Second wave shocks stocks – Whats next?

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By: Andria Pichidi

Investors breathed a sign of relief after Wall Street bounced on Friday, though closing off the day’s highs and recouping only about one-third of Thursday’s steep losses. The USA30 rallied 1.9%, with the USA500 up 1.3%, while the USA100 climbed another 1%, and continues to pace the upside in June, up 1.0%.

With FOMO (fear of missing out) still in play, Thursday’s plunge presented a buying opportunity. Treasuries, meanwhile, eroded on the bounce in risk appetite. The long end led the slide in a bear steepener with the curve widening back to 50 bps from 46.6 bps Thursday, though it was as wide as 64.7 bps last Monday.

The massive amount of liquidity in the system, and with talk of another government package could provide a ground for US futures however for the timing being the fear of the second wave of coronavirus infections remain front and centre. Beijing reported dozens of new cases in recent days, all stemming from a wholesale food market. In response, the city has gone into lockdown. Also, the r-rate has been creeping back above 1, indicating an exponential spread, in several states in the U.S. and some areas in Europe.

Hence safe haven positioning in global markets, have caused a sharp decline in stocks  on the bad news from virus front. However the declines for US futures started after the a rather pessimistic outlook from the Fed, which was the spark to catalyse a correction in the asset markets. There are a lot of criticism around Fed’s stance, however Fed has not done anything wrong other than to point out what we already knew – that the US/global economy was in a bad place .

The Fed has strongly used its tools and will continue to do whatever it takes to promote maximum employment and price stability goals. He noted the improvement in the May jobs report in part by some returning to work and with support from the government’s PPP. The Fed cautioned that the unemployment rate remains historically high, however, and repeated in the last statement that a full recovery is not likely until people feel safe in getting back to their daily lives.  Hence with or without optimistic signs from US labour /housing/ auto market, it is unlikely to see a fast recovery.

Fed Committee continued to discuss the different tools it might use including yield curve control and explicit forward guidance, but they are still open for discussion, as the Fed wants to learn more about the economy’s path before really deciding. So what else could be done if not negative rates? What the yield control could offer? What could the equity markets anticipated?

Therefore, factors of US stocks decline by more than 9% in June are fear of 2nd wave as a vaccine and/or effective treatment remaining elusive (Alaska, Arizona, Arkansas, California, Florida, North Carolina, Oklahoma and South Carolina all had record numbers of new cases in the past three days.), mixed US economic data  and as mentioned the Fed’s unflattering economic outlook.

Nonetheless, there is also the Overbought scenario, meaning that simply there is always the possibility that Stocks have drifted so much simply because they have gone too much up, causing profit -taking actions. Hence it could be a compo of things.

The USA100 despite the reversal of nearly 23.6% of the gains seen since mid March, sustains the picture of a technical correction in an OB rally. The asset holds a move  the 9,000 barrier, and the 50- and 200-day EMA since April 8. The breakout on Thursday of the of the previous record high at 9,740 left an extremely strong Support level, which questions now whether the decline could switch the overall positive outlook for USA100. That brought into our attention the next significant band at 9, 100 (50-day EMA) and the 9,000 (round number and Resistance March and April).  Daily Momentum indicators have been impacted slightly by the selling pressure, with RSI rejecting the 75 high and turning at neutral zone while MACD lines fell below signal line, sustaining through a move well above 0. Hence only a break of the Support area mentioned above, along with a turned of the daily indicators below neutral zone could suggest that the market is turning from a correction into a potential reversal move of the 3-month rally.

From fundamental perspective, attention will be turned now to Fed Chair Powell, who will go before Congress (Tuesday, Wednesday) to deliver his semi-annual Monetary Policy Report. The prepared testimony largely reflected last week’s FOMC policy statement, noting how the pandemic and subsequent safety measures taken have “tremendous human and economic hardship,” and how the Fed remains committed to to using its full range of tools to support the economy.

However, the Q&A offers the chance for him to nuance his tone after a relatively gloomy outlook in the FOMC’s projections, and especially the 0% to 0.25% rate stance through 2022 and whether he will suggest more of a “V” recovery is possible.


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