Twiddling Their Thumbs

Investors are twiddling their thumbs
Awaiting the next news that comes
The Old Lady’s meeting’s
Impact will be fleeting
And Jay’s finished flapping his gums

Which leads to the question at hand
Is risk on or has it been banned?
The one thing we know
Is growth’s awfully slow
Beware, markets could well crash land

Markets are taking a respite this morning with modest movement across all three major asset classes. While the Bank of England is on tap with their latest policy announcement, the market feels certain they will leave rates on hold, at 0.10%, and that they will increase their QE purchases by £100 billion, taking the total to £745 billion, in an effort to keep supplying liquidity to the economy. It is somewhat interesting that the story from earlier in the week regarding positive movement on Brexit had such a modest and short-term impact on the pound, which has actually begun to decline a bit more aggressively as I type. After peaking a week ago, the pound has ceded 2.5% from that top (-0.6% today). There is nothing in the recent UK data that would lead one to believe that the economy there is going to be improving faster than either the EU or the US, and with monetary policy at a similar level of ease on a relative basis, any rationale to buy pounds is fragile, at best. I continue to be concerned that the pound leads the way lower vs. the dollar, at least until the current sentiment changes. And while the BOE could possibly change that sentiment, I would estimate that given yesterday’s inflation reading (0.5%) and their inflation target (2.0%), they see a weaker pound as a distinct benefit. Meanwhile, remember the current central bank mantra, ease more than expected. If there is any surprise today, look for £150 billion of QE, which would merely add further urgency to selling pounds.

But aside from the BOE meeting, there is very little of interest to the markets. The ECB announced that their TLTRO III.4 program had a take-up of €1.31 trillion, within the expected range, as 742 banks in the Eurozone got paid 1.0% to borrow money from the ECB in order to on lend it to their clients. But while an interesting anecdote, it is not of sufficient interest to the market to respond. In fact, the euro sits virtually unchanged on the day this morning, waiting for its next important piece of news.

In the G10 space, the only other mover of note is NOK, which has rallied 0.5% on the back of two stories. First, oil prices have moved a bit higher, up slightly less than 1% this morning, which is clearly helping the krone. But perhaps more importantly, the Norgesbank met, left rates on hold at 0.00%, but explained that there was no reason for rates to decline further, once again taking NIRP off the table.

However, away from those two poles, there is very little of interest in the G10 currency space. As to the EMG space, it too is pretty dull today, with RUB the leading gainer, +0.55%, on the oil move and ZAR the leading decliner, -0.4%, amid rising concern over the spread of Covid there as the infection curve remains on a parabolic trajectory. Similar to the G10 space, there is not much of broad interest overall.

Equity markets have also “enjoyed” a mixed session, with Asian markets showing gainers, Shanghai +0.1%, and losers, Nikkei -0.25%, but nothing of significant size. In Europe, the news is broadly negative, but other than Spain’s IBEX (-1.0%) the losses are quite modest. And finally, US futures are mixed but all within 0.1% of yesterday’s closing prices.

Lastly, bond markets are generally firmer, with yields falling slightly as 10-year Treasuries have decline 3 basis points on the session, broadly in line with what we are seeing in European government bond markets. Arguably, we should see the PIGS bonds perform well as that TLTRO money finds its way into the highest yielding assets available.

Perhaps we can take this pause in the markets as a time to reflect on all we have learned lately and try to determine potential outcomes going forward. From a fundamental perspective, the evidence points to April as the nadir of economic activity, which given the widespread shutdowns across the US and Europe, should be no surprise. Q2 GDP data is going to be horrific everywhere, with the Atlanta Fed’s GDPNow number currently targeting -45.5%. But given the fact that economies on both sides of the Atlantic are reopening, Q3 will certainly show a significant rebound, perhaps even the same percentage gain. Alas, a 45% decline followed by a 45% rebound still leaves the economy more than 20% lower than it was prior to the decline. And that, my friends, is a humongous growth gap! So, while we will almost certainly see a sharp rebound, even the Fed doesn’t anticipate a recovery of economic activity to 2019 levels until 2022. Net, the economic picture remains one of concern.

On the fiscal policy front, the US story remains one where future stimulus is uncertain and likely will not be nearly as large as the $2.2 trillion CARES act, although the Senate is currently thinking of $1 trillion. In Europe, the mooted €750 billion EU program that would be funded by joint taxation and EU bond issuance, is still not completed and is still drawing much concern from the frugal four (Austria, Sweden, the Netherlands and Denmark). And besides, that amount is a shadow of what is likely necessary. Yes, we have seen Germany enact their own stimulus, as has France, Spain and Italy, but net, it still pales in comparison to what the US has done. Other major nations continue to add to the pie, with both China and Japan adding fiscal stimulus, but in the end, what needs to occur is for businesses around the world to get back to some semblance of previous activity levels.

And yet, investors have snapped up risk assets aggressively over the past several months. The value in an equity is not in the ability to sell it higher than you bought it, but in the future stream of earnings and cashflows the company produces. The multiple that investors are willing to pay for that future stream is a key determinant of long-term equity market returns. It is this reason that there are many who are concerned about the strength of the stock market rebound despite the destruction of economic activity. This conundrum remains, in my view, the biggest risk in markets right now and while timing is always uncertain, provides the potential for a significant repricing of risk. In that event, I would expect that traditional haven assets would significantly outperform, including the dollar, so hedgers need to stay nimble.

A quick look at this morning’s data shows Initial Claims (exp 1.29M), Continuing Claims (19.85M), Philly Fed (-21.4) and Leading Indicators (+2.4%). The claims data remains the key short-term variable that markets are watching, although it appears that economists have gotten their models attuned to the current reality as the last several prints have been extremely close to expectations.

Overall, until something surprising arises, it feels like the bulls remain in control, so risk is likely to perform well. Beware the disconnect, though, between the dollar and the stock market, as that may well be a harbinger of that repricing on the horizon.

Good luck and stay safe
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