Author Archives: fxpoet

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
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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
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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

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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
Adf

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
Adf

Appalled

Posted on by

As Covid continues to spread
In Europe, it’s come to a head
Relief has been stalled
‘Cause most are appalled
That Hungary, old norms, has shred

It seems like only yesterday when the market was talking about the shape of future monetary support by the ECB and how that would fit with the EU’s fiscal package and help the continent recover from the Covid induced recession.  While current lockdowns throughout Europe are painful, with a vaccine on the horizon and the historic agreement on joint liability, the future of Europe seemed bright and adding to risk profiles was seen as appropriate.  And perhaps that is because it was only yesterday when that was the market’s theme.  At least yesterday morning’s theme.  But as Dinah Washington first sang to us in 1959, “What a difference a day makes!”  This morning, the optimists have lost the spring in their step as risk appetite has waned.  It seems that the news that Hungary and Poland are digging in their heels with respect to the EU rescue package has suddenly been recognized as a problem.

For those of you who thought that the only place where there was political discord was in the US, that has never been the case.  The EU has also seen the type of political division seen here; it just takes a different form in Europe.  Rather than red and blue states, Europe has red and blue countries, with Hungary and Poland being the reddest of them all, at least in US terminology.  The governments of both these nations have objected to much of the EU agenda since 2015 and the flood of refugees entering the continent from the Middle East and Northern Africa in the wake of several civil wars ongoing then (and still).  It seems the folks in Brussels wanted to dictate how many refugees each nation in the EU needed to absorb, and given both these country’s geographic location, amongst the first countries any refugee from the Levant would enter, they were instructed to take a disproportionate number.  At least, disproportionate in their eyes.  And that didn’t sit well with the citizenship in both countries, who then elected nationalist/populist leadership.  Since that time, both nations have sought to roll back numerous EU edicts regarding various issues like the judiciary and immigration.  This has caused serious griping in Brussels as well as in Budapest and Warsaw.

Fast forward to the current situation, where the EU is seeking to pass their €1.8 trillion Covid relief package (their version of our CARES package from March).  The problem is that EU law states support must be unanimous, and these two nations are fighting back against a provision in the text about recipients of aid following the “rule of law”.  That innocuous sounding statement is code for the EU leadership’s insistence that laws restricting immigration, or an independent judiciary are verboten.  The upshot is the relief package is written so that any nation that does not follow the “rule of law” will not be entitled to any funding.  Naturally, Hungary and Poland want the money, but they, as yet, have been unwilling to give ground on the issue, hence the stalemate.  Now, like most political stand-offs, this one had seemed likely to be resolved before it got too heated.  However, as of this morning, it seems market participants are beginning to question if a package will get approved.  And there is another issue in the background as well, Brexit.  By that, I mean with the UK just about gone from the EU, if two other nations were to opt out of the bloc, what would that do to the EU as a whole, as well as to confidence in the political leadership across the continent.  This is not to say that either Hungary or Poland is on the way out.  It is merely a recognition that the post Brexit EU will not be all sunshine and rainbows.

And apparently, that has been enough for investors to decide that profit-taking is a prudent move.  Which leads us to this morning’s risk-off session.  Despite more forceful comments from Madame Lagarde, and news that there is now a third vaccine that has proven effective, it seems that fear is creeping back into the picture.  We saw it late in the US session yesterday, with all three major indices closing about 1% lower and on session lows.  It was followed in Asia by the Nikkei (-0.35%) falling for a third consecutive session and the Hang Seng (-0.7%).  Shanghai (+0.5%), however, broke the mold as the Chinese government’s ability to issue euro-denominated debt at negative yields in the 5-year added to recent enthusiasm that China’s growth story remains unimpinged by Covid.

Turning to Europe, which is, after all, the epicenter of today’s angst, it is no surprise that all markets are in the red, with the DAX, CAC and FTSE 100 all lower by roughly 1.0%.  As to the US futures complex, larger losses earlier have been pared, but we are still looking at declines on the order of 0.25%-0.4%.

Bond yields are generally lower, as expected, with Treasuries down by 1.5bps, a similar move to both Bunds and French OATS.  In fact, the only European bond market in the red is Greece, where yields have backed up by 4bps.  In the meantime, oil (WTI -1.0%) and gold (-0.5%) are leading the entire commodity bloc lower.

In the FX markets, the dollar reigns supreme this morning, higher against all its G10 counterparts.  That said, the magnitude of movement has been modest with AUD (-0.4%), NZD (-0.4%) and SEK (-0.3%) the leading decliners.  Clearly, pressure on commodities is undermining the former two, while SEK tends to move in the same direction as the bloc, just in larger increments.  (As an aside, USDSEK option volatility has consistently traded at a 2.5% premium to EURUSD volatility for the past eight months.)

In the emerging markets, a space that has received a lot of positive press of late, only one currency has rallied vs. the dollar this morning, TRY (+1.4%) after the Turkish central bank raised short-term interest rates by 4.75% to help support the currency as well as fight inflation, which is running at nearly 12% there.  But the rest of the bloc is weaker, led by KRW (-1.0%) and IDR (-0.6%), with even CNY (-0.4%) suffering on the day.  The won sold off after FinMin Hong Nam-ki said that they could step in to stabilize (read sell won) the market at “any time”.  A clear threat to speculators, and one well-heeded, at least today.  The rupiah fell after the central bank there cut rates by 25 basis points in a surprise move, as the country continues to try to cope with rising infections and thus is willing to add further support.  As to CNY, given the spectacular run it has had lately, a modest pullback needs no explanation.

Data has been sparse overnight, with only Australian job growth a bit higher than expected after the Victoria lockdown was eased.  This morning brings a few key readings here starting with Initial Claims (exp 700K) and Continuing Claims (6.4M).  Also, at 8:30 we see Philly Fed (23.0) then Leading Indicators (+0.7%) and Existing Home Sales (6.47M) at 10:00am.  While the Initial Claims numbers remain paramount, recall that Empire Manufacturing on Monday was much weaker than expected, so we may see clues as to just how Q4 is turning out.  For what it’s worth, the Atlanta Fed’s GDPNow forecast is currently sitting at 5.6% for Q4, so still a pretty positive outlook.

Two more Fed speakers today are likely to continue to tell us that we need more fiscal stimulus but that they have plenty of ammo left.  And that’s really it.  The early fear seems to be abating somewhat as I finish just past 7am.  As such, it wouldn’t be that surprising to see a late day equity rally and the dollar cede its gains.  But absent some other piece of news, large movement seems unlikely.

Good luck and stay safe
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Growth’s Embers

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Said Madame Lagarde, come December
There’s something you all must remember
It’s not ‘bout the size
But how we comprise
Our policy to fan growth’s embers

For a consensus driven institution, the ECB is, apparently, finding it pretty hard to arrive at a consensus on what the promised policy expansion should contain.  You may recall that at their meeting in late October, the ECB appeared pretty explicit that they would be increasing monetary support at the upcoming meeting.  The narrative quickly developed that another €500 billion of PEPP purchases would be appropriate, although there were some ideas that the ECB could expand the APP, their original QE program.  With this in mind, it is crucial to remember that markets typically take the most simplistic approach toward any analysis, and so respond to numbers.  Subtleties are either misunderstood or ignored by the trading community as they require far too much time to appreciate before responding.  After all, it is much easier for algorithms (and traders) to be programmed to buy on a large number and sell on a small number than to dig into the meaning of the words offered up by the ECB.

Keeping this in mind, it is quite interesting that recently, we have started to hear from numerous ECB members that the size of the program adjustments are not as important as their nature.  (Now where have we heard that before?)   Just this morning, Madame Lagarde herself was quoted as follows, “What is really important is that we make sure that the financing conditions are stable, are conducive to economic recovery as it comes.”  She also emphasized that “[market participants must] not only know that the level of financing is going to be there, but that it will be available for a period for time that will last long enough.”  Reading between the lines, this sounds like the mooted €500 billion expansion that has been the market baseline premise since the October meeting, is not going to be realized.  Looking back over the past week, comments from numerous other ECB members, including Chief Economist Philip Lane, as well as Finland’s Olli Rehn, Belgium’s Yves Mersch and Spain’s Pablo Hernandez de Cos have also highlighted that size doesn’t matter, but instead it is the nature and duration of the program that is important.

What are we to make of this change in emphasis?  Initially there are two conclusions that can be drawn.  First, some of the more hawkish members of the ECB; Germany, Austria and the Netherlands most likely, have made it clear that they don’t want to see an unlimited amount of asset purchases as those three nations still believe that central bank financing of government spending is a bad idea.  Thus, the fact that central bankers from more dovish countries are trying to temper expectations is playing to the hawks.

But there is another, more intriguing possibility, and that is that the ECB, who has been terrified of an overly strong euro, has realized that the Chinese renminbi’s consistent strength vs. the dollar (+8.6% since late May) has now been sufficient to offset the euro’s appreciation since that same time.  Essentially, the euro saw a very sharp rise from May through August but has been biding its time since then while the renminbi has been steadily climbing almost every day.  The point is, on a trade-weighted basis, the euro is no longer nearly as strong as it was in August, and so if EURUSD rises a bit further, the ECB may not be too troubled.  This is not to imply that they will be happy to see the euro go screaming up through 1.25 anytime soon, but if it trades to 1.20 or 1.21, it will probably not be ringing alarm bells.

Putting it all together leads me to believe that the ECB no longer is feeling quite as stressed about the euro’s strength vs. the dollar this summer, and so does not feel compelled to increase QE by that much in order to prevent a further rise.  The $2.2 trillion question (that is roughly the amount of EURUSD transacted each day according to the BIS) is, if the ECB disappoints the narrative, despite their claims, and the euro rallies sharply, what will they do then?  Poor Christine already has enough trouble speaking to the market effectively.  If this message gets muddled, it will really create problems, as well as the chance for an emergency program early next year.

With that in mind, let’s look at today’s activities.  After a modest sell-off in the US yesterday, Asia had another mixed session with the Nikkei (-1.1%) falling for a second day after its long run of gains, while the Hang Seng (+0.5%) and Shanghai (+0.2%) both finished with small pluses.  The European markets are all green, but the movement has been de minimis, with the DAX and CAC (+0.2% each) essentially leading the way while the FTSE 100 is simply flat.  Certainly, there is no massive risk-on attitude apparent.  Finally, US futures are all modestly higher at this hour, but 0.2% is a good description here as well.

Bond markets are also fairly muted this morning with Treasury yields essentially unchanged, having retraced half of the vaccine related movement of the past week.  European markets are similarly little changed, except for Greek bonds, where yields have fallen nearly 5 basis points.  But the rest of the curve is within one basis point of yesterday’s levels.  Again, it is hard to discern much risk attitude here.

Oil prices have pushed higher by 1% this morning but have not yet reclaimed the heights seen in the wake of the vaccine announcement.  Gold, meanwhile, has been wandering aimlessly of late, although there is a growing hubbub about Bitcoin, which has traded to $18k this morning.

Finally, to the dollar, which is clearly under pressure virtually across the board this morning.  In the G10 space, NOK (+0.55%) is the leader, following oil prices higher as ongoing enthusiasm over a vaccine driven recovery continues to be felt.  But we are seeing gains in SEK (+0.4%), once again showing its deserved status as a high beta currency, and JPY (+0.2%), which has recouped more than half of its very sharp decline seen last Monday in the wake of the first vaccine announcement.  As this doesn’t appear to be a risk-off scenario, I would attribute the yen’s gains more to the dollar’s broad weakness than anything else.  However, do not be surprised if we test, and this time break, 103.00 before too long.

Emerging market currencies are also broadly stronger, but the movement has been fairly contained.  Leading the pack is CLP (+0.7%) as copper prices are benefitting from the vaccine enthusiasm, as well as RUB (+0.6%) on the back of oil’s strength.  After that, the gains are far less impressive, but they are evident across all three major blocs.  On the downside, today’s notable loser is THB (-0.5%) as the central bank there commented on the baht’s recent strength (+3.0% in the past two weeks) and is set to unveil a package to rein in that strength.

On the data front, yesterday saw weaker than expected Retail Sales numbers here in the States, although that didn’t have much impact on things.  Overnight we have seen CPI data from Europe, which was largely in line with expectations and remains right near 0.0%.  This morning brings Housing Starts (exp 1460K) and Building Permits (1567K), which also seem unlikely to have much impact.  Four more Fed speakers are on the docket, but unlike the ECB, there doesn’t seem to be much disagreement on what needs to be done in the US (more fiscal stimulus, please!)

And that’s it really.  The dollar’s weakness feels a bit overdone in the very short term, but with this new attitude by the ECB, if I am correct, an eventual grind toward 1.21 seems possible.  However, do not mistake that for a dollar collapse in any way, shape or form.

Good luck and stay safe
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