends to deliver the 250k bpd cut in output.  Although support may be seen near $20, the contract low, set March 30, is about $19.25.  Only a move above $29 is significant. 

US Rates: The US 10-year yield rose for the first time in four weeks.  The 12 basis point increase lifted the generic yield to 72 bp, a three-week high.  The 20-day moving average is at 80 bp, and outside for the hellish days of March 17-March 19,  the yield has been below this moving average since early January.  Similarly, the June note futures contract has found support at its 20-day moving average near 137-20.  That said, the momentum indicators are pointing lower (higher rates).  The low yield print of the 2-year was a near 19.5 bp on April 2.  It reached almost 30 bp on April 7 but saw 20.5 bp ahead of the long holiday weekend.  The 2-10 year curve steepened by roughly 13 bp to nearly 50 bp.  The fact that LIBOR remains elevated is evidence that there the dollar funding market is not functioning correctly.  However, last week, the benchmark three-month LIBOR fell about 17 bp to 1.22%.  It is the second week the rate has declined after surging 60 bp in the last two weeks of March.  In Q4 19, three-month LIBOR traded 30-40 bp on top of OIS.  At the end of last week, the spread was still a lofty 114 bp.  

S&P 500:  The MSCI World Index that tracks the performance of developed markets rose ~11% last week after falling 13.5%.  The MSCI Emerging Market Index rose 6.8% last week.  It fell by about 15.6% last month. The S&P 500 gained 10.4% last week, recouping the lion's share of March's 12.5% drop.  The US benchmark gapped higher to start the week and never looked back. The three-day island left in its wake may be an important part of the base that is arguably being carved.  The S&P 500 gapped higher ahead of the holiday weekend and saw an intraday move above 2800 for the first time since March 11. As we have noted, the 2792 area corresponds to the middle of this year's range.  The (61.8%) retracement level is near 2935.   Although the momentum indicators are still trending higher, a cautionary note comes from the Bollinger Bands, where the benchmark flirted with ahead of the weekend.  

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