Thursday 16 April 2020

Are Bonds and FX pointing towards the next leg lower starting next week?

I have had the view that at least since late March markets have been trading on technicals, not really even news flow. Question is when does QE induced technicals take a back seat to economic reality?

In the last couple of days equities and junk bonds have stopped rallying and traded around their Fibonacci retracement lines. While I do think there is a chance at a bit more upside for a few more days, most of the technical rebound had been had. Yet at the same time Treasury yields have broken lower and the USD has started to try to move higher again, which if it continues, I believe is the start of the next move lower, the proper liquidation event. 

The next leg down I think is catalysed by the realisation there is no V-shaped recovery from Corona, that the lock down disruption will drag on a bit longer and that in Q2 going into Q3 we will see the peak pessimism on the outlook. 

While the Fed can magically control a large part of the fixed income markets, in the end default and earnings expectations combined with a lack of market making capacity drive credit and equity valuations with exaggerated moves in both directions now part of the market normal.

In prior posts I have looked at prior shocks and recoveries and also prior bear market rallies. In bear market rallies only a partial retracement happens and it tends to happen over a similar time horizon as the sell off, in this case about 1 month. Well we are roughly a week from the start of the current bear market rally, the 23rd, so next week might be pivotal for risk assets. 

US 10 year has broken lower from its wedge:

USD has broken higher from its short term wedge:

 And is on medium term support and breaking higher:

Equities are a little short of the 3000 level/ 200 day MA/ 62% retracement but we still have a few days yet:

JNK which is a bit closer to the direct effects of QE is hovering around the 62% retracement:

If the compression of the US yield curve restarts QE repatriation, look out below:

The Fed has magically caused a recovery in investment grade credit. But ultimately it cant buy a meaningful amount of corporate credit directly unless the Treasury massively expands the recently created Secondary Market Corporate Credit Facility (which it will):

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