The resulting collapse in US Treasury yields is spectacular on any measure. We believe investors have not had time to absorb that this is the death of one of the most popular carry trades globally – that is, borrowing at negative interest rates (i.e., -0.50%) in the euro exchange rate (EUR) to buy U.S. assets, specifically the NASDAQ-100 Index. This is known as the “US Exceptionalism trade.”
The short EUR/USD position is not tourism; it is structural and deeply embedded in the market. It has been used either as a yield enhancement on European asset longs or to fund risk asset purchases internationally. Along the way, the volatility-adjusted carry in EUR/USD has been the best in G10, and the most liquid asset. With the Fed potentially cutting interest rates down to the Effective Lower Bound (ELB), the call has already started for a move in EUR/USD to between 1.17-1.24. As a result of the volatility-adjusted carry collapsing, a key structural buyer of US equities is missing.
Secondly, US corporations are hesitant to increase their buyback strength at lower stock prices like in the past. Why? Because they do not know the current impact of the coronavirus relative to their cash flow needs and balance sheet, and whether or not they will be able to raise debt financing to fund the buybacks. After all, the market of investment-grade corporate credit primary issuance has been shut for the last weeks except for one day.
Collectively, the two strongest-handed buyers of stock market weakness are currently absent, or much less involved than normal.
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