For Italy, France and for Spain
The data released showed their pain
Each nation recorded
A number quite sordid
And each, Covid, still can’t contain
As awful as the US GDP data was yesterday, with an annualized decline of 32.9%, this morning saw even worse data from Europe. In fact, each of the four largest Eurozone nations recorded larger declines in growth than did the US in Q2. After all, Germany’s 10.1% decline was a Q/Q number. If we annualize that, it comes to around 41%. Today we saw Italy (-12.4% Q/Q, -50% annualized), France (-13.8% Q/Q or -55% annualized) and Spain, the worst of the lot (-18.5% Q/Q or -75% annualized). It is, of course, no surprise that the Eurozone, as a whole, saw a Q/Q decline of 12.1% which annualizes to something like 49%. At those levels, precision is not critical, the big figure tells you everything you need to know. And what we know is that the depths of recession in Europe were greater than anywhere else in Q2.
The thing is, none of this really matters any more. The only thing the Q2 GDP data did was establish the base from which future growth will occur. We saw this in the US yesterday, where equity markets rallied, and we are seeing and hearing it today throughout Europe as the narrative is quite clear; Q2 was the nadir and things should get better going forward. In fact, that is the entire thesis behind the V-shaped recovery. Certainly, one would be hard pressed to imagine a situation where Q3 GDP could shrink relative to Q2, but unfortunately the rebound story is running into some trouble these days.
The trouble is making itself known in various ways. For example, the fact that the Initial Claims data in the US has stopped declining is a strong indication that growth is plateauing. This is confirmed by the resurgence of Covid cases being recorded throughout the South and West and the reimposition of lockdown measures and closures of bars and restaurants in California, Texas and Arizona. And, alas, we are seeing the same situation throughout Europe (and in truth, the rest of the world) as nations that had been lionized for their ability to act quickly and prevent the spread of the virus through draconian measures, find that Covid is quite resilient and infections are surging in Spain, Italy, Germany, the UK, Japan, Singapore, South Korea and even in China. You remember China, the origin of the virus, and the nation that explained they had eradicated it completely just last month. Maybe eradicated was too strong a word.
So, the real question is, what happens to markets if the future trajectory of growth is much shallower than a V? It is not difficult to argue that equity markets, especially in the US, are priced for the retracement of all the lost growth. That seems to be at odds with the situation on the ground where thousands of small businesses have closed their doors forever. And not just small businesses. The list of bankruptcy filings by large, well-known companies is staggeringly long.
Can continued monetary and fiscal support from government institutions really replace true economic activity? Of course, the answer to that question is no. Money from nothing and excessive debt issuance will never substitute for the creation of real goods and services that are demanded by the population. So, while equity markets trade under the assumption that government support is a stop-gap filler until activity returns to normal, the recent, high-frequency data is implying that the gap could be much longer than initially anticipated.
And as has been highlighted in many venues, the bond market is telling a different story. Treasury yields out to 10 years are now trading at record lows. The amount of negative yielding debt worldwide is climbing again, now back to $16 trillion, and heading for the record levels seen at the end of last August. This price behavior is the very antithesis of expected strong growth in the future. Rather it signals concerns that growth will be absent for years to come, and with it inflationary pressures. At some point, these two asset classes will both agree on a story, and one of them will require a major repricing. My money is on the stock market to change its tune.
But that is a longer term discussion. For now, let us review the overnight session. It is hard to characterize it as either risk-on or risk-off, as we continue to see mixed signals from different markets. In Asia, the Nikkei was the worst performer, falling 2.8% as concerns grow that a second wave of Covid infections is going to stop the signs of recovery. Confirming those fears, a meeting of government and central bank officials took place where they discussed what to do in just such a situation, which of course means there will be more stimulus, both monetary and fiscal, on its way soon. The yen behaved as its haven status would dictate, rallying further and touching a new low for the move at 104.19 before backtracking and sitting unchanged on the day as I type. The thing about the yen is that 105 had proven to be a strong support level and is now likely going to behave as resistance. While I don’t see a collapse, USDJPY has further to fall.
The rest of Asia saw weakness (Hang Seng -0.5%, Sydney -2.0%) and strength (Shanghai +0.7%) with the latter responding to modestly better than expected PMI data, while the former two are feeling the impact of the rise in infections. Europe, on the other hand, is green across the board, with Italy’s FTSE MIB (+1.25%) leading the way, although the DAX (+0.7%) is performing well. Here, just like in the US, investors seem to believe in the V-shaped recovery and now that the worst has been seen, those investors are prepared to jump in with both feet.
As discussed above, bond markets continue to rally, and yields continue to fall. That is true throughout Europe as well as in the US. In fact, it is true in Asia as well, with China the lone exception, seeing its 10-year yield rise 4bps overnight.
And finally, the dollar can only be described as mixed. In the G10, NZD (-0.5%) and AUD (-0.2%) are the worst performers as both suffer from concerns over growing numbers of new Covid cases, while SEK and GBP (+0.25% each) lead the way higher. It is ironic as there is concern over the growing number of cases in those nations as well, and, in fact, the UK is locking down over 4 million people in the north because of a rise in infections. But the pound has been on fire lately, and that momentum shows no signs of abating for now. One would almost think that a Brexit deal has been agreed, but the latest news has been decidedly negative there. This is simply a reminder that FX is a perverse market.
Emerging markets have also seen mixed activity, although it is even more confusing. Even though commodities are having a pretty good day, with both oil and gold prices higher, the commodity currencies are the worst performers today, with ZAR (-1.35%), RUB (-1.0%) and MXN (-0.9%) all deeply in the red. On the positive side, THB (+0.85%) and CNY (+0.5%) are showing solid strength. The renminbi, we already know, is benefitting from the better than expected PMI data while the baht benefitted from ongoing equity inflows.
This morning we see another large grouping of data as follows: Personal Income (exp -0.6%), Personal Spending (5.2%), core PCE Deflator (1.0%), Chicago PMI (44.5) and Michigan Sentiment (72.9). As inflation is no longer even a concern at the Fed, or any G10 central bank, the market is likely to look at two things, Spending data which could help cement the idea that things are rebounding nicely, or not, and Chicago PMI, as an indication of whether industrial activity is picking up again.
Overall, regardless of the data, the trend remains for the dollar to decline, at least against its G10 brethren and I see nothing that is going to change that trend for now. At some point, it will make sense for receivables hedgers to take advantage, but it is probably still too early for that.
Good luck, good weekend and stay safe