Author Archives: fxpoet

Death Knell

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Though dinner was not quite a bust
And everything key was discussed
No deal was secured
And now we’re assured
Past Sunday all hope will combust

The pound, not surprisingly, fell
As traders have heard its death knell
Now eyes have all turned
To Frankfurt, concerned
Christine, Europe’s problems, won’t quell

One need only look at the pound’s performance this morning (GBP -0.8%) to understand that last night’s much touted dinner meeting between Boris and Ursula did not come to any conclusions.  While there appeared to be great comradery all around, and both parties were quick to say they understand how the other side feels, neither was willing to give ground.  The upshot is that the newest deadline appears to be this Sunday coming, when if a deal is not reached, there is a consensus that no deal will be reached in time.  While I continue to believe that this remains political theater, even if Sunday is simply another false deadline, the real deadline is now exactly 3 weeks away, so something needs to happen soon if a no-deal Brexit is to be prevented.  History has shown that deals of this nature, especially in Europe, always come down to the last possible moment.  We shall see if Sunday is that moment.  As to the potential impact on the pound, no-deal could easily take us to 1.25, while a successful conclusion is probably good for 1.40.

On to the day’s other major event, the ECB meeting, where Madame Lagarde is presiding over her fractious team once again as they seek to explain to us exactly what recalibration means.  You may recall that at the October meeting, Lagarde promised that the ECB would “recalibrate” its tools by this meeting.  This has come to be code for increased monetary policy easing of the following nature: €500 billion of additional PEPP purchases and a minimum 6-month extension of both the emergency pandemic program as well as the original QE, the APP (Asset Purchase Program) to run through the end of 2021.  In addition, the TLTRO III program is expected to be extended and expanded.  Expectations are growing that there may be two more tranches of these loans, that the loan tenors may be extended beyond 3 years, and that the interest rate, currently -1.0%, could be cut further.  One of the problems with the TLTRO, though, is that the two biggest users, Italy and Spain, have almost run out of capacity to use more of these loans, so any benefit on this front, even with expansion, is likely limited.

And truthfully, those are really the two key stories of the session so far.  Interestingly, yesterday’s news about an agreement regarding the EU’s pandemic budget seems to have had virtually no impact on the markets as yet.  You may recall that when this was first mooted, back in the summer, and the idea that the EU would issue joint bonds was agreed, many thought this was Europe’s Hamiltonian moment, finally bringing Europe’s fiscal house under one roof, and preparing for great things going forward.  So far, this has not been the case.  But the lack of market response to key steps forward must be a little disheartening for those involved.  Of course, it remains to be seen if this budget is truly the beginning of something new, or simply a response to the Covid pandemic, where Germany and its frugal neighbors felt they had no choice but to accept the outcome.  Certainly, if this is the true way forward, it removes one of the biggest structural impediments to the single currency and opens the way for a secular appreciation.  We shall see.

As to markets today, yesterday’s late day sell-off in the US was followed with modest Asian weakness (Nikkei -0.2%, Hang Seng -0.35%, Shanghai 0.0%) although European bourses have held onto modest gains.  Right now, the FTSE 100 (+0.7%) is leading the way (remember, a weaker pound typically helps the FTSE), with the CAC (+0.3%) and DAX (+0.1%) showing much less promise.  As to US futures, they are very little changed at this hour with no real information from their movement of a few points in either direction.

Bond markets, however, are a little more consistent, generally rallying slightly with yields edging lower.  The biggest mover are UK Gilts, with 10-year yields lower by 5.7 basis points as investors and traders are betting on a weaker UK economy with a no-deal outcome.  After that, the PIGS are doing well, with yields lower between 2-4 bps, as visions of further ECB purchases dance in investors’ heads.  Treasuries are moving in the same direction, but the 1 basis point decline in yield is hardly game-changing.

Commodity markets continue their confusing ways, this time with oil rallying slightly, (WTI
+1.5%) while gold is declining, -0.3%.  And finally, the dollar is having, what can only be described, as a mixed session.  In the G10, the pound has actually extended its early losses and is now down -1.0%.  As well, JPY (-0.3%) is also weaker despite (because of?) what seemed to be pretty reasonable manufacturing data overnight.  The rest of the bloc, however, is firmer vs. the dollar led by AUD (+0.6%) on the back of rising iron ore prices, although the gains fall away to much more modest outcomes beyond that.  CAD (+0.3%) seems to be benefitting from the rise in oil prices but nothing else is even noteworthy.

Emerging market currencies are also mixed, with the gainers led by BRL (+0.8% on the open) after the central bank left rates on hold last night, as universally expected, but also explained that the pledge to keep rates at that level may be coming to an end as inflation starts to rise in the country.  This was taken as quite hawkish, so I would look for further BRL appreciation going forward.  Elsewhere on the plus side is RUB (+0.45%) clearly benefitting from oil’s rise, and HUF (+0.35%) which continues to benefit from the EU budget deal.  On the downside, ignoring TRY, ZAR (-0.4%) is the worst performer, seeming to suffer from a surge in Covid cases, with KRW (-0.3%) seeming to feel the pressure of yesterday’s tech stock sell-off in the US.

We finally get some data of note this morning led by the weekly Initial Claims (exp 725K) and Continuing Claims (5.21M) data.  But we also see the latest reading on headline CPI (0.1%, 1.1% Y/Y) and core (0.1%, 1.5% Y/Y).  The great inflation/deflation debate continues amongst the economic community with the deflationists continuing to point to the data as their trump card, but the inflationists continuing to point to real life.  My money is on inflation, probably as soon as next year, that is far higher than the Fed currently anticipates.

And that’s really it for the day.  All eyes will be on the tape at 7:45 when the ECB releases their statement, and then Madame Lagarde will be on camera starting at 8:30am.  Barring a breakthrough on Brexit today (which seems highly unlikely) the pound seems to have room to fall further.  As to the euro, that is in Lagarde’s hands.  And the dollar in general?  The recent slow trend lower remains intact, and I wouldn’t start that fight quite yet.

Good luck and stay safe
Adf

The Table is Set

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In Brussels, the table is set
As Boris and Ursula bet
That dinner together
Will be the bellwether
To ending the hard Brexit threat

So, appetite for risk is whet
With central banks sure to abet
More equity buying
As they keep on trying
To buy every last piece of debt

There hasn’t been this much interest in a meal in Europe since the one painted by DaVinci some 530 years ago.  Clearly, the big story is this evening’s dinner date between UK PM Boris Johnson and European Commission President Ursula von der Leyen, where they will make what appears to be the final attempt to get some political agreement on the last issues outstanding in order to complete the Brexit trade deal.  With just over three weeks before the UK exits the EU, time is clearly of the essence at this stage.  I remain confident that an agreement will be reached as it is in both sides’ collective interest to do so.  Rather, the current political theater is seen as necessary, again for both sides, in order to demonstrate they did everything they could to achieve the best possible outcome.  After all, Boris is going to have to cede some portion of UK sovereignty, and the EU is going to have to cede some adherence to their extraordinarily large canon of laws.

The FX market seems to share my opinion as the pound has rallied more than 1% since I wrote yesterday and is currently firmer by 0.7% since yesterday’s close.  As I wrote last week, I remain convinced that the market has not actually priced in a successful completion of a deal, rather that the pound’s performance over the past several months, a nearly 10% rise since July 1st, has simply been reflective of the broad dollar decline and not a bet on a positive Brexit outcome.  As such, I believe there is a good amount of upside potential for the pound in the event of a positive result, perhaps as much as 3% right away, and 5%-6% over time.  Similarly, if a deal is not reached, a 5% decline is in the cards.  But, for now, all we can do is wait to hear the outcome.  Dinner is at 8pm in Brussels, so likely there will be little news before 4pm this afternoon.

Away from the Brexit story, however, the market discussion continues to revolve around prospects for a quick implementation of the Covid-19 vaccine and the resumption of pre-pandemic economic activity.  One of the conundrums in this regard is that despite what appears to be a growing belief that the vaccine will solve the covid crisis, thus enabling a return to economic growth, the central banking community will continue to inject unfathomable sums of liquidity into banks, (and by extension markets and maybe even the economy), to support economic growth.  It seems a bit duplicative to me, but then I’m just an FX salesman sans PhD.  After all, if the vaccine will allow people to revert to their former selves, what need is there for central banks to keep buying bonds?  (And in some cases, equities.  As an aside, yesterday the BOJ reached a milestone as the largest equity holder in Japan, outstripping the government pension fund, GPIF, and now in possession of nearly 8% of the entire market there.)

The thing is, there is no prospect that this behavior is going to change.  For instance, tomorrow the ECB’s final meeting of the year will conclude, and they are expected to expand the PEPP by at least €500 billion and extend the tenor of the program between six months and a year.  In addition, they are expected to expand the TLTRO III program (targeted long-term refinancing operations) by another year, and there were even some hints at a rate cut there.  The latter would be extraordinary as the current rate is -1.0%.  This means that European banks that borrow funds in this program pay -1.0% (receive 1.0% pa) as long as they lend these funds on to corporate and business clients, with no restrictions on what they can charge.  Balances in this program have fallen from €1.3 trillion to just €180 billion since the summer, so it is believable that the rate will change.  The ECB particularly likes this program as they believe it really encourages business loans.

Something else to watch in tomorrow’s meeting is whether either the statement, or Madame Lagarde in her press conference opening, discusses the exchange rate.  Since the euro first traded above 1.20 back in September, which brought an immediate response from the ECB via some jawboning, the single currency had really done very little, until November, when the latest move higher began.  Now, after a 4% rally, it would not be surprising for the ECB to once again mention the importance of a “competitive” (read: weak) euro.  With inflation in the Eurozone remaining negative, Lagarde and company simply cannot afford for the euro to rise much further.  And none of this discussion includes what may well come from the FOMC next week!

But on to today’s activity.  Risk appetite continues to be strong where equity markets in Asia (Nikkei +1.3%, Hang Seng +0.75%) and Europe (DAX +0.8%, CAC +0.2%, FTSE 100 +0.4%) are all continuing yesterday’s modest gains.  The one exception here is Shanghai (-1.3%) which seemed to respond to inflation data overnight (CPI -0.5%).  The cause here seems to be declining pork prices (remember last year the Asian Swine Flu resulted in the culling of Chinese herds and dramatic price rises) but also the expectation that the PBOC is not going to change course with respect to forcing the deleveraging of the real estate sector and concomitant bubble there.

Bond markets are behaving as one would expect in a risk-on scenario, with Treasury yields reversing yesterday’s 2bp decline, while Bunds and OATs have both seen yields edge higher by 1 basis point.  Oil prices have rallied 1.5%, partly on risk attitude and partly on the story of an attack on Iraqi oil assets disrupting supply.  Finally, gold, which has really been rebounding since the end of last month, has given up 0.65% this morning.

Lastly, the dollar is generally softer today, against most G10 and EMG currencies.  AUD (+0.9%) is the leader this morning after the Westpac Consumer Confidence Survey printed at a much higher than expected 112.0.  For reference, that was the highest print since October 2010!  But as mentioned, the pound is firmer, as is virtually the entire bloc, albeit with less impressive moves.

In emerging markets, HUF (+0.8%) is the leading gainer, followed by PLN (+0.7%) and CZK (+.4%), all of which are far outperforming the euro (+0.1%).  It seems that the EU Stimulus deal, which was being held up by Hungary and Poland over language regarding the rule of law, has finally been agreed by all parties, with those three nations set to receive a significant boost when it is finally implemented next year.  On the flip side, TWD (-0.4%) was the worst performer as a late session sell-off wiped out early gains.  At this point, there is no obvious catalyst for the move, which looks very much like a large order going through an illiquid market onshore.

There is no data of note this morning and no speakers either.  Risk appetite remains the driver, with not only vaccine euphoria, but also hopes for a US stimulus bill rising as well.  In other words, everything is fantastic!  What could possibly go wrong?

As long as equities continue to rally, the dollar is likely to remain under pressure, but with the ECB on tap for tomorrow, I don’t expect a breakout, unless something really positive (or negative) comes out of dinner in Brussels.

Good luck and stay safe
Adf

A New Paradigm

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Awaiting a new paradigm
The market is biding its time
Will Brexit be hard?
Or will Ms. Lagarde
Do something that’s truly sublime?

And what of next week and the Fed?
Are traders now looking ahead?
Will Jay make a change?
And thus rearrange
The views that are now so widespread

Come with me now, on a trip down memory lane.  Back to a time when hope (for a vaccine) sprung eternal, the blue wave was cresting, and investors were sidling up to the all-you-can-eat risk buffet with a bottomless appetite.  You remember, November.  Reflation was on the menu, along with a massive fiscal stimulus bill; progress was concrete with respect to Brexit negotiations; and the prospect of another wave of government shutdowns, worldwide, was just a gleam in petty tyrants’ politicians’ eyes.  Well, it turns out that those expectations were somewhat misplaced.  While we did, indeed, get that vaccine announcement, with the milestone first injection made today in the UK, many of those views turned out differently than expected.  As we are all aware, there was no blue wave in the US election.  Regarding Brexit, it appears that the time has finally come for the leaders of both sides to sit down and hash things out.  This morning brought news that Boris and Ursula will be meeting tomorrow to see if they can agree on what each side is willing to accept as their top negotiators have clearly reached their limits.

As to risk appetite, certainly November was beyond impressive, with massive risk rallies in equities around the world while haven assets, notably Treasuries and gold, suffered significant losses.  Since then, however, the euphoria has been far less prevalent, with some sessions even winding up in the red.  Lockdowns?  Alas, those have returned in spades, with seemingly new orders each and every day by various governmental authorities around the world.

The upshot of this mixture of news is that the market is now searching for the next big thing.  Don’t misunderstand, the 2021 conviction trades remain on the table.  Thus, expectations for a much weaker dollar, huge returns in emerging markets, both bonds and stocks, and continued strength in the US market are rife.  Just not right now.  The short-term view is more muddled which is why the price action we are currently experiencing is so mixed and until that new view develops, choppy markets with no net directional movement is the most likely outcome.  For instance, let’s look at today’s activity, which is a perfect example of the situation.

Equity markets around the world are softer, but not aggressively so.  Asian markets sold off modestly last night (Nikkei -0.3%, Hang Seng -0.75%, Shanghai -0.3%), but look simply to be consolidating what have been impressive gains since the beginning of November.  European markets are also a bit softer this morning, led by the CAC (-0.65%) although the DAX (-0.3%) and FTSE 100 (-0.4%) are drifting lower as well.  We did see some data from Europe, with ZEW readings from Germany turning out bi-polar (Expectations were strong at 55.0, Current Situation was weak at -66.5), thus showing how financial markets continue to focus on the post-covid economy while ignoring the current situation.  Meanwhile, US futures are all pointing a bit lower, between 0.4%-0.5%, after a mixed performance yesterday.  In other words, all that risk appetite from last month appears to have been satisfied for now, although we are, by no means, seeing serious risk reduction.

In the bond market, surprisingly, 10-year Treasury yields have actually edged higher by 0.7bps this morning, despite the modest risk-off theme, whereas in Europe, we see marginal yield declines across Germany, France and the UK. Bonds from the PIGS, however, are definitely feeling a little stress as they are trading with yields nearly 2bps higher than yesterday.  And that is a bit surprising given that Thursday, the ECB is going to announce their latest expansion of monetary policy, thus guaranteeing to buy yet more debt from these nations.  (We will cover the ECB tomorrow).

Commodities?  Well, gold has been rocking since its nadir on November 30, having rebounded more than 6% since then, and while unchanged on the day, remains in a short-term uptrend.  Oil, meanwhile, is ever so slightly softer this morning, just 0.5%, but also remains in its powerful uptrend, which has seen it rally more than 33% since its nadir on November 2nd.  In fact, metals and energy overall remain well bid and in strong uptrends.  Clearly, they are looking ahead to stronger growth (or possibly higher inflation) once the pandemic finally fades.

And lastly, the dollar, which can best be described as mixed today, remains the linchpin for many market expectations in 2021.  Remember this; given the dollar’s place in the world economy, as the financing vehicle of choice, a too strong dollar is generally associated with broad economic underperformance.  As debt loads worldwide have exploded, even at remarkably low interest rates, the need for foreign issuers, whether private or government, to acquire dollars to service that debt is perpetual.  When the dollar is strong, it crimps the ability of those foreign debtors to both invest and repay the outstanding debt, with investment suffering.  So, while a strong dollar may signal growth in the US economy, given that the US economy now represents only about 20% of the global economy, well down from its previous levels, and that trade continues to represent such a small portion of the US economy, just 12%, these days, a strong dollar simply hurts foreign economies without the previous benefits of knock-on global growth.  This is the key link between the views of a weaker USD and strong EMG performance next year, the two are tightly linked on a fundamental basis.

But as for today, the proper description of the dollar would be mixed.  In the G10, SEK (-0.45%) and GBP (-0.45%) are the leading decliners, with the latter clearly under pressure from the ongoing concerns over Brexit while the former seems to be feeling the sting of hints from the Riksbank that ZIRP will remain longer than previously expected.  On the plus side, the gains are less impressive, with CHF (+0.2%) the leader, while the euro has edged higher by 0.1%.  However, trying to explain a movement that small is a waste of time.

EMG currencies, on the other hand, are showing a little life, led by ZAR (+0.55%) and RUB (+0.5%) as commodity prices continue to hold the bulk of their gains.  INR (+0.5%) also had a good evening after the FinMin there explained that there would be no reduction in fiscal support for the economy for the foreseeable future, and that the government would continue to work with the RBI to insure a return to sustainable growth.  On the downside, KRW (-0.3%) is the laggard after the president there urged people to cancel holiday plans and stay home.

On the data front, NFIB Small Business Optimism fell to 101.4, a bit weaker than expected, but given the stories of closures around the nation, this cannot be that surprising.  A little later we get Nonfarm Productivity (exp 4.9%) and Unit Labor Costs (-8.9%), although neither is likely to excite the market.  There are no speakers on the docket, so the dollar will be taking its cues from the equity markets in all likelihood.  Right now, with futures pointing lower, that implies the dollar may have a bit of a rebound coming.  However, until that new narrative forms, I don’t anticipate too much movement.

Good luck and stay safe
Adf

Slipping Away

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Last week it appeared conversations
On Brexit, had built expectations
To broker a deal
That both sides would feel
Was fruitful for all Europe’s nations

Alas, based on headlines today
That good will is slipping away
Concern has now grown
That both sides condone
No deal, to the market’s dismay

Apparently, Brexit talks have reached their denouement, with the weekend efforts of PM Johnson and European Commission President Von der Leyen unable to bridge the final gaps.  The key issues regarding fishing in UK waters and state support for UK companies remain outstanding and neither side has yet been willing to budge.  There is clearly a great deal of brinksmanship ongoing here, but with the timeline so compressed, the chance for a No-deal outcome is still remarkably high.  In fact, as of a bit past 6am in NY, the headlines claim that negotiations might end by this evening in Europe, after one final call between the two leaders.

So, is this the end?  Is Brexit upon us, three weeks early?  And if so, what can we expect going forward?

The first thing to remember about international negotiations is they are never over, even when they have ended, especially in a situation of this nature.  The economic impact in both the UK and throughout Europe will be significant in a no-deal outcome, and this is something that neither side really wants to occur, despite any rhetoric to the contrary.  The most recent analyst estimates indicate that the UK’s economy will suffer a long-term reduction of 3.0% in GDP compared to the situation if a deal is completed.  Meanwhile, the EU’s impact will be a much smaller 0.5% of GDP, but that impact will be unevenly distributed, with Ireland expected to suffer a 6% decline in economic activity, while various other nations see much smaller effects.  Germany, too, will feel the pain, as German auto exports to the UK are one of the most lucrative parts of German industry, and with tariffs imposed, they will certainly decline.

And, ultimately, that is why the best bet remains that a deal will be done.  Especially given the economic disruption of the pandemic, the ability for either the UK or EU to blithely sit by and allow a critical trade relationship to crumble is virtually nil.  So, even if the talks ostensibly end later today, they will not have ended.  Both sides will still be seeking a deal, as both sides desperately need one.

However, investors are clearly worried, as evidenced by this morning’s price action across markets.  Perhaps the most obvious outcome is that of the pound, which has fallen 1.3% on the news.  Last week I was making the case that the market had not fully priced in a positive deal, and any agreement was likely to see the pound rally.  At the same time, a true collapse in talks with a no-deal outcome is likely to see a further decline, with 5%-7% seen as a reasonable result.  This morning’s movement is just a down payment on that, if no deal actually is the outcome.

But this news seems to have forced investors across markets to reconsider their current positioning and potential market responses to negative news.  Perhaps you are not old enough to remember what negative news actually is, so I will give a brief refresher here.  Negative news is a situation where not only is the economic impact indisputably harmful to a (country, company, currency), but that a central bank response of further policy ease will be unable to change the outcome.  Thus, Friday’s weaker than expected NFP number was not really negative because it encouraged the view that the Fed will ease further next week, thus offsetting any bad economics.  But Brexit changes the structure, not just the data, and no matter what the BOE does, customs checks are still going to slow down trade and commerce.

It is with this in mind that we look at markets this morning and see that risk is broadly being reduced.  Asian equity markets started the move as the Nikkei (-0.75%), Hang Seng (-1.25%) and Shanghai (-0.8%) all showed solid declines.  And this was despite Chinese data showing that exports from the mainland had increased a much greater than expected 21% and fostered a record large trade surplus.  In Europe, the situation is similar with one real exception.  The DAX (-0.3%) and CAC (-0.8%) are leading the Continent lower as investors react to the potential crimp in economic activity.  However, the FTSE 100 (+0.5%) is higher as most members of the index will benefit greatly from a weaker pound, and so are responding to the pound’s market leading decline.

Speaking of the pound, it has fallen 1.3% from Friday’s closing levels and is the leading decliner across all major currencies.  But weakness is evident in the commodity bloc as AUD (-0.5%), NZD (-0.4%) and CAD (-0.2%) are all suffering alongside oil (WTI -0.9%) and gold (-0.4%).  EUR (-0.1%) has been a relative outperformer as the market continues to estimate a much smaller impact of a no-deal scenario.  Meanwhile, in the EMG bloc, losses are virtually universal, but the magnitude is not that substantial.  For example, MXN (-0.7%) is the worst performer today, obviously suffering from oil’s decline, but we have also seen weakness throughout the CE4 (HUF -0.4%, CZK -0.3%, PLN -0.2%) along with ZAR and RUB, both having fallen 0.3%.  In fact, the one bloc that has outperformed today is APAC, where only two currencies (MYR -0.2% and SGD -0.15%) are in the red.  Given the genesis of the problems is in Europe, this should not be that surprising.

Bond markets are taking the risk-off theme seriously with Treasury yields lower by 2.2 basis points and European govvies seeing substantial demand.  Gilts lead the way, with a 5.6bps decline, but Bunds (-3.0bps) and OAT’s (-2.6bps) are also rallying nicely.  Remember, too, that the ECB meets Thursday with expectations built in for a €500 billion increase in PEPP as well as a maturity extension of between six and twelve months in addition to an increase in the TLTRO program, with a maturity extension there as well.  One other thing to watch from the ECB is whether or not they mention the euro and its recent rally.  Madame Lagarde and her colleagues cannot countenance a significant rally from current levels, and I expect they will make that clear.

As to data this week, aside from the ECB, CPI is the biggest thing in the US:

Tuesday NFIB Small Business 102.5
Nonfarm Productivity 4.9%
Unit Labor Costs -8.9%
Wednesday JOLTs Job Openings 6.325M
Thursday Initial Claims 725K
Continuing Claims 5.27M
CPI 0.1% (1.1% Y/Y)
-ex food & energy 0.1% (1.6% Y/Y)
Friday PPI 0.1% (0.7% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Michigan Sentiment 76.0

Source: Bloomberg

With the last FOMC meeting of the year next Wednesday, the Fed is in their quiet period so there will be no commentary on that front.  With this in mind, the dollar, which continues to trend lower, will likely need some new catalyst to take the next step.  At this point, the biggest surprise is likely to be a positive conclusion to the Brexit talks, but given what we have seen over the past eight months, it is pretty clear that investors remain hugely bullish on the idea of the post-pandemic economy and will not be denied in their belief that stocks can only go up.  My gut tells me that US equities, where futures are currently lower by 0.3% or so, will finish the day higher, and the dollar will cede much of its overnight gains, even without a deal.

Good luck and stay safe
Adf

Still a Threat

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For Boris, and all Brexiteers
They can’t wait for this, Eve, New Year’s
Alas, as of yet
There is still a threat
That no deal might bring both sides tears

Investors, however, seem sure
The UK, a deal, will secure
That’s why Britain’s pound
Is robustly sound
Let’s hope that view’s not premature

EU official sees UK trade deal “imminent” barring last-minute glitch

This Reuters News headline from this morning, aside from being inane, is a perfect example of the market narrative in action.  The broad view is that a deal will be reached, despite the fact that deadline after deadline has been missed during these negotiations.  The pound has rallied nearly 10% since the only deadline of consequence on June 30.  That was the date on which both sides would have been able to extend the current negotiations.  However, no extension was sought by the UK and none granted, so we are heading into the last four weeks of the year with nothing concrete completed.  And yet, markets on the whole continue to trade under the assumption a deal will be reached and there will be no meaningful disruption to either the UK or EU economy on January 1st.

And that is the point of the headline.  It is essentially telling us a deal is a given, and both sides are now just playing to their domestic constituencies to show how hard they are working to achieve a ‘good’ deal.  In fact, once again today, the French held out the possibility that they would veto a deal as French European Affairs Minister, Clement Beaune, told us, “If there is a deal which is not good, then we would oppose it.  We always said so.”  This comment appears to be just another part of the ongoing theater.  A senior UK official, meanwhile, claimed talks had regressed because of a change in the EU’s position regarding the fishing issue.

But let’s go back to the pound.  A 10% rally in five months is a pretty impressive outcome.  Can this movement be entirely attributed to Brexit beliefs?  At this stage, I think not.  Consider, that during that same period, both SEK and NOK have rallied nearly 11%.  And even the laggard of the G10, JPY, has rallied 3.5% in the second half of the year.  The point is that perhaps the market has not priced in as high a probability of a successful outcome as many, including me, had thought likely.  After all, if the other nine G10 currencies have rallied an average of 8.0% in a given time frame, at the margin, the additional 1.6% that cable has rallied does not seem that impressive after all.

What are the potential ramifications of this line of thinking?  Well, assuming that a deal is actually reached on time, and I believe that is the most likely outcome, it seems possible that the pound has considerably more upside than the rest of the G10.  Looking back to the original referendum in the summer of 2016, the pound touched 1.50 the night of the vote, before it became clear that Brexit was going to be the outcome.  Since then, in Q1 2018, the pound traded above 1.40, but that too, was simply a reflection of the times as the euro was trading above 1.25.  In other words, the Brexit impact on the pound, other than in the immediate aftermath of the vote, seems to have been remarkably modest.  Certainly, month-to-month movement has been in lockstep with all the other G10 currencies, and it is only the level of the pound, which adjusted back in June 2016, which is different.  The implication is that the announcement of a successful deal is likely to see the pound outperform higher.  This is opposite my previous views but appears to account for the historical price action more effectively.  Remember, within two days of the Brexit vote, the pound fell 11%.  While a deal seems unlikely to recoup that entire amount, perhaps half of that is available, which from current levels means that a move above 1.40 is viable without a corresponding rise in the euro.  At that point, the pound will revert to being just another G10 currency, with price movement locked into the dollar narrative, not the Brexit narrative.  Food for thought.

As to today’s session, it is payrolls day with the following expectations according to Bloomberg:

Nonfarm Payrolls 470K
Private Payrolls 540K
Manufacturing Payrolls 45K
Unemployment Rate 6.7%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%
Trade Balance -$64.8B
Factory Orders 0.8%

The question, of course, is has this data yet returned to its prior place of importance in investors’ minds.  And arguably, the answer is no.  There continues to be a strong market narrative that the current data is unimportant because everyone knows that the ongoing lockdowns are going to make things look worse.  This is true all over the world (except, perhaps, China).  But given the near universal central bank promises of low rates forever for the foreseeable future, investors continue to add risk to their portfolios with abandon.  In order to change that mindset, I believe we would need to see a number so shocking, something like -1000K, that it could indicate the impact of Covid might not be temporary.  But barring that, my sense is the payroll number has lost its luster.

It will be interesting to see if that luster returns in the post-Covid environment, or perhaps some other statistic will embody the zeitgeist in the future.  Remember, NFP has not always been that important.  When Paul Volcker was Fed Chair, M2 money supply was the only number that mattered.  Once Alan Greenspan took over, it was the trade data that drove markets.  Perhaps inflation will be deemed “THE” number going forward, especially in the event that MMT becomes the norm.

Ahead of the data, a tour of markets shows that risk appetite is positive, if modest.  European equity markets are generally firmer (CAC +0.3%, FTSE 100 +0.8%) although the DAX just gave up its earlier gains and is now lower by 0.2%.  Overnight, things were also fairly dull as the Nikkei (-0.2%) slipped modestly while both the Hang Seng (+0.4%) and Shanghai (+0.1%) edged higher.  In fact, the best performer overnight was South Korea with the KOSPI (+1.3%) rallying on continued strong data and KRW (+1.35%) rallying on the back of inflows to the KOSPI as well as market technicals.  Meanwhile, US futures are higher by roughly 0.3% at this hour.

The bond market has slipped a bit with yields rising by 2bps in Treasuries, but European govvies, which had been softer (higher yields) earlier in the session, have found support with yields now edging lower by about 0.5bps.  It seems a Bloomberg story released a short time ago indicated that the ECB is likely to extend their PEPP by a full year, not the 6 months mooted by most analysts.

As to the dollar, it is actually mixed in the G10, but movement has been modest in both directions.  So, CHF (+0.25%) and GBP (+0.2%) are leading the way, but realistically don’t tell us much given how insignificant the moves have been.  On the downside, NZD (-0.4%) and AUD (-0.2%) are lagging, but neither has released data of note.  Essentially, this all seems like position adjustments.

Emerging markets, however, have seen a bit more demand with the commodity bloc supported after OPEC+ reached a compromise and helped oil prices back above $46/bbl.  This is the highest they have been since before the Covid panic, so it is quite important from a market technical perspective.  In the meantime, RUB (+0.55%) and MXN (+0.5%) are leading the way (after KRW of course) with most others in this space higher by much lesser amounts.

And that’s where we stand heading into payrolls and then the weekend.  Nothing has changed the dollar weakening narrative, and the pound remains the true wildcard.  Despite my change of heart regarding the pound’s upside, that does not change my view that if the negotiations fall apart and no Brexit deal is reached, the pound can decline 5%-7%.  Arguably, we are looking at some symmetry there.  In any event, a case for a larger move in the pound is very viable, one way or the other.

Good luck, good weekend and stay safe
Adf

Further Afflictions

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Each day there is growing conviction
The buck is due further affliction
More views now exist
The Fed will soon ‘Twist’
Thus, slaking the market’s addiction

But even if Powell and friends
Do act as the crowd now contends
Does anyone think
Lagarde will not blink
And cut rates at which her group lends?

You cannot read the financial press lately without stumbling across multiple articles as to why the dollar is due to fall further.  There is no question it has become the number one conviction trade in the hedge fund community as well as the analyst community.  There are myriad reasons given with these the most common:

1.     The introduction of the vaccine will lead to a quicker recovery globally and demand for risk assets not havens like the dollar
2.     The Biden administration will be implementing a new, larger stimulus package adding to the global reflation trade
3.     The Fed is going to embark on a new version of Operation Twist (where they swap short-dated Treasuries for long-dated Treasuries) in order to add more stimulus, thus weakening the dollar
4.     The market technical picture is primed for further dollar weakness in the wake of recent price action breaking previous dollar support levels.

Let’s unpack these ideas in order to try to get a better understanding of the current sentiment.

The vaccine story is front page news worldwide and we have even had the first country, the UK, approve one of them for use right away.  There is no question that an effective vaccine that is widely available, and widely taken, could easily alter the current zeitgeist of fear and loathing.  If confidence were to make a comeback, as lockdowns ended and people were released from home quarantines, it would certainly further support risk appetite.  Or would it?

Consider that risk assets, at least equities, are already trading at record high valuations as investors have priced in this outcome.  You may remember the daily equity rallies in October and November based on hopes a vaccine would be arriving soon.  The point is, it is entirely possible, and some would say likely, that the vaccine implementation has already been priced into risk assets.  One other fly in this particular ointment is that so many businesses have already permanently closed due to the government-imposed restrictions worldwide, that even if economic demand rebounds, supply may not be available, thus driving inflation rather than activity.

How about the idea of a new stimulus package adding to global reflation?  Again, while entirely possible, if, as is still widely expected, the Republicans retain control of the Senate, any stimulus bill is likely to disappoint the bulls.  As well, if this is US stimulus, arguably it will help support the US economy, US growth and extend the US rebound further and faster than its G10 and most EMG peers.  Yes, risk will remain in favor, but will that flow elsewhere in the world?  Maybe, maybe not.  That is an open question.

Certainly, a revival of Operation Twist, where the Fed extends the maturity of its QE purchases in order to add further support to the economy by easing monetary policy further would be a dollar negative.  I thought it might be instructive to see how the dollar behaved back in 2011-12 when Ben Bernanke was Fed Chair and embarked on the first go-round of this policy.  Interestingly enough, from September 2011 through June 2012, the first leg of Operation Twist, the dollar rallied 8.7% vs. the euro.  When the Fed decided to continue the program for another six months, the first dollar move was a continuation higher, with another 2.75% gain, before turning around and weakening about 6%.  All told, through two versions of the activity, the dollar would up slightly firmer (2.5%) than when it started.

And this doesn’t even consider the likelihood that if the Fed eases further, all the other major central banks will be doing so as well.  Remember, FX is a relative game, so relative monetary policy moves are the driver, not absolute ones.  And once again, I assure you, that if the euro starts to rally too far, the ECB will spare no expense to halt that rally and reverse it if possible.  Currently, the trade-weighted euro is back to levels seen in early September but remains 1.75% below the levels seen in 2018.  It is extremely difficult to believe that the ECB will underperform next week at their meeting if the euro is climbing still higher.  Deflation in Europe is rampant (CPI was just released at -0.3% in November), and a strong currency is not something Lagarde and her compatriots can tolerate.

Finally, looking at the technical picture, it may well be the best argument for further dollar weakness.  To the uninitiated (including your humble author) the variety of technical indicators observed by traders can be dizzying.  However, some include satisfying the target of an “inverted hammer” pattern, recognition of the next part of an Elliott Wave ABC correction and DeMark targets now formed for further dollar weakness.  While that mostly sounded like gibberish, believe me when I say there are many traders who base every action on these indicators, and when levels are reached in the market, they swarm in to join the parade.  At the same time, the hedge fund community, while short a massive amount of dollars, is reputed to have ample dry powder to increase those positions.

In sum, ironically, I would contend that the technical picture is the strongest argument for the dollar to continue its recent decline.  Risk assets are already priced for perfection, the vaccine is a known quantity and any Fed move is likely to be matched by other central banks.  This is not to say that the dollar won’t decline further, just that any movement is likely to be grudging and limited.  The dollar is not about to collapse.

A quick recap of today’s markets shows that risk appetite, not unlike yesterday’s lack of enthusiasm, remains satisfied for now.  Asian equities were mixed with the Hang Seng (+0.7%) the leader by far as both the Nikkei (0.0%) and Shanghai (-0.2%) showed no life.  European bourses are mostly lower (DAX -0.4%, CAC -0.25%) although the FTSE 100 is flat on the day.  And US futures are also either side of flat.

Bond markets, are rebounding a bit from their recent decline, with Treasuries seeing yields lower by 1 basis point and European bonds all rallying as well, with yields falling between 2bps and 3bps.  The latter may well be due to the combination of weaker than expected Services PMI releases as well as the news that Germany is extending its partial lockdown to January 10.  (Tell me again why the euro is a good bet here!)

Gold continues to rebound from its correction last week, up another $10 while the dollar, overall, this morning is somewhat softer, keeping with the recent trend.  GBP (+0.6%) is the leading gainer in the G10 on continued hopes a Brexit deal will soon be reached, but the rest of the bloc is +/-0.2%, or essentially unchanged.  EMG gainers include HUF (+0.7%) as the government there expands infrastructure spending, this time on airports, while the rest of the bloc has seen far smaller gains, which seem to be predicated on the idea of US stimulus talks getting back on track.

Initial Claims (exp 775K) data leads the calendar this morning with Continuing Claims (5.8M) and then ISM Services (55.8) at 10:00.  Yesterday’s Beige Book harped on the negative impact that government shutdowns have had on companies with no sign, yet, of vaccine hopes showing up in businesses.  At the same time, Chairman Powell, in his House testimony yesterday, explained that there was no rift between the Fed and the Treasury, and the Fed response when Treasury Secretary Mnuchin said he was recalling unused funds from the CARES act, was merely reinforcement of the idea that the Fed was not going to back away from their stated objectives.

In the end, the dollar remains under pressure and the trend is your friend.  With that in mind, though, it strikes that a decline of more than another 1%-2% will be very difficult to achieve without a more significant correction first.  Again, for receivables hedgers, these are good levels to consider.

Good luck and stay safe
Adf

Many Pains

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In England and Scotland and Wales
The vaccine will soon be for sale
But Brexit remains
A source of more pains
If talks this week run off the rails

What a difference a day makes, twenty-four little hours.  Yesterday morning at this time, the bulls ruled the world.  Equity markets were rallying strongly everywhere, bond markets were under pressure, and the dollar was breaking below two-year support levels.  Although most commodity prices were having difficulty extending their recent gains, gold did manage to rebound sharply all day, and, in fact, is higher by another 0.7% this morning, its death being widely exaggerated.

However, aside from gold, this morning looks quite different on the risk front.  Perhaps, ahead of a significant amount of data coming the rest of the week (ADP this morning, NFP on Friday), as well as next week’s ECB meeting, this is, as a well-known Atlanta based beverage company first told us in 1929, the pause that refreshes.

Arguably, the biggest news this morning is that the UK has cleared the first vaccine for use against Covid-19 with the initial doses to be injected as early as next week.  I don’t think anyone can argue with the idea this is an unalloyed positive for just about everything.  If it proves as effective as the initial testing indicated, and if a sufficient percentage of the population gets inoculated, and if that leads to a rebound in confidence and the end of all the government imposed economic restrictions and lockdowns, it could open the door for 2021 to be a gangbuster-type year of growth and activity.  But boy, that sure is a lot of ifs!

And a funny thing about the market response to this news is that…nothing has happened.  The FTSE 100 is higher by a scant 0.2%, and has not shown the strength necessary to support other European markets as both the DAX (-0.3%) and CAC (-0.2%) are in the red.  Is it possible that the markets have already priced in all the ifs mentioned above?  And, if that is the case, what does it say about the future direction of risk appetite?

This being 2020, the year with imperfect hindsight, it should also be no surprise that the good news regarding the vaccine was offset with potential bad news about Brexit.  Michel Barnier, the EU’s top negotiator, indicated that while the mood was still positive in the round-the-clock negotiations, it is very possible that no deal is reached in time to be ratified by all parties.  And that time is drawing near.  After all, the previous deadlines were all artificial, to try to goose negotiations, but December 31st is written into a treaty signed by both sides.  The contentious issues remain access to UK waters by EU fishing vessels and the idea of what will constitute a level playing field between UK and EU companies given their newly different legal and regulatory masters.  In the event, GBP (-0.8%) is today’s worst G10 currency performer as it quickly fell when Barnier’s comments hit the tape.  Something else to keep in mind regarding the pound is that it feels an awful lot like a successful completion of a Brexit deal is entirely priced in.  So, if that deal is reached, the pound’s upside is likely to be quite limited.  Conversely, if no deal is agreed, look for a substantial shock to the pound, certainly as much as 5%-7% in short order.

And with that cheery thought in mind, let us peruse the overall market condition this morning, where eyeglasses are losing their tint.  Equity markets in Asia overnight were as close to unchanged as a non-holiday session would allow, with the largest movement from a main index, the Hang Seng, just +0.1%.  Both the Nikkei and Shanghai moved less, as investors seemed to be coping with a bit of indigestion after the recent sharp rally.  As mentioned above, European bourses have been no better, with only Spain’s IBEX (+0.4%) showing any hint of life, but the rest of the continental exchanges all in the red.  Even US futures markets are under modest pressure, with all three lower by about 0.2%.

The Treasury market saw an impressive decline yesterday, with yields rising 7 basis points in the 10-year, as the risk rally exploded all day long.  European bond markets also declined, but not quite like that.  Given the ECB’s reported -0.3% CPI reading, the case that bond yields on the continent should be rising is very difficult to make.  This morning, though, movement is measured in fractions of basis points, with only Italian BTP’s having recorded anything larger than a 1 basis point move today, in this case a decline in yields.  Otherwise, we are + / – 0.5 basis points or less in Treasuries, Bunds, OAT’s and Gilts.  In other words, nothing to see here.

Oil is feeling a bit toppish here, having rallied 36% during the month of November, but how ceding about 4% during the past few sessions.  OPEC+ talks remain mired in disagreement with the previous production cuts potentially to be abandoned.  However, taking a longer-term view, analysts are pointing to the changes in the US fracking community (i.e. bankruptcies there) and forecasting a significant decline in US oil production in 2021, which, if that occurs, is likely to provide significant price support.

And finally, the dollar, which fell sharply against virtually every currency yesterday, led by BRL (+2.7%) in the emerging markets and EUR (+1.2%) in the G10, has found its footing today.  Looking at the G10 first, NOK (-0.65%) is the laggard alongside the aforementioned pound and SEK (-0.5%).  The euro (-0.25%) has maintained the bulk of its gains after having finally pushed through key resistance at 1.2011-20, the levels seen in early September. Remember, short USD is the number one conviction trade for Wall Street for 2021, and EUR positions remain near all-time highs.

An aside in the euro is that markets continue to look to next week’s ECB meeting with expectations rife the PEPP will be expanded and extended.  Madame Lagarde promised us things would change, and every speaker since, including the Latvian central bank President, who this morning explained that €500 billion more in the PEPP with a timing extension to mid-2022 would be acceptable, as would an extension in the maturity of TLTRO loans to 5 years.  The point is that despite the confidence so many have that the dollar is destined to collapse next year, there is no way other central banks will allow that unimpeded.

Back to markets, on the EMG slate, the situation is similar with more losers than gainers led by ZAR (-1.1%) and PLN (-0.6%).  Of course, both these currencies saw stronger gains yesterday, so this seems to be a little catch-up price action.  Actually, CLP (+0.65%) has opened stronger this morning, simply adding to yesterday’s gains without an obvious catalyst, while KRW(+0.5%) continues to benefitt from better than expected trade and GDP data.

On the data front, this morning brings ADP Employment (exp 430K) as well as the Beige Book this afternoon.  As well, we will hear again from Chairman Powell, who in the Senate yesterday told us all that there needed to be more fiscal stimulus and that the Fed would do all they can to support the economy.  Given this has been the message for the past six months, nobody can be surprised.  However, one idea that seems to be developing is that the Fed could well announce purchases of longer dated bonds at their December meeting in two weeks’ time, which would certainly have an impact on the bond market, and would be seen as easier money, thus likely impact the dollar as well.  When he speaks to the House today, don’t look for anything new.

All told, today is a breather.  Clearly momentum is for a weaker dollar right now, but I continue to believe these are excellent levels for receivables hedgers to act.

Good luck and stay safe
Adf

Nothing but Cheerful

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While yesterday traders were fearful
Today they are nothing but cheerful
The vaccine is coming
While Bitcoin is humming
It’s only the bears who are tearful

Risk is back baby!!  That is this morning’s message as a broad-based risk-on scenario is playing out across all markets.  Well, almost all markets, oil is struggling slightly, but since according to those in the know (whoever they may be) we have reached so-called ‘peak oil’, the oil market doesn’t matter anymore.  So, if it cannot rally on a day when other risk assets are doing so, it is of no consequence.

Of course, this begs the question, what is driving the reversal of yesterday’s theme?  The most logical answer is the release of the newest batch of Manufacturing PMI data from around the world, which while not universally better, is certainly trending in the right direction.  Starting last night in Asia, we saw strength in Australia (55.8), Indonesia (50.6), South Korea (52.9), India (56.3) and China (Caixin 54.9).  In fact, the only weak print was from Japan (49.0), which while still in contractionary territory has improved compared to last month.  With this much renewed manufacturing enthusiasm, it should be no surprise that equity markets in Asia were all bright green.  The Nikkei (+1.35%), Hang Seng (+0.85%) and Shanghai (+1.75%) led the way with New Zealand the only country not to join in the fun.

Turning to European data, it has been largely the same story, with Germany (57.8) leading the way, but strong performances by the UK (55.6) and the Eurozone (53.8) although Italy (51.5) fell short of expectations and France (49.6) while beating expectations remained below the key 50.0 level.  Spain (49.8), too, was weak failing to reach expectations, but clearly, the rest of the Continent was quite perky in order for the area wide index to improve.  Equity markets on the Continent are also bright green led by the FTSE 100 (+1.95%) but with strong performances by the DAX (+1.0%) and CAC (+1.1%) as well.  In fact, here, not a single market is lower.  Even Russian stocks are higher despite the weakest PMI performance of all (46.3).

The point is, there is no risk asset that is not welcome in a portfolio today.  However, while the broad sweep of PMI data is certainly positive, it seems unlikely, given the market’s history of ignoring both good and bad data from this series, that this is the only catalyst.  In fairness, there was some other positive data.  For example, German Unemployment fell to 6.1%, a tick below last month and 2 ticks below expectations.  At the same time, Eurozone CPI was released at a slightly worse than expected -0.3% Y/Y in November, which only encourages the bullish view that the ECB is going to wow us next week when they unveil their latest adjustments to PEPP.

And perhaps, that is a large part of the story, expectations for ongoing central bank largesse to support financial markets continue to be strong.  After all, the buzz in the US is that the combination of Fed Chair Jay Powell alongside former Fed Chair Janet Yellen as Treasury Secretary means that come January or February, the taps will once again open in the US with more fiscal and monetary assistance.  Alas, what we know is that the bulk of that assistance winds up in the equity markets, at least that has been the case to date, so just how much this new money will help the economy itself remains in question.

But well before that, we have a number of key events upcoming, notably next week’s ECB meeting and the Fed meeting the following week.  Focusing first on Frankfurt, recall that Madame Lagarde essentially promised action at their late October get together, and the market wasted no time putting numbers on those expectations.  While no rate cut is anticipated, at least not in the headline Deposit rate (currently -0.50%), the PEPP is expected to be increased by up to €600 billion with its tenor expected to be extended by an additional six months through the end of 2021.  However, before we get too used to that type of expansion, perhaps we should heed the words of Isabel Schnabel, the German ECB Executive Board member who today explained that while further support would be forthcoming, thoughts that the ECB would take the Mario Draghi approach of exceeding all expectations should be tempered.  Of course, the question is whether a disappointing outcome next week, say just €250 billion additional purchases, would have such a detrimental impact on the markets economy.  Remember, while Madame Lagarde has a great deal of political nous, she has thus far demonstrated a tin ear when it comes to market signals.  The other topic on which she opined was the TLTRO program, which she seems to like more than PEPP, and which she implied could see both expansion and even a further rate cut from the current -1.00%.

And perhaps, that is all that is needed to get the juices flowing again, a little encouragement that more money is on its way.  Certainly, the bond markets are exhibiting risk on tendencies, although yield increases of between 0.2bps (Germany) and 1.1bps (Treasuries) are hardly earth shattering.  They are certainly no indication of the reflation trade that had gotten so much press just a month ago.

And finally, the dollar, which is definitely softer this morning, but only after having rallied all day yesterday, so is in fact higher vs. yesterday morning’s opening levels.  The short dollar trade remains one of the true conviction trades in the market right now and one where positioning is showing no signs of abating.  Almost daily there seems to be another bank analyst declaring that the dollar is destined for a great fall in 2021.  Perhaps they are correct, but as I have repeatedly pointed out, no other central bank, certainly not the ECB or BOJ is going to allow the dollar to decline sharply without some action on their part to try to slow or reverse it.

A tour of the market this morning shows that CHF (+0.4%) is the leading gainer in the G10, although followed closely by SEK (+0.4%) and EUR (+0.35%).  Of course, if you look at the movement since Friday, CHF and EUR are higher by less than 0.1% and SEK is actually lower by 0.45%.  In other words, do not believe that the dollar decline is a straight-line affair.

Emerging markets are seeing similar price action, although as the session has progressed, we have seen more currency strength.  Currently, CLP (+0.9%), ZAR (+0.85%) and BRL (+0.8%) are leading the way here, all three reliant on commodity markets, which have, other than oil, performed well overnight.  The CE4 are also higher (HUF +0.6%, CZK +0.5%), tracking the euro’s strength, and Asian currencies had a fair run overnight as well, with INR (+0.5%) the best performer as a beneficiary of an uptick in stock and bond investments made their way into the country.

On the data front, today brings ISM Manufacturing (exp 58.0) and Construction Spending (0.8%), with the former certainly of more interest than the latter.  This is especially so given the PMI data overnight and the market response.  But arguably, of far more importance is Chairman Powell’s Senate testimony starting at 10:00 this morning, which will certainly overshadow comments from the other three Fed speakers due later.

Yesterday at this hour, with the dollar under pressure, it seemed we were going to take out some key technical levels and weaken further.  Of course, that did not happen.  With the dollar at similar levels to yesterday morning, and another dollar weakening sentiment, will today be the day that we break 1.20 in the euro convincingly?  As long as CNY remains strong, it is certainly possible, but I am not yet convinced.  Receivables hedgers, these are the best levels seen in two years, so it may not be a bad time to step in.

Good luck and stay safe
Adf

Post-Covid Themes

Posted on by

With Thanksgiving now in the past
And Christmas approaching quite fast
The only thing clear
Through end of the year
Is dollar shorts have been amassed

For many, conviction is strong
That currencies, they need be long
The idea, it seems
Is post-Covid themes
Mean risk averse views are now wrong

Having been away for a week, the most interesting thing this morning is the rising conviction in the view that the dollar has much further to decline in 2021.  Much is made of the fact that since its Covid induced highs in March, the dollar has fallen by more than 12% vs the Dollar Index (DXY) which is basically the euro.  Of course, that is nothing compared to the recoveries seen by the commodity currencies like NOK (+33.2%), AUD (+27.6%) and NZD (+23.6%) over the same period.  Yet when viewed on a year-to-date basis, the movement is far less impressive, with NOK actually unchanged on the year, and the leader, SEK, higher by 10.8%.  It is also worth remembering that the euro has rallied by a relatively modest 6.9% thus far in 2020, hardly worthy of the term dollar collapse.

In addition, as I have written before, but given the growing dollar bearish sentiment, I feel worth repeating, is that in the broad scheme of things, the dollar is essentially right in the middle of its long-term trading range.  For instance, from the day the euro came into existence, January 1, 1999, the average daily FX rate, according to Bloomberg, has been 1.1999, almost exactly where it currently trades.  It has ranged from a low of 0.8230 in October 2000 to a high of 1.6038 the summer before the GFC hit.  The point is EURUSD at 1.20 is hardly unusual, neither can it be considered weak nor strong.

Unpacking the rationale, as best I understand it, for the dollar’s imminent decline, we see that a great deal of faith is put upon the idea of a continuing risk rally over the next months as the global economy recovers with the advent of the Covid vaccines that seem likely to be approved within weeks.  The sequence of events in mind is that the distribution of the vaccine will have the dual impact of dramatically reducing the Covid caseloads while simultaneously reinvigorating confidence in the population to resume pre-Covid activities like going out to restaurants, bars and the movies, as well as resuming their travel plans.  The ensuing burst of activity will result in a return to pre-Covid levels of economic activity and all will be right with the world.  (PS  pre-Covid economic activity was a desultory 1.5% GDP growth with low inflation that caused the central bank community to maintain ultra-low interest rates for a decade!)

Equity markets, which are seemingly already priced for this utopian existence, will continue to rally based on the never-ending stream of central bank liquidity…or is it based on the massive growth in earnings given the near certainty of higher taxes and higher interest rates in the future.  No, it can’t be the second view, as higher taxes and higher interest rates are traditionally equity negatives.  So perhaps, equity markets will continue to rally as the prospect of future growth will remain just close enough to seem real, but far enough away to discourage policymakers from changing the rules now.  Perhaps this is what is meant by the Goldilocks recovery.

Of course, while commodity markets have bought into the story hook, line and sinker, it must be recalled that they have been the greatest underperforming segment of markets for the past decade.  Since December 1, 2010, the Goldman Sachs Commodity Index (GSCI) has fallen 36.5%, while the S&P500 has rallied 191%.  My point is the fact that commodity markets are performing well with the prospects of incipient economic growth ought not be that surprising.

The fly in the ointment, however, is the bond market, where despite all the ink spilled regarding the reflation trade and the steepening of the US Treasury yield curve, 10-year Treasuries refuse to confirm the glowing views of the future. At least, while they may be agnostic on growth, there is certainly little concern over a rekindling of inflation, despite the earnest promises of every central banker in the world to stoke the fires and bring measured inflation back to their targets.  As I type this morning, 10-year Treasury yields are 0.85%, right in the middle of its range since the US election.  You remember that, the event that was to usher in the great reflation?

In the end, while sentiment has clearly been growing toward a stronger recovery next year, encouraging risk appetites in both G10 and, especially, EMG economies, as yet, the data has not matched expectations, and positioning remains based on hope rather than evidence.

Now a quick tour around today’s markets shows that the equity rally has paused, at the very least, with weakness in Asia (Nikkei -0.8%, Hang Seng -2.1%, Shanghai -0.5%) despite stronger than expected economic data from both Japan (IP +3.8%) and China (Mfg PMI 52.1, non-Mfg PMI 56.4).  European markets are also mostly in the red, although the DAX (+0.2%) is the exception to the rule.  However, the CAC (-0.4%) and FTSE 100 (-0.15%) have joined the rest of the continent lower despite positive comments regarding a Brexit deal being within reach this week.  US futures have a bit of gloom about themselves as well, with both DOW and SPX futures pointing to 0.5% declines at the open, although NASDAQ futures are little changed at this hour.

Surprisingly, despite the soft tone in the equity markets, European government bond yields are all edging higher, with Bunds (+1.6bps) pretty much defining the day’s activity as most other major markets are seeing similar moves, including Treasuries (+1.8 bps).  Commodity prices are under pressure with oil (-1.3%) and gold (-0.9%) both suffering although Bitcoin seems to be regaining its footing, rallying 2.3% this morning.

Finally, the dollar, is under a modicum of pressure this morning with G10 currencies mostly a bit firmer (NOK and SEK +0.4%) GBP (+0.3%), although AUD (-0.1%) seems to be getting nosebleeds as it approaches its highest level in two years.  Potentially, word that China has slapped more tariffs on Australian wines, as the acrimony between those two nations escalates, could be removing the rose-colored tint there.  Meanwhile, in the EMG bloc, there is a mix of activity, with some gainers (HUF +0.8%) and BRL (+0.65%), and some losers (ZAR -0.3%), KRW (-0.25%).  Broadly, the commodity focused currencies here are feeling a little pressure from the underperformance in oil and metals, while the CE4 are tracking the euro nicely.

It is an important data week, and we also hear from numerous central bankers.

Today Chicago PMI 59.0
Tuesday ISM Manufacturing 58.0
Construction Spending 0.8%
Wednesday ADP Employment 420K
Fed Beige Book
Thursday Initial Claims 765K
Continuing Claims 5.81M
ISM Services 57.6
Friday Nonfarm Payrolls 500K
Private Payrolls 608K
Manufacturing Payrolls 46K
Unemployment Rate 6.8%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Trade Balance -$64.8B
Factory Orders 0.8%

Source: Bloomberg

In addition, we have seven Fed speakers this week, including most importantly, Chairman Powell’s testimony to the Senate Banking Committee tomorrow and the House Finance Panel on Wednesday.  We also hear from Madame Lagarde twice this week, and with the euro hovering just below 1.20, be prepared for her to mention that a too-strong euro is counterproductive.  You may recall in early September, the last time the euro was at these levels, that both she and Philip Lane, ECB Chief Economist, were quickly on the tape talking down the single currency.  Although since that time CNY has rallied strongly (+4%) thus removing some of the pressure on the ECB, there is still no way they want to see the euro rally sharply from here.

But do not be surprised to see the market test those euro highs today or tomorrow, if only to see the ECB response and pain threshold.  Clearly, momentum is against the greenback lately, and today is no exception, but I do not buy the dramatic decline story, if only because no other central bank will sit idly by and allow it.

Good luck and stay safe
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Pandemic Support

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Til now the direction’s been clear
As Jay and Mnuchin did fear
If they didn’t spend
The US can’t mend
And things would degrade through next year

But now, unless there’s a breakthrough
It seems Treasury won’t renew
Pandemic support
Which likely will thwart
A rebound til late Twenty-Two

Just when you thought things couldn’t get more surprising, we wind up with a public disagreement between the US Treasury Secretary and the Federal Reserve Chair.  To date, Steve Mnuchin and Jay Powell have seemed to work pretty well together, and at the very least, were both on the same page.  Both recognized that the impact of the pandemic would be dramatic and there was no compunction by either to invent new ways to support both markets and the economy.  As well, both were appointed by the same president, and although their personal styles may be different, both seemed to have a single goal in mind, do whatever is necessary to maintain as much economic activity as possible.

Aah, but 2020 is unlike any year we have ever seen, especially when it comes to policy decisions.  The legalities of the alphabet soup of Fed programs (e.g. PMCCF, SMCCF, MMLF, etc.) require that they expire at the end of the year and must be renewed by the Treasury Department.  And in truth, this is a good policy as expiration dates on spending programs require continued debate as to their efficacy before renewal.  The thing is, given the rapid increase in covid infections and rapid increase in state economic restrictions and shutdowns, pretty much every economist and analyst agrees that all of these programs should continue until such time as the spread of the coronavirus has slowed or herd immunity has been achieved.  Certainly, every FOMC member has been vocal in the need for more fiscal stimulus as they know that their current toolkit is inadequate.  (Just yesterday we heard from both Loretta Mester and Robert Kaplan with exactly that message.)  But to a (wo)man, they have all explained that the Fed will continue to do whatever it can to help, and that means continuing with the current programs.

Into this mix comes the news that Secretary Mnuchin sent a letter to the Fed that they must return the funds made available to backstop some of the Fed’s lending programs, as they were no longer needed.  The Fed immediately responded by saying “the full suite” of programs should be maintained into 2021.

Let’s consider, for a moment, some of the programs and what they were designed to do.  For instance, the Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility do seem superfluous at this stage.  After all, more than $1.9 trillion of new corporate debt has been issued so far in 2020 and the Fed has purchased a total of $45.8 billion all year, just 2.4%, mostly through ETF’s.  It seems apparent that companies are not having any difficulty accessing financing, at very low rates, in the markets directly.  In the Municipal space, the Fed has only bought $16.5 billion while more than $250 billion has been successfully issued year to date.  Mnuchin’s point is, return the unused funds and deploy them elsewhere, perhaps as part of the widely demanded fiscal policy support.  The other side of that coin, though, is the idea that the reason the market’s have been able to support all that issuance is because the Fed backstop is in place, and if it is removed, then markets will react negatively.

In fairness, both sides have a point here, and perhaps the most surprising outcome is the public nature of the spat.  Historically, these two agencies work closely together, especially during difficult times.  But as I said before, 2020 is unlike any time we have seen in our lifetimes.  There is one other potential driver of this dissension, and that could be that politically, the Administration is trying to get Congress to act on a new stimulus plan quickly by threatening to remove some of the previous stimulus.  However, whatever the rationale, it clearly has the market on edge, interrupting the good times, although not yet resulting in a significant risk-off outcome.

If this disagreement is not resolved before the next FOMC meeting in three weeks’ time, the market will be looking for the Fed to expand its stimulus measures in some manner, either by increasing QE purchases or by purchasing longer tenor bonds, thus weighing on the back end of the curve as well as the front.  And for our purposes, meaning in the FX context, that would be significant, as either of those actions are likely to see a weaker dollar in response.  Remember, while no other central bank is keen to see the dollar weaken vs. their own currency, as long as CNY continues to outperform all, further dollar weakness vs. the euro, yen, pound, et al, is very much in the cards.

So, with that as our backdrop, markets today don’t really know what to do and are, at this point, mixed to slightly higher.  Asia, overnight, saw further weakness in the Nikkei (-0.4%), but both the Hang Seng and Shanghai exchanges gained a similar amount.  European bourses have slowly edged higher to the point where the CAC, DAX and FTSE 100 are all 0.5% higher on the day, although US futures are either side of unchanged as traders try to figure out the ultimate impact of the spat.  Bonds are mixed with Treasury yields higher by 1 basis point, but European yields generally lower by the same amount this morning.  Of course, a 1 basis point move is hardly indicative of a directional preference.

Both gold and oil are essentially flat on the day, and the dollar can best be described as mixed, although it is starting to soften a bit.  In the G10 space, NZD (+0.45%) leads the way with the rest of the commodity bloc (AUD, NOK, CAD) all higher by smaller amounts.  Meanwhile, the havens are under a bit of pressure, but only a bit, with JPY and CHF both softer by just (-0.1%).  EMG currencies have seen a similar performance as most Asian currencies strengthened overnight, but by small amounts, in the 0.2%-0.3% range.  Meanwhile, the CE4 were following the euro, which had been lower most of the evening but is now back toward flat, as are the CE4.  And LATAM currencies, as they open, are edging slightly higher.  But overall, while there is a softening tone to the dollar, it is modest at best.

On the data front, there is none to be released in the US today, although early this morning we learned that UK Retail Sales were a bit firmer than expected while Italian Industrial activity (Sales and Orders) was much weaker than last month.  On the speaker front, four more Fed speakers are on tap, but they all simply repeat the same mantra, more fiscal spending, although now they will clearly include, don’t end the current programs.

For the day, given it is the Friday leading into Thanksgiving week, I expect modest activity and limited movement.  However, if this spat continues and the Treasury is still planning on ending programs in December, I expect the Fed will step in to do more come December, and that will be a distinct dollar negative.

One last thing, I will be on vacation all of next week, so there will be no poetry until November 30.

Good luck, good weekend, stay safe and have a wonderful holiday
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