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Undeterred

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Said Christine, we are “undeterred”
By Germany’s court that inferred
QE is lawbreaking
As there’s no mistaking
Our power, from Brussels’, conferred

Thus, QE is here til we say
The ‘conomy’s finally okay
More bonds we will buy
And don’t even try
To hint there might be a delay!

Last week, when the German Constitutional Court ruled that the ECB’s original QE program, PSPP, broke EU laws about monetary financing of EU governments, there was a flurry of interest, but no clear understanding of the eventual ramifications of the ruling. This morning, those ramifications are beginning to become clear. Not surprisingly the ruling ruffled many feathers within the EU framework, as it contradicted the European Court of Justice, which is the EU’s highest court. This is akin to a State Supreme Court contradicting the US Supreme Court on a particular issue. At least, that’s what the legal difference is. But in one way, this is much more dangerous. There is no serious opportunity for any US state to leave the union, but what we have learned over the course of the past several years is that while the German people, on the whole, want to remain in the Eurozone and EU, they also don’t want to pay for everybody else’s problems. So, the question that is now being raised is, will Frau Merkel and her government be able to contain the damage?

In the end, this will most likely result in no changes of any sort by the ECB. There will be much harrumphing about what is allowed, and a great deal of technical jargon will be discussed about the framework of the EU. But despite Merkel’s weakened political state, she will likely manage to prevent a blow-up.

The thing is, this is the likely outcome, but it is certainly not the guaranteed outcome. The EU’s biggest problem right now is that Italy, and to a slightly lesser degree Spain, the third and fourth largest economies in the EU, have run are running out of fiscal space. As evidenced by the spreads on their debt vs. that of Germany, there remains considerable concern over either country’s ability to continue to provide fiscal support during the Covid-19 crisis. The ECB has been the only purchaser of their bonds, at least other than as short-term trading vehicles, and the entire premise of this ruling is that the ECB cannot simply purchase whatever bonds they want, but instead, must adhere to the capital key.

The threat is that if the ECB does not respond adequately, at least according to the German Court, then the Bundesbank would be prevented from participating in any further QE activities. Since they are the largest participant, it would essentially gut the program and correspondingly, the ECB’s current monetary support for the Eurozone economies. As always, it comes down to money, in this case, who is ultimately going to pay for the current multi-trillion euros of largesse. The Germans see the writing on the wall and want to avoid becoming the Eurozone’s ATM. Will they be willing to destroy a structure that has been so beneficial for them in order to not pick up the tab? That is the existential question, and the one on which hangs the future value of the euro.

Since the ruling was announced, the euro has slumped a bit more than 1.25% including this morning’s 0.2% fall. This is hardly a rout, and one could easily point to the continued awful data like this morning’s Italian March IP release (-28.4%) as a rationale. The thing about the data argument is that it no longer seems clear that the market cares much about data. As evidenced by equity markets’ collective ability to rally despite evidence of substantial economic destruction, it seems that no matter how awful a given number, traders’ attitudes have evolved into no data matters in the near-term, and in the longer-term, all the stimulus will solve the problem. With this as background, it appears that the euro’s existential questions are now a more important driver than the economy.

But it’s not just the euro that has fallen today, in fact the dollar is stronger across the board. In the G10 space, Aussie (-0.7%) and Kiwi (-0.8%) are the leading decliners, after a story hit the tapes that China may impose duties on Australia’s barley exports to the mainland. This appears to be in response to Australia’s insistence on seeking a deeper investigation into the source of the covid virus. But the pound (-0.65%), too, is softer this morning as PM Johnson has begun lifting lockdown orders in an effort to get the country back up and running. However, he is getting pushback from labor unions who are concerned for the safety of their members, something we are likely to see worldwide.

Interestingly, the yen is weaker this morning, down 0.6%, in what started as a risk-on environment in Asia. However, we have since seen equity markets turn around, with most of Europe now lower between 0.3% and 1.3%, while US futures have turned negative as well. The yen, however, has not caught a bid and remains lower at this point. I would look for the yen to gain favor if equity markets start to add to their current losses.

In the EMG space, the bulk of the group is softer today led by CZK (-1.1%) and MXN (-1.0%), although the other losses are far less impressive. On the plus side, many SE Asian currencies showed marginal gains overnight while the overall risk mood was more constructive. If today does turn more risk averse, you can look for those currencies to give back last night’s gains. A quick look at CZK shows comments from the central bank that they are preparing for unconventional stimulus (read QE) if the policy rate reaches 0%, which given they are currently at 0.25% as of last Thursday, seems quite likely. Meanwhile, the peso seems to be preparing for yet another rate cut by Banxico this week, with the only question being the size. 0.50% is being mooted, but there is clearly scope for more.

On the data front, to the extent this still matters, this week brings a modicum of important news:

Tuesday NFIB Small Biz Optimism 85.0
  CPI -0.8% (0.4% Y/Y)
  -ex food & energy -0.2% (1.7% Y/Y)
Wednesday PPI -0.5% (-0.3% Y/Y)
  -ex food & energy 0.0% (0.9% Y/Y)
Thursday Initial Claims 2.5M
  Continuing Claims 24.8M
Friday Retail Sales -11.7%
  -ex autos -6.0%
  IP -12.0%
  Capacity Utilization 64.0%
  Empire Manufacturing -60.0
  Michigan Sentiment 68.0

Source: Bloomberg

But, as I said above, it is not clear how much data matters right now. Certainly, one cannot look at these forecasts and conclude anything other than the US is in a deep recession. The trillion-dollar questions are how deep it will go and how long will this recession last. Barring a second wave of infections following the reopening of segments of the economy, it still seems like it will be a very long time before we are back to any sense of normalcy. The stock market continues to take the over, but the disconnect between stock prices and the economy seems unlikely to continue growing. As to the dollar, it remains the ultimate safe haven, at least for now.

Good luck and stay safe
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Trade is the Word

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Remember last year when Phase One
Was all that was needed to run
The stock market higher,
Light bears’ hair on fire
And help all the bulls to have fun?

Well, once again trade is the word
Investors are claiming has spurred
Their risk appetite
Both morning and night
While earnings and growth are deferred

Another day, another rally in equity markets as the bulls now point to revamped conversations between the US and China regarding trade as the critical feature to return the economy to a growth stance. Covid-19 was extremely effective at disrupting the phase one trade deal on two fronts. First, given a key part of the deal was the promise of substantial agricultural purchases by China, the closure of their economy in February and corresponding inability to import virtually anything, put paid to that part of the deal. Then there was the entire issue about the origin of Covid-19, and President Trump’s insistence on ascribing blame to the Chinese for its spread. Certainly, that did not help relations.

But yesterday, the White House described renewed discussions between senior officials to help ensure that the trade deal remains on track. Apparently, there was a phone conversation including Chinese Premier, Liu He, and both Treasury Secretary Mnuchin and Trade Rep Lighthizer last night. And this is the story on the lips of every buyer in the market. The thesis here is quite simple, US economic output will be goosed by a ramp up by the Chinese in buying products. Recall, they allegedly promised to purchase in excess of $50 billion worth of agricultural goods, as well as focus on the prevention of IP theft and open their economy further. Covid slowed their purchases significantly, so now, in order to meet their obligations, they need to dramatically increase their buying pace, thus supporting US growth. It’s almost as though last year’s news is driving this year’s market.

Nonetheless, that is the situation and yesterday’s US performance has carried over through Asia (Nikkei +2.6%, Hang Seng +1.0%, Shanghai + 0.8%) and on into Europe (DAX +0.9%, CAC + 0.8%). Not to worry, US futures are right in line, with all three indices currently higher by just over 1.0%.

Bond markets are rallying today as well, which after yesterday’s rally and the broader risk sentiment seems a bit out of place. But 10-year Treasury yields are down 10bps in the past two sessions, with this morning’s price action worth 3bps. Bunds have seen a similar, albeit not quite as large, move, with yields falling 5bps since Wednesday and down 1.5bps today. In the European market, though, today’s big story is Italy, where Moody’s is due to release its latest credit ratings update this afternoon. Moody’s currently has Italy rated Baa3, the lowest investment grade rating, and there is a risk that they cut Italy to junk status. However, we are seeing broad optimism in markets this morning. In fact, Italian BTP yields have fallen (bonds rallied) 8bps this morning and 14bps in the past two sessions. In other words, it doesn’t appear that there is great concern of a downgrade, at least not right now. Of course, that means any surprise by Moody’s will have that much larger of a negative impact.

Put it all together and you have the makings of yet another positive risk day. Not surprisingly, the dollar is under pressure during this move, with most G10 and EMG currencies in the black ahead of the payroll data this morning. And pretty much, the story for all the gainers is the positive vibe delivered by the trade news. That has helped oil prices to continue their recent rally and correspondingly supported CAD, RUB, MXN and NOK. And the story has helped renew hopes for a return to a pickup in international trade, which has fallen sharply during the past several months.

The data this morning is sure
To set records that will endure
For decades to come
As depths it will plumb
And question if hope’s premature

Here are the most recent median expectations according to Bloomberg:

Nonfarm Payrolls -22.0M
Private Payrolls -21.855M
Manufacturing Payrolls -2.5M
Unemployment Rate 16.0%
Average Hourly Earnings 0.5% (3.3% Y/Y)
Average Weekly Hours 33.5
Participation Rate 61.0%
Canadian Change in Employment -4.0M
Canadian Unemployment Rate 18.1%

Obviously, these are staggeringly large numbers in both the US and Canada. In fact, given the US economy is more than 12x the size of Canada, the situation north of the border looks more dire than here at home. Of course, the market has likely become somewhat inured to these numbers as we have seen Initial Claims numbers grow 30M in the past six weeks. But that does not detract from the absolute carnage that Covid-19 has caused to the economy. The question at hand, though, is whether the confirmation of economic destruction is enough to derail the idea that a V-shaped recovery is in the cards.

Once again, I look at the dichotomy of price action between the equity markets and the Treasury market in an effort to find an answer. The anticipated data this morning is unequivocal evidence of destruction of huge swathes of the US economy. We are looking at a decade’s worth of job growth disappearing in one month. In addition, it does appear likely that a significant proportion of these jobs will simply not return as they were. Instead, we are likely to see major transformations in the way business is carried out in the future. How long will it be before people are comfortable in large crowds? How long before they want to jostle each other in a bar to watch a football game? Or just go out on a Thursday night? The point is, equity markets don’t see the glass half full, they see it overflowing. However, 10-year Treasury yields at 0.60% are hardly an indication of strong economic demand. In fact, they are the opposite, an indication that future growth is going to be extremely subdued when it returns, and the fact that the entire term structure of rates is so low tells me that return is likely to take a long time. Much longer than a few quarters. To complete the analogy, the bond market sees that same glass as virtually emplty. So, stocks continue to point to a V and bonds to an L. Alas, history has shown the bond market tends to get these things right more often than the stock market.

The point is that the current robust risk appetite seems unlikely to have staying power, and that means that the current dollar weakness is likely to be fleeting. The bigger picture remains that the dollar, for the time being, will remain the ultimate haven currency. Look for its bid to return.

Good luck, good weekend and stay safe
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Somewhat More Bold

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The Old Lady left rates on hold
But Norway was somewhat more bold
They cut rates to nil
And won’t move them til
The virus is fin’lly controlled

Once again, central banks are sharing the headlines with Covid-19 as they attempt to address the havoc the virus is causing throughout the world. The latest moves come from the Bank of England, which while leaving policy unchanged, hinted at further stimulus to come next month, and the Norgesbank.

The base rate in the UK is currently at a record low level of 0.10%, and they have been adamant that there is no place for negative rates in the island nation. This means that QE is the only other serious tool available, and while they did not increase the amount of purchases at this meeting, it seems the current guidance, to reach a total of £465 billion, will be exhausted in July. Hence, two MPC members voted to increase QE today with the rest indicating that is a more appropriate step next month. In sum, expectations are now for a £100 billion increase at the June meeting. The other noteworthy thing from the meeting was the BOE’s economic forecast, which forecast a 14% decline in GDP in 2020 before a sharp rebound in 2021. This is by far the most dire forecast we have seen for the UK. Through it all, though, the pound has held its own, and is actually modestly higher this morning, although it remains lower by nearly 2% this month.

Meanwhile, the Norgesbank surprised almost every analyst by cutting its Deposit rate to 0.0%, a new record low for the country. With oil prices having rebounded so sharply over the past two weeks, one might have thought that prospects in Norway were improving. However, the commentary accompanying the cut indicated that the council members are trying to ensure that there will be no liquidity constraints when the economy starts to reopen post-virus, and so sought to stay ahead of the curve. They also indicated that there was virtually no chance that interest rates would move into negative territory, although we have heard that song before. The market is now expecting the Deposit Rate to remain at 0.0% for another two years. As to the krone, it is actually the strongest currency in the G10 (and the world) this morning, having risen by 1.6% vs. the dollar as I type, although it was even stronger prior to the Norgesbank action.

Today’s news simply reinforces that central banks remain the first line of defense for nearly every nation with regard to economic support during this period. As much as fiscal stimulus is critical for helping support any rebound going forward, central banks are still best positioned to adjust policies as necessary on a timely basis. Just remember how long and hard the process was for the US congress to write, debate, vote on and implement the CARES act. The same is true throughout the developed world, where legislative bodies don’t move at the speed of either the virus or markets. And so, for the foreseeable future, central banks will remain the primary tool for virtually every nation in seeking to mitigate the impact of Covid-19.

The biggest problem with this circumstance is that most central banks, and certainly the major ones, have nearly exhausted their ammunition in this fight. In the G10, the highest overnight rate currently is 0.25%, with the US, Canada, Australia and New Zealand all at that level. While QE was clearly a powerful tool when first widely introduced in 2010, it has lost some of its strength. At least with respect to aiding Main Street as opposed to Wall Street. That is why QE has evolved from government bond purchases to central bank purchases of pretty much any asset available. And yet, despite their collective efforts, monetary policy remains an extremely inefficient instrument with which to fight a viral outbreak. However, you can be sure that there will be many distortions to the economy for years to come as a result of all this activity. And that has much longer-term implications, likely slowing the pace of any recovery and future growth significantly.

Meanwhile, markets this morning are in fairly fine fettle, with equity indices in Europe all higher by something under 1%. And this is despite some pretty awful data releases showing French IP fell 16.2% in March and 17.3% Y/Y. Germany’s data, while better than that, was still awful (IP -9.2% in March and -11.6% Y/Y) and Italy regaled us with collapsing Retail Sales data (-21.3% in March). But no matter, investors are now looking into 2021 and the prospects of a strong recovery for their investment thesis. The only problem with this theory is that the potential for a non-V-shaped recovery is quite high. If this is the case, I would look for markets to reprice valuations at some point. Earlier, APAC equity markets were mixed, with the Nikkei edging higher by 0.3%, but Hang Seng (-0.6%) and Shanghai (-0.2%) both a bit softer. Finally, US futures are looking pretty good at this hour, higher by nearly 1.5% across the board.

Bond prices have edged a bit lower this morning, but movement has been modest to say the least. Yesterday saw Treasury yields rise from 10-years on out as the Treasury announced a surprisingly large 20-year auction of $20 billion. It seems that we are about to see more significant Treasury issuance going forward, and if the Fed does not continue to expand its balance sheet, we are likely to see the back end continue to sell off with correspondingly higher interest rates and a steeper yield curve. But that is a story for another day.

Elsewhere in the FX markets, Aussie (+0.9%) and Kiwi (+0.7%) have been the next best performers after NOK, as both are benefitting from the current narrative of reopening economies leading to the bottom of the economic peril. On the flip side, the yen (-0.4%) has given back some of its recent gains as risk appetite grows.

In the EMG space, the major loser is TRY, which has fallen 1.0% this morning, to a new historic low, after the central bank enacted rules to try to prevent further speculation against the currency. Alas, as long as it is freely traded, those rules will have a tough time stopping the rout. On the plus side, the three main movers have been RUB (+0.9%), ZAR (+0.8%) and MXN (+0.65%), all of which are benefitting from this morning’s positive risk attitude. One other thing to note is BRL, which while not yet open, fell another 2.5% yesterday and is back pushing its historic low levels vs. the dollar. The story there continues to be political in nature, with increasing pressure on President Bolsonaro as his most popular cabinet members exit and markets lose confidence in his presidency. My take is 6.00 is coming soon to a screen near you.

On the data front, yesterday’s ADP print of -20.236M was pretty much on the money and didn’t seem to have much impact. This morning we see Initial Claims (exp 3.0M), Continuing Claims (19.8M), Nonfarm Productivity (-5.5%) and Unit Labor Costs (4.5%). At this stage, we will have to see much worse than expected data to have a market impact, something which seems a bit unlikely, and beyond that, given tomorrow is the NFP report, I expect far more attention will be focused there than on this morning’s releases.

Overall, risk is in the ascendancy and so I would look for the dollar to generally remain under pressure for today, but I would not be surprised to see it recoup some of its early losses before the session ends.

Good luck and stay safe
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Overkill

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The talk in the market is still
‘Bout German high court overkill
While pundits debate
The bond program’s fate
The euro is heading downhill

Amid ongoing dreadful economic data, the top story continues to be the German Constitutional Court’s ruling on (rebuke of?) the ECB’s Public Sector Purchase Program, better known as QE. The issue that drew the court’s attention was whether the ECB’s actions to help support the Eurozone overall are eroding the sovereignty of its member states. Consider, if any of the bonds that are bought by the central banks default, it is the individual nations that will need to pay the cost out of their respective budgets. That means that the unelected officials at the ECB are making potential claims on sovereign nations’ finances, a place more rightly accorded to national legislatures. This is a serious issue, and a very valid point. (The same point has been made about Fed programs). However, despite the magnitude of the issues raised, the court gave the ECB just three months to respond, and if they are not satisfied with that response, they will bar the Bundesbank from participating in any further QE programs. And that, my friends, would be the end. The end of the euro, the end of the Eurozone, and quite possibly the end of the EU.

Remember, unlike the Fed, which actually executes its monetary policy decisions directly in the market, the ECB relies on each member nation’s central bank to enter the market and purchase the appropriate assets. So, the ECB’s balance sheet is really just a compilation of the balance sheets of all the national central banks. If the Bundesbank is prevented from implementing ECB policy on this score, given Germany’s status as the largest nation, and thus largest buyer in the program, the effectiveness of any further ECB programs would immediately be called into question, as would the legitimacy of the entire institution. This is the very definition of an existential threat to the single currency, and one that the market is now starting to consider more carefully. It is clearly the driving force behind the euro’s further decline this morning, down another 0.5% which makes 1.5% thus far in May. In fact, while we saw broad dollar weakness in April, as equity markets rallied and risk was embraced, the euro has now ceded all of those gains. And I assure you, if there is any doubt that the ECB will be able to answer the questions posed by the court, the euro will decline much further.

The euro is not the only instrument under pressure from this ruling, the entire European government bond market is falling today. Now, granted, the declines are not that sharp, but they are universal, with every member of the Eurozone seeing bond prices fall and yields tick higher. This certainly makes sense overall, as the ECB has been the buyer of (first and) last resort in government bond markets, and the idea that they may be prevented from acting in the future is a serious concern. Simply consider how much more debt all Eurozone nations are going to need to issue in order to pay for their fiscal programs. Across the entire Eurozone, forecasts now point to in excess of €1 trillion of new bonds this year, already larger than the ECB’s PEPP. And if there is a second wave of the virus, forcing a reclosing of economies with a longer period of lockdown, that number is only going to increase further. Without the ECB to absorb the bulk of that debt, yields in Eurozone debt will have much further to climb. The point is that this issue, which was initially seen as minor and technical, may actually be far more important than anything else. And while the odds are still with the ECB to continue with business as usual, the probability of a disruption is clearly non-zero.

Away from the technicalities of the German Constitutional Court, there is far less of interest in the markets overall. Equity markets are mixed, with gainers and losers in both the Asian session as well as Europe. US futures, at this time, are pointing higher, with all three indices looking toward 1% gains at the open. And the dollar is broadly, though not universally, higher.

Aside from the euro’s decline, we have also seen weakness in the pound (-0.4%) after the Construction PMI (the least impactful of the PMI measures) collapsed to a reading of 8.2, from last month’s dreadful 39.2. This merely reinforces what type of hit the UK economy is going to take. On the plus side, the yen is higher by 0.3%, seemingly on the back of position adjustments as given the other risk signals, I would not characterize today as a risk-off session.

In the EMG space, there are far more losers than gainers today, led by the Turkish lira (-1.0%) and the Russian ruble (-0.8%). The lira is under pressure after new economic projections point to a larger economic contraction this year of as much as 3.4%. This currency weakness is despite the central bank’s boosting of FX swaps in an effort to prevent a further decline. Meanwhile, despite oil’s ongoing rebound (WTI +3.6%) the ruble seems to be reacting to recent gains and feeling some technical selling pressure. Elsewhere in the space, we have seen losses on the order of 0.3%-0.5% across most APAC and CE4 currencies. The one exception to the rule is KRW, which rallied 0.6% overnight as expectations grow that South Korea is going to be able to reopen the bulk of its economy soon. One other positive there is that demand for USD loans (via Fed swap lines) has diminished so much the BOK is stopping the auctions for now. That is a clear indication that financial stress in the nation has fallen.

On the data front, this morning brings the ADP Employment number (exp -21.0M), which will be the latest hint regarding Friday’s payroll data. Clearly, a month of huge Initial Claims data will have taken its toll. Yesterday’s Fed speakers didn’t tell us very much new, but merely highlighted the fact that each member has their own view of how things may evolve and none of them are confident in those views. Uncertainty remains the word of the day.

For now, the narratives of the past several weeks don’t seem to have quite the strength that they did, and I would say that the focus is on the process of economies reopening. While that is very good news, the concern lies after they have reopened, and the carnage becomes clearer. Just how many jobs have been permanently erased because of the changes that are coming to our world in the wake of Covid-19? It is that feature, as well as the nature of economic activity afterwards, that will drive the long-term outcome, and as of now, no clear path is in sight. The opportunity for further market dislocations remains quite high, and hedgers need to maintain their programs, especially during these times.

Good luck and stay safe
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To Aid and Abet

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The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
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Risk Off’s Set To Soar

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Though April saw rallies galore
In equities, bonds and much more
The first days of May
Seem set to convey
A tale that risk-off’s set to soar

Last week finished on a down note for risk appetite, as we saw equities decline sharply on Friday, at least in those markets that were open, as well as the first cracks in the rebound in currencies vs. the dollar. This morning, those trends are starting to reassert themselves and we look to be heading toward a full-blown risk-off session.

A quick recap reminds us that Thursday, which was month end, saw a modest decline in equities which was easily attributed to portfolio rebalancing. After all, the April rally was impressive in any context, let alone the current situation where huge swathes of the global economy have been shuttered for more than a month. Friday, while a holiday in many markets around the world, saw far more significant equity market declines in countries that were open, with US markets falling between 2.5% and 3.2%. The weekend saw loads of stories highlighting the adage, ‘Sell in May and go away’, as an appropriate strategy this year. This was compounded by the far more bearish take by Warren Buffett regarding the US economy, where he explained that Berkshire Hathaway had exited its positions in airline stocks and instead had grown its cash pile to $138 billion. These are not the signs of confidence that investors crave, and so this morning, European equity markets are all much lower, led by the CAC (-4.0%) and DAX (-3.5%). While both China and Japan were closed for holidays, the Hang Seng had a terrible performance, falling 4.2%, and we saw sharp declines throughout the rest of Emerging Asia. Meanwhile, US futures markets are all lower by about 1% as I type.

I guess the question at hand remains the sustainability of last month’s price action. Right now, there are two key subjects where the underlying narrative is up for grabs; risk appetite and inflation. For the former, there is a large contingent who believe that the worst is over with respect to Covid-19, and its spread is abating. This means that over the course of the next few weeks and months, economies are going to reopen and that the situation will return to normal. There is much talk of a V-shaped recovery on the strength of the extraordinary efforts of central banks and governments around the world. The flip side of this argument is that despite the tentative steps toward reopening economies worldwide, the pace of recovery will be significantly slower than the pace of the decline. Concerns about how much of the economy has been irrevocably destroyed, with small businesses worldwide closing, and unemployment everywhere rising sharply, are rife. While we are still in the first half of Q1 earnings season, the data to date have not been pretty, and remember, the virus only became a significant issue in March, generally. This implies that the bearish view may have more legs, and it is the side I believe fits the fact pattern more accurately.

The inflation narrative is just as fierce, with the hard money advocates all decrying the central bank activity as opening the door to currency collapses and hyperinflation right around the corner. Meanwhile, the other side of the argument looks to the history of the past twenty years, where Japan has been printing yen and effectively monetizing its debt, while still unable to achieve any sort of inflation at all. In this case, I think the deflationistas make the best case for the near term, as the combination of unprecedented demand destruction as well as extraordinary growth in debt both point to slower growth and price declines in the short and medium term. However, that is not to ignore the fact that central banks have gone far outside the boundaries of what had traditionally been viewed as their bailiwick, and especially if we do see a debt jubilee of some type, where government debt owned by a nation’s own central bank is forgiven, then the opportunity for a significant inflationary outcome remains on the table. Just not right away.

Adding it up for today points to a reduced risk appetite as evidenced by those equity markets that are open. Bond markets have not played along as one might have expected, with Treasury yields lower by only 1bp, and Bund yields, along with the rest of Europe’s, actually higher this morning. That price action seems to be a response to concerns over the outcome of the German Constitutional Court’s ruling due tomorrow, regarding the legality of QE, the PEPP and, perhaps more critically, the necessity of the ECB to follow the Capital Key when purchasing bonds.

In the FX markets, the dollar has resumed its role as king of the world, rallying against every currency except the yen, which has essentially stayed flat. In the G10 space, NOK is the leading decliner, down 1.2% as oil prices are back on the schneid with WTI down 6.3% this morning. But we are seeing the pound (-0.8%) and Swedish krone (-0.7%) under significant pressure as well. GBP traders are looking ahead to Thursday’s BOE meeting where expectations are rising for another bout of policy ease, which fits in with the broad risk-off framework. The krone, meanwhile, is suffering as the Riksbank finds itself in a difficult spot regarding its QE program. It seems that despite its claims that it would be purchasing not only government bonds, but corporates as well, that is illegal based on the bank’s guiding legislation, and so there is some monetary policy confusion now undermining the currency.

In the EMG space, IDR (-1.45%) and RUB (-1.3%) have been the weakest performers, with the ruble suffering from both weaker oil prices as well as the recent increase in the pace of infections in Russia. While things there are already under pressure, they could well get worse before they get better. Meanwhile, Indonesia saw a reversal of half of last week’s currency gains as PMI data (27.5) highlighted just how weak the near-term looks for the island nation. While the bulk of the rest of the space has suffered on the back of the overall risk-off sentiment, there has been a later reversal in ZAR, where the rand is now higher by 0.75% after its PMI data surprised one and all by printing at 46.1, well above expectations and a very modest decline compared to March, albeit still in contractionary territory.

On the docket this week, we see a great deal of information culminating in the payroll report on Friday, and that is certain to be frightful.

Today Factory Orders -9.4%
Tuesday Trade Balance -$44.2B
  ISM Non-Manufacturing 37.8
Wednesday ADP Employment -20.5M
Thursday Initial Claims -3.0M
  Continuing Claims -19.6M
  Nonfarm Productivity -5.5%
  Unit Labor Costs 3.8%
  Consumer Credit $15.0B
Friday Nonfarm Payrolls -21.3M
  Private Payrolls -21.7M
  Manufacturing Payrolls -2.25M
  Unemployment Rate 16.0%
  Average Hourly Earnings 0.3% (3.3% Y/Y)
  Average Weekly Hours 33.5
  Participation Rate 61.6%

Source: Bloomberg

The range of expectations for the payroll number highlight the ongoing confusion, with estimates between -840K and -30.0M. Regardless, the number will be a record, of that there is no doubt.

In addition to all this data, we hear from the RBA and the BOE on Thursday, with further ease on the cards, and we get to hear from five different Fed speakers. In these unprecedented times, as policymakers struggle to keep up with the economic destruction, we will soon become inured to shocking data. But that will not make it any better, and I fear that shock or not, risk appetites will continue to diminish as the month, and year, progresses. This means that the dollar is likely to retain its bid for a while yet.

Good luck and stay safe
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A Bit Out of Sorts

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The ECB stepped to the plate
Effectively cutting the rate
At which it will lend
To help countries spend
As well, to help prices inflate

But last night some earnings reports
Put traders a bit out of sorts
And too, from Down Under
It’s really no wonder
The data inspired some shorts

With many markets globally closed today for the May Day holiday, one would have expected fairly limited price action overall. One would have been wrong. In fact, despite the best efforts of the ECB yesterday to demonstrate further support for the European economies, it turns out that disappointing data has suddenly been recognized. This data story started last evening with key Tech earnings reports from two of the FAANG stocks, both disappointing on the profit side and calling into question the ability of even these companies to be able to withstand the remarkable demand shrinkage caused by Covid-19.

Then, though most of Asia was closed for the holiday, Australia (Manufacturing Index) and New Zealand (Consumer Confidence) both reported weaker than expected economic data. Suddenly, it seems that data was an important issue for markets, a change of recent heart. And there is one more thing to remember, the calendar turned the page. The calendar matters because, especially given the remarkable price action in April, there was a significant amount of month-end rebalancing in institutional portfolios. Remember, we saw a sharp rally in stocks, so it should be no surprise that they were sold off in order for portfolios to get back to desired asset allocations.

Taking it all together resulted in some serious equity market declines in the few markets open overnight, with the Nikkei (-2.85%) and Australia’s ASX 200 (-5.0%) putting in truly awful performances. Meanwhile, in Europe, only the FTSE 100 is trading today, and it is lower by 2.1%. US futures are following suit, currently down around 2.0% across the board.

So, what of the ECB’s actions? Well, they effectively cut interest rates by lowering the rate at which TLTRO funds are borrowed by 0.25%, to -0.25%. That means that Eurozone banks which lend new money to companies can earn to fund themselves. A pretty sweet deal if they charge a positive rate on the loans. In addition, they created yet another loan program, the PELTRO, which has even lower rates, as low as -1.0% funding costs for banks lending under this criterion. Of course, the problem remains that while many companies may borrow in order to try to get through the current ceasing of activity, future growth opportunities will simply be further hindered by the additional debt on corporate balance sheets. Two other things of note from the ECB are that they did not increase their QE programs as there remains considerable concern that the German Constitutional Court may rule next week that QE is illegal, essentially funding governments throughout the Eurozone, and that will call into question everything they have done. The second was the dire forecast from Madame Lagarde that Eurozone growth could see GDP shrink 12% in 2020, which if you consider yesterday’s Q1 data (-3.8% Q/Q) implies a modest rebound by year end.

Turning to the FX markets, it can be no surprise that both AUD (-1.0%) and NZD (-0.8%) are the worst performing currencies in the G10 space. Not only did both report lousy data, but both (AUD +17%, NZD +13%) have been rallying pretty steadily since their nadir on March 19. Thus, if the paradigm is changing back to the future is not as bright, I would look for both these currencies to give up much of last month’s rally. Meanwhile, the oil proxies, CAD (-0.6%) and NOK (-0.7%) are both suffering from oil’s modest declines this morning, with WTI ceding about 2.0% of its recent spectacular gains. After all, even ignoring the odd dip into negative territory two weeks ago, oil has rallied more than 200% since that fateful day, based on the June WTI contract. On the plus side, we see JPY (+0.35%) on what appears to be a modest risk-off trade, leading the way higher, with the rest of the bloc +/- 0.2% and lacking any new information.

EMG currencies have been largely spared movement overnight as the APAC bloc was closed for the holiday although CNH has managed to fall 0.6% in the absence of a domestic market. The three main deliverable EMG currencies, MXN (-1.4%), ZAR (-1.4%) and TRY (-0.7%) have a decidedly risk-off tone to their price action, with the peso being truly impressive. Since Tuesday, we have seen MXN first rally 5.0% then decline 4.1% from its peak. Net it is stronger, but the current trend seems to point to further weakness. Again, if the risk appetite from April begins to wane further, these currencies have the opportunity to fall significantly.

On the data front, this morning brings Construction Spending (exp -3.5%) and ISM Manufacturing (36.0) with the Prices Paid (33.0) and New Orders (30.0) indices looking equally dire. Yesterday we learned that Personal Income fell sharply, and Personal Spending fell even more sharply, a record-breaking 7.5% decline. Initial Claims data was a touch weaker than the median forecast at 3.84M with Continuing Claims (which lag the Initial claims data by a week) not rising quite as much as expected, to ‘just’ 18.0M.

Ultimately, the history of Covid-19’s impact will be written as the most extraordinary destruction of demand in history. The US (and global) economy had evolved from a manufacturing base a century ago, to a service-based economy par excellence. Nobody considered what shelter-in-place and social distancing would do to that construct. It is becoming increasingly clear that the answer to that is those restrictions will cause extreme economic damage that is likely to take several years to recoup. Alas, we are not done with this disease, and the restrictions will continue to wreak havoc on the global economy, and asset values, for a while yet. We have not seen the last of risk-off, nor the last of the dollar’s strength.

Good luck, good weekend and stay safe
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Riven By Obstinacy

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Said Jay, in this challenging time
Our toolkit is truly sublime
It is our desire
More bonds to acquire
And alter the Fed’s paradigm

In contrast, the poor ECB
Is riven by obstinacy
Of Germans and Dutch
Who both won’t do much
To help save Spain or Italy

Is anybody else confused by the current market activity? Every day reveals yet another data point in the economic devastation wrought by government efforts to control the spread of Covid-19, and every day sees equity prices rally further as though the future is bright. In fairness, the future is bright, just not the immediate future. Equity markets have traditionally been described as looking forward between six months and one year. Based on anything I can see; it is going to take far more than one year to get global economies back to any semblance of what they were like prior to the spread of the virus. And yet, the S&P is only down 9% this year and less than 13% from its all-time highs set in mid-February. As has been said elsewhere, the economy is more than 13% screwed up!

Chairman Powell seems to have a pretty good understanding that this is going to be a long, slow road to recovery, especially given that we have not yet taken our first steps in that direction. This was evidenced by the following comment in the FOMC Statement, “The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” (My emphasis.) And yet, we continue to see equity investors scrambling to buy stocks amid a great wave of FOMO. History has shown that bear markets do not end in one month’s time and I see no reason to believe that this time will be different. I don’t envy Powell or the Fed the tasks they have ahead of them.

So, let’s look at some of the early data as to just how devastating the response to Covid-19 has been around the world. By now, you are all aware that US GDP fell at a 4.8% annualized rate in Q1, its sharpest decline since Q4 2008, the beginning of the GFC. But in truth, compared to the European data released this morning, that was a fantastic performance. French Q1 GDP fell 5.8%, which if annualized like the US reports the data, was -21.0%. Spanish Q1 GDP was -5.2% (-19.0% annualized), while Italy seemed to have the best performance of the lot, falling only 4.8% (-17% annualized) in Q1. German data is not released until the middle of May, but the Eurozone, as a whole, printed at -3.8% Q1 GDP. Meanwhile, German Unemployment spiked by 373K, far more than forecast and the highest print in the history of the series back to 1990. While these were the highlights (lowlights?), the story is uniformly awful throughout the continent.

With this in mind, the ECB meets today and is trying to determine what to do. Last month they created the PEPP, a €750 billion QE program, to support the Eurozone economy by keeping member interest rates in check. But that is not nearly large enough. After all, the Fed and BOJ are at unlimited QE while the BOE has explicitly agreed to monetize £200 billion of debt. In contrast, the ECB’s actions have been wholly unsatisfactory. Perhaps the best news for Madame Lagarde is the German employment report, as Herr Weidmann and Frau Merkel may finally recognize that the situation is really much worse than they expected and that more needs to be done to support the economy. Remember, too, that Germany has been the euro’s biggest beneficiary by virtue of the currency clearly being weaker than the Deutschemark would have been on its own and giving their export industries an important boost. (I am not the first to notice that the euro’s demise could well come from Germany, Austria and the Netherlands deciding to exit in order to shed all responsibility for the fiscal problems of the PIGS. But that is a discussion for another day.)

The consensus is that the ECB will not make any changes today, despite a desperate need to do more. One of the things holding them back is an expected ruling by the German Constitutional Court regarding the legality of the ECB’s QE programs. This has been a bone of contention since Signor Draghi rammed them through in 2012, and it is not something the Germans have ever forgiven. With debt mutualization off the table as the Teutonic trio won’t even consider it, QE is all they have left. Arguably, the ECB should increase the PEPP by €1 trillion or more in order to have a truly positive impact. But thus far, Madame Lagarde has not proven up to the task of forcing convincing her colleagues of the necessity of bold action. We shall see what today brings.

Leading up to the ECB announcement and the ensuing press briefing, Asian equity markets followed yesterday’s US rally higher, although early gains from Europe have faded since the release of the sobering GDP data. US futures have also given back early gains and remain marginally higher at best. Bond markets are generally edging higher, with yields across the board (save Italy) sliding a few bps, and oil prices continue their recent rebound, although despite some impressive percentage moves lately, WTI is trading only at $17.60/bbl, still miles from where it was at the beginning of March.

The dollar, in the meantime, remains under pressure overall with most G10 counterparts somewhat firmer this morning. The leaders are NOK (+0.45%) on the strength of oil’s rally, and SEK (+0.4%) which seems to simply be continuing its recent rebound from the dog days of March. Both Aussie and Kiwi are modestly softer this morning, but both of those have put in stellar performances the past few days, so this, too, looks like position adjustments.

In the EMG bloc, IDR was the overnight star, rallying 2.8% alongside a powerful equity rally there, as investors who had been quick to dump their holdings are back to hunting for yield and appreciation opportunities. As markets worldwide continue to demonstrate a willingness to look past the virus’s impact, there are many emerging markets that could well see strength in both their currencies and stock markets. The next best performers were MYR (+1.0%) and INR (+0.75%), both of which also responded to a more robust risk appetite. As LATAM has not yet opened, a quick look at yesterday’s price action shows BRL having continued its impressive rebound, higher by 3.0%, but strength too in CLP (+2.9%), COP (+1.2%) and MXN (2.5%).

We get more US data this morning, led by Initial Claims (exp 3.5M), Continuing Claims (19.476M), Personal Income (-1.5%), Personal Spending (-5.0%) and Core PCE (1.6%) all at 8:30. Then, at 9:45 Chicago PMI (37.7) is due to print. As can be seen, there is no sign that things are doing anything but descending yet. I think Chairman Powell is correct, and there is still a long way to go before things get better. While holding risk seems comfortable today, look for this to turn around in the next few weeks.

Good luck and stay safe
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How Far Did It Sink?

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This morning the data we’ll see
Is highlighted by GDP
How far did it sink?
And is there a link
Twixt that and the FOMC?

Which later today will convene
And talk about Covid-19
What more can they do
To help us all through
The havoc that we all have seen

Market activity has been somewhat mixed amid light volumes as we await the next two important pieces of information to add to the puzzle. Starting us off this morning will be the first look at Q1 GDP in the US. Remember, the virus really didn’t have an impact on the US economy until the first week of March, although the speed of its impact, both on markets and the broad economy were unprecedented. A few weeks ago, I mentioned that I created a very rough model to forecast Q1 GDP and came up with a number of -13.6% +/- 2%. This was based on the idea that economic activity was cut in half for the last three weeks of the month and had been reduced by 25% during the first week. My model was extremely rough, did not take into account any specific factors and was entirely based on anecdotal evidence. After all, sheltering in home, it is exceedingly difficult to survey actual activity. As it turns out, my ‘forecast’ is much more bearish than the professional chattering classes which, according to the Bloomberg survey, shows the median expectation is for a reading of -4.0%, with forecasts ranging from 0.0% to -10.0%. Ultimately, a range of forecasts this wide tells us that nobody has any real idea what this number is going to look like.

Too, remember that while things have gotten worse throughout April, as much of the nation has been locked down, the latest headlines highlight how many places will be easing restrictions in the coming days and weeks. So, it appears that the worst of the impact will straddle March and April, an inconvenient time for quarterly reporting. In the end, the issue for markets is just how much devastation is already reflected in prices and perhaps more importantly, how quick of a recovery is now embedded in the price. It is this last point which gives me pause as to the current levels in equity markets, as well as the overall risk framework. The evidence points to a strong investor belief that the trillions of dollars of support by central banks and governments around the world is going to ensure that V-shaped rebound. If that does not materialize (and I, for one, am extremely skeptical it will), then a repricing of risk is sure to follow.

The other key feature today is the FOMC meeting, with the normal schedule of a 2:00 statement release and a 2:30 press conference. There are no updated forecasts due to be released, and the general consensus is that the Fed is unlikely to add any new programs to the remarkable array of programs already initiated. Arguably, the biggest question for today’s meeting is will they try to clarify their forward guidance regarding the future path of rates and policy or is it still too early to change the view that policy will remain accommodative until the economy weather’s the storm.

While hard money advocates bash the Fed and many complain that their array of actions has actually crossed into illegality, Chairman Powell and his crew are simply trying to alleviate the greatest disruption any economy has ever seen while staying within a loose interpretation of the previous guidelines. Powell did not create the virus, nor did he spend a decade as Fed chair allowing significant financial excesses to be built up. For all the grief he takes, he is simply trying to clean up a major mess that he inherited. But market pundits make their living on being ‘smarter’ than the officials about whom they write, so don’t expect the commentary to change any time soon.

With that as prelude, a survey of this morning’s activity shows that equity markets in Europe are generally slightly higher, although a few, France and Switzerland, are in the red. Interestingly, Italy’s FTSE MIB is higher by 0.4% despite the surprise move by Fitch to cut Italy’s credit rating to BBB-, the lowest investment grade rating and now the same as Moody’s rating. S&P seems to have succumbed to political pressure last week and left their rating one notch higher at BBB although with a negative outlook. Though Italian stocks are holding in, BTP’s (Italian government bonds) have fallen this morning with yields rising 4bps. In fact, a conundrum this morning is the fact that the bond market is clearly in risk-off mode, with Treasury and bund yields lower (2bp and 3bp respectively) while PIGS yields are all higher. Meanwhile, European equities are performing fairly well, US equity futures are all higher by between 0.5%-1.0%, and the dollar is softer virtually across the board. These latter signal a more risk-on scenario.

Speaking of the dollar, it is lower vs. all its G10 counterparts except the pound this morning although earlier gains of as much as 1.0% by AUD and NZD have been cut by more than half as NY walks in. This currency strength is despite weaker than expected Confidence data from the Eurozone, although with an ECB meeting tomorrow, market participants are beginning to bet on Madame Lagarde adding to the ECB’s PEPP. Meanwhile, CAD and NOK seem to be benefitting from a small rebound in the price of oil, although that seems tenuous at best given the fear of holding the front contract after last week’s dip into negative territory on the previous front contract.

EMG currencies are also uniformly stronger this morning, led by IDR (+1.0%) after a well-received government bond issuance increased confidence the country will be able to get through the worst of the virus’ impact. We are also seeing ZAR (+0.9%) firmer on the modestly increased risk appetite, and MXN (+0.7%) follow yesterday’s rally of nearly 1.7% as the worst fears over a collapse in LATAM activity dissipate. Yesterday also saw Brazil’s real rebound 2.75%, which is largely due to aggressive intervention by the central bank. The background story in the country continues to focus on the political situation with the resignation of Justice Minister Moro and yesterday’s Supreme Court ruling that an investigation into President Bolsonaro could continue regarding his firing of the police chief. However, BRL had fallen nearly 14% in the previous two weeks, so some rebound should not be surprising. In fact, on a technical basis, a move back to 5.40 seems quite viable. However, in the event the global risk appetite begins to wane again, look for BRL to once again underperform.

Overall, this mixed session seems to be more likely to evolve toward a bit of risk aversion than risk embrasure unless the Fed brings us something new and unexpected. Remember, any positive sign from the GDP data just means that Q2 will be that much worse, not that things are better overall.

Good luck and stay safe
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Yields Are Appalling

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Though prices for oil keep falling
And Treasury yields are appalling
The stock market’s view
Is skies will be blue
If Covid’s spread’s finally stalling

The ongoing dichotomy between equity market performance, traditionally a harbinger of future economic activity, and commodity market performance, also a harbinger of future economic activity, remains glaring. The commodity markets are clearly signaling significant demand destruction amid the economic devastation that has followed the spread of Covid-19. At the same time, equity markets around the world continue to recover from the lows seen in March, telling a completely different tale; that the future is bright.

When two key leading indicators offer such different portents, we need to look elsewhere to build our case of likely future outcomes. Clearly, government bond markets are the next best indicator, but their signal has been clouded by the more than $15 trillion that central banks around the world have spent buying those bonds since the financial crisis in 2008-09. Absent those purchases, would 10-year Treasury yields really be 0.65% like they are this morning? Would 10-year German bund yields really be at -0.44%, their 356th consecutive day yielding less than zero? Consider how much new debt has been issued and how that debt would have been absorbed absent central bank intervention. My point is that perhaps, using bond yields now as a proxy for future economic activity may no longer be quite as useful.

Which leaves us with the FX markets as our last signal for future activity. What does the dollar’s value tell us about expectations for the future? The problem with the dollar as an indicator is, its track record is extremely unclear. Throughout history, the US economy has been strong with both a strong dollar and a weak dollar. If anything, the dollar is a far better coincident indicator than anything else. After all, what is the risk-off/risk-on characteristic other than a signal of investors’ current views of the market. Thus, when fear is rampant, which was evident last month, the dollar performed extremely well. A quick look at currency returns during the month of March showed the dollar rising against 9 of its G10 Brethren, from 0.2% vs. the Swiss franc, to 10.7% vs. the oil-linked Norwegian krone. Only the yen, which managed a 0.75% rise, was able to outperform the dollar.

Not surprisingly, the EMG space saw some much more significant declines led by the Mexican peso (-18.1%) and Russian ruble (-15.3%). The broad theme in this bloc was that the best performers, those that fell the least, were APAC currencies with closer links to China, while LATAM and EEMEA were generally devastated. But, again, this was a real-time response to coincident activities, not a harbinger of the future.

The lesson to learn from this brief look at recent history is that there is no consensus view as to how things are going to evolve from here. Both sides make their respective cases strongly, and both sides can point to a substantial amount of data that supports their argument. However, the only universal truth is that economic disruptions that have been caused by the response to Covid-19 are unprecedented in both size and speed, and econometric models built for a different environment are unlikely to be very effective. Modeling of complex systems, whether the economy, the climate or the spread of a pathogen is an extremely fraught undertaking. More often than not, models will produce useless results. Their benefits generally come from the need to define conditions and factors, thus helping to better think and understand a particular situation, not from spurious calculations that produce a result. And this is why hedging is an important part of risk management, because regardless of what certain harbingers indicate, the reality is nobody knows what the future will bring.

But back to today’s activity. As we have seen for the past several sessions, the prospect of the reopening of economies is being seen by the equity markets as a clear positive. Despite abysmal earnings results across most industries, once again equity markets are firmer this morning, with most of Europe higher by 1.5%-2.0% and US futures pointing to gains of more than 1.0% on the open. Countries throughout Europe are starting to announce their plans to reopen with May 11 seeming to be the date where things will really start. And of course, the same process is ongoing in the US, with Georgia dipping its toe into the water yesterday, and other states lining up to do the same. Of course, the end of the lockdown does not mean that that things will return to the pre-virus situation. Incalculable damage has been done to every nation’s economy as regardless of government attempts, thousands upon thousands of small businesses will never return. Arguably, the one thing we know about the future is that it is going to be different than what was envisioned on January 1st.

Bond markets are behaving consistently with a modest risk-on view as Treasury and bund yields edge higher, while yields for the PIGS continue to slide. And finally, the dollar remains under pressure this morning, sliding against most of its counterparts as short-term fears abate. The best performers today in the G10 bloc are SEK and NOK, with the former rallying on what was perceived as a more hawkish than expected message from the Riksbank, when they didn’t cut rates back below zero at today’s meeting, and merely promised to continue to buy more bonds. NOK is a bit more difficult to explain given that oil prices (WTI -7.7%) continue to suffer from either significant excess supply or a complete lack of demand, depending on your point of view. However, given that NOK has been the worst performing G10 currency this year, it is probably due for some recovery given the positive sentiment seen today.

EMG currencies are also generally firmer, with MXN (+1.5%) atop the charts, as it, too, is ignoring the declining price of oil and instead finding demand after a precipitous fall this year. but we are also seeing strength in ZAR (+1.2%) and most EEMEA currencies, as some of last month’s excesses seem to be unwinding as we approach the end of April.

On the data front this morning are two minor releases, Case Shiller Home Prices (exp 3.19%) and Consumer Confidence (87.0). Rather, with the FOMC’s two-day meeting beginning this morning at 9:00, discussions will continue to focus on expectations for the Fed tomorrow, as well as the first look at Q1 GDP. But for today, I expect that we will continue to see this mildly positive risk attitude and the dollar to remain under modest pressure. My view remains that there are still significant issues ahead and the market is not pricing in the length of how bad things are going to be, but clearly for now, I am in the minority.

Good luck and stay safe
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