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