Coronavirus Adds Another Wild Card for Sentiment to Absorb 

When it comes to the standard themes I have been following closely these past few months – growth fears, trade wars and monetary policy effectiveness – there have been frequent updates and it hasn’t been particularly challenging to take their temperature at any particularly time. While the threat of a recession or trade war that threatens to encompass much of the world will not exactly inspire confidence among investors, the knowledge that there are regular updates along the way offers at least some relief. And, as we have seen through this economic and financial cycle, any relief is interpreted by a class of complacent speculators to push their advantage. Yet, the formula changes when the risks are more vague in terms of timing, duration and intensity. That was initially the situation with the US-Iran escalation earlier this month when the former executed an airstrike on the Quds Force general’s convoy and the latter retaliated with an missile attack on US bases in Iraq. However, when both sides  offered their unique brand of conciliatory boasting, the market returned to its risk-seeking self. 

Looking out over the coming months, the approach of the US Presidential election will represent just such an abstract risk. For now, the focus is on something more erratic by its very nature: the spread of the coronavirus. Since the highly communicable virus first made the international headlines a little over a week ago, cases have spread well beyond the Chinese city of Wuhan where they were first reported and have seen people fall ill in surrounding Asian countries, Australia, France and the United States among other nations. It is difficult to determine exactly what impact this medical and social threat can have on markets and/or the economy, but highly-tuned sentiment can certainly amplify the reaction. Consider the cases of SARS in 2003 and swine flu in 2009 which had a material impact on market-based headlines – though whether that was owing to an already ‘raw’ confidence is up for debate. As more cases are reported of this pandemic are reported, it is worth watching whether the market responds to the additional uncertainty by de-risking any further. 

The Pull of the EURUSD 

The FX market is very large in terms of sheer liquidity. It is easy to group the entire asset class into a certain category of depth that adds an innate stoicism and inactivity that seems natural. While the ‘majors’ in the currency market are typically far less volatile than indices, commodities and a range of other popular asset classes on average; they are not themselves quiet. History has shown substantial volatility from even the deepest of the exchange rates, EURUSD – just look at the tumble the pair suffered from May 2014. That said, there is little doubt that currencies have suffered from the same lethargy that has overtaken most other financial markets. While the S&P 500-based VIX has consolidated back down around 12, the FX market equivalent has notched an even more extreme. The popular currency volatility measures from JPMorgan and Deutsche Bank have dropped back to record and near-record lows respectively. My own measure of an equally-weighted implied volatility of EURUSD, GBPUSD, USDJPY and AUDUSD has done the same. Naturally, when these conditions hit, defenses are progressively dropped. Traders don’t expect significant moves so default to either positioning for the carry (for which there is very little nowadays) or trade the range. 

That is the context with which we saw just a glimmer of activity from the EURUSD to end this past week. The ECB rate decision and then global January PMIs seemed to stir in investors enough attention to push the pair through its narrow three-month rising trend channel and what happened to be a 100-day moving average that was hovering around 1.1070. As far as technical developments go, few chart traders would likely consider this a systemic shift for the benchmark. Sure, it was running out of room with the much larger channel resistance capping upside progress below 1.1250, but the drop seemed a path of least resistance resolution with 1.0900/0875 still intact below to cap any serious concern of bearish momentum. Nevertheless, the boost to activity seemed to generate some serious attention in FX circles. This makes sense given the pair is the baseline for all of the FX market. According to the BIS, EURUSD accounts for 24% of all FX transactions while the Dollar is one side of 88% of all trades as of April and Euro 32%. Given that it has moved deeper into an established 2019 range, we should watch to see whether implied volatility settles. That said, there is some heavy event risk ahead to beat back the dark of inactivity. The Fed rate decision along with the US and Eurozone 4Q GDP readings are top events on this week’s docket. 

S&P 500 Goes 72 Days Without a 1 Percent Daily Change 

The world’s most heavily traded index (through derivatives and financial agents) has signaled extraordinary quiet through a number of remarkable statistics earned these past months and years. That is a understandable consequence of a market that continues to push to record highs. While the financial system has suffered very few shocks over the past decade and growth trends are generally steady, the environment doesn’t exude the economic potential nor the yield that normally encourages market participants to play down their risks and continually build their exposure to progressively lower rates of risk-adjusted returns. Eventually, the quiet will be so threadbare that speculators will see little choice other than to significantly reduce their exposure. Of course, the question is always “when”. 

For most, the spark is expected to be a trigger from the headlines like the failure of the Lehman Brothers back in 2008 was for the financial crisis that followed. Such developments can certainly rock the financial system and send markets careening. On the other hand, I think there is something to say about the environment that builds up to the symbolic lighting of the future. The SPX pushing record highs and the VIX settling back towards the lower bounds of its extreme range are one thing, but experiencing a long stretch of extremely quiet days adds incredulity to the mix. The same index has passed 71 consecutive trading days without a 1 percent move either higher or lower (see SPX_1pct_71 attached) . That is two days shy of the period through Oct 8th, 2018 just before the tumble in the 4Q accelerated, and still well short of the 95 day run through Jan 25th, 2018 that preceded the near-bearish shift (20 percent correction from highs) in that period. Looking further back, we have to go all the way to 1995 and then 1972 to find anything comparable. Clearly enough, this is exceptional; and market activity is mean reverting. When we see a balancing from extreme quiet, it isn’t usually a slow pickup to more reasonable levels but rather a dramatic restoration that eventually settles.