As travel restrictions expand
And quarantines spread ‘cross the land
It’s hard to believe
That we’ll soon achieve
A surge to pre-Covid demand

Risk is having a tough day today as new travel restrictions announced by the UK, regarding travelers from France and the Netherlands, as well as four small island nations, has raised the specter of a second wave of economic closures. In fact, while the headlines are hardly blaring, the number of new infections in nations that had been thought to have achieved stability (Germany, France, Spain and New Zealand) as well as those that have never really gotten things under control (India, Brazil and Mexico) indicates that we remain a long way from the end of the pandemic. Given the market response to this news, it is becoming ever clearer that expectations for that elusive V-shaped recovery have been a key driver to the ongoing rebound in risk appetites worldwide.

However, most recent data has pointed to a slowing of economic activity in the wake of the initial bounce. Exhibit A is China, where Q2 GDP grew a surprising 3.2%, but where the monthly data released last evening showed IP (-0.4% YTD) and Retail Sales (-9.9% YTD) continue to lag other production indicators. The very fact that Retail Sales continues to slump is a flashing red light regarding the future performance of the Chinese economy. Remember, they have made a huge effort to convert their economy from a highly export-oriented one to a more domestic consumer led economy. But if everyone is staying home, that becomes a problem for growth. And the word is, at least based on several different BBG articles, that many Chinese are reluctant to resume previous activities like going out to dinner or the movies.

The upshot is that the PBOC will very likely be back adding stimulus to the economy shortly, after a brief hiatus. Since it bottomed at the end of May, the renminbi had rallied 3.35%, and engendered stories of ongoing strength as the Chinese sought to reduce USD utilization. A big part of that story has been the idea that China has left the pandemic behind and was set to get back to its days of 6% annual GDP growth. Alas, last night’s data has put a crimp in that story, halting the CNY rally, at least for the moment.

But back to the broader risk picture, which shows that equity markets in Europe are suffering across the board (DAX -1.3%, CAC -2.0%, FTSE 100 -2.1%) as not only has the UK quarantine news shocked markets, but the data continues to be abysmal. This morning it was reported that Eurozone employment had fallen 2.8% in Q2, the largest decline since the euro was born in 1999, and essentially wiping out 50% of all jobs created during the past two decades. Meanwhile, Eurozone GDP fell 12.1% in Q2 and was lower by 15% on a year over year basis last quarter. While the GDP outcome may have been forecast by analysts, it remains a huge gap to overcome for the economies in the Eurozone and seems to have forced some reconsideration about the pace of future growth.

And perhaps, that is today’s story. It seems that there is a re-evaluation of previous assumptions regarding the short-term future of the global economy. US futures are pointing lower although are off their worst levels of the overnight session. Treasury yields, after rising sharply yesterday in the wake of a pretty lousy 30-year auction, have fallen back 2.5 basis points to 0.70%, still well above the lows seen two weeks ago, but unappetizing, nonetheless. Commodity prices are slipping with both oil (-0.5%) and gold (-0.4%) a bit lower. And the dollar is modestly firmer along with the yen, an indication that risk is under pressure.

In the G10, aside from the yen, which seems clearly to be benefitting from today’s risk mood, the pound has actually edged a bit higher, 0.3%, after comments by the UK’s chief Brexit negotiator, David Frost, indicated his belief a deal could be reached by the end of September. Meanwhile, NOK (-0.5%) is the worst performer in the bloc as the decline in oil prices has combined with a strong weekly performance driving profit-taking trades and pushing the currency back down. The rest of the bloc is broadly softer, but the movement has been modest at best.

In the EMG space, there are more losers than gainers with RUB (-0.6%) not surprisingly the laggard, although TRY (-0.5%) continues to demonstrate how to destroy a currency’s value with bad policymaking. The rest of the space is generally softer by much smaller amounts and there has only been one gainer, PHP (+0.2%) which, remarkably, seems to be benefitting from the idea that the central bank is openly monetizing debt. Historically, this type of activity, especially in emerging market economies, was seen as a disaster-in-waiting and would result in a much weaker currency. But apparently, in the new Covid age, it is seen as a mark of sound policy.

A quick diversion into debt monetization and the potential consequences is in order. By this time, MMT has become a mantra to many who believe that inflation is a thing of the past and without inflation, there is no reason for governments that print their own currency to ever stop doing so, thus supporting economic activity. But I fear that view is hugely mistaken as the lessons learned from the economic response to the GFC are not applicable here. Back then, all the new liquidity that was created simply sat on bank balance sheets as excess reserves at the Fed. Very little ever made its way into the real economy. Obviously, it did make it into the stock market.

But this time, there is not merely monetary support, but fiscal support, with much of the money being spent by those recipients of the $1200 bonus check, the $600/week of topped up Unemployment benefits, and the $billions in PPP loans. At the same time, factory closures throughout the nation have reduced the production of ‘stuff’ while government restrictions have reduced the availability of many services (dining, movies, health clubs, etc.) Thus, it becomes easy to see how we now have a situation where a lot more money is chasing after a lot less stuff. Yes, the savings rate has risen, but this is a recipe for inflation, and potentially a lot of it. MMT proponents claim that inflation is the only thing that should moderate government spending. But ask yourself this question, is it realistic to expect the government to slow or stop spending just because inflation starts to rise? Elected officials will never want to derail that gravy train, despite the consequences. And while MMT is not official policy, it is certainly a pretty fair description of what the Fed is currently doing, buying virtually all the new Treasury debt issued. Do not be surprised when next month’s CPI figures are higher still! And the month after…

Anyway, this morning brings Retail Sales (exp +2.1%, +1.3% ex autos) as well as Nonfarm Productivity (1.5%), Capacity Utilization (70.3%), IP (3.0%), Business Inventories (-1.1%) and finally, Michigan Sentiment (72.0). Retail Sales will get all the press. A soft number is likely to enhance the risk-off mood and help the dollar edge a bit higher, while a strong print should give the bulls a renewed optimism with the dollar suffering as a consequence.

Good luck, good weekend and stay safe
Adf