Deep-Sixed

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
Adf

 

Faded Away

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

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

Adf

 

 

 

 

 

Riddle Me This

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

Adf

 

Poison Pens

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

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

Adf

 

Struck by the Flu

If you think that Jay even thought
‘bout thinking ‘bout thinking he ought
To raise interest rates
He’ll not tempt the fates
Despite all the havoc ZIRP’s wrought

Meanwhile, ‘cross the pond what we learned
Is Germany ought be concerned
Their growth in Q2
Was struck by the flu
As exports, their customers, spurned

(Note to self; dust off “QE is Our Fate” on September 16, as that now seems a much more likely time to anticipate how the Fed is going to adjust their forward guidance.) Yesterday we simply learned that rates are going to remain low for the still indeterminate, very long time. Clearly, the bond market has gotten the message as yields along the Treasury curve press to lows in every tenor out through 7-year notes while the 10-year sits just 1.5 bps above the lows seen in March at the height of the initial panic. This should be no surprise as the FOMC statement and ensuing press conference by Chairman Powell made plain that the Fed is committed to use all their available tools to support the economy. Negative rates are not on the table, yield curve control is already there, effectively, so the reality is they only have more QE and forward guidance left in their toolkit. Powell promised that QE would be maintained at least at the current level, and the question of forward guidance is tied up with the internal discussions on the Fed’s overall policy framework. Those discussions have been delayed by the pandemic but are expected to be completed by the September meeting. Perhaps, at that time, they will let us know what they plan to do about their inflation mandate. The smart money is betting on a commitment to allow inflation to overshoot their target for an extended period in order to make up for the ground lost over the past decade, when inflation was consistently below target. I guess you need to be a macroeconomist to understand why rising prices helps Main Street, because, certainly from the cheap seats, I don’t see the benefit!

The market response was in line with what would be expected, as yields fell a bit further, the dollar fell a bit further and stocks rallied a bit further. But that is soooo yesterday. Let’s step forward into today’s activities.

Things started on a positive note with Japanese Retail Sales jumping far more than expected (+13.1%) in June which took the Y/Y number to just -1.2%. That means that Japanese Retail Sales are almost back to where things were prior to the outbreak. Unfortunately, this was not enough to help the Nikkei (-0.3%) and had very little impact on the yen, which continues to trade either side of 105.00. Perhaps it was the uptick in virus cases in Japan which has resulted in further restrictions being imposed on bars and restaurants that is sapping confidence there.

Speaking of the virus, Australia, too, is dealing with a surge in cases, as Victoria and Melbourne have seen significant jumps. As it is winter in the Southern Hemisphere, there is growing concern that when the weather cools off here, we are going to see a much bigger surge in cases as well, and based on the current government response to outbreaks, that bodes ill for economic activity in the US come the fall.

But then, Germany reported their Q2 GDP data and it was much worse than expected at -10.1%. Analysts had all forecast a less severe decline because Germany seemed to have had a shorter shutdown and many fewer unemployed due to their labor policies where the government pays companies to not lay-off workers. So, if the shining star of Europe turned out worse than expected, what hope does that leave us for the other major economies there, France, Italy and Spain, all of which are forecast to see declines in Q2 GDP in excess of 15%. That data is released tomorrow, but the FX market wasted no time in selling the euro off from its recent peak. This morning, the single currency is lower by 0.35%, although its short-term future will also be highly dependent on the US GDP data due at 8:30.

Turning to this morning’s US data, today is the day we get the most important numbers, as the combination of GDP (exp -34.5%), to see just how bad things were in Q2, and Initial (1.445M) and Continuing (16.2M) Claims, to see how bad things are currently, are to be released at 8:30. After the combination of weak German data and resurgence in virus cases in areas thought to have addressed the issue, it should be no surprise that today is a conclusively risk-off session.

We have seen that in equity markets, where both the Hang Seng (-0.7%) and Shanghai (-0.25%) joined the Nikkei lower in Asia while European bourses are all in the red led by the DAX (-2.3%) and Italy’s FTSE MIB (-2.2%). And don’t worry, US futures are all declining, with all three major indices currently pointing to 1% declines at the open.

We have already discussed the bond market, where yields are lower in the US and across all of Europe as well with risk being pared around the world. A quick word on gold, which is lower by 0.8%, and which may seem surprising to some. But while gold is definitely a long-term risk aversion asset, its day to day fluctuations are far more closely related to the movement in the dollar and today, the dollar reigns supreme.

In the G10 bloc, NOK is the laggard, falling 1.0% as oil prices come under pressure given the weak economic data, but we have seen substantial weakness throughout the entire commodity bloc with AUD (-0.6%) and CAD (-0.57%) also suffering. In fact, the only currency able to hold its own this morning is the pound, which is essentially unchanged on the day. In the EMG bloc, there are several major declines with ZAR (-1.6%), RUB (-1.4%) and MXN (-1.0%) leading the way down. The contributing factor to all three of these currencies is the weakness in the commodity space and corresponding broad-based dollar strength. But the CE4 are all lower by between 0.3% and 0.6%, and most Asian currencies also saw modest weakness overnight. In other words, today is a dollar day.

And that is really the story. At this point, we need to wait for the data releases at 8:30 to get our next cues on movement. My view is that the Initial Claims data remains the single most important data point right now. Today’s expectation is for a higher print than last week, which the market may well read as the beginning of a reversal of the three-month trend of declines. A higher than expected number here is likely to result in a much more negative equity day, and correspondingly help the dollar recoup even more of its recent losses.

Good luck and stay safe
Adf

QE is Our Fate

The Fed Chair, a banker named Jay
Will meet with his comrades today
Though no one expects
A change, it’s what’s next
That has traders set to make hay

Will guidance be tied to the rate
Of joblessness? Or will they state
Inflation is key
And ‘til there we see
Advances, QE is our fate

Today’s primary feature in the markets is the FOMC meeting where at 2:00 they will release their latest policy statement, and then at 2:30 Chairman Powell will hold a virtual press conference. As is often the case, market activity ahead of the meeting is muted as investors and traders are wary of taking on new positions ahead of a possible change in policy.

However, the punditry is nearly unanimous in its belief that there will be no policy changes today, and that the statement will be nearly identical to the previous version, with just some updates relating to the data that has been released since then. The big question is whether or not Chairman Powell will give an indication of what the next steps by the Fed are likely to be.

A quick review of the current policy shows that the Fed has a half dozen lending programs outstanding, which they extended to run through the end of 2020 in an announcement yesterday, and which are focused on corporate bonds, both IG and junk, municipal securities and small business loans. Of course, they continue to buy both Treasury and mortgage-backed securities as part of their more ordinary QE measures. And the Fed Funds rate remains at the zero bound. Consensus is that none of this will change.

The problem for the Fed is, short of simply writing everyone in the country a check (which is really fiscal policy) they are already buying all the debt securities that exist. While eventually, they may move on to purchasing equities, like the BOJ or SNB, at this point, that remains illegal. So, the thinking now goes that Forward Guidance is the most likely next step, essentially making a set of promises to the market about the future of policy and tying those promises to specific outcomes in the economic data. Given their mandate of full employment and stable prices, it is pretty clear they will tie rate movements to either the Unemployment Rate or the inflation rate. You may recall in the wake of the GFC, then Chairman Bernanke did just this, tying the eventual removal of policy accommodation to the Unemployment Rate. Alas, this did not work as well as the Fed had hoped. The first problem was that as the unemployment rate declined, it did not lead to the expected rise in inflation, so the Fed kept having to move its target lower. This did not inspire credibility in the central bank’s handling of the situation, nor its models. But the bigger problem is that the market became addicted to ZIRP and QE, and when Bernanke mentioned, off hand, in Congressional testimony, that some day the Fed would start to remove accommodation, he inspired what is now called the ‘Taper Tantrum’ where 10-year Treasury yields rose 1.3% in just over three months

You can be certain that Powell does not want to set up this type of situation, but, if anything, I would argue the market is more addicted to QE now than it was back then. At any rate, given the Fed’s need to show they are doing something, you can be sure that tied forward guidance is in our future. The question is, to what statistic will they tie policy? It is here where the pundits differ. There is a range of guesses as follows: policy will be unchanged until, 1) inflation is steadily trending to our 2.0% target, 2) inflation reaches out 2.0% target, or 3) inflation spends time above our 2% target in an effort to ‘catch up’ for previous low readings. This in order of most hawkish to least. Of course, they could focus on the Unemployment rate, and choose a level at which they believe full employment will be reached and thus start to pressure inflation higher.

The problem with the inflation target is that they have been trying to achieve their 2.0% target, based on core PCE, and have failed to do so consistently for the past 10 years. It is not clear why a claim they are going to continue to maintain easy money until they reach it now, let alone surpass that target, would have any credibility. On the Unemployment front, given what are certainly dramatic changes in the nature of the US economy in the wake of Covid-19, it beggars belief that there is any confidence in what the appropriate level of full employment is today. Again, it is hard to believe that their models have any semblance of accuracy in this area either.

And one other thing, most pundits don’t anticipate the announcement of new forward guidance until the September meeting, so this is all anticipation of something unlikely to occur for a while yet. But, as a pundit myself, we do need to have something to discuss on a day when markets remain uninteresting.

So, let’s take a quick look at today’s market activities. Equity markets remain mixed with both gainers (Shanghai +2.1%) and losers (Nikkei -1.2%) in Asia and in Europe (CAC +0.7%, DAX 0.0%, Italy -0.8%). US futures are edging higher, but not with any enthusiasm. Bond markets are all within a basis point of yesterday’s closing levels, although Treasuries did rally in the mild risk-off session we saw Tuesday with 10-year yields back below 0.60%. Yesterday, gold had a wild day, making new highs early in the overnight session and falling back 4% in NY before rebounding to close at $1960/oz. This morning it is little changed, but the trend remains higher.

Finally, the dollar is softer this morning, although yesterday saw a mixed session. The pound (+0.25%) has been a steady performer lately and is pressing toward 1.30 for the first time since early March, pre-Covid. While there was UK data on lending and money supply, this movement appears to be more technical in nature, with the added benefit that the dollar remains under pressure against all currencies. Elsewhere in the G10, oil’s strength this morning is helping NOK (+0.5%), while the rest of the bloc is just marginally firmer vs. the dollar.

In the emerging markets, the big winner today was THB (+0.8%) where the central bank is trying to make a change in the local gold market. Interestingly, gold traded in baht is a huge market, and one where the recent flows have resulted in excess baht strength. As such, the central bank is trying to change the market into a USD based gold market, which should remove upward pressure from the currency. But away from that, while the bulk of the bloc is firmer, the movement is 0.3% or less, hardly the stuff of dreams, and with no coherent message other than the dollar is soft.

And that’s really it for the day. There is no data of note to be released and so all eyes are on the FOMC. My money is on inflation based forward guidance, likely the most dovish type shooting for above target outcomes, but not to be put in place until September. And that means, the dollar’s recent downtrend is likely to continue to be the situation for the immediate future.

Good luck and stay safe
Adf

Deferred

In Europe, despite what you’ve heard
The rebound could well be deferred
The ECB told
The banks there to hold
More capital lest they’re interred

It seems that the ECB is still a bit concerned about the future of the Eurozone economy.  Perhaps it was the news that the Unemployment rate in Spain jumped up to 15.3%.  Or perhaps it was the news that cases of Covid are growing again in various hot spots across the Continent.  But whatever the reason, the ECB has just informed the Eurozone banking community that dividends are taboo, at least for the rest of 2020, and that they need to continue to bolster their capital ratios.  Now, granted, European banks have been having a difficult time for many years as the fallout from Negative interest rates has been accumulating each year.  So, not only have lending spreads shrunk, but given the Eurozone economy has been so slothful for so long, the opportunities for those banks to lend and earn even that spread have been reduced.  It should be no surprise that the banking community there is in difficult shape.

However, from the banks’ perspective, this is a major problem.  Their equity performance has been dismal, and cutting dividends is not about to help them.  So, the cost of raising more capital continues to rise while the potential profit in the business continues to fall.  This strikes me as a losing proposition, and one that is likely to lead to another wave of European bank mergers.  Do not be surprised if, in a few years, each major country in Europe has only two significant banks, and both are partly owned by the state.  Banking is no longer a private industry, but over the course of the past decade, since the GFC, has become a utility.  But unlike utilities that make a solid return on capital and are known for their steady dividend payouts, these are going to be owned and directed by the state, with any profits going back to the state.  I foresee the conservatorship model the US Treasury used for FNMA and FHLMC as the future of European banking.

The reason I bring this up is because amidst all the cooing about how the EU has finally changed the trajectory of Europe with their groundbreaking Pandemic relief package, and how this will establish the opportunity for the euro to become the world’s favored reserve currency, there are still many fundamental flaws in Europe, and specifically in the Eurozone, which will effectively prevent this from happening.  In fact, there was a recent study by Invesco Ltd, that showed central banks around the world expect to increase their reserve allocation to USD in the next year, not reduce those allocations.  This has been a key plank for the dollar bears, the idea that the world will no longer want dollars as a reserve asset.  Whatever one thinks about the US banking community and whether they serve a valuable purpose properly, the one truth is that they are basically the strongest banks in the world from a capital perspective.  And in the current environment, no country can be dominant without a strong banking sector.

In fact, this may be the strongest argument for the dollar to remain overpriced compared to all those econometric models that focus on the current account and trade flows.  A quick look at China’s banks shows they are likely all insolvent, with massive amounts of unreported, but uncollectable loans outstanding.  China has been the most active user of the extend and pretend model, rolling loans over to insolvent state companies in order to make it appear those loans will eventually be repaid.  Only US banks have the ability to write off significant amounts of their loan portfolio (remember, in Q2 the number was $38 billion) and remain viable and active institutions.  In fact, this is one of the main reasons the US economy has outperformed Europe for the past decade.  Covid or no, European banks will continue to drag the European economy down, mark my words.  And with that, the euro’s opportunity for significant gains will be limited.

But that is a much longer-term view.  Let us look at today’s markets now.  If pressed, I would describe them as ever so slightly risk-off, but the evidence is not that convincing.  Equity markets in around the world have been mixed, with few being able to follow the US markets continued strength.  For example, last night saw the Nikkei (-0.25%) slide along with Sydney (-0.4%) while both Shanghai and the Hang Seng rallied a solid 0.7%.  Europe, on the other hand has much more red than green, with the DAX (-0.35%) and CAC (-0.75%) leading the way, although Spain’s IBEX (+0.3%) seems to be rebounding from yesterday’s losses despite the employment data.  Meanwhile US futures, which were essentially unchanged all evening, have just turned modestly lower.

The bond market, though, is a little out of kilter with the stock market, as yields throughout Europe have moved higher despite the stock market performances there.  Meanwhile, Treasury yields are a half basis point lower than yesterday’s close, although yesterday saw the 10-year yield rise 4bps as risk fears diminished.  Gold and silver are consolidating this morning, with the former down 0.85% as I type, and the latter down 5.0%.  But in the overnight session, gold did trade to a new all-time high, at $1981/oz.  The rally in gold has been extremely impressive this year, and after touching new highs, there are now a few analysts who are growing concerned a correction is imminent.  From a trading perspective, that certainly makes sense, but in the end, the underlying story remains quite positive, and is likely to do so as long as central banks believe it is their duty to print as much money as they can as quickly as they can.

As to the dollar, it is broadly firmer this morning, although the movement has not been that impressive.  In the G10, kiwi is the biggest loser, down 0.5%, as talk of additional QE is heating up there.  But other than SEK (-0.4%), the rest of the block is just a bit softer, with CHF and JPY actually 0.1% firmer at this time.  Emerging market activity shows RUB (-0.8%) as the weakest of the lot, although we are also seeing softness in TRY and ZAR (-0.6% each) and MXN (-0.5%).  Softening oil and commodity prices are clearly not helping either the rand or peso, but as to TRY, it remains unclear what is driving it these days.

On the data front, yesterday saw Durable Goods print largely as expected, showing the initial bounce in the economy.  This morning brings Case Shiller Home Prices (exp 4.05%) and Consumer Confidence (95.0), neither of which seems likely to move the needle.  With the Fed on tap for tomorrow, despite the fact they are likely to leave well enough alone, there will be much ink spilled over the meeting.

In the end, the short-term trend remains for the dollar to soften further, today notwithstanding, but I don’t believe in the dollar collapse theory.  As such, receivables hedgers should really be looking for places to step in and add to your programs.

Good luck and stay safe

Adf

 

 

 

Hardly a Sign

The thing that I don’t understand
Is why people think it’s not planned
The dollar’s decline
Is hardly a sign
The FOMC’s lost command

Based on the breathless commentary over the weekend and this morning, one would have thought that the dollar is in freefall.  It’s not!  Yes, the dollar has been sliding for the past two months, but that is a blink of an eye compared to the fact that it has been trending higher since its nadir a bit more than twelve years ago.  In fact, if one uses the euro as a proxy, which many people do, at its current level, 1.1725 as I type, the single currency remains below the average rate over its entire life since January 1999.  The point is, the current situation is hardly unprecedented nor even significant historically, it is simply a time when the dollar is weakening.

It is, however, instructive to consider what is happening that has the punditry in such a tizzy.  Arguably, the key reason the dollar has been declining lately is because real US interest rates have been falling more rapidly than real rates elsewhere.  After all, the Eurozone has had negative nominal rates since 2014.  10-year German bunds went negative in May 2019 and have remained there ever since.  Given that inflation has been positive, albeit weak, there real rates have been negative for years so the world is quite familiar with negative rates in Europe.  The US story, however, is quite different.  While nominal rates have not yet crossed the rubicon, real rates have moved from positive to negative quite recently and done so rapidly.  So, what we are really witnessing is the FX market responding to this relative change in rates, at least for the most part.  Undoubtedly, there are dollar sellers who are bearish because of their concerns over the macro growth story in the US, the second wave of Covid infections in the South and West and because of the growth in US debt issuance.  But history has shown that the most enduring impacts on a currency’s value are driven by relative interest rates and their movement.  And that is what we are seeing, US rates are falling relative to others and so the dollar is falling alongside them.

In other words, the current price action is quite normal in the broad scheme of things, and not worthy of the delirium it seems to be inspiring.  As I mentioned Friday, this is also what is driving the precious metals complex, which has seen further strength this morning (XAU +$40 or 2.1%, XAG +$1.50 or 6.7%).  And it must be noted that gold is now at a new, all-time nominal high of $1943/oz.  But since we are focusing on the concept of real valuation, while the price is higher than we saw in 2011 on a nominal basis, when adjusted for inflation it still lags pretty substantially, by about 18%, and both current and 2011 levels are significantly below gold’s inflation adjusted price seen in 1980 right after the second oil crisis.

However, the fact that the current reporting of the situation appears somewhat overhyped does not mean that the dollar cannot fall further.  And in fact, I expect that to be the case for as long as the Fed continues to add liquidity, in any form, to the economy.  Markets move at the margin, and the current marginal change is the decline in US real interest rates, hence the dollar is likely to continue to fall if US rates do as well.

The current dollar weakness begs the question about overall risk attitude.  So, a quick look around equity markets globally today shows a mixed picture at best, certainly not a strong view in either direction.  For instance, last night saw the Nikkei edge lower by 0.2% (after having been closed since Wednesday) and the Hang Seng (-0.4%) also slide.  But Shanghai (+0.25%) managed to eke out small gains.  In Europe, the DAX (+0.3%) is pushing ahead after the IFO figures bounced back much further than expected, although the CAC and FTSE 100 (-0.2% each) have both suffered slightly.  A special mention needs to be made for Spain’s IBEX (-1.3%) as the sharp increase in Covid infections seen in Catalonia has resulted in several European nations, notably the UK and Sweden, reimposing a 14-day quarantine period on people returning from Spain on holiday.  Naturally, the result is holidays that had been booked are being quickly canceled.  As to US futures, they are currently in the green, with the NASDAQ up 1.0%, although the others are far less enthusiastic.

Bond markets continue to show declining yields, with Treasuries down another basis point plus and now yielding 0.57%.  Bunds, too, are seeing demand, with yields there down 3 bps, although both Spanish and Italian debt are being sold off with yields edging higher.  In other words, the bond market is not pointing to a risk-on session.

Finally, the dollar is weak across the board, against both G10 and EMG currencies.  In the latter bloc, ZAR is the leader, up 1.3% on the back of the huge rally in precious metals, but we are also seeing the CE4 currencies all keeping pace with the euro, which is higher by 0.6% this morning.  As a group, those four currencies are higher by about 0.65%.  Asian currencies also performed well, but not quite to the standards of the European set, but it is hard to find a currency that declined overnight.  In G10 space, the SEK is the leader, rising 1.0%, cementing its role as the highest beta G10 currency.  But we cannot forget about the yen, which has rallied 0.75% so far this morning, and is now back to its lowest level since the Covid spike, and before that, prices not seen since last August.  A longer-term look at the yen shows that 105 has generally been very strong support with only the extraordinary events of this past March driving it below that level for the first time in four years.  Keep on the lookout for a move toward those Covid inspired lows of 102, although much further seems hard to believe at this point.

On the data front, this week’s highlight is undoubtedly the FOMC meeting on Wednesday, but there is plenty to see.

Today Durable Goods 7.0%
  -ex Transport 3.6%
Tuesday Case Shiller Home Prices 4.10%
  Consumer Confidence 94.4
Wednesday FOMC Rate Decision 0.0% – 0.25%
Thursday GDP Q2 -35.0%
  Personal Consumption -34.5%
  Initial Claims 1.445M
  Continuing Claims 16.3M
Friday Personal Income -0.5%
  Personal Spending 5.4%
  Core PCE 0.2% (1.0% Y/Y)
  Chicago PMI 43.9
  Michigan Sentiment 72.8

Source: Bloomberg

Of course, the GDP data on Thursday will be eye opening, as a print anywhere near forecasts will be the largest quarterly decline in history.  However, that is backward looking.  Of more importance, after the Fed of course, will be the Initial Claims data, which last week stopped trending lower.  Another tick higher there and the V-shaped recovery narrative is likely to be mortally wounded.  As to the Fed, while we will discuss it at length later this week, it seems unlikely they will do or say anything that is going to change the current market sentiment.  And that sentiment continues to be to sell dollars.

Good luck and stay safe

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