Monthly Archives: January 2020

Leavers Cheer

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The Governor, in his last meeting
Said data, of late, stopped retreating
There’s no reason why
We need to apply
A rate cut as my term’s completing

Yet all the news hasn’t been great
As Eurozone stats demonstrate
Plus Brexit is here
And though Leavers cheer
The impact, growth, will constipate

Yesterday saw a surprising outcome from the BOE, as the 7-2 vote to leave rates on hold was seen as quite a bit more hawkish than expected. The pound benefitted immensely, jumping a penny (0.65%) in the moments right (before) and after the announcement and has maintained those gains ever since. In fact, this morning’s UK data, showing growth in Consumer Credit and Mortgage Approvals, has helped it further its gains, and the pound is now higher by 0.2% this morning. (As to the ‘before’ remark; apparently, the pound jumped 15 seconds prior to the release of the data implying that there may have been a leak of the news ahead of time. Investigations are ongoing.) In the end, despite the early January comments by Carney and two of his comrades regarding the need for more stimulus, it appears the recent data was sufficient to convince them that further stimulus was just not necessary.

Of course, that pales in comparison, at least historically, with today’s activity, when at 11:00pm GMT, the UK will leave the EU. With Brexit finally completed all the attention will turn to the UK’s efforts to redefine its trading relationship with the rest of the world. In the meantime, the question at hand is whether UK growth will benefit in the short-term, or if we have already seen the release of any pent-up demand that was awaiting this event.

What we do know is that Q4 was not kind to the Continent. Both France (-0.1%) and Italy (-0.3%) saw their economies shrink unexpectedly, and though Spain (+0.5%) continues to perform reasonably well, the outcome across the entire Eurozone was the desultory result of 0.1% GDP growth in Q4, and just 1.0% for all of 2019. Compare that with the US outcome of 2.1% and it is easy to see why the euro has had so much difficulty gaining any ground. It is also easy to see why any thoughts of tighter ECB policy in the wake of their ongoing review make no sense at all. Whatever damage negative rates are doing to the Eurozone economies, especially to banks, insurance companies and pensions, the current macroeconomic playbook offers no other alternatives. Interestingly, despite the soft data, the euro has held its own, and is actually rallying slightly as I type, up 0.1% on the day.

It may not seem to make sense that we see weak Eurozone data and the euro rallies, but I think the explanation lies on the US side of the equation. The ongoing aftermath of the FOMC meeting is that analysts are becoming increasingly dovish regarding their views of future Fed activity. It seems that, upon reflection, Chairman Powell has effectively promised to ease policy further and maintain a more dovish overall policy as the Fed goes into overdrive in their attempts to achieve the elusive 2.0% inflation target. I have literally seen at least six different analyses explaining that the very modest change in the statement, combined with Powell’s press conference make it a lock that ‘lower for longer’ is going to become ‘lower forever’. Certainly the Treasury market is on board as 10-year yields have fallen to 1.55%, a more than 40bp decline this month. And this is happening while equity markets have stabilized after a few days of serious concern regarding the ongoing coronavirus issue.

Currently, the futures market is pricing for a rate cut to happen by September, but with the Fed’s policy review due to be completed in June, I would look for a cut to accompany the report as they try to goose things further.

Tacking back to the coronavirus, the data continues to get worse with nearly 10,000 confirmed cases and more than 200 deaths. The WHO finally figured out it is a global health emergency, and announced as much yesterday afternoon. But I fear that the numbers will get much worse over the next several weeks. Ultimately, the huge unknown is just how big an economic impact this will have on China, and the rest of the world. With the Chinese government continuing to delay the resumption of business, all those global supply chains are going to come under increasing pressure. Products built in China may not be showing up on your local store’s shelves for a while. The market response has been to drive the prices of most commodities lower, as China is the world’s largest commodity consumer. But Chinese stock markets have been closed since January 23, and are due to open Monday. Given the price action we have seen throughout the rest of Asia when markets reopened, I expect that we could see a significant downdraft there, at least in the morning before the government decides too big a decline is bad optics. And on the growth front, initial estimates are for Q1 GDP in China to fall to between 3.0% and 4.0%, although the longer this situation exists, the lower those estimates will fall.

Turning to this morning’s activity, we see important US data as follows:

Personal Income 0.3%
Personal Spending 0.3%
Core PCE Deflator 1.6%
Chicago PMI 48.9
Michigan Sentiment 99.1

Source: Bloomberg

Arguably, the PCE number is the most important as that is what is plugged into Fed models. Yesterday’s GDP data also produces a PCE-type deflator and it actually fell to 1.3%. If we see anything like that you can be certain that bonds will rally further, stocks will rally, and rate cut probabilities will rise. And the dollar? In that scenario, look for the dollar to fall across the board. But absent that type of data, the dollar is likely to continue to take its cues from the equity markets, which at the moment are looking at a lower opening following in Europe’s footsteps. Ultimately, if risk continues to be jettisoned, the dollar should find its footing.

Good luck and good weekend
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Another Cut’s Quite Apropos

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The Chair said, ‘inflation’s too low
And there’s something you all need to know
Lest prices soon rise
We’ll not compromise
Thus another cut’s quite apropos

There are a number of discussion topics in the market this morning so let’s get right to it.

First the Fed surprised exactly nobody yesterday afternoon by leaving policy unchanged, (except for a ‘technical’ adjustment to IOER, which they raised by the expected 5bps). However, the talk this morning is all about the tone of the statement and the ensuing press conference. In the end, it appears that the Fed is leaning slightly more dovish than they had seemed to be previously, with a still greater focus on inflation. Powell and friends appear to be increasingly concerned that inflation expectations are still declining, and are terrified of an ultimate outcome similar to the past two decades in Japan. As such, it appears they are getting set to move from an inflation target to a price level target. This means that if inflation runs below target for a period of time, as it has been doing ever since it was officially announced in 2012, they will be comfortable allowing it to run above target in order to make up ground. The conclusion is that the bar to raising rates is now impossibly high, at least assuming prices don’t follow the lead of Argentina or Venezuela. And if anything, especially with the impact of the coronavirus still just being discussed and modeled, the likelihood is for more rate cuts before the end of the year.

Speaking of the coronavirus, the WHO has suddenly figured out what the rest of the world has known for a week, this is a serious problem that is spreading quickly. The death toll is over 170 and the number of cases is quickly approaching 8000. The economic impact is growing as more and more companies halt activity in China, more flights are canceled to and from all cities in China, and fear spreads further. Last night, Taiwan’s stock market reopened for the first time in a week and fell 5.75%. Meanwhile the Taiwan dollar fell 1.0%. And the renminbi? Well onshore markets are still closed, and will be so through Monday, at least, but the CNH traded below 7.00 (dollar higher) in London early this morning and remains within basis points of that level as NY walks in. As I wrote on Monday, this will be the best indicator of sentiment as it is the only thing that can actively trade that reflects opinions on the mainland. It should be no surprise that the other Asian equity markets that were open also fell sharply (Nikkei -1.7%, Hang Seng -3.1%, KOSPI -1.7%) as investors just don’t know what to do at this stage. Fear remains the key driver, and will continue to be until there is some sense that the infection rate is slowing down. To date, that has not been the case.

And finally, the Old Lady just announced no change in the base rate, which according to the futures market had been a 50:50 chance. The pound’s response was an immediate pop and it is now higher by 0.4% on the day, making it the best performing G10 currency. Data early in the month prompted a number of dovish comments from three BOE members, including Governor Carney himself, but the data we have seen recently has shown much more positive momentum in the wake of PM Johnson’s December electoral victory. Clearly, a number of fears have receded and tomorrow is the big day, when the UK officially leaves the EU. The EU Parliament voted overwhelmingly to approve the deal, as the UK’s Parliament did last week. So the UK has reclaimed its total sovereignty and now must make its own way in the world. As I have said all along, while there is a risk that no trade deal is agreed by year end, I think the odds are vanishingly small that Boris will risk his current political strength by pushing things to that level. Come summer, a short delay will be agreed and eventually a deal will be signed. Meanwhile, the US will be seeking a deal as well. Overall, I like the pound throughout the year on the twin features of an increasingly weaker USD (QE related) and the positivity of the situation on the ground there.

And those are the three big stories of the morning. We did get some data, notably the German employment report which showed the Unemployment Rate remained unchanged at 5.0%, while the number of people unemployed fell by…2k. This was better than the expected 5k increase in unemployment, but can we step back for a moment and consider what this actually means. Do you know how many people are employed in Germany? I didn’t think so. But the answer is 41.73 million. So, this morning’s data, showing a net change of 7k vs. expectations represents exactly a 0.0167% improvement. In other words, IT DOESN’T MATTER. And I think we need to consider this issue on a regular basis. So much is made of a number being better or worse than expected when most of the time it is well within the margin of error of any estimate. Nonetheless, the euro has edged higher this morning, by just 0.15%, but my goodness it has been stable of late. And quite frankly, in the short term, barring a massive uptick in coronavirus cases which changes broad risk sentiment, I see no reason for it to do much. Ultimately, I still like the single currency to edge higher throughout the year on the back of my weaker dollar call.

This morning brings two more data points in the US, with Initial Claims (exp 215K) and Q4 GDP (2.0%) released at 8:30. However, unless the GDP number is significantly different from expectations, the market focus will remain on the coronavirus issue. Equity markets in Europe are under pressure (DAX -1.1%, CAC -1.4%) and US futures are pointing in the same direction, with all 3 indices leaning about 0.75% lower. Meanwhile, Treasury yields continue to fall with the 10-year now at 1.56%, its lowest level in three months. With no Fed speakers on the docket, today is a risk day, and that arrow is pointing lower. Look for EMG currencies to suffer, while the yen benefits.

Good luck
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Just Look What You’ve Wrought!

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On Monday it seems we all thought
That crises were sold and not bought
On Tuesday we learned
Those sellers got burned
Chair Powell; just look what you’ve wrought!

hubris: noun
hu·bris | \’hyü-brƏs \
Definition of hubris : exaggerated pride or self-confidence
Example of hubris in a sentence
//It takes remarkable hubris to survey the ongoing situation regarding the 2019-nCoV virus and decide that Monday’s 1.5% decline in the S&P 500 was a buy signal.

I saw a note on Twitter this morning that really crystalized the current market condition. All prices are based on flow, not value. It is a fool’s errand to try to determine what the underlying value of any financial asset is these days, as it has no relevance regarding the price of that asset. This is most evident in the equity markets, but is equally true in the currency markets as well. So for all of us who are trying to determine what possible future paths are for market movements, the primary focus should be on how favored they are, for whatever reason, compared to the rest of the investment universe. In fact, this is the key outcome of the financialization of the global economy. And while this is just fine, maybe even great, when flows are driving equity prices, and other assets, higher, it will be orders of magnitude worse going the other way.

But the bigger issue is the financialization of the economy. Prior to the financial crisis and recession of 2008-2009, there seemed to be a reasonable balance between finance and production within the global economy. In other words, financial questions represented a minority of the impact on how companies were managed and on how much of anything was produced. This balance, which I would have put at 80% production / 20% finance, give or take a nickel, was what underpinned the entire economics profession. Finance was simply a relatively small part of every productive endeavor with the goal of insuring production could continue.

But in the wake of that recession, the fear of allowing massively overpriced markets to actually clear resulted in central banks stepping in and essentially taking over. The initial corporate reaction was to take advantage of the remarkably low interest rates and refinance their businesses completely. The problem was that since markets never cleared, there was still a dearth of demand on an overall basis. This is what led to a decade of subpar growth. Remember, the average annual GDP growth in the decade following the GFC was about 1.5%, well below the previous decade’s 3.0%. At the same time, the ongoing shortening of attention spans, especially for investors, forced corporate management to figure out how to make more money. Unfortunately, the fact that slow GDP growth prevented an actual increase in profits forced senior management to look elsewhere. And this is when it quickly became clear that levering up corporate balance sheets, while ZIRP and NIRP were official policy, made a great deal of sense. If a company couldn’t actually make more money, it sure could make it seem that way by issuing debt and buying back stock, thus reducing the denominator in the key metric, EPS.

And that is where we are today, in an economy that continues to grow at a much slower pace than prior to the financial crisis, but at the same time allows ongoing growth in a key metric, EPS, through financial engineering.

Which brings me back to the idea of flow. It is financial flows that determine the future paths of all assets, so the more money that is made available by the central banking community (currently about $100 billion per month of new cash), the higher the price assets will fetch. Let me say that they better not stop providing that new cash anytime soon.

With that as a (rather long) preamble, today’s market discussion is all about the Fed. This afternoon at 2:00 we will get the latest communique and then Chairman Powell will meet the press at 2:30. Current expectations are for no policy changes although there seems to be a growing view that the ongoing coronavirus situation, and its likely negative impact on Chinese/global GDP growth, will force a more dovish hue to both the statement and the press conference. Remember, the Fed is currently going through a major policy review, similar to that of the ECB, as they try to determine what tools are best to manage the economy achieve their mandated goals going forward. Given that ongoing policy review, it would take a remarkable catalyst to drive a near-term policy change, and apparently a global pandemic doesn’t rise to that standard.

Oh yeah, what about that coronavirus? Well, the death toll is now above 130, and the number of cases is touching 10,000, far more than seen in the SARS outbreak of 2003. (And I ask, if so many are skeptical of Chinese economic data, why would we believe that this data is accurate, especially as it would not reflect China in a positive light?) At any rate, while the Hang Seng fell sharply last night, its first session back since last week, the rest of the global equity market seems pretty comfortable. And hey, Apple earnings beat big time (congrats), so all is right with the world!!

What will this do to flows in the FX market? Broadly speaking, the dollar continues to see small gains vs. its G10 brethren as US rates remain the highest around. Granted Canadian rates are in the same place, but with oil’s recent decline, and growing concern over the housing bubble in Canada’s main cities, it seems like the dollar is safer to earn those rates. At the same time, many emerging markets currently carry rates that are far higher than in the US, and what we saw yesterday was significant interest in owning those currencies, especially MXN, RUB, BRL and COP, all of which gained between 0.5% and 1.0% in yesterday’s session. While those currencies have edged lower this morning, the flow story remains the key driver, and if markets maintain their hubris, the carry trade will quickly return.

On the data front, yesterday’s US Consumer Confidence number was much better than expected at 131.6. This morning we saw slightly better than expected GfK Consumer Confidence in Germany (9.9 vs. 9.6 exp) and better than expected French Consumer Confidence (104 vs 102). That is certainly a positive, but it remains to be seen if the spread of the coronavirus ultimately has a negative impact here. Ahead of the Fed, there is no important US data, so we are really in thrall to the ongoing earnings parade until Chairman Powell steps up to the mic. As to the dollar, it continues to perform well, and until the Fed, that seems likely to continue.

Good luck
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FOMC Tryst

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While problems in China persist
And risk is still on the blacklist
More talk is now turning
To Powell concerning
Tomorrow’s FOMC tryst

The coronavirus remains the primary topic of conversation amongst the economic and financial community as analysts and pundits everywhere are trying to estimate how large the impact of this spreading disease will be on economic output and growth. The statistics on the ground continue to worsen with more than 100 confirmed deaths from a population of over 4500 confirmed cases. I fear these numbers will get much worse before they plateau. And while I know that science and technology are remarkable these days, the idea that a treatment can be found in a matter of weeks seems extremely improbable. Ultimately, this is going to run its course before there is any medication available to address the virus. It is this last idea which highlights the importance of China’s actions to prevent travel in the population thus reducing the probability of spreading. Unfortunately, the fact that some 5 million people left the epicenter in the past weeks, before the problem became clear, is going to make it extremely difficult to really stop its spread. Today’s news highlights how Hong Kong and Macau are closing their borders with China, and that there are now confirmed cases in France, Germany, Canada, Australia and the US as well as many Asian nations.

With this ongoing, it is no surprise that risk appetite, in general, remains limited. So the Asian stock markets that were open last night, Nikkei (-0.6%), KOSPI (-3.1%), ASX 200 (-1.35%) all suffered. However, European markets, having sold off sharply yesterday, have found some short term stability with the DAX unchanged, CAC +0.15% and FTSE 100 +0.2%. As to US futures, they are pointing higher at this hour, looking at 0.2%ish gains across the three main indices.

Of more interest is the ongoing rush into Treasury bonds with the 10-year yield now down to 1.57%, a further 3bp decline after yesterday’s 7bp decline. In fact, since the beginning of the year, the US 10-year yield has declined by nearly 40bps. That is hardly the sign of strong growth in the underlying economy. Rather, it has forced many analysts to continue to look under the rocks to determine what is wrong in the economy. It is also a key feature in the equity market rally that we have seen year-to-date, as lower yields continue to be seen as a driver of the TINA mentality.

But as I alluded to in my opening, tomorrow’s FOMC meeting is beginning to garner a great deal of attention. The first thing to note is that the futures market is now pricing in a full 25bp rate cut by September, in from November earlier this month, with the rationale seeming to be the slowing growth as a result of the coronavirus’s spread will require further monetary stimulus. But what really has tongues wagging is the comments that may come out regarding the Fed’s review of policy and how they may adjust their policy toolkit going forward in a world of permanently lower interest rates and inflation.

One interesting hint is that seven of the seventeen FOMC members have forecast higher than target inflation in two years’ time, with even the most hawkish member, Loretta Mester, admitting that her concerns over incipient inflation on the back of a tight labor market may have been misplaced, and that she is willing to let things run hotter for longer. If Mester has turned dovish, the end is nigh! The other topic that is likely to continue to get a lot of press is the balance sheet, as the Fed continues to insist that purchasing $60 billion / month of T-bills and expanding the balance sheet is not QE. The problem they have is that whatever they want to call it, the market writ large considers balance sheet expansion to be QE. This is evident in the virtual direct relationship between the growth in the size of the balance sheet and the rally in the equity markets, as well as the fact that the Fed feels compelled to keep explaining that it is not QE. (For my money, it is having the exact same impact as QE, therefore it is QE.) In the end, we will learn more tomorrow afternoon at the press conference.

Turning to the FX markets this morning, the dollar continues to be the top overall performer, albeit with today’s movement not quite as substantial as what we saw yesterday. The pound is the weakest currency in the G10 space after CBI Retailing Reported Sales disappointed with a zero reading and reignited discussion as to whether Governor Carney will cut rates at his last meeting on Thursday. My view remains that they stay on the sidelines as aside from this data point, the recent numbers have been pretty positive, and given the current level of the base rate at 0.75%, the BOE just doesn’t have much room to move. But that was actually the only piece of data we saw overnight.

Beyond the pound, the rest of the G10 is very little changed vs. the dollar overnight. In the EMG bloc, we saw some weakness in APAC currencies last night with both KRW and MYR falling 0.5%, completely in sync with the equity weakness in the region. On the positive side this morning, both CLP and RUB have rallied 0.5%, with the latter benefitting on expectations Retail Sales there rose while the Chilean peso appears to be seeing some profit taking after a gap weakening yesterday morning.

Yesterday’s New Home Sales data was disappointing, falling back below 700K despite falling mortgage rates. This morning we see Durable Goods (exp 0.4%, -ex Transport 0.3%), Case Shiller Home Prices (2.40%) and Consumer Confidence (128.0). At this stage of the economic cycle, I think the confidence number will have more to tell us than Durable Goods. Remarkably, Confidence remains quite close to the all-time highs seen during the tech bubble. But it bodes well for the idea that any slowdown in growth in the US economy is likely to be muted. In the end, while the US economy continues to motor along reasonably well, nothing has changed my view that not-QE is going to undermine the value of the dollar as the year progresses.

Good luck
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Truly a Curse

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In China, it’s gotten much worse
This virus that’s truly a curse
How fast will it spread?
And how many dead?
Ere treatment helps it to disperse.

Despite the fact that we have two important central bank meetings this week, the Fed and the BOE, the market is focused on one thing only, 2019-nCoV, aka the coronavirus. The weekend saw the number of confirmed infections rise to more than 2800, with 81 deaths as of this moment. In the US, there are 5 confirmed cases, but the key concern is the news that prior to the city of Wuhan (the epicenter of the outbreak) #fom locked down, more than 5 million people left town at the beginning of the Lunar New Year holiday. While I am not an epidemiologist, I feel confident in saying that this will seem worse before things finally settle down.

And it’s important to remember that the reason the markets are responding has nothing to do with the human tragedy, per se, but rather that the economic impact has the potential to be quite significant. At this point, risk is decidedly off with every haven asset well bid (JPY +0.35%, 10-year Treasury yields -7bps, gold +0.8%) while risk assets have been quickly repriced lower (Nikkei -2.0%, DAX -2.0%, CAC -2.1%, FTSE 100 -2.1%, DJIA futures -1.4%, SPX futures -1.4%, WTI -3.0%).

Economists and analysts are feverishly trying to model the size of the impact to economic activity. However, that is a Sisyphean task at this point given the combination of the recency of the onset of the disease as well as the timing, at the very beginning of the Lunar New year, one of the most active commercial times in China. The Chinese government has extended the holiday to February 2nd (it had been slated to end on January 30th), and they are advising businesses in China not to reopen until February 9th. And remember, China was struggling to overcome a serious slowdown before all this happened.

It should be no surprise that one of the worst performing currencies this morning is the off-shore renminbi, which has fallen 0.8% as of 7:00am. In fact, I think this will be a key indicator of what is happening in China as it is the closest thing to a real time barometer of sentiment there given the fact that the rest of the Chinese financial system is closed. CNH is typically a very low volatility currency, so a movement of this magnitude is quite significant. In fact, if it continues to fall sharply, I would not be surprised if the PBOC decided to intervene in order to prevent what it is likely to believe is a short-term problem. There has been no sign yet, but we will watch carefully.

And in truth, this is today’s story, the potential ramifications to the global economy of the spreading infection. With that in mind, though, we should not forget some other featured news. The weekend brought a modestly surprising outcome from Italian regional elections, where Matteo Salvini, the populist leader of the League, could not overcome the history of center-left strength in Emilia-Romagna and so the current coalition government got a reprieve from potential collapse. Salvini leads in the national polls there, and the belief was if his party could win the weekend, it would force the governing coalition to collapse and new elections to be held ushering in Salvini as the new PM. However, that was not to be. The market response has been for Italian BTP’s (their government bonds) to rally sharply, with 10-year yields tumbling 18bps. This has not been enough to offset the risk-off mentality in equity markets there, but still a ray of hope.

We also saw German IFO data significantly underperform expectations (Business Climate 95.9, Expectations 92.9) with both readings lower than the December data. This is merely a reminder that things in Germany, while perhaps not accelerating lower, are certainly not accelerating higher. The euro, however, is unchanged on the day, as market participants are having a difficult time determining which currency they want to hold as a haven, the dollar or the euro. Elsewhere in the G10, it should be no surprise that AUD and NZD are the laggards (-0.85% and -0.65% respectively) as both are reliant on the Chinese economy for economic activity. Remember, China is the largest export destination for both nations, as well as the source of a significant amount of inbound tourism. But the dollar remains strong throughout the space.

Emerging markets are showing similar activity with weakness throughout the space led by the South African rand (-1.0%) on the back of concerns over the disposition of state-owned Eskom Holdings, the troubled utility, as well as the general macroeconomic concerns over the coronavirus outbreak and its ultimate impact on the South African economy. Meanwhile, the sharp decline in the price of oil has weighed on the Russian ruble, -0.9%.

As I mentioned above, we do have two key central bank meetings this week, as well as a significant amount of data as follows:

Today New Home Sales 730K
  Dallas Fed Manufacturing -1.8
Tuesday Durable Goods 0.5%
  -ex Transport 0.3%
  Case Shiller Home Prices 2.40%
  Consumer Confidence 128.0
Wednesday Advance Goods Trade Balance -$65.0B
  FOMC Rate Decision 1.75% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  GDP (Q4) 2.1%
Friday Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE Deflator 1.6%
  Chicago PMI 49.0
  Michigan Sentiment 99.1

Source: Bloomberg
Regarding the BOE meeting, the futures market is back to pricing in a 60% probability of a rate cut, up from 47% on Friday, which seems to be based on the idea that the coronavirus is going to have a significant enough impact to require further monetary easing by central banks. As to the Fed, there is far more discussion about what they may be able to do in the future as they continue to review their policies, rather than what they will do on Wednesday. Looking at the spread of data this week, we should get a pretty good idea as to whether the pace of economic activity in the US has changed, although forecasts continue to be for 2.0%-2.5% GDP growth this year.

And that’s really it for the day. Until further notice, the growing epidemic in China remains the number one story for all players, and risk assets are likely to remain under pressure until there is some clarity as to when it may stop spreading.

Good luck
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Don’t Be Fooled

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Said Christine Lagarde, don’t be fooled
That we’re on hold can be overruled
If data gets worse
Or else the reverse
Then our policies can be retooled

Madame Lagarde was in fine fettle yesterday between her press conference in Frankfurt following the ECB’s universally expected decision to leave policy unchanged, and her appearance on a panel at the WEF in Davos. The essence of her message is that the ECB’s policy review is critical to help lead the bank forward for the next decades, but that there is no goal in sight as they start the review, other than to try to determine how best to fulfill their mandate. She was quite clear, as well, that the market should not get complacent regarding policy activity this year. Currently, the market is pricing for no policy movement in 2020. However, Lagarde emphasized that at each meeting the committee would evaluate the current situation, based on the most recent data, and respond accordingly.

With that as a backdrop, it is interesting to look at this morning’s flash PMI data, which showed that while manufacturing across the Eurozone may be starting to improve slightly, overall growth remains desultory at best. Interestingly it was France that was the bigger laggard this month, with its Services and Composite data both falling well below expectations, and printing well below December’s numbers. Germany was more in line with expectations, but the situation overall is not one of unadulterated economic health. The euro, not surprisingly has suffered further after the weak data, falling another 0.2% this morning which takes the year-to-date performance to a 1.6% decline. While that is certainly not the worst performer in the G10 (Australia holds the lead for now) it is indicative that despite everything happening in the US politically, the economy continues to lead the G10 pack.

Perhaps a bit more surprising this morning is the British pound’s weakness. It has fallen 0.3% despite clearly more robust PMI data than had been expected. Manufacturing PMI rose to 49.8, well above expectations and the highest level since last April. Meanwhile, the Composite PMI jumped to 52.4, its highest point since September 2018, and indicative of a pretty substantial post-election rebound in the economy. Even better was that some of the sub-indices pointed to even faster growth ahead, and the econometricians have declared that this points to UK GDP growth of 0.2% in Q1, again, better than previously expected. Remember, the BOE meets next Thursday, and a week ago, the market had been pricing in a 70% probability of a 25bp rate cut. This morning that probability is down to 47% and the debate amongst analysts has warmed up on both sides. My view is the recent data removes the urgency on the BOE’s part, and given how little ammunition they have left, with the base rate sitting at 0.75%, they will refrain from moving. That means there is room for the pound to recoup some of its recent losses, perhaps trading back toward the 1.3250 level where we started the year.

Away from those stories, the coronavirus remains a major story with the Chinese government now restricting travel in cities with a total population of more than 40 million. While the WHO has not seen fit to declare a global health emergency, the latest count shows more than 800 cases reported with 27 deaths. The other noteworthy thing is the growing level of anger being displayed on social media in China, with the government getting blamed for everything that is happening. (I guess this is the downside of taking credit for everything good that happens). At any rate, if the spread is contained at its current levels, it is unlikely to have a major impact on the Chinese economy overall. However, if the virus spreads more aggressively, and there are more shutdowns of cities and travel restrictions, it is very likely to start impacting the data. With Chinese markets closed until next Friday, our only indicator in real-time will be CNH, which this morning is unchanged. Watch it closely as weakness there next week could well be an indicator that the situation on the ground in China is getting worse.

But overall, today’s market activity is focused on adding risk. Japanese equities, the only ones open in Asia overnight, stabilized after yesterday’s sharp declines. And European equities are roaring this morning, with pretty much every market on the Continent higher by more than 1.0%. US futures are pointing higher as well, albeit just 0.25%. In the bond market, Treasuries and bunds are essentially unchanged, although perhaps leaning ever so slightly toward higher rates. And gold is under pressure today, along with both the yen and Swiss franc. As I said, risk is back in favor.

There is neither data nor Fedspeak today, so the FX market will need to take its cues from other sources. If equities continue to rally, look for increased risk appetite leading to higher EMG currencies and arguably a generally softer dollar. What about the impeachment? Well, to date it has had exactly no impact on markets and I see no reason for that to change.

Good luck and good weekend
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Insane Consequences

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The last time the Year of the Rat
Was with us, the markets fell flat
In two thousand eight
The crisis was great
Let’s hope this year’s better than that

Alas as the New Year commences
The Chinese can’t offer pretenses
That virus is spreading
And fears are it’s heading
Worldwide, with insane consequences

Markets this morning are on alert as fears increase regarding a more rapid spread of the coronavirus first identified last week in China. Late yesterday afternoon, Wuhan, the epicenter of the virus’ outbreak was shut down by Chinese authorities. This means that all air and long distance train travel out of the city has been halted. The thing is Wuhan has 11 million residents, larger than NYC, and keeping tabs on all of them is impossible. Then just hours ago, two other cities with a combined population of 8.5 million, Huanggang and Ezhou, announced they, too, were restricting all long distance travel out as well as closing public spaces like movie theaters and internet cafes. The death toll attributed to this virus is up to 17 now, and more than 500 confirmed cases have been recorded.

The timing of all this is extraordinarily poor. China is about to embark on a week-long holiday celebration of the New Year, this year being the Year of the Rat. Typically, this is a time of active travel within and out of China, as well as a time of significant consumer activity. But clearly, locking down major cities with a population approaching 20 million is not instilling confidence anywhere. Chinese equity markets, which historically have always rallied in the last session prior to the New Year holiday, fell sharply last night, with Shanghai falling 2.75% and the Hang Seng down 1.5%. While this fear has not filtered into European equity markets, they remain essentially flat, we have seen increasing demand for Treasuries with the yield on the 10-year falling to 1.75% and German bund yields falling to -0.275%. The last piece of this puzzle is the yuan, which fell 0.4% in its last on-shore session ahead of the holiday. However, CNH continues to trade so do not be surprised to see further weakness there if we continue to hear more negative stories regarding the health situation in China.

But, back to the Year of the Rat. What does it mean in economic and financial terms? The Chinese have a twelve year cycle within their calendar, so the last Year of the Rat was in 2008. I’m sure you all remember how 2008 finished, with the financial crisis unfolding in the wake of Lehman Brothers’ bankruptcy that September. Clearly, nobody wants to see that happen again! But there are certainly anecdotal indicators that might give one pause. The latest anecdote comes from Bob Prince, CIO of Bridgewater Associates, the giant hedge fund, who explained that “…we’ve probably seen the end of the boom-bust cycle.” This is disturbingly similar to a different Prince, Chuck, the former CEO of Citibank, when he defended loosening lending standards in 2008 by remarking, “As long as the music is playing, you’ve got to get up and dance. We’re still dancing.” Perhaps an even more famous comment of this nature was made by Irving Fisher, the renowned economist whose work on debt-deflation and in monetary economics earned him wide acclaim, but who just nine days before the stock market crash of 1929 declared that stocks had “reached what looks like a permanently high plateau.” Now granted, 1929 was not the Year of the Rat, but pronouncements of this nature do have a habit of coming back to bite the speaker in the butt. Given the remarkably long tenure of the current economic and stock market gains, caution that things might change is in order. I’m not predicting an imminent collapse of anything, just highlighting that many market prices seem somewhat excessive and reliant upon a continued perfect outcome of moderate growth and easy money.

Looking at this morning’s activity, the major news will be made in Frankfurt, where the ECB has left policy unchanged (Deposit rate -0.5%, QE €20 billion/month) and now all eyes and ears will turn to Madame Lagarde’s press conference at 8:30 NY time. She is expected to announce the results of the ECB’s internal review of their inflation target, with the ongoing “close to but below 2.0%” likely to be changed to a more precise 2.0%, with an emphasis on the symmetry of that target, implying that slightly higher inflation will be acceptable as well. Alas for the ECB, higher inflation is just not in the cards, at least as long as they maintain interest rates at -0.5%. They can push on that string as much as they like and still will not achieve their goals. As to the single currency, this morning it is unchanged, continuing to hover just below 1.11, right in the middle of its effective 1.10/1.12 range that has been in place since October. We will need something really significant to change this mindset, and my sense is it will not come from within the Eurozone, but rather be driven by the US.

Other than that story, the UK Parliament approved the Brexit bill, which now needs to be ratified by the rest of the EU and is due to be addressed next Wednesday. Then Brexit will well and truly be done, a scant forty-two months after the initial vote. Of course, the next step is the trade negotiations, but even Boris would not risk blowing things up, now that he is in power, so look for an approved delay and an eventual deal next year. Meanwhile, the pound, which has been the best performing G10 currency this week, has stopped its run higher for now, and is actually lower by a modest 0.15% this morning. The other G10 currency movement of note was the Aussie dollar, rallying 0.4% after Unemployment surprisingly fell to 5.1%, thus offering some good news for a change.

In the emerging markets, while CNY is the biggest loser, the rest of the space has been pretty uneventful. On the positive side, CLP is higher by 0.5% after the central bank there indicated they would start to intervene if the peso started to decline too rapidly on the back of weakening commodity prices.

Aside from the ECB press conference, there are two pieces of data today; Initial Claims (exp 214K) and Leading Indicators (-0.2%). But at this point, unless Lagarde says something very surprising, it is shaping up as a very quiet session.

Good luck
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Turning the Screws

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There once was a great city state
That introduced rules and debate
However its heirs
Lead muddled affairs
Thus Roman woes proliferate

Meanwhile from the UK, the news
Gave Johnson’s opponents the blues
Improvements reported
In confidence thwarted
The Sterling bears, turning the screws

Italian politics has once again risen to the top of the list of concerns in the Eurozone. This morning, 5-Star leader, Luigi Di Maio, is on the cusp of resigning from the government, thus forcing yet another election later this year. The overriding concern from the rest of Europe is that the man leading the polls, Silvio Matteo, is a right-wing populist and will be quick to clash with the rest of the EU on issues ranging from fiscal spending to immigration policy. In other words, he will not be welcome by the current leading lights as his views, and by extension the views of the millions who vote for him, do not align with the rest of the EU leadership. Of course, there has been steady dissent from that leadership for many months, albeit barely reported on this side of the Atlantic. For example, the gilets jaunes continue to protest every week around the country, as they voice their disagreement with French President Macron’s attempts to change the rules on issues ranging from pensions to taxes to labor regulations. And they have been protesting for more than a year now, although the destructive impact has been greatly reduced from the early days. As well, there are ongoing protests in the Catalonia region of Spain with separatists continuing to try to make their case. The point is that things in Europe are not quite as hunky-dory as the leadership would have you believe.

However, for today, it is Italy and the potential for more dissent regarding how Europe should be managed going forward. The result has been the euro reversing its early 0.25% gains completely, actually trading slightly lower on the day right now. While there is no doubt the recent Eurozone data has been better than expected, it remains pretty awful on an absolute basis. But markets respond to movements at the margin, so absent non-market events, like Italian political ructions, it is fair to expect the euro to benefit on this data. In fact, there is an ongoing evolution in the analyst community as a number of them have begun to change their ECB views, with several implying that the ECB’s next move will be policy tightening, and some major Investment Banks now forecasting 10-year German bunds to trade back up to 0.0% or even higher by the end of the year. We shall see. Certainly, if Madame Lagarde hints at tighter policy tomorrow, the euro will benefit. But remember, the ECB is still all-in on QE, purchasing €20 billion per month, so trying to combine the need to continue QE alongside a discussion of tighter policy seems a pretty big ask. At this point, the euro remains under a great deal of pressure overall, but I do expect this pressure to ebb as the year progresses and see the dollar decline eventually.

As to the UK, the hits there just keep on coming. This morning, the Confederation of British Industry (CBI), which is essentially the British Chamber of Commerce, reported that both orders and price data improved modestly more than expected, but more importantly their Optimism Index jumped to +23 from last month’s -44, which is actually its highest level since April 2014, well before Brexit was even a gleam in then-PM David Cameron’s eye. Not surprisingly, the pound has rallied further on this positive jolt, jumping 0.5% this morning and is the leading performer against the dollar overall today. It should also be no surprise that the futures market has reduced its pricing for a BOE rate cut next week to a 47% probability, down from 62% yesterday and 70% on Friday. Ultimately, I think that Carney and company would rather not cut if at all possible, given how little room they have with the base rate at 0.75% currently. If we see solid PMI flash data on Friday, I would virtually rule out any chance for a cut next week, and expect to see the pound rally accordingly.

Away from those two stories though, market activity has been far less interesting. The rest of the G10, beyond the pound, is generally within 10bps of yesterday’s closing levels. As to the Emerging markets, the big winner has been ZAR, which has rallied 0.65% after CPI rose to 4.0%, although that remains well below the midpoint of the SARB’s target range of 3.0% – 6.0%. Expectations are for continued policy ease and continue investment inflows to help support the currency. But other than the rand, it has been far less interesting in the FX market.

The ongoing fears over the spread of the coronavirus seem to be abating as China has been aggressively working to arrest the situation, canceling flights out of Wuhan and being remarkably transparent with respect to every new case reported. In fact, equity markets around the world have collectively decided that this issue was a false alarm and we have seen stocks rally pretty much everywhere (Italy excepted) with US futures pointing higher as well.

And that really sums up the day. The ongoing impeachment remains outside of the framework of the market as nobody believes that President Trump will be removed from office. The WEF participants continue to demonstrate their collective ability to pontificate about everything, but do nothing. And so, we need to look ahead to today’s data, and probably more importantly to equity market performance for potential catalysts for movement. Alas, the only US data of note is Existing Home Sales (exp 5.43M), something that rarely moves markets. This leaves us reliant on equity market sentiment to drive the FX market, and with risk definitively on this morning, I expect to see EMG currencies benefit while the dollar suffers mildly.

Good luck
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Cashiered!

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In China, a virus appeared
That seems to be worse than first feared
It’s spreading so quickly
That markets turned sickly
And stock market bulls got cashiered!

Some of you may remember the SARS virus from the winter of 2002-3, when a respiratory illness, emanating from Guangdong in China, spread quickly around the world resulting in some 800 odd deaths, but more importantly from the market’s perspective, created a very real risk-off environment. As an example, from January through March of 2003, the Dow Jones fell more than 16%, largely on fears that the virus would continue to spread and ultimately reduce economic activity worldwide. Fortunately, that was not the case, as those diagnosed with the virus were isolated and the spread of the disease ended. Naturally, risk was reignited and all was right with the world…until 2008.

I remind everyone of this history as this morning, there is another coronavirus that has been discovered in central China, this time Wuhan seems to be ground zero, and has begun to spread rapidly from human to human. In just a few weeks, more than 200 cases have been reported with several deaths. However, the big concern is that the Lunar New Year celebration begins on Saturday and this is the heaviest travel time of the year within China and for Chinese people around the world. And if your goal was to spread a virus, there is no better way to do so than by getting infected people on airplanes and sending them around the world! Of course, this is nobody’s goal, however it is a very real potential consequence of the confluence of the new virus and the Lunar New Year. The market has reacted just as expected, with risk aversion seen across markets (equities lower, bonds higher) and specific stocks reacting to anticipated direct effects. For example, every Asian airline stock has been aggressively sold lower, while manufacturers of things like latex gloves and face masks have rallied sharply.

Now, while none of this should be surprising, a quick look at market levels shows us that the current impact of this virus has been widespread, at least from a market perspective. For example, equity markets have suffered across the board, although Asia was worst hit (Nikkei -0.9%, Hang Seng -2.8%, Shanghai -1.4%, DAX -0.25%, CAC -0.85%, FTSE -1.0%). Treasury yields have fallen 2bps, although bund yields are actually higher by 0.5bps this morning on the back of stronger than expected ZEW survey data.

And in the currency market, the dollar is broadly, although not universally, higher. It can be no surprise that APAC currencies are under the most pressure given the risk-off causality, with KRW -0.75% and CNY -0.55%, its largest daily decline since last August. But we are also seeing weakness throughout LATAM with both BRL (-0.45%) and MXN (-0.35%) among the day’s worst performers.

In the G10 space, the results have been a bit more mixed, and actually seem more related to data than the general risk sentiment. For example, the pound is today’s big winner, +0.35% after UK Employment data was released with much better than expected results. While the Unemployment Rate remained unchanged at 3.8%, the 3M/3M Employment Change rose 208K, nearly double expectations and the first really good piece of data seen from the UK in two weeks (recall PMI data was a bit better than expected). This has resulted in some traders questioning whether the BOE will cut rates next week after all. Futures markets continue to price a 61% probability, although that is down from 70% on Friday.

Elsewhere, the euro reversed small early losses and now has small gains after the ZEW Expectations data (26.7 vs. 15.0 expected), while the yen has benefitted ever so slightly on two different fronts. First, the broad risk-off market flavor has helped keep the yen underpinned, but more importantly, the BOJ met last night, and although they left policy unchanged, as universally expected, there continues to be a growing belief that the next move there is going to be a tightening! This was reinforced by the BOJ raising its growth estimates for both 2019 (0.8%, up from 0.6%) and 2020 (0.9% up from 0.7%). Of course, offsetting that somewhat was the decline in the BOJ’s inflation forecast, down to 0.8% in 2020 from the previous expectation of 0.9%. In the end, it is difficult to get overly excited about the Japanese economy’s prospects, with a much greater likelihood of significant yen strength emanating from a more severe risk-off event.

Looking ahead to the week, not only is the Fed in its quiet period, but there is a very limited amount of US data set to be released.

Wednesday Existing Home Sales 5.43M
Thursday Initial Claims 214K
  Leading Indicators -0.2%

Source: Bloomberg

Of course, there are two other events this week that may have a market impact, although my personal belief is that neither one will do so. This morning the US Senate takes up the Articles of Impeachment for President Trump that were finally proffered by the House of Representatives. And while the politicos in Washington and the talking heads on TV are all atwitter over this situation, financial markets have collectively yawned throughout the entire process. I see no reason for that stance to change at this point.

The other event is the World Economic Forum in Davos, the annual get together of the rich and famous, as well as those who want to be so, to pontificate on all things they deem important. However, it beggars belief that anything said from this conference is going to change any investment theories, let alone any fiscal or monetary policies. This too, from the market’s perspective, is unlikely to have any impact at all.

And that’s really it for today. Lacking catalysts, I anticipate a quiet session overall. Short term, the dollar still seems to have some life. But longer term, I continue to look for a slow decline as the effects of the Fed’s QE begin to be felt more keenly.

Good luck
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Throw Her a Bone

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Next week at the ECB meeting
We’re sure to hear Christine entreating
The whole Eurozone
To throw her a bone
And spend more, lest growth start retreating

In England, though, it’s now too late
As recent releases all state
The ‘conomy’s slowing
And Carney is knowing
Come month end he’ll cut the base rate

The dollar is finishing the week on a high note as it rallies, albeit modestly, against virtually the entire G10 space. This is actually an interesting outcome given the ongoing risk-on sentiment observed worldwide. For instance, equity markets in the US all closed at record highs yesterday, and this morning, European equities are also trading at record levels. Asia, not wanting to be left out, continues to rally, although most markets in APAC have not been able to reach the levels seen during the late 1990’s prior to the Asian crisis and tech bubble. At the same time, we continue to see Treasury and Bund yields edging higher as yield curves steepen, another sign of a healthy risk appetite. Granted, commodity prices are not uniformly higher, but there are plenty that are, notably iron ore and steel rebar, both crucial signals of economic growth.

Usually, in this type of market condition, the dollar tends to decline. This is especially so given the lack of volatility we have observed encourages growth in carry trades, with investors flocking to high yield currencies like MXN, IDR, BRL and ZAR. However, it appears that at this juncture, the carry trade has not yet come back into favor, as that bloc of currencies has shown only modest strength, if any, hardly the signal that investor demand has increased.

This leaves us with an unusual situation where the dollar is reasonably well-bid despite the better risk appetite. Perhaps investors are buying dollars to jump on board the US equity train, but I suspect there is more to the movement than this. Investigations continue.

Narrowing our focus a bit more, it is worthwhile to consider the key events upcoming, notably next week’s ECB and BOJ meetings and the following week’s FOMC and BOE meetings. Interestingly, based on current expectations, the Fed meeting is likely to be far less impactful than either the ECB or BOE.

First up is the BOJ, where there is virtually no expectation of any policy changes, and in fact, that is true for the entire year. With the policy rate stuck at -0.10%, futures markets are actually pricing in a 5bp tightening by the end of the year. Certainly, Japan has gone down the road of increased fiscal stimulus, and if you recall last month’s outcome, the BOJ essentially admitted that they would not be able to achieve their 2.0% inflation target during any forecastable timeline. With that is the recent history, and given that inflation remains either side of 1.0%, the BOJ is simply out of bullets, and so will not be doing anything.

The ECB, however, could well be more interesting as the market awaits their latest thoughts on the policy review. Madame Lagarde has made a big deal about how they are going to review procedures and policy initiatives to see if they are designed to meet their goals. Some of the things that have been mooted are a change in the inflation target from “close to but below 2.0%” to either a more precise target or a target range, like 1.5% – 2.5%. Of even more interest is the fact that they have begun to figure out that their current inflation measures are inadequate, as they significantly underweight housing expense, one of the biggest expenses for almost every household. Currently, housing represents just 4% of the index. As a contrast, in the US calculation, housing represents about 41% of the index! And the anecdotes are legion as to how much housing costs have risen throughout European cities while the ECB continues to pump liquidity into markets because they think inflation is missing. Arguably, that has the potential to change things dramatically, because a revamped CPI calculation could well inform that the ECB has been far too easy in policy and cause a fairly quick reversal. And that, my friends, would result in a much higher euro. Today however, the single currency has fallen prey to the dollar’s overall strength and is lower by 0.25%.

As I mentioned, I don’t think the FOMC meeting will be very interesting at all, as there is a vanishingly small chance they change policy given the economy keeps chugging along and inflation has been fairly steady, if not rising to their own 2.0% target. The BOE meeting, however, has the chance to be much more interesting. This morning’s UK Retail Sales data was massively disappointing, with December numbers printing at -0.8%, -0.6% excluding fuel. This was hugely below the expected outcomes of +0.8% and +0.6% respectively. Apparently, Boris’s electoral victory did not convince the good people of England to open their wallets. And remember, this was during Christmas season, arguably the busiest retail time of the year. It can be no surprise that the futures market is now pricing a 75% chance of a rate cut and remember, earlier this week we heard from three different BOE members that cutting rates was on the table. The pound, which has been rallying for the entire week has turned around and is lower by 0.2% this morning with every chance that this slide continues for the next week or two until the meeting crystalizes the outcome.

The other noteworthy news was Chinese data released last night, which showed that GDP, as expected, grew at 6.0%, Retail Sales also met expectations at 8.0%, while IP (+6.9%) and Fixed Asset Investment (+5.4%) were both a bit better than forecast. The market sees this data as proof that the economy there is stabilizing, especially with the positive vibe of the just signed phase one trade deal. The renminbi has benefitted, rallying a further 0.3% on the session, and has now gained 4.6% since its weakest point in early September 2019. This trend has further to go, of that I am confident.

On the data front this morning, we have Housing Starts (exp 1380K), Building Permits (1460K), IP (-0.2%), Capacity Utilization (77.0%), Michigan Sentiment (99.3) and JOLT’s Job Openings (7.25M). So plenty of news, but it is not clear it is important enough to change opinions in the FX market. As such, I expect that today’s dollar strength is likely to continue, but certainly not in a major way.

Good luck and good weekend
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