More volatility ahead as virus spreads

Hussein Sayed,
Chief Market Strategist at FXTM

“Coronavirus deaths topped 500,000 worldwide”, is the first headline to grab investors’ attention Monday morning. The mission is unaccomplished and the virus is still winning the fight in several countries, particularly in the US, Brazil and India.

Hopes of a robust economic recovery following the pandemic are now shattered. The risks of re-imposing lockdowns are high, and monetary policy stimulus which explains most of the recovery in asset prices from the March lows will become less effective going forward if it doesn’t translate into a rebound in economic activity and better prospects for corporate earnings. Risk asset valuations remain elevated and the next few weeks ahead will tell us whether they will continue to hold or get bumped.

At this stage, there is a lack of visibility as even technical indicators share a similar view. The S&P 500 closed Friday 11 points below its 200-day moving average and is just hovering around the psychological 3,000 level. If the index trades for two to three days below these two benchmarks, that will attract more sellers and could drive the index 5 – 10% lower from current levels. However, holding above may have the opposite impact but that will lead to a further divergence from fundamentals, which in theory should not hold for long unless the Administration provides new fiscal stimulus plans.

The divergence is not just among asset prices and fundamentals, but also within assets themselves. US 10-year and 30-year treasury yields are sitting at one-month lows of 1.37% and 0.64% respectively, indicating there’s still huge demand for the safety of US government bonds. If yields on long term maturities continue to head lower that should mean the big players are reducing their risk exposure heading into the third quarter.

While the trajectory of the Covid-19 infections and deaths remains the most effective barometer for risk, investors need to keep an eye on several other factors this week.

The US job’s report will be released on Thursday instead of Friday due to the Independence Day holiday. Markets anticipate the headline figure will add three million jobs in June following 2.5 million added in May. Given the volatility in the employment data, we may see another surprise although a positive one is needed to prove that economic activity is gathering pace. Investors will also be focusing on Fed Chairman Jerome Powell when he testifies before the House Financial Service Committee tomorrow for any hints on new monetary policy measures, while also needing to closely scrutinize the FOMC minutes on Wednesday.

Longer-term, market participants need to keep an eye on US election polls. So far Joe Biden is leading by a significant margin and that doesn’t seem to be priced in yet. Biden made it clear that he will roll back Trump’s corporate tax reforms, and that requires substantial revisions for earnings expectations in 2021. If he continues to lead in the polls, expect a further pull back in stocks.