Playing Hardball

Last night China shocked one and all
With two policy shifts not too small
They’ve now become loath
To target their growth
And in Hong Kong they’re playing hardball

It seems President Xi Jinping was pining for the spotlight, at least based on last night’s news from the Middle Kingdom. On the economic front, China abandoned their GDP target for 2020, the first time this has been the case since they began targeting growth in 1994. It ought not be that surprising since trying to accurately assess the country’s growth prospects during the Covid-19 crisis is nigh on impossible. Uncertainty over the damage already done, as well as the future infection situation (remember, they have seen a renewed rise in cases lately) has rendered economists completely unable to model the situation. And recall, the Chinese track record has been remarkable when it comes to hitting their forecast, at least the published numbers have a nearly perfect record of meeting or beating their targets. The reality on the ground has been called into question many times in the past on this particular subject.

The global economic community, of course, will continue to forecast Chinese GDP and current estimates for 2020 GDP growth now hover in the 2.0% range, a far cry from the 6.1% last year and the more than 10% figures seen early in the century. Instead, the Chinese government has turned its focus to unemployment with the latest estimates showing more than 130 million people out of a job. In their own inimitable way, they manage not to count the rural unemployed, meaning the official count is just 26.1M, but that doesn’t mean those folks have jobs. At this time, President Xi is finding himself under much greater pressure than he imagined. 130 million unemployed is exactly the type of thing that leads to revolutions and Xi is well aware of the risks.

In fact, it is this issue that arguably led to the other piece of news from China last night, the newly mooted mainland legislation that will require Hong Kong to enact laws curbing acts of treason, secession, sedition and subversion. In other words, a new law that will bring Hong Kong under more direct sway from Beijing and remove many of the freedoms that have set the island territory apart from the rest of the country. While Covid-19 has prevented the mass protests seen last year from continuing in Hong Kong, the sentiments behind those protests did not disappear. But Xi needs to distract his population from the onslaught of bad news regarding both the virus and the economy, and nothing succeeds in doing that better than igniting a nationalistic view on some subject.

While in the short term, this may work well for President Xi, if he destroys Hong Kong’s raison d’etre as a financial hub, the downside is likely to be much greater over time. Hong Kong remains the financial gateway to China’s economy largely because the legal system their remains far more British than Chinese. It is not clear how much investment will be looking for a home in a Hong Kong that no longer protects private property and can seize both people and assets on a whim.

It should be no surprise that financial markets in Asia, particularly in Hong Kong, suffered last night upon learning of China’s new direction. The Hang Seng fell 5.6%, its largest decline since July 2015. Even Shanghai fell, down 1.9%, which given China’s announcement of further stimulus measures despite the lack of a GDP target, were seen as positive. Meanwhile, in Tokyo, the Nikkei slipped a more modest 0.9% despite pledges by Kuroda-san that the BOJ would implement even more easing measures, this time taking a page from the Fed’s book and supporting small businesses by guaranteeing bank loans made in a new ¥75 trillion (~$700 billion) program. It is possible that markets are slowly becoming inured to even further policy stimulus measures, something that would be extremely difficult for the central banking community to handle going forward.

The story in Europe is a little less dire, although most equity markets there are lower (DAX -0.4%, CAC -0.2%, FTSE 100 -1.0%). Overall, risk is clearly not in favor in most places around the world today which brings us to the FX markets and the dollar. Here, things are behaving exactly as one would expect when investors are fleeing from risky assets. The dollar is stronger vs. every currency except one, the yen.

Looking at the G10 bloc, NOK is the leading decliner, falling 1.1% as the price of oil has reversed some of its recent gains and is down 6% this morning. But other than the yen’s 0.1% gain, the rest of the bloc is feeling it as well, with the pound and euro both lower by 0.4% while the commodity focused currencies, CAD and AUD, are softer by 0.5%. The data releases overnight spotlight the UK, where Retail Sales declined a remarkable 18.1% in April. While this was a bit worse than expectations, I would attribute the pound’s weakness more to the general story than this particular data point.

In the EMG bloc, every market that was open saw their currency decline and there should be no surprise that the leading decliner was RUB, down 1.1% on the oil story. But we have also seen weakness across the board with the CE4 under pressure (CZK -1.0%, HUF -0.75%, PLN -0.5%, RON -0.5%) as well as weakness in ZAR (-0.7%) and MXN (-0.6%). All of these currencies had been performing reasonably well over the past several sessions when the news was more benign, but it should be no surprise that they are lower today. Perhaps the biggest surprise was that HKD was lower by just basis points, despite the fact that it has significant space to decline, even within its tight trading band.

As we head into the holiday weekend here in the US, there is no data scheduled to be released this morning. Yesterday saw Initial Claims decline to 2.44M, which takes the total since late March to over 38 million! Surveys show that 80% of those currently unemployed expect it to be temporary, but that still leaves more than 7.7M permanent job losses. Historically, it takes several years’ worth of economic growth to create that many jobs, so the blow to the economy is likely to be quite long-lasting. We also saw Existing Home Sales plummet to 4.33M from March’s 5.27M, another historic decline taking us back to levels last seen in 2012 and the recovery from the GFC.

Yesterday we also heard from Fed speakers Clarida and Williams, with both saying that things are clearly awful now, but that the Fed stood ready to do whatever is necessary to support the economy. This has been the consistent message and there is no reason to expect it to change anytime soon.

Adding it all up shows that investors seem to be looking at the holiday weekend as an excuse to reduce risk and try to reevaluate the situation as the unofficial beginning to summer approaches. Trading activity is likely to slow down around lunch time so if you need to do something, early in the morning is where you will find the most liquidity.

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

 

Feeling the Heat

As tensions continue to flare
Twixt China and Uncle Sam’s heir
The positive feelings
In equity dealings
Could easily turn to a bear

Meanwhile down on Threadneedle Street
The Old Lady’s fairly downbeat
Thus negative rates
Are now on their plates
With bank stocks there feeling the heat

A yoyo may be the best metaphor for market price action thus far in May as we have seen a nearly equal number of up and down days with the pattern nearly perfect of gains followed by losses and vice versa. Today is no different as equity markets are on their back foot, after yesterday’s gains, in response to increasing tensions between Presidents Trump and Xi. Realistically, this is all political, and largely for each President’s domestic audience, but it has taken the form of a blame game, with each nation blaming the other for the instance and severity of the Covid-19 outbreak. What is a bit different this time is that President Trump, who had been quick to condemn China in the past, had also been scrupulous in maintaining that he and President Xi had an excellent working relationship. However, last night’s Twitter tirade included direct attacks on Mr Xi, a new tactic and one over which markets have now shown concern.

Thus, equity markets around the world are lower this morning with modest losses seen in Asia (Nikkei -0.2%, Hang Seng and Shanghai -0.5%) and slightly larger losses throughout the Continent (DAX -1.6%, CAC -1.1%, FTSE 100 -1.0%). US futures are pointing in the same direction with all three indices currently down about 0.7%. Has anything really changed? Arguably not. After all, both broad economic data and corporate earnings numbers remain awful, yet equity market prices, despite today’s dour mood, remain within sight of all-time highs. And of course, the bond market continues to point to a very different future as 10-year Treasury yields (-1bp today) continue to trade near historically low levels. To reiterate, the conundrum between a bond market that is implying extremely slow economic activity for the next decade, with no concomitant inflation seems an odd companion to an equity market where the median P/E ratio has once again moved above 20, well above its long-term average. This dichotomy continues to be a key topic of conversation in the market, and one which history has shown cannot last forever. The trillion-dollar question is, which market adjusts most?

With the increasing dissent between the US and China as a background, we also learned of the specter of the next country to move toward a negative interest rate stance, the UK. When Mark Carney was governor there, he categorically ruled out negative interest rates as an effective tool to help support the economy. He got to closely observe the experiment throughout Europe and concluded the detriments to the banking community outweighed any potential economic positives. (This is something that is gaining more credence within the Eurozone as well although the ECB continues to insist NIRP has been good for the Eurozone.) However, Carney is no longer governor, Andrew Bailey now holds the chair. And he has just informed Parliament, “I have changed my position a bit,” on the subject, and is now willing to consider negative rates after all. This is in concert with other members of the MPC, which implies that NIRP is likely soon to be reality in the UK. It should be no surprise that UK banking stocks are suffering after these comments as banks are the second victims of the process. (Individual savers are the first victims as their savings no longer offer any income, and in extreme cases decline.)

The other natural victim of NIRP is the currency. As discussed earlier this week, there is a pretty solid correlation between negative real rates and a currency’s relative value. Now granted, if real rates are negative everywhere, then we are simply back to the relative amount of negativity that exists, but regardless, this potential policy shift is clearly new, and one would expect the pound to suffer accordingly. Surprisingly, it is little changed this morning, down less than 0.1% amid a modest trading range overnight. However, it certainly raises the question of the future path of the pound.

When the Eurozone first mooted negative interest rates, in 2014, the dollar was already in the midst of a strong rally based on the view that the Fed was getting set to start to raise interest rates at that time. Thus, separating the impact of NIRP from that of expected higher US rates on the EUR/USD exchange rate is no easy task. However, there is no question that the euro’s value has suffered from NIRP as there is limited incentive for fixed income investment by foreigners. It should therefore be expected that the pound will be weaker going forward as foreign investment interest will diminish in the UK. Whether negative rates will help encourage foreign direct investment is another story entirely, and one which we will not understand fully for many years to come. With all this in mind, though, the damage to the pound is not likely to be too great. After all, given the fact that negative real rates are widespread, and already the situation in the UK, a base-rate cut from 0.1% to -0.1% doesn’t seem like that big a deal overall. We shall see how the market behaves.

As to the session today, FX markets have been as quiet as we have seen in several months. In the G10 space, Aussie and Kiwi are the underperformers, but both are lower by a mere 0.35%, quite a small move relative to recent activity, and simply a modest unwind of yesterday’s much more powerful rally in both. But away from those two, the rest of the bloc is less than 0.2% different from the close with both gainers (EUR, DKK) and losers (GBP, JPY) equidistant from those levels.

On the EMG side, there is a bit more constructive performance with oil’s continued rally (+2%) helping RUB (+0.4%) while the CE4 are also modestly firmer simply following the euro higher. APAC currencies seem a bit worse for wear after the Twitter spat between Trump and China, but the losses are miniscule.

Data this morning showed the preliminary PMI data from Europe is still dire, but not quite as bad as last month’s showing. In the US today we see Initial Claims (exp 2.4M), Continuing Claims (24.25M) and Existing Home Sales (4.22M). But as I have been writing all month, at this point data is assumed to be dreadful and only policy decisions seem to have an impact on the market. Yesterday we saw the Minutes of the Fed’s April 29 meeting, where there was a great deal of discussion about the economy’s problems and how they can continue to support it. Ideas floated were firmer forward guidance, attaching rate moves to numeric economic targets, and yield curve control, where the Fed determines to keep the interest rate on a particular tenor of Treasury bonds at a specific level. Both Japan and Australia are currently executing this, and the Fed has done so in its history, keeping long-term yields at 2.50% during WWII. My money is on the 10-year being pegged at 0.25% for as long as necessary. But that is a discussion for another day. For today, the dollar seems more likely to rebound a bit rather than decline, but that, too, is one man’s view.

Good luck and stay safe
Adf

Patience is Needed

Mnuchin said patience is needed
While Powell said growth must be seeded
As both testified
And each justified
Their views, which both said must be heeded

Two months into the response to Covid-19, differences in policy views between the Fed and the Administration are starting to appear. In Senate testimony yesterday, Treasury Secretary Mnuchin indicated the belief that sufficient fiscal support has been authorized and its implementation is all that is needed, alongside the relaxation of lockdown rules around the country, for the economy to rebound sharply. The Administration’s base case remains a V-shaped recovery, with Q3 and Q4 showing substantial growth after what everyone agrees will be a devastatingly awful Q2 result.

Meanwhile, the Fed, via Chairman Powell, took the view that we remain in a critical period and that further stimulus may well be necessary to prevent permanent long-term damage to the economy. He continued to focus on the idea that until people feel safe with personal interactions, any rebound in the economy will be substandard. Of course, to date, of the $454 billion that Congress authorized for the Treasury to use as seed money underlying Fed lending schemes, less than $75 billion has been utilized. It seems that if Chairman Powell was truly that concerned, he would be ramping up the use of those funds more quickly. While part of the problem is the normal bureaucratic delays that come with implementing any new program, it is also true that the Fed is not well suited to support small businesses and individuals. Programs of that nature tend to require more fiscal than monetary support, at least as currently defined and implemented in today’s world. Remember, the Fed is not able to take losses according to its charter, which is why all the corporate bond buying and main street lending programs are already on shaky legal grounds.

The interesting thing about the dueling testimonies was just how little of an impact they had on market behavior yesterday. In fact, the late day equity market sell-off was almost certainly driven by the concern that yesterday’s media darling, the biotech firm Moderna, Inc., may not actually have a viable vaccine ready this year. Remember, it was the prospect that a vaccine was imminent and so lockdowns could be lifted that was critical in investor minds yesterday. If the vaccine story is no longer on track, it is much harder to justify paying over the top for equities. At any rate, that late day move set the tone for a much more subdued session in both Asia and Europe overnight.

Looking at markets, last night saw a mixed equity picture in Asia (Nikkei +0.8%, Shanghai -0.5%) and a very modest positive light in Europe (DAX +0.6%, CAC 0.0%, FTSE 100 +0.2%). More positively, US futures are pointing higher as I type, with all three indices looking at a 1% gain on the open if things hold. Bond markets are similarly uninspired this morning, with Treasury yields higher by less than 1bp while German bund yields are down by the same. In fact, looking across the European market, half are slightly higher, and half are slightly lower. Again, nothing of interest here.

Commodity markets show that oil continues to rebound sharply, up another 1% this morning and now above $32/bbl for WTI. Remember, it was less than a month ago that the May futures contract settled at -$37/bbl as storage was nowhere to be found. Certainly, any look at commodity markets would indicate that economic growth was making a return. But it sure doesn’t feel like that yet.

Finally, FX markets continue to see the dollar cede some recent gains as fears over USD funding by global counterparts continue to ebb on the back of Fed lending programs. In fact, this is exactly where the Fed can do the most good, helping to ensure that central banks around the world have the ability to access USD liquidity for their local markets.

A tour of the G10 shows that today’s biggest winner is NZD (+0.65%) followed by AUD and CHF, both higher by about 0.4%. The Kiwi dollar was supported by central bank comments about NIRP remaining a distant prospect, at best, with many hurdles to be jumped before it would make sense. Aussie seems to have benefitted from Japanese investment flows into their government bond markets, which are now relatively attractive vs. US Treasuries. Finally, after a short-lived decline yesterday afternoon, apparently driven by some options activity, the Swiss franc is simply returning to its previous levels. The other seven currencies are within a few bps of yesterday’s closing levels with only the background story of the Franco-German détente on EU economic support even getting press in the group.

In the EMG space, ZAR is today’s runaway leader, currently higher by 1.75% as a combination of continued strength in the price of gold and a major technical break have helped the rand. It must be remembered that the rand, even after today’s sharp rally, has been the third worst performing currency over the past three months having fallen more than 16%. This morning, the technicians are all agog as the spot rate traded back through its 50-day moving average, a strong technical signal to buy the currency. While economic prospects continue to be dim overall there and there is no evidence that the rate of infection is slowing, technical algorithms will continue to support the currency for the time being.

Otherwise, it is RUB (+1.1%) and MXN (+0.9%) that are trailing only the rand higher this morning, with both clearly benefitting from the ongoing rebound in oil and, more importantly, in the broad sentiment in the future for oil. Last month it appeared that oil was never going to matter again. That is not so much the case anymore. On the downside today, KRW (-0.4%) is the leading, and only, decliner in the space as the BOK creates a 10 trillion won (~$8 billion) SPV to inaugurate a QE program.

On the data front, yesterday’s housing data was pretty much as expected, with both Starts and Permits falling sharply. Today the only news of note comes at 2:00 when the FOMC Minutes are released. But given how much we have heard from Powell and the rest of the committee, will this really have that big an impact? I would be surprised.

The dollar continues under pressure for the time being and will stay that way as long as USD funding pressures overseas remain in check. While there are no obvious drivers in the near term, I continue to look at the pending change of heart in Europe regarding fiscal support and see an opportunity for a more structural case for dollar weakness over time.

Good luck and stay safe
Adf

 

Won’t Be Repaid

Said Merkel and French Prez Macron
This calls for a grant, not a loan
When speaking of aid
That won’t be repaid
By nations where Covid’s full-blown

The euro is firmer this morning, up a further 0.35% after yesterday’s 0.9% rally, as the market responds to the news that German Chancellor Angela Merkel and French President Emanuel Macron have agreed on a plan for EU-wide assistance to all members. This is the first time that there has been German support for a plan that includes grants to nations, not loans to be repaid, and that these grants are to be distributed to the membership, not based on the capital key, but rather based on where the money is needed most. The funding will come from debt issued by the European Commission and paid out of that entity’s budget. In sum, while this is not actually Eurozone bond issuance, it is a clear step in that direction.

Of course, nothing in the EU is easy, and this is no different. Immediately upon the announcement, Austrian Chancellor Kurz explained that there is no path forward for grants, and that Austria is happy to lend money to those countries in need. Too, the Dutch, Danes and Finns are none too happy about this outcome, but with Germany on board, it will be very difficult to fight. Even so, French FinMin LeMaire made it clear that it will take time to complete the procedure (and he is 100% behind the idea) with the first funds not likely available before early 2021.

However, the importance of this step cannot be underestimated. The tension within the Eurozone has always revolved around how much Germany and its frugal northern neighbors would be willing to pay to the more profligate south in order to maintain the euro as a functioning currency. When looking at which nations benefit most from the single currency, Germany tops the list as the euro is certainly weaker than the Deutschemark would have been in its stead, and thus Germany’s export industries, and by extension its economic performance, have benefitted significantly. It appears that Chancellor Merkel and her administration have now done the math and decided that spending some money to maintain that export advantage is a smart investment. While in the past I have been suspect of the euro’s longevity, this appears to be the first step toward a joint fiscal policy resulting in a far stronger basis for the euro. While there will no doubt be rough seas for this process ahead, if Germany and France are on board, they will ultimately drag everyone else along. This is arguably the most bullish long-term euro story since its creation two decades ago.

The other bullish news for markets yesterday was the announcement that a tiny biotech company in Massachusetts, Moderna Inc, with just 25 employees (although a $29 billion market cap) has seen extremely positive results from a Covid vaccine trial. Apparently, it not only does the job, but does so with limited side effects to boot. While it has yet to undergo larger phase 2 and phase 3 trials, it is certainly extremely bullish news.

The combination of these stories was extremely beneficial for risk assets yesterday, which explains the 3+% rallies in US equity indices, the sell-off in Treasuries (10-year yields rose 7bps) and the dollar’s overall weakness. That bullishness followed through overnight with Asian equity markets gaining nicely (Nikkei +1.5%, Hang Seng +1.9%, Shanghai +0.8%) and Europe starting in the green as well. However, those early gains in Europe have turned red now, with what appears to be profit taking after yesterday’s substantial gains. Clearly, European equity markets were the main beneficiaries of the Franco-German announcement on debt although Italian debt has not done too badly either, with yields on 10-year BTP’s falling 22bps since Friday’s close.

Put it all together and we have a very positive backdrop for the near-term. While data continues to be dreadful, with today’s poster child being the 856K jump in Jobless Claims in the UK last month, we already know the market is looking through the bad news toward the recovery. Of much more importance to market sentiment is the prospect for the reopening of economies around the world. This is where the vaccine story supports everything, because undoubtedly, if there was a widely available vaccine, the stories of devastation would diminish and confidence would quickly return. And while there will certainly be changes in the way people behave going forward, they are not likely to be as dramatic as once imagined. After all, if people are confident they are immune to Covid-19 after a vaccination, they will likely return to their previous lifestyle as quickly as they can.

So, with that overall bullish framework, we cannot be surprised that the other key haven assets, the dollar and the yen, are under pressure this morning. Yesterday’s dollar weakness has extended this morning virtually across the board. In the G10 space, it is the high beta currencies, NZD (+0.85%) and SEK (+0.6%) leading the way, but even the pound, after that terrible employment data, is higher by 0.5%. Only the yen (-0.2%) has ceded ground to the dollar this morning in what is clearly a straight risk-on session.

The EMG bloc is much the same, with every currency on the board firmer vs. the dollar this morning led by HUF (+1.4%) and CZK (+1.2%) as clear beneficiaries of the mooted EU financing program. Remember, this €500 billion can be spent anywhere desired by the Commission. But we are also seeing commodity currencies benefit as MXN (+1.0%) and ZAR (+0.8%) continue to perform well. In fact, over the past two sessions, one is hard-pressed to find a currency that has not appreciated vs. the dollar.

On the data front, beyond the awful UK data, we did see a much better than expected German ZEW Expectations outcome, printing at 51.0, although the current conditions index remains horrendous at -93.5. But the future is much brighter this morning, adding to the euro’s strength. At home, we see Housing Starts (exp 900K) and Building Permits (1000K), neither of which is likely to have a big impact, although stronger than expected data would surely add to the overall positive risk feeling this morning.

As well, Chairman Powell will be testifying to the Senate Banking Committee, but after Sunday night’s performance it is not clear what they will ask that he has not already answered. The Fed is all-in to do everything possible to support the economy. Arguably, the bigger question is will they be able to stop once things have evidently turned better. History shows that once government programs get going, they are virtually indestructible. In this instance, that implies ongoing Fed largesse far past when it is needed, thus much lower interest rates than are appropriate. Combine negative real rates in the US with a bullish structural story in the EU and we have the recipe for a much weaker dollar over time. This week could well be the beginning of a new trend.

Good luck and stay safe
Adf

 

Our Fears

Said Powell, it may take two years
Ere Covid’s impact finally clears
All central banks pleaded
More spending is needed
But really, it’s down to our fears

Fed Chairman Powell continues to be the face of the global response to the Covid-19 economic disruption. Last night, in a 60 Minutes interview broadcast nationwide, he said, “Assuming there’s not a second wave of the coronavirus, I think you’ll see the economy recover steadily through the second half of this year. For the economy to fully recover, people will have to be fully confident, and that may have to await the arrival of a vaccine.” He also explained that the Fed still has plenty of ammunition to continue supporting the economy, although he was clear that fiscal policy had a hugely important role to play and would welcome further efforts by the government on that score. Tomorrow, he will be testifying before the Senate Banking Committee where the Republican leadership has indicated they would prefer to wait and watch to see how the CARES act has fared before opting to double down.

In the meantime, it does appear that the spread of the virus has slowed more substantially. In addition, we continue to see more state governors reopening parts of their local economies on an ad hoc basis. And globally, restrictions are being lifted throughout Europe and parts of Asia as the infection curve truly seems to be in decline. It is this latter aspect that seems to be the current theory as to why there will be a V-shaped recovery which is supporting equity markets globally.

But when considering the prospects of a V, it is critical to remember this important feature of the math behind investing. A 10% decline requires an 11.1% recovery just to return to the previous level. And as the decline grows in size, the size of the recovery needs to be that much larger. For instance, the Atlanta Fed’s latest GDPNow forecast is calling for a, very precise, 42.81% contraction in Q2. If that were to come to pass, it means that a recovery to the previous level will require a 74.8% rebound! While the down leg of this economic contraction is clearly shaped like the left-hand side of a V, it seems highly unlikely that the speed of the recovery will approach the same pace. The final math lesson is that if Q3 were to rebound 42.81%, it would still leave the economy at just under 82% of its previous level. In other words, still in depression.

However, math is clearly not the strong suit of the investment community these days, as once again this morning, we continue to see a strong equity market performance. In fact, we have seen a strong performance in equities, bonds, gold, oil, and virtually everything else that can be bought. One explanation for this behavior would be that investors are concerned that the current QE Infinity programs across nations are going to debase currencies everywhere and so the best solution is to own assets with a chance for appreciation. While historically, the flaw in that theory would be the bond market, which should be selling off dramatically on this sentiment, it seems that the knowledge that central banks are going to continue to mop up all the excess issuance is seen as reason enough to continue to hold fixed income. With that in mind, I would have to characterize today’s session is a risk grab-a-thon.

The Brits and the EU have met
With no progress really made yet
The British are striving
To just keep trade thriving
The EU’s a different mindset

Meanwhile, remember Brexit? With all the focus on Covid, it is not surprising that this issue had moved to the back of the market’s collective consciousness. It has not, however, disappeared. If you recall, the terms of the UK exit were that a deal needs to be reached by the end of this year and that if there is to be another extension, that must be agreed by the end of June. Well, it seems that Boris is sticking to his guns that he will not countenance an extension and has instructed his negotiators to focus on a trade deal only. The EU, however, apparently still doesn’t accept that Brexit occurred and is seeking a deal that essentially requires the UK to remain beholden to the European Court of Justice as well as to adhere to all EU conditions on issues like the environment and diversity. The result is that the negotiations have become a game of chicken with a very real, and growing, probability that we will still have the feared hard Brexit come December. In a funny way, Covid could be a blessing for PM Johnson’s Brexit strategy, because given the negative impact already in play, at the margin, Brexit is not likely to make a significant difference. Arguably, it is the growing realization that a hard Brexit is back on the table that has undermined the pound’s performance lately. Despite a marginal 0.1% gain this morning, the pound is the worst performing G10 currency this month, down about 4.0%. At this time, I see no reason for the pound to reverse these losses barring a change in the tone of the negotiations.

As to this morning’s session, the overall bullish tone to most markets has left the dollar on the sidelines. It is firmer against some currencies, weaker vs. others with no clear patterns, and in truth, most movement has been limited. The biggest gainer today has been RUB, which has rallied 1.0% on the strength of oil’s 8% rally. In fact, oil is back over $30/bbl for the first time in two months. Not surprisingly we are seeing strength in MXN (+0.75%) and ZAR (+0.65%) as well on the same commodity rally story. On the flipside, APAC currencies were the main losers with MYR (-0.5%) and INR (-0.45%) the worst of the bunch as Covid infections are making a comeback in the area. In the G10 bloc, NOK (+0.75%) and AUD (+0.7%) are the leaders as they, too, benefit most from commodity strength.

On the data front, last night saw Japanese GDP print at -3.4% annualized, confirming the technical recession that has begun there. (Remember, Q4 was a disaster, -7.3%, because of the imposition of the national sales tax increase.) Otherwise, there were no hard data points from Europe at all. Looking ahead to this week, it is a muted schedule focused on housing.

Tuesday Housing Starts 923K
  Building Permits 1000K
Wednesday FOMC Minutes  
Thursday Initial Claims 2.425M
  Continuing Claims 23.5M
  Philly Fed -40.0
  Leading Indicators -5.7%
  Existing Home Sales 4.30M

Source: Bloomberg

In truth, with the market still reacting to Powell’s recent comments, and his testimony on Tuesday, as well as comments from another six Fed members, I would argue that this week is all about them. For now, the V-shaped rebound narrative continues to be the driver. If the Fed speakers start to sound a bit less optimistic, that could bode ill for the bulls, but likely bode well for the dollar. If not, I imagine the dollar will remain under a bit of pressure for now.

Good luck and stay safe
Adf

Terribly Slow

From Germany data did show
That Q1 was terribly slow
As well, for Q2
Recession’s in view
Their hope remains Q3 will grow

Meanwhile last night China revealed
‘twill be a long time ere its healed
Despite what they’ve said
‘bout moving ahead
Consumers, their checkbooks, won’t wield

While the market has not yet truly begun to respond to data releases, they are nonetheless important to help us understand the longer-term trajectory of each nation’s economy as well as the overall global situation. So, despite very modest movement in markets overnight, we did learn a great deal about how Q1 truly fared in Europe. Remember, Covid-19’s impact really only began in the second half of March, just a small slice of the Q1 calendar. And yet, Q1 GDP was released early this morning from Germany, with growth falling at a 2.2% quarterly rate, which annualized comes in somewhere near -9.0%. In addition, Q4 data was revised lower to -0.1%, so Germany’s technical recession has already begun. Remember, prior to the outbreak, Germany’s economy was already in the doldrums, having printed negative quarterly GDP data in three of the previous six quarters. Of course, those numbers were much less dramatic, but the point is the engine of Europe was sputtering before the recent calamity. Forecasts for Q2 are even worse, with a quarterly decline on the order of 6.5% penciled in there despite the fact that Germany seems to be leading the way in reopening their economy.

For the Eurozone as a whole, GDP in Q1 fell 3.8% in Q1 as Germany’s performance was actually far better than most. Remember, Italy, Spain and France all posted numbers on the order of -5.0%. The employment situation was equally grim, as despite massive efforts by governments to pay companies to keep employees on the payroll, employment fell 0.2%, the first decline in that reading since the Eurozone crisis in 2012-13. One other highlight (lowlight?) was Italian Industrial Activity, which saw both orders and sales fall more than 25% in March. Q2 is destined to be far worse than Q1, and the current hope is that there is no second wave of infections and that Q3 sees a substantial rebound. At least, that’s the current narrative.

The problem with the rebound narrative was made clear, though, by the Chinese last night when they released their monthly statistics. Retail Sales there have fallen 16.2% YTD, a worse outcome than forecast and strong evidence that despite the “reopening” of the Chinese economy, things are nowhere near back to normal. Fixed Asset Investment printed at -10.3% with Property Investment continuing to decline as well, -3.3%. Only IP showed any improvement, rising 3.9% in April, but the problem there is that inventories are starting to build rapidly as consumers are just not spending. Again, the point is that shutting things down took mere days or weeks to accomplish. Starting things back up will clearly take months and likely years to get back close to where things were before the outbreak.

However, as I mentioned at the top, market reactions to data points have been virtually nonexistent for the past two months. At this point, investors are well aware of the troubles, and so data confirming that knowledge is just not that interesting. Rather, the information that matters now is the policy response that is in store.

The one thing we have learned over the past decade is that the stigma of excessive debt has been removed. Japan is the poster child for this as JGB’s outstanding represent more than 240% of Japan’s GDP, and yet the yield on 10-year JGB’s this morning is -0.01%. Obviously, this is solely because the BOJ continues to buy up all the issuance these days, but in the end, the lesson for every other nation is that you can issue as much debt and spend as much money as you like with few, if any consequences. Central bank reaction functions have been to support the economy via market actions like QE whenever there is a hint of a downturn in either the economy or the stock market. Both the Fed and ECB have learned this lesson well, and look set to continue with extraordinary support for the foreseeable future.

But the consequence of this in the one market that is not directly supported (at least in the case of the G10), the FX market, is what we need to consider. And as I observe central bank activity and try to discern its economic impacts, I have become persuaded that the medium-term outlook for the dollar is actually much lower.

Consider that the Fed is clearly going to continue its QE programs across as many assets as they deem necessary. Not merely Treasuries and Agencies, but Corporates, Munis and Junk bonds as well. And as is almost always the case, these ‘emergency’ measures will evolve into ordinary policy, meaning they will be doing this forever. The implication of this policy is that yields on overall USD debt are going to decline from a combination of continued reductions in Treasury yields and compression of credit spreads. After all, don’t fight the Fed remain a key investment philosophy. Thus, nominal yields are almost certain to continue declining.

But what about real yields? Well, that is where we get to the crux of the story and why my dollar view has evolved. CPI was just released on Tuesday and fell to 0.3% Y/Y. Thus, strictly speaking, 10-year Treasuries show a +0.31% real yield this morning (nominal of 0.61% – CPI of 0.3%). The thing is, while current inflation readings are quite low, and may well fall for another few months, the supply shock we have felt in the economy is very likely to raise prices considerably over time. Inflation is not really on the market’s radar right now, nor on that of the Fed. If anything, the concern is over deflation. But that is exactly why inflation remains a far more dangerous concern, because higher prices will not only crimp consumer spending, it will create a policy conundrum for the Fed of epic proportions. After all, Paul Volcker taught us all that raising interest rates was how to fight inflation, but that is directly at odds with QE. The point is, if (when) inflation does begin to rise, the Fed is certain to ignore the evidence for as long as possible. And that means we are going to see increasingly negative real rates in the US. History has shown that when US real rates turn negative; the dollar suffers accordingly. Hence the evolution in my medium- and long-term views of the dollar.

A quick look at this morning’s markets shows that yesterday’s late day equity rally in the US has largely been followed through Asia and Europe. Bonds are also in demand as yields throughout the government sector are mostly lower. And the dollar this morning is actually little changed overall, with a smattering of winners and losers across both G10 and EMG blocs, and no truly noteworthy stories.

We do see a decent amount of US data this morning led by Retail Sales (exp -12.0%, -8.5% ex autos). We also see Empire Manufacturing (-60.0), IP (-12.0%), Capacity Utilization (63.8%), JOLTs Job Openings (5.8M) and finally Michigan Sentiment (68.0). Only the Empire number is truly current, but to imply that a rise from -78.2 to -60.0 is progress really overstates the case. As I’ve pointed out, the data has not been a driver. Markets are exhausted after a long period of significant volatility. My expectation is for the dollar to do very little today, and actually until we see a new narrative evolve. So modest movement should be the watchword.

Good luck, good weekend and stay safe
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Enough Wherewithal

The Chairman explained to us all
The Fed has enough wherewithal
To counter the outbreak
But, too, Congress must take
More actions to halt the shortfall

The US equity markets led global stocks lower after selling off in the wake of comments from Chairman Powell yesterday morning. In what was a surprisingly realistic, and therefore, downbeat assessment, he explained that while the Fed still had plenty of monetary ammunition, further fiscal spending was necessary to prevent an even worse economic and humanitarian crisis. He also explained that any recovery would take time, and that the greatest risk was the erosion of skills that would occur as a huge swathe of the population is out of work. It cannot be a surprise that the equity markets sold off in the wake of those comments, with a weak session ending on its lows. It is also not surprising that Asian markets overnight followed US indices lower (Nikkei -1.75%, Hang Seng -1.45%, Shanghai -1.0%), nor that European markets are all in the red this morning (DAX -1.6%, CAC -1.7%, FTSE 100 -2.2%). What is a bit surprising is that US futures, at least as I type, are mixed, with the NASDAQ actually a touch higher, while both the Dow and S&P 500 see losses of just 0.2%. However, overall, risk is definitely on its back foot this morning.

But the Chairman raised excellent points regarding the timeline for any recovery and the potential negative impacts on economic activity going forward. The inherent conflict between the strategy of social distance and shelter in place vs. the required social interactions of so much economic activity is not a problem easily solved. At what point do government rules preventing businesses from operating have a greater negative impact than the marginal next case of Covid-19? What we have learned since January, when this all began in Wuhan, China, is that the greater the ability of a government to control the movement of its population, the more success that government has had preventing the spread of the disease. Alas, from that perspective, the inherent freedoms built into the US, and much of the Western World, are at extreme odds with those government controls/demands. As I have mentioned in the past, I do not envy policymakers their current role, as no matter the decision, it will be called into question by a large segment of the population.

What, though, are we now to discern about the future? Despite significant fiscal stimulus already enacted by many nations around the world, it is clearly insufficient to replace the breadth of lost activity. Central banks remain the most efficient way to add stimulus, alas they have demonstrated a great deal of difficulty applying it to those most in need. And so, despite marginally positive news regarding the slowing growth rate of infections, the global economy is not merely distraught, but seems unlikely to rebound in a sharp fashion in the near future. Q2 has already been written off by analysts, and markets, but the question that seems to be open is what will happen in Q3 and beyond. While we have seen equity weakness over the past two sessions, broadly speaking equity markets are telling us that things are going to be improving greatly while bond markets continue to point to a virtual lack of growth. Reading between the lines of the Chairman’s comments, he seems to be siding with the bond market for now.

Into this mix, we must now look at the dollar, and its behavior of late. This morning had seen modest movement until about 6:30, when the dollar started to rally vs. most of its G10 counterparts. As I type, NOK, SEK and AUD are all lower by 0.5% or so. The Aussie story is quite straightforward as the employment report saw the loss of nearly 600K jobs, a larger number than expected, with the consequences for the economy seen as potentially dire. While restrictions are beginning to be eased there, the situation remains one of a largely closed economy relying on central bank and government largesse for any semblance of economic activity. As to the Nordic currencies, SEK fell after a weaker than expected CPI report encouraged investors to believe that the Riksbank, which had fought so hard to get their financing rate back to 0.00% from several years in negative territory, may be forced back below zero. NOK, however, is a bit more confusing as there was no data to see, no comments of note, and the other big key, oil, is actually higher this morning by more than 4%. Sometimes, however, FX movement is not easily explained on the surface. It is entirely possible that we are seeing a large order go through the market. Remember, too, that while the krone is the worst performing G10 currency thus far in 2020, it has managed to rally more than 7% since late April, and so we are more likely seeing some ordinary back and forth in the markets.

One other comment of note in the G10 space was from BOE Governor Andrew Bailey, who reiterated that negative interest rates currently have no place in the BOE toolkit and are not necessary. While the comments didn’t impact the pound, which is lower by 0.25% as I type, it continues to be an important distinction as along with Chairman Powell, the US and the UK are the only two G10 nations that refuse to countenance the idea of NIRP, at least so far.

In the emerging markets, what had been a mixed and quiet session earlier has turned into a pretty strong USD performance overall. The worst performer is ZAR, currently down 0.9% the South African yield curve bear-steepens amid continued unloading of 10-year bonds by investors. But it is not just the rand falling this morning, we are seeing weakness in the CE4 (CZK -0.7%, HUF -0.5%, PLN -0.4%) and once again the Mexican peso is finding itself under strain. While the CE4 appear to simply be following the lead of the euro (-0.35%), perhaps with a bit more exuberance, I think the peso continues to be one of the more interesting stories out there.

Both MXN and BRL have been dire performers all year, with the two currencies being the worst two performers in the past three months and having fallen more than 20% each. Both currencies continue to be extremely volatile, with daily ranges averaging in excess of 2% for the past two months. The biggest difference is that BRL has seen a significant amount of direct intervention by the BCB to prevent further weakness, while MXN continues to be a 100% free float. The other thing to recall is that MXN is frequently seen as a proxy for all LATAM because of its relatively better liquidity and availability. The point is, further problems in Brazil (and they are legion as President Bolsonaro struggles to rule amid political fractures and Covid-19) may well result in a much weaker Mexican peso. This is so even if oil prices rebound substantially.

Turning to data, we see the weekly Initial Claims number (exp 2.5M) and Continuing Claims (25.12M), but otherwise that’s really it. While we have three more Fed speakers, Kashkari, Bostic and Kaplan, on the calendar, I think after yesterday’s Powell comments, the market may be happier not to hear their views. All the evidence points to an overbought risk atmosphere that needs to correct at some point. As that occurs, the dollar should retain its bid overall.

Good luck and stay safe
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