This Terrible Blight

The data from China last night
Showed PMI looking alright
But what does this mean?
Has China now seen
The end of this terrible blight?

Many pundits were both shocked and amazed when China’s PMI data was released last night and printed back above 50 (Manufacturing 52.0 and Composite 53.0), given the ongoing global economic shutdown. But if you simply consider the question asked to create the statistic; are things worse, the same or better than last month, it seems pretty plausible that things were at least the same as the previous month when commerce on the mainland shut down. And arguably, given the word that some proportion of the Chinese economy is starting to get back to work, the idea that a small proportion of respondents indicated improvement is hardly shocking. Instead, what I think we need to do is reconsider exactly what the PMI data describes.

Historically, when the global economy was functioning on, what we used to consider, a normal basis, the difference of a few tenths of a percent were seen as important. They seemed to tell a story of marginal improvement or decline on an early basis. Perhaps this was a false precision, but it was clearly the accepted narrative. The PMI data remains a key input into many econometric models, and those tenths were enough to alter forecasts. But that was then. As we all are abundantly aware, today’s economy and working conditions are dramatically different than they were, even in January. And so, the key question is; does the data we used to focus on still tell us the same story it did? Forward looking survey data is going to be far more volatile than in the past given the extraordinary actions taken by governments around the world. Quarantine, shelter-in-place and working from home will require a different set of measurements than the pre-Covid commuting world with which most of us are familiar.

Certainly, measurements of employment and consumption will remain key, but things like ISM, Fed surveys and productivity measurements are going to be far more suspect in the information they provide. After all, when the lockdowns end, and the surveys shoot higher, while the relative gains will be large, we are still likely to be in a much slower and different economic situation than we were back in January. A major investment bank is now forecasting Q2 GDP to decline by 34% annually, while Q3 is forecast to rebound 19%. The total story is one of overall decline, but the Q3 story will certainly be played up for all it is worth as the fastest growth in US history. My point is, be a little careful with what the current data is describing because it is not likely the same things we are used to from the past. The new narrative has yet to form, as the new economy has yet to emerge. While we can be pretty sure things will be different, we just don’t yet know exactly in which sectors and by how much. In other words, data will continue to be uncertain for a while, and its impact on markets will be confusing.

With that in mind, let’s take a look at where things stand this morning. After a very strong start to the week yesterday, at least on the equity front, things are a bit more mixed today. Asian markets saw both strength (Hang Seng + 1.8%) and weakness (Nikkei -0.9%), although arguably there were a few more winners than losers. Interestingly, despite the blowout Chinese PMI data, Shanghai only rose 0.1%. It seems the equity market there had a reasonable interpretation of the data. In Europe, meanwhile, things are generally positive, but not hugely so, with the DAX and FTSE 100 both higher by 0.8%, although the CAC has edged lower by 0.1%. at this time, US futures are pointing modestly higher and well off the earlier session highs.

Bond markets suffered yesterday on the back of the equity rally, as risk assets had some short-term appeal, but this morning the picture is more mixed. Treasury yields have fallen by 4bps, but Bund yields are little changed on the day. And in the European peripheral markets, Italian BTP’s are seeing yields edge higher by 1bp while Greek yields have softened by 4bps. I think today’s price action has much more to do with the fact it is month and quarter end, and there is a lot of rebalancing of portfolios ongoing, rather than as a signal of future economic/intervention activity.

In the FX market, though, the dollar continues to reign supreme with only NOK able to rally this morning in the G10 space as oil prices have rebounded sharply. A quick peek there shows WTI +7.5% and Brent +3.9%, although the price of oil remains near its lowest levels since 2001’s recession. But away from NOK, the dollar is quite firm with AUD under the most pressure, down 1.4% after some awful Australian confidence data. Clearly, the surprisingly positive Chinese data had little impact. But the euro has fallen 1.0% as concerns grow over Italy’s ability to repay its debt and what that will mean for the rest of the continent with respect to picking up the tab. Even the yen is under pressure today, perhaps on the news that the government is preparing a ¥60 trillion support package, something that will simply expand their already remarkable 235% debt/GDP ratio.

In the emerging markets, it should be no surprise that Russia’s ruble is top dog today, +1.3% on the oil rebound. Meanwhile, ZAR and KRW have also moved higher by 0.5% each with the rand benefitting from a massive influx of yield seekers as they auctioned a series of debt with yields ranging from 7.17% for 3-year to 11.37% for the 10-year variety. Meanwhile, in Seoul, the results of the USD swap auctions showed that liquidity there is improving, meaning there is less pressure on the currency. On the downside, CE4 currencies are under the gun as they track the euro lower, with the entire group down by between 0.8% and 1.3%. Perhaps the biggest disappointment today is MXN, which despite the big rebound in oil is essentially unchanged today after a 2% decline yesterday. The peso just cannot seem to get out of its own way, and as long as AMLO continues to be seen as ineffective, it is likely to stay that way.

There is some data due this morning, with Case Shiller Home Prices (exp 3.23%) and the Conference Board’s Consumer Confidence Index (110.0 down from 130.7), but it is not clear it will have much impact. Yesterday’s Dallas Fed Manufacturing Index was released at -70, the worst print in its 16-year history, but one that cannot be surprising given the nationwide shutdowns and problems in the oil patch. I don’t see today’s data having an impact, and instead, expect that the focus will be on the next bailout package, the implementation of this one, and month-end rebalancing. It is hard to make the case that the dollar will decline in this environment, but that remains a short-term view.

Good luck
Adf

Rule By Decree

The virus continues to be
Our number one priority
The global response
Has been to ensconce
The idea of rule by decree

Thus governments, both left and right
Expand as they all try to fight
Their total demise
And what that implies
‘Bout politics as a birthright

Covid-19 has created a new lens through which we view everything these days, from financial market activity to whether or not to answer the doorbell. And in every task, we have become more circumspect as to the potential effects of our choices. As Dorothy said, “I don’t think we’re in Kansas anymore.” But despite the major upheavals we have seen, we must still seek the best possible outcomes at our appointed tasks, be they as important caring for our loved ones, or as mundane as hedging FX risk. Of course, this note talks about the latter not the former, so while I truly wish you all to stay healthy and safe, that will not be the topic du jour.

Instead, I thought it might be worthwhile to discuss just how much firepower central banks and governments have thrown at Covid-19, or more accurately at the disruptions the spread of the virus has wrought. I have gathered from central bank websites the remarkable amount of actions that they have taken so far in just March of this year. This is not meant to be exhaustive but merely illustrative of the breadth of activity we have seen:

Central Bank Rate cuts Current rate QE  Bio USD equivalent
Fed -1.50% 0.25% 5000
BOC -1.50% 0.25% 90
Norgesbank -1.25% 0.25%
RBNZ -0.75% 0.25%
Chile -0.75% 1.00%
RBI -0.75% 4.40% 12
Bank of England -0.65% 0.10% 240
RBA -0.50% 0.25% 80
BOKorea -0.50% 0.75%
Philippines -0.50% 3.75%
BCBrazil -0.50% 3.75%
Colombia -0.50% 3.75%
Banxico -0.50% 6.50%
Thailand -0.25% 0.75%
Indonesia -0.25% 4.50%
PBOC -0.20% 2.20%
SNB 0.00% -0.75%
ECB 0.00% -0.50% 1100
BOJ 0.00% -0.10% 205
Riksbank 0.00% 0.00% 30
MASingapore 0.00% 1.26%
Russia 0.00% 6.00%
Danmark Nationalbank 0.15% -0.60%

The collective amount of rate cutting has been 10.70%! And QE that was easily confirmed now totals more than $6.75 trillion equivalent. Central banks are pulling out all the stops. Meanwhile, governments, to the extent they are separate than central banks, have been adding fiscal stimulus by the truckload as they create inventive new ways to support both businesses and individuals in this most remarkable of situations. Will it be enough to stem the tide? Only time will tell, but nobody can accuse these officials of not trying, that’s for sure.

Of course, as I have discussed previously, the biggest concern ought to be just how much of the economy is controlled by governments, especially in ostensibly free market nations, when all this finally passes. And even more importantly, how quickly they reduce that control. Alas, if history is any guide, it will require a revolution for governments to cede their grip on the economy, and by extension the power it brings. There is a book, “The Fourth Turning” by Neil Howe, which discusses the cycles of history. It is a fascinating read, and one which seems quite prescient as to the current global political situation. I highly recommend taking a look.

In the end, what seems quite certain is that what we assumed was normal just two months ago may never return. This is true of businesses as well as market behaviors. Safe havens have lost much of their luster as investors find themselves in a very difficult situation. How can getting paid just 0.6% nominally for 10 years (current 10-year treasury yield) be considered a safe place to hold your funds with inflation running at 2.3%, and after a likely short-term deflationary bout due to demand destruction, set to move to heights not seen since prior to the GFC? Of course, the answer is, it can’t. But then Treasuries have a higher return than Gilts, Bunds or JGB’s, the other nations to which one would naturally gravitate for a safe haven. Equities certainly don’t create warm and fuzzy feelings given the extraordinary situation with businesses shutting down everywhere and revenues and earnings collapsing. Commodities? Even gold has had a tough time, although it is marginally higher since all this really got going in earnest, but as a safe haven? Cryptocurrencies? (LOL). In fact, despite the ongoing depreciation of the dollar through creeping inflation, Benjamins are clearly the one thing that remain accepted as a place to maintain value. They are fungible and recognized worldwide as a store of value and medium of exchange. It is with this in mind that we should recognize the near-term outlook for the dollar should remain positive.

So what has happened overnight? The dollar is king once again, rising against all its G10 counterparts with CAD the laggard, -1.1%, after oil prices once again sold off sharply (WTI briefly traded below $20/bbl and isdown about 5.2%) this morning. But the weakness is widespread with SEK -1.0% and EUR -0.8% following closely behind the Loonie. European data released this morning showed, not surprisingly, that Economic Confidence (94.5 from 103.5) had fallen at its fastest pace ever, although it has not yet plumbed the depths of the Eurozone crisis in 2012. Give it time!

Emerging markets are also under significant pressure, with MXN today’s biggest loser, down 1.8%, as the combination of tumbling oil prices, the rapid decline of US demand and AMLO’s remarkably insouciant response to Covid-19 has investors fleeing despite the highest yields available in LATAM. But RUB (-1.3%) on the back of declining oil prices and ZAR (-1.1%) on the back of declining commodity prices as well as internal credit problems, are also suffering. In fact, just two currencies, MYR and PHP were able to rally today, each by about 0.2% as each nation announced additional fiscal and monetary support.

Looking ahead this week, aside from the ongoing virus news, we do get more data as follows:

Tuesday Case Shiller Home Prices 3.29%
  Chicago PMI 40.0
  Consumer Confidence 110.0
Wednesday ADP Employment -150K
  Construction Spending 0.5%
  ISM Manufacturing 45.0
  ISM Prices Paid 41.8
Thursday Trade Balance -$40.0B
  Initial Claims 3150K
  Factory Orders 0.2%
Friday Nonfarm Payrolls -100K
  Private Payrolls -110K
  Manufacturing Payrolls -10K
  Unemployment Rate 3.8%
  Average Hourly Earnings 0.2% (3.0% Y/Y)
  Average Weekly Hours 34.2
  Participation Rate 63.3%
  ISM Non-Manufacturing 44.0

Source: Bloomberg

Obviously, much of this is still backward looking and the real question on the NFP report is just how much of the disruption took place during the survey week, which was 3 weeks ago. I think the Initial Claims number will have more power this month, as well as the ISM data. But boy, next month’s NFP report is going to be UGLY!

At any rate, there is not going to be anything positive from the economic data set this week, or probably throughout April. Rather the next piece of positive news we will hear is when the infection curve has started to flatten and there is an end to this disruption in sight. As of now, one man’s view is we will be like this for another month at least. I sincerely hope for everyone, that it is shorter than that.

Good luck and stay safe
Adf

Overrun

Our planet, third rock from the sun
Has clearly now been overrun
By Covid-19
Whose spread is unseen
And cannot be fought with a gun

It is certainly difficult, these days, to keep up with the latest narrative about how quickly the virus will continue to spread and when we will either flatten the infection curve or will get past its peak. Every day brings a combination of optimistic views, that within a few weeks’ things will settle down, as well as pessimistic views, that millions will die from the virus and it will be many months before life can return to any semblance of normal. And the thing is, both sets of opinions can come from reasonably well-respected sources. Adding to the confusion is the fact that there is still a huge political divide in the US, and that many comments are politically tinged in order to gain advantage. After all, while it has not been the recent focus, there is still a presidential election scheduled for November, a scant seven plus months from now.

With this as the baseline, it cannot be that surprising that we have seen the extraordinary volatility present throughout markets in recent weeks. And while volatility may have peaked, it is not about to fall back to the levels present two months ago. In fact, the one thing of which I am certain is it will take a long time for markets to settle back into the rhythms that had seemed so pleasing and normal for so many years.

Something else to note is that while central banks seem to have been able to positively impact market behavior in recent days, the cost of doing so has gone up dramatically. For example, during the financial crisis, the widely hated TARP bill had a price tag of $700 billion, clearly a large number. And yet that is one-third of what the present stimulus bill will cost. And the Fed? Well it took them three months in 2008 to expand their balance sheet by $1 trillion. This time it took less than three weeks. And they are not even close to done!

It is the latter point that brings the greatest risk to markets, the fact that the cost of addressing market failures has grown far faster than the global economy. This is a result of the serial bubble blowing that we have seen since October 1987, when the Maestro himself, then Fed Chair Alan Greenspan, promised the Fed would support markets and not allow things to collapse. That inaugurated a pattern of central bank behavior that prevented markets of any kind from clearing excesses because the political fallout would have been too great. But as we have seen, each bubble blown since has had a larger and larger price tag to overcome. The question now is, have we reached the limits of what policymakers can do to prevent markets from clearing? Certainly, they will never admit that is the case, but much smarter people than me have made the case that their capabilities have been stretched to the limit.

It is with this as background that I think it makes sense to discuss what we have seen this week alone! Using the S&P 500 as our proxy, we saw a sharp decline on Monday, over 4%, and then a three-day rebound of nearly 18%! In fact, from its lows on Monday, the rebound has been more than 20%. Many in the financial press have been saying this is now a bull market. My view is that is bull***t. A bull market needs to be defined as a market where prices are rising on the back of strong underlying fundamentals and where long-term prospects are strong. The recent fixation on 20% movements as defining a bull or bear market are completely outdated. Instead, I think the case is far easier to make that we are ensconced in the beginning of a bear market, where the long-term, or at least medium-term, fundamentals are quite weak and prospects are uncertain, at best, and realistically quite negative for the coming quarters. Declaring a bull market on the same day that Initial Unemployment Claims printed at nearly 3.3 million, far and away the highest in history, is ridiculous! I fear that the movement this week in stocks and the dollar, is not the beginning of a new trend, but a reactive bounce to previous price action.

Turning to the dollar, after a remarkable rally in the buck throughout the month of March, it too has fallen sharply during the past several sessions. The proximate cause was the Fed, which when it announced its laundry list of new programs on Monday evening was able to calm immediate fears over a lack of USD liquidity. It appears that the dollar’s two week run of strength was driven by global fears over a shortage of dollar liquidity available coming into quarter end next week. We saw this in the movement of basis swap spreads, which blew out in favor of dollars, and we saw this in the FX forward market, where every price that encompassed the turn was no longer linearly interpolated. But the Fed has thrown $5 trillion at the problem and for now, that seems like it is enough, at least for this quarter. Markets have settled, and the fear over coming up short of dollars has abated for the time being.

But this is not over, not by a longshot. Navigating the next few months will be quite difficult as we are sure to see more negative news regarding the virus, followed by policy attempts to address that news. Until a solid case is made that globally, the peak of the infection curve is behind us, we are going to remain in a tenuous market state with significant volatility.

Finishing with a brief look at the dollar this morning, it is actually having a mixed session. In the G10, NOK continues to be the most volatile currency by far, down 1.3% this morning after an intervention led 14% rally in the past week. Of course, that was after it fell nearly 29% in the previous two weeks! And you thought only EMG currencies were volatile! But the rest of the G10 space shows JPY strength, +0.9%, as repatriation flows help the currency, and then much lesser movements in both directions from the rest of the bloc.

In the emerging markets, the story is similar, with KRW the biggest gainer, +1.8% overnight, as the BOK confirmed its recent activity qualifies as QE, and more importantly, that they will continue to do everything necessary to support the economy. Meanwhile, on the opposite end of the spectrum is the Mexican peso, which has fallen 1.5% this morning after Standard & Poor’s downgraded the country’s credit rating by a notch to BBB and left them on negative watch. The peso, too has had a wild ride this month, declining nearly 6 full pesos at its worst level, or 30%, before rallying back sharply this week by 10% at its peak, now more like 8.2%. Again, the point is that we can expect ongoing sharp movements in both directions for now.

With spot today being month-end, I realize many companies will be active in their balance sheet rolling programs. Forward bid-ask spreads continue to be wider than normal but have definitely moderated from what we saw in the past two weeks. This is the new normal though, so for the next several months, be prepared for wider pricing than we all learned to love.

Good luck, good weekend and stay safe
Adf

Outrageous

The ECB’s fin’lly decided
That limits were badly misguided
So, starting today
All bonds are in play
To purchase, Lagarde has confided

As well, in the Senate, at last
The stimulus bill has been passed
Amidst all its pages
The Fed got outrageous
New powers, and hawks were aghast

Recent price action in risk assets demonstrated the classic, ‘buy the rumor, sell the news’ concept as equity market activity in the past two sessions had been strongly positive on the back of the anticipated passage of a huge stimulus bill in the US. And last night, the Senate finally got over their procedural bickering and hurdles and did just that. As such, it should be no great surprise that risk assets are under pressure today, with only much less positive news on the horizon. Instead, we can now look forward to death tolls and bickering about government responses to the quickly evolving crisis. If that’s not a reason to sell stocks, I don’t know what is!

But taking a break from descriptions of market activity, I think it is worthwhile to discuss two other features of the total government response to this crisis. And remember, once government powers are enacted, it is extremely difficult to remove them.

The first is from the US stimulus bill, where there is a $500 billion portion of the bill that is earmarked for support of the business community. $75 billion is to go to shore up airlines and the aerospace infrastructure, but the other $425 billion is added to the Treasury’s reserve fund which they can use to backstop, at a 10:1 leverage ratio, Fed lending. In other words, all of the programs about which we have been hearing, including the CP backstop, the primary dealer backstop, and discussion of purchases of municipal and corporate bonds as well as even equities, will now have the funding in place to the tune of $4.25 trillion. This means that we can expect the Fed balance sheet to balloon toward at least $9 trillion before long, perhaps as quickly as the end of the year. Interestingly, just last year we consistently heard from mainstream economists as well as Chairman Powell and Secretary Mnuchin, how Modern Monetary Theory (MMT) was a crock and a mistake to consider. And yet, here we are at a point where it is now the best option available and about to effectively be enshrined in law. It seems this crisis will indeed be quite transformational with the death of the Austrian School of economics complete, and the new math of MMT at the forefront of the dismal science.

Meanwhile, Madame Lagarde could not tolerate for Europe to be left behind in this monetary expansion and so the ECB scrapped their own eligibility rules regarding purchases of assets to help support the Eurozone member economies. This means that the capital key, the guideline the ECB used to make sure they didn’t favor one nation over another, but rather executed their previous QE on a proportional basis relative to the size of each economy, is dead. This morning the ECB announced that they can buy whatever they please and they will do so in size, at least €750 billion, for the rest of this year and beyond if they deem it necessary. This goes hand in hand with the recent German repudiation of their fiscal prudence, as no measure is deemed unreasonable in an effort to fight Covid-19. In addition to this, the OMT program (Outright Monetary Transactions) which was created by Signor Draghi in the wake of the Eurozone bond crisis in 2012 but never utilized, may have a new lease on life. The problem had been that in order for a country (Italy) to avail themselves of the ECB hoovering up their debt, the country needed to sign up for specific programs aimed at addressing underlying structural problems in said country. But it seems that wrinkle is about to be ironed out as well, and that OMT will finally be utilized, most likely for Italian bonds.

While neither the Fed nor ECB will be purchasing bonds in the primary market, you can be sure that is not even remotely a hindrance. In fact, buying through the secondary market ensures that the bank intermediaries make a profit as well, another little considered, but important benefit of these programs.

The upshot is that when this crisis passes, and it will do so at some point, governments and central banks will have even more impact and control on all decisions made, whether business or personal. Remember what we learned from Milton Friedman, “nothing is so permanent as a temporary government program.”

Now back to market behavior today. It is certainly fair to describe the session as a risk-off day, with equity markets have been under pressure since the beginning of trading. Asia was lower (Nikkei -4.5%, Hang Seng -0.75%), Europe has been declining (DAX -2.3%, CAC -1.8%, FTSE 100 -2.1%) and US futures are lower (SPU’s -1.4%, Dow -1.0%). Meanwhile, Treasury yields have fallen 6bps, and European government bonds are all rallying on the back of the ECB announcement. After all, the only price insensitive buyer has just said they are coming back in SIZE. Commodity prices are soft, with WTI falling 2%, and agriculturals softer across the board although the price of gold continues to be a star, as it is little changed this morning but that means it is holding onto its recent 11% gain.

And finally, in the FX markets, while G10 currencies are all looking robust vs. the dollar, led by the yen’s 1.2% gain and Norway’s continued benefit from recent intervention helping it to rally a further 0.75%, EMG currencies are more mixed. ZAR is the worst of the day, down 0.9% as an impending lockdown in the country to fight Covid-19, is combining with its looming credit rating cut to junk by Moody’s to discourage buying of the currency. We’ve also seen weakness in an eclectic mix of EMG currencies with HUF (-0.35%), KRW (-0.25%) and MXN (-0.2%) all softer this morning. In fairness, the peso had a gangbusters rally yesterday, jumping nearly 3.5%, so a little weakness is hardly concerning. On the plus side, APAC currencies are the leaders with MYR, IDR and INR all firmer by 1.2% on the strength of their own stimulus (India’s $22.6 billiion package) or optimism over the impact of the US stimulus.

Perhaps the biggest thing on the docket this morning is Initial Claims (exp 1.64M) which would be a record number. But so you understand how uncertain this forecast is, the range of forecasts is from 360K to 4.40M, so nobody really has any idea how bad it will be. My fear is we will be worse than the median, but perhaps not as high as the 4.4M guess. And really, that’s the only data that matters. The rest of it is backward looking and will not inform any views of the near future.

We have seen two consecutive days of a risk rally, the first two consecutive equity rallies in more than a month, but I expect that there are many more down days in our future. The dollar’s weakness in the past two sessions is temporary in my view, so if you have short term receivables to hedge, now is a good time. One other thing to remember is that bid-ask spreads continue to be much wider than we are used to, so do not be shocked when you begin your month-end balance sheet activity today.

Good luck and stay safe
Adf

 

Hawks Acquiesce

In Germany and the US
The crisis made hawks acquiesce
To spending more dough
Despite and although
Things ultimately will be a mess

There is only one story of note this morning, at least from the market’s collective perspective, and that is the news that the Senate has agreed the details of a stimulus package in the US. The price tag is currently pegged at $2.0 trillion, although it would not surprise me if when this bill gets to the House, they add a bit more lard. Fiscal hawks have been set aside and ignored as the immediate concerns over the virtual halt in the US (and global) economy has taken precedence over everything else. The package offers support for small and medium sized businesses, direct cash payments to individuals and increased allocations to states in order to help them cope with Covid-19. But overall, what it does is demonstrate that the US is not going to sit by and watch as the economy slides into a deep recession.

And that seems to be the signal that markets were awaiting. We have already seen Germany discard decades of fiscal prudence in their effort to address the collapse in business activity there. In fact, their social demands are even greater than in the US, with no groups of more than 2 people allowed to congregate together. While it cannot be a surprise that the IFO indicator was revised lower this morning, with the Expectations Index falling to within a whisker of its financial crisis lows of 79.2. The real question is if the measures invoked to stop the spread of the virus continue for another month, just how low can this reading go? The one thing that is clear is that we are going to continue to see some unprecedented damage to economic statistics as the next several months evolve.

But none of that matters today, at least in the world of finance. The promise of more money being spent has led to some spectacular rallies in equity markets in the past twenty-four hours. By now you are all aware of yesterday’s late day melt-up in the US, where the Dow closed higher by 11.4%, outpacing even the NASDAQ (+8.1%). And overnight, the Nikkei rocketed 8% higher as a follow-through on the US news and despite the news that the 2020 Tokyo Olympics are now going to be the 2021 Tokyo Olympics. The rest of Asia rose as well (Hang Seng +3.8%, Shanghai +2.7%, Australia +5.5%) and Europe started out on fire. But a funny thing happened in the past hour, it seems that more sober heads took over.

European equity indices, which had exploded higher at the opening (DAX +4.4%, CAC +4.9%) have given back most of those early gains and are now mixed with the DAX lower by 0.4% although the CAC clinging to +0.9% gain. US futures, which were similarly much higher earlier, between 2% and 3%, have now erased all those gains and are now marginally lower on the session. In fact, I suspect that this is going to continue to be the situation in equity markets as each piece of new news will need to be absorbed into the pricing matrix. And for now, there is just as much bad news as good, thus driving significant volatility in this asset class going forward.

Bond markets are seeing similar style moves, alternating between risk-on and risk-off, although with much of the leverage having already been wiped out of these markets, and central banks around the world directly supporting them through massive QE purchases, the magnitude of the moves are much smaller. Early this morning, we saw Treasuries under pressure, with yields higher by as much as 4bps, but now they have actually rallied, and the 10-year yield is lower by 1bp. There is similar price action in European government bond markets although the recent rally has not quite reversed all the early losses. Of course, the ECB’s €750 billion program is dwarfed by the Fed’s QE Infinity, so perhaps that should not be a great surprise.

And finally, turning to the FX markets, the dollar remains under pressure, as we have seen all week, as fears over the availability of dollars has diminished somewhat in the wake of the Fed’s actions. This has led to NOK once again being the leader in the clubhouse, rallying a further 2.1% this morning which takes its movement this week to 7.5%! It seems that the first batch of weekly FX flow statistics from the Norgesbank confirm that they did, indeed, intervene earlier this week, which given the price action, can be the only explanation. (I am, however, proud of them for not publicly blaring it, rather simply doing the job and allowing markets to respond.) And given the oil price collapse and the damage that will do to the Norwegian economy, it makes sense that they would want to manage the situation. But most currencies are firmer so far this week, with AUD (+3.8%) and SEK (+2.75%) recouping at least a part of what had been devastating recent losses. As to today’s session, aside from NOK, the pound is the next best performer, rallying 0.9% on the strength of a new liquidity program by the BOE as well as what appears to be hope that recent government pronouncements regarding social distancing and shelter in place rules, seems to demonstrate Boris is finally going to come into line with the rest of the world’s governments on the proper containment strategy.

EMG currencies are also performing well this morning as the broad-based dollar decline lifts most of them. KRW is the best performer today, +1.6%, which is in line with last night’s euphoria over the US stimulus bill. MXN had been sharply higher early but has since given up some of its gains and is now higher by only 1% as I type. The market is not pleased with AMLO’s attitude toward the virus, nor it seems are the Mexican people based on the erosion in his approval ratings. Meanwhile, the other major LATAM economy, Brazil, is poised to see its currency weaken even further as President Bolsonaro also ignores the current protocols of self-quarantine or shelter-in-place and encourages his nation to ignore the virus and go about their lives. I have a feeling that President Bolsonaro is going to be a one-term president. BRL hasn’t opened yet but has fallen more than 2% this week already. I expect more will come.

On the data front, yesterday’s PMI data while awful, was actually not nearly as bad as the data seen in Europe or Asia. This morning brings Durable Goods (exp -1.0%, -0.4% ex transport) although these are February numbers, so will not really tell us much about the current state of the economy. Rather, all eyes are turning to tomorrow’s Initial Claims data, to see just how high that number will climb. There are numerous stories of state employment websites crashing from the overflow in volumes.

In the end, while the stimulus bill is good news, the proof remains in the pudding, as it were, and we need to see if all of that spending will help stabilize, then lift the US economy back to its prior trajectory. If this virtual lockdown lasts past Easter, the economic damage will become much more difficult to reverse and will make the hoped for V-shaped recovery that much harder to achieve. For now, though, we can only watch and wait. The one thing that remains clear is that in the end, the US dollar remains the haven of all havens, no matter the fiscal situation in the US. It will always be preferred to the alternative.

Good luck and stay safe
Adf

 

Truly a Beast

The PMI data released
Showed just how fast growth has decreased
Tis services that
Have fallen so flat
This virus is truly a beast

But yesterday two bits of news
May help prevent any more blues
The Fed started things
By spreading their wings
And buying all debt that accrues

As well, in a break from the past
The Germans decided at last
To open the taps
As well as, perhaps
Support debt Italians amassed

And finally, where it began
The virus, that is, in Wuhan
Two months from their dawn
Restrictions are gone
Defining the lockdown’s lifespan

Markets have a much better tone this morning as traders and investors react to two very important responses to the ongoing Covid-19 crisis. The first thing that is getting a positive, albeit delayed, response is the Fed’s enactment of a series of new programs including support for CP, mortgage-backed securities, primary dealers and money market funds as well as embarking on QE Infinity, buying $75 billion of Treasuries and $50 billion of mortgage-backed securities every day this week, and then on into the future. Previous concerns about the size of the Fed’s balance sheet relative to the US economy have been completely dismissed, and you can bet that we will soon see a Fed balance sheet with $10 trillion in assets, nearly 50% as large as the economy. But the announcement, while at first not getting quite the positive impact desired, seems to be filtering through into analysis and is definitely seen in a more positive light this morning than yesterday at this time.

The second piece of news was that not only is Germany going to embark on a €750 billion spending program to help the economy, but, more importantly, they are willing to support Italy via European wide programs like the European Stability Mechanism, and even jointly issued coronaviru bonds, to prevent a further catastrophe there. In truth, that seems to be a bigger deal than the Fed, as the long-term implications are much greater and point to a real chance that the European experiment of integration could eventually work. If they move down the path to jointly issue and support debt available to all members, that is a massive change, and likely a long term positive for the single currency. We have to see if they will actually go forward, but it is the most promising structural comment in Europe in years, perhaps even since the euro was formed.

However, we cannot forget that the current reality remains harsh, and were reminded of such by this morning’s Flash PMI data, which, unsurprisingly, fell to record lows throughout Europe and the UK. Services were hit much harder than Manufacturing with readings of 29.0 in France, 34.5 in Germany, 31.4 in the Eurozone and 35.7 in the UK. Japan also released their data, which was equally dismal at 32.7 for Services PMI there. And they added to the story by releasing Department Store Sales, which fell a healthy 12.2%. Of course, everyone knows that the data is going to be awful for the time being, and since we saw China’s PMI data last month, this was expected. Granted, analysts had penciled in slightly higher numbers, but let’s face it, everybody was simply guessing. Let’s put it this way, we are going to see horrific data for at least the next month, so it will have to be extraordinarily bad to really garner a negative market reaction. This is already built into the price structure. While the US has historically looked far more closely at ISM data, to be released next week, than PMI data, we do see the US numbers later this morning, with forecasts at 42.0 for Services and 43.5 for Manufacturing.

So the data is not the driver today, which has seen a more classic risk-on framework, rather I think it is not only the absorption of the Fed and German actions, but also, perhaps, the news from Wuhan that the restrictions on travel, imposed on January 23, are being lifted, nearly two months to the day after imposition. Arguably, that defines the maximum lockdown period, although yesterday President Trump hinted that the US period will be much shorter, with 14 or 15 days mooted. If that is the case, and I would place the start date as this week, we are looking at heading back to our offices come April 6. If the Fed is successful in preventing financial institution collapse, and Congress finally passes a stimulus bill to address the massive income dislocation that is ongoing, (which they will almost certainly do in the next two days), there is every chance that while Q2 GDP will be hit hard, the panic inducing numbers of -30% GDP growth (Morgan Stanley’s forecast) or -50% GDP growth (St Louis Fed President Bullard’s forecast), will be referred to as the height of the panic. We shall see.

But taking a look at markets this morning, we see the dollar under pressure across the board, with the Norwegian krone today’s champion, rallying 5.4% as a follow on to yesterday’s reversal and ultimate 1.2% gain. But the pound has bounced 2.0% this morning along with SEK and AUD is higher by 1.7%. It is entirely possible that what we are seeing is a relief in the funding markets as the Fed’s actions have made USD available more widely around the world and reduced some of that pressure.

EMG markets are seeing similar strength in their currencies, led by MXN (+2.6%) and HUF (+2.3%), but every currency in both blocs is higher vs. the greenback today. Equity markets are all green as well, with major rallies in Asia (Nikkei +7.1%, Hang Seng +4.5%, Shanghai +2.7%) and Europe (DAX +6.25%, CAC +5.25%, FTSE 100 +4.0%) with US equity futures limit up in all three indices. Bonds, meanwhile, have sold off slightly, with yields higher in both the US and Germany by 2bps. I think given the overall backdrop, bonds are unlikely to sell off sharply anytime soon, especially given the central bank promises to buy unlimited quantities of them.

And I would be remiss if I didn’t mention gold, which is up 2.5% today and 6.2% since Friday’s close as investors realize that all the money printing and fiscal stimulus is likely to lead to a much different view on inflation, namely that it is going to rise in the future.

Volatility remains the watchword as 5% daily moves in the equity market, even when they are up moves, remain extremely taxing on all trading activities. Market liquidity remains suspect in most markets, with bid-ask spreads still far wider than we’ve come to expect. Forward FX spreads of 5-10 pips for dates under 1 year are not uncommon in the majors, let alone in things like MXN or BRL. Keep that in mind as you prepare for your balance sheet rolling programs later this week.

Good luck and stay safe
Adf

No Respite

This weekend, alas, brought no respite
As markets are still in the cesspit
A worrying trend
While govs try to end
The panic, is that they turn despot

Well, things have not gotten better over the weekend, in fact, arguably they continue to deteriorate rapidly. And I’m not talking markets here, although they are deteriorating as well. More and more countries have determined that the best way to fight this scourge is to lockdown their denizens and prevent gatherings of more than a few people while imposing minimum distance restrictions to be maintained between individuals. And of course, given the crisis at hand, a virulently contagious disease, it makes perfect sense as a way to prevent its further spread. But boy, doesn’t it have connotations of a dictatorship?

The attempt to prevent large groups from gathering is a hallmark of dictators who want to prevent a revolution from upending their rule. The instructions to maintain a certain distance are simply a reminder that the government is more powerful than you and can force you to act in a certain manner. Remember, too, that governments, once they achieve certain powers, are incredibly loathe to give them up willingly. Those in charge want to remain so and will do almost anything to do so. Milton Friedman was spot on when he reminded us that, “nothing is so permanent as a temporary government program.” The point is, while the virus could not be foreseen, the magnitude of the economic impact is directly proportional to the economic policies that preceded it. In other words, a decade of too-easy money led to a massive amount of leverage, which under ‘normal’ market conditions was easily serviceable, but which has suddenly become a millstone around the economy’s neck. And adding more leverage won’t solve the problem. Both the economic and financial crisis have a ways to go yet, although they will certainly take more twists and turns before ending.

None of this, though, has dissuaded governments worldwide from trying every trick suggested to prevent an economic depression. At the same time, pundits and analysts are in an arms race, to make sure they will be heard, in forecasting economic catastrophe. Q2 US GDP growth is now being forecast to decline by anywhere from 5% to 50%! And the high number ostensibly came from St Louis Fed President James Bullard. Now I will be the first to tell you that I have no idea how Q2 will play out, but I also know that given the current circumstances, and the fact that the virus is a truly exogenous event, it strikes me that any macroeconomic model built based on historical precedents is going to be flat out wrong. And remember, too, we are still in Q1. If the draconian measures implemented are effective, recovery could well be underway by May 15 and that would result in a significant rebound in the second half of Q2. Certainly, that’s an optimistic viewpoint, but not impossible. The point is, we simply don’t know how the next several quarters are going to play out.

In the meantime, however, there is one trend that is becoming clearer in the markets; when a country goes into lockdown its equity market gets crushed. India is the latest example, with the Sensex falling 13.1% last night after the government imposed major restrictions on all but essential businesses and reduced transportation services. Not surprisingly, the rupee also suffered, falling 1.2% to a new record low. RBI activity to stem the tide has been marginally effective, at best, and remarkably, it appears that India is lagging even the US in terms of the timeline of Covid-19’s impact. The rupee has further to fall.

Singapore, too, has seen a dramatic weakening in its dollar, falling 0.9% today and trading to its lowest level since 2009. The stock exchange there also tumbled, -7.3%, as the government banned large gatherings and limited the return of working ex-pats.

These are just highlights (lowlights?) of what has been another difficult day in financial markets around the world. The one thing we have seen is that the Fed’s USD swap lines to other central banks have been actively utilized around the world as dollar liquidity remains at a premium. Right now, basis swaps have declined from their worst levels as these central bank activities have reduced some of the worst pressure for now. A big concern is that next Tuesday is quarter end (year end for Japan) and that dollar funding requirements over the accounting period could be extremely large, exacerbating an already difficult situation.

A tour around the FX markets shows that the dollar remains king against most everything although the yen has resumed its haven status, at least for today, by rallying 0.3%. Interestingly, NOK has turned around and is actually the strongest currency as I type, up 0.8% vs. the dollar after having been down as much as 1.3% earlier. This reversal appears to be on the back of currency intervention by the Norgesbank, which is the only thing that can explain the speed and magnitude of the movement ongoing as I type. What that tells me is that when they stop, NOK will resume its trip lower. But the rest of the G10 is on its heels, with kiwi the laggard, -1.25%, after the RBNZ jumped into the QE game and said they would be buying NZD 30 billion throughout the year. AUD and GBP are both lower by nearly 1.0%, as both nations struggle with their Covid responses on the healthcare front, not so much the financial front, as each contemplates more widespread restrictions.

In the emerging markets, IDR is actually the worst performer of all, down 3.7%, as despite central bank provision of USD liquidity, dollars remain in significant demand. This implies there may be a lack of adequate collateral to use to borrow dollars and could presage a much harsher decline in the future. But MXN and KRW are both lower by 1.5%, and remember, South Korea has been held up as a shining example of how to combat the disease. Their problem stems from the fact that as an export driven economy, the fact that the rest of the world is slowing rapidly is going to be devastating in the short-term.

Turning to the data, this week things will start to be interesting again as we see the first numbers that include the wave of shut-downs and limits on activity.

Today Chicago Fed Activity -0.29
Tuesday PMI Manufacturing 44.0
  PMI Services 42.0
  New Home Sales 750K
Wednesday Durable Goods -1.0%
  -ex transport -0.4%
Thursday Initial Claims 1500K
  Q4 GDP 2.1%
Friday Personal Income 0.4%
  Personal Spending 0.2%
  PCE Deflator core 0.2% (1.7% Y/Y)
  Michigan Sentiment 90.0

Source: Bloomberg

Tomorrow’s PMI data and Thursday’s Initial Claims are the first data that will have the impact of the extraordinary measures taken against the virus, so the real question is, just how bad will they be? I fear they could be much worse than expected, and that is not going to help our equity markets. It will, however, perversely help the dollar, as fear grows further.

Forecasting is a mugs game at all times, but especially now. The only thing that is clear is that the dollar continues to be in extreme demand and is likely to be so until we start to hear that the spread of Covid-19 has truly slowed down. That said, the dollar will not rally forever, so payables hedgers should be thinking of places where they can add to their books.

Good luck and stay well
Adf