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
- 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.