BMA Market Insights: Is the Sell-Off in Equities and Rates Justified?

U.S. equity and rates markets point to a positive open after a week that saw global markets sell-off as fears mount over the spread of the 2019-nCoV or novel (new) coronavirus outbreak. Compared to a week ago, the number of confirmed cases worldwide has increased from nearly 3,000 people to over 17,390 people, with nearly 99% of the confirmed cases in China. The ratio of mortalities from the new virus continues to hover around 2.2%. By comparison, the U.S. alone has had at least 19 million flu-related illnesses, 180,000 hospitalizations, and 10,000 deaths (0.05%) from the flu thus far, according to the Centers for Disease Control and Prevention (CDC) for the week ending January 25, 2020. While the number of deaths from the flu, thus far, is significantly higher, emotional fear of the unknown (virus) tends to result in irrational investment behaviour, creating unique opportunities in the market. 

Upbeat test results, over the weekend, from physicians in Thailand may potentially be driving the market uptick this morning as administering a drug combination of two HIV drugs (lopinavir and ritonavir) plus an anti-flu medication (Tamiflu) appear to successfully treat patients with the 2019 novel Coronavirus. S&P 500 futures point to a +0.43% higher open while 10-year U.S. Treasury yields are 3.8 bps higher to 1.545%, a -14.3bps change from a week ago. Last week, the shape of the yield curve once again inverted as investors sought safety in the 10-year U.S. Treasury with 3-month T-Bills trading higher than the 10-year Treasury Note by -5bps. The spread has since flipped back to +1bp, in overnight trading. 

U.S. Corporate Earnings

The current U.S. corporate earnings season continues to impress, overall, with 38.6% of companies in the S&P 500 has released earnings. Companies in the S&P 500 are now expected to report an earnings rise of +0.7% year-over-year vs. the +0.3% originally expected. Technology companies such as Microsoft, Apple, and Intel continue to outperform while Boeing continues to be a drag on the index.

U.S. Economic Data

• GDP increased by 2.1% annualized in Q4 2019, as expected.
  • Domestic sales increased by 1.4%, a four year low.
    Consumption growth slowed below 2%.
  • Business investments contracted for a third consecutive quarter.
  • Consumer confidence was solid and carried the GDP print higher.
• Consumer growth and business investments are expected to pick up this year as phase-one of the U.S.-China trade deal is complete, though the coronavirus represents a downside risk to Q1 2020.

The Federal Reserve

• The FOMC deliberated from Tuesday to Wednesday, last week, and voted to keep its primary target Fed Funds interest rate unchanged between 1.50% and 1.75%.
• The Fed reiterated that the U.S. is growing at a “moderate rate”.
• Fed Chair, Jerome Powell, stressed that the FOMC was committed to getting core inflation back “to” the 2% target rate rather than just “near” to it (its current target is 2% PCE inflation).
  • Fed officials are clearly “not satisfied” if not, perplexed, with the persistent under-shooting of the inflation target.
  • There is potential for the Fed this year to modify its inflation target by either 1) strengthening the language or 2) adopt an average inflation target.

The Bank of England and Brexit

• Sterling gained last Thursday after the Bank of England keeps rates unchanged at 0.75%.
  • Traders had pointed to a 50% probability of a rate cut to help grow the U.K. economy.
  • Interest rate futures quickly priced out a rate cut at the March BoE meeting as well.
  • Money markets, however, point to a 25bps cut at the September meeting.
• After nearly four years since the Brexit referendum, the United Kingdom finally cut ties from the European Union on Friday.
  • Now that the “easy” part is done, Britain will have its work cut out for them as they negotiate trade terms with its former European Union alliance, the United States, China, and many others.

Commodities Market

In the crude oil (WTI and Brent) and base metal (copper) markets, prices have fallen 10% from its January peaks. Concerns over the spread of the new coronavirus could impact oil demand in China, the world’s second-largest economy and consumer of crude oil. Fears of the coronavirus have also weighed down European natural gas (TTF) prices as well as incoming new LNG supply.

Key events coming up this week:

• A slew of U.S. economic data will be released this week including manufacturing on Wednesday and nonfarm payrolls reports on Friday.
• Fed speak is scattered throughout the week with Atlanta Fed’s Raphael Bostic kicking off on Monday, Governor Lael Brainard on Wednesday, and Dallas Fed’s Robert Kaplan and Vice Chairman Randal Quarles on Thursday.
• The Fed is also scheduled to release its semi-annual monetary policy report to Congress on Friday.