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Already sanctions-wracked Iran now has the worst coronavirus outbreak in the Middle East. The official death toll has climbed to 26, with 240 confirmed cases (with thousands still being tested); however, the true numbers are believed much, much higher – also given at least seven government leaders have been infected, including the vice president and a former ambassador to the Vatican and Egypt, Hadi Khosroshahi, who died of the illness, as well as Deputy Health Minister Iraj Harirchi. Media reports suggest the true number of infected could now be closer to 20,000. 

And yet in the latest speech by President Hassan Rouhani, he vowed not to quarantine any cities, and ranted against the virus becoming “a weapon at the hands of our enemies,” as part of “propaganda” against the Islamic Republic.

However, Friday prayers have been ordered canceled by Tehran authorities in 23 cities across the country, including Qom, and schools remain closed until at least next week, but the Islamic Republic’s powerful clerical establishment has remained defiant. As the WSJ reports, “Some worshipers in Qom are defying those orders and pushing clerics to continue delivering prayers, say residents of the city.”

“The signs of public defiance in Iran signal challenges ahead for authorities across the region that are hosting large numbers of religious pilgrims or confronting the prospect of their citizens returning from infected areas, particularly in Iran,” the WSJ notes further.

At a moment nearby Saudi Arabia has taken the unprecedented step of blocking all visas for the Islamic pilgrimage to Mecca, which sees on average two to three million plus visitors per year, Shia clerics in the holy city of Qom appear defiant. The city is home to one of the most revered shrines in Shia Islam, which sees some 20 million religious pilgrims a year. “Health experts have expressed concern about Iran’s decision not to restrict access to the shrine of Hazrat Masumeh in Qom,” the BBC noted previously.

Though political and health officials are busy urging Iranians not to visit Qom, considered ground zero for Iran’s outbreak, it appears the powerful clerical establishment has held sway, preventing total closure of some among key sites. In fact, Qom’s Shia clerics are actually still positively encouraging travel to the city’s shrines for “healing”. The WSJ cites custodian of the holiest site in the city, the Fatima Masumeh Shrine, as announcing:

“We consider this holy shrine a house for cure. House for cure means people would come here to get cured from mental and physical diseases,” the custodian, Ayatollah Mohammad Saeedi, said in a video interview published Wednesday by Jamaran, an Iranian news site.

“It should be open, and people should be encouraged to come here. Of course, we believe caution is required, and we follow hygienic issues.”

“We have no plan to quarantine any district or any city. We only quarantine individuals. If an individual has early symptoms, that person must be quarantined,” Rouhani said in a Wednesday speech. 

Underscoring that it’s the clerics running the show in Iran, even as the deadly outbreak spreads, the BBC reports further of the emerging divide between politicians in Tehran and powerful clerics on the ground at Shia holy sites in Qom: 

Its custodian has insisted it should be kept open as a “house for cure”.

This even as borders have been shut, given Iran has lately been the source of infections in neighboring countries of Afghanistan, Bahrain, Iraq, Kuwait, Oman and Pakistan.

An extensive investigative report published Thursday in The Daily Beast says Iran’s Islamic Revolutionary Guard Corps (IRGC) is involved in an information crackdown, geared toward concealing the true numbers of virus cases: 

As The Daily Beast’s partner publication, IranWire, revealed in an exclusive report Thursday, Iran’s Islamic Revolutionary Guard Corps has tried to address the epidemic by telling doctors to shut up about it, much as Chinese authorities in Wuhan did, disastrously, when the disease was just starting to spread last December.

The “official figures” from Iran give the game away. At last count, 16 people have died from COVID-19, but only 95 cases had been confirmed. As Wired UK points out, that would be a death rate of about 17 percent, when the data available from China, where there are huge numbers to work with, suggests the death rate is closer to 2 percent. The statistics don’t add up. Canadian researchers cited by Wired suggest the Iran outbreak probably involves more than 18,000 people, and counting.

As the devastating report observes, Iran’s leaders are putting the world at risk.

One doctor cited in the Daily Beast report alleged Iran’s government has no plans for containing the epidemic. Officials have “no other choice except secrecy,” he said. “This will disgrace the Islamic Republic, if it becomes known that its government is clueless. But this can lead to a humanitarian disaster.”

Meanwhile, Turkey has announced that for 72 hours it will open it’s previously sealed border with Idlib province, making good on prior Erdogan threats to “open the gates” of refugee hordes on Europe. It must be remembered that Iran and Turkey share a border, and that the region is full of vulnerable refugee “tent cities”. 

By all appearances we could still be in the earliest phases of a global disaster of apocalyptic proportions in the making. Certainly Iran’s clerics are helping to bring the region and the globe to the brink.

Authored by Bruce WIlds via Advancing Time blog,

The dollar’s weakness in the last few days can be explained from the yen being used as a conduit for wealth fleeing China and the euro enjoying a “dead cat” bounce. The dollar still sits at the higher part of its range. 

Currencies seem to be locked in a narrow trading range which could be another indication that Central Bank manipulation has gone nuclear. Near the end of 2015, a great deal of wealth began flowing into America seeking protection from the ravages fostered upon it. Much has happened since then. Between Trump and many others talking down the dollar, trade wars, and the introduction of several cryptocurrencies the dollar has backed off a bit. Still, the dollar remains relatively strong with any big increase in strength seen as a ticking time bomb for the global financial system.

Is The Dollar Has Been Held In Its Trading Range

The dollar’s strength has been largely a result of  many countries adopting even worse policies than those America’s leaders have chosen to pursue. Investors across the globe are engaged in a massive game of speculation that contains a lot of risks. This is driven by the need to get reasonable yields in a challenging environment. Still, all this tends to reinforce the fact the dollar is the linchpin of global finance and has guaranteed itself a place at the head of the table until dethroned.

A strengthening dollar sends a signal that the global economy is unstable which is something central banks want to avoid at all costs. This may account for why central banks all seem to be marching in lockstep as they take turns injecting more liquidity into the system. To be perfectly blunt, none of the rapid expansion of debt and credit during the last decade could have occurred without the Fed being complicit and in agreement. It has been the Fed that decided to allow the dollar to be used as a global prop. This exploded following the 2008 financial crisis when then-Fed Chairman Ben Bernanke adopted policies of massive quantitative easing (QE) to stimulate the economy when normal monetary policy became ineffective.

Today QE has become the lifeblood of a sick financial system rather than the jolt needed to restore its health. This circles back to the little held idea the policy adjustments Fed chairman Powell has made are driven more out of fear a strengthening dollar would crash the system than the monkey hammering he received from President Trump. It also could tie into the recent “repo-liquidity” problems and questions as to where all the money has gone.

The Fed Has Allowed This To Happen

A stable dominate currency forces other currencies to toe the line or pay a stiff price. Ignoring this economic reality translates into pain for those holding the currency of any country that abuses this economic law. This plays out in the account balances of any country that watches its currency fall as it imports far more than it brings in. As a rule, wealth tends to flow towards where it will be safe and protected. This is especially true today when wealth is able to rapidly move across borders. The inflow or outflow of capital is a big deal.

Throughout history, strong currencies have attracted wealth and this means money and wealth from all over the world could be headed towards America’s shores. The money coming into America flows into both bonds and stocks supporting lower interest rates and the stock market. Those of you who have read other articles I have written know I think the market is overvalued and the bond market is a “bubble ready to pop”, but as long as we remain the best and safest place to hide money do not discount the dollar. If this turns into a self-feeding loop the dollar may soon get much stronger especially if I’m correct in my suspicion that its recent narrow trading range is indeed artificial.

The important part of this theory the central banks have rigged the currency markets is based on the idea several currencies have become rather fragile. With this in mind, the central banks appear to be making every effort to reinforce feelings of economic stability by keeping currencies trading in a “quiet” range. It is in their advantage that people think the global economy is on sound footing as central banks across the world continued to print and pump out money in search of the “ever-elusive growth” that never quite arrives.

Do not underestimate the power of cross-border money moving into a country as a powerful economic force. While the dollar has been described as the cleanest dirty shirt in the closet, or the best house in a bad neighborhood, both place it as the least worse option. The reality is other options fail to pass the smell test. This is partly because the dollar sports a huge advantage over other currencies because of its role as the world’s reserve currency. This makes it the “default currency” and by the size of its market, float, and liquidity the currency by which all others are weighed, measured, and often pegged.

Very Important Chart In Understanding The Dollar

The chart above shows four major currencies dominating the world stage. They are the pound, the euro, the yen, and of course the dollar. All remaining currencies are small players in the overall scheme of things. John Maynard Keynes said, By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens. As the central banks print like crazy to control interest rates on bonds they devalue the currency. While there are not many Bond Vigilantes there is a slew of  Currency Vigilantes always ready to make their presence known.

Low-interest rates coupled with easy money pouring into the economy through the expansion of credit tend to create an illusion of prosperity. A “Trojan horse method” by which countries steal wealth is by the monetization of debt. This is done by printing massive amounts of new currency or new taxes. If you look close you will see the currency markets are beginning to reflect diminished confidence in the system central banks have created. This can be seen by the renewed interest in Gold and a slew of new cryptocurrencies.

The false economy we have created can rapidly vanish. Proof of just how much this economy relies on the continued flow of cheap money was highlighted when the stock market started to wobble and President Trump to ratcheted up his attacks on Fed Chairman Jerome Powell for “ruining the party”.  Trump has become the market’s head cheerleader and constantly points to the soaring stock market as confirmation of his skill in growing the economy. In truth, his flawed tax reform package has mainly benefited the rich by fostering massive stock buybacks, it is only this coupled with massive deficit spending has allowed the false illusion of prosperity to continue.

The central banks’ experiment in money creation has painted them in a corner. Their current policies should make us question the use of currencies as an economic tool going forward. It has also increased the risk that more currencies will fail as their capability to safely store wealth comes under scrutiny. Currencies are morphing into a tool of governments and have become weaponized which takes them further away from their original role as a medium of exchange in commerce. Again it must be stated, the dollar’s role as a reserve currency gives it oversized importance in world markets. It is without a question the benchmark by which other currencies and commodities are valued.

When all things are considered, fiat currencies are in general a rather weak lot. This means it is best not to look too closely or the system glued together by faith and a prayer could come crashing down. Overall the dollar remains a far better currency to hold than its weak sisters, the euro and the yen. If indeed the central banks are behind currencies trading in their rather narrow range it must be noted such currency manipulation is a very dangerous path to start down. It is a slippery slope bringing into question the real value of a currency and further distorts true price discovery.

As the currency games continue to ratchet ever higher it is becoming apparent that much of our financial structure is built on shifting sand. This means the schemes bankers have used for years to hide and transfer debt are coming under attack. If the current system crumbles it will climax in a reset of the economic system across the globe. If people all over the world try to get out of their home currencies a surge in the value of the dollar is logical. In the end, this would not be the salvation of America or its economy but it sure would create a lift that we would be wise to use to our advantage.

Acting White House Chief of Staff Mick Mulvaney said on Friday that the coronavirus is likely to cause disruptions to every day life – including likely school closures and changes to public transportation.

“Are you going to see some schools shut down? Probably. Maybe see impacts on public transportation? Sure, but we do this. We know how to handle this,” Mulvaley said while speaking at the Conservative Political Action Conference (CPAC) outside of Washington on Friday.

Mulvaney also slammed the media for painting a narrative that the Trump administration is “scrambling” to contain the virus, noting that he briefed Congress along with top health officials six weeks ago. He accused the media of ignoring coronavirus until now, according to The Hill.

“Why didn’t you hear about it?” Mulvaney asked the audience while sitting down with Heritage Foundation economist Stephen Moore. “The press was covering their hoax of the day because they thought it would bring down the president.”

“Is it real? It absolutely is real,” Mulvaney said. “But you saw the president the other day — the flu is real.“

Mulvaney then downplayed the risk of the new coronavirus, saying that people should be focusing on the mortality rate which is currently, officially, between 2 and 3%.

Acting White House Chief of Staff Mick Mulvaney: “What I might do today to calm the markets is tell people to turn their televisions off for 24 hours…This is not Ebola. It’s not SARS. It’s not MERS.” #coronavirus #CPAC2020

Full video here: https://t.co/E5ktAPiy6c pic.twitter.com/tkNBr0gRzd

— CSPAN (@cspan) February 28, 2020

What Mulvaney didn’t note is that COVID-19 is hyper-virulent, and can reinfect people who have already had it. If even 1/10 of the world is infected, that’s 15 – 22  million dead – a global crisis by any standard. He also didn’t mention the economic impact of tens of millions of people who will survive, but can’t function for several weeks.

If coronavirus gains a foothold in American cities and we begin to see footage of people falling over in the streets, we suspect the Trump administration will have much explaining to do for their early attempts to downplay the threat.

With global markets in freefall, the S&P opening 3% lower and cementing its worst week since the global financial crisis; the Dow (or is thar Down Joanes) plunging more than 4,000 points this week, traders (especially levered ones) are left with just one option to stave off a career (and personal fortune)-ending margin call: praying, though not to god but rather to the Fed.

To be sure, the Fed itself has given enough reasons for this: on Monday the biggest uber-dove in history, former Minneapolis Fed and the Fed’s only negative “dot” ever, Narayana Kocherlakota penned a Bloomberg op-ed saying the Fed should cut not once but twice, and do it on an emergency basis ahead of the March FOMC meeting.

Then, this morning, one day after he penned a similar Op-Ed, former Fed Governor Kevin Warsh – who has finally crushed his “hawkish” facade as he guns to replace Powell as the Fed’s Chair – echoed Kocherlakota when he said he expects the Fed and other central banks around the world to act soon in response to the coronavirus outbreak. Warsh, no longer even pretending to give a rat’s ass about efficient markets and price discovery that is independent of Fed manipulation, recommended the Fed act as quickly as Sunday to assuage financial markets that have been in an aggressive swoon all week as the virus has spread.

“Chairman Powell needs to reach out to his counterparts around the world and buy some time. That’s what a quarter-point could do.” Former Fed Gov. Warsh says the Fed should respond quickly to coronavirus fears: “I think the sooner they cut the better.” https://t.co/tNbNRvhiz5 pic.twitter.com/hg6HUXNiSE

— CNBC (@CNBC) February 28, 2020

Adding fuel to the speculative fire that a coordinated central bank action is coming is that the Bank of Korea shocked markets when it did not cut rates on Thursday, with some readers suggesting that the only reason it did not “was to preserve ammo to cut with other CBs this weekend.”

Needless to say, the market expects all this and more, with Eurodollar options now suggesting some traders are expecting more than 1 rate cut at the March meeting, amid rising bets for a rate cut ahead of the next scheduled meeting.

So with two former Fed officials (and potentially one future Fed chair), opining that the Fed may announce an emergency rate cut as soon as this weekend, sinking traders – desperate to grab hold to any stick – have been scrambling all morning to create a rumor, or at least a rumor, that on Sunday night the Fed will step in.

Picking up on this theme, Nomura’s CHarlie McElligott summarizes today’s market action, writing that we are now going through “dangerous times, as recently overwhelming Dealer short gamma hedging into the down trade, mechanical systematic deleveraging and dynamic shorting of Futures now are at risk of a “turn,” as Equities downside / VIX upsides hedges are increasingly likely to be monetized, creating violently “squeezy” flows in the Equities market which has recently been purged.” And while none of this is news to regular readers, as we have covered all the technical and flow aspect of the ongoing historic crash in great detail, what is notable is that Charlie adds that all this is happening “with the background “upside catalyst” of the growing-likelihood of “imminent” Central Bank coordinated policy response statement as soon as this wknd, ahead of the Sunday Asian reopen.” 

The problem is that whereas just one week ago, the mere rumor of coordinated central bank action would have been sufficient to send stocks soaring,  any attempts at a bounce for Equities (such as the 70-handle move in Spooz off the earlier overnight lows—similar to yesterday morning) will come down to likely – and imminent – monetization of large options hedges in the market, with McElligott noting that tactical traders looking to sell their Puts in S&P products / take-off VIX Calls (even see retail redeem their “long vol” VIX ETNs) to book the positive PNL against whatever hits they’ve taken in their “long” books—and probably thereafter switch into a more “dynamic hedging” stance, just trading futures thereafter to manage exposures whether “long” or “short.”

In other words, the ongoing phase transition from negative dealer gamma to positive (should those who hold hedges monetize them), is now keeping stocks lower, and preventing any bullish rumors from taking hold!

* * *

Which, once again brings us to the key topic: while it may be impossible to front run it, is the Fed about to activate a global coordinated bailout, and if so, how should one trade it? This is where it gets complicated. According to Nomura’s cross-asset strategist, the fear of this potentially imminent – and coordinated- central bank “interventionary” response (most likely time is this upcoming Sunday night, before the Asian open) will keep markets in a dangerous space, because strategies and traders which are potentially “pressing” shorts:

1. either directionally (CTA model now “in play” of outright “short SPX” as noted above) or
2. pressing-shorts to managed “net exposures” or hedge long books, will be exposed to a surge squeeze higher, while investors who have been “grossed-down” by their risk management VaR models won’t be exposed to an “up-trade” in risk and likely feel obligated to “grab into” a short squeeze

The danger after a coordinated central bank response (assuming one comes), is that investors will be forced into chasing that potential move higher in Equities out of fear that they “missed the lows,” but again into that inevitable “cluster” report of confirmed cases in a global mega-city outside of China (see what’s happening in California now as prime target), “as the pandemic is now certainly “real”—which could drive another shock-down, but this time, without the hedges which, on the way down, can also act as “insulation” when monetized.”

In other words, if or rather when the corona pandemic gets even worse after central banks have launched its bazooka, it will be orders of magnitude worse as central banks will have staked their credibility on being able to offset the economic consequences of the pandemic (they can’t, unless they can print viral antibodies), while investors will now be looking into the abyss without any hedges left.

And that could be catastrophic.

Which may explain why, in case the Fed does nothing on Sunday night, the NYSE announced that it would conduct “disaster recovery testing in the Cermak Data Center between 8:30 – 11:00 am ET” on March 7 amid Coronavirus fears.

As Charlie Gasparino adds…

BREAKING: @NYSE announces “disaster recovery testing in the Cermak Data Center between 8:30 – 11:00 am ET” on March 7 amid Coronavirus fears..”During this test, NYSE will facilitate electronic Core Open and Closing Auctions as if the 11 Wall Street trading floor were unavailable”

— Charles Gasparino (@CGasparino) February 28, 2020

… “During this test, NYSE will facilitate electronic Core Open and Closing Auctions as if the 11 Wall Street trading floor were unavailable.” In other words, testing as if a viral pandemic had swept across Wall Street…

While expectations dipped from the preliminary data, overall UMich sentiment jumped to almost its highest since 2004.

The gauge of current conditions increased from the prior month to 114.8 and the expectations index rose to 92.1, data showed Friday.

Source: Bloomberg

 

Appetite for buying houses dipped modestly in February…

Source: Bloomberg

Longer-term inflation expectations dropped to 2.3% this month from 2.5% in January. Federal Reserve officials watch this figure closely as Chairman Jerome Powell has warned lower expectations can drag actual inflation even lower. Inflation expectations for the year ahead fell to 2.4% from 2.5% in January. The preliminary February reading also was 2.5%.

The gauge of sentiment about current personal finances was the second-highest since 1998.

Notably, only 8% of all consumers in February mentioned the virus when describing the economic outlook, though the share rose to 20% in the final two days of the survey. Interviews were conducted Jan. 29 through Feb. 25.

Still, “the domestic spread of the virus could have a significant impact on consumer spending,” Richard Curtin, director of the University of Michigan consumer survey, said in a statement.

“If the virus spreads into U.S. communities, consumers are likely to limit their exposure to stores, malls, theaters, restaurants, sporting events, air travel, and the like.”

Panic is best avoided by a strong sense of confidence in local, state, and federal responses that aim to control the potential spread of the virus as well as limit any resulting damage to the economic welfare of consumers. The most effective fiscal and monetary policies include proposed reactions to the virus that are transparent, well understood, and act to maintain confidence in government economic policies close to its nearly two-decade high…

While the final February sentiment reading is the latest sign consumers remain a steady hand for the U.S. economy, a rapidly spreading coronavirus, the stock market collapse and the approaching elections nonetheless represent risks.

Gold prices are down around $25 this morning, despite a collapse in stocks and bond yields – and generally weak trend lower in the dollar.

The question is why? Or more appropriately, who?

We may have an answer to this outlier move. Last week we asked (rhetorically): “Are The Japanese Losing Faith? Yen Crashes Near Record Lows Against Gold?“

Noting that JPY and gold had massively decoupled, seemingly breaking out of their unofficial peg.

Perhaps this week’s crisis was enough to force the BIS or Bank of Japan back into the precious metals market to stabilize faith in fiat as the chart above shows a series of high volume dumps pressuring gold lower, and the chart below shows a huge roundtrip back into the ‘peg’ for yen against gold…

So did Kuroda and his pals step in?

“free markets” eh?

After January’s unexpected plunge to multi-year lows, Chicago PMI rebounded in February (from 42.9 to 49.0), beating expectations of 46.0.

This is the eighth straight month of contraction (sub-50) for Chicago’s Business Barometer…

Source: Bloomberg

As the chart above shows, the soft survey picture cross regional surveys is extremely mixed to say the least.

5 components of the Chicago PMI rose vs last month:

• Prices paid rose at a slower pace, signaling expansion

• New orders fell at a slower pace, signaling contraction

• Employment fell at a faster pace, signaling contraction

• Inventories fell at a slower pace, signaling contraction

• Supplier deliveries rose at a faster pace, signaling expansion

• Production rose and the direction reversed, signaling expansion

• Order backlogs fell at a slower pace, signaling contraction

Once again we remind readers that this number is entirely irrelevant as it hit before the impact of Covid-19 and the stock market collapse.

In a somewhat shocking sounding move, given administration officials’ ongoing effort to calm the public fears over the spread of Covid-19, The New York Stock Exchange has announced it will commence disaster-recovery testing in its Cermak Data Center on March 7 amid coronavirus concern, Fox Business reports in a tweet, citing the exchange.

“During this test, NYSE will facilitate electronic Core Open and Closing Auctions as if the 11 Wall Street trading floor were unavailable,” Fox says.

To reiterate, the disaster recovery plan is to check the process that would occur if Covid-19 ‘public distancing’ proposals come into effect and effectively shut the trading floor?!

The test is reported to occur March 7 between 8:30 am-11 am.

Remember, do not panic!

Dip-buyers tried – and failed – yesterday to bring an end to the avalanche of stock market losses, but the moves in bonds, FX, and commodities are just as stunning and in an overnight note, Goldman Sachs explains how the cross-asset sell-off changed on Thursday… and what they are watching.

Via Goldman Sachs,

As we look across moves in equity, credit, rates, commodities, China equities, US Health Care and volatility, we believe the timing of moves in each asset helps us to estimate how sentiment has shifted. We believe that understanding these sentiment shifts has implications for asymmetric moves around upcoming political and macro catalysts as well as the steady stream of COVID-19 updates. We detail these shifts and our favorite options trades below.

Exhibit 1: How the sell-off developed and what we are watching now

Total return of FXI, SPX, CDX IG 5Y, VXX, TLT, USO

How the cross-asset selloff developed:

A. Early January: Treasuries rallied and oil declined as institutional investors used these assets to reduce the risk of multi-asset portfolios to a global growth slowdown.

B. Late January: China Equities began to decline in late January as COVID-19 cases increased in China. US Health Care stocks sold off more than SPX in anticipation of the Iowa Caucus (not shown).

C. Early February: Broad US equities rallied as individual investors bought ETFs and select Tech/Consumer stocks as the Iowa catalyst passed. China equities rallied as the rate of growth of COVID-19 cases in China seemed to plateau.

D. Monday-Wednesday of this week: US Equities, US Credit, Treasuries and Oil all declined in a correlated sell-off. This pushed Treasuries and Oil to even further extremes. US Health Care Equities sold off more than the SPX demonstrating that political risk was a significant driver of selling pressure.

E. Thursday of this week: The VIX spiked to its highest level since February 2018 and SPX futures liquidity dropped to near all-time lows. Low liquidity likely amplified the price impact of equity selling flow. This marked a significant change in the velocity of the sell-off.

What we are watching now:

F. China Equities were up 2% in the month of February as of yesterday’s close, outperforming the SPX by 9%. Some underperformance of the SPX vs FXI during a period when investors have become more concerned about the impact of COVID-19 on the broader global economy was understandable; however, the resilience of FXI in recent days seems inconsistent with a view that global growth risk has significantly accelerated. We will be closely watching equity performance in China looking for opportunities to buy puts on FXI or calls on US/European markets.

G. Treasuries and Oil prices were leading indicators heading into this broad equity decline; we will be closely watching these markets for evidence that investors are removing these hedges and positioning for a rebound in growth sentiment. We have yet to see investors reduce these hedges. This indicator is not yet supportive of buying calls on US equities. Buying TLT puts appears attractive for investors that expect global growth sentiment to improve.

Four Notable Derivatives Market Developments:

1. SPX futures liquidity declined significantly on Thursday, reaching its lowest level since December 2018. 

This supports the idea that the sell-off accelerated due to a lack of liquidity rather than an increase in fundamental investors selling. Single stock liquidity also declined, but is at less extreme levels.

Exhibit 2 : S&P Futures liquidity declined to near all-time-lows yesterday

Daily median E-mini future bid-ask depth ($mm notional), based on 5-minute intraday snapshots

Exhibit 3 : Single Stock liquidity has declined, but is slightly above Dec-2018 lows

% of market cap tradable while only expecting to move the stock 10bps for Russell 3000 companies

2. Systematic Options selling flows: Rolling of short put positions likely exacerbated SPX moves on Thursday. 

As of Wednesday, the SPX broke out of the +/-3% range relative to its 1 month moving average. We estimate, there are over $100b of AUM in systematic SPX 1 month put and strangle selling strategies. These portfolio managers generally sell 1-month puts and strangles and only adjust positions if the options sold trade significantly in-the-money. We use the 1-month moving average of the SPX as a proxy for the SPX level when they initiated their positions. On Wednesday, the SPX traded to 5.7% below the 1-month moving average, likely beginning to trigger rolling activity (these investors would buy back their in-the-money-puts and sell new out-of-the-money puts). This activity is visible as excess selling pressure on SPX futures and pressure on SPX option put-call skew. On Thursday, we believe this rolling activity combined with lower SPX futures liquidity than in prior days, likely exacerbated price moves as the SPX declined to 9.5% below its 1-month moving average.

Exhibit 4 : Rolling of short options positions outsized underlying equity liquidity

SPX relative to its 1 month moving average

3. Investors have rushed to hedge single stocks, showing a fear of further sell-off acceleration. 

We find S&P 500 average stock put-call skew has been statistically more useful than index put-call skew as a contrarian indicator for predicting forward returns of the SPX over a two-month period (R-squared of 12% over the past 3 years). Ahead of earnings season, this signal suggested muted returns for stocks. Single stock skew is calculated using the volatility surfaces of all individual stocks in the S&P 500 and it is more likely to be indicative of broad positioning across the market and less likely to be influenced by a few large trades by macro investors in index options.

Exhibit 5 : Elevated concerns are priced into single stock options

S&P 500 average stock put-call skew

4. Healthcare stocks underperformed the SPX early this week showing that investor worries about political risk increased sharply following the results from Nevada on Saturday. 

Weakness in Health Care stocks as we approach Super Tuesday looks similar to the last week of January when political concerns led investors to reduce risk ahead of the Iowa Caucus. We see unusually high potential for a relief rally in Health Care stocks next week as investor concerns are likely to be relieved in the short term by the passing of Super Tuesday.

Exhibit 6: Options pricing suggests Health Care sentiment is at bearish extremes

XLV total return relative to the 1 year rolling percentile rank of 3 month implied volatility and put-call normalized skew

We believe that investors have reduced Health Care exposure and implemented hedges this week in anticipation of Super Tuesday as a catalyst and will see fewer near-term catalysts after we pass Super Tuesday. To be clear, we are not taking a view on the result of Super Tuesday as we believe a wide variety of potential outcomes are likely to lead to an improvement in sentiment for Health Care stocks.

However, amid all this chaos,  NorthmanTrader.com’s Sven Henrich, highlights the real tragedy in all this…

…the real message will likely get lost in all this. Most likely the popular narrative will be to blame the coronavirus as the unforeseen event, nobody could have seen this coming, this was not something anyone could have prepared for.

While that’s true on the surface it completely misses the larger point: The Fed, with it liquidity operations masked all the underlying issues in the markets over the past year. We had no earnings growth in 2019, we had multiple expansion. The bond market never confirmed the reflation trade, Gold had been rallying for months signaling something was amiss. And now the Fed left itself vulnerable to not being able to deal with a real crisis and basically openly invited people to TINA chase stocks into high valuations.

The Fed gave no warning to investors, instead it cheerlead investors off the cliff. Even last week Fed officials defended valuations and saw nothing wrong with anything adding to the atmosphere of complacency.

And now everyone will blame the virus, but not the reckless chase into stocks into historic valuations to begin with.

But, as Nomura’s Charlie McElligott warned, the fear of this potentially imminent – and likely coordinated – central bank “interventionary” response (let’s call it: this upcoming Sunday night, before the Asian open) will keep markets in a dangerous space, because strategies and traders which are potentially “pressing” shorts 1) either directionally (CTA model now “in play” of outright “short SPX”) or 2) pressing-shorts to managed “net exposures” or hedge long books, will be exposed to a surge squeeze higher, while investors who have been “grossed-down” by their risk management VaR models won’t be exposed to an “up-trade” in risk and likely feel obligated to “grab into” a short squeeze.

Trade accordingly.