Off to the Races

Though headlines describe the new cases
Of Covid, in so many places
The market’s real fear
Is later this year
The trade war is off to the races

Risk is under pressure today as, once again, concerns grow that increased trade tensions will derail the rebound from the Covid inspired global recession. You may recall yesterday’s fireworks in Asia after Peter Navarro seemed to describe the phase one trade deal as over. (Remember, too, President Trump quickly remedied that via Twitter.) This morning has seen a somewhat less dramatic market impact, although it has shown more staying power, after the Trump Administration explained that it was targeting $3.1 billion of European and UK goods for tariffs in a WTO sanctioned response to the EU’s illegal Airbus subsidies. Of course, the fact that they are sanctioned does not make them any less damaging to the economic rebound. Pretty much the last thing the global economy needs right now is something else to impede the flow of business. According to reports, the targeted goods will be luxury goods and high-end liquors, so the cost of that Hendricks and Tonic just might be going up soon. Naturally, the EU immediately responded that they would have to retaliate, although they have not released a list of their targets.

Needless to say, even the unbridled optimism over a central bank induced recovery was dented by these announcements as they are a direct attack on the idea that growth will rebound to previous levels quickly. Now, those tariffs are not yet in place, and the US has said they are interested in negotiating a better solution, but investors and traders (and most importantly, algorithms) are programmed to read tariffs as a negative and sell stocks. And so, what we have seen this morning is a solid decline across European bourses led by the DAX (-2.1%) and FTSE 100 (-2.3%) although the rest of the continent is looking at declines between of 1.25% and 1.75%. It is a bit surprising that the bond market has not seen things in quite the same light, with 10-year Treasury yields almost unchanged at this hour, as are German bund yields, and only Italian BTP’s seeing any real movement as yields there rise (prices fall) by 2bps. Of course, we recognize that BTP’s are more akin to stocks than bonds these days.

In the background, though, we continue to hear of a resurgence in Covid cases in many places throughout the world. In the US, newly reported infections are rising in many of the states that are going through a slow reopening process. There are also numerous reports of cases popping up in places that had seemed to have eliminated the virus, like Hong Kong, China and Japan. And then, there are areas, notably LATAM nations, that are seeing significant growth in the caseload and are clearly struggling to effectively mitigate the impact. The major market risk to this story is that economies around the world will be forced to stage a second shutdown with all the ensuing economic and financial problems that would entail. Remember, too, that if a second shutdown is in our future, governments, which have already spent $trillions they don’t have, will need to find $trillions more. At some point, that is also likely to become a major problem, with emerging market economies likely to be impacted more severely than developed nations.

So, with those unappetizing prospects in store, let us turn our attention to this morning’s markets. As I mentioned, risk is clearly under pressure and that has manifest itself in the foreign exchange markets as modest dollar strength. In the G10 space, NZD is the laggard, falling 0.9% after the RBNZ, while leaving policy on hold, promised to do more to support the economy (ease further via QE) if necessary. Apparently, the market believes it will be necessary, hence the kiwi’s weakness. But away from that, the dollar’s strength has been far more muted, with gains on the order of 0.2%-0.3% against the higher beta currencies (SEK, AUD and CAD) while the euro, yen and pound are virtually unchanged on the day.

In the EMG bloc, it has been a tale of two sessions with APAC currencies mostly gaining overnight led by KRW (+0.8%), which seemed to be responding to yesterday’s news of sunshine, lollipops and roses modestly improving economic data leading toward an end to the global recession. Alas, all those who bought KRW and its brethren APAC currencies will be feeling a bit less comfited now that the trade war appears to be heating up again. This is made evident by the fact that the CE4 currencies are all lower this morning, led by HUF (-0.6%) and CZK (-0.4%). In no uncertain terms, increased trade tensions between the US and Europe will be bad for that entire bloc of economies, so weaker currencies make a great deal of sense. As to LATAM, they too are under pressure, with MXN (-0.5%) the only one open right now, but all indications for further weakness amid the combination of the spreading virus and the trade tensions.

On the data front, we did see German IFO data print mildly better than expected, notably the Expectations number which rose to 91.4 from last month’s reading of 80.1. But for context, it is important to understand that prior to the onset of Covid-19, these readings were routinely between 105 and 110, so we are still a long way from ‘normal’. The euro has not responded to the data, although the trade story is likely far more important right now.

In the US we have no data of note today, and just two Fed speakers, Chicago’s Evans and St Louis’ Bullard. However, as I have pointed out in the recent past, every Fed speaker says the same thing; the current situation is unprecedented and awful but the future is likely to see a sharp rebound and in the meantime, the Fed will continue to expand their balance sheet and add monetary support to the economy.

And that’s really all there is today. US futures are pointing lower, on the order of 0.75% as I type, so it seems to be a question of watching and waiting. Retail equity investors continue to pile into the stock market driving it higher, so based on recent history, they will see the current decline as another opportunity to buy. I see no reason for the dollar to strengthen much further barring yet another trade announcement from the White House, and if my suspicions about the stock market rebounding are correct, a weaker dollar by the end of the day is likely in store.

Good luck and stay safe
Adf

 

It’s Over

“It’s over”, Navarro replied
When asked if the trade deal had died
The stock market’s dump
Forced President Trump
To tweet the deal’s still verified

What we learned last night is that the market is still highly focused on the trade situation between the US and China. Peter Navarro, the Director of Trade and Manufacturing Policy, was interviewed and when asked if, given all the issues that have been ongoing between the two countries, the trade deal was over, he replied, “it’s over, yes.” The market response was swift, with US equity futures plummeting nearly 2% in minutes, with similar price action seen in Tokyo and Sydney, before the president jumped on Twitter to explain that the deal was “fully intact.”

One possible lesson to be gleaned from this story is that the market has clearly moved on from the coronavirus, per se, and instead is now focusing on the ramifications of all the virus has already wrought. The latest forecasts from the OECD show trade volumes are expected to plummet by between 10% and 15% this year, although are expected to rebound sharply in 2021. The key is that infection counts and fatality rates are no longer market drivers. Instead, we are back to economic data points.

Arguably, this is a much better scenario for investors as these variables have been studied far more extensively with their impact on economic activity reasonably well understood. It is with this in mind that I would humbly suggest we have moved into a new phase of the Covid impact on the world; from fear, initially, to panicked government response, and now on to economic fallout. Its not that the economic impact was unimportant before, but it came as an afterthought to the human impact. Now, despite the seeming resurgence in infections in many spots around the world, at least from the global market’s perspective, we are back to trade data and economic stories.

This was also made evident by all the talk regarding today’s preliminary PMI data out of Europe, which showed French numbers above 50 and the Eurozone, as a whole, back to a 47.5 reading on the Composite index. However, this strikes me as a significant misunderstanding of what this data describes. Remember, the PMI question is, are things better, worse or the same as last month? Now, while April was the nadir of depression-like economic activity, last month represented the second worst set of numbers recorded amidst global shutdowns across many industries. It is not a great stretch to believe that this month is better than last. But this does not indicate in any manner that the economy is back to any semblance of normal. After all, if we were back to normal, would we all still be working from home and wearing masks everywhere? So yes, things are better than the worst readings from April and May, but as we will learn when the hard data arrives, the economic situation remains dire worldwide.

But while the economic numbers may be awful, that has not stopped investors traders Robinhooders from taking the bull by the horns and pouring more energy into driving stocks higher still. Of course, they are goaded on by the President, but they seem to have plenty of determination on their own. Here’s an interesting tidbit, the market cap of the three largest companies, Apple, Microsoft and Amazon now represents more than 20% of US GDP! To many, that seems a tad excessive, and will be pointed to, after prices correct, as one of the greatest excesses created in this market.

And today is no different, with the risk bit in their teeth, equity markets are once again trading higher across the board. Once the little trade hiccup had passed, buyers came out of the woodwork and we saw Asia (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.2%) and Europe (DAX +2.7%, CAC +1.6%, FTSE 100 +1.2%) all steam higher. US futures are also pointing in that direction, currently up between 0.6% and 0.8%. Treasury yields are edging higher as haven assets continue to lose their allure, with 10-year Treasury yields up another basis point and 2bp rises seen throughout European markets. Interestingly, there is one haven that is performing well today, gold, which is up just 0.15% this morning, but has rallied more than 5% in the past two weeks and is back to levels not seen since 2012.

Of course, the gold explanation is likely to reside in the dollar, which in a more typical risk-on environment like we are currently experiencing, is sliding with gusto. Yesterday’s weakness has continued today with most G10 currencies firmer led by NOK (+0.9%) and SEK (+0.75%) on the back of oil’s ongoing rebound and general optimism about future growth. It should be no surprise that the yen has declined again, but its 0.1% fall is hardly earth shattering. Of more interest is the pound (-0.3%) which after an early surge on the back of the UK PMI data (Mfg 50.1), has given it all back and then some as talk of the UK economy faring worse than either the US or Europe is making the rounds.

In the EMG bloc, the dollar’s weakness is broad-based with MXN and KRW (+0.6% each) leading the way but INR an PLN (+0.5% each) close behind. As can be seen, there is no one geographic area either leading or lagging which is simply indicative of the fact that this is a dollar story, not a currency one.

On the data front in the US, while we also get the PMI data, it has never been seen as quite as important as the ISM data due next week. However, expectations are for a 50.0 reading in the Manufacturing and 48.0 in the Services indices. We also see New Home Sales (exp 640K) which follow yesterday’s disastrous Existing Home Sales data (3.91M, exp 4.09M and the worst print since 2010 right after the GFC.) We hear from another Fed speaker today, James Bullard the dove, but I have to admit that Chairman Powell has everybody on the FOMC singing from the same hymnal, so don’t expect any surprises there.

Instead, today is very clearly risk-on implying that the dollar ought to continue to trade a bit lower. My hypothesis about the dollar leading stocks last week has clearly come a cropper, and we are, instead, back to the way things were. Risk on means a weaker dollar and vice versa.

Good luck and stay safe
Adf

Tremors of Dread

This weekend we learned nothing new
‘Bout what central bankers will do
As they look ahead
With tremors of dread
That QE’s a major miscue

There is a bit of a conundrum developing as headlines shout about a surge in new cases of the coronavirus at the same time that countries around the world continue to reopen from their previous lockdowns. It has become increasingly apparent that governments everywhere have determined that the economic damage of the shutdown in response to Covid now outweighs the human cost of further fatalities from the disease. Of course, three months on from when the epidemic really began to rage in the West, there is also a much better understanding of who is most vulnerable and how to maintain higher levels of safe behavior, notably social distancing and wearing masks. And so, while there are still extremely vocal views on both sides of the argument about the wisdom of reopening, it is very clear economies are going to reopen.

Meanwhile, central banks continue to bask in the glow of broadly positive press that their actions have been instrumental in propping up the stock market preventing an even greater contraction of economic activity than what has actually played out. The constant refrain from every central bank speaker has been that cutting rates and expanding their balance sheets has been very effective. Oh, they are also prepared to do even more of both if they deem such action necessary because it turns out it wasn’t effective.

However, despite these encomiums about central bank perspicacity, investors find themselves at a crossroads these days. Risk assets continue to perform extremely well overall, with stocks having recouped most of their losses from March, but haven assets continue to demonstrate significant concern over the future as long-term government bond yields continue to point to near-recessionary economic activity over the medium and long term. At the end of the day, however, I think the only universal truth is that the global economy, and certainly financial markets, have become addicted to QE, and the central banks are not about to stop providing that liquidity no matter what else happens.

On this subject, this morning we had two very different visions espoused, with BOE Governor Bailey explaining that when things get better, QT will be the first response, not a raising of rates. Of course, we all remember the “paint drying” effect of QT in the US in 2018, and how it turns out removing that liquidity is really hard without causing a financial earthquake. At the same time, the ECB’s Madame Lagarde and her minions have been enthusiastically describing just how proportionate their QE purchases have been in response to the German Constitutional Court ruling from last month. Frankly, it would be easy for the ECB to point out the proportionality of buying more Italian debt given there is much more Italian debt than any other type in the EU. But I don’t think that was the German court’s viewpoint. At any rate, there is no reason to expect anything but ongoing QE for the foreseeable future. In fact, the only thing that can stop it is a significant uptick in measured inflation, but that has not yet occurred, nor does it seem likely in the next couple of quarters. So, the presses will continue to roll.

With this as background, a turn to the markets shows a fairly benign session overall. Equity market in Asia were very modestly lower (Nikkei -0.2%, Hang Seng -0.5%, Shanghai flat) while European markets are also a touch softer (DAX -0.1%, CAC -0.2%, FTSE 100 flat) although US futures are pointing higher, with all three indices up about 0.75% as I type. Meanwhile, bond markets are also showing muted price action, although the tendency is toward slightly lower yields as Treasuries have decline 1bp and Bunds 2bps. While the direction here is consistent with a risk off session, the very slight magnitude of the moves makes it less convincing.

As to the dollar, it is definitely on its back foot this morning, falling against most G10 and many EMG currencies. Kiwi is atop the leaderboard this morning, rallying 0.6% with Aussie just behind at 0.5%, as both currencies recoup a bit of the past two week’s losses. In fact, that seems to be the story behind most of the G10 today, we are seeing a rebound from the dollar’s last two weeks of strength. The only exception is the yen, which is essentially unchanged, after its own solid recent performance, and NOK, which has edged lower by 0.15% on the back of a little oil price weakness.

In the EMG bloc, the picture is a bit more mixed with APAC currencies having suffered last night, led by KRW (-0.5%) as tensions with the North increase, and IDR (-0.35%) as the market demonstrated some concern over the future trajectory of growth and interest rates there. On the positive side, it is the CE4 that is showing the best gains today with PLN (+0.8%) far and away the best performer after posting a much better than expected Retail Sales number of +14.5%, which prompted the government to highlight the opportunity for a v-shaped recovery.

Looking ahead to data this week, nothing jumps out as likely to have a big impact.

Today Existing Home Sales 4.09M
Tuesday PMI Manufacturing 50.8
  PMI Services 48.0
  New Home Sales 635K
Thursday Initial Claims 1.35M
  Continuing Claims 19.85M
  Durable Goods 10.9%
  -ex transport 2.3%
  GDP Q1 -5.0%
Friday Personal Income -6.0%
  Personal Spending 8.8%
  Core PCE 0.0% (0.9% Y/Y)
  Michigan Sentiment 79.0

Source: Bloomberg

The thing about the PMI data is that interpretation of the data is more difficult these days as a rebound from depression levels may not be indicative of real strength, rather just less weakness. In fact, the bigger concern for policymakers these days is that the Initial Claims data is not declining very rapidly. After that huge spike in March, we have seen a substantial decline, but the pace of that decline has slowed alarmingly. It seems that we may be witnessing a second wave of layoffs as companies re-evaluate just how many employees they need to operate effectively, especially in a much slower growth environment. And remember, if employment doesn’t rebound more sharply, the US economy, which is 70% consumption based, is going to be in for a much longer period of slow or negative growth. I assure you that is not the scenario currently priced into the equity markets, so beware.

As to the dollar today, recent price activity has not been consistent with the historic risk appetite, and it is not clear to me which is leading which, stocks leading the dollar or vice versa. For now, it appears that the day is pointing to maintaining the overnight weakness, but I see no reason for this to extend in any major way.

Good luck and stay safe
Adf

Sand on the Beach

The central bank known as the Fed
Injected more funds, it is said
Than sand on the beach
While they did beseech
The banks, all that money to spread

But lately the numbers have shown
Liquidity, less, they condone
Thus traders have bid
For dollars, not quid
Nor euros in every time zone

A funny thing seems to be happening in markets lately, which first became evident when the dollar decoupled from equity markets a few days ago. It seemed odd that the dollar managed to rally despite continued strength in equity markets as the traditional risk-on stance was buy stocks, sell bonds, dollars and the yen. But lately, we are seeing stock prices continue higher, albeit with a bit tougher sledding, while the dollar has seemingly forged a bottom, at least on the charts.

The first lesson from this is that markets are remarkably capable at sussing out changes in underlying fundamentals, certainly far more capable than individuals. But of far more importance, at least with respect to understanding what is happening in the FX market, is that dollar liquidity, something the Fed has been proffering by the trillion over the past three months, is starting to, ever so slightly, tighten. This is evident in the fact that the Fed’s balance sheet actually shrunk this week, to “only” $7.14 trillion from last week’s $7.22 trillion. While this represents just a 1% shrinkage, and seemingly wouldn’t have that big an impact, it is actually quite a major change in the market.

Think back to the period in March when the worst seemed upon us, equity markets were bottoming, and central banks were panicking. The dollar was exploding higher at that time as both companies and countries around the world suddenly found their revenue streams drying up and their ability to service and repay their trillions of dollars of outstanding debt severely impaired. That was the genesis of the Fed’s dollar swap lines to other central banks, as Chairman Jay wanted to insure that other countries would have temporary access to those needed dollars. At that time, we also saw the basis swap bottom out, as borrowing dollars became prohibitively expensive, and in the end, many institutions decided to simply buy dollars on the foreign exchange markets as a means of securing their payments.

However, once those swap lines were in place, and the Fed announced all their programs and started growing the balance sheet by $75 billion/day, those apocalyptic fears ebbed, investors decided the end was not nigh and took those funds and bought stocks. This explains the massive rebound in the equity markets, as well as the dollar’s weakness that has been evident since late March. In fact, the dollar peaked and the stock market bottomed on the same day!

But as the recovery starts to gather some steam, with recent data showing that while things are still awful, they are not as bad as they were in April or early May, the Fed is reducing the frequency of their dollar swap operations to three times per week, rather than daily. They have reduced their QE purchases to less than $4 billion/day, and essentially, they are mopping up some of that excess liquidity. FX markets have figured this out, which is why the dollar has been pretty steadily strengthening for the past seven sessions. As long as the Fed continues down this path, I think we can expect the dollar to continue to perform.

And this is true regardless of what other central banks or nations do. For example, yesterday’s BOE action, increasing QE by £100 billion, was widely expected, but interestingly, is likely to be the last of their moves. First, it was not a unanimous vote as Chief Economist, Andy Haldane, voted for no change. The other thing is that expectations for future government Gilt issuance hover in the £70 billion range, which means that the BOE will have successfully monetized the entire amount of government issuance necessary to address the Covid crash. But regardless of whether this appears GBP bullish, it is dwarfed by the Fed activities. Positive Brexit news could not support the pound, and now it is starting to pick up steam to the downside. As I type, it is lower by 0.3% on the day which follows yesterday’s greater than 1% decline and takes the move since its recent peak to more than 3.4%.

What about the euro, you may ask? Well, it too has been suffering as not only is the Fed beginning to withdraw some USD liquidity, but the ECB, via yesterday’s TLTRO loans has injected yet another €1.3 trillion into the market. While the single currency is essentially unchanged today, it is down 2.0% from its peak on the 10th of June. And this pattern has repeated itself across all currencies, both G10 and EMG. Except, of course, for the yen, which has rallied a bit more than 1% since that same day.

Of course, in the emerging markets, the movement has been a bit more exciting as MXN has fallen more than 5.25% since that day and BRL nearly 10%. But the point is, this pattern is unlikely to stop until the Fed stops withdrawing liquidity from the markets. Since they clearly take their cues from the equity markets, as long as stocks continue to rally, so will the dollar right now. Of course, if stocks turn tail, the dollar is likely to rally even harder right up until the Fed blinks and starts to turn on the taps again. But for now, this is a dollar story, and one where central bank activity is the primary driver.

I apologize for the rather long-winded start but given the lack of interesting idiosyncratic stories in the market today, I thought it was a good time for the analysis. Turning to today’s session, FX market movement has been generally quite muted with, if anything, a bias for modest dollar strength. In fact, across both blocs, no currency has moved more than 0.5%, a clear indication of a lack of new drivers. The liquidity story is a background feature, not headline news…at least not yet.

Other markets, too, have been quiet, with equity markets around the world very slightly firmer, bond markets very modestly softer (higher yields) and commodity markets generally in decent shape. On the data front, the only noteworthy release was UK Retail Sales, which rebounded 10.2% in May but were still lower by 9.8% Y/Y. This is the exact pattern we have seen in virtually every data point this month. As it happens, there are no US data points today, but we do hear from four Fed speakers, Rosengren, Quarles, Mester and the Chairman. However, they have not changed their tune since the meeting last week, and certainly there has been no data or other news which would have given them an impetus to do so.

The final interesting story is that China has apparently recommitted to honoring the phase one trade deal which means they will be buying a lot of soybeans pretty soon. The thing is, I doubt it is because of the trade deal as much as it is a comment on their harvest and the fact they need them. But the markets have largely ignored the story. In the end, at this point, all things continue to lead to a stronger dollar, so hedgers, take note.

Good luck, good weekend and stay safe
Adf

Twiddling Their Thumbs

Investors are twiddling their thumbs
Awaiting the next news that comes
The Old Lady’s meeting’s
Impact will be fleeting
And Jay’s finished flapping his gums

Which leads to the question at hand
Is risk on or has it been banned?
The one thing we know
Is growth’s awfully slow
Beware, markets could well crash land

Markets are taking a respite this morning with modest movement across all three major asset classes. While the Bank of England is on tap with their latest policy announcement, the market feels certain they will leave rates on hold, at 0.10%, and that they will increase their QE purchases by £100 billion, taking the total to £745 billion, in an effort to keep supplying liquidity to the economy. It is somewhat interesting that the story from earlier in the week regarding positive movement on Brexit had such a modest and short-term impact on the pound, which has actually begun to decline a bit more aggressively as I type. After peaking a week ago, the pound has ceded 2.5% from that top (-0.6% today). There is nothing in the recent UK data that would lead one to believe that the economy there is going to be improving faster than either the EU or the US, and with monetary policy at a similar level of ease on a relative basis, any rationale to buy pounds is fragile, at best. I continue to be concerned that the pound leads the way lower vs. the dollar, at least until the current sentiment changes. And while the BOE could possibly change that sentiment, I would estimate that given yesterday’s inflation reading (0.5%) and their inflation target (2.0%), they see a weaker pound as a distinct benefit. Meanwhile, remember the current central bank mantra, ease more than expected. If there is any surprise today, look for £150 billion of QE, which would merely add further urgency to selling pounds.

But aside from the BOE meeting, there is very little of interest to the markets. The ECB announced that their TLTRO III.4 program had a take-up of €1.31 trillion, within the expected range, as 742 banks in the Eurozone got paid 1.0% to borrow money from the ECB in order to on lend it to their clients. But while an interesting anecdote, it is not of sufficient interest to the market to respond. In fact, the euro sits virtually unchanged on the day this morning, waiting for its next important piece of news.

In the G10 space, the only other mover of note is NOK, which has rallied 0.5% on the back of two stories. First, oil prices have moved a bit higher, up slightly less than 1% this morning, which is clearly helping the krone. But perhaps more importantly, the Norgesbank met, left rates on hold at 0.00%, but explained that there was no reason for rates to decline further, once again taking NIRP off the table.

However, away from those two poles, there is very little of interest in the G10 currency space. As to the EMG space, it too is pretty dull today, with RUB the leading gainer, +0.55%, on the oil move and ZAR the leading decliner, -0.4%, amid rising concern over the spread of Covid there as the infection curve remains on a parabolic trajectory. Similar to the G10 space, there is not much of broad interest overall.

Equity markets have also “enjoyed” a mixed session, with Asian markets showing gainers, Shanghai +0.1%, and losers, Nikkei -0.25%, but nothing of significant size. In Europe, the news is broadly negative, but other than Spain’s IBEX (-1.0%) the losses are quite modest. And finally, US futures are mixed but all within 0.1% of yesterday’s closing prices.

Lastly, bond markets are generally firmer, with yields falling slightly as 10-year Treasuries have decline 3 basis points on the session, broadly in line with what we are seeing in European government bond markets. Arguably, we should see the PIGS bonds perform well as that TLTRO money finds its way into the highest yielding assets available.

Perhaps we can take this pause in the markets as a time to reflect on all we have learned lately and try to determine potential outcomes going forward. From a fundamental perspective, the evidence points to April as the nadir of economic activity, which given the widespread shutdowns across the US and Europe, should be no surprise. Q2 GDP data is going to be horrific everywhere, with the Atlanta Fed’s GDPNow number currently targeting -45.5%. But given the fact that economies on both sides of the Atlantic are reopening, Q3 will certainly show a significant rebound, perhaps even the same percentage gain. Alas, a 45% decline followed by a 45% rebound still leaves the economy more than 20% lower than it was prior to the decline. And that, my friends, is a humongous growth gap! So, while we will almost certainly see a sharp rebound, even the Fed doesn’t anticipate a recovery of economic activity to 2019 levels until 2022. Net, the economic picture remains one of concern.

On the fiscal policy front, the US story remains one where future stimulus is uncertain and likely will not be nearly as large as the $2.2 trillion CARES act, although the Senate is currently thinking of $1 trillion. In Europe, the mooted €750 billion EU program that would be funded by joint taxation and EU bond issuance, is still not completed and is still drawing much concern from the frugal four (Austria, Sweden, the Netherlands and Denmark). And besides, that amount is a shadow of what is likely necessary. Yes, we have seen Germany enact their own stimulus, as has France, Spain and Italy, but net, it still pales in comparison to what the US has done. Other major nations continue to add to the pie, with both China and Japan adding fiscal stimulus, but in the end, what needs to occur is for businesses around the world to get back to some semblance of previous activity levels.

And yet, investors have snapped up risk assets aggressively over the past several months. The value in an equity is not in the ability to sell it higher than you bought it, but in the future stream of earnings and cashflows the company produces. The multiple that investors are willing to pay for that future stream is a key determinant of long-term equity market returns. It is this reason that there are many who are concerned about the strength of the stock market rebound despite the destruction of economic activity. This conundrum remains, in my view, the biggest risk in markets right now and while timing is always uncertain, provides the potential for a significant repricing of risk. In that event, I would expect that traditional haven assets would significantly outperform, including the dollar, so hedgers need to stay nimble.

A quick look at this morning’s data shows Initial Claims (exp 1.29M), Continuing Claims (19.85M), Philly Fed (-21.4) and Leading Indicators (+2.4%). The claims data remains the key short-term variable that markets are watching, although it appears that economists have gotten their models attuned to the current reality as the last several prints have been extremely close to expectations.

Overall, until something surprising arises, it feels like the bulls remain in control, so risk is likely to perform well. Beware the disconnect, though, between the dollar and the stock market, as that may well be a harbinger of that repricing on the horizon.

Good luck and stay safe
Adf

 

Making More Hay

The Chairman explained yesterday
That more help would be on the way
If things turned out worse
Thus he’s not averse
To Congress soon making more hay

Chairman Powell testified before the Senate Banking Committee yesterday and continued to proffer the message that while the worst may be behind us, there is still a long way to go before the recovery is complete. He continued to highlight the job losses, especially in minority communities, and how the Fed will not rest until they have been able to foster sufficient economic growth to enable unemployment to fall back to where it was prior to the onset of the Covid crisis. He maintains, as does the entire FOMC, that there are still plenty of additional things the Fed can do to support the economy, if necessary, but that he hopes they don’t have to take further measures. He also agreed that further fiscal stimulus might still be appropriate, although he wouldn’t actually use those words in his effort to maintain the fiction that the Fed is independent of the rest of the government. (They’re not in case you were wondering.) In other words, same old, same old.

The market’s response to the Chairman’s testimony was actually somewhat mixed. Equity prices continue to overperform, although they did retreat from their intraday highs by the close, but the dollar, despite what was clearly an increasing risk appetite, reversed early weakness and strengthened further. Initially, that dollar strength was attributed to a blow-out Retail Sales number, +17.7%, but that piece of the rally faded in minutes. However, as the day progressed, dollar buyers were in evidence as the greenback ignored traditional sell signals and continued to forge a bottom.

Recently, there seems to have been an increase in discussion about the dollar’s imminent decline and the end of its days as the global reserve currency. Economists point to the massive current account deficit, the debasement by the Fed as it monetizes debt and the concern that the current administration will not embrace previous global norms. My rebuttal of this is simple: what would replace the dollar as the global monetary asset that would be universally accepted and trusted to maintain some semblance of its value? The answer is, there is nothing at this time, that could possible do the job. The euro? Hah! Not only is it still dealing with existential issues, but the fact that there is no European fiscal policy will necessarily result in missing support when needed. The renminbi? Hah! The idea that the free world would rely on a currency controlled by the largest communist regime is laughable. The Swiss franc? Too small. Bitcoin? Hahahahah! ‘Nuff said. Gold? Those who are calling the end of the dollar’s importance in the world are not the same people calling for a return to the gold standard. In fact, the views of those two groups are diametrically opposed. For now, the dollar remains the only viable candidate for the role, and that is likely to remain the case for a very long time. As such, while it will definitely rise and fall over short- and medium-term windows, do not believe the idea of a coming dollar collapse.

Meanwhile, ‘cross the pond in the land
Where Boris is still in command
Inflation is sinking
While Bailey is thinking
He ought, the B/S, to expand

Turning to more immediate market concerns, UK data this morning showed CPI falling to 0.5% Y/Y, well below the BOE’s target of 2.0%. With the BOE on tap for tomorrow, the market feels quite confident that Governor Bailey will be increasing QE purchases by £100 billion, taking the total to £745 billion, or slightly more than one-third of the UK economy. The thing is, it is not clear that QE lifts prices of anything other than stocks. I understand that central banks are limited by monetary tools, but if we have learned anything since the GFC in 2008-09, it is that monetary tools are not very effective when addressing the real economy. There is no evidence that this time will be different in the UK than it has been everywhere else in the world forever. The pound, however, has suffered in the wake of the current UK combination of events. So rapidly declining inflation along with expectations of further monetary policy ease have been more than enough to offset yesterday’s positive Brexit comments explaining that both sides believe a deal is possible. Perhaps the question we ought to be asking is, even if hard Brexit is avoided, should the pound really rally that much? My view remains that while a hard Brexit would definitely be a huge negative, the pound has enough troubles on its own to avoid rising significantly from current levels. I still cannot make a case for 1.30, not in the current situation.

As to the rest of the FX market, it is having a mixed session today, with both gainers and losers, although no very large movers in either direction. For instance, the best G10 performer today is NOK, which has rallied just 0.3% despite oil’s lackluster performance today. Meanwhile, the worst performer is the euro, which has fallen 0.2%. The point is, movement like this does not need a specific explanation, and is simply a product of position adjustments over time.

Emerging market currency activity has been no different, really, with MXN the best performer (you don’t hear that much) but having rallied just 0.35%. the most positive story I’ve seen was that the Mexican president, AMLO, has promised to try to work more closely with the business community there to help address the still raging virus outbreak. On the downside, KRW, yesterday’s best performer, is today’s worst, falling 0.55%. This seems to be a response to the increasingly aggressive rhetoric from the North, who is now set to deploy troops to the border, scrapping previous pledges to maintain a demilitarized zone between the nations. However, it would be wrong not to mention yesterday’s BRL price action, where the real fell 1.7%, taking its decline over the past week to more than 5.1%. The situation on the ground there seems to be deteriorating rapidly as the coronavirus is spreading rapidly, more than 37K new cases were reported yesterday, and investors are taking note.

On the data front this morning, we see Housing Starts (exp 1100K) and Building Permits (1245K), neither of which seems likely to be a market mover. The Chairman testifies before the House today, but it is only the Q&A that will be different, as his speech is canned. We also hear from the Uber-hawk, Loretta Mester, but these days, even she is on board for all the easing that is ongoing, so don’t look for anything new there.

Ultimately, I continue to look at the price action and feel the dollar is finding its footing, regardless of the risk attitude. Don’t be too greedy if you are a receivables hedger, there is every chance for the dollar to strengthen further from here.

Good luck and stay safe
Adf

 

Looking Distressed

The market was looking distressed
So, Jay clearly thought it was best
To tell everyone
The Fed had begun
To buy corporates at his behest

Frankly, I’m stunned. Anyone who believes that the Fed is focusing on any variable other than the S&P 500 was completely disabused of that notion yesterday. While I know it seems like it was weeks ago, yesterday morning there was concern that Chairman Powell’s comments last week about a long, tough road to recovery were still top of mind to market participants. Concerns over a rising infection rate in some states and countries were growing thus driving investors to react negatively. After all, if the mooted second wave of Covid comes and the nascent economic revival is squashed at the outset, the case for the V-shaped recovery and stratospheric stock prices would quickly die. And so, Chairman Powell responded by explaining that the Fed would expand the SMCCF* program to start buying individual bonds today. Remember, the initial story was ETF’s were the only purchases to be made. Now, the Fed is effectively cherry-picking which investors it wants to help as certainly the companies whose bonds the Fed buys will not be getting any of that money. Or will they? Perhaps the hope is that if the Fed owns individual corporate bonds, in the coming debt jubilee, they will tear up those bonds as well as their Treasuries, thus reducing leverage in a trice.

A debt jubilee, for those who are unfamiliar with the term, is a government sanctioned erasure of outstanding debts. Its origins are in the book of Deuteronomy in the Old Testament, when every 50 years there was a call for the release of all debts, both monetary and personal (indenture). Of course, in the modern world it is a bit more difficult to accomplish as all creditors would be severely impacted by the concept. All creditors except one, that is, a nation’s central bank.

Now that we are in a fiat currency system where central banks create money from nothing (paraphrasing Dire Straits), any public debt that they hold on their balance sheets can simply be forgiven by decree, thus reducing the leverage outstanding. While there would seem to be some inflationary consequences to the action (after all, an awful lot of funds would be instantly freed up to chase after other goods, services and investments), the modern central bank viewpoint on inflation is that it is dangerously low and a problem at current levels, so those consequences are likely to be quickly rationalized away. Thus, if the Fed owns individual corporate bonds, especially of highly indebted companies, they will be able forgive those, reduce leverage and support those companies’ prospects to maintain a full-sized staff. You see, the rationalization is it will support employment, not help investors.

To be clear, there is no official plan for a debt jubilee, but it is something that is gaining credence amongst a subset of the economics community. Especially because of the inherent concerns over near- and medium-term growth due to Covid-19, as future consumer behavior is likely to be very different than past consumer behavior, I expect that a debt jubilee is something about which we will hear a great deal more going forward. Nonstop printing of money by the world’s central banks is not a sustainable activity in the long run. Neither is it sustainable for governments to run deficits well in excess of GDP. A debt jubilee is a potential solution to both those problems, and if it can be accomplished by simply having central banks tear up debt, other creditors will not be destroyed. Truly a (frightening) win-win.

It can be no surprise that the stock market reacted positively to the news, turning around morning losses to close higher by 0.85% in the US with the sharpest part of the move happening immediately upon the statement’s release at 2:15 yesterday. This euphoria carried over into Asia with remarkable effect as the Nikkei (+4.9%) and KOSPI (+5.3%) exploded higher while the rest of the region merely saw strong gains of between 1.4% (Shanghai) and 3.9% (Australia). And naturally, Europe is a beneficiary as well, with the DAX (+2.8%) leading the way, but virtually every market higher by more than 2.0%. US futures? Not to worry, all three indices are currently higher by more than 1.1%.

In keeping with the risk-on attitude, we also saw Treasury bonds sell off in the afternoon with yields rising a bit more than 4bps since the announcement. In Europe, bund yields are higher as are gilts, both by 2.5bps, but the PIGS are basking in the knowledge that their future may well be brighter as we are seeing Portugal (-2bps), Italy (-5.5bps), Greece (-6.5bps) and Spain (-3bps) all rallying nicely.

And finally, the dollar, which had started to show some strength yesterday, has also reversed most of those gains and is broadly, though not deeply, softer this morning. In the G10, the pound is the leader, higher by 0.45%, as the market ignored Jobless Claims in the UK falling by 529K, only the second worst level on record after last month’s numbers, and instead took heart that a Brexit deal could well be reached after positive comments from both Boris Johnson and the EU leadership following a videoconference call earlier today. While nothing is confirmed, this is the best tone we have heard in a while. However, away from the pound gains are limited to less than 0.25% with some currencies even declining slightly.

In the emerging markets, the leading gainer is KRW (+0.75%) despite the fact that North Korea blew up the Joint Office overnight. That office was the sight of ongoing discussions between the two nations and its destruction marks a significant rise in hostility by the North. In my view, the market is remarkably sanguine about the story, especially in light of its response to the news out of India, where Chinese soldiers ostensibly attacked and killed three Indian soldiers in the disputed border zone. There, the rupee fell 0.25% on the report as concerns grow over an escalation of tensions between the two nations. But aside from those two currencies, there were many more gainers in APAC currencies as funds flowed into local stock markets on the Fed inspired risk appetite.

On the data front, we see Retail Sales (exp 8.4%, 5.5% ex autos) as well as IP (3.0%) and Capacity Utilization (66.9%), with all three numbers rebounding sharply from their lows set in April. We saw a similar rebound in German ZEW Expectations (63.4 and its highest since 2006), but recall, that is based on the change of view month to month.

Chairman Powell testifies to the Senate this morning, so all ears will be listening at 10:00. Yesterday we heard from two Fed speakers, Dallas’s Kaplan and San Francisco’s Daly, both of whom expressed the view that a rebound was coming, that YCC was not appropriate at this time and that the Fed still had plenty they could do, as they made evident with yesterday afternoon’s announcement.

While equity markets continue to react very positively to the central bank activities, the dollar seems to be finding a floor. In the end, investment flows into the US still seem to be larger than elsewhere and continue to be a key driver for the dollar. Despite a positive risk appetite, it appears the dollar has limited room to fall further.

Good luck and stay safe
Adf

*Secondary Market Corporate Credit Facility

Money to Burn

If Covid is back on the rise
It’s likely it will compromise
The mooted return
Of money to burn
Instead, growth it will tranquilize

For the past two or three months, market behavior has been driven by the belief that a V-shaped recovery was in the offing as a combination of massive fiscal and monetary stimulus alongside a flatter infection curve and the reopening of economies would bring everything back close to where it was prior to the outbreak of Covid-19. However, since last Thursday, that narrative has lost more than a few adherents with the growing concern that the dreaded second wave of infections was starting to crest and would force economies, that were just starting to reopen, back into hibernation.

The most recent piece of evidence for the new storyline comes from Beijing, where the weekend saw the reporting of 100 new infections after several weeks of, allegedly, zero infections in the country. This has resulted in the Chinese government re-imposing some restrictions as well as massively increasing testing again. Chinese data last night showed that the economy remains under significant pressure, although analysts fell on both sides of the bullish-bearish spectrum. The four key data points are Retail Sales (-13.5% YTD, up from April’s -16.2% and right on the economic estimates); IP (-2.8% YTD, up from -4.9% and slightly better than -3.0% expected); Fixed Asset Investment (-6.3% YTD vs. -10.3% last month and -6.0% expected); and the Jobless Rate (5.9%, as expected and down from 6.0% last month). My read is that the Chinese economy remains quite troubled, although arguably it has left the worst behind it. The PBOC continues to inject liquidity into the market and the Chinese government continues to add fiscal support. Unfortunately for President Xi, China remains an export led economy and given the complete demand destruction that has occurred everywhere else in the world, the near-term prospects for Chinese growth would seem to be muted at best.

For political leaders everywhere, this is not the story that they want to tell. Rather, the narrative of the V-shaped recovery was crucial to maintaining some level of confidence for their populations as well as for their own popularity. Remember, at the government level, everything is political, so crafting a story that people believe accept is just as important, if not more so, than actually implementing policies that work to address the problems.

Another chink in the narrative’s armor is the fact that despite the approach of the summer solstice, and the northern hemisphere warming that accompanies it, infection levels are growing in many different places; not only Beijing, but Korea, Japan, California, Texas and Florida, all locations that had begun to reopen their respective economies due to reduced infections. Remember, a key part of the narrative has been that the virus, like the ordinary flu, thrives in cold weather, and warmth would be a natural disinfectant, if you will. While it remains too early to claim this is not the case, the recent flare-ups are not helping that storyline.

Ultimately, what is abundantly clear is we still don’t know that much about the virus and its potential and weaknesses. While we will certainly see more businesses reopen over the next weeks, it is unclear how long it will take for actual economic activity to start to revert to any semblance of normal. Equity markets have been wearing rose-colored glasses for at least two months. Beware of those slipping off and haven assets regaining their bid quite quickly.

So, a quick look at markets this morning simply reinforces the changing narrative, with equity markets lower around the world, bond markets rallying and the dollar reasserting itself. Overnight, Asian markets all fell pretty sharply, led by the Nikkei’s 3.5% decline, but also seeing weakness in the Hang Seng (-2.2%) and Shanghai (-1.0%). European indices are also bleeding this morning, with the DAX (-0.9%) and CAC (-0.8%) slipping on increasing concerns over the growth of the second wave. US futures will not miss this party, with all three indices sharply lower, between 1.5% and 2.0%.

In the bond market, Treasury yields are sliding, down 3 basis points, as haven assets are in demand. We are seeing increased demand across European bond markets as well, surprisingly even in the PIGS, although that seems more in anticipation of the almost certain increase in the pace of ECB QE. What is clear, however, is that we are seeing a rotation from stocks to bonds this morning.

Finally, the dollar is feeling its oats this morning, rallying against the high-beta G10 currencies with AUD the leading decliner (-0.9%) followed by NOK (-0.6%) and CAD (-0.5%). The latter two are clearly feeling the pressure from oil’s declining price, down 1.75% as I type, although it had been even lower earlier in the session. While we do see both JPY and CHF slightly firmer, the emphasis is on slightly, with both less than 0.1% higher than Friday’s closing levels. Meanwhile the euro and pound are both slightly softer, also less than 0.1% off Friday’s levels, which simply implies a great deal of uncertainty over the next big move. This is corroborated by price action in the option market, where implied volatility continues to climb, as 1mo EURUSD volatility is up 1.3 points in the past week. Of perhaps more interest is the fact that the 1mo risk reversal has flipped from 0.5 for euro calls to 0.35 for euro puts in the same time frame. Clearly, concern is growing that all is not right with the world.

As to the EMG bloc, one would not be surprised to see the Mexican peso as the biggest laggard this morning, down 1.5% as the combination of declining oil prices, increasing infections and risk reduction all play into the move. Asian currencies did not have a good evening, led by KRW (-1.0%) which suffered from a combination of concern over the US-Korean alliance (as the US withdrew some troops unexpectedly and continues to demand more payment for protection) as well as some warmongering from the North. But we have also seen weakness across the rest of the region, with declines in the 0.2%-0.5% range nearly universal. Too, the rand is under pressure this morning, falling 1.0%, on what appears to be broad-based risk reduction as there are no specific stories to note there.

Data this week is on the light side with Retail Sales tomorrow likely to garner the most attention.

Today Empire Manufacturing -30.0
Tuesday Retail Sales 8.0%
  -ex autos 5.3%
  IP 3.0%
  Capacity Utilization 66.9%
Wednesday Housing Starts 1100K
  Building Permits 1250K
Thursday Initial Claims 1.29M
  Continuing Claims 19.65M
  Philly Fed -25.0
  Leading Indicators 2.4%

Source: Bloomberg

We also hear from six Fed speakers in addition to the Chairman’s congressional testimony on Tuesday and Wednesday. Clearly, it will be the latter that keeps everyone most interested. There are those who complain that Powell should have done more last week, starting YCC or adding more stimulus, but that remains a slight minority view. Most mainstream economists seem to believe that we are fast approaching the point where excessive central bank largesse is going to create much bigger problems down the road. In fact, ironically, I believe that is one of the reasons we are in risk-off mode overall, growing concerns that the future is not as bright as markets have priced to date.

My sense is that the dollar is set to end its slide overall and start to regain traction as the reality that the V-shaped recovery is not coming begins to hit home. Hedgers beware, and don’t miss these opportunities.

Good luck and stay safe
Adf

Yesterday’s News

The first bit of data we’ve seen
Has shown what economists mean
When most business stops
And GDP drops
Reacting to Covid – 19

This data describes people’s fear
Another wave just might appear
But right now those views
Are yesterday’s news
And ‘buy the dip’ traders are here

The UK is an interesting study regarding GDP growth because they actually publish monthly numbers, rather than only quarterly data like the rest of the developed world. So, this morning, the UK reported that GDP activity in April declined 20.4% from March, which had declined 5.8% from February when the first impact of Covid-19 was felt. This has resulted in the UK economy shrinking back to levels last seen in 2002. Eighteen years of growth removed in two months! Of course, when things recover, and they will recover as the lockdowns are eased around the world, we will also get to see the fastest growth numbers in history. However, we must remember that a 20% decline will require a 25% rebound to get back to where we started. Keep that in mind when we start to see large positive numbers in the summer (hopefully) or the autumn if people decide that the risks of Covid outweigh the benefits of returning to previous activities.

Needless to say, this has been an unprecedented decline, on a monthly basis, in the economy for both its depth and speed. But the more remarkable thing, is that despite this extraordinary economic disruption, a look at financial markets shows a somewhat different story. For example, on February 28, the FTSE 100 closed at 6580.61 and the pound finished the session at 1.2823. On April 30, after the worst two-month economic decline in the UK’s history, its main stock market had declined 10.3% while the pound had fallen just 1.8%. Granted, both did trade at substantially lower levels in the interim, bottoming in the third week of March before rebounding. But it seems to me that those are pretty good performances given the size of the economic dislocation. And since then, both the FTSE 100 and the pound have rallied a bit further.

The question is, how can this have occurred? Part of the answer is the fact that on a contemporaneous basis, investors could not imagine the depths of the economic decline that was taking place. While there were daily stories of lockdowns and death counts, it is still hard for anyone to have truly understood the unprecedented magnitude of what occurred. And, of course, part of the answer was this did not happen in a vacuum as policymakers responded admirably quickly with the BOE cutting rates by a total of 0.65% in the period while expanding their balance sheet by £150 billion (and still growing). And the UK government quickly put together stimulus packages worth 5% of then measured GDP. Obviously, those measures were crucial in preventing a complete financial market collapse.

Another thing to remember is that the FTSE 100 was trading at a P/E ratio of approximately 15 ahead of the crisis, which in the long-term scheme of things was actually below its average. So, stock prices in the UK were nowhere near as frothy as in the US and arguably had less reason to fall.

As to the pound, well, currencies are a relative game, and the same things that were happening in the UK were happening elsewhere as well to various degrees. March saw the dollar’s haven status at its peak, at which point the pound traded below 1.15. But as policymakers worldwide responded quite quickly, and almost in unison, the worst fears passed and the ‘need’ to own dollars ebbed. Hence, we have seen a strong rebound since, and in truth a very modest net decline.

The questions going forward will be all about how the recovery actually unfolds, both in timing and magnitude. The one thing that seems clear is that the uniformity of decline and policy response that we saw will not be repeated on the rebound. Different countries will reduce safety measures at different paces, and populations will respond differently to those measures. In other words, as confusing as data may have been before Covid, it will be more so going forward.

Now, quickly, to markets. Yesterday’s equity market price action in the US was certainly dramatic, with the Dow falling nearly 7% and even the NASDAQ falling 5.25%. The best explanation I can offer is that reflection on Chairman Powell’s press conference by investors left them feeling less confident than before. As I wrote in the wake of the ECB meeting last week, the only way for a central banker to do their job (in the market’s eyes) these days is to exceed expectations. While analysts did not expect any policy changes, there was a great deal of talk on trading desks floors chatrooms about the next step widely seen as YCC. The fact that Jay did not deliver was seen as quite disappointing. In fact, it would not be surprising to me that if stock markets continued to decline sharply, the Fed would respond.

But that is not happening as buying the dip is back in fashion with European markets higher by roughly 1.5% and US futures also pointing higher. Meanwhile, with risk back in favor, Treasury yields have backed up 3bps and the dollar is under pressure.

On the FX front, the G10 is a classic depiction of risk-on with the yen (-0.5%) and Swiss franc (-0.3%) both declining while the rest of the bloc is higher led by CAD and AUD, both up 0.5%. In truth, this has the feeling of a bounce from yesterday’s dollar strength, rather than the beginning of a new trend, but that will depend on the broader risk sentiment. If equity market ebullience this morning fades as the session progresses, look for the dollar to take back its overnight losses.

Meanwhile, EMG markets are having a more mixed session with APAC currencies all having fallen last night in the wake of the US equity rout. APAC equities were modestly lower to unchanged but had started the session under far more pressure. At the same time, the CE4, with the benefit of the European equity rebound and higher US futures are mostly firmer led by PLN (+0.6%). But the biggest winner today in this space is MXN, which has rebounded 0.7% from yesterday’s levels, although that represented a nearly 4% decline! In other words, the defining characteristic of the peso these days is not its rate but its volatility. For example, 10-day historic volatility in the peso is currently 28.37%, up from 13.4% last Friday and 21.96% in the middle of May when we were looking at daily 3% moves. Do not be surprised if we see another bout of significant peso volatility, especially given the ongoing concerns over AMLO’s handling of Covid.

On the data front, only Michigan Sentiment (exp 75.0) is on the docket today, which may have an impact if it is surprisingly better than expected, but I don’t anticipate much movement. Rather, FX remains beholden to the overall risk sentiment as determined by the US equity markets. If the rebound continues, the dollar will remain under pressure. If the rebound fails, look for the dollar to resume yesterday’s trend.

Good luck, good weekend and stay safe
Adf

 

Jay Was Thinking

If anyone thought Jay was thinking
‘Bout raising rates while growth was sinking
The chairman was clear
That long past next year
Their balance sheet will not be shrinking

The money quote: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” said Mr. Powell.  And this pretty much sums up the Fed stance for the time being.  While there are those who are disappointed that the Fed did not add to any programs or announce something like YCC or, perhaps, more targeted forward guidance, arguably the above quote is even more powerful than one of those choices.  Frequently it is the uncertainty over a policy’s duration that is useful, not the policy itself.  Uncertainty prevents investors from anticipating a change and moving markets contrary to policymakers’ goals.  So, for now, there is no realistic way to anticipate the timing of the next rate hike.  Perhaps the proper question is as follows: is timing the next hike impossible because of the lack of clear targets?  Or is it impossible because there will never be another rate hike?

What the Fed did tell us (via the dot plot) is that only two of the seventeen FOMC members believe interest rates will be above 0.0% in 2022 (my money is on Esther and Mester, the two most hawkish members), but mercifully, not a single dot in the dot plot was in negative territory.  They also expressed a pretty dour view of the economy as follows:

 

  2020 2021 2022
Real GDP -6.5% 5.0% 3.5%
Core PCE 1.0% 1.5% 1.7%
Unemployment 9.3% 6.5% 5.5%

Source: Bloomberg

It is, of course, the 11.5% gain from 2020 to 2021 that encourages the concept of the V-shaped recovery as evidenced by simply plotting the numbers (including 2019’s 2.3% to start).

Screen Shot 2020-06-11 at 9.30.05 AM

So, perhaps the bulls are correct, perhaps the stock market is a screaming buy as growth will soon return and interest rates will remain zero for as far as the eye can see.  There is, however, a caveat to this view, the fact that the Fed is notoriously bad at forecasting GDP growth over time.  In fact, they are amongst the worst when compared with Wall Street in general.  But hey, at least we understand the thesis.

Another interesting outcome of the meeting was the tone of the press conference, where Chairman Jay sounded anything but ebullient over the current economic situation, especially the employment situation.  And it is this takeaway that had the biggest market impact.  After the press conference, equity markets in the US sold off from earlier highs (the NASDAQ set another all-time high intraday) and Treasuries rallied with yields falling again.  In other words, despite the prospect of Forever ZIRP (FZ), equity investors seemed to lose a bit of their bullishness.  This price action has been in place ever since with Asian equity markets all falling (Nikkei -2.8%, Hang Seng -2.3%, Shanghai – 0.8%) and Europe definitely under pressure (DAX -2.1%, CAC -2.2%, FTSE 100 -2.0%).  US futures are also lower with the Dow (-1.9%) currently the laggard, but even NASDAQ futures are lower by 1.1% at this hour.

It should be no surprise that bond markets around the world are rallying in sync with these equity declines as the combination of risk-off and the prospect for FZ lead to the inevitable conclusion that lower long term rates are in our future.  This also highlights the fact that the Fed’s concern over the second part of its mandate, stable prices, has essentially been set aside for another era.  The belief that inflation will remain extremely low forever is clearly a part of the current mindset.  Yesterday’s CPI (0.1%, 1.2% core) was simply further evidence that the Fed will ignore prices going forward.  So, 10-year Treasury yields are back to 0.7% this morning, 20 basis points below last Friday’s closing levels.  In other words, the impact of last Friday’s NFP number has been erased in four sessions.  But we are seeing investors rotate from stocks to bonds around the world, perhaps getting a bit nervous about the frothiness of the recent rallies.  (Even Hertz, the darling of the Robinhooders, is looking like Icarus.)

With risk clearly being jettisoned around the world, it should be no surprise that the dollar has stopped falling, and in fact is beginning to rally against almost all its counterparts.  While haven assets like CHF (+0.2%) and JPY (+0.1%) are modestly higher, NOK (-0.9%) and AUD (-0.85%) are leading the bulk of the G10 lower.  Norway is suffering on, not only broad dollar strength, but oil’s weakness this morning, with WTI -3.1% on the session.  As to Aussie, the combination of weaker commodity prices, the strong dollar, and market technicals as it once again failed to hold the 0.70 level, have led to today’s decline.

Emerging market activity is also what you would expect in a risk-off session, with MXN (-1.6%), ZAR (-1.1%) and RUB (-0.7%) leading the way lower.  Obviously, oil is driving both MXN and RUB, while ZAR is suffering from the weakness in the rest of the commodity complex.  I think the reason that the peso has fallen so much further than the ruble is that MXN has seen remarkable gains over the past month, more than 13% at its peak, and so seems overdue for a correction.  One notable exception to this price action today is THB, which is higher by 0.65% on a combination of reports of a fourth stimulus package and a breach of the 200-day moving average which got technicians excited.

This morning’s data brings the latest Initial Claims data (exp 1.55M), as well as Continuing Claims (20.0M) and PPI (-1.2%, 0.4% core).  While nobody will care about the latter, there will be ongoing intense scrutiny on the former as Chairman Jay made it abundantly clear that employment is the only thing the Fed is focused on for now.  With the FOMC meeting behind us, we can expect to start to hear from its members again, but on the schedule, nothing happens until next week.

It is not hard to make the case that both the euro and pound have been a bit toppish at recent levels, and with risk decidedly off today, further declines there seem quite viable.

 

Good luck and stay safe

Adf