Casting a Pall

The Chairman explained to us all
Deflation is casting a pall
On future advances
While NIRP’s what enhances
Our prospects throughout the long haul

The bond market listened to Jay
And hammered the long end all day
The dollar was sold
While buyers of gold
Returned, with aplomb, to the fray

An announcement to begin the day; I will be taking my mandatory two-week leave starting on Monday, so the next poetry will be in your inbox on September 14th.

Ultimately, the market was completely correct to focus all their attention on Chairman Powell’s speech yesterday because he established a new set of ground rules as to how the Fed will behave going forward.  By now, most of you are aware that the Fed will be targeting average inflation over time, meaning that they are happy to accept periods of higher than 2.0% inflation in order to make up for the last eight years of lower than 2.0% inflation.

In Mr. Powell’s own words, “…our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

You may have noticed that Powell adds no specificity to this new policy, with absolutely no definition of ‘some time’ nor what ‘moderately above’ means.  But there was more for us, which many may have missed because it was a) subtle, and b) not directly about inflation.

“In addition, our revised statement says that our policy decision will be informed by our “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level” as in our previous statement.”

This is the rationale for their new willingness to let inflation run hot, the fact that the benefits of full employment outweigh those of stable prices.  The lesson they learned from the aftermath of the GFC in 2008-9 was that declining unemployment did not lead to higher general inflation.  Of course, they, along with many mainstream economists, attribute that to the breakdown of the Phillips curve relationship.  But the Phillips curve was not about general inflation, rather it was about wage inflation.  Phillips noted the relationship between falling unemployment and rising wages in the UK for the century from 1861-1957.  In fact, Phillips never claimed there was a causality, that was done by Paul Samuelson later and Samuelson extended the idea from wage to general inflation.  Eventually Milton Friedman created a theoretical underpinning for the claim unemployment and general inflation were inversely related.

Arguably, the question must be asked whether the labor market situation in the UK a century ago was really a valid model for the current US economy.  As it turns out, the time of Downton Abbey may not be a viable analogy.  Who would’ve thought that?

Regardless, Powell made it clear that with this new framework, the Fed has more flexibility to address what they perceive as any problems in the economy, and they will use that flexibility as they see fit.  In the end, the market response was only to be expected.

Starting with the bond market, apparently, I wasn’t the only one who thought that owning a fixed income instrument yielding just 1.4% for 30 years when the Fed has explicitly stated they are going to seek to drive inflation above 2.0% for some time was a bad idea.  The Treasury curve steepened sharply yesterday with the 10-year falling one point (yield higher by 6.5bps) while the 30-year fell more than three points and the yield jumped by more than 10 basis points.  My sense is we will continue to see the back end of the Treasury curve sell off, arguably until the 30-year yields at least 2.0% and probably more.  This morning the steepening is continuing, albeit at a bit slower pace.

As to the dollar, it took a while for traders to figure out what they should do.  As soon as Powell started speaking, the euro jumped 0.75%, but about 5 minutes into the speech, it plummeted nearly 1.2% as traders were uncertain how to proceed.  In the end, the euro recouped its losses slowly during the rest of the day, and has risen smartly overnight, up 0.7% as I type.  In fact, this is a solid representation of the entire FX market.  Essentially, FX traders and investors have parsed the Chairman’s words and decided that US monetary policy is going to remain uber easy for as far in the future as they can imagine.  And if that is true, a weaker dollar is a natural response.  So, today’s broad-based dollar decline should be no surprise.  In fact, it makes no sense to try to explain specific currency movements as the dollar story is the clear driver.

However, that does not mean there is not another important story, this time in Japan.

Abe has ulcers
Who can blame him with Japan’s
Second wave rising?

PM Shinzo Abe has announced that he has ulcerative colitis and will be stepping down as PM after a record long run in the role.  Initially, there was a great deal of excitement about his Abe-nomics plan to reflate the Japanese economy, but essentially, the only thing it accomplished was a weakening of the yen from 85.00 to 105.00 during the past eight years.  Otherwise, inflation remains MIA and the economy remains highly regulated.  The market reaction to the announcement was to buy yen, and it is higher by 1.15% this morning, although much of that is in response to the Fed.  However, it does appear that one of the frontrunners for his replacement (former Defense Minister Shigeru Ishiba) has populist tendencies, which may result in risk aversion and a stronger yen.

As to the equity market, the Nikkei (-1.4%) did not appreciate the Abe news, but Shanghai (+1.6%) seemed to feel that a more dovish Fed was a net benefit, especially for all those Chinese companies with USD debt.  Europe has been a little less positive (DAX -0.3%, CAC -0.1%) as there is now a growing concern that the euro will have much further to run.  Remember, most Eurozone economies are far more reliant on exports than the US, and a strong euro will have definite repercussions across the continent.  My forecast is that Madame Lagarde will be announcing the ECB’s policy framework review in the near future, perhaps as soon as their September meeting, and there will be an extremely dovish tone.  As I have written before, the absolute last thing the ECB wants or needs is a strong euro.  If they perceive that the Fed has just insured further dollar weakness, they will respond in kind.

Turning to the data, we see a plethora of numbers this morning.  Personal Income (exp -0.2%), Personal Spending (1.6%) and Core PCE (1.2%) lead us off at 8:30.  Then later, we see Chicago PMI (52.6) and Michigan Sentiment (72.8).  The thing is, none of these matters for now.  In fact, arguably, the only number that matters going forward is Core PCE.  If it remains mired near its current levels, the dollar will continue to suffer as not only will there be no tightening, but it seems possible the Fed will look to do more to drive it higher.  On the other hand, if it starts to climb, until it is over 2.0%, the Fed will be standing pat.  And as we have seen, getting Core PCE above 2.0% is not something at which the Fed has had much success.  For now, the dollar is likely to follow its recent path and soften further.  At least until the ECB has its say!

Good luck, good weekend and stay safe

Waiting for Jay

Investors are waiting for Jay
Their fears, about rates, to allay
They want it made clear
That rates will be here
From now ‘til we reach judgement day

From the market’s perspective, the world has essentially stopped spinning, at least until we finally hear the words of wisdom due from Chairman Powell beginning at 9:10 this morning.  Trading volumes across products are currently running at 50%-70% of recent average activity, highlighting just how little is ongoing.  And remember, too, as it is the last week of August, summer holidays are in full swing with most trading desks, on both the buy and sell sides, more lightly staffed than usual.  In other words, liquidity is clearly impaired right now, although by 10:00 this morning I expect that things will be back closer to normal.

As discussed yesterday, the working assumption of most analysts and investors is that Jay is going to explain the benefits of targeting average inflation over time.  The implication being that the Fed’s new policy framework, when officially announced later this year, is going to include that as a KPI.  Of course, the big question about this policy is the average over exactly which period.

Consider, it has been 102 months since then-Chairman Bernanke established the target for core PCE at 2.0%.  During that time, core PCE has been between 1.9% and 2.1% just 12 times with 89 of the other 90 readings below 1.9% and a single print above 2.1%, which happens to have been the first print after the announcement.  Meanwhile, this past April’s reading of 0.931% is the lowest reading.  The average of the two extremes is 1.53%.  Is the Fed going to be happy if core PCE jumps to 2.47% and stays there for a while?  The average of all periods since January 2012 is 1.633%, does that mean we can expect the Fed to target 2.367% core PCE readings for the next eight plus years? The point is, without some specificity on what average inflation means, it is very difficult to understand how to incorporate the idea into investment and trading decisions.

But what if Chairman Powell does not bring clarity to the discussion, merely saying that average inflation over time seems like a good future benchmark.  How might different markets react to such a lack of specificity?

Starting with equity markets, certainly those in the US will rally because…well that’s all they do these days.  Good news, bad news, no news, none of that matters.  The rationale will be stocks are a good inflation hedge if inflation goes higher (they’re not) or stocks will benefit from ongoing low interest rates if inflation remains below target.  Parabolic markets are frightening, but there is no indication that Powell’s comments are going to change that situation.  We need a different catalyst here.

Now let’s look at the bond market and what might happen there.  Specificity on how much higher the Fed is going to target inflation is going to be a pretty distinct negative.  If you own 10-year Treasuries that are yielding 0.68% (today -1bp), and the Fed explains that they are going to push inflation above 2.0%, there is going to be a pretty spectacular decline in the price of your bond should they achieve their goal.  Will investors be willing to hold paper through that type of decline?  It would not be a surprise to see a pretty sharp sell-off in Treasuries on that type of news.  Remember, too, that Treasury yields have backed up nearly 20 basis points in the past three weeks, perhaps in anticipation of today’s comments.  If Powell delivers, there is likely far more room to run.  If he doesn’t, and there is no clarity, bond investors will be back to reading the economic tea leaves, which continues to be remarkably difficult at this time.

How about the gold market?  Well, here I think the case is quite straight forward.  Clarity as to the Fed’s efforts to drive inflation higher will result in anticipation of lower real yields, and that will be an unalloyed benefit (pun intended).  A lack of clarity and gold will likely continue to consolidate its recent gains.

And finally, what about the dollar?  How will it respond to the Chairman’s speech?  Consider that despite the dollar’s recent rebound, short dollar positions remain at near record levels against both the euro and the DXY futures.  The market scuttlebutt is that the hedge fund community, which was instrumental in the dollar’s recent modest strength as they pared short dollar positions, is ready and raring to buy euros on the idea that higher US inflation will lead to a weaker dollar à la economic theory.  Certainly, if Treasuries sell off, the dollar will see some downward pressure, but one of the things that does not get as much press in the FX market is the equity market impact.  Namely, as long as US equity indices continue to set records, international investors are going to continue to buy them, which will underpin the dollar.

But what if the speech is a dud?  If there is no clarity forthcoming, then the dollar story will revert to its recent past. The bear case continues to be that the Fed’s largesse will dwarf all other nations’ policy easing and so the dollar should resume its decline.  The bull case is that the US economy, at least by recent data, appears to continue to be outperforming its major counterparts, and thus inward investment flows will continue.  That current account deficit is only a problem if international investors don’t want to fund it, and with US equity markets amongst the best performing asset classes globally, that funding is easy to find.  I know I’m not a technician, but recent price action certainly appears to have created a top at the highs from last week, and a further pullback toward 1.1650 seems quite viable.

It is difficult to draw many conclusions from today’s market activity, which is why I have largely ignored it.  Equity markets are leaning a bit lower, although the movement is not large, less than 1%, and the dollar is mixed against both the G10 and EMG blocs.

Arguably, the biggest market risk is that Powell doesn’t tip his hand at all, and that we are no wiser at 10:10 than we are now.  If that is the case, I think the dollar’s consolidation will continue, and by the end of the day, I imagine stock prices will have recouped their early losses.

But for today, it is all about Jay.

Good luck and stay safe

The Chairman Regales

Tomorrow the Chairman regales
Us all with the latest details
Of ways that the Fed,
When looking ahead,
Might ever consider bond sales

The one thing of which we are sure
Is ZIRP, for some years, will endure
The worry is Jay
Has nothing to say
On what he’ll do when there’s a cure

Markets have been biding their time overnight and seem likely to do so for the rest of today’s session as investors and traders await the wisdom of Chairman Powell.  Tomorrow morning’s speech is expected to define the basics of the new Fed operating framework.  In other words, it will describe their latest views on how to achieve their Congressional mandate of achieving “…maximum employment, stable prices and moderate long-term interest rates.”

It was in 2012 when the FOMC decided that 2.0% inflation was the definition of stable prices and formalized that number as their target. (Interestingly, the history of the 2.0% inflation target starts back in New Zealand in the late 1980’s, when inflation there was consistently between 15%-20%.  Donald Brash was appointed RBNZ governor and in one of his first actions decided that 2.0% inflation represented a good compromise between rampant inflation and price stability.  There was neither academic literature nor empirical data that supported this view, it was simply his feeling.  But it has since become the watchword in central banking with respect to price stability.  Remember, at 2.0% annual inflation, the real value of things halves every 20 years. Many argue that does not define price stability.)  Fortunately for us all, the Fed has been largely unable to reach their target, with measured inflation averaging 1.6% since then.  Of course, there are issues with the way inflation is measured as well, especially the Fed’s preferred gauge of Core PCE.

But regardless of any issues with the measurement of inflation, that process is not due for adjustment.  Rather, this is all about how the Fed is going to approach the problem of achieving something they have not been able to do consistently since they began the process.

The consensus view is that the Fed is now going to target the average inflation rate over time, although over what time period seems to be left unsaid.  The rationale seems to be that with the Philips Curve relationship now assumed dead (the Phillips curve is the model that explains as unemployment falls, inflation rises), and given the current dire economic situation with unemployment in double digits, the Fed wants to assure everyone that they are not going to do anything to prevent an economic recovery from not only taking off, but extending well into the future.  Thus, the idea is that even when the recovery starts to pick up steam, and presumably inflation rises alongside that recovery, the Fed will happily allow higher prices in order to help to continue to drive unemployment lower.  In other words, the famous dictum of ‘removing the punch bowl just as the party gets started’ is to be assigned to the trash heap of history.

The reason this matters to us all is that future path of inflation, and just as importantly expectations about that path, are what drive interest rates in the market, especially at the long end of the curve.  While the Fed can exert significant control over interest rates out to 2 years, and arguably out to 5 years, once you get past that, it becomes far more difficult for them to do so.  And given the fact that ZIRP and NIRP reign supreme throughout G10 economies, the long end of the curve is the only place where any yield is available.

The problem for investors is that with 30-year Treasuries yielding 1.4%, if the Fed is successful at getting inflation back above 2.0%, the real return on those bonds will be negative, and significantly so.  The alternative, of course, is for investors to sell their current holdings of those bonds, driving down prices and correspondingly raising yields to levels that are assumed to take into account the mooted higher rate of inflation.  The problem there is that the US government, who has been issuing bonds at record rates to fund the spending for Covid programs as well as to make up for lost tax revenue from the economic slowdown, will have to pay a lot more for their money.  That, too, is something that the Fed will want to prevent.  In other words, there are no really good solutions here.

However, what we have begun to see in markets is that investors are expressing concern over a rise in inflation, and so Treasury yields, as well as bond yields elsewhere, are beginning to rise.  Now, nobody would ever call 0.7% on the 10-year a high yield, but that is 0.2% higher than where it was just three weeks ago.  The same is true in the 30-year space, with similar moves seen throughout the rest of the G10 bond markets.  While deflation concerns remain the primary focus of central bankers everywhere, bond markets are beginning to look the other way.  And that, my friends, will be felt in every market around the world; equities, commodities and FX.

So, a quick look at markets this morning shows us that equities in Asia had a mixed to weaker session (Nikkei +0.0%, Hang Seng +0.0%, Shanghai -1.3%) while European bourses are mostly very modestly higher (DAX +0.5%, CAC +0.3%, FTSE 100 -0.2%).  US futures are mixed as well, although NASDAQ (+0.5%) futures continue to power ahead, the Dow and S&P are essentially unchanged.

Bond markets continue to slowly sell off as they are seeming to price in the idea that if the Fed is willing to accept higher inflation going forward, so will every other central bank.  Thus, another 3bp rise this morning in 10-year Treasuries, Bunds and Gilts has been seen.  Meanwhile, as interest rates go higher, gold is losing some of its luster, having fallen another 0.6% today which takes it nearly 8% below its recent historic peak.

And finally, the dollar is having what can only be described as a mixed session.  Versus the G10, it has gained slightly against the Euro, Danish krone and Swiss franc, and edged lower vs NZD.  Those movements are on the order of just 0.2%-0.3%, with the rest of the bloc +/- 0.1% and offering no information.  Emerging market currencies have seen similar price action, albeit with a bit more oomph, as HUF (-0.8%) and CZK (-0.6%) demonstrate their higher beta characteristics compared to the euro, while ZAR (+0.5%) continues to find buyers for their still highest yielding debt available.

As I said at the top, markets appear to be biding their time for the Chairman’s speech tomorrow morning at 9:15 NY time.  On the data front, this morning only brings Durable Goods (exp 4.8%, 2.0% ex Transport), which while generally important, will unlikely be enough to shake up the trading or investment community.  For now, the dollar’s medium-term trend lower has been halted.  Its future direction will depend largely on Mr Powell and what he has to tell us tomorrow.  Until then, don’t look for very much movement at all.

Good luck and stay safe

Amid Hyperbole

When Two Thousand Twenty began
The narrative with which we ran
Explained Trump and Xi
Were ‘bout to agree
On terms for a new trade game plan

The deal was agreed and then signed
But Covid infected mankind
Economies tanked
The market got spanked
And trade thoughts were soon left behind

So please tell me how it can be
That trade is now, quite suddenly
The reason that bulls
Are grabbing handfuls
Of risk amid hyperbole

As if to prove there is nothing new under the sun, the recent equity/risk rally is ostensibly based on the fact that the US-China phase 1 agreement, you remember the one signed back on January 15th of this year, is being enforced and followed by both sides.  It seems that good vaccine news is suffering from the law of diminishing returns, so a new story was needed to support the bull case.  Hence, news that there was a video conference between Messrs. Lighthizer, Mnuchin and He was quickly trotted out to show that all the benefits of the trade deal are still set to accrue to the US.  (It is coincidences like this one that encourage the conspiracy theorists in the world.)  At any rate, ostensibly, the result of the conversation was that both sides are fully committed to adhering to the deal, which basically means that China will be purchasing huge amounts of agricultural products from the US for the rest of the year.  Now, given that China is facing serious food shortages with food prices rising rapidly throughout the country, this shouldn’t be all that surprising.  And yet, this is the alleged impetus to go out and buy the FANGMAN group of stocks, none of whom sell as much as a single ear of corn.  Go figure!

Perhaps, however, I am being too hasty in describing the trade story as the driver of risk.  After all, it could be that German GDP ‘only’ fell -9.7% in Q2, not the -10.1% initially estimated.  Or perhaps it was the good news from Norway, where GDP was a surprisingly robust -6.3% in Q2.  If that doesn’t fit the bill, we should look to the UK, where the CBI Retailing Sales report fell back to -6, rather than rising to +6 as forecast.  I mean, isn’t this the type of news that quickens investors’ hearts?

Obviously, the point remains that the dichotomy of ongoing asset market rallies alongside ongoing economic distress has yet to change.  And while there is no question that markets are forward looking constructs, their recent ability to ignore significantly distressing economic situations and assume that economies will be returning to pre-pandemic levels of activity sooner, rather than later, is truly impressive.  Perhaps that will be the case, but as I highlighted yesterday, it may well be the most severe case of ‘buy the rumor, sell the news’ in the history of markets when that occurs.  Remember, if economies are ticking over nicely again, what rationale is there for central banks to continue to add liquidity to markets?  Why would interest rates remain pegged at 0.0% worldwide amid economic growth?  These are questions which will be much more difficult for the bulls to answer in the future, but for now, there is no need to do so.

And so, risk is rising again this morning.  We saw it in Asia, where the Nikkei (+1.35%) performed quite well, although both the Hang Seng (-0.25%) and Shanghai (-0.35%) couldn’t really get going.  European bourses, on the other hand, are uniformly green this morning, with both the DAX and CAC higher by 0.75% as I type.  And US futures have been steadily climbing all evening and are now pointing to gains of ~0.5% on the opening.

Perhaps the better risk gauge, though, is the bond market, where Treasury yields have backed up a further 3.7 basis points this morning and are pushing toward 0.70%.  Similarly, we are seeing significant selling pressure across all European government bond markets, with Bunds (+5.4bps) and Gilts (+3.7bps) having trouble finding buyers. Perhaps what is even more interesting is that Italian BTP’s (+7.1bps) are performing worst of all.  But more than simply risk-on is at work here.  In addition, we are seeing an uptick in the supply of bonds throughout the continent, and despite the ECB’s ongoing purchases, subscription rates for the new paper is falling to lower than expected levels with coverage ratios below 2.0.  I think Madame Lagarde will need to rev up the ECB’s purchases even more, which will, coincidentally, help prevent the euro from rallying too far as well.

Speaking of the euro, it has managed to trade higher by 0.3% amid broad-based dollar weakness today.  Given the news out of the Eurozone has been anything but bullish, the single currency’s strength is likely to be attributed to the dollar’s decline.  For instance, the pound has rallied 0.55% despite, arguably, worse economic data.  While NOK (+0.7%) has been leading the way in the G10 space.  Perhaps that GDP data was seen as a positive!  Confirming the idea that today is a risk-based session, the yen is the only currency weaker than the dollar, and substantially so, having fallen 0.5% thus far.  As there was no data or news overnight, the risk framework is the most likely explanation for the move.

EMG currencies have also benefitted from the risk framework today, although aside from ZAR (+1.0%) the movement has been less significant, with most currencies rising on the order of 0.25%-0.35%.  The ZAR story continues to be driven by the highest real yields available these days, and in times of limited risk concern, that is extremely attractive.

As I didn’t cover the upcoming data yesterday, let’s see what is on tap for the rest of the week:

Today Case Shiller Home Prices 3.60%
Consumer Confidence 93.0
New Home Sales 790K
Wednesday Durable Goods 4.5%
-ex Transport 1.9%
Thursday Initial Claims 1.0M
Continuing Claims 14.4M
Q2 GDP -32.5%
Friday Personal Income -0.3%
Personal Spending 1.5%
Core PCE Deflator 1.2%
Chicago PMI 52.5
Michigan Sentiment 72.8

Source: Bloomberg

Of course, despite some important data, notably the ongoing Initial Claims story, in truth, all eyes will be on Chairman Powell who speaks Thursday morning at 9:15am NY at the virtual Jackson Hole gathering.  Expectations are high that he will be explaining the Fed’s newly developed views on how they are going to manage monetary policy, and more importantly, on how they are going to view their inflation target going forward.  The consensus view is we will be moving to an average inflation target of 2.0%, meaning if inflation runs hot for a while after it has run cold for a while, they will not feel compelled to act to try to moderate it.  Given that inflation has run cold for the past decade, at least based on the way they measure it, get ready for much higher inflation in your everyday lives going forward.

And that’s really it for the day.  It strikes me that the risk-on narrative is weak this morning, and it wouldn’t surprise me to see the dollar claw back its early losses before we end the day.

Good luck and stay safe

A Shot of Caffeine

It’s true that, eternal, hope springs
And sessions like this give it wings
The news, seemingly
Is twixt Trump and Xi
Less angst will lead to better things

As well, hope has grown, a vaccine
Is likely, this year, to be seen
Now bulls rule the roost
Thus, giving a boost
To stocks like a shot of caffeine

Another day, another round of stories seemingly designed solely to boost equity markets around the world.  The first of these is a bit oblique, as the word from ‘insiders’ is that the Trump administration, despite its increasingly vocal hard line vs. the Chinese, is maintaining back channel communications, specifically regarding the WeChat app, and US companies’ ability to continue to use it in their advertising and marketing campaigns in China.  This is important as WeChat is a critical advertising venue for virtually every company in China, and if the mooted ban by the Trump administration in the US was a world-wide ban, most US companies would see their Chinese businesses devastated. If we forget, for a moment, the convenient timing of these leaked comments, this is, unarguably, good news for those US companies active in China.  Certainly, this is worth some added value to equity prices.

But let’s unpack the second story, the one about the vaccine.  While this weekend saw an announcement for the approval of another treatment, convalescent plasma injections, the big prize remains a working vaccine that is both safe and efficacious.  Briefly, the idea behind the plasma injections is that individuals who have recovered from the disease have antibodies in their blood, which can be separated and injected into severely ill patients in an effort to boost the patient’s own disease fighting capability.  As in everything to do with Covid-19, it remains experimental and there is controversy as to how well the therapy may work.  But given the desperation of some patients to get something done, the President has decided to overrule other voices and give emergency clearance.  However, this is a treatment, not a preventative.

The vaccine remains the holy grail.  To date, there are on the order of 180 different vaccines in various stages of development, 10 of which are in Phase 3 or have been given limited approvals.  Clearly, pharmaceutical companies see this as the newest potential blockbuster drug.  But the real question seems to be, even when (if) a vaccine is created, will it really change the nature of the spread of Covid-19 by that much?  It is unambiguous that the market narrative’s answer to that question is a resounding yes.  However, perhaps it is worth casting a skeptical eye on the idea.

Using influenza as our model, as it is the closest thing we have with respect to its contagion and even the structure of the disease and working under the assumption that human nature remains constant, the numbers don’t point to a vaccine as panacea.

Consider, in the US, roughly 45% of the population receives the flu vaccine each year.  In addition, it is only effective for, at most, two-thirds of those who do receive the vaccine.  Thus, the protective ‘shield’ that the flu vaccine creates is effective for roughly 30% of the population.  One of the reasons we consistently hear so much every year about getting the flu vaccine via PSA’s is that the virology community calculates we need a greater percentage of the population vaccinated to achieve a herd immunity.  And yet, the 45% inoculation rate has been pretty steady for years.  Human nature is pretty hard to change.

This begs the question, will the take-up of a Covid-19 vaccine be higher than that for the flu?  And if so, will it reach the level’s necessary to achieve herd immunity, thus encouraging governments to relax many of the current restrictions and people to resume some semblance of their former lives?

The argument for a higher take-up rate is that the media has gone out of its way to highlight the deadliness of Covid-19, in some cases exaggerating the numbers for effect, in what appears to be an attempt to sow fear in the population.  The underlying belief to this strategy is to convince a large portion of the population of the criticality of receiving the vaccine once it becomes available.  And perhaps this will be a successful strategy.  But human nature has taken a long time to evolve to where it currently resides, and the case for a flu-like take-up rate, and thus a failure to achieve herd immunity, is based on the idea that unless one has been sickened already, or personally knows someone who has, it is hard to make the case that inoculation rates will increase over those of the flu vaccine.

Alas, my money is on the under.  However, will that matter for the markets?  That is an entirely different question, and one which speaks to confidence, not data.  At this time, I would contend the underlying market belief is that a vaccine is going to be approved, and be effective, within the next twelve months.  The result will be an end to the lockdowns and a resumption in economic activity worldwide that is much closer to the pre-Covid time.  But if this is so, one needs to be careful that we are not looking at the biggest ‘but the rumor’ reaction in history, and that the approval of a safe vaccine could well be the proverbial bell for the top of the equity market.  Remember, economic growth is still a product of population growth and productivity, and there is nothing about a Covid vaccine that will have increased either of those from pre-Covid days.

That exceptionally long discussion was driven by the remarkable ongoing rally in risk assets seen this morning.  Equity markets in Asia were all higher (Nikkei +0.3%, Hang Seng +1.75%) and Europe is really on fire (DAX +2.3%, CAC +2.15%).  US futures are currently 1.0% higher and climbing.  Bonds are under modest pressure, with 10-year yields higher by 1 basis point in the US and most of Europe.  Oil prices, along with gold, are higher by 0.5%-0.7%, modest by their recent standards.  And the dollar is definitely under a bit of pressure.

In the G10 space, SEK and AUD lead the way, both higher by 0.5%, although the gains are fairly solid across the board.  In fact, despite extending the lockdown in Auckland, NZ, kiwi has retraced early losses and is higher by 0.25%.  In the EMG bloc, ZAR leads the way, up 1.2%, as the combination of risk positive stories and higher commodity prices continues to encourage investors to buy South African bonds.  But virtually the entire space is firmer this morning with two outliers, KRW (-0.25%) which fell after the central bank downgraded the economic outlook further, and TRY (-0.8%), which continue to see capital flee as the central bank is prevented by President Erdogan from raising rates.

There has been virtually no data today, and in truth, all eyes will be on Chairman Powell Thursday morning, when he speaks at the virtual Jackson Hole gathering.  Expectations are he is going to outline the new Fed framework, with a higher inflation target, and other potential changes.  But we will look into that later this week.  As for today, I see no reason to believe that the current risk attitude is going to change, so further dollar weakness is likely on the cards.

Good luck and stay safe

Destined to Suck

Remember when everyone said
That Europe’s response was ahead
Of that in the States
Well turns out the rates
Of growth, have in Europe, gone red
Plus, all of that talk of the buck
And how it was destined to suck
Well don’t write it off
Though it’s seen a trough
The bulls might soon find they’re in luck

By definition, the market narrative is difficult to rewrite.  It tends to be an evolutionary affair, something that helps to describe the zeitgeist of a particular point in time and the collection of data and comments that are most frequently highlighted and discussed at that time.  Examples are; as long as the Fed keeps printing money, equities can only go higher, or Europe handled the Covid pandemic much better than the US and so the euro will continue to rally as economic activity returns more quickly to the Continent than to the States.

About that second one…  it seems that perhaps the narrative may have gotten a bit ahead of itself.  The formulation of that narrative was based on the initial infection data, where there is no question that the US found itself with a larger infection count.  Meanwhile, draconian measures taken throughout much of Europe, after serious problems appeared in Italy, Spain and Germany, appeared to have been pretty successful in moderating the impact.  The price of those policies was made evident in Q2 GDP data, where the US, despite its horrific -9.5% quarterly result, actually outperformed even the best in Europe, Germany’s -10.2%, let alone the -12.5% to -18.7% declines seen in France, Italy and Spain.

But the working assumption was that was the nadir, and that as most of Europe had begun to reopen, things were destined to steadily get better.  Alas, this morning’s flash PMI data seems to tell a different story.  The reality is that the burgeoning second wave in Europe, where infection numbers have been increasing in all the major nations as restrictions were relaxed, has created a hiccup.  For instance, French Manufacturing PMI fell more than expected and back to 49.0, signaling contraction not growth.  Services PMI there remained above 50 but fell more than 5 points to 51.9.  These are not numbers that suggest robust economic activity.  We saw a similar outcome in Germany, with Services PMI also falling 5 points to just 50.8, although Manufacturing actually improved slightly, to 53.0 from last month’s reading of 51.0.  Overall in the Eurozone, the Services situation has deteriorated significantly, with the bloc-wide Services PMI falling to 50.1 and implying that both Italy and Spain were likely below 50.0.  Let me simply say that the narrative has “some ‘splainin’ to do”1.

Interestingly, the UK data was quite a contrast, with flash Manufacturing PMI there rising to 55.3 and Services data jumping to 60.1.  Once again, the narrative, which continues to harp on how awful things are in the UK, on what a terrible job Boris has done and how Brexit will be the death of the economy, seems to be at odds with the data.

Now, one month does not a trend make, but it certainly requires a re-evaluation of the narrative.  And that is what we are seeing this morning, and arguably what we have seen the past couple of sessions.  The euro, which just two days ago was threatening to trade above 1.20 for the first time since May 2018, is now below 1.1800 and down 0.6% on the day.  Seemingly, what we are witnessing is the combination of the most overcrowded trade (long euros/short dollars) and data releases that are directly at odds with the underlying thesis.  Of course, it is possible that later this morning, when Markit releases the US PMI data (exp 52.0 Mfg, 51.0 Services), that it too disappoints, and the euro’s losses will be unwound.  But for now, short dollar positions have to be getting a bit more uncomfortable.

Of course, there is something else we need to consider with the euro, and that is the ECB.  Yesterday’s release of the ECB Minutes from their July meeting explained that not only would the ECB purchase all the bonds authorized under the PEPP, but that they would consider doing far more as well.  And remember, if you think that the ECB is going to sit by and watch the euro rally indefinitely, undermining the export performance of the Eurozone economy, you are clearly mistaken.  The very last thing Madame Lagarde wants to see is the euro booming.  Remember, despite the flowery rhetoric regarding inflation and unemployment that comes from all G10 central banks, beggar thy neighbor currency policy remains a key policy initiative for every one of them, the Fed included.  

And so, with this as backdrop, a quick tour of the markets shows that the risk meme is difficult to assess right now.  Equity markets in Asia were modestly higher (Nikkei +0.2%, Shanghai +0.5%) but those in Europe are flat to modestly lower (DAX 0.0%, CAC -0.1%, FTSE 100 -0.1%).  Meanwhile, US futures are softening as I type, but the damage is 0.25% or less at this time.  Bond markets continue to see inflows as yields throughout the world edge lower. Treasuries and Bunds have both rallied such that yields have declined 1.5 basis points, and we have seen similar movement in the UK despite the release of data showing that the UK’s debt load has risen above £2 trillion for the first time and the debt/GDP ratio is now above 100%.

Commodity prices continue to chop a great deal but have not really gone anywhere.  This morning, oil is lower by a bit more than 1%, but it is actually slightly higher on the week.  Gold too, is a bit softer this morning, but basically back to where it started out on Monday.  Overall, there has been no real directional information coming from this sector.

As to the dollar, it is definitely having another good day in the markets.  Only JPY (+0.15%) and NZD (+0.1%) have managed to hold their own vs. the greenback today with the rest of the G10 lower.  The fact is, there is no real explanation in either of these currencies to describe their modest strength, other than position modification into the weekend.  Meanwhile, SEK (-0.7%) has been the worst performer after data showed that Industry Capacity fell to a record low, and far worse than expected 82.8%.

EMG currencies are also under pressure this morning with the CE4 bearing the brunt of the fall (HUF -1.2%, PLN -0.8%, CZK -0.7%).  Asian currencies saw much less movement, with the entire space +/- 0.25% as several countries in the region celebrated obscure holidays.  However, I can assure you that if the dollar has found a short-term bottom, these currencies are destined to suffer as well.

And that’s really it as we head into the weekend.  Aside from the PMI data, we see Existing Home Sales (exp 5.41M) at 10:00 and there are no Fed speakers on the docket.  So, once again the FX markets are likely to take their cues from the equity space, and if futures are pointing the way, a bit more USD strength is in order.

Good luck, stay safe and good weekend


  1. For those unfamiliar with I Love Lucy, I can only suggest you watch reruns on Netflix.  It is one of the all-time greatest sitcoms and the source of the phrase.

Hard to Construe

The Fed explained that in their view
The future was hard to construe
That’s why they decided
No guide be provided
Instead on the data they’ll chew
In what cannot be a surprise
The market did not think this wise
And so, it transpired
Investors desired
The Fed, its next moves, formalize

There is only one story in the markets today and it began yesterday afternoon with the release of the FOMC Minutes from the July meeting.  Expectations were running high that the Fed would not merely have discussed the formalization of forward guidance but would have come close to deciding to which factors they wanted to tie their future actions.  The mooted choices were the inflation rate, the unemployment rate, the level of the S&P 500 or the calendar.  (Yield Curve Control had already seemed to be a dead issue before that meeting occurred.)  Alas, they did none of the above.  Instead, the Minutes showed that while the discussion was had, no decisions had been made, and given their collective concern that the future path of economic growth could be hindered further by any resurgence in Covid-19, the best course of action was to leave all options on the table.  

Some would contend that this was, in fact, as dovish as the Fed could possibly be.  After all, they simply maintained that they will do whatever they deem necessary to support the economy and the smooth functioning of markets.  But apparently, that is the minority view.  What we saw instead was a clear indication that the investor community thought this was a hawkish outcome as evidenced by both the sell-off in equity markets and just as importantly, the rebound in the dollar.

At this point in time, one cannot read a financial website without seeing at least one article each day about the dollar’s incipient decline.  Futures markets show record short dollar positions and the fundamentalists continually point to the burgeoning twin deficits (budget and current account) as well as the Fed’s ultra-easy monetary policy as the reasons the dollar is soon to fall sharply.  Clearly, the dollar bears were counting on the Fed cementing even more policy ease into the mix, thus undermining the greenback further.

Surprise!  It turns out that the Fed’s unwillingness to commit was seen as hawkish instead.  The result was that the short dollar trade, which has been quite successful this summer (EUR +5.2%, GBP +5.0%, SEK +6.9% since July 1st) had also become increasingly crowded and the lack of commitment by the Fed served as either a signal or an excuse to lighten up positions.  Hence, the dollar, which in fairness had started to rebound yesterday morning, jumped even further and is now nearly 1% stronger than the lows seen yesterday.  It is entirely possible that this is simply a short-term correction in what is potentially a long-term trend of dollar weakness.  It is also possible that this may have marked the medium-term bottom for the dollar as investors reconsider where to deploy their assets.  Just like the Fed explained, the future is very uncertain, especially with the ongoing wildcard of Covid-19 and the potential for a second wave of infections having a significantly negative impact on the economy.  And ironically, if things get worse, especially if it leads to the jettisoning of risk by investors, the dollar is far more likely to rebound further than to decline.

With that in mind, let’s take a look at markets this morning.  The clear theme, following from yesterday’s price action, is that risk is under assault today.  Equity markets in Asia saw declines across the board (Nikkei -1.0%, Hang Seng -1.5%, Shanghai -1.3%) and Europe is a sea of red as well (DAX -0.9%, CAC -1.1%, FTSE 100 -1.15%).  US futures?  All are lower, but in fairness not by very much, less than 0.3% in all three indices.

But bond markets are also seeing risk-off behavior as Treasury yields continue to slide with the 10-year down another 2.5 basis points, to 0.65%, and most European government bond markets rallying as well.  

Commodity prices are little changed as both oil and gold consolidate recent moves.  One thing we can confirm these days is that commodity prices are living up to their historical reputation for excessive movement.  For example, this week alone, gold has rallied more than 3.5% and then reversed all that rally and then some and is now lower by 0.75% since Monday’s open.  That calculates to something on the order of 40% annualized volatility, levels which have not been seen in decades.

Finally, the dollar this morning is doing generally quite well, although it is off its early session highs.  Keeping with the risk-off theme, we have seen both CHF (+0.4%) and JPY (+0.2%) rally alongside the dollar in the G10 space.  Meanwhile, the commodity currencies and Skandies are suffering today with the euro simply unchanged.  In the EMG space, most CE4 currencies are holding their own, having rebounded from early session lows, but we saw pretty consistent weakness from Asian currencies (THB -0.7%, KRW -0.5%) and both TRY (-0.8%) and RUB (-0.7%) are feeling the strain right now.  The baht is suffering as investors have been liquidating equity investments there during an increase in protests over the government’s handling of the Covid pandemic.  The won is also suffering from Covid induced weakness as the number of cases continues to expand and further restrictions are considered by the government.  

Looking ahead to today’s session, we receive some hard data with the potential to alter views.  At 8:30 we get Initial Claims (exp 920K), Continuing Claims (15.0M) and Philly Fed (20.8).  Last week was the first since early March where the Initial Claims data printed below one million, but there continues to be concern that since the US government has not been able to agree on a new fiscal support package, we may see that number start to turn back higher.  That would be dire indeed.  In fact, if we have seen the nadir in the Claims data, we should expect the Fed to become far more active once again, arguably satisfying the investment community and perhaps pushing the dollar lower.  As to the Philly Fed Survey, expectations are for the rebound to continue, but the Empire Manufacturing data on Monday was quite disappointing.  Watch for weakness there as it, too, could result in calls for more Fed ease.

The dollar has fallen a pretty long way in less than two months.  Much of that movement has come from the reduction in overall economic fear.  While Tuesday’s housing data was quite strong, I think the employment situation remains far more important to the Fed and so any indication the recent positive trend is reversing is likely to bring a reaction.  That is likely to halt the dollar’s rebound in its tracks.  Otherwise, another percent or two higher would not be a surprise.

Good luck and stay safe


Gone Undetected

When Covid, last winter, emerged
Most government bond prices surged
As havens were sought
And most people thought
That price pressures would be submerged

But since then, with six months now passed
Economists all are aghast
Deflation expected
Has gone undetected
As price levels beat their forecasts

You may recall that when the coronavirus first came to our collective attention at the end of January, it forced China to basically shut down its economy for three weeks. At that time, expectations were for major supply chain disruptions, but concerns over the spread of the virus were not significant. Economists plugged that information into their models and forecast price rises due to supply constraints. Of course, over the next two months as Covid-19 spread rapidly throughout the rest of the world and resulted in lockdowns of economic activity across numerous countries, the demand destruction was obvious. Economists took this new information, plugged it into their models and declared that the deflationary pressures would be greater than the supply chain disruptions thus resulting in deflation, and more ominously, could result in a deflationary spiral like the one the US suffered during the Great Depression.

Central banks didn’t need their arms twisted to respond to that message, especially since the big three central banks, the Fed, ECB and BOJ, had all been struggling to raise inflation to their respective targets for nearly ten years. Thus began the greatest expansion of monetary stimulus in history. Throughout this period, central bankers pooh-poohed the idea that inflation would emerge by pointing to the financial crisis of 2008-9, when they implemented the previously greatest expansion in monetary policy, flooding economies with money, yet no inflation was recorded. At least, price inflation in goods and services, as measured by governments, remained subdued throughout the period.

But there is a very big difference between the current economic situation and the state of things back in 2009. During the financial crisis, banks were the epicenter of the problem, and printing money and injecting it into banks was all that was needed to prevent a further collapse in the economy. In fact, fiscal policy was relatively tight, so all that money basically sat on bank balance sheets as excess reserves at the Fed. There was no increase in buying pressure and thus no measured inflation. In fact, the only thing that inflated was financial asset prices, as the central bank response led to a decade long boom in both stock and bond prices.

In 2020 however, Covid-19 has inspired not just central bank action, but massive fiscal stimulus as well. At this point, over $10 trillion of fiscal stimulus has been implemented worldwide, with the bulk of it designed to get money into the hands of those people who have lost their jobs due to the economic shutdowns worldwide. In other words, this money has entered the real economy, not simply gone into the investment community. When combining that remarkable artificial increase in demand with the ongoing supply chain breakages, it is not hard to understand that price pressures are going to rise. And so they have, despite all the forecasts for deflation.

Just this morning, the UK reported CPI rose 1.0% Y/Y in July, 0.4% more than expected. Core CPI there rose 1.8% Y/Y, 0.6% more than expected. This outcome sounds remarkably like the US data from last week and shows this phenomenon is not merely a US situation. The UK has implemented significant fiscal stimulus as well as monetary support from the BOE. The UK has also seen its supply chains severely interrupted by the virus. The point is, prices seem far more likely to rise during this crisis than during the last one. We are just beginning to see the evidence of that. And as my good friend, @inflation_guy (Mike Ashton) explains, generating inflation is not that hard. Generating just a little inflation is going to be the problem. Ask yourself this, if the economy is still dragging and inflation starts to rise more rapidly than desired, do you really think any central bank is going to raise rates? I didn’t think so. Be prepared for more inflation than is currently forecast.

With that in mind, let us consider what is happening in markets today. Once again the picture is mixed, at least in Asia, as today the Nikkei (+0.25%) found a little support while the Hang Seng (-0.75%) and Shanghai (-1.25%) came under pressure. European exchanges are showing very modest gains (DAX +0.25%, CAC +0.1%) and US futures are all barely in the green. This is not a market that is excited about anything. Instead, investors appear to be on the sidelines with no strong risk view evident.

Turning to bond markets, we continue to see Treasury yields, and all European bond yields as well, slide this morning, with the 10-year Treasury yield down 2 basis points and similar declines throughout Europe. Commodity markets are showing some weakness, with both oil (WTI -0.9%) and gold (-0.6%) softer this morning. Add it all up and it feels like a bit of risk aversion rather than increased risk appetite.

And what of the dollar? Despite what has the feeling of some risk aversion, the dollar is slightly softer on the day, with most currencies showing some strength. In the G10 space, NZD is the outlier, rising 0.7% on the back of a massive short squeeze in the kiwi. But away from that, the movement has been far more muted, and, in fact, the pound is softer by 0.2% as traders are beginning to ask if Brexit may ultimately be a problem. In addition, while the UK inflation data was much higher than expected, there is certainly no indication at this time that the BOE is going to reverse course anytime soon. I have to say that the pound above 1.32 does seem a bit overextended.

EMG currencies are a more mixed picture with RUB (-0.3%) responding to oil’s modest decline, while ZAR has pushed higher by 0.6% on the back of strong foreign inflows for today’s local bond auctions. In what appears to be a benign environment, the hunt for yield is fierce and South Africa with its nominal yields above 9% in the 10-year and inflation running well below 3% is certainly attractive. But otherwise, movement has been uninteresting with most currencies edging higher vs. the dollar this morning.

On the data front today, the only US release is the FOMC Minutes from the July meeting where analysts will be searching for clues as to the Fed’s preferred next steps. More specific forward guidance tied to economic indicators seems to be in the cards, with the key question, which indicators?

Add it all up and we have another slow summer day where the dollar drifts lower. Arguably, the biggest unknown right now would be an agreement on the next US fiscal stimulus package, which if announced would likely result in a weaker dollar. However, I am not willing to forecast the timing of that occurring.

Good luck and stay safe

Their Siren Song

The trend ‘gainst the dollar is strong
With bears playing their siren song
As long as real rates
Are in dire straits
‘Twould be a mistake to go long

While there is usually some interesting tidbit on which to focus regarding market behavior that is not specifically FX related, this morning that does not seem to be the case. In fact, today’s most noteworthy story is that the dollar continues to drive lower vs. almost all its counterparts. As there was no specific news or data that appears to be driving other currencies higher, I can only attribute this broad resumption of the dollar downtrend to the fact that real interest rates in the US have turned back lower.

Looking back a few weeks, 10-year US real interest rates (nominal – CPI) bottomed at -1.08% on August 6th. That coincided with the peak price in gold, as well as the euro’s local high. But then Treasury yields began to back up as the bond market started getting indigestion from the Treasury issuance schedule ($316 billion total since then, of which $112 billion were Notes and Bonds.) The problem is that not merely is the size of the issuance unprecedented, but that it shows no signs of slowing down as the government continues to run massive deficits.

At any rate, real yields backed up by 14 basis points in the ensuing week, which resulted in both a sharp correction in the price of gold, and support for the dollar. But it seems that phase of the market may be behind us as Treasury yields have been sliding on both a nominal and real basis, and we have seen gold (and silver) recoup those losses while the dollar has ceded its gains and then some.

At this point, the question becomes, what is driving real yields? Is it fears of rising inflation? Is it hope that the Fed will maintain ultra-easy monetary policy even if the economy recovers strongly? Or is it something else?

Regarding the pace of inflation, while last week’s CPI data was certainly a shock to most eyes, it doesn’t seem as though it is the driver. I only point this out because the nadir in real yields occurred a week before the CPI data was released. Now it is certainly possible that bond investors were anticipating a higher inflation print, but there was absolutely no indication it would be as high as it turned out to be. In fact, based on the CPI release, I would have anticipated real yields to fall further, as the combination of higher inflation and a Fed that is essentially ignoring inflation at the current time is a recipe for further declines there. Remember, everything we have heard from the Fed is that not merely are they unconcerned with inflation, but that they welcome it and are comfortable allowing it to run hotter than their target for a time going forward.

This latter commentary implies that there is not going to be any change in the Fed’s policy stance in the near future either. Rather, Chairman Powell has made it clear that the Fed is going to provide ongoing support and liquidity to the markets economy for as long as they deem it necessary. Oh, and by the way, they have plenty of tools left with which to do so.

If these are not viable explanations for the change in trend, one other possible driver is the vagaries of the ongoing pandemic. Perhaps there is a relationship between increases in infection rates and investor assessments of the future. Logically, that would not be far-fetched, and there is growing evidence that there is a correlation between market behavior and covid news. Specifically, when it appears that covid is in retreat, bond yields tend to rise, and so real rates have been moving in lockstep. As well, when the news indicates that the virus is resurgent, the yield complex tends to head lower. Thus, in a convoluted way, perhaps the dollar bearishness that has become so pervasive is being driven by the idea that the US continues to suffer the most from Covid-19, and as long as that remains the case, this trend will remain intact.

Now, I would not want to base all my trading and hedging decisions on this idea, but it is certainly worth keeping in mind when looking at short-term risk exposures and potential timing to manage them.

But as I said at the top, overall, there is very little of note in the financial press and not surprisingly, market activity has been fairly muted. For example, equity markets in Asia basically finished either side of unchanged on the day (Nikkei -0.2%, Hang Seng +0.1%, Shanghai +0.3%). Europe, which had been largely unchanged all morning has been on a late run and is now nicely higher (DAX +0.9%, CAC +0.6%) and US futures have also edged up from earlier unchanged levels. As discussed, Treasury yields continue to drift lower (-1.5 basis points) and gold is rocking (+1.0% and back over $2000/oz.)

And the dollar? Well, it is definitely on its back foot this morning, with the entire G10 complex firmer led by GBP (+0.5%) on the strength of optimism over the resumption of Brexit talks and JPY (+0.45%) which seems to be benefitting from the ongoing premium for owning JGB’s and swapping back to USD.

In the EMG bloc, RUB (+0.8%) is the leader today, followed by ZAR (+0.7%) and MXN (+0.65%). All of these are benefitting from firmer commodity prices which, naturally are helped by the dollar’s broad weakness. But other than TRY (-0.2%) which has fallen in nine of the past ten sessions as President Erdogan and the central bank undermine the lira, and IDR (-0.3%), which has also seen a string of suffering, but this based on difficulty dealing with Covid effectively, the rest of the bloc is modestly firmer vs. the greenback.

On the data front, this morning brings Housing Starts (exp 1245K) and Building Permits (1326K), which if wildly different than expectations could have a market impact, although are likely to be ignored by traders. Rather, the trend in the dollar remains lower, with the euro actually setting new highs for the move this morning, and until we see a change in the rate structure, either by US real rates rising, or other real rates falling more aggressively, I expect this trend will continue. Hedgers, choose your spots, but don’t miss out.

Good luck and stay safe

A Tiny Tsunami

Covid’s wrought havoc
Like a tiny tsunami
Can Japan rebound?

In what is starting off as a fairly quiet summer morning, there are a few noteworthy items to discuss. It cannot be surprising that Japan’s economy suffered greatly in Q2, given the damage to economic activity seen worldwide due to Covid-19. Thus, although the -7.8% Q2 result was slightly worse than forecast, it merely served to confirm the depths of the decline. But perhaps the more telling statistic is that, given Japan was in recession before Covid hit, the economy there has regressed to its size in 2011, right after the Tohoku earthquake and tsunami brought the nation to its knees.

Back then, the dollar had been trending lower vs. the yen for the best part of the previous four years, so the fact that it dropped sharply on the news of the earthquake was hardly surprising. In fact, it was eight more months before the dollar reached its nadir vs. the yen (75.35), which simply tells us that the trend was the driver and the singular event did not disrupt that trend. And to be clear, that trend was quite steep, averaging nearly 11% per year from its beginning in 2007. In comparison, the current trend in USDJPY, while lower, is much less dramatic. Since its recent peak in June 2015, the entire decline has been just 15.5% (~3.2% per annum). Granted, there have been a few spikes lower, most recently in March during the first days of the Covid panic, but neither the economic situation nor the price action really resembles those days immediately after Tohoku.

The point is, while the dollar is certainly on its back foot, and the yen retains haven status, the idea of a dollar collapse seems far-fetched. I’m confident that Japan’s Q3 data will show significant improvement compared to the Covid inspired depths just reported, but given the massive debt overhang, as well as the aging demographics and trend growth activity in the country, it is likely to be quite a few years before Japan’s economy is once again as large as it was just last year. Ironically, that probably means the yen will continue to trend slowly higher over time. But even getting to 100 will be a long road.

The other interesting story last night was from China, where the PBOC added substantially more liquidity to the markets than had been anticipated, RMB 700 billion in total via one-year injections. This more than made up for the RMB550 billion that is maturing over the next week and served as the catalyst for the Shanghai Exchange’s (+2.35%) outperformance overnight. This merely reinforces the idea that excess central bank liquidity injections serve a singular purpose, goosing stock market returns supporting economic activity.

There is something of an irony involved in watching the central banks of communist nations like China and Russia behave as their actions are essentially identical to the actions of central banks in democratic nations. Is there really any difference between the PBOC injecting $100 billion or the Fed buying $100 billion of Treasuries? In the end, given the combination of uncertainty and global ill will, virtually all that money finds its way into equity markets, with the only question being which nation’s markets will be favored on any given day. It is completely disingenuous for the Fed, or any central bank, to explain that their activities are not expanding the current bubble in markets; they clearly are doing just that.

But the one thing of which we can be certain is that they are not going to stop of their own accord. Either they will be forced to do so after changes in political leadership (unlikely) or the investment community will become more fearful of their actions than any possible inaction on their parts. It is only at that point when this bubble will burst (and it will) at which time central banks will find themselves powerless and out of ammunition to address the ensuing financial distress. As to when that will occur, nobody knows, but you can be certain it will occur.

And with that pleasant thought now past, a recap of the overnight activity shows that aside from Shanghai, the equity picture was mixed in Asia (Nikkei -0.8%, Hang Seng +0.6%) while European bourses are similarly mixed (DAX +0.2%, CAC 0.0%, Spain’s IBEX -0.75%). US futures are modestly higher at this point, but all well less than 1%. Bond markets are starting to find a bid, with 10-year Treasuries now down 1.5 basis points, although still suffering indigestion from last week’s record Treasury auctions. And in fact, Wednesday there is another huge Treasury auction, $25 billion of 20-year bonds, so it would not be surprising to see yields move higher from here. European bond markets are all modestly firmer, with yields mostly edging lower by less than 1bp. Commodity markets show oil prices virtually unchanged on the day while gold (and silver) are rebounding from last week’s profit-taking bout, with the shiny stuff up 0.5% (AG +2.1%).

Finally, the dollar is arguably slightly softer overall, but there have really been no large movements overnight. In G10 world, the biggest loser has been NZD (-0.3%) as the market voted no to the announcement that New Zealand would be postponing its election by 4 weeks due to the recently re-imposed lockdown in Auckland. On the plus side, JPY leads the way (+0.25%, with CAD and AUD (both +0.2%) close by on metals price strength. Otherwise, this space is virtually unchanged.

Emerging markets have had a bit more spice to them with RUB (-1.25%) the outlier in what appears to be some position unwinding of what had been growing RUB long positions in the speculative community. But away from that, HUF (-0.6%) is the only other mover of note, as investors grow nervous over the expansion of the current account deficit there.

This week’s data releases seem likely to be less impactful as they focus mostly on housing:

Today Empire Manufacturing 15.0
Tuesday Housing Starts 1240K
  Building Permits 1320K
Wednesday FOMC Minutes  
Thursday Initial Claims 915K
  Continuing Claims 15.0M
  Philly Fed 21.0
Friday Manufacturing PMI 51.8
  Services PMI 51.0
  Existing Home Sales5.40M  

Source: Bloomberg

Of course, the FOMC Minutes will be greatly anticipated as analysts all seek to glean the Fed’s intentions regarding the policy overhaul that has been in progress for the past year. Away from the Minutes, though, there are only two Fed speakers, Bostic and Daly. And let’s face it, pretty much every FOMC member is now on board with the idea that raising the cost of living inflation is imperative, and that if inflation runs hot for a while, there is no problem. Clearly, they don’t do their own food-shopping!

It is hard to get too excited about markets one way or the other today, but my broad view is that though the medium-term trend for the dollar may be lower, we continue to be in a consolidation phase for now.

Good luck and stay safe