While stock markets make all-time highs
The world’s central banks still advise
More money they’ll print
In case there’s a hint
That prices will simply not rise
In a chicken and egg type question, it is worth asking; is the fact that equity markets continue to rally (yet another all-time high was recorded yesterday, this time by the Dow) despite the fact that economies worldwide remain in chaos and operating at a fraction of their capacity, as governments impose another wave of lockdowns throughout Europe, the UK and many US states, logical? Obviously, the link between those dichotomous outcomes is the support provided by the central banking community. Perhaps the way to frame the question is, if markets have already seen past the end of the pandemic, and are willing to fund the business community right now, why do central banks feel they need to, not merely continue with their programs, but promise to increase them going forward?
This was made clear, yet again, when Fed Vice-Chair, Richard Clarida, explained that the FOMC is carefully evaluating the current situation and will not hesitate to use all available tools to help support the economy. The punditry sees this as a code for an increase in the size of the asset purchase program, from the current $120 billion each month (split $80 billion Treasuries and $40 billion mortgages) to as much as $160 billion each month, with the new money focused on Treasuries. At the same time, ECB Chief Economist, Philip Lane, explained that the central bank will provide enough monetary stimulus to make sure governments, companies and households have access to cheap credit throughout the coronavirus crisis.
And perhaps, that is the crux of the problem we face. Despite investor optimism that the future is bright, and despite central banks’ proven inability to get funding to those most in need, namely individual households, those same central banks continue to do the only thing they know how to do, print more money, and by extension fund governments and large companies, who already have access to funding. As the saying goes, the rich get richer.
The cycle goes as follows: central banks cut interest rates => investors move out the risk curve seeking returns => corporations and governments issue more debt at cheaper levels => an excess (and ultimately unsustainable) amount of debt outstanding. Currently, that number, globally, is approaching 400% of GDP, and on current trends, has further to go. The problem is, repayment of this debt can only be achieved in one of two ways, realistically, neither of which will be pleasant. Either, inflation actually begins to rise sufficiently to diminish the real value of the debt or we get to a debt jubilee, where significant portions are simply written off.
If you were ever wondering why central banks are desperate for higher inflation, this is your answer. While they are mostly economists, they still recognize that inflation is exactly the kind of debt destructive force necessary to eventually balance the books. It will take time, even if they can manage the rate of inflation, but their firmly held belief is if they could just get inflation percolating, all that debt would become less of a problem. At least for the debtors. Creditors may not feel the same excitement.
On the other hand, the debt jubilee idea is being bandied about in many forms these days, with the latest being the cancellation of student debt outstanding. That’s $1.6 trillion that could be dissolved with the signing of a law. Now, who would pay for that? Well, I assure you it is not a free lunch. In fact, the case could be made that it is this type of action that will lead to the central banks’ desired inflation outcome. Consider, wiping out that debt would leave $1.6 trillion in the economy with no corresponding liabilities. That’s a lot of spending power which would suddenly be used to chase after a still restricted supply of goods and services. And that is just one small segment of the $100’s of trillions of dollars of debt outstanding. The point is, there are still many hard decisions yet to be made and there are going to be winners and losers based on those decisions. Covid-19 did not cause these issues to arise, it merely served as a catalyst to make them more widely known, and potentially, will push us toward the endgame. Be prepared!
But that is all just background information to help us try to understand market activity a bit better. Instead, let’s take a look at the market today, where yesterday’s risk appetite seems to have developed a bit of indigestion. Overnight saw a mixed equity picture (Nikkei +0.4%, Hang Seng +0.1%, Shanghai -0.2%) with the magnitude of movements more muted than recent activity. Europe, on the other hand, has been largely in the red (DAX -0.35%, CAC -0.3%, FTSE -1.15%) as apparently Mr Lane’s comments were not seen as supportive enough, or, more likely, markets are simply overbought after some enormous runs this month, and are seeing a bit of profit taking. US futures are mixed at this point, with the DOW and S&P both down -0.5%, while the NASDAQ is up about 0.3%. The biggest stock market story is S&P’s decision to add Tesla to the S&P500 index starting next month, which has helped goose the stock higher by another 10%.
Bond markets this morning are a tale of three regions. Asian hours saw Australian and New Zealand bonds fall sharply with 10-year yields rising about 7 basis points, as the RBA’s YCC in the 3-year space is starting to really distort markets there. However, in Europe, we are seeing a very modest bond rally, with yields slightly softer, about 1 basis point throughout the continent, and Treasuries have seen yields slip 1.5 basis points so far in the session. Clearly, a bit of risk-off attitude here.
FX markets, however, are not viewing the world quite the same way as the dollar, at least vs. its G10 counterparts, is somewhat softer, although has seen a more mixed session vs. EMG currencies. Leading the way in the G10 is GBP (+0.5%) as stories make the rounds that a Brexit deal will be agreed next week. Now, they are just stories, with no official comments, but that is the current driver. Next in line is JPY (+0.3%) which perhaps we can attribute to a risk-off attitude, especially as CHF (+0.25%) is moving the same way. As to the rest of the bloc, gains have been much smaller, and there has been absolutely zero data released this morning.
In the EMG bloc, EEMEA currencies have been the weak spot, with HUF (-0.5%) the worst performer, although weakness in PLN (-0.3%) and RUB (-0.25%) is also clear. This story has to do with the Hungarian and Polish vetoes of the EU budget and virus recovery fund, as they will not accept the rule of law conditions attached by Brussels. You may have heard about the concerns Brussels has over these two nations move toward a more nationalist viewpoint on many issues like immigration and judicial framework, something Brussels abhors. On the positive side, BRL (+0.5%) has opened strongly, and CNY (+0.45%) led the Asian bloc higher overnight. The China story continues to focus on the apparent strength of their economic rebound as well as the fact that interest rates there are substantially higher than elsewhere in the world and drawing in significant amounts of investor capital. As to BRL, it seems the central bank has hinted they will be increasing the amount of dollars available to the market, thus adding to pressure on the dollar.
On the data front, yesterday saw a weaker than expected Empire Mfg number, but this morning is really the week’s big number, Retail Sales (exp 0.5%, 0.6% ex autos) as well as IP (1.0%) and Capacity Utilization (72.3%) a little later. On the Fed front, we have Chairman Powell speaking at 1:00, but not a speech, part of a panel, as well as another five Fed members on the tape at 3:00. However, I anticipate the only thing we will learn is that the entire group will back up Vice-Chair Clarida regarding additional actions.
Despite the lack of risk appetite, the dollar is on its back foot this morning. Ironically, I expect that we will see a rebound in risk appetite, rather than a rebound in the dollar as the session unfolds.
Good luck and stay safe