With Thanksgiving now in the past
And Christmas approaching quite fast
The only thing clear
Through end of the year
Is dollar shorts have been amassed
For many, conviction is strong
That currencies, they need be long
The idea, it seems
Is post-Covid themes
Mean risk averse views are now wrong
Having been away for a week, the most interesting thing this morning is the rising conviction in the view that the dollar has much further to decline in 2021. Much is made of the fact that since its Covid induced highs in March, the dollar has fallen by more than 12% vs the Dollar Index (DXY) which is basically the euro. Of course, that is nothing compared to the recoveries seen by the commodity currencies like NOK (+33.2%), AUD (+27.6%) and NZD (+23.6%) over the same period. Yet when viewed on a year-to-date basis, the movement is far less impressive, with NOK actually unchanged on the year, and the leader, SEK, higher by 10.8%. It is also worth remembering that the euro has rallied by a relatively modest 6.9% thus far in 2020, hardly worthy of the term dollar collapse.
In addition, as I have written before, but given the growing dollar bearish sentiment, I feel worth repeating, is that in the broad scheme of things, the dollar is essentially right in the middle of its long-term trading range. For instance, from the day the euro came into existence, January 1, 1999, the average daily FX rate, according to Bloomberg, has been 1.1999, almost exactly where it currently trades. It has ranged from a low of 0.8230 in October 2000 to a high of 1.6038 the summer before the GFC hit. The point is EURUSD at 1.20 is hardly unusual, neither can it be considered weak nor strong.
Unpacking the rationale, as best I understand it, for the dollar’s imminent decline, we see that a great deal of faith is put upon the idea of a continuing risk rally over the next months as the global economy recovers with the advent of the Covid vaccines that seem likely to be approved within weeks. The sequence of events in mind is that the distribution of the vaccine will have the dual impact of dramatically reducing the Covid caseloads while simultaneously reinvigorating confidence in the population to resume pre-Covid activities like going out to restaurants, bars and the movies, as well as resuming their travel plans. The ensuing burst of activity will result in a return to pre-Covid levels of economic activity and all will be right with the world. (PS pre-Covid economic activity was a desultory 1.5% GDP growth with low inflation that caused the central bank community to maintain ultra-low interest rates for a decade!)
Equity markets, which are seemingly already priced for this utopian existence, will continue to rally based on the never-ending stream of central bank liquidity…or is it based on the massive growth in earnings given the near certainty of higher taxes and higher interest rates in the future. No, it can’t be the second view, as higher taxes and higher interest rates are traditionally equity negatives. So perhaps, equity markets will continue to rally as the prospect of future growth will remain just close enough to seem real, but far enough away to discourage policymakers from changing the rules now. Perhaps this is what is meant by the Goldilocks recovery.
Of course, while commodity markets have bought into the story hook, line and sinker, it must be recalled that they have been the greatest underperforming segment of markets for the past decade. Since December 1, 2010, the Goldman Sachs Commodity Index (GSCI) has fallen 36.5%, while the S&P500 has rallied 191%. My point is the fact that commodity markets are performing well with the prospects of incipient economic growth ought not be that surprising.
The fly in the ointment, however, is the bond market, where despite all the ink spilled regarding the reflation trade and the steepening of the US Treasury yield curve, 10-year Treasuries refuse to confirm the glowing views of the future. At least, while they may be agnostic on growth, there is certainly little concern over a rekindling of inflation, despite the earnest promises of every central banker in the world to stoke the fires and bring measured inflation back to their targets. As I type this morning, 10-year Treasury yields are 0.85%, right in the middle of its range since the US election. You remember that, the event that was to usher in the great reflation?
In the end, while sentiment has clearly been growing toward a stronger recovery next year, encouraging risk appetites in both G10 and, especially, EMG economies, as yet, the data has not matched expectations, and positioning remains based on hope rather than evidence.
Now a quick tour around today’s markets shows that the equity rally has paused, at the very least, with weakness in Asia (Nikkei -0.8%, Hang Seng -2.1%, Shanghai -0.5%) despite stronger than expected economic data from both Japan (IP +3.8%) and China (Mfg PMI 52.1, non-Mfg PMI 56.4). European markets are also mostly in the red, although the DAX (+0.2%) is the exception to the rule. However, the CAC (-0.4%) and FTSE 100 (-0.15%) have joined the rest of the continent lower despite positive comments regarding a Brexit deal being within reach this week. US futures have a bit of gloom about themselves as well, with both DOW and SPX futures pointing to 0.5% declines at the open, although NASDAQ futures are little changed at this hour.
Surprisingly, despite the soft tone in the equity markets, European government bond yields are all edging higher, with Bunds (+1.6bps) pretty much defining the day’s activity as most other major markets are seeing similar moves, including Treasuries (+1.8 bps). Commodity prices are under pressure with oil (-1.3%) and gold (-0.9%) both suffering although Bitcoin seems to be regaining its footing, rallying 2.3% this morning.
Finally, the dollar, is under a modicum of pressure this morning with G10 currencies mostly a bit firmer (NOK and SEK +0.4%) GBP (+0.3%), although AUD (-0.1%) seems to be getting nosebleeds as it approaches its highest level in two years. Potentially, word that China has slapped more tariffs on Australian wines, as the acrimony between those two nations escalates, could be removing the rose-colored tint there. Meanwhile, in the EMG bloc, there is a mix of activity, with some gainers (HUF +0.8%) and BRL (+0.65%), and some losers (ZAR -0.3%), KRW (-0.25%). Broadly, the commodity focused currencies here are feeling a little pressure from the underperformance in oil and metals, while the CE4 are tracking the euro nicely.
It is an important data week, and we also hear from numerous central bankers.
|Fed Beige Book|
|Average Hourly Earnings||0.1% (4.2% Y/Y)|
|Average Weekly Hours||34.8|
In addition, we have seven Fed speakers this week, including most importantly, Chairman Powell’s testimony to the Senate Banking Committee tomorrow and the House Finance Panel on Wednesday. We also hear from Madame Lagarde twice this week, and with the euro hovering just below 1.20, be prepared for her to mention that a too-strong euro is counterproductive. You may recall in early September, the last time the euro was at these levels, that both she and Philip Lane, ECB Chief Economist, were quickly on the tape talking down the single currency. Although since that time CNY has rallied strongly (+4%) thus removing some of the pressure on the ECB, there is still no way they want to see the euro rally sharply from here.
But do not be surprised to see the market test those euro highs today or tomorrow, if only to see the ECB response and pain threshold. Clearly, momentum is against the greenback lately, and today is no exception, but I do not buy the dramatic decline story, if only because no other central bank will sit idly by and allow it.
Good luck and stay safe