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Don’t fight the Fed, or the second wave?

Amid bankrupt stocks like Hertz and Chesapeake rallying, we have signs of rationality coming back into the markets today. The second wave caution that investors and traders have has played excellently in the markets. However, fundamentals have not been forgotten either.

As cases in Beijing and the United States spike, investors are aware of the effects of a second wave on the stock market. And we have seen that play out perfectly today. Safe havens Gold and Bonds are up on Fed buying and investor cautiousness. Stocks are up on investors buying the dip, which they have been taught to do since the Global Financial Crisis. Oil is up on signs that supply-side issues are being resolved. Hertz and Chesapeake - are down. Markets are reacting to new information as they should be – speculation aside. However, the second wave may destroy any optimism the market has in a full recovery – or will it?

Second wave risks bursting market optimism

There is a common saying – Do not fight the Fed. The general idea is that if the Fed is cutting interest, not only does this signal to the market that 100 or so individuals with Ph.D.'s think the American economy is in need for accommodative financial conditions, they provide the conditions to do so by lowering interest rates. Therefore, it would be wise to invest in equities as companies are likely to perform better during this period of low-interest rates.

However, during this Coronavirus pandemic, the Fed has come with a gun with unlimited ammunition – quantitative easing. While interest rates can take time to show fundamental effects in firms' bottom lines, quantitative easing uses the Fed's ability to virtually print money to buy anything it pleases, mainly government and corporate debt. Long story short, the intended result is to pump cash/liquidity into the markets. However, it has the effect of saving lenders from losing money as the Fed takes on the debt risk. Therefore, the spread of the damage would be limited to the stockholders if a company goes bankrupt. This sentiment, where the Fed will most likely prop up markets, has fueled the rally since the start of May.

The Feds balance sheet. Asset purchases have ballooned in comparison to 2008

But a potential second wave will put the Fed's powers to the test. During the initial downturn in mid-April, little was known about the lengths the Fed was willing to go to stabilize the American economy. But now things are much clearer – they will do everything in their power (and in this case, their power is unlimited asset purchases) to save the American economy.

Second wave vs the Fed: Who wins?

This has implicitly put investors on two teams: The second wave, or the Fed. Investors are either betting on the second wave to push investors and traders to sell their positions, outpacing the Fed's buying. Or betting that the Fed's asset purchases will keep asset prices high, even if there is a second wave. Who will win?

This has been front and center on many investors' minds, including mine. Unlike the first wave, we are better prepared for the second wave, with the Fed ready to ramp up purchases at a moment's notice. However, a second wave may finally solidify the threat on earnings the Coronavirus has on companies. As Bill Blain from Shard Capital states – "As the recession bites, and unemployment rises… markets could experience a serious reality check."

Regular investors who want to back the Fed may hedge their risk slightly by keeping some cash on the sidelines, averaging down if prices take a tank. Investors who support the second wave may want to stay fully invested in safe havens such as bonds or Gold.

Which side are you backing?

Week ahead: Fed Powell Speeches, consumer data

Traders should brace for a volatile week ahead as the world starts its road to recovery. The 17th day of protests continues for the killing of George Floyd, with the United States seeing spikes in Coronavirus cases. In comparison, New Zealand has no Coronavirus cases as is fully removes Coronavirus restrictions, while Japan, Korea, the United States, and Australia prepare for a potential second wave. Currently, the world approaches 7.53 Million Coronavirus cases, with 421k deaths. Here is your week ahead.

All dates are at NZDT.

Jerome Powell Testifies and FED Speech – Tuesday 16th and Friday 19th June.

With the FED leaving rates unchanged at 0.25% alongside promising low rates until at least 2022, Chairman Jerome Powell sent dovish signals to the markets. Both speeches this week should mirror each other, with both speeches possibly being market movers concerning the USD and the major indices. With an increase in outbreaks in individual states, a second wave is definitely on the table for the United States. This is in contrast to Anthony Fauci stating that the “US may not see a second wave” and President Donald Trump insisting that “[the government] are not going to close the country” if there is a second wave.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             

RBA Meeting Minutes and Australian unemployment rate – Tuesday 16th and Thursday 18th June.

With citizens experiencing a fairly non-restrictive Coronavirus period, Australia has had similar results to New Zealand without an extreme lockdown. However, with random Coronavirus cases popping up in sporadic places, with protests increasing the likelihood of the spread of the Coronavirus, it is not clear whether their method prevails. Futhermore, Australia plans to lift virus curbs by the end of July. Analysts expect a relatively coordinated speech at the RBA meeting minutes conference, backing the RBA’s decision to keep rates at 0.25%. Furthermore, analysts predict an increase in unemployment to 7%, from 6.2%.

Bank of Japan Interest Rate Decision - Tuesday 16th June

With Tokyo reporting 47 new Coronavirus cases, Japan is preparing for a second wave of the Coronavirus. Facing pre-Coronavirus issues such as an aging population and slowing GDP alongside an increase in unemployment, analysts predict a change from -0.1% rate currently; however, uncertainty plagues the decision.

 

GBP Unemployment and Consumer Price Index - Tuesday 16th and Wednesday 17th June

With one of the worst fatality rates in the world, the UK is likely to be struck in the next couple of months with regards to consumer spending and unemployment. Furthermore, Prime Minister Boris Johnson has been touting a 10% unemployment rate by Christmas rate not seen since the 1930s. CPI growth is set to fall to 0.5% from 0.8% as consumers restrict their spending due to the Coronavirus.

The second wave will likely dictate the course of the market in the next following weeks. Therefore, investors and traders should specifically be cautious on the upcoming US data in the week ahead, as flares up in Coronavirus cases have been slowly increasing.

Gold may see $1,800 if there is a second wave

Gold has been rallying in the past couple of days as stocks dip. Threats of a second wave hitting the western countries alongside fears extraordinary quantitative easing will devalue significant currencies have traders and investors seeking refuge.

Gold has been outperforming bonds as the safe ballast as of lately with the Coronavirus pandemic ravaging economies all around the world. To South Korea shutting nightclubs to China, ushering in new restrictions, a second wave hitting Asia is spooking market participants. It is a reminder to many countries coming out of lockdown that the real test has yet to come.

Gold has been rallying in the past three days edging closer to that psychological $1750 mark. This mark has been tested in the past two months, but bulls cannot fully break past it. Unlike oil, there have been many investors turning to physical Gold as a storage of wealth. Due to travel restrictions, Gold has been fighting COVID kits for space on planes due to hedge funds and investments in Gold ETFs craving this age-old storage of wealth. However, hedge funds have been touting a more fundamental reason as to why they believe Gold will increase in value – fears that extraordinary quantitative easing (QE) will devalue significant currencies.

Paul Singer's Elliot Management told his investors that Gold was "one of the most undervalued" assets and that its fair value was "multiples of its current price", citing "fanatical debasement of money by all the world's central banks" and low-interest rates. Has this been the case in past recessionary periods?

Less Quicker Maths

We can take a look at 3 significant instances where central banks implemented quantitative easing: Bank of Japan in 1997, The Federal Reserve in 2009, and the European Central Bank in 2015. For each case, I took the currency that the central bank was situated and paired it with a currency that was not implementing quantitative easing. I took the returns of the currency pair against the returns of Gold a year after the central bank implemented quantitative easing, and attempted to see whether there was a correlation between the two.

Year/Country Currency Pair Correlation
Bank of Japan, 1997 USD/YEN -.50
Federal Reserve, 2009 USD/GBP -.64
European Central Bank, 2015 USD/EUR -.53

The results show that there was a negative correlation between the returns of the currency and the returns of Gold ie. As the currency of the country that was implementing quantitative easing depreciated, the value of Gold appreciated. Suffice to say; these hedge funds may be onto something.

However, a breach of $1,800 may require both a second wave alongside central banks' quantitative easing. But a second wave may wreak havoc in other parts of the market, making a break to the upside in Gold possibly redundant.

Anish Lal did some great technical analysis Gold. You can watch it here.