Market Overview

13 March 2020

The Fed's Large Liquidity Injections Failed to Halt the Markets' Free Fall

The global markets were under increasing pressure once again on Thursday. The beginning of a negative wave this time chronologically coincided exactly with US President Trump's live statement to the nation. However, the situation looked somewhat surreal as if the markets were ready for their own disappointment and rushed to attack the previous seemingly distant lower levels, which was also helped by the panicked artillery fire blazing from the media.


Investors were already gripped by doubts and anxiety, plus there was a real problem when it came to reviewers who had previously whetted a special interest in Trump's address, somehow daring to sing in chorus that the US President should have to utter more details on the payroll tax reduction during this speech. The oddity of such expectations was that the presidential team members raised the very issue of a possible payroll tax cut only the day before, and these proposals have yet to be worked out and pass through a stubborn resistance of both bipartisan chambers of the Congress. Apparently, Trump had no plans for this evening to cook a hare in public before catching it.


But the market crowd was full of emotions at that very moment and desperate for immediate detailed actions. They didn't care what Donald Trump really wanted to say but reacted immediately in a negative way as Mr Trump banned all travels from the 26 EU countries, except Ireland, to the United States. The ban is not applied to the United Kingdom as well. Trump said, trade relations will not be affected by the restrictions, and has also announced some steps to defer tax payments for US companies which have been hit directly by the consequences of the epidemic. The stock markets, however, went their own way and another round of a sharp sell-off began, because they were already looking for any reason to do so.


The prices have easily seeped under the next several layers of solid ground under the feet, and by the time of the surprising information was released by the Federal Reserve (Fed) representatives, the S&P500 stock index had already fell by more than 5.5% since the beginning of the day. Trading was halted minutes after the opening bell and it triggered a 15-minute cut out.


"It's not just the fear of the economy going weak, but basically being on the brink of shutting down," said Dennis Dick, proprietary trader at Bright Trading LLC in Las Vegas. "President Trump set out to calm everyone's concerns, and he added fuel to the fire," added Jack Ablin, chief investment officer of Cresset Capital Management, a Chicago-based wealth-management firm.


However, about 10 minutes before the bidding deadline for $16 billion auction of new 30-year bonds, the statement by the Federal Reserve Bank of New York initiated a solid surge that recouped two-thirds of the previous intraday drop.


Nevertheless, the Fed's measures managed to help the market for less than 15 minutes. Then prices resumed their free fall, deepening further in minutes. The Fed's bid to address "temporary disruptions" on Treasury financing markets when it said it would offer $500 billion in a three-month repo operation on Thursday and another $500 billion in a three-month repo operation and in a one-month repo operation, failed to calm the markets. The monetary regulator had even promised to continue this offering on a weekly basis through the remainder of the program.


The Fed has been supporting the short-term funding market for months now in an effort to avoid a repeat of the liquidity crunch that occurred in September last year, when short-term funding rates surged, triggering a sharp sell-off on Wall Street. The central bank has railed against all calls that its liquidity purchases mark a new form of quantitative easing (QE). The Fed had stressed that its $60 billion balance sheet expansion was not QE because the purchases were in short-term securities. But this Thursday the Fed recognised a need to extend its purchases "across a range of maturities" including bills, notes, Treasury's Inflation-Protected Securities as well as other instruments. The purchases started on Thursday and will continue through to April 13.


It seems highly unlikely that amid such a reluctant response from stock markets to the Federal Reserve sobering moves, that the hype and sell-offs may end before the US monetary regulator cuts interest rates again on March 18. Many traders believe that the whole shooting match in the media was needed primarily by the Fed to legitimise a future sharp reduction of rates amid a growing economic cycle in the US economy. The reduction of the Fed's rate to almost zero could be necessary but perhaps also insufficient for starting a truly real recovery of the previous state of the market rally.


US central bankers delivered an emergency half percentage-point cut on March 3 and market priced in they may move again as some economists predict that they could slash rates down to 0.00-0.25% or to 0.25-0.50% range from 1.00-1.25% currently.


This could keep US bond yields at levels near zero and may create a turbulence in EUR/USD and in other currency pairs with the US Dollar. Some currencies of those countries that will keep interest rates level over the coming month, may have an advantage as the ECB Governing Council decided not to lower rates on Thursday.


The volatility of markets is now at a very high magnitude. The reassessment of the market sentiment should be carried out every day. These volatile trends have shown themselves for the second time in the past two weeks, even in such money accumulation tool as gold futures. Gold rose twice to the area of $1700 per troy ounce. The price of Gold has continuously been growing since autumn, 2018. The conditions for a sharp reduction in interest rates of many countries may create an investment in gold contracts, which may be potentially one of the most attractive investments. But there are some nuances with gold. The bullion prices plunged more than $60 per ounce on Thursday as investors cashed out some of their long positions in a scramble to cover margins and losses on shares. "Gold investors are scratching their head as the fear trade is only seeing steady flows into Treasuries right now. Gold should see some technical buying around the $1,550 area, but if that breaks, we could easily see another prices slide another $100 to $1,450," said Ed Moya, analyst at online trading platform OANDA.


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