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V-shaped recovery takes a U-turn

V-shaped recovery takes a U-turn

Risk asset prices crumbled overnight as the market narrative turned from “V-shaped recovery” to “second-leg down”. Traders and investors sought haven in the US dollar, the Japanese yen and bonds as stocks and industrial commodities took a belting. After the fact explanations abound, including rising Covid-19 infections in southern US states and a cautious and dovish Federal Reserve.

However the most likely source of the sharp sentiment reversal is the sheer strength of the risk recovery rally over the previous four to five weeks. The optimism that lifted the US SPX index 44% off the March low, and crude oil prices from single digits to above $40 a barrel, defied clear evidence of economic damage. The break in momentum may see markets move to levels that better reflect a balance between potential opportunities and risks.

The Fed’s unwillingness to play along provided the trigger. Its projection of zero cash rates throughout 2022, and the caution it expressed about damage from the pandemic, reined in bullish enthusiasm. The sharpness of the reversal broke short-term uptrends and important support levels in many markets, providing a technical spur for further selling. Traders view the huge volumes as a confirmation of the chart based signals.

Asia Pacific markets are in for a rough ride today. Futures are pointing to opening falls of 2% to 3.5% for stock indices in Hong Kong, Japan, Singapore and Australia. The sudden reversal in strength for the Australian, New Zealand and Singapore dollars could see international selling add weight to local share market pressure.

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