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Known knowns, Unknown unknowns


Written on 30/04/2020 by Lukman Otunuga, Senior Research Analyst at FXTM

The ebb and flow of markets is something which we as traders all yearn for and volatility continues to pervade markets, sometimes in ways which have not been seen for many years. As Covid-19 curves start to flatten and economies slowly move from lockdown to a gradual opening-up phase, so trading opportunities present themselves while risk sentiment remains unpredictable.

Fears about second wave infections alternate with positive news about drug trials, while policy initiatives to support the economic devastation wrought by the supply and demand shock are released and still debated. The EU’s Recovery Fund is one such example, offering hope of a pan-European fiscal policy response but also posing an existential threat to the region, as policymakers ‘kick the can down the road’ again in a tug-of-war between north and south.

These are unprecedented times, a word badly overused, and yet there is no more apposite description. No-one knows how the disease transmission will unfold, how consumers will behave as lockdown easing kicks off. The extraordinary array of measures to combat the virus do though reveal the scope and scale of the shock.

And lessons have certainly been learnt from the GFC, as the US Federal Reserve especially has acted swiftly in implementing the 2008 playbook, as well as rolling out more controversial programs, some of which have yet to start.

Primed with these facilities and trillion-dollar packages, US stock markets have rebounded strongly trading up 30% from their March lows, led by the narrowest breadth of ‘winners’ since October 2008. This bounce implies that investors are reassured by government and central bank action, and relatively optimistic about the shape of the economic recovery.

However, oil prices are telling a different story. The May WTI futures contract tumbled deeply into negative territory, the first time in its history and Brent crude has hit levels not seen since 1999. Oversupply will remain a constant in the coming months even with OPEC+ cuts, as demand destruction wreaks havoc on the oil industry. Storage capacity will be the main driver near-term, which means negative prices could reappear soon.

Oil is often said to be a proxy for global demand, so we ask ourselves whether it is a better reflection of the global economic outlook than equities? Sure, speculators and politics abound but the energy sector is less directly affected by official stimulus plans.

Long-term traders are well known for being experts of the current ‘topic du jour’ for 15 minutes, and then moving on unceremoniously to the next market theme. Think Japanese nuclear reactors or subprime mortgages. As we look up vaccines and virus reactivations, we know that the global economy is experiencing an extraordinary downturn and the wider theme of globalisation will be stressed further in the second half of the year.

History suggests investors can put up with bad news if they are confident the worst is behind them. Oil, as a measure of the crisis, will be in focus as the normalisation process commences, albeit in slow-mo.

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Source: https://www.forextime.com/
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