Monthly Archives: January 2021

Was It Ever?

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The BOJ asked
Is QE still effective?
Or…was it ever?

One of the constants in financial markets since 2012 has been the BOJ’s massive intervention in Japanese markets.  They were the first major central bank to utilize QE, although they call it QQE (Quantitative and Qualitative Easing – not sure what quality it brings) and have now reached a point where the BOJ owns more than 51% of the JGB market.  In fact, given their buy and hold strategy removes those bonds from trading, the liquidity in the JGB market has suffered greatly.  Remember, too, that JGB issuance is greater than 230% of the Japanese GDP, which means the BOJ’s balance sheet is larger than the Japanese economy, currently sitting at ~$6.74 Trillion or 133.2%.

But they don’t only purchase JGB’s, they are also actively buying equity ETF’s in Japan, and by using their infinite printing press have now become the largest single shareholder in the country with holdings of ~$435 Billion, or roughly 7.5% of all the equities outstanding in the country.  And you thought the Fed was pursuing an activist monetary policy!

The thing is, it is not hard to describe all these efforts as utter failures in achieving their aims.  Those aims were to support growth and push inflation up to 2.0%.  (As an aside, it is remarkable how 2.0% has become the ‘magic’ number for the right amount of inflation in central banking circles.  Thank you Donald Brash.)  However, a quick look at the history of inflation in Japan since Kuroda-san’s appointment to Governor of the BOJ in March 2013, and the latest surge in activist monetary policy, shows that the average inflation rate during his tenure as been 0.73%.  Inflation peaked in May 2014, in the wake of the GST hike (a tax rise on consumption) at 3.7%, and spent 12 months above the 2.0% level as that impact was felt, but then the baseline was permanently higher and inflation quickly fell back below 1.0%, never to consider another rise to that level.

Looking at growth, the picture is similar, with the average Q/Q GDP growth during Kuroda-san’s tenure just 0.1%.  It is abundantly clear that central bankers are no Einsteins, as they seem constantly surprised that the same strategies they have been using for years do not produce new results.  Perhaps you must be insane to become a central banker.

What makes this relevant today is that last night, it was learned that BOJ policymakers are considering some changes to their policies.   It’s current policy of YCC has short-term rates at -0.1% and a target for 10-year yields of 0.00% +/- 0.20% leeway.  They also currently purchase ¥12 Trillion ($115 Billion) of equity ETF’s per year.  However, their new plans indicate that they are going to change the mix of JGB purchases, extending the tenor and cutting back purchases of short-term bonds, while also allowing more flexibility in the movement of 10-year yields, with hints it could widen that band from the current 40bps to as much as 60bps.  While that may not seem like a lot, given the minimal adjustments that have been made to these policies over the past 8 years, any movement at all is a lot.

And the market took heed quickly, with JPY (-0.5%) falling to its weakest point vs. the dollar since mid-November.  Technically, USDJPY has broken through some key resistance levels and the prospects are for further USD appreciation, at least in the short run.

In China, the PBOC
Is worried that bubbles will key
More problems ahead
And to punters’ dread
Have drained out more liquidity

China is the other noteworthy story this morning, where the central bank has aggressively drained liquidity from the market as they remain extremely wary of inflating bubbles.  Overnight funding costs rose 29bps last night, to their highest level since March 2015.  Not surprisingly, Chinese equity markets suffered with Shanghai (-0.6%) and the Hang Seng (-0.95%) both unable to follow yesterday’s US rally.  (The Nikkei (-1.9%) also suffered as concerns were raised that the BOJ, in their revamp of policy, may choose to buy less equities.)  What is so interesting about this action is that if you ask any Western central banker about bubbles you get two general responses; first, they cannot tell when a bubble exists; and second, anyway, even if they could, it is not their job to deflate them.  Yet, the PBOC is very clear that not only can they spot a bubble, but they will address it.

I think it is fair to say that given the recent activity in certain stocks like GameStop and AMC, the US market is really exhibiting bubble-like tendencies.  Rampant speculation by individual investors is always a sign of a bubble.  We saw that in 1999-2000 during the Tech bubble, when people quit their day jobs to become stock traders and we saw that in the housing bubble of 2007-8, when people quit their day jobs to speculate in real estate and flip houses.   It also seems pretty clear that the combination of current monetary and fiscal policies has resulted in equity markets being the final repository of that cash.  Having lived, and traded, through the previous two bubbles, I can affirm the current situation exhibits all the same hallmarks, with one exception, the fact that central banks are explicitly targeting asset purchases.  However, this situation cannot extend forever, and at least one part of the financial framework will falter. When that starts, price action will become extremely volatile, similar to what we saw last March, but for a longer period of time, and market liquidity, which has already suffered, will get even worse.  All this points to the idea that hedging financial risk remains critical.  Do not be dissuaded by some volatility, because I assure you, it can get worse.

Anyway, a quick tour of markets shows some real confusion today.  Equities, which we saw fell sharply in Asia, are falling across Europe as well (DAX -0.8%), CAC (-0.9%), FTSE 100 (-1.0%) despite the fact that preliminary GDP data from the continent indicated growth in Q4 was merely flat, not negative. US futures are all pointing lower as well, between 0.5% and 0.9%.

Bonds, however, are all being sold as well, with Treasury yields rising 2.6bps, and European market seeing even greater rate rises (Bunds +3.3bps, OATs +3.3bps, Gilts +3.9bps).  So, investors are selling both stocks and bonds.  What are they buying?

Commodities are in favor this morning, with oil (+0.5%) and the ags rising, but precious metals are in even greater favor (Gold +1.1%, Silver +3.25%).  And finally, the dollar, is under broad pressure, with only the yen really underperforming today.  NOK (+0.9%) is leading the way in the G10, while the rest of the bloc, though higher, is less enthusiastic with gains ranging from 0.1%-0.3%.  Emerging market currencies are having a much better day, led by ZAR (+1.3%) on the back of the commodity rally, followed by TRY (+0.85%) and MXN (+0.45%).  CNY (+0.25%) has rallied on the back of the Chinese monetary actions and BRL (-0.1%) is the only laggard in the bloc as bets on rate hikes, that had been implemented earlier in the week, seem to be getting unwound.

There is important data this morning as well, led by Personal Income (exp 0.1%) and Personal Spending (-0.4%), but also Core PCE (1.3%), Chicago PMI (58.5) and Michigan Sentiment (79.3).  The PCE data has the best chance of being the most interesting, as a higher than expected print will get tongues wagging once more regarding the reflation trade and higher bond yields.

But, when looking at the markets in their totality, there is no specific theme.  Risk is neither on, nor off, but looks more confused.  If I had to describe things, I would say that fiat linked items are under pressure while real items are in demand.  Alas, given current monetary policy globally, I fear that is the future in a nutshell.  As to the dollar, relative to other currencies, clearly, today it is under the gun, but arguably, it is really just consolidating its recent modest gains.

Good luck, good weekend and stay safe
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No Bonds Will They Shed

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Chair Powell explained that the Fed
Cared not about bubbles widespread
Employment’s the key
And ‘til he can see
Improvement, no bonds will they shed

Meanwhile, cross the pond, Ollie Renn
Repeated the mantra again
The ECB will
Not simply stand still
And let euros outgain the yen

At the first FOMC meeting of 2021, Chairman Powell was very clear as to what was in focus, employment.  To nobody’s surprise, they left policy rates on hold and did not change the purchase metrics of the current QE program.  However, in the statement, they downgraded their outlook for the economy, which given the ongoing vaccination program seemed somewhat surprising.  However, the fact that vaccinations are taking longer to be administered than had been expected, seems to be driving their discussion.  He was also explicit that the Fed was set to continue their current program until such time as they achieve their twin goals of maximum employment and 2% average inflation.  Based on the recent rising trajectory of Initial Claims (expected today at 875K) and given even Powell described the fact that the Unemployment Rate likely significantly understates the true situation, it will be a very long time before the Fed even considers reducing their program.

When asked at the press conference following the meeting about potential bubbles in asset markets, with several questions specifically about GameStop stock (a truly remarkable story in its own right), the Chairman was also clear that employment was the thing that mattered, and the Fed was not focused on things like this.  He even explained that the Fed fully expected inflation data to rise this summer but would not waver from their course until maximum employment is achieved.  So, the message is clear, the balance sheet will continue to grow regardless of any ancillary issues that arise.

Keeping our focus on central banks, we turn to the ECB, where this morning it was Finnish Central Bank president Ollie Renn’s turn to explain to the markets that the ECB was carefully watching the exchange rate and its impact on inflation, and would use all the tools necessary to help boost inflation, including addressing a ‘too strong’ euro.  Kudos for their consistency as this was exactly the same message we heard yesterday from Klaas Knot, the Dutch central bank chief.  As well, during yesterday’s session there was an ECB statement that “markets [are] underestimating rate-cut odds.”  You may recall the Knot specifically mentioned the possibility of cutting interest rates by the ECB as well.  All told, there is a consistent message here as well, the euro is a key focus of the ECB and they will not allow it to trade higher unabated.  I have made this point for months, as the dollar bearish views became more entrenched, that the ECB would not sit idly by and allow the euro to rally significantly without responding.  This is the first response.

What are we to conclude from these two messages?  The conclusion I draw is that beggar thy neighbor policies continue to be at the forefront of monetary policy discussions within every major central bank.  While I’m sure they are not actually described in that manner, the results, nevertheless are just that, every central bank is committed to continuing to expand their balance sheet while adding accommodation to their respective economies, and so the relative impact remains muted.  In the end, nothing has changed my view that the Fed will cap yields, which right now are doing a good job of that all by themselves (10-year Treasury yields are -1bp today and back to 1.00%, their lowest level since the break higher on the Georgia election results), and that the dollar will suffer as real yields in the US plummet.  But again, that is Q2 or Q3, not Q1.

Perhaps, what is more interesting is that despite all this promised central bank largesse, yesterday was a massive risk-off session and today is following right in those footsteps.  Starting with equity markets, the bloodbath is universal.  Asia saw sharp declines (Nikkei -1.5%, Hang Seng -2.6%, Shanghai -1.9%) following the US selloff.  And it wasn’t just the main indices, literally every Asian market that was open yesterday fell, most by more than 1%.  European bourses are also all red this morning, but the magnitude of losses has been more muted.  Of course, they got to participate in yesterday’s sell-off, so perhaps that is not too surprising.  As I type, the CAC (-0.1%) is the best performer, with the DAX (-0.6%) and FTSE 100 (-1.0%) suffering more acutely.  Here, too, every market is in the red.  Interestingly, US futures are mixed, with DOW futures actually higher by 0.1%, but NASDAQ futures are down 0.7% after weaker than expected earnings and guidance from some of the Tech megacaps last night.

Bond markets are pretty much all in the green, with yields lower, but essentially, the entire space has seen yields decline just 1 basis point.  That is not really a sign of panic.  Perhaps, with yields so low, investors are beginning to understand that bonds no longer offer the hedge characteristics for risk that they have historically held.  In other words, is earning -0.64% to hold 10-year bunds really hedging negative outcomes in your equity portfolio?  A key part of the thesis that bonds are a haven is that you earn a stable return during tough times.  These days, that is just not the case, and the risk that yields normalize means the potential losses attendant to holding a bond portfolio at current yields is quite substantial.

Commodity prices are generally softer, but not by very much.  WTI (-0.4%) continues to consolidate its gains from Q4 but has basically gone nowhere for the past two weeks.  Gold (-0.2%), too, is treading water lately, although the technicians are starting to say it is in a mild downtrend.

And finally, the dollar is basically stronger once again this morning.  This is true vs. every G10 currency, with AUD (-0.7%) the worst performer, but all the commodity currencies (NZD -0.5%, CAD -0.4%) under pressure along with the havens (JPY -0.2%, CHF -0.2%).  This is simply another dollar up day, with risk still in question.  In the emerging markets, KRW (-1.35%) is by far the worst performer, suffering from the changing risk appetite as well as weaker than expected earnings from Samsung, the largest company in the country.  Capital exited the KOSPI and drove the won to its lowest level since early November.  But we are seeing weakness in the usual suspects with RUB (-0.6%), MXN (-0.4%) and BRL (-0.3%) all under some pressure.  The outlier here is ZAR (+0.2%) which after a very weak start alongside other commodity linked currencies, has rebounded on the news that the first Covid vaccines would be arriving by the end of the week.

There is a bunch of data this morning led by Initial Claims but also Q4 GDP (exp 4.2%), Leading Indicators (0.3%) and New Home Sales (870K).  This is the first reading for Q4, but the market is more intently focused on Q1 and Q2, so it is not clear the print will matter much.  Housing we know continues to perform extremely well, so the Claims data is likely the most important release, especially given Powell’s focus on employment.

As of now, risk remains on its heels, but it would not be that surprising if things turned around as Powell’s message of non-stop stimulus should encourage the bulls.  If that is the case, I would look for the dollar to cede some of its gains, but it is certainly not a signal to sell aggressively.

Good luck and stay safe
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You’d Better Think Twice

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If you thought Lagarde doesn’t care
About how her euros compare
To dollars in price
You’d better think twice
‘Cause she is acutely aware

This morning, her colleague, Klaas Knot
Was clear when explaining they’ve got
The tools they may need
To help them succeed
In cooling a euro that’s hot

With the FOMC meeting on tap for later today, the market is mostly biding its time until they hear if anything will be changing at the Mariner Eccles Building.  However, that seems highly unlikely at this time given the following factors:  first, the last we heard from Chairman Powell was that now is not the time to consider removing any policy accommodation, even if things seem to be looking up; and second, it is not clear that things are looking up.  While certainly there are some parts of the economy that are doing well, notably housing and manufacturing, the service sector remains under severe pressure as lockdowns pervade the country.  True, it appears that some of the more draconian lockdowns may be coming to an end, but the hit to the employment situation has been turning much worse.  Recall, the December NFP data printed at a much worse than expected -140K, and Initial Claims data has been running higher lately than back then.  Too, remember that the Fed modified their mandate to seek to achieve “maximum employment” which means declining NFP data is more likely to drive further policy ease than tightness.

So, in truth, today’s FOMC meeting is likely to be a pretty dull affair, with limited market expectations for any movement of any sort.  On the other hand, the ECB, which met last week and took no further action, remains concerned about the euro’s strength.  I have been quite clear in my warnings that the ECB would not allow the euro to trade higher without a response as they simply cannot afford that outcome.  Remember, the ECB’s playbook (and in truth, most central bank playbooks) defines the reaction function for specific conditions.  According to the book, too low inflation requires lower interest rates and a weaker exchange rate.  In fact, one of the primary reasons to lower interest rates is to weaken the exchange rate.  The idea is that a weak currency can help import inflation while simultaneously helping the competitive stance of that nation’s export community.  The problem with this strategy is that it was designed to be used in isolation.  So, if one country is behaving in that manner, it has a chance to succeed.  Unfortunately, the Covid pandemic has resulted in virtually every country trying to use these tools at the same time, thus canceling out each other’s efforts.

Of course, one player is much larger than the others, namely the Fed.  The Fed’s ability to ease policy seems to be outstripping that of the ECB, and every other country as well.  Adding to that has been the extraordinary fiscal policy ease we have seen here, which has been larger than elsewhere, and with the still robust expectations of another $1.9 trillion of fiscal support coming, has been one of the defining features of the bearish dollar outlook.

Which brings us to this morning’s comments from Klaas Knot, the Dutch Central Bank President and ECB Governing Council member.  He was quite clear in explaining the ECB has the necessary tools, including interest rate cuts, to prevent any further strengthening of the euro which could undermine inflation.  “That is something we, of course, monitory very, very carefully.  It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going.”  In other words, euro bulls need to understand the ECB is not going to sit by and watch the single currency rally unabated.  It should be no surprise that the market responded to these comments by selling off the single currency, which is now down 0.4% on the day.  Adding to the bearish euro scenario was the release of the German GfK Consumer Confidence survey, which printed at -15.6, its third lowest reading in history, trailing only the May and June readings post the start of the Covid crisis last year.  Once again, I will reiterate my view, while eventually the dollar will decline more sharply as real yields in the US fall into further negative territory later this year, for now, the dollar’s decline seems to be on hold.

Ok, let’s quickly look at markets.  Risk is starting to become more suspect as the morning wears on, with European equity markets now all sharply in the red vs. their earlier little changed price action.  In the wake of the Knot comments, the DAX (-1.55%), CAC (-1.0%) and FTSE 100 (-0.8%) have all sold off hard.  Asian markets, which had closed before the comments, had a more mixed day, with the Nikkei (+0.3%) recouping a little of yesterday’s losses, but the Hang Seng (-0.3%) and Shanghai (+0.1%) doing little overall.  As to US futures, the DOW (-0.9%) and SPU (-1.0%) lead the way down with the NASDAQ (-0.25%) still outperforming after some pretty good earnings data last night from Microsoft.

It should be no surprise that bond markets have found a bid, with Treasury yields lower by 1.4bps, while Bunds (-1.4bps) and OATs (-1.0bps) are also now trading higher.  Again, earlier in the session, yields had actually crept a bit higher, so this reversal of risk attitude is growing.

Commodity markets are being impacted as well, with oil back to flat on the day from early session gains of 0.5% and gold is actually lower by 0.5%.  Only the ags remain well bid, as I guess everyone needs to eat, even during a pandemic.

Finally, the dollar is stronger across the board, with the strength becoming more evident after the Asian close.  In the G10, NOK (-0.9%) is the leading decliner as oil prices have turned, but we are seeing weakness throughout the commodity bloc (AUD -0.6%, NZD -0.4%, CAD -0.4%) as well.  In fact, even the havens are weaker today with both JPY and CHF off by 0.2%.  Today is just a dollar positive day.  In the EMG bloc, the few green spots on the chart are all APAC currencies with very modest gains (KRW +0.2%, TWD +0.1%).  On the other hand, all the markets that are currently open are showing sharp declines led by ZAR (-0.9%), MXN (-0.85%) and RUB (-0.8%).  It is remarkable how closely these three currencies trade to each other.  But really, everything else is weak as well.  There are no specific stories of note here, it is just a day to reduce risk.

On the data front, this morning brings Durable Goods (exp 1.0%, 0.5% ex transport) and then the FOMC statement at 2:00 followed by the Powell press conference at 2:30.  It seems unlikely that the market will react to the Durables data, so things seem to be shaping up as a dollar up day, at least until we hear from Jay.  However, I don’t foresee the dollar exploding higher, just continuing this drift, at least vs. the G10.  EMG is always a different story, so be careful there.

Good luck and stay safe
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No Bubble’s Detected

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While Jay and his friends at the Fed
Claim when they are looking ahead
No bubble’s detected
So, they’ve not neglected
Their teachings and won’t be misled

But China views markets and sees
Their policy has too much ease
So, money they drained
As they ascertained
Investors, they need not appease

Perhaps there is no clearer depiction of the current difference between the Fed (and truly all G10 central banks) and the PBOC than the fact that last night, the PBOC drained liquidity from the market.  Not only did they drain liquidity, they explained that they were concerned about bubbles in asset markets like stocks and real estate, inflating because of current conditions.  Think about that, the PBOC did not simply discuss the idea that at some point in the future they may need to drain liquidity, they actually did so.  I challenge anyone to name a G10 central banker who could possibly be so bold.  Certainly not Chairman Powell, who tomorrow will almost certainly reiterate that this is not the time to be considering the removal of policy support.  Neither would ECB President Lagarde venture down such a road given the almost instantaneous damage that would inflict on the PIGS economies.

One cannot be surprised that stock markets fell in Asia after this action, with the Hang Seng (-2.6%) leading the way, while Shanghai (-1.5%) also fared poorly.  By contrast, the Nikkei’s -1.0% performance looked pretty good.  It should also be no surprise that the stock markets of the APAC nations whose trade relations with China define their economies saw weak outcomes.  Thus, Korea’s KOSPI (-2.1%) and Taiwan’s TAIEX (-1.8%) suffered as well.  And finally, it cannot be surprising that the Chinese renminbi traded higher (+0.15%) and is pushing back to levels last seen in June 2018.

Arguably, the key question here is, what does this mean for markets going forward?  Despite constant denials by every G10 central banker, it remains abundantly clear that equity market froth is a direct result of central bank policy.  The constant addition of liquidity to the economic system continues to spill into financial markets and push up equity (and bond and other asset) prices.  If the PBOC action were seen as a harbinger of other central bank activity, I expect that we would see a very severe repricing of risk assets.  However, a quick look at European equity markets shows that no such thing is occurring.  Rather, the powerful rally we are seeing across the board on the continent today (DAX +1.5%, CAC +1.1%, FTSE MIB +0.85%) indicates just the opposite.  Investors are not merely convinced that the ECB will never remove liquidity, but we are likely seeing some of the money that fled Asia finding a new home amid the easy money of Europe.

If the PBOC continues down this road, it is likely to have a far greater impact over time.  In fact, if they are successful in deflating the asset bubbles in China without crushing the economy, something that has never successfully been done by any central bank, it would certainly bode well for China going forward, as global investors would beat a path to their door.  While that is already happening (in 2020, for the first time, China drew more direct investment than the US), the speed with which it would occur could be breathtaking, especially in the current environment when capital moves at a blinding pace.  And that implies that Western equity markets might lose their allure and deflate.  The irony is that a communist nation firmly in the grip of the government would be deemed a better investment opportunity than the erstwhile bastion of free markets.  Ironic indeed!

However, that will only take place over a longer time frame, while we want to focus on today.  So, don’t ignore this occurrence, but don’t overreact either.

In the meantime, a look at today’s activity shows that there is little coherence in markets right now.  As you’ve seen, European equity markets are rallying nicely despite the fact that the Italian government just fell as PM Giuseppe Conte resigned.  A few months ago, this would have been seen as a significant negative for Italian assets, but not anymore.  Not only are Italian stocks higher, but BTP’s have seen yields decline another 3 basis points, taking their rally since Friday to 10 basis points!  As I have often written, BTP’s and the bonds of the other PIGS countries trade more like risk assets than havens, so it should be no surprise they are rallying.  In fact, haven assets all over are declining with Treasuries (+2.2bps), Bunds (+1.4bps) and Gilts (+1.6bps) all being sold today.

Recapping the action so far shows APAC stocks falling sharply, European stocks rallying sharply and haven bonds falling.  Is that risk-on?  Or risk-off?  Beats me!  Commodity prices point to risk-on, with oil rising 0.55% and most agricultural products higher by between 0.4%-1.0%.

Finally, looking at the dollar gives us almost no further information.  While the SEK (-0.25%) is under pressure on a complete lack of news, and the NZD (+0.2%) has moved higher after PM Arcern explained that the country would remain closed to outside travelers until the pandemic ended, the rest of the bloc is +/- 0.1% or less.  In the EMG bloc, the picture is also mixed, with KRW (-0.5%) the worst performer followed by IDR (-0.3%).  Given China’s monetary move last night, this should be no surprise.  On the plus side, TRY (+0.7%) leads the way followed by BRL (+0.4%), with the former benefitting from the IMF raising its GDP growth forecast to 6% in 2021, from a previous estimate of 5%. Meanwhile, the real has benefitted from the news that the BCB meeting last week contained discussions of raising interest rates from their current historically low level of 2.0%.  Concern over inflation picking up has some of the more hawkish members questioning the current policy stance.  Certainly, given that BRL has been one of the worst performing currencies for the past year, having declined 26% since the beginning of 2020, there is plenty of room for it to rise on the back of higher interest rates.

On the data front, this morning brings Case Shiller Home Prices (exp +8.7%) and Consumer Confidence (89.0).  On the former, this reflects historically low mortgage rates and a lack of inventory.  As to the latter, it must be remembered that this reading was above 120 for the entire previous Administration’s tenure until Covid came calling.  Alas, there is no indication that people are feeling ready to head back to the malls and movies yet.

With the FOMC on tap for tomorrow, I expect that the FX market will take its cues from equities.  If the US follows Europe, I would expect to see the dollar give up a little ground, but as I type, futures are little changed with no consistent direction.  While the dollar’s medium-term trend lower has been interrupted, for now, it also appears that the correction has seen its peak.  However, it could take a few more sessions before any downward pressure resumes in earnest, subject, naturally, to what the Fed tells us tomorrow.

Good luck and stay safe
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Covid Comes Calling

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The German economy’s stalling
In Q1, as Covid comes calling
But still there’s belief
That fiscal relief
Will stop it from further snowballing

Consensus is hard to find this morning as we are seeing both gains and losses in the various asset classes with no consistent theme.  Perhaps the only significant piece of news was the German IFO data, which disappointed across the board, not merely missing estimates but actually declining compared with December’s data.  This is clearly a response to the renewed lockdowns in Germany and the fact that they have been extended through the middle of February.  The item of most concern, is that the manufacturing sector, which up until now had been the brightest spot, by far, is also seeing softness.  Now part of this problem has to do with the fact that shipping has been badly disrupted with insufficient containers available to ship products.  This has resulted in higher shipping costs and reduced volumes, hence reduced sales.  But part of this issue is also the fact that since virtually all of Europe is in lockdown, economic activity on the continent is simply slowing down.  It is the latter point that informs my view of the ECB’s future activities, namely non-stop monetary ease for as far as the eye can see.

When combining that view, the ECB will continue to aggressively ease policy, with the fact that the Fed is also going to continue to ease policy, it becomes much more difficult to estimate which currency is going to underperform.  Heading into 2021, the strongest conviction trade across markets was that the dollar was going to decline sharply, continuing the descent from its March 2020 highs.  And that’s exactly what we saw…for the first week of the year.  However, since then, the dollar has reversed those losses and currently sits higher on the year vs. most currencies.  My point is, and has consistently been, that in the FX market, the dollar is a relative game, and the policies of both nations are critical in establishing its value.  Thus, if every nation is aggressively easing policy, both monetary and fiscal, then the magnitude of those policy efforts are critical.  Perhaps, the fact that Congress has yet to pass an additional stimulus bill, especially given the strong belief that the Blue Wave would quickly achieve that, has been sufficient to change some views of the dollar’s future strength (weakness?).  Regardless, the one thing that is clear is that the year has just begun and there is plenty of time for more policy action as well as more surprises.  In the end, I do believe that as inflation starts to climb in the US, and real interest rates fall to further negative levels, the dollar will ultimately fall.  But that is a Q2-Q3 outcome, not really a January story.

And remarkably, that is basically the biggest piece of news from overnight.  At this point, traders and investors are turning their attention to the FOMC meeting on Wednesday, although there are no expectations for policy shifts yet.  However, the statement, and Chairman Powell’s press conference, will be parsed six ways to Sunday in order to try to glean the future.  Based on what we heard from a majority of Fed speakers before the quiet period began, there is no current concern over the backup in Treasury yields, and there is limited sentiment for the Fed to even consider tapering their policy of asset purchases, with just four of the seventeen members giving it any credence.  One other thing to remember is that the annual rotation of voting regional presidents has turned more dovish, with Cleveland’s Loretta Mester, one of the two most hawkish members, being replaced by Chicago’s Charles Evans, a consistent dove.  The other changes are basically like for like, with Daly for Kashkari (two extreme doves) and Barkin and Bostic replacing Harker and Kaplan.  These four are the minority who discussed the idea that tapering purchases could be appropriate by the end of the year, so, again, no change in voting views.

With this in mind, we can see the lack of consistent message from overnight activity.  Asian equity markets were all firmer, led by the Hang Seng (+2.4%), with the Nikkei (+0.7%) and Shanghai (+0.5%) trailing but in the green.  However, Europe has fared less well after the soft IFO data with all three major markets (DAX, CAC and FTSE 100) lower by -0.6%.  As to US futures, they are the perfect embodiment of a mixed session with NASDAQ futures higher by 0.8% while DOW futures are lower by 0.2%,

Bond markets, though, have shown some consistency, with yields falling in Treasuries (-1.0bp) and Europe (Bunds -1.7bps, OATs -1.5bps, Gilts -2.2bps).  The biggest winner, though, are Italian BTPs, which have rallied more than half a point and seen yields decline 5.3 basis points.  It seems that concerns over the government falling have abated.  Either that or the 0.70% yield available is seen as just too good to pass up.

On the commodity front, oil prices have edged up by the slightest amount, just 0.1%, as the consolidation of the past three months’ gains continues.  Gold has risen 0.4%, but there is a great deal of discussion that, technically, it has begun a downtrend and has further to fall.  Again, consistent with my view that real interest rates are likely to decline sharply in Q2, when inflation really starts to pick up, we could easily see gold slide until then, before a more emphatic recovery.

And lastly, the dollar, where both G10 and EMG blocs show a virtual even split of gainers and losers.  Starting with the G10, NZD (+0.3%) is today’s “big” winner, with SEK (+0.25%) next in line.  Market talk is about the reduction of restrictions in Australia’s New South Wales state as a reason for optimism in AUD (+0.15%) and NZD.  As for SEK, this is simply a trading move, with no obvious catalysts present.  On the flip side, the euro (-0.1%) is the worst performer, arguably suffering from that German IFO data, with other currencies showing little movement in either direction.

The EMG bloc is led by TRY (+0.4%), as it seems discussions between Turkey and Greece to resolve their competing claims over maritime boundaries is seen as a positive.  After the lira, though, no currency has gained more than 0.2%, which implies there is nothing of note to describe.  On the downside, ZAR (-0.4%) is the worst performer, which appears to be a positioning move as long rand positions are cut amid concerns over the spread of Covid and the lack of effective government response thus far.

On the data front, the week is backloaded with Wednesday’s FOMC clearly the highlight.

Tuesday Case Shiller Home Prices 8.65%
Consumer Confidence 89.0
Wednesday Durable Goods 1.0%
-ex transport 0.5%
FOMC Meeting 0.00%-0.25% (unchanged)
Thursday Initial Claims 880K
Continuing Claims 5.0M
GDP Q4 4.2%
Leading Indicators 0.3%
New Home Sales 860K
Friday Personal Income 0.1%
Personal Spending -0.4%
Core PCE 1.3%
Chicago PMI 58.0
Michigan Sentiment 79.2

Source: Bloomberg

So, plenty of stuff at the end of the week, and then Friday, two Fed speakers hit the tape.  One thing we know is that the housing market continues to burn hot, meaning data there is assumed to be strong, so all eyes will be on the PCE data on Friday.  After all, that is the Fed’s measuring stick.  The other thing that we have consistently seen during the past six months is that inflationary pressures have been stronger than anticipated by most analysts.  And it is here, where the Fed remains firmly of the belief that they are in control, where the biggest problems are likely to surface going forward.  But that is a story for another day.  Today, the dollar is wandering.  However, if the equity market in the US can pick up its pace, don’t be surprised to see the dollar come under a little pressure.

Good luck and stay safe
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If Things Cohere

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Said Madame Lagarde, it’s not clear
If the PEPP need extend past next year
It could be the case
We’ll slow down the pace
Of purchases if things cohere

Yesterday’s ECB meeting presented mixed messages to the market as it has become evident there is a growing split between the hawks and doves.  While policy was left unchanged, as universally expected, the question of the disposition of the PEPP was front and center.  Once again, Madame Lagarde indicated that they would continue supporting the economy, but that the need to utilize the entire amount of authorized spending power could be absent.  Despite the fact that she admitted Q1 GDP growth would likely be negative, thus causing a second recession, she would not commit to full utilization, let alone any additional monetary stimulus.  Rather, she discussed “financing conditions” which need to remain “favorable” for the ECB to be happy.  Alas, there is no definition of what those conditions are, nor how to track them.   She mentioned a number of indicators they monitor including; bank lending, credit conditions, corporate yields, and sovereign bond yields, but not which may have more or less importance nor how they combine them.  There doesn’t appear to be an index of any sort although as part of their ongoing strategic review, they are investigating whether or not to create one.  In the end, though, it appears they are very keen to insure they don’t get pinned down to a mechanical reaction function based on either economic or financial indicators.  Instead, they will continue to wing it.

As to the growing split, it is becoming evident that the hawkish contingent, almost certainly led by Germany but likely including the Frugal Four, has been pushing back on any additional stimulus as they already see sufficient money in the system.  Remember, German DNA has been informed by the hyperinflation of the Weimar Republic in the 1930’s and Bundesbankers, like Jens Weidmann, everywhere and always see the specter of too much money leading to a recurrence of that outcome.  While that hardly seems like a possible outcome in the current situation, especially with most European countries extending lockdowns through February now, thus further stressing the economy, they know that debt monetization is the first step toward hyperinflation. And while the ECB will never explicitly monetize the debt, they can pretty easily do it implicitly.  All that has to happen is for them to permanently reinvest the proceeds of maturing sovereign debt into the same securities, and that money will be permanently in the system.

Consider, because of the ECB’s construction, with 19 central bank members, the way policy is promulgated is that each national central bank is instructed to purchase sovereign bonds issued by their own country in a given amount. So, the Banca d’Italia buys BTP’s and the Bundesbank buys bunds.  If instructions from the ECB council are to replace maturing debt with newly issued debt constantly, then the country never has to repay the bond, and therefore, the money injection is permanent, i.e. debt monetization.  It seems likely, this is the hawks’ major concern.  It is almost certainly why they insist on repeating the idea that full utilization of the PEPP is not a given, and why Lagarde cannot follow her instincts to throw more money at the second recession.  But of course, this is anathema to the hawks, who want to see the collective ECB balance sheet slowly wound down.  In the end, this tension will inform the ECB’s actions going forward, which implies, to me, that the ECB will be less dovish than some other central banks, namely the Fed, and which implies the euro could well head somewhat higher over time.

And perhaps, despite a clear risk-off theme for today’s trading activity, that is why the euro is retaining a better bid than its G10 brethren.  As equity markets around the world pare back some of their recent gains (Nikkei -0.4%, Hang Seng -1.6%, Shanghai -0.4%, DAX -0.85%, CAC -1.2%, FTSE 100 -0.7%), the clear message is risk is to be reduced heading into the weekend.  And yes, US futures are all pointing lower as well, between -0.5% and -0.8%.  Meanwhile, bond markets are playing their part, true to form, on this risk-off day, with Treasury yields lower by 1.9bps, Bunds by 2.0bps and Gilts by 2.5bps.  However, Italian BTPs have seen yields climb 3.6bps as the market responds to this newly created concern that the ECB will not be supporting Italy as they had in the past.  Add to that the ongoing political concerns in Italy, where PM Conte has just indicated he may be forced to call a new election, and the fact that today’s PMI data showed the recent lockdowns have really been crushing the economy there, and BTP’s are behaving like the risk asset they truly are, rather than the haven asset they aspire to be.

Commodity prices are under pressure across the board this morning, led by oil (-2.5%) but seeing the same in gold (-1.1%) and the entire agricultural bloc, with prices down between 0.8% (cotton) and 2.4% (soft red wheat).

This brings us back to the dollar, which is broadly higher this morning in both G10 and EMG space.  The euro (+0.1%) is the star performer today, as per the above discussion, but beyond that and the CHF (+0.05%), the rest of the bloc is weaker.  NOK (-0.8%) leads the way down with the rest of the commodity bloc (AUD -0.7%, NZD -0.5%, CAD -0.5%) not quite as badly impacted.  At the same time, EMG currencies are also under broad pressure led by RUB (-1.4%) on weaker oil, MXN (-1.0%) and BRL (-1.0%) both on weaker commodities and general risk aversion, and ZAR (-0.9%) as its main export, gold, falls. As to the positive side of the ledger, only minor East European currencies, BGN and RON (both +0.05%), have managed to eke out any gains, apparently tracking the euro ever so slightly higher.

The data picture has not helped inspire any risk taking this morning as preliminary PMI data for January showed weakness throughout.  As we have seen, manufacturing continues to hold up fairly well, but services have seen no respite.  Of all those countries reporting today, the UK was in the worst shape (PMI Services 38.8, down from 49.4) but the Eurozone as a whole (Services 45.0) was no great shakes.  It is abundantly clear that Europe is in the midst of a double-dip recession.  On the US calendar, the preliminary PMI data is released (exp Manufacturing 56.5, Services 53.4) and then Existing Home Sales (6.56M) at 10:00.  One thing we learned yesterday is that the housing market in the US remains quote robust.

But, with the Fed still in its quiet period until the meeting next Wednesday, and Yellen’s testimony done and dusted, FX is going to be reliant on other markets for direction.  If risk continues to be shed, the dollar should be able to hold its own, and even edge a bit higher.  But if equity markets manage to reverse course, then the dollar could well head back lower.

Good luck, good weekend and stay safe
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The Largesse They Bestow

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The status is clearly still quo
For central bank policy so
All rates are on hold
And markets consoled
By all the largesse they bestow

But Covid continues to spread
And Q1 growth seems to be dead
So, Christine and Jay
Will soon have to say
More QE is coming ahead

It has been an active week for central banks so far, at least with respect to the number of meetings being held.  By the end of today we will have heard from six different major central banks from around the world (Canada, Brazil, Japan, Indonesia, Norway and the ECB) although not one of them has changed policy one iota.  The implication is that monetary policy has found an equilibrium for now, with settings properly attuned to the current economic realities.

A summary of current central bank policies basically shows that whatever the absolute level of interest rates being targeted, it is almost universally at historically low levels, with 14 key banks having rates 0.25% or lower.  The point is, a central bank’s main tool is interest rate policy, and while negative nominal rates are clearly viable, after all the SNB, ECB and BOJ currently maintain them, central banks are clearly running out of ammunition.  (PS; the efficacy of negative rates has been widely argued and remains unproven.)  Interestingly, prior to this crisis, reserve requirements were seen as an important central banking tool, with a broad ability to inject more liquidity into the markets or remove it if so desired.  However, in the wake of the GFC, when banks worldwide were shown to be too-highly levered, it seems central banks are a bit more reluctant to open those floodgates.  Even if they did, though, it is unclear if it would make a difference.  Perhaps the lesson we should all learn from the Covid crisis, especially the central banks themselves, is that monetary policy is very good at slowing down economies all by itself, but when it comes to helping them pick up, they need help.

So, with interest rate policy basically at its limit, central banks have been forced to implement new and different tools in their quest to support their respective economies, with QE at the forefront.  Of course, at this point, QE has also become old hat, and has yet to be shown to support the economy.  It has, however, done a bang-up job supporting equity markets around the world, as well as other risk assets like commodities.  And that is exactly what it was designed to do.  QE’s transmission mechanism was to be a trickle-down philosophy, where the ongoing search for yield by investors pushed capital into riskier ventures, helping to support increased investment and more economic growth.  Alas, the only thing QE has really served to do is inflate a number of asset bubbles.  This was never clearer than when the data showed more money was spent by corporations on stock repurchases than on R&D.  Thus, if the stated goal of QE was to support economic growth, it is fair to say it has failed at that task.

At any rate, a recap of the central bank comments shows that economic forecasts and expectations have been tweaked lower for Q1 and higher for Q2 and Q3 with a universal assumption that the widespread inoculation of the population via the new vaccines will help reopen economies all over.  And yet, if anything, we continue to hear of more and more draconian measures being put into place to slow the spread of Covid.  This certainly confirms the idea of a weak Q1 growth pattern, but the leap to a stronger Q2 is harder to make in my mind.

Add it all up and it appears that central banks, globally, are pretty much all in the same position, promulgating extremely easy monetary policy with limited hope that it will, by itself, reignite economic growth.  In effect, until it is shown that the vaccines are really changing people’s behavior, assuming governments allow people back out of the house, central banks can do all they want, and it will not have much impact on the economy.  Markets, however, are a different story, as all that monetary largesse will continue to flow to the riskiest, highest yielding assets around.  Until they don’t!  It will not be pretty when this bubble deflates.

So, is that happening today?  Not even close.  Equity markets continue to rise almost universally, with the Nikkei (+0.8%) and Shanghai (+0.8%) leading the way in Asia.  Europe, meanwhile, is not quite as robust, but still largely in the green led by the DAX (+0.5%) and FTSE 100 (+0.25%) although the CAC (-0.1%) is lagging a bit.  And not surprisingly, US markets continue to power ahead on the ongoing belief that there will be yet more stimulus coming, so futures are all higher by roughly 0.3% or so.

Bond markets are playing their part as well, with 10-year yields higher in all the major markets, with Treasuries, Bunds, OATs and Gilts all seeing yields climb about 1 basis point.  The interesting thing about Treasuries, and truthfully all these markets, is that since the Georgia run-off election, when the market assumption for more stimulus was cemented, the yield has barely moved.  Let me say that the reflation trade seems to be on hold, at least for now.

For a change, oil prices have edged a bit lower this morning, with WTI down 0.6%, as it consolidates its spectacular gains since November.  Gold is little changed, although it had a big day yesterday, rising 1.5% as inflation concerns seem to be percolating.  And finally, as perhaps a harbinger of that deflating bubble, Bitcoin is lower this morning and has been falling pretty steadily, if with still spectacular volatility, for the past 2 weeks, and is now down 24% from its recent highs.

Finally, the dollar is under clear pressure this morning, falling against all its G10 peers and all but one of its EMG peers.  In G10, NOK (+0.8%) leads the way as the Norgesbank did not cut rates which some had expected and were less negative on the economy than expected as well.  But NZD (+0.7%) and SEK (+0.6%) are also putting in fine performances amid stronger commodities and hopes for more stimulus.  In fact, CAD (+0.15%) is the laggard, although it had a strong performance yesterday (+0.7%) after the BOC left rates on hold rather than performing a microcut (10 bps) as some analysts had expected.

In the EMG space, CLP (+1.15%) and BRL (+1.1%) lead the way with the former benefitting from strong investor demand in USD and EUR denominated government bonds, leading to a positive outlook, while the latter seems to be responding to hints that tighter policy may be coming soon given rising inflation forecasts.   But really, the dollar’s weakness is pervasive across all three major blocs.

We finally see some data today as follows: Initial Claims (exp 935K), Continuing Claims (5.3M), Housing Starts (1560K), Building Permits (1608K) and Philly Fed (11.8).  The Claims data has certainly deteriorated during the past several weeks given the renewed lockdowns around the country, which doesn’t bode well for the NFP report in 2 weeks’ time.  The housing market remains on fire given the ongoing exodus to the suburbs from large cities and the historically low mortgage rates.  Meanwhile, Philly Fed should show the strength of the manufacturing sector, which continues to far outperform services.

Still no Fed speakers, so beyond the data, which is all at 8:30, we will also hear from Madame Lagarde in her press conference at the same time.  The risk, to me, is that she comes off more dovish than the market anticipates, thus halting the euro’s modest rebound.  But otherwise, there is no obvious catalyst to stop the risk-on meme and dollar’s renewed decline.

Good luck and stay safe
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Desperate Straits

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When yield curve control was designed
Its goal was a rate be defined
Which can’t be exceeded
With bonds bought as needed
To help governments in a bind

Lagarde, though, when looking ahead
Must work at controlling the spread
So BTP rates
Don’t reach desperate straits
Vs. bunds, an outcome she would dread

Ahead of the inauguration of President Biden, the market has turned its focus to Europe and the ongoing situation in Italy.  Prime Minister Giuseppe Conte has been struggling to lead a fractious coalition from the left and was just subject to no-confidence votes in both houses of the Italian government.  (They have a House and Senate similar to the US.)  This occurred when one of his former allies, Matteo Renzi, split from the coalition triggering the vote.  Renzi leads the Viva Italia party, a center-left group focused on progressive reforms to the Italian government, and it appears Conte has become a little too status quo for his taste.  While Conte was able to cobble together a majority in the lower house, today’s vote in the Senate was less successful, with a majority of votes cast, but no majority in the Senate overall.  This means he has a minority government whose stability has now been called into question.  Estimates are that he has two weeks to develop a majority or the President may call for parliament to be dissolved and new elections held.

As this story has unfolded, investors have been focused on the bond market, specifically the spread between Italian BTP’s and German bunds.  This spread is seen as a key metric, by both the market and the ECB, as to the health of the European economy overall.  The narrower that spread, the healthier the situation.  This is based on the idea that investors are not demanding as great a yield premium to fund Italy’s debt as they are Germany’s.

A quick history shows that for the first eight years of the euro’s existence, that spread hovered between 25 and 45 basis points, with investors not particularly concerned by Italy’s profligate ways.  The GFC awakened many to the potential risks in Italy and the spread ballooned as high as 160 basis points at that time.  But that was nothing compared to the Eurozone bond crisis in 2012, when Greece was on the ropes and the term PIGS was invented.  At that time, Italian yields peaked at 5.525% higher than German yields.  The second time this level was reached, in July 2012, led to Mario Draghi’s famous words, “whatever it takes” regarding the ECB’s will to save the euro.  Since that time, the spread has only ever edged below 1.0% briefly, lately reaching a peak of 2.8% at the beginning of the Covid crisis and currently trading around 1.14%.

The point here is that the ECB watches this spread very carefully.  But now, it appears they are interested in more than merely watching the spread.  Rather, they want to control it.  Yield curve control (YCC) is currently ongoing in both Japan and Australia and has generated a good deal of discussion in the US.  But those three central banks have a single government rate to manage.  The ECB has no such luck, and so they need to find other ways to control things.  Hence, their newest idea is Yield spread control (YSC), where the ECB will buy whatever amount of bonds are necessary to prevent a particular spread from rising above a particular level.  Obviously, this means they will be looking at the bonds of the PIGS, as those are the nations with the biggest outstanding issues.  The problem Lagarde has is the ECB, by law, is not allowed to finance government spending, and QE in Europe was designed to be implemented along the lines of the ECB buying bonds in proportion to national economic size.  But this will require something completely different, as in order to prevent that spread from widening beyond whatever level they choose, the ECB will need to purchase an unlimited number of Italian BTP’s.  As such, this idea is not without controversy, but do not be surprised to hear about it tomorrow when the ECB meeting ends.  While it may not be implemented right away, it does appear they are actively considering the idea.

At this point you are likely asking yourself why you care about this esoteric concept.  And the answer is because it will have an impact on the value of the euro, and therefore the dollar, going forward.  Given the current draconian lockdowns throughout Europe and the significant negative impact they will have on the Eurozone economy, and combine that with a political morass in the 3rd largest economy in the Eurozone, and you have a recipe for a more severe downturn in a double dip recession in Europe.  As the ECB has already used up its basic toolkit of extraordinary measures, it needs to develop new ones if it is to keep the money flowing.  And that is the point.  Especially after yesterday’s testimony by Janet Yellen, where it is clear that the Treasury is not going to slow down spending and the Fed will be right there buying up those new bonds, the ECB is growing concerned that the dollar could fall much further.  They have recently been reminding us that they are paying attention to the exchange rate, and while intervention is not likely in the cards, a new easing policy that results in lower yields and a correspondingly weaker euro just might be.  One has to be impressed with central bank creativity when it comes to spending/printing more money.

But for now, investors remain sanguine to the risk inherent in this strategy and continue to add risk to their portfolios.  This can be seen in the continued rallies in equity markets around the world.  For instance, last night saw strength throughout Asia, except for the Nikkei (-0.4%).  Europe, this morning is showing far more green than red (DAX +0.5%, CC +0.3%. FTSE 100 -0.1%) and US futures, following yesterday’s tech inspired rally, are all higher again this morning.

Bond markets are under pressure generally, with Treasury yields backing up 1.4bps, although still unable to break the recent highs of 1.15%, Gilts are also softer with yields higher by 1.2bps while bunds and OATs are little changed. BTP’s, however, have fallen ¼ point with yields higher by 2.5bps, which means that spread has risen by the same amount.  Keep an eye on this.

Oil (WTI +1.3%) and gold (+0.5%) are both firmer this morning while the dollar is broadly under pressure.  However, the magnitude of that weakness is fairly minimal, with AUD (+0.35%) the biggest gainer in the G10 on the back of firmer commodity prices, while SEK (-0.35%) is the laggard on what appears to be position unwinding.  The euro (-0.15%) is definitely not following a classic risk-on pattern here, with some reason to believe traders are beginning to take the YSC into account.  In the EMG space, the moves are also limited, with TRY (+0.4%) and BRL (+0.25%) the leading gainers while CE4 currencies (CZK and PLN both -0.1%) are the laggards.  But overall, the risk theme does not appear to be having an impact in FX.

Once again there is no data released today and we are still in the quiet period, so no Fedspeak.  And we don’t even have Yellen to testify, so the FX market is going to be paying attention to equity movements and the bond market, probably in that order.  If risk continues to be acquired, I expect the dollar will have difficulty gaining any traction, but if we start to see a reversal, don’t be surprised to see some of the massive dollar short positions unwound.

Good luck and stay safe
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Go Big

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This morning, a former Fed chair
Will speak and is set to declare
It’s time to “go big”
In order to dig
The nation out from its despair

After a quiet holiday shortened session yesterday, markets are showing modest positivity overall, although European equity markets seem to be lacking any oomph.  However, most other risk indicators are pointing to a resumption of risk appetite with haven assets declining, commodity prices rising and the dollar under pressure.

Though we await the outcomes from three key central bank meetings later this week, there is little in the way of data to consider otherwise, so market participants are looking for other potential catalysts.  Chief among those catalysts today is the testimony by former Fed Chair, Janet Yellen, in the Senate as she is being vetted for Treasury Secretary in the new administration.

According to the release of the prepared statement, ahead of questions, she will explain that the US has been suffering from a K-shaped recovery for many years (in fact since she exacerbated that situation as Fed chair) and therefore the government needs to support policies that will help more people.  On the subject of issuing more Treasury debt, it appears she has weighed the consequences of excessive government debt and will say, with rates so low, it is time to “go big” and issue even more in order to fund the new administration’s priorities.  One other key topic of market interest is the dollar, where she will explain that a market set exchange rate is the best possible outcome, and that should be true of all nations.

For our purposes, the question is how these policies will impact markets overall, and the dollar specifically.  It is abundantly clear from the Treasury market’s performance ever since the Georgia run-off elections (10-year yields have risen 20.6 basis points, including 3.6 today) that the market is already anticipating the Treasury ‘going big’ when it comes to further debt issuance.  In fact, that is part and parcel of the reflation trade that has come back into vogue, with the expected further steepening of the yield curve.  In other words, while there may be some pushback from specific Senators, it seems implausible that reconfirming there will be significant new debt issuance to fund deficits will be seen as a mainstream concern.  Rather, the question will be how the Fed will respond when interest rates continue to rise and the cost of funding all that new debt issuance increases.

As to the dollar, while it appears she will not explicitly state a preference with respect to a weak or strong dollar, it seems pretty clear that the combination of the new administration debt policies with a Fed that is unlikely to allow interest rates to rise to true market-clearing levels will result in significantly more negative real yields as inflation continues to rise.  The result of this process will inevitably be a much weaker dollar.  While the market is currently in a consolidation phase, the dollar’s weakness has been manifesting since last spring.  And though positioning in this trade is huge, it does not mean the idea underpinning those positions is wrong.  As well, I believe there will be a very clear signal for when the dollar will begin it next leg lower; the Fed hinting at   whatever rate mitigation strategy they choose will be clear evidence that the negative real yield structure will expand, and the dollar will henceforth decline more substantially.  However, it could well be several months before that is the case, as we will need to see a continued climb in inflation data as well as the increased debt issuance to drive nominal interest rates higher thus forcing the Fed’s response.

But, as I said, that dollar story is still several months into the future, so let us focus on today’s happenings.  Overall, risk appetite is continuing to improve.  Asian equity markets were mostly stronger (Nikkei +1.4%, Hang Seng +2.7%) although Shanghai (-0.8%) didn’t manage to join in the fun.  While money is flowing rapidly into Hong Kong, it seems there is some concern that the PBOC may be tapping the brakes on liquidity in the real estate market in China, thus removing some of the spare cash and hurting equities as a side effect.  Europe, though, has had a different type of session this morning, with the three main markets all just marginally higher (DAX +0.3%, CAC +0.1%, FTSE 100 +0.2%) and several continental exchanges in the red.  The most notable piece of data from the Eurozone was the German ZEW Expectations survey, which was released slightly better than expected at 61.8, which while historically low, does indicate continue confidence in a recovery there.  US futures, though, are all in for more government spending and are currently higher by between 0.65% (DOW) and 1.0% (NASDAQ).  Clearly, there is no concern over too much debt there.

Speaking of debt, bond markets are behaving as you would expect in a risk-on scenario, with haven bonds declining around the world.  While Treasury yields have risen the most on the day, we seen Bunds (+1.1bps), OATs (+0.5bps) and Gilts (+1.5bps) all under pressure this morning.  Similarly, the PIGS are seeing demand grow on the back of increasing risk appetite with yields in those four nations’ bonds declining between 1 and 2 basis points.

Commodity prices are firmer with oil higher by 0.4% and the ags al looking at gains of between 0.25% and 2.0%, with most of them at multi-year highs.  And finally, the dollar is under pressure almost universally, with only JPY (-0.3%) weaker in the G10, the classic risk-on price action.  SEK (+0.9%) and NOK (+0.8%) are leading the way higher here, with oil clearly supporting the latter while the former is simply demonstrating its high beta with respect to the euro (+0.45%).

In the EMG bloc, ZAR (+1.3%) leads the way on the stronger commodity story, while BRL (+0.85%) and HUF (+0.8%) are next in line.  The real seems to be responding to both firmer commodity prices as well as news that the Covid vaccination program, which had been delayed through bureaucratic misfires, is finally set to get going, which is especially important given the surge in cases there.  As to HUF, the story is more about the CE4 rallying with the euro than with any specific economic or political stories from the country.  But the entire EMG bloc is higher, with the worst performers simply unchanged on the day.

On the data front, there is no mainstream data today, and no Fed speakers either as we are in the quiet period ahead of next Wednesday’s FOMC meeting.  Which brings us back to Yellen’s testimony as the most significant potential new information we are likely to see.  As Fed chair, she was one of the most dovish in history and there is no reason to believe that she will have changed that stance as Treasury secretary.  Instead, I fear we will see a virtual combination of the Fed and Treasury, and the resultant monetization of US debt will be a long term drag on the economy amid rising inflation.  That is not a dollar positive, I assure you, but not today’s problem.

Good luck and stay safe
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Sh*t Out of Luck

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Consensus remains that the buck
This year is just sh*t out of luck
Though lately it’s jumped
It soon will be dumped
Or so say the bears run amok

This will be a holiday-shortened note to match our holiday shortened session today.  The broad theme in markets this morning is one of risk avoidance, with most European equity markets lower (CAC -0.4%, FTSE 100 -0.3%, DAX 0.0%), following the Nikkei (-1.0%) although we did see strength in China with both the Hang Seng (+1.0%) and Shanghai (+0.8%) putting in solid sessions.  The Chinese market activity comes on the heels of their latest data which showed that GDP in 2020 grew 2.3%, slightly better than forecast and certainly the only major economy that will show positive growth for the year.  Interestingly, the other data released was not quite as robust with Retail Sales rising a less than forecast 4.6%, down from November and investment activity rising more slowly than anticipated, both Fixed Asset (2.9%) and Property (7.0%).  However, no matter how you slice it, the Chinese economy seems to have weathered the pandemic better than most.

One of the interesting things we have seen of late is the seeming breakdown in the correlation between stocks and bonds.  Whereas the risk meme had generally been stocks falling led to haven asset buying, so Treasuries and the big 3 European government bonds would rally, that is not today’s story.  While the Treasury market is closed today, looking across Europe, despite the weakness in stocks, we are seeing weakness in bonds, with Bund (+1.2bps), OAT (+1.8bps) and Gilt (+0.8bps) prices all sliding a bit on the day.  The news from the PIGS is worse, with yields rising between 1.9 and 2.8 basis points, although given those assets are more risk than haven, this is no real surprise.

There have been three main stories out of Europe this morning, the election of a new CDU party leader in Germany, Armin Laschet, who will replace the retiring Angela Merkel.  However, there is concern that he is a weak candidate for Chancellor and may face a challenge amid slumping popularity ratings.  A weak German Chancellor is not a Eurozone positive, keep that in mind.  The second story is the French dismissal of the unsolicited bid for Carrefour, the largest grocery chain in the country.  Once again, they have proven they have little interest in a free market and will name any company critical to the national interest to prevent the loss of control.  And finally, in Italy, it appears PM Giuseppe Conte is losing his grip on power after a key ally, Matteo Renzi, took his party out of the ruling coalition.  The broader concern there is that if an election is called, Matteo Salvini, the head of the League, a right-wing party with nationalist tendencies could win the election outright, and wreak significant havoc on the Continent with respect to issues like monetary and fiscal policy, immigration and even addressing Covid.

However, at this point, the bulk of that news is fairly noncommittal and almost certainly not having a real impact on the FX markets…yet.  Rather, the story that caught my eye was that Janet Yellen, whose vetting by the Senate for her role as Treasury Secretary takes place tomorrow, will reputedly say she believes the dollar’s value should be determined by the market and that the Treasury will neither speak to it, nor attempt to weaken it directly in any manner.  Of course, the disingenuous part of that statement is that her other policies, which when combined with the Fed’s activity, will almost certainly drive real yields to greater and greater depths of negativity, will undermine the dollar without her having to ever mention the currency once.

Ironically, for now, the dollar continues its rebound from its nadir on January 6th, just three days into the year.  In fact, in the G10, it is stronger against the entire bloc except JPY (+0.1%), with the commodity bloc leading the way lower (NO -0.45%, AUD -0.45%, CAD -0.4%).  You won’t be surprised to know commodities are pulling back a bit as well today (WTI -0.3%).  In the EMG space, the screen is largely red as well, led by RUB (-0.85%) and ZAR (-0.65%) with only BRL (+0.15%) showing any support on the day.  That support seems to be emanating from a survey of Brazilian economists who are calling for a return to growth in 2021 alongside rising interest rates, with the Selic rate (their overnight rate) forecast to rise 125 basis points this year and a further 150 basis points next year to get back to 4.75%.  If that is the case, BRL will certainly find significant support as expectations remain that dollar rates are not going to rise at all.

On the data front, it is a pretty light week, and remember, there are no Fed speakers either.

Thursday ECB meeting -0.5%
Initial Claims 923K
Continuing Claims 5250K
Philly Fed 11.3
Housing Starts 1560K
Building Permits 1603K
Friday Existing Home Sales 6.55M

Source: Bloomberg

While the Fed doesn’t meet until next week, we do hear from the Bank of Canada (exp no change), BOJ (no change) and the ECB (no change) this week, although as you can tell from the forecasts, there is no anticipated movement on policy at this time.  So, adding it all up, it feels to me like the dollar’s short-term momentum remains modestly firmer, although this has not changed my longer-term view that the Fed will be forced to cap nominal yields and as real yields decline, so will the dollar.  But that is more of a summer phenomenon I believe, late Spring at the earliest.

Good luck and stay safe
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