Overrun

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Outrageous

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

 

Hawks Acquiesce

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

 

Truly a Beast

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

No Respite

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay well
Adf

Has Panic Subsided?

This morning a look at the screen
Shows everything coming up green
Has panic subsided?
Or is it misguided
To think that a bottom’s been seen?

It certainly feels less frightening in markets this morning as assets of all nature, equity, commodity and fixed income, are rallying nicely and the panic buying of dollars seems to have ended for the time being. Of course, this is an interesting outcome if one reads the news, given that virus stories have not only continued apace, but the statistics and government responses are getting more draconian. Arguably, the biggest story is that the entire state of California, with its population of 40 million, has been put on lockdown, with stay-at-home restrictions imposed by the Governor. By itself, California is, famously, the fifth largest economy in the world, just ahead of the UK, so the idea that economic activity there is going to come screeching to a halt cannot be seen as a positive. At least not in the short term. In addition, virus related deaths in Italy have now surpassed those from China, and further personal restrictions are being contemplated by PM Conte in order to get a handle on the situation. Thus, the fact remains that Italy is in dire straits from an economic perspective, again at least in the short term. Yet the FTSE MIB (the main Italian stock market index) is higher by 3.8% as I type this morning.

This all begs the question, why are markets reversing course from what has been several hellacious weeks of price declines? Let’s consider a few possible reasons:

It could be that the combination of expanded central bank and government activity around the world has finally achieved a point where investors believe that apocalyptic scenarios overstate the case.

While this is possible, it seems a bit far-fetched to believe that in the course of 36 hours, investors have suddenly decided to accept all the actions, and there have been many, have done the job.

A recap of the major actions shows:
• ECB creates €750 billion PEPP as additional QE measures
• Fed extends USD swap lines to 9 additional central banks to allow USD liquidity to reach all G10 nations and several more developed EMG nations like South Korea
• Fed creates money market fund liquidity backstop to insure that CP issuance by US corporates is able to continue and companies are able to fund operations
• BOJ added ¥5.3 trillion in liquidity to markets while snapping up ¥201 billion of new ETF’s
• RBA cut rates by 0.25%, added new liquidity to markets and started a QE program to control the 3-year AGB at a rate of 0.25%

There is no question that this is an impressive list of actions put into place in very short order which demonstrates just how seriously governments are taking the Covid-19 outbreak. And this doesn’t include any of the fiscal stimulus packages which either have been enacted or are on the cusp of being so. In fact, a total of 31 central banks around the world have cut rates, added liquidity or started QE programs in the past week in order to stem the tide. (I have to add that the Danish central bank actually raised its base rate by 0.15%, to -0.60%, yesterday morning in a truly shocking move. Apparently there was growing concern that with the ongoing problems in Italy, investors were flocking to DKK from EUR and driving that cross, which the central bank uses as its monetary benchmark, strongly in favor of the krona. In this instance, strongly represents a 3.5 basis point move, which has since been reversed.) And perhaps the market is telling us, they’ve done enough. But I doubt it.

Remember, the problem is not financial at its heart, it is a medical issue and efforts to contain the virus remain only partially effective thus far. The medical news, however, continues to get worse, at least in Europe and the US, as the caseload continues to increase rapidly, as well as the death toll, and governments are imposing stricter and stricter regulations on the population. So along with California’s action, New York has mandated that no more than 25% of a company’s workforce is allowed to work at the office (at SMBC we are below 15%), while New Jersey has closed all personal service businesses, like hair salons, exercise facilities and tattoo parlors. And these are just the most recent ones that I have seen because of where I live and work. I know there are countless measures throughout the US and Europe. And all of those measures inflict significant pain on the economy.

Yesterday’s Initial Claims number jumped to 281K, significantly higher than model forecasts, but just a fraction of what we are likely to see going forward as small service businesses like restaurants and hair salons and so many others are forced to close for now and cannot afford to continue paying their staff. Hence I’ve seen estimates that we could see those numbers jump as high as 2 million! So while it is not an economic or financial condition at its heart, it is certainly having that impact.

A second thought, one which I think has more substance to it is that during the past three weeks we have seen a substantial amount of position liquidation by highly leveraged fund managers who were forced to sell assets (or cover shorts) at ANY price due to margin calls. The only way to get market movements of 5%-10% or more is to have market participants be price insensitive. In other words, sales (short covers) were mandated, not by choice. However, once those positions are closed, and the evidence is that most have been so, markets revert to price discovery in the normal fashion, with buyers and sellers putting their money to work based on views of the asset. So while there is still significant trepidation by investors, my gut tells me that we have seen the worst of the financial market activity and volatility. It will still be quite a while before things truly settle down, and there is every chance that as the economic data comes over the next weeks and months and shows just how badly things were impacted, we will see sharp market downdrafts. So I am not calling a bottom per se, but think that going forward it will be less dramatic than we have seen during the first three weeks of March.

A quick recap of this morning’s markets shows equity markets around the world higher, with many substantially so (CAC +5.1%, DAX +4.2%, Hang Seng +5.0%); government bond markets also rallying nicely with yields almost everywhere falling (Treasuries -14bps, Gilts -14bps, Bunds -9bps); commodity prices rallying virtually across the board (WTI +2.4%,Copper +1.7%, Gold +2.3%); and finally, the dollar selling off virtually universally, with some of the worst recent performers regaining the most. So KRW (+3.0%), AUD (+2.6%) and GBP (+2.3%) are all unwinding some of the excess movement we saw in the past weeks. If I am correct and the worst has passed, I expect the dollar will cede more of its recent gains. However, given my timeline of May, I expect it will be another month before we see that in any material way. So, if you are a payables hedger, these are likely to be some of the best opportunities you are going to see for quite a while. Don’t miss out!

Good luck, good weekend and please all stay safe and socially distant
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All the PIGS in Her Fief

Said Madame Lagarde, ‘Well I guess
Things really are in quite a mess’
And so up we’ll step
To introduce PEPP
As we try to deal with the stress

The market’s response was relief
That Europe’s new central bank chief
Has realized at last
The time is long past
To help all the PIGS in her fief

Another day, another bunch of new programs! First, though, a quick observation about the overall situation right now. There is no panic in the streets (after all the streets are mostly empty due to shelter-in-home and self-quarantining) but there is panic in… Washington DC, London, Bonn, Frankfurt, Paris, Madrid, etc. And that panic emanates from the fact that all those elected politicians are facing the biggest crisis of all…they might not get reelected because of Covid-19. I believe it is the belated realization that their jobs are on the line that has seen a significant acceleration in the number of new programs being proposed and introduced around the world.

Central banks, which had borne the brunt of the heavy lifting, are starting to get help from fiscal policy actions, but those central banks are still on the front lines. To wit, in an unprecedented intermeeting action, last night the ECB unveiled a new QE program called the Pandemic Emergency Purchase Program (PEPP) which will authorize the purchase of €750 billion of public and private assets for the rest of the year, or longer if deemed necessary. This time they are including Greek government bonds, which the ongoing QE program would not touch due to the credit rating, they are ignoring the capital key, which means they can purchase far more Italian debt than Italy’s share of the Eurozone economy would dictate, and they are expanding the corporate purchases to non-financial CP. And the market liked what they heard with European government bonds rallying sharply pushing 10-year benchmark yields down by 47bps in Portugal, 71bps in Italy, 167bps in Greece and 45bps in Spain. Equity markets in Europe have stopped collapsing, but we still see pressure in Germany and the UK, while the PIGS are all higher. One other thing about Germany was the release of the IFO Expectations Index which fell to 82.0, its lowest point since the financial crisis in 2008. Certainly short-term prospects seem dire there.

And what about the euro you may ask? Well, it continues to slide, down 1.0% this morning, but is actually about middle of the pack in the G10. If you want to see real carnage, look no further than Norway, where the krone has fallen another 2.75% as I type, but that is only after it had been lower by nearly 7.5% at 6:00 this morning, which forced a response from the Norgesbank that they would be intervening if things got worse. Looking over price action during the past month, when oil prices collapsed from $53.78 to as low as $20.06 (currently $22.88), which has been a 57% decline, the worst performing currencies have been; MXN (-23.8%), RUB (-21.2%), NOK (-19.7%) and COP (-17.3%). Two caveats on this list are Norway was down much further earlier this morning, and Colombia hasn’t opened yet today, so has room for a further decline. The only positive I can take from this is that the correlation between the currencies of oil producers and the price of oil remains intact. At least we know what to expect!

But there was plenty of other activity as well. For instance, the RBA cut rates again, by 25bps, taking their base rate to a historic low of 0.25%. In addition they have implemented their first QE plan where they are targeting the yield on 3-year AGB’s at 0.25%. The problem is that the 10-year bond got hammered on the news with yields there jumping 23bps overnight, taking the move since Monday to 57bps. Look for the RBA to do more, and probably soon. And the Aussie dog dollar? Down a further 1% this morning, which takes the decline in the past month to 14.3% and it is now trading at levels not seen since 2003.

And let’s not forget South Korea, which is stepping into the market to buy KRW 1.5 trillion (~$1.1 billion) of government bonds, as it prepares both bond and stock stabilization funds to help support markets there. In other words, the government is going to be buying equities to stop the slide. The KRW response? -3.2%!

Japan would not be left out of this parade, buying a new record ¥201.6 billion of ETF’s last night while injecting ¥5.3 trillion yen in new liquidity to the money markets. Unfortunately, the Nikkei continued its decline, although fell only 1.0%, arguably an improvement over recent performance. The yen has no haven characteristics this morning, falling 1.50%, which is actually now the worst performing currency as NOK continues to rebound as I type on the back of Norgesbank activity.

Finally, I would be remiss if I didn’t mention that the Fed has unveiled yet another program, this time to backstop money market funds, a key part of the US financial plumbing system, and one that when it broke in 2008 after Lehman’s bankruptcy, resulted in financial markets seizing up entirely. The fund is there to make liquidity available to funds to meet increased redemptions without having to sell their holdings. Instead, they will pledge them as collateral and receive cash from the Fed.

This note is too short to go through every action taken, but we continue to see other central bank rate cuts and we continue to see fiscal packages starting to get enacted. In fact, President Trump signed into law the latest yesterday, to support paid sick leave and increased unemployment benefits, and now Congress turns to the MOAS (mother of all stimuli) packages which may include helicopter money as well as bailouts of airlines and hospitality businesses that have been decimated by the virus response. Mooted price tag…$1.3 trillion, but my bet is it winds up larger than that.

Meanwhile, the dollar remains the single place to be. It has rallied against everything yet again as holding cash is seen as the only response to the current situation. And the cash everyone wants to hold is green. Foreign borrowers are scrambling and struggling as their local currencies collapse and swap spreads blow out. And domestic borrowers are wondering how they are going to repay or roll over their debt given the absolute collapse in economic activity.

For now, this is likely to continue to be the situation, as there is no obvious end in site. However, the growing sense of urgency in those national capitals leads me to believe that we are going to start to see much bigger fiscal packages and a newfound belief that printing money and giving it out is a better solution than allowing economic activity to seize up completely. As I said last week, the MMT proponents have won the day. It has just not yet been made explicit.

Good luck and stay safe
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