Fear’s Stranglehold

All week the poor dollar’s been sold
As traders break fear’s stranglehold
How far can it fall?
The popular call
Is very, though ‘twill be controlled

Once again the dollar is under pressure this morning, although interestingly, we are not seeing equity market strength. Up til now, this week has proven decidedly risk-on with equity markets rallying, commodity prices performing well, and long dollar positions, established during the past months due to fears of impaired liquidity, getting reduced. After all, there is no need to hold a forex position if you can borrow dollars without paying a huge premium. But this morning, there is a bit of a conundrum in the markets as equity prices are falling around the world, but the dollar is continuing its decline.

The popular risk narrative focuses on increasing tensions between the US and China in the wake of China’s recent passage of a law increasing its control over Hong Kong. That simply adds to the general fears that the constant butting of heads between the two nations could escalate to a more significant confrontation. Certainly, this action by the Chinese is not a risk positive, but there is no evidence that funds are rapidly flowing out of Hong Kong because of the situation. This has been made clear by both the exchange rate, where HKD remains right at the top of its band with the dollar and the Hang Seng, which while down 18% YTD, remains well above the lows seen in the global crash in March, and hardly seems in danger of collapse.

Rather, given that it is month end, it appears far more likely that today’s price action in equities is being driven by portfolio rebalancing. After all, asset allocators are now longer equities relative to debt and so will be selling stocks to put themselves back to their target levels. As to the dollar, it too is likely to be feeling the impact of portfolio rebalancing as money continues to flow out of overweight US equity positions to other geographies.

After all, the rate structure has hardly changed at all this month, with yields having remained quite stable in general. For instance, 10-year Treasury yields had an 11 basis point range all month while the havens in Europe saw a similar lack of volatility. Only the PIGS saw their yields trade more dramatically, and for all of them, it was a straight line higher in prices, with yields falling accordingly, in the wake of the EU announcement of steps toward debt mutualization. With this in mind, one can hardly blame relative rate changes for the dollar’s month-long weakness.

On the economic front, the data has been very consistent around the world as well. It is uniformly awful, but it is also beginning its slow rebound from the nadir reached in late March/early April. As Covid-19 spread around the world, different countries have been impacted at different times, but the pattern everywhere is quite similar. In fact, this is the driving market narrative, that economic activity is set to rebound sharply and that as lockdowns around the world are lifted, all will be back to where it was prior to the spread of Covid. And perhaps this will, in fact, be the case. However, the destruction of economic activity combined with the forced changes in working conditions certainly raises the possibility that the rebound will not be nearly as robust as currently anticipated by markets. In other words, do not rule out another repricing of risk. But despite some lingering fears, the general mood in markets remains positive.

Turning to today’s session, as mentioned, we are seeing red across the board in the equity markets with Asia soft (Nikkei -0.2%), Hang Seng (-0.7%), Europe under pressure (DAX -1.0%, CAC -0.8%, FTSE 100 -0.9%) and US futures also declining (DJIA -0.4%, SPX and NASDAQ -0.3%). Also, given the overall lack of volatility seen all month in the bond market, it should be no surprise that Treasury yields are only modestly changed, down 2bps, with German, French and UK yields similarly lower. Meanwhile, oil prices, which have rallied more than 65% this month, are slightly softer today, down 3% and the price of gold, which has had a choppy month, is adding 0.5% to achieve its MTD gain of 1.5%. (As an aside, the gold story is one of great conviction on both sides as the bulls look at the amount of new money in the system without a corresponding increase in production, actually a significant decline there, and wonder how hard assets cannot increase in value. Meanwhile, the bears point to the absence of demand for goods, looking at things like crashing retail sales and rising savings rates, and see deflation on the horizon and no reason to hold anything other than fixed income in this environment.)

As to the dollar, it is almost uniformly lower this morning, with the entire G10 firmer led by Sweden’s krona, up 1.0%, after the country released a surprisingly positive Q1 GDP growth outcome of +0.1%, far better than the anticipated -0.3%, and helping to maintain positive Y/Y growth. That has clearly energized NOK (+0.7%) as well as EUR (+0.5%). But in reality, a great deal of this activity is dollar weakness, rather than specific country strength.

In the EMG bloc, the dollar is under pressure across the space with only the Turkish lira declining on the day, and that by just 0.2%. On the positive side, the CE4 are leading the way with CZK (+0.8%) and HUF (+0.7%) atop the leaderboard. The other noteworthy mover has been IDR (+0.7%) after comments from the central bank governor, Perry Warjiyo, indicated his belief that the rupiah was undervalued and could appreciate somewhat with no problems to the economy.

On the data front, yesterday saw the first decline in Continuing Claims data since the onset of Covid-19, with a surprisingly low print of 21.0M. Initial Claims continue to slide as well, rising ‘only’ 2.1M last week. GDP data were revised slightly lower, to -5.0% annualized for Q1, although there remains a contest to see whose depiction of Q2, with current forecasts between -20% and -50%, will be closest to the mark. This morning we see Personal Income (exp -6.0%), Personal Spending (-12.8%), Core PCE (1.1%), Chicago PMI (40.0) and Michigan Sentiment (74.0). The April income and spending data will be much worse than the previous print, as that encompasses the worst of the shutdown. But the May data is forecast to rebound from its worst levels, consistent with what we are seeing around the world.

As long as fear is in abeyance, I expect that dollar demand will remain more muted than we had seen during the past several months. The big picture story of a more unified Europe with mutual debt, and my ongoing expectations of negative real interest rates in the US points to further dollar weakness over time. This is not going to be a collapse, but rather a steady grind lower.

Good luck, good weekend and stay safe
Adf