Their Siren Song

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The trend ‘gainst the dollar is strong
With bears playing their siren song
As long as real rates
Are in dire straits
‘Twould be a mistake to go long

While there is usually some interesting tidbit on which to focus regarding market behavior that is not specifically FX related, this morning that does not seem to be the case. In fact, today’s most noteworthy story is that the dollar continues to drive lower vs. almost all its counterparts. As there was no specific news or data that appears to be driving other currencies higher, I can only attribute this broad resumption of the dollar downtrend to the fact that real interest rates in the US have turned back lower.

Looking back a few weeks, 10-year US real interest rates (nominal – CPI) bottomed at -1.08% on August 6th. That coincided with the peak price in gold, as well as the euro’s local high. But then Treasury yields began to back up as the bond market started getting indigestion from the Treasury issuance schedule ($316 billion total since then, of which $112 billion were Notes and Bonds.) The problem is that not merely is the size of the issuance unprecedented, but that it shows no signs of slowing down as the government continues to run massive deficits.

At any rate, real yields backed up by 14 basis points in the ensuing week, which resulted in both a sharp correction in the price of gold, and support for the dollar. But it seems that phase of the market may be behind us as Treasury yields have been sliding on both a nominal and real basis, and we have seen gold (and silver) recoup those losses while the dollar has ceded its gains and then some.

At this point, the question becomes, what is driving real yields? Is it fears of rising inflation? Is it hope that the Fed will maintain ultra-easy monetary policy even if the economy recovers strongly? Or is it something else?

Regarding the pace of inflation, while last week’s CPI data was certainly a shock to most eyes, it doesn’t seem as though it is the driver. I only point this out because the nadir in real yields occurred a week before the CPI data was released. Now it is certainly possible that bond investors were anticipating a higher inflation print, but there was absolutely no indication it would be as high as it turned out to be. In fact, based on the CPI release, I would have anticipated real yields to fall further, as the combination of higher inflation and a Fed that is essentially ignoring inflation at the current time is a recipe for further declines there. Remember, everything we have heard from the Fed is that not merely are they unconcerned with inflation, but that they welcome it and are comfortable allowing it to run hotter than their target for a time going forward.

This latter commentary implies that there is not going to be any change in the Fed’s policy stance in the near future either. Rather, Chairman Powell has made it clear that the Fed is going to provide ongoing support and liquidity to the markets economy for as long as they deem it necessary. Oh, and by the way, they have plenty of tools left with which to do so.

If these are not viable explanations for the change in trend, one other possible driver is the vagaries of the ongoing pandemic. Perhaps there is a relationship between increases in infection rates and investor assessments of the future. Logically, that would not be far-fetched, and there is growing evidence that there is a correlation between market behavior and covid news. Specifically, when it appears that covid is in retreat, bond yields tend to rise, and so real rates have been moving in lockstep. As well, when the news indicates that the virus is resurgent, the yield complex tends to head lower. Thus, in a convoluted way, perhaps the dollar bearishness that has become so pervasive is being driven by the idea that the US continues to suffer the most from Covid-19, and as long as that remains the case, this trend will remain intact.

Now, I would not want to base all my trading and hedging decisions on this idea, but it is certainly worth keeping in mind when looking at short-term risk exposures and potential timing to manage them.

But as I said at the top, overall, there is very little of note in the financial press and not surprisingly, market activity has been fairly muted. For example, equity markets in Asia basically finished either side of unchanged on the day (Nikkei -0.2%, Hang Seng +0.1%, Shanghai +0.3%). Europe, which had been largely unchanged all morning has been on a late run and is now nicely higher (DAX +0.9%, CAC +0.6%) and US futures have also edged up from earlier unchanged levels. As discussed, Treasury yields continue to drift lower (-1.5 basis points) and gold is rocking (+1.0% and back over $2000/oz.)

And the dollar? Well, it is definitely on its back foot this morning, with the entire G10 complex firmer led by GBP (+0.5%) on the strength of optimism over the resumption of Brexit talks and JPY (+0.45%) which seems to be benefitting from the ongoing premium for owning JGB’s and swapping back to USD.

In the EMG bloc, RUB (+0.8%) is the leader today, followed by ZAR (+0.7%) and MXN (+0.65%). All of these are benefitting from firmer commodity prices which, naturally are helped by the dollar’s broad weakness. But other than TRY (-0.2%) which has fallen in nine of the past ten sessions as President Erdogan and the central bank undermine the lira, and IDR (-0.3%), which has also seen a string of suffering, but this based on difficulty dealing with Covid effectively, the rest of the bloc is modestly firmer vs. the greenback.

On the data front, this morning brings Housing Starts (exp 1245K) and Building Permits (1326K), which if wildly different than expectations could have a market impact, although are likely to be ignored by traders. Rather, the trend in the dollar remains lower, with the euro actually setting new highs for the move this morning, and until we see a change in the rate structure, either by US real rates rising, or other real rates falling more aggressively, I expect this trend will continue. Hedgers, choose your spots, but don’t miss out.

Good luck and stay safe
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A Tiny Tsunami

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Covid’s wrought havoc
Like a tiny tsunami
Can Japan rebound?

In what is starting off as a fairly quiet summer morning, there are a few noteworthy items to discuss. It cannot be surprising that Japan’s economy suffered greatly in Q2, given the damage to economic activity seen worldwide due to Covid-19. Thus, although the -7.8% Q2 result was slightly worse than forecast, it merely served to confirm the depths of the decline. But perhaps the more telling statistic is that, given Japan was in recession before Covid hit, the economy there has regressed to its size in 2011, right after the Tohoku earthquake and tsunami brought the nation to its knees.

Back then, the dollar had been trending lower vs. the yen for the best part of the previous four years, so the fact that it dropped sharply on the news of the earthquake was hardly surprising. In fact, it was eight more months before the dollar reached its nadir vs. the yen (75.35), which simply tells us that the trend was the driver and the singular event did not disrupt that trend. And to be clear, that trend was quite steep, averaging nearly 11% per year from its beginning in 2007. In comparison, the current trend in USDJPY, while lower, is much less dramatic. Since its recent peak in June 2015, the entire decline has been just 15.5% (~3.2% per annum). Granted, there have been a few spikes lower, most recently in March during the first days of the Covid panic, but neither the economic situation nor the price action really resembles those days immediately after Tohoku.

The point is, while the dollar is certainly on its back foot, and the yen retains haven status, the idea of a dollar collapse seems far-fetched. I’m confident that Japan’s Q3 data will show significant improvement compared to the Covid inspired depths just reported, but given the massive debt overhang, as well as the aging demographics and trend growth activity in the country, it is likely to be quite a few years before Japan’s economy is once again as large as it was just last year. Ironically, that probably means the yen will continue to trend slowly higher over time. But even getting to 100 will be a long road.

The other interesting story last night was from China, where the PBOC added substantially more liquidity to the markets than had been anticipated, RMB 700 billion in total via one-year injections. This more than made up for the RMB550 billion that is maturing over the next week and served as the catalyst for the Shanghai Exchange’s (+2.35%) outperformance overnight. This merely reinforces the idea that excess central bank liquidity injections serve a singular purpose, goosing stock market returns supporting economic activity.

There is something of an irony involved in watching the central banks of communist nations like China and Russia behave as their actions are essentially identical to the actions of central banks in democratic nations. Is there really any difference between the PBOC injecting $100 billion or the Fed buying $100 billion of Treasuries? In the end, given the combination of uncertainty and global ill will, virtually all that money finds its way into equity markets, with the only question being which nation’s markets will be favored on any given day. It is completely disingenuous for the Fed, or any central bank, to explain that their activities are not expanding the current bubble in markets; they clearly are doing just that.

But the one thing of which we can be certain is that they are not going to stop of their own accord. Either they will be forced to do so after changes in political leadership (unlikely) or the investment community will become more fearful of their actions than any possible inaction on their parts. It is only at that point when this bubble will burst (and it will) at which time central banks will find themselves powerless and out of ammunition to address the ensuing financial distress. As to when that will occur, nobody knows, but you can be certain it will occur.

And with that pleasant thought now past, a recap of the overnight activity shows that aside from Shanghai, the equity picture was mixed in Asia (Nikkei -0.8%, Hang Seng +0.6%) while European bourses are similarly mixed (DAX +0.2%, CAC 0.0%, Spain’s IBEX -0.75%). US futures are modestly higher at this point, but all well less than 1%. Bond markets are starting to find a bid, with 10-year Treasuries now down 1.5 basis points, although still suffering indigestion from last week’s record Treasury auctions. And in fact, Wednesday there is another huge Treasury auction, $25 billion of 20-year bonds, so it would not be surprising to see yields move higher from here. European bond markets are all modestly firmer, with yields mostly edging lower by less than 1bp. Commodity markets show oil prices virtually unchanged on the day while gold (and silver) are rebounding from last week’s profit-taking bout, with the shiny stuff up 0.5% (AG +2.1%).

Finally, the dollar is arguably slightly softer overall, but there have really been no large movements overnight. In G10 world, the biggest loser has been NZD (-0.3%) as the market voted no to the announcement that New Zealand would be postponing its election by 4 weeks due to the recently re-imposed lockdown in Auckland. On the plus side, JPY leads the way (+0.25%, with CAD and AUD (both +0.2%) close by on metals price strength. Otherwise, this space is virtually unchanged.

Emerging markets have had a bit more spice to them with RUB (-1.25%) the outlier in what appears to be some position unwinding of what had been growing RUB long positions in the speculative community. But away from that, HUF (-0.6%) is the only other mover of note, as investors grow nervous over the expansion of the current account deficit there.

This week’s data releases seem likely to be less impactful as they focus mostly on housing:

Today Empire Manufacturing 15.0
Tuesday Housing Starts 1240K
  Building Permits 1320K
Wednesday FOMC Minutes  
Thursday Initial Claims 915K
  Continuing Claims 15.0M
  Philly Fed 21.0
Friday Manufacturing PMI 51.8
  Services PMI 51.0
  Existing Home Sales5.40M  

Source: Bloomberg

Of course, the FOMC Minutes will be greatly anticipated as analysts all seek to glean the Fed’s intentions regarding the policy overhaul that has been in progress for the past year. Away from the Minutes, though, there are only two Fed speakers, Bostic and Daly. And let’s face it, pretty much every FOMC member is now on board with the idea that raising the cost of living inflation is imperative, and that if inflation runs hot for a while, there is no problem. Clearly, they don’t do their own food-shopping!

It is hard to get too excited about markets one way or the other today, but my broad view is that though the medium-term trend for the dollar may be lower, we continue to be in a consolidation phase for now.

Good luck and stay safe
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Hard to Believe

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As travel restrictions expand
And quarantines spread ‘cross the land
It’s hard to believe
That we’ll soon achieve
A surge to pre-Covid demand

Risk is having a tough day today as new travel restrictions announced by the UK, regarding travelers from France and the Netherlands, as well as four small island nations, has raised the specter of a second wave of economic closures. In fact, while the headlines are hardly blaring, the number of new infections in nations that had been thought to have achieved stability (Germany, France, Spain and New Zealand) as well as those that have never really gotten things under control (India, Brazil and Mexico) indicates that we remain a long way from the end of the pandemic. Given the market response to this news, it is becoming ever clearer that expectations for that elusive V-shaped recovery have been a key driver to the ongoing rebound in risk appetites worldwide.

However, most recent data has pointed to a slowing of economic activity in the wake of the initial bounce. Exhibit A is China, where Q2 GDP grew a surprising 3.2%, but where the monthly data released last evening showed IP (-0.4% YTD) and Retail Sales (-9.9% YTD) continue to lag other production indicators. The very fact that Retail Sales continues to slump is a flashing red light regarding the future performance of the Chinese economy. Remember, they have made a huge effort to convert their economy from a highly export-oriented one to a more domestic consumer led economy. But if everyone is staying home, that becomes a problem for growth. And the word is, at least based on several different BBG articles, that many Chinese are reluctant to resume previous activities like going out to dinner or the movies.

The upshot is that the PBOC will very likely be back adding stimulus to the economy shortly, after a brief hiatus. Since it bottomed at the end of May, the renminbi had rallied 3.35%, and engendered stories of ongoing strength as the Chinese sought to reduce USD utilization. A big part of that story has been the idea that China has left the pandemic behind and was set to get back to its days of 6% annual GDP growth. Alas, last night’s data has put a crimp in that story, halting the CNY rally, at least for the moment.

But back to the broader risk picture, which shows that equity markets in Europe are suffering across the board (DAX -1.3%, CAC -2.0%, FTSE 100 -2.1%) as not only has the UK quarantine news shocked markets, but the data continues to be abysmal. This morning it was reported that Eurozone employment had fallen 2.8% in Q2, the largest decline since the euro was born in 1999, and essentially wiping out 50% of all jobs created during the past two decades. Meanwhile, Eurozone GDP fell 12.1% in Q2 and was lower by 15% on a year over year basis last quarter. While the GDP outcome may have been forecast by analysts, it remains a huge gap to overcome for the economies in the Eurozone and seems to have forced some reconsideration about the pace of future growth.

And perhaps, that is today’s story. It seems that there is a re-evaluation of previous assumptions regarding the short-term future of the global economy. US futures are pointing lower although are off their worst levels of the overnight session. Treasury yields, after rising sharply yesterday in the wake of a pretty lousy 30-year auction, have fallen back 2.5 basis points to 0.70%, still well above the lows seen two weeks ago, but unappetizing, nonetheless. Commodity prices are slipping with both oil (-0.5%) and gold (-0.4%) a bit lower. And the dollar is modestly firmer along with the yen, an indication that risk is under pressure.

In the G10, aside from the yen, which seems clearly to be benefitting from today’s risk mood, the pound has actually edged a bit higher, 0.3%, after comments by the UK’s chief Brexit negotiator, David Frost, indicated his belief a deal could be reached by the end of September. Meanwhile, NOK (-0.5%) is the worst performer in the bloc as the decline in oil prices has combined with a strong weekly performance driving profit-taking trades and pushing the currency back down. The rest of the bloc is broadly softer, but the movement has been modest at best.

In the EMG space, there are more losers than gainers with RUB (-0.6%) not surprisingly the laggard, although TRY (-0.5%) continues to demonstrate how to destroy a currency’s value with bad policymaking. The rest of the space is generally softer by much smaller amounts and there has only been one gainer, PHP (+0.2%) which, remarkably, seems to be benefitting from the idea that the central bank is openly monetizing debt. Historically, this type of activity, especially in emerging market economies, was seen as a disaster-in-waiting and would result in a much weaker currency. But apparently, in the new Covid age, it is seen as a mark of sound policy.

A quick diversion into debt monetization and the potential consequences is in order. By this time, MMT has become a mantra to many who believe that inflation is a thing of the past and without inflation, there is no reason for governments that print their own currency to ever stop doing so, thus supporting economic activity. But I fear that view is hugely mistaken as the lessons learned from the economic response to the GFC are not applicable here. Back then, all the new liquidity that was created simply sat on bank balance sheets as excess reserves at the Fed. Very little ever made its way into the real economy. Obviously, it did make it into the stock market.

But this time, there is not merely monetary support, but fiscal support, with much of the money being spent by those recipients of the $1200 bonus check, the $600/week of topped up Unemployment benefits, and the $billions in PPP loans. At the same time, factory closures throughout the nation have reduced the production of ‘stuff’ while government restrictions have reduced the availability of many services (dining, movies, health clubs, etc.) Thus, it becomes easy to see how we now have a situation where a lot more money is chasing after a lot less stuff. Yes, the savings rate has risen, but this is a recipe for inflation, and potentially a lot of it. MMT proponents claim that inflation is the only thing that should moderate government spending. But ask yourself this question, is it realistic to expect the government to slow or stop spending just because inflation starts to rise? Elected officials will never want to derail that gravy train, despite the consequences. And while MMT is not official policy, it is certainly a pretty fair description of what the Fed is currently doing, buying virtually all the new Treasury debt issued. Do not be surprised when next month’s CPI figures are higher still! And the month after…

Anyway, this morning brings Retail Sales (exp +2.1%, +1.3% ex autos) as well as Nonfarm Productivity (1.5%), Capacity Utilization (70.3%), IP (3.0%), Business Inventories (-1.1%) and finally, Michigan Sentiment (72.0). Retail Sales will get all the press. A soft number is likely to enhance the risk-off mood and help the dollar edge a bit higher, while a strong print should give the bulls a renewed optimism with the dollar suffering as a consequence.

Good luck, good weekend and stay safe
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Prices Bespeak

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It seems that the rate of inflation
Is rising across our great nation
Demand remains weak
But prices bespeak
The need for some new Fed mentation

Does inflation still matter to markets? That is the question at hand given yesterday’s much higher than expected, although still quite low, US CPI readings and various market responses to the data. To recap, CPI rose 0.6% in July taking the annual change to 1.0%. The core rate, ex food & energy, also rose 0.6% in July, which led to an annual gain of 1.6%. For good order’s sake, it is important to understand that those monthly gains were the largest in quite a while. For the headline number, the last 0.6% print was in June 2009. For the core number, the last 0.6% print was in January 1991!

The rationale for inflation’s importance is twofold. First, and foremost, the Fed (and in fact, every central bank) is charged with maintaining stable prices as a key part of their mandate. As such, monetary policy is directly responsive to inflation readings and designed to achieve those targets. Second, economic theory tells us that the value of all assets over time is directly impacted by the change in the price level. This concept is based on the idea that investors and asset holders want to maintain the real value of their savings (and wealth) over time so that when they need to draw on those savings, they can maintain their desired level of consumption in the future.

Of course, the Fed has made a big deal about the fact that inflation remains far too low and one of the stated reasons for ZIRP and QE is to help push the inflation rate back up to their 2.0% target. Remember, too, that target is symmetric, which means that they expect inflation to print higher than their target as well as lower, and word is, come the September meeting, they are going to formalize the idea of achieving an average of 2.0% inflation over time. The implication here is that they are going to be willing to let the inflation rate run above 2.0% in order to make up for the last decade when their preferred measure, core PCE, only touched 2.0% in 11 of the 103 months since they established the target.

Looking at the theory, what we all learned in Economics 101 was that higher inflation led to higher nominal interest rates, higher gold prices and a weaker currency. The equity question was far less clear as there are studies showing equities are a good place to be and others showing just the opposite. A quick look at the market response to yesterday’s CPI data shows that yields behaved as expected, with 10-year Treasuries seeing yields climb 3.5 basis points. Gold, on the other hand, had a more mixed performance, rallying 1.0% in the first hours after the release, but ultimately falling 1.0% on the day. And finally, the dollar also behaved as theory would dictate, falling modestly in the wake of the release, probably about 0.25% on average.

So yesterday, the theory held up quite well, with markets moving in the “proper” direction after the news came out. But a quick look at the longer-term relationship between inflation and markets tells a bit of a different story. The correlation between US CPI and EURUSD has been 0.01% over the past ten years. In the same timeframe, gold’s correlation to CPI has actually been slightly negative, -0.05%, while Treasury yields have shown the only consistent relationship with the proper sign, but still just +0.2%.

What this data highlights are not so much that inflation impacts market prices, but that we should only care about inflation, from a market perspective at least, because the Fed (and other central banks) have made it part of their mantra. Thus, the answer to the question, does inflation still matter is that only insofar as the Fed continues to care about it. And what we have gleaned from the Fed over the past five months, since the onset of the covid pandemic, is that inflation is way down their list of priorities right now. In other words, look for higher inflation readings going forward with virtually no signal from the Fed that they will respond. At least, not until it gets much higher. If you were wondering how we could get back to the 1970’s situation of stagflation, we are clearly setting the table for just such an outcome.

But on to markets today. Risk is under a bit of pressure this morning as equity markets in Asia and Europe were broadly lower, the only exception being the Nikkei (+1.8%) which saw a large tech sector rally drive the entire index higher. Europe, on the other hand, is a sea of red although only the FTSE 100 in London is down appreciably, -1.1%. And at this hour, US futures are essentially flat.

Bond markets are less conclusive today. Treasury yields are lower by 1 basis point at this hour, although that is well off the earlier session price highs, but European government bond markets are actually falling today, with yields edging higher, despite the soft equity market performance. As to gold, it is currently higher by 1.0%, which simply takes it back to the level seen at the time of yesterday’s CPI release.

Turning to the dollar, it is definitely softer as in the G10, only NZD (-0.3%), which seems to be responding to the sudden recurrence of Covid-19 cases in the country, is weaker than the greenback. But NOK (+0.6%) with oil continuing to edge higher, leads the pack, followed closely by the euro and pound, both of which are firmer by 0.5% this morning. Perhaps French Unemployment data, which showed an unemployment rate of just 7.1% instead of the 8.3% forecast, is driving the bullishness. But arguably, we are simply watching the continuation of the dollar’s recent trend lower.

In the emerging markets, the CE4 are all solidly higher as they track the euro’s movement with a bit more beta. But the rest of the space has seen almost no movement with those currency markets that are open showing movement on the order of +/- 10 basis points. In other words, there is no real story here to tell.

On the data front, we get the weekly Initial Claims (exp 1.1M) and Continuing Claims (15.8M) data at 8:30, but that is really all there is. We continue to hear from some Fed speakers, with today bringing Bostic and Brainard, but based on what we have heard from other FOMC members recently, there is nothing new we will learn. Essentially, the Fed continues to proselytize for more fiscal support and blame all the economy’s problems on Covid-19, holding themselves not merely harmless for the current situation, but patting themselves on the back for all they have done.

With this in mind, it is hard to get excited about too much activity today, and perhaps the best bet is the dollar will continue to drift lower for now. While the dollar weakening trend remains intact, it certainly has lost a lot of its momentum.

Good luck and stay safe
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Deep-Sixed

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This morning the UK released
Fresh data that showed growth decreased
By quite an extent
(Some twenty percent)
Last quarter. Boy, Covid’s a beast!

But really the market’s transfixed
By gold, where opinions are mixed
It fell yesterday
An awfully long way
With shorts praying it’s been deep-sixed

Two stories are vying for financial market headline supremacy this morning; the remarkable collapse in gold (and silver) prices, and the remarkable collapse in the UK economy in Q2. And arguably, they are sending out opposite messages.

Starting with the gold price, yesterday saw the yellow metal fall nearly 6%, which translated into $114/oz decline. On a percentage basis, silver actually fell far further, -14.7%, although for now let’s simply focus on gold. The question is, what prompted such a dramatic decline? Arguably, gold’s rally has been based on two key supports, the increasingly larger negative real yield in US interest rate markets and an underlying concern over the impact of massive monetary stimulus by the Fed and other central banks undermining all fiat currencies. These issues drove a speculative frenzy where gold ETF’s were trading above NAV and demand for physical metal was increasing faster than production.

Looking at the real yield story, last Thursday saw the nadir, at least so far, in that metric, with real10-year Treasury yields falling to -1.08%. However, as risk appetite recovered a bit, nominal yields rebounded by 10bps, and real yields did the same, now showing at ‘just’ -0.99%. At this point, it is important to remember that markets move at the margin, so even though real yields remain highly negative, the modest rebound changed the tone of the trade and encouraged a bout of profit-taking in gold. Simultaneously, we saw a much more positive risk environment, especially after Germany’s ZEW survey showed much better than forecast Expectations, pumping up European equity markets and US ones as well. This simply added to the rationale to take profits on what had been a very sharp, short-term increase in the precious metals markets. As these things are wont to do, the selling begat more selling and bingo, a major correction resulted.

Is this the end of the gold story? I sincerely doubt it, as the underlying drivers are likely to continue their original trend. If anything, what we continue to see from central banks around the world is additional stimulus driving ever lower nominal and real yields. We saw this last night in New Zealand, where the RBNZ increased their QE program and openly discussed NIRP, pushing kiwi (-0.5%) lower. But in this context, the important issue is that, yet another G10 central bank is leaning closer to negative nominal yields, which will simply drive real yields even lower. Simultaneously, additional QE is exactly the issue driving concern over the ultimate value of fiat currencies, so both key factors in gold’s rise are clearly still relevant and growing today. Not surprisingly, gold’s price has rebounded about 1.0% this morning, although it did fall an additional 2.5% early in the Asian session.

As to the other story, wow is all you can say. Q2 GDP fell 20.4% in the UK, more than double the US decline and the worst G10 result by far. Social distancing is a particularly damaging policy for the UK economy because of the huge proportion of services activity that relies on personal contact. But the UK government’s relatively slow response to the outbreak clearly did not help the economy there, and the situation on the ground indicates that there are still several pockets of rampant infection. One thing working in the UK’s favor, and thus the pound’s as well, is that despite the depths of the Q2 data, recent activity reports on things like IP and capital formation have actually been better than expected. The point is, this data, while shocking, is old news, as is evidenced by the fact that the pound is unchanged on the day while the FTSE 100 is higher by more than 1% as I type.

So, what are the mixed messages? Well, the collapse in gold prices on the back of rising yields would ordinarily be an indication of a stronger than expected economic result, as increased activity led to more credit demand and higher yields. But the UK GDP result is just the opposite, a dramatic decline that has put even more pressure on both PM Johnson’s government as well as the BOE to increase fiscal and monetary stimulus, thus driving yields lower and debasing the currency even further. So which story will ultimately dominate? That, of course, is the $64 trillion question, but for now, my money is on weaker growth, lower yields and a gold rebound.

Not dissimilar to the mixed messages of those two stories, today’s session has seen a series of mixed outcomes. For instance, equity markets are showing no consistency with both gainers (Nikkei +0.4%, Hang Seng +1.4%) and losers (Shanghai -0.6%) in Asia with similar mixed action in Europe (CAC +0.4%, DAX 0.0%, Stockholm -0.5%). Not to worry, US futures are pointing higher across the board by roughly 0.75%.

Bond markets, however, are pretty consistent, with 10-year yields higher in virtually every market (New Zealand excepted), as Treasuries rise 2.5bps, UK gilts a similar amount and German bunds a bit more than 3bps. In fact, Treasury yields, now at 0.67%, are 17bps higher in the past 6 sessions, the largest move we have seen since May. But again, I see no evidence that the big picture stories have changed nor any reason for US yields, at least in the front end, to rebound any further. One can never get overly excited by a single day’s movement, especially in as volatile an environment as we currently sit.

Finally, the dollar, too, is having a mixed session, with kiwi the leading decliner, but weakness also seen in JPY (-0.45%) and AUD (-0.25%). Meanwhile, the ongoing rally in oil prices continues to support NOK (+0.55%), with SEK (+0.45%) rising on the back of firmer than expected CPI data this morning. (As an aside, the idea that we are in a massively deflationary environment is becoming harder and harder to accept given that virtually every nation’s inflation data has been printing at much higher than expected levels.)

EMG currencies, keeping with the theme of the day, are also mixed, with TRY (-1.3%) the worst in the world as investors and locals continue to flee the currency and the country amid disastrous monetary policy activity. IDR (-0.55%) is offered as Covid cases continue to rise and despite the central bank’s efforts to contain its weakness, and surprisingly, RUB (-0.25%) is softer despite oil’s rally. On the plus side, the gains are quite modest, but CZK (+0.3%) and ZAR (+0.3%) lead the way with the former simply adding to yesterday’s gains while the rand seemed to benefit from a positive economic survey result.

This morning brings US CPI (exp 0.7%, 1.1% ex food & energy) on an annual basis, but as Chairman Powell and his minions have made clear, inflation is not even a top ten concern these days. However, if we see a higher than expected print, it is entirely realistic to see Treasury yields back up further.

Overall, the dollar remains under modest pressure, but one has to wonder if yesterday’s gold price action is a precursor to a correction here as well. Remember, positioning is extremely short the dollar, so any indication that the Fed will be forced to address inflation could well be a signal for position reductions, and hence a dollar rebound.

Good luck and stay safe
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Faded Away

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It started when Trump hinted that
The capital gains tax was at
A rate much too high
And cuts were close by
His words, thus, a rally begat

Then Germany joined in the fray
As data from their ZEW survey
Exploded much higher
Now stocks are on fire
While havens have faded away

It used to be that you could determine the nature of a nation’s government by their response time to major events. So, autocratic nations were able to respond extremely quickly to negative events because a single man (and it was always a man) made the decisions and those who didn’t follow orders found themselves removed from the situation. Conscientious objection was not a viable alternative. Meanwhile, democratically elected governments always took more time to react because the inherent nature of democratic debate was slow and messy, with everyone needing to make their case, and then a majority formed to move forward.

This broad view of government decision-making was generally true for as long as economies were based on the production of real goods and services. However, that economic model has been essentially retired and replaced by the new concept of financialization. This is the process by which private actors recognize there is more value to be obtained (and with less risk!) if they spend their time and effort re-engineering their balance sheet rather than investing in their underlying business.

The upshot of the financialization of economies is that government response times to crises have been shortened remarkably. (It is important to understand that in this context, central banks, despite their “independence”, are part of the government). So, now even democratically elected governments can respond with alacrity to ongoing crises. This begs the question of whether democratically elected governments have become more autocratic (lockdowns anyone?), or whether this is simply the natural evolution of the democratic process when combined with media tools like Facebook and Twitter, where responses can be formulated and disseminated in minutes.

At any rate, the key observation is that government officials everywhere have taken the combination of financialization and high-speed response quite seriously, and we now get policies floated and implemented in a fraction of the time it used to take. The main reason this can be done is because policies that address financial questions are much easier to implement than policies that address production bottlenecks. After all, it is a lot easier for the Fed to decide to buy Fallen Angels than it is for 535 people, many of whom hate each other, to agree on a package of policies that might help support small businesses and shop owners.

This has been a build-up to help understand the key theme today: risk is back!! Or perhaps, the proper statement is risk-on is back. Last evening, President Trump floated the idea that a capital gains tax cut was just the remedy to help the US economy get back on its feet. But the reality is that the only thing a capital gains tax cut will accomplish is to help boost the stock market further. After all, the S&P 500, after yesterday’s modest 0.3% rally, is still 1.0% below its all-time high. Such lagging performance cannot be tolerated apparently, hence the genesis of this idea. But it was enough to achieve its goal, a further boost in equity markets worldwide.

A quick look at markets overnight shows the Nikkei (+1.9%) and Hang Seng (+2.1%) followed the bullish sentiment, although surprisingly, Shanghai (-1.1%) could not hold onto early gains. Even with that decline, the Shanghai Composite is up more than 5% in the past two weeks, hardly a true laggard. Meanwhile, Europe has really taken the bit in its teeth and is flying this morning, getting a good start from the Asian movement and then responding extremely positively to the German ZEW survey results where the Expectations component printed at 71.5, its highest level since December 2003. So, despite the growth in Covid cases in Germany, the business community is looking forward to robust times in the near future. This was all equity traders and investors needed to see to get going and virtually every European bourse is higher by more than 2.2% this morning. Of course, it would not be a successful outcome if US markets didn’t rise as well, and futures this morning are all green, pointing to between 0.5% (NASDAQ) and 1.0% (DJIA) gains on the opening.

Naturally, the risk on environment has resulted in Treasury bond sales. After all, there is no need to own something as pedantic as a bond when not only are stocks available, but the tax rate on your gains is going to be reduced! And so, 10-year Treasury yields have risen 3bps this morning, and are back at 0.60%, 10bps higher than the new lows seen just one week ago today. And that price behavior is common amongst all European government bond markets, with German bund yields higher by 3.3bps and UK gilts nearly 4bps higher.

But the biggest victim of this move has clearly been gold, which has tumbled 2% this morning and is back below $2000/oz for the first time in a week. There is no question that precious metals markets have been getting a bit frothy, so this pullback is likely simple profit taking and not a change in any trend.

Finally, as we turn to the dollar, the risk-on attitude is playing out in its traditional fashion this morning, with the buck falling against 9 of its G10 counterparts with only the yen weaker versus the dollar. NOK (+0.8%) is the big gainer, rallying on the back of the ongoing rally in oil prices (WTI +2.5%), but we are seeing solid gains of roughly 0.4% across most of the rest of the bloc. The one laggard, aside form JPY (-0.14%), is the pound where the UK released employment data today that simply demonstrated how difficult things are there. This seems to have held the pound back as it is only higher by 0.2% this morning.

In the EMG space, RUB and ZAR (both +0.8%) are the leaders with the former clearly an oil beneficiary, while the latter, despite gold’s decline, has been the beneficiary of the hunt for yield as South Africa continues to have amongst the highest real yields in the world. But pretty much the whole bloc is in the green today as the simple concept of risk-on is the driver.

On the data front, the NFIB Small Business Index disappointed at 98.8, a clear indication that a capital gains tax cut does not seem to be the best solution for the economy. At 8:30 we get PPI (exp -0.7% Y/Y, +0.1% Y/Y core) but not only is this data backwards looking, the Fed has basically told us they don’t care about inflation at all anymore. We also hear from two Fed speakers, Barkin and Daly, but again, there is very little new that is likely to come from their comments.

Today is a risk-on day and after a brief consolidation, the dollar feels like it has further room to decline. Versus the euro, I imagine a test of 1.20 is coming soon, but it is not clear to me how much further we can go from there. As such, for receivables hedgers, adding a little to the mix at current levels is likely to be a good strategy.

Good luck and stay safe
Adf

More Growth to Ignite

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While Congress continued to fight
The President stole the limelight
Four orders he signed
As he tries to find
The kindling, more growth to ignite

As I return to action after a short hiatus, it doesn’t appear the market narrative has changed very much at all.  Broadly speaking, markets continue to be focused on, and driven by, the Fed and other central banks and the ongoing provision of extraordinary liquidity.  Further fiscal stimulus remains a key objective of both central bankers and central planners everywhere, and the arguments for the dollar’s decline and eventual collapse are getting inordinate amounts of airtime.

Starting with the fiscal side of the equation, the key activity this weekend was the signing, by President Trump, of four executive orders designed to keep the fiscal gravy train rolling.  By now, we are all aware that the Democratic led House had passed a $3.5 trillion fiscal stimulus bill while the Republican led Senate had much more modest ambitions, discussing a bill with a price tag of ‘only’ $1.0-$1.5 trillion.  (How frightening is it that we can use the term ‘only’ to describe $1 trillion?)  However, so far, they cannot agree terms and thus no legislation has made its way to the President’s desk for enactment.  Hence, the President felt it imperative to continue the enhanced unemployment benefits, albeit at a somewhat reduced level, as well as to prevent foreclosures and evictions while reducing the payroll tax.

Naturally, this has inflamed a new battle regarding the constitutionality of his actions, but it will certainly be difficult for either side of the aisle to argue that these orders should be rescinded as they are aimed directly at the middle class voter suffering from the economic effects of the pandemic.

Another group that must be pleased is the FOMC, where nearly to a (wo)man, they have advocated for further fiscal stimulus to help them as they try to steer the economy back from the depths of the initial lockdown phase of the pandemic.  Perhaps we should be asking them why they feel it necessary to steer the economy at all, but that is a question for a different venue.  However, along with central banks everywhere, the Fed has been at the forefront of the calls for more fiscal stimulus.  Again, despite the unorthodox methodology of the stimulus coming to bear, it beggars belief that they would complain about further support.

So, while political squabbles will continue, so will enhanced unemployment benefits.  And that matters to the more than 31 million people still out of work due to the impact of Covid-19 on the economy.  Of course, the other thing that will continue is the Fed’s largesse, as there is absolutely no indication they are going to be turning off the taps anytime soon.  And while their internal discussions regarding the strength of their forward guidance will continue, and to what metrics they should tie the ongoing application of stimulus, it is already abundantly clear to the entire world that interest rates in the US will not be rising until sometime in 2023 at the earliest.

Which brings us to the third main discussion in the markets these days, the impending collapse of the dollar.  Once again, the weekend literature was filled with pontifications and dissertations about why the dollar would continue its recent decline and why it could easily turn into a rout.  The key themes appear to be the US’s increasingly awful fiscal position, with debt/GDP rising rapidly above 100%, the fact that the Fed is going to continue to add liquidity to the system for years to come, and the fact that the US is losing its status as the global hegemon.

And yet, it remains exceedingly difficult, at least in my mind, to make the case that the end of the dollar is nigh.  As I have explained before, but will repeat because it is important to maintain perspective, not only is the dollar not collapsing, it is actually little changed if we look at its value since the beginning of 2020.  And as I recall, there was no discussion of the dollar collapsing back then.  Whether looking at the G10 or the EMG bloc, what we see is that there are some currencies that have performed well, and others that have suffered this year.  For example, despite the dollar’s “collapse”, CAD has fallen 3.0% so far in 2020, and NOK has fallen 2.9%.  Yes, SEK is higher by 7.0% and CHF by 5.3%, but the tally is six gainers and four laggards, hardly an indication of irretrievable decline.

Looking at the EMG bloc, it is even clearer that the dollar’s days are not yet numbered.  YTD, BRL has tumbled 25.9%, ZAR has fallen 21.2% and TRY, the most recent victim of true economic mismanagement, is lower by 18.6%.  The fact that the Bulgarian lev (+4.8%) and Romanian leu (+3.8%) are a bit higher does not detract from the fact that the dollar continues to play a key role as a haven asset.

Finally, I must mention the euro, which has gained 4.8% YTD.  When many people think of the dollar’s value rising or falling, this is the main metric.  But again, keeping things in context, the euro, currently trading around 1.1750, is still below the midpoint of its historic range (0.8230-1.6038) as well as its lifetime average (1.2000).  The point is, there is no evidence of a collapse.  And there are two other things to keep in mind; first, the fact that it is assumed the Fed will continue to ease policy for years ignores the fact that the ECB will almost certainly be required to ease policy for an even longer time.  And second, long positioning in EURUSD is now at historically high levels, with the CFTC showing record long outstanding positions.  The point is, there is far more room for a correction than for a continued collapse.

One last thing to consider is that despite the shortcomings of the US economy right now, the reality remains that there is currently no viable alternative to replace the greenback as the world’s reserve currency.  And there won’t be one for many years to come.  While modest further dollar weakness vs. the euro and some G10 currencies is entirely reasonable, do not bet on a collapse.

With that out of the way, the overnight session was entirely lackluster across all markets, as summer holidays are what most traders are either dreaming about, or living, so I expect the next several weeks to see less volatility.  As to the data this week, Retail Sales and CPI are the highlights, although I continue to look at Initial Claims as the most important number of all.

Today JOLTS Job Openings 5.3M
Tuesday NFIB Small Business 100.4
  PPI 0.3% (-0.7% Y/Y)
  -ex food & energy 0.1% (0.0% Y/Y)
Wednesday CPI 0.3% (0.7% Y/Y)
  -ex food & energy 0.2% (1.1% Y/Y)
Thursday Initial Claims 1.1M
  Continuing Claims 15.8M
Friday Retail Sales 1.9%
  -ex autos 1.3%
  Nonfarm Productivity 1.5%
  Unit Labor Costs 6.2%
  IP 3.0%
  Capacity Utilization 70.3%
  Business Inventories -1.1%
  Michigan Sentiment 71.9

Source: Bloomberg

While I’m sure Retail Sales will garner a great deal of interest, it remains a backward-looking data point, which is why I keep looking mostly at the weekly claims data.  In addition to this plethora of new information, we hear from six different Fed speakers, but ask yourself, what can they say that is new?  Arguably, any decision regarding the much anticipated changes in forward guidance will come from the Chairman, and otherwise, they all now believe that more stimulus is the proper prescription going forward.

Keeping everything in mind, while the dollar is not going to collapse anytime soon, that does not preclude some further weakness against select currencies.  If I were a hedger, I would be thinking about taking advantage of this dollar weakness, at least for a portion of my needs.

Good luck and say safe

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Riddle Me This

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On Monday, the dollar went higher
Though stocks, people still did acquire
So riddle me this
Is something amiss?
Or did links twixt markets expire?

The risk-on/risk-off framework has been critical in helping market participants understand, and anticipate, market movements.  The idea stems from the fact that market psychology can be gleaned from the herd behavior of investors.  As a recap, observation has shown that a risk-off market is one where haven assets rally while those perceived as riskier decline.  This means that Treasury bonds, Japanese yen, Swiss francs, US dollars and oftentimes gold are seen as stable stores of value and see significant demand during periods of fear.  Similarly, equities, credit and most commodities are seen as much riskier, with less staying power and tend to suffer during those times.  Correspondingly, a risk-on framework is typified by the exact opposite market movements, as investors are unconcerned over potential problems and greed drives their activities.

What made this framework so useful was that for those who interacted with the market only periodically, for example corporate hedgers, they could take a measure of the market tone and get a sense of when the best time might be to execute their needed activities.  (It also helped pundits because a quick look at the screens would help explain the bulk of the movement across all markets.)  And, in truth, we have been living in a risk-on/risk-off world since the Asia crisis and Long Term Capital bankruptcy in 1998.  That was also the true genesis of the Powell (nee Greenspan) Put where the Fed was quick to respond to any downward movement in equity markets (risk coming off) by easing monetary policy.  Not surprisingly, once the market forced the Fed’s hand into easing policy, it would revert to snapping up as much risk as possible.

Of course, what we have seen over the past two plus decades is that the size of each downdraft has grown, and in turn, given the law of diminishing returns, the size of the monetary response has grown even more, perhaps exponentially.

Overall, market participants have become quite comfortable with this operating framework as it made decision-making easier and created profit opportunities for the nimblest players.  After all, in either framework, a movement in a stock index was almost assured to see a specific movement in both bonds and the dollar.  Given that stocks are typically seen as the most visible risk signal, causality almost always moved in that direction.

But lately, this broad framework is being called into question.  Yesterday was a perfect example, where stock markets performed admirably, rising between 0.75% and 2.5% throughout the G10 economies and at the same time, the dollar rose along with bond yields.  Now I grant you that neither increase was hugely significant, and in fact it faded somewhat toward the end of the session, but nonetheless, the correlations had the wrong sign.  And yesterday was not the first time we have seen that price action, it has been happening more frequently over the past several months.

So, the question is, has something fundamental changed?  Or is this merely a quirk of recent markets?  Looking at the nature of the assets in question, I think it is safe to say that both equities and credit remain risk assets which are solidly representative of investors’ overall risk appetite.  In fact, I challenge anyone to make the case in any other way.  If this is the case, then it points to a change in the nature of the haven assets.

Regarding bonds, specifically Treasuries, there is a growing dispersion of views as to their ultimate use as a safe haven.  I don’t believe anyone is actually concerned with being repaid, the Fed will print the dollars necessary to do so, but rather with the safety of holding an asset with almost no return (10-year yields at 0.54%, real yields at -1.0%), that correspondingly has massive convexity.  This means that in the event bonds start to sell off, every basis point higher results in a much more significant capital depreciation, exactly the opposite of what one would be seeking in a haven asset.  Quite frankly, I don’t think this issue gets enough press, but it is also not the purview of this commentary.

Which takes us to the dollar, and the yen and Swiss franc.  Here the narrative continues to evolve toward the idea that given the extraordinary amount of monetary and fiscal ease promulgated by the US, the dollar’s value as a haven asset ought to diminish.  Ironically, I believe that the narrative argument is exactly backwards.  In fact, the creation of all those dollars (which by the way has been in response to extraordinary foreign demand) makes the dollar that much more critical in times of stress and should reinforce the idea of the dollar as a safe haven.  The one thing of which you can be certain is that the dollar will be there and allow the holder to acquire other things.  And after all, isn’t that what a haven is supposed to do?  A haven asset is one which will maintain its value during times of stress.  This encompasses its value as a medium of exchange, as well as a store of value.  Dollars, at this point, will always be accepted for payment of debt, and that is real value.  In the end, I expect that recent market activity is anomalous and that we are going to see a return to the basic risk-on/risk-off framework by the Autumn.

Today, however, continues to show market ambivalence.  Other than Asian equity markets, which were generally strong on the back of yesterday’s US performance, the picture today is mixed.  European bourses show no pattern (DAX -0.4%, CAC +0.1%), US futures are ever so slightly softer and bond markets are very modestly firmer (yields lower) with 10-year Treasuries down 1.5bps.

However, along with these movements, the dollar and yen are generally a bit softer. Or perhaps a better description is that the dollar is mixed.  We have seen dollar strength vs. some EMG currencies (ZAR -1.35%, RUB -0.9%, MXN -0.5%) all of which are feeling the strains of declining commodity prices (WTI and Brent both -1.5%).  But several Asian currencies along with the CE4 have all continued to perform well this morning, notably THB (+0.45%) as investor demand for baht bonds continues to grow.  In the G10 space, the picture is mixed as well, with the pound the worst performer (-0.3%) and the Swiss franc the best (+0.25%).  The thing is, given the modest amount of movement, it is difficult to spin much of a story in either case.  If we continue to see eqity market weakness today, I do expect the dollar will improved slightly as the session progresses.

As to data for the rest of the week, there is plenty with payrolls the piece de resistance on Friday:

Today Factory Orders 5.0%
Wednesday ADP Employment 1.2M
  Trade Balance -$50.2B
  ISM Services Index 55.0
Thursday Initial Claims 1.414M
  Continuing Claims 16.9M
Friday Nonfarm Payrolls 1.5M
  Private Payrolls 1.35M
  Manufacturing Payrolls 280K
  Unemployment Rate 10.5%
  Average Hourly Earnings -0.5% (4.2% Y/Y)
  Average Weekly Hours 34.4
  Participation Rate 61.8%
  Consumer Credit $10.0B

Source: Bloomberg

The thing is, while all eyes will be on the payroll report on Friday, I still believe Thursday’s Initial Claims number is more important as it gives a much timelier indication of the current economic situation.  If we continue to plateau at 1.4 million lost jobs a week, that is quite a negative sign for the economy.  Meanwhile, there are no Fed speakers today, although yesterday we heard a chorus of, ‘rates will be lower for longer and if inflation runs hot there are no concerns’.  Certainly, that type of discussion will undermine the dollar vs. some other currencies but does not presage a collapse (after all, the BOJ has been saying the same thing for more than two decades and the yen hasn’t collapsed!).  For the day, I expect that the market is getting just a bit nervous and we may see a modest decline in stocks and a modest rally in the dollar.

Finally, I am taking several days off so there will be no poetry until Monday, August 10.

Good luck, stay safe and have a good rest of the week

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Poison Pens

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The headlines all weekend have shouted
The dollar is sure to be routed
If Covid-19
Remains on the scene
A rebound just cannot be touted

But ask yourself this my good friends
Have nations elsewhere changed their trends?
Infections are rising
Despite moralizing
By pundits who wield poison pens

Based on the weekend’s press, as well as the weekly analysis recaps, the future of the dollar is bleak. Not only is it about to collapse, but it will soon lose its status as the world’s reserve currency, although no one has yet figured out what will replace it in that role. This is evident in the sheer number of articles that claim the dollar is sure to decline (for those of you with a Twitter account, @pineconemacro had a great compilation of 28 recent headlines either describing the dollar’s decline or calling for a further fall), as well as the magnitude of the short dollar positions in the market, as measured by CFTC data. As of last week, there are record long EUR positions and near-record shorts in the DXY.

So, the question is, why does everybody hate the dollar so much? It seems there are two reasons mentioned most frequently; the impact of unbridled fiscal and monetary stimulus and the inability of the US to get Covid-19 under control. Let’s address them in order.

There is no question that the Fed and the Treasury, at the behest of Congress, have expended extraordinary amounts of money to respond to the Covid crisis. The Fed’s balance sheet has grown from $4.2 trillion to $7.0 trillion in the course of four months. And of course, the Fed has basically bought everything except your used Toyota in an effort to support market functionality. And it is important to recognize that what they continue to explain is that they are not supporting asset prices per se, rather they are simply insuring that financial markets work smoothly. (Of course, their definition of working smoothly is asset prices always go higher.) Nonetheless, the Fed has been, by far, the most active central bank in the world with respect to monetary support. At the same time, the US government has authorized about $3.5 trillion, so far, of fiscal support, although there is much anxiety now that the CARES act increase in unemployment benefits lapsed last Friday and there is still a wide divergence between the House and Senate with respect to what to do next.

But consider this; while the US is excoriated for borrowing too much and expanding both the budget deficit and the amount of debt issued, the EU was celebrated for coming to agreement on…borrowing €2 trillion to expand the budget deficit and support the economies of each nation in the bloc. Debt mutualization, we have been assured, is an unalloyed good and will help the EU’s overall economic prospects by allowing the transfer of wealth from the rich northern nations to the less well-off southern nations. And of course, given the collective strength of the EU, they will be able to borrow virtually infinite sums from the market. Perhaps it is just me, but the stories seem pretty similar despite the spin as to which is good, and which is bad.

The second issue for the dollar, and the one that is getting more press now, is the fact that the US has not been able to contain Covid infections and so we are seeing a second wave of economic shutdowns across numerous states. You know, states like; Victoria, Australia; Melbourne, Australia; Tokyo, Japan; the United Kingdom and other large areas. This does not even address the ongoing spread of the disease through the emerging markets where India and Brazil have risen to the top of the worldwide caseload over the past two months. Again, my point is that despite reinstituted lockdowns in many places throughout the world, it is the US which the narrative points out as the problem.

It is fair to describe the dollar’s reaction function as follows: it tends to strengthen when either the US economy is outperforming other G10 economies (a situation that prevailed pretty much the entire time since the GFC) or when there is unbridled fear that the world is coming to an end and USD assets are the most desirable in the world given its history of laws and fair treatment of investors. In contrast, when the US economy is underperforming, it is no surprise that the dollar would tend to weaken. Well the data from Q2 is in and what we saw was that despite the worst ever quarterly decline in the US, it was dwarfed by the major European economies. At this time, the story being told seems to be that in Q3, the rest of the world will rapidly outpace the US, and perhaps it will. But that is a pretty difficult case to make when, first, Covid inspired lockdowns are popping up all around the world and second, the consumer of last resort (the US population) has lost their appetite to consume, or if not lost, at least reduced.

Once again, I will highlight that the dollar, while definitely in a short-term weakening trend, is far from a collapse, and rather is essentially right in the middle of its long-term range. This is not to say that the dollar cannot fall further, it certainly can, but do not think that the dollar is soon to become the Venezuelan bolivar.

And with that rather long-winded defense of the dollar behind us, let’s take a look at markets today. Equity markets continue to enjoy central bank support and have had an overall strong session. Asia saw gains in the Nikkei (+2.25%) and Shanghai (+1.75%) although the Hang Seng (-0.55%) couldn’t keep up with the big dogs. Europe’s board is no completely green, led by the DAX (+2.05%) although the CAC, which was lower earlier, is now higher by 1.0%. And US futures, which had spent the evening in the red are now higher as well.

Bond markets are embracing the risk-on attitude as Treasury yields back up 2bps, although are still below 0.55% in the 10-year. In Europe, the picture is mixed, and a bit confusing, as bund yields are actually 1bp lower, while Italian BTP’s are higher by 2bps. That is exactly the opposite of what you would expect for a risk-on session. But then, the bond market has not agreed with the stock market since Covid broke out.

And finally, the dollar, is having a pretty strong session today, perhaps seeing a bit of a short squeeze, as I’m sure the narrative has not yet changed. In the G10, all currencies are softer vs. the greenback, led by CHF (-0.6%) and AUD (-0.55%), although the pound (-0.5%) which has been soaring lately, is taking a rest as well. What is interesting about this move is that the only data released overnight was the monthly PMI data and it was broadly speaking, slightly better than expected and pointed to a continuing rebound.

EMG currencies are also largely under pressure, led by ZAR (-1.15%) and then the CE4 (on average -0.7%) with almost the entire bloc softer. In fact, the outlier is RUB (+0.8%), which seems to be the beneficiary of a reduction in demand for dollars to pay dividends to international investors, and despite the fact that oil prices have declined this morning on fears that the OPEC+ production cuts are starting to be flouted.

It is, of course, a huge data week, culminating in the payroll report on Friday, but today brings only ISM Manufacturing (exp 53.6) with the New Orders (55.2) and Prices Paid (52.0) components all expected to show continued growth in the economy.

With the FOMC meeting now behind us, we can look forward, as well, to a non-stop gabfest from Fed members, with three today, Bullard, Barkin and Evans, all set to espouse their views. The thing is, we already know that the Fed is not going to touch rates for at least two years, and is discussing how to try to push inflation higher. On the latter point, I don’t think they will have to worry, as it will get there soon enough, but their models haven’t told them that yet. At any rate, the dollar has been under serious pressure for the past several months. Not only that, most of the selling seems to come in the US session, which leads me to believe that while the dollar is having a pretty good day so far, I imagine it will soften before we log out this evening.

Good luck and stay safe
Adf

 

Quite Sordid

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For Italy, France and for Spain
The data released showed their pain
Each nation recorded
A number quite sordid
And each, Covid, still can’t contain

As awful as the US GDP data was yesterday, with an annualized decline of 32.9%, this morning saw even worse data from Europe.  In fact, each of the four largest Eurozone nations recorded larger declines in growth than did the US in Q2.  After all, Germany’s 10.1% decline was a Q/Q number.  If we annualize that, it comes to around 41%.  Today we saw Italy (-12.4% Q/Q, -50% annualized), France (-13.8% Q/Q or -55% annualized) and Spain, the worst of the lot (-18.5% Q/Q or -75% annualized).  It is, of course, no surprise that the Eurozone, as a whole, saw a Q/Q decline of 12.1% which annualizes to something like 49%.  At those levels, precision is not critical, the big figure tells you everything you need to know.  And what we know is that the depths of recession in Europe were greater than anywhere else in Q2.

The thing is, none of this really matters any more.  The only thing the Q2 GDP data did was establish the base from which future growth will occur.  We saw this in the US yesterday, where equity markets rallied, and we are seeing and hearing it today throughout Europe as the narrative is quite clear; Q2 was the nadir and things should get better going forward.  In fact, that is the entire thesis behind the V-shaped recovery.  Certainly, one would be hard pressed to imagine a situation where Q3 GDP could shrink relative to Q2, but unfortunately the rebound story is running into some trouble these days.

The trouble is making itself known in various ways.  For example, the fact that the Initial Claims data in the US has stopped declining is a strong indication that growth is plateauing.  This is confirmed by the resurgence of Covid cases being recorded throughout the South and West and the reimposition of lockdown measures and closures of bars and restaurants in California, Texas and Arizona.  And, alas, we are seeing the same situation throughout Europe (and in truth, the rest of the world) as nations that had been lionized for their ability to act quickly and prevent the spread of the virus through draconian measures, find that Covid is quite resilient and infections are surging in Spain, Italy, Germany, the UK, Japan, Singapore, South Korea and even in China.  You remember China, the origin of the virus, and the nation that explained they had eradicated it completely just last month.  Maybe eradicated was too strong a word.

So, the real question is, what happens to markets if the future trajectory of growth is much shallower than a V?  It is not difficult to argue that equity markets, especially in the US, are priced for the retracement of all the lost growth.  That seems to be at odds with the situation on the ground where thousands of small businesses have closed their doors forever.  And not just small businesses.  The list of bankruptcy filings by large, well-known companies is staggeringly long.

Can continued monetary and fiscal support from government institutions really replace true economic activity?  Of course, the answer to that question is no.  Money from nothing and excessive debt issuance will never substitute for the creation of real goods and services that are demanded by the population.  So, while equity markets trade under the assumption that government support is a stop-gap filler until activity returns to normal, the recent, high-frequency data is implying that the gap could be much longer than initially anticipated.

And as has been highlighted in many venues, the bond market is telling a different story.  Treasury yields out to 10 years are now trading at record lows.  The amount of negative yielding debt worldwide is climbing again, now back to $16 trillion, and heading for the record levels seen at the end of last August.  This price behavior is the very antithesis of expected strong growth in the future.  Rather it signals concerns that growth will be absent for years to come, and with it inflationary pressures.  At some point, these two asset classes will both agree on a story, and one of them will require a major repricing.  My money is on the stock market to change its tune.

But that is a longer term discussion.  For now, let us review the overnight session.  It is hard to characterize it as either risk-on or risk-off, as we continue to see mixed signals from different markets.  In Asia, the Nikkei was the worst performer, falling 2.8% as concerns grow that a second wave of Covid infections is going to stop the signs of recovery.  Confirming those fears, a meeting of government and central bank officials took place where they discussed what to do in just such a situation, which of course means there will be more stimulus, both monetary and fiscal, on its way soon.  The yen behaved as its haven status would dictate, rallying further and touching a new low for the move at 104.19 before backtracking and sitting unchanged on the day as I type.  The thing about the yen is that 105 had proven to be a strong support level and is now likely going to behave as resistance.  While I don’t see a collapse, USDJPY has further to fall.

The rest of Asia saw weakness (Hang Seng -0.5%, Sydney -2.0%) and strength (Shanghai +0.7%) with the latter responding to modestly better than expected PMI data, while the former two are feeling the impact of the rise in infections.  Europe, on the other hand, is green across the board, with Italy’s FTSE MIB (+1.25%) leading the way, although the DAX (+0.7%) is performing well.  Here, just like in the US, investors seem to believe in the V-shaped recovery and now that the worst has been seen, those investors are prepared to jump in with both feet.

As discussed above, bond markets continue to rally, and yields continue to fall.  That is true throughout Europe as well as in the US.  In fact, it is true in Asia as well, with China the lone exception, seeing its 10-year yield rise 4bps overnight.

And finally, the dollar can only be described as mixed.  In the G10, NZD (-0.5%) and AUD (-0.2%) are the worst performers as both suffer from concerns over growing numbers of new Covid cases, while SEK and GBP (+0.25% each) lead the way higher.  It is ironic as there is concern over the growing number of cases in those nations as well, and, in fact, the UK is locking down over 4 million people in the north because of a rise in infections.  But the pound has been on fire lately, and that momentum shows no signs of abating for now.  One would almost think that a Brexit deal has been agreed, but the latest news has been decidedly negative there.  This is simply a reminder that FX is a perverse market.

Emerging markets have also seen mixed activity, although it is even more confusing.  Even though commodities are having a pretty good day, with both oil and gold prices higher, the commodity currencies are the worst performers today, with ZAR (-1.35%), RUB (-1.0%) and MXN (-0.9%) all deeply in the red.  On the positive side, THB (+0.85%) and CNY (+0.5%) are showing solid strength.  The renminbi, we already know, is benefitting from the better than expected PMI data while the baht benefitted from ongoing equity inflows.

This morning we see another large grouping of data as follows: Personal Income (exp -0.6%), Personal Spending (5.2%), core PCE Deflator (1.0%), Chicago PMI (44.5) and Michigan Sentiment (72.9).  As inflation is no longer even a concern at the Fed, or any G10 central bank, the market is likely to look at two things, Spending data which could help cement the idea that things are rebounding nicely, or not, and Chicago PMI, as an indication of whether industrial activity is picking up again.

Overall, regardless of the data, the trend remains for the dollar to decline, at least against its G10 brethren and I see nothing that is going to change that trend for now.  At some point, it will make sense for receivables hedgers to take advantage, but it is probably still too early for that.

Good luck, good weekend and stay safe

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