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Risk Aversion to Come Back in Q2 as Stocks and Yields Recouple

Intensifying recession fear was the main theme in the markets in March, alongside never-ending Brexit and trade tensions. With downside risks to growth starting to materialize, major global central banks started their dovish turns. Most notably, Fed now forecasts no rate hike this year. ECB will keep interest rates unchanged at least through the end of the year, and downgraded economic forecasts. BoC dropped tightening bias. And RBNZ has just indicated last week that next move is a cut.

Bond yields tumbled sharply globally. More importantly, 3-month to 10-yield yield, the most accurate predictor of US recession, inverted for a short period of time. However, the negative sentiments were no so much reflected in the stock markets. In March, DOW closed the month up 0.05%. S&P 500 rose 1.79% while NASDAQ rose 2.61%. In Europe, even after terribly poor Germany manufacturing data, DAX closed the move up 0.09%. CAC was boosted by China Airbus deal and rose 2.10%. FTSE also rose 2.89%. Nikkei was the sole major index that closed down -0.84%. China Shanghai SSE rose 5.09%. Hong Kong HSI rose 1.46% and Singapore Strait Times rose 0.01%.

To us, it’s just a matter of time stocks and bond markets align back together. Considering the technical picture of major indices, while more upside cannot be ruled out in the near term, reversals are likely around the corner, in particular in Nikkei. Upcoming March and April data should reveal more about the underlying development in the economies. It will likely be a rough ride for investors in Q2. For forex traders, should risk aversion dominates, there are prospects for more upside in Dollar and Yen.

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In the currency markets, Sterling was the worst performing one last week after the Parliament rejected the Brexit Withdrawal Agreement again while disapproving all other alternatives. Without any deal, Brexit deadline is now set at April 12. UK has just around two weeks time to decide how they’d like to move forward, a long delay, referendum, general election, or even just leave with no-deal. New Zealand Dollar was the second weakest after RBNZ indicates that next move is a cut.

Meanwhile, Canadian Dollar was the strongest one last week after strong January GDP data. WTI crude oil also extended recent uptrend to as high as 60.72, ignoring verbal intervention by Trump. Australian Dollar was surprisingly the second strongest. It’s partly supported by buying in AUD/NZD, and partly by resilience in Chinese stocks. However, Aussie could be vulnerable this week if RBA hints on a rate cut earlier than expected.

For the month, Yen and Swiss Franc are the strongest, followed by Aussie. Sterling was the weakest, followed by Euro and Canadian.

Recession fears clearly reflected in bond markets

Pessimistic sentiments were clearly reflected in safe haven flow into bonds globally. German 10-year yield hit as high as 0.278 in January and opened March at around 0.20. 10-year bund yield then turned negative in March to close at -0.069. Japan 10-year yield also hit as high as 0.047 in January, then gyrated down to -0.090 on Friday.

US 10-year yield also suffered steep decline after Fed turned dovish in the month. TNX hit as low as 2.356 last week before recovering to close at 2.414. There seems to be some support from 61.8% projection of 3.248 to 2.554 from 2.759 at 2.330. And some consolidations might be seen in near term. But firm break of 2.554 support turned resistance is needed to confirm short term bottoming. Otherwise, the decline from 3.248 is expected to resume sooner or later.

Also, note that the solid break of long term channel support suggests that rise from 1.336 has completed at 3.248. For now, we’re viewing decline from 3.248 as correcting this up trend only. But even so, TNX will likely extend to 2.034/66 support zone (61.8% retracement of 1.336 to 3.248 at 2.066, 100% projection of 3.248 to 2.554 from 2.759 at 2.065, 2.034 medium term support and 2.0 psychological). That is that level where the decline from 3.248 would likely complete.

With last week’s recovery, 10-year yield is now back above 3-month yield at 2.396. But based on the above view on TNX, it should be just a matter of time this part of the yield curve inverts again.

Stocks stayed firm in general, lagging behind treasury yields

However, the bond “panic” was not so much reflected in stocks, yet. In US, DOW just turned sideway after hitting 26241.42 in late February. Solid support was seen from 55 day EMA despite decline attempts. For now, further rise is still in favor in the early part of Q2. But we maintain the view that rise from 21712.53 is only a leg inside the long term consolidation pattern from 26951.81. Hence, upside potential should be limited with next rise and firm break of 26951.81 is not envisaged. Instead, break of 25208 will be a strong sign of near term bearish reversal.

In Europe, despite all the dovish talks of slowdown and even recession in Germany, DAX managed to stay in near term rising channel. Terribly poor manufacturing and export outlook is still offset by solid domestic and service demand. However, upside momentum is DAX is rather weak as seen in daily MACD. Even if it could mange to breach 11726.62 support turned resistance, 50% retracement of 13596.89 to 10279.20 at 11938.04 will likely cap upside.

In Asia, Nikkei looks somewhat more vulnerable. 50% retracement of 24448.07 to 18948.58 at 21698.32 proves to be a rather strong resistance level. With break of medium term channel support, risk of reversal is increasing. In case of another recovery, upside should be limited well below 21860.39 resistance. Sustained break 20911.51 support could trigger downside acceleration back to 20000 handle.

Chinese stocks performed rather well despite lack of concrete progress in trade negotiations with US. And a bit like DOW, Shanghai SSE composite turned sideway after hitting 3129.93 in early March. Such consolidative pattern in turn suggests that rise from 2440.90 isn’t over yet. More