U.S. stocks dropped and Treasuries rose as Federal Reserve Chairman Jerome Powell said the economic outlook is uncertain and downside risks are significant.

The S&P 500 traded down on Powell’s sombre view that “the recovery may take some time to gather momentum and the passage of time can turn liquidity problems into solvency problems.” Led lower by cyclical sectors such as autos and banks, investors weighed the risk of a second wave of virus infections if lockdowns ease too soon.

The roller coaster recovery continues to be the theme of the week. And as we saw in 2008/2009, the path from government intervention to broader asset price expansion is dangerous and rocky with lots of wobbles before it is all systems go.

And while investors will take solace in the fact the Fed stands ready and committed to making battle stations to deploy its remaining arsenal, and while acknowledging negative rates, Chair Powell suggested it is not something the Fed is reconsidering as there is already a useful fiscal tool kit at his disposal.

But today could also provide a poignant pivot that eventually, it’s market pricing that drives Fed policy, not the other way around.

On the surface, the comments from Fed’s Powell should not have been as negative for risk. But we are back to the familiar debate between the divergence between Main Street and Wall Street.

No V-shape recovery

Powell is making it clear there will not be a V-shape recovery as it could take several quarters to get the jobless rate back below single digits. But the problem for risk markets is having this laid out in unambiguous terms as eventually “liquidity problems turn into solvency problems”, for instance.

The markets turned incredibly jittery as the Fed worries about the risks of corporate failure and associated permanent job losses.

The market is back to where it was in mid-April, although the SPX range over this period has been 6%. It remains challenging to justify aggregate market levels (and Stan Druckenmiller – best trader in the world hands down) said the other day he thought the risk/reward for stocks is the worse he is ever seen).

With the wall of worry building around the economy and secondary breakout fears, it’s unlikely a significant move higher this side of expiry will unfold. Hence, it remains prudent to own some index protection for a possible more profound risk setback rather than outright delta short.

More broadly, after a good night’s sleep, I can confirm it is just not me. Still, the ASEAN market is tired after the macro community spent the better part of the past two weeks buying all sorts of stock market goodies. Indeed, there are definite signs the splurge is beginning to dissipate to some degree as volumes do not lie.

Worries over the easing of coronavirus lockdowns and that alone suggest it certainly seems prudent to take some risk off the table, with the concern that the weakness seen in Cyclical’s spreads to the broader areas of the market, namely Staples and Tech.

International markets analysis and insights from Stephen Innes, Chief Global Market Strategist at AxiCorp