The Feathers of Hawks

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It seems like the feathers of hawks
Turn whiter when each of them talks
On Monday, Loretta
Said policy betta
Stay easy for pumping up stocks

For those of you not familiar with a word ladder, it is a type of puzzle where you start with a word, Hawk, for example, and change one letter in each step, while maintaining the order of the letters, to form another word and keep doing so until you arrive at the desired second word.  The object is to complete this task in as few moves as possible.  In this way, this morning’s task is to use a word ladder to turn hawk into dove (one possible answer below).

Once upon a time, in the economic community, there were two schools of thought as to how monetary policy would best serve a nation.  There were hawks, who believed that Ludwig von Mises and Friedrich Hayek had identified the most effective way for central banks to behave; namely minimalist activity and allowing the markets to work.  The consequences of this policy view were that economic cycles would exist but would be moderated naturally rather than allowing bubbles to inflate and interest rates would be set by the intersection of supply and demand.  On the other side of the debate were the doves, whose hero was John Maynard Keynes (although Stephanie Kelton of MMT fame is quickly rising up the ranks) and who believed that an activist central bank was the most effective.  This meant constant monetary interventions to support demand, alongside fiscal interventions to support more demand.  As to the consequences of this policy, like unsustainable debt loads, or rising inflation, they were seen as ephemeral and unimportant.

But that was soooo long ago, at least a full year.  In the interim, Covid-19 appeared as a deadly and virulent disease. While we have learned that it is particularly dangerous for the elderly and for those with comorbidities, there is also another group which has basically been made extinct, monetary hawks in public policy positions.  For the longest time, the two most hawkish members of the FOMC were Kansas City’s Esther George and Cleveland’s Loretta Mester.  However, at the very least, Ms. Mester has now shown that she coos like a dove as per her comments yesterday about US monetary policy, “We’re going to be accommodative for a very long time because the economy just needs it to get back on its feet.”

The global central bank community is all-in on the idea that ZIRP, NIRP and QE are the new normal, and as long as equity markets around the world continue to rally, they are not going to change their views.  In a related note, the BOJ is in the midst of continuing its policy review and the question of how they should describe their ETF purchases has come up.  It seems that while a number of board members would like to pare back the purchases, they are unwilling to explain that for fear the market would misinterpret their adjustments as a policy change and the result would be a sharp equity market sell-off.  And we know that cannot be tolerated!

The point is, no matter which central bank you consider, they have all reached the point where their previous actions have resulted in fragile markets and they appear to have lost the ability to change policy.  In other words, there is no end in sight to easy money, inflation be damned.

Which, of course, is exactly what we saw yesterday in markets, as equities rallied in the US, with all three major indices closing at new all-time highs.  Asian markets mostly followed through with the Nikkei (+0.4%), Hang Seng (+0.5%) and Shanghai (+2.0%) all nicely firmer, although Australia’s ASX (-0.9%) couldn’t find any love.  And perhaps, that is the story in Europe, as well, this morning, with various shades of red painting the screen.  The DAX (-0.5%) is the worst performer, with both the CAC (-0.1%) and FTSE 100 (-0.1%) more pink than red.  As to US futures, they find themselves in the unusual position of being negative at this hour, but only just, with all three indices looking at losses of between 0.1% and 0.2%.

Bond markets are clearly in more of a risk-off mood than a risk-on one, with Treasury yields lower by 2.2bps this morning and more than 4bps lower than the peak seen yesterday.  European markets have seen less movement, with yields in the major markets all down less than one basis point, hardly a strong signal, although notably, Italian 10-year yields, at 0.502%, have traded to a new historic low level.  Excitement over the prospect that Super Mario can fix Italy remains high.

On the commodity front, oil’s early gains have reversed, and it is now essentially flat on the day, although it remains within pennies of the highs set early this morning above $58/bbl.  Gold (+0.7%) is rebounding strongly, from the lows seen last Tuesday, with silver (+1.3%) even stronger.  Of course, all these non-fiat currency plays pale in comparison to Bitcoin (+17%) which exploded higher as the progenitor of one bubble (a certain EV maker in California) explained it bought $1.5 billion worth of Bitcoin for its Treasury reserves.

With this type of price action in commodities, as well as with the ongoing conversion of US monetary hawks into doves, it should not be surprising that the dollar is lower this morning, pretty much across the board.  In the G10 space, CHF and JPY are leading the way higher (+0.6% each) as investors seem to be running for havens not called the dollar.  But the euro (+0.45%) has also gained nicely and any thoughts that January’s price action was anything other than a short-term correction are now quickly fading away.  It will be interesting to see how the market responds to tomorrow’s CPI data, as that has the opportunity, if it prints higher than forecast, to alter views on real interest rates.  I have maintained that declining real yields will undermine the dollar, but I have to admit, I didn’t expect it to happen this early in the year.

EMG currencies are also firm this morning, led by ZAR (+0.6%) and RUB (+0.5%), on the back of commodity price rises, but with a pretty uniform strength throughout the CE4 and LATAM.  The one exception is BRL (-0.3%), the worst performing currency in the world this morning, as a lower than expected CPI print for January has traders shedding the belief that the central bank may be forced to raise rates any time soon.

On the data front, NFIB Small Business Optimism printed lower than last month and worse than expected at 95.0, not a good sign for the economy, but probably a boost for the view that more stimulus is coming.  At 10:00, we see JOLTs Job Openings (exp 6.4M), although that tends to be ignored.

The only Fed speaker today is St Louis’ Bullard, whose tendencies before Covid-19 were dovish, and he certainly hasn’t changed his views.  As such, and given that the market seems to have rejected the notion of a further USD correction higher, it looks like the dollar’s downtrend is getting set to resume.

Good luck and stay safe
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One possible answer:  I would love to see others
Hawk
Hark
Hare
Have
Hove
Dove

De Minimis Sellin’

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There once was a Fed Chair named Yellen
Whose term saw di minimis sellin’
Of bonds or of stocks
As from her soapbox
She promised a balance sheet swellin’

But now she’s the Treasury Sec
And her goal’s to get a blank check
For spending, not saving
Though that might be paving
The way to a financial wreck

Investors continue to add to their risk portfolios this morning amid the never-ending hopes for yet more fiscal stimulus from the US.  This can be seen most clearly from the combination of rising stock prices and rising bond yields.  In classic risk-on fashion, the ongoing speculative mania continues to drive equity markets higher around the world.  Asia is uniformly green, with the Nikkei (+2.1%) leading the way but strength in Shanghai (+1.0%) and Hong Kong (+0.1%).  The concern for the latter has to do with the upcoming Lunar New Year holiday and the fact that the link between the mainland and Hong Kong stock markets will be turned off during that period, thus reducing inflows. Meanwhile, Europe is also firmer across the board with Italy’s FTSE MIB (+1.4%) the leader as investors gain confidence that Super Mario Draghi will be as “successful” a PM as he was an ECB President.  But the FTSE 100 (+0.95%), CAC (+0.6%) and DAX (+0.3%) are all firmer with the DAX lagging on the back of weaker than expected IP data (0.0%, exp +0.3%) indicating that the ongoing lockdowns in Germany, which are slated to continue for another 6 to 8 weeks, are taking a toll.  And don’t worry, US futures are all green too, higher by roughly 0.4% each.

The second piece of this puzzle is the bond market, which is behaving exactly as expected in a risk-on session by selling off nicely.  In fact, Treasury yields have touched new highs for the move with the 10-year at 1.19% (+2.9bps) while 30-year bonds have just traded to 2.00% for the first time since Feb 19 of last year, right as the Covid crisis was beginning.  But this is not an isolated US feature, we are seeing higher yields throughout Europe, Italy excepted, as Bunds (+2.6bps), OATs (+2.5bps) and Gilts (+3.3bps) are all under pressure today.  Why, you may ask, are European bond markets selling off if the story is US stimulus?  Because it’s one big global trade, and if the $1.9 trillion stimulus package gets passed, the idea is a faster US recovery will support European and Asian companies that sell into the US.

Of course, politics being what it is, even control of the House and Senate doesn’t mean that passing a bill this large is easy.  And this is where Ms Yellen comes in, she needs to forcefully make the case passage is critical for the nation’s economy.  The problem is that the recent data trend, which has been generally better than expected (excluding Friday’s jobs data) points to the fact that perhaps not so much stimulus is needed.  So, on the Sunday morning talk shows she was emphatic in her comments that it is critical, and that erring by spending too much is a significantly better mistake than spending too little.  Interestingly, even some left-leaning economists don’t back that view.  Notably, Larry Summers, former director of the National Economic Council for President Obama, and Olivier Blanchard, former chief economist at the IMF, have highlighted the risks to this package on two fronts; first, it could result in inflation and second, it may prevent the passage of other legislation focused on infrastructure and green investment deemed more important.

Now, the one thing we know about Congress is that virtually none of the members of either the House or Senate have any understanding of economics or finance.  As such, they take their cues from their financial backers staffers and the pronouncements of eminent economists from their side of the aisle.  And this is what makes the Summers and Blanchard comments noteworthy, they are both clearly left of center and both are arguing for less Covid stimulus. Janet has her work cut out for her to get what she wants.  Ironically, the fact that this package may not be passed until March is probably a positive for stocks, after all, that means another 4-6 weeks of stimulus hopes!

A quick look at commodity prices shows that virtually every commodity price is higher this morning led by oil (+1.3%), but with strength in precious metals (gold +0.4%, silver +1.0%) and agriculturals (wheat +0.7%, corn +0.6%).  Again, this is a risk-on market.

The one piece of the relation trade narrative that continues to fail, however, is the weak dollar story.  For now, before inflation data starts to rise sharply and real yields tumble, rising US rates are leading to a rising US dollar.  So, this morning the pound (-0.4%) is the laggard, but the weakness is across the board.  Even NOK (-0.1% and CAD (-0.15%) are softer despite the ongoing oil price rally.  In fact, the entire commodity bloc is suffering despite firmer commodity prices.  This is true in emerging markets as well which is led lower by ZAR (-1.0%) and both BRL (-0.7%) and MXN (-0.7%) today.  The rand story continues to be virus related as the vaccine rollout stalls given the realization that the new strain of virus is not responding well to the AstraZeneca vaccines they have.  In fact, the vaccine story is part of the LATAM problems, but of greater consequence is the fact that as US yields rise, the carry trade is becoming less attractive, and both these currencies are beneficiaries of carry.  On the plus side in EMG, KRW (+0.35%) is the best performing currency around after virus restrictions were eased somewhat amid declining infection statistics.

Speaking of statistics, it is a very quiet week on the data front, with CPI the marquis number on Wednesday.

Tuesday NFIB Small Biz Optimism 97.5
JOLTs Job Openings 6.4M
Wednesday CPI 0.3% (1.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Thursday Initial Claims 760K
Continuing Claims 4.41M
Friday Michigan Sentiment 80.9

Source: Bloomberg

Regarding the CPI data, it has printed higher than the survey in all but one month since June and given the ongoing inflationary pressures of higher commodity prices and supply chain issues, my sense is we will see that again.  On the speaking front, just three Fed speakers this week, Mester today, Bullard tomorrow and then Chairman Powell speaks Wednesday afternoon.  This makes Wednesday the day to watch.  Until then, I expect the market will focus on stimulus matters and equity prices.  If US yields continue to rise I suspect the dollar will test resistance again, with the key level in the euro at 1.1910.  Once again, nothing has changed my medium-term view about dollar weakness, and last week did see a halving of the long euro positions in the CFTC data, but for now, I feel like the dollar still has the upper hand.

Good luck and stay safe
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Money’s Still Free

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There once was a time, long ago
When traders all just had to know
If payrolls were strong
So they could go long
If not, they would sell with the flow

But these days, with ZIRP and QE
Attention’s not on NFP
Instead it’s the pace
Of central bank grace
And making sure money’s still free

One of the biggest changes in the market environment since the onset of the global pandemic has been the change in what markets find important.  This is not the first time market focus has changed, nor will it be the last, but a change has definitely occurred.  Consider, for a moment, why the market focuses so intently on certain data points.  Essentially, traders and investors are looking for the information that best describes the policy focus of the time, and therefore, changes in that information are sufficient to change opinions, at least in the short term, about markets.  And remember, that policy focus can come from one of two places, either the Fed or the Administration.

A step back in time shows that in the early 1980’s, when Paul Volcker was Fed Chair, the number that mattered the most was the M2 money supply which was reported on Thursday afternoons.  In fact, the market impact grew so large that they had to change the release time from 3:50 pm to 4:10 pm, after the stock market closed, to reduce market volatility. Trading desks would have betting pools on the number and there were a group of economists, Fed watchers, whose entire job was to observe Fed monetary activity in the markets and make estimates of this number.  At the time, the Fed would not explicitly publish their target Fed Funds rate, they would add and remove liquidity from the money markets in order to achieve it.  And, in fact, you never heard comments from FOMC members which is why Fed Chairs are now compelled to testify to Congress twice a year.

But as time passed and the economy recovered from the recession of 1980-81, the Reagan Administration became highly focused on the US Trade Balance, (especially the deficit with Japan) which became THE number right up through the early 90’s.  Once again, betting pools were common on trading desks and futures markets would move sharply in the wake of the 8:30am release.

At some point there, while Alan Greenspan was still Fed Chair, but there was a new administration, the market turned its attention away from trade and started to focus on domestic indicators, with payrolls claiming the mantle of the best indicator of economic activity.  This suited the Fed, given its mandate included employment, and it suited the Clinton Administration, given they were keen to show how well the economy was doing in order to distract the populace from various scandals.

With the change in Fed Chair from Greenspan to Ben Bernanke, the Fed suddenly became a very different source of market information.  No longer did economists need to read tea leaves, but instead the Fed told us explicitly what they were doing and where rates were set.  Thus, during the GFC, Bernanke was on the tape constantly trying to guide markets to his preferred place.  And that place was full employment, so payrolls still mattered a great deal.  Of course, the market still cared about other things, like the level of interest rates, but still, NFP was seen as the single best indicator available.  Remember, during Bernanke’s leadership, the Fed initiated the QE that began the expansion of its balance sheet and changed the way the Fed worked, seemingly forever.  No longer would the Fed adjust the reserve balances in the system, instead, they would simply post an interest rate and if supply or demand didn’t suffice to achieve that rate, they would step into the markets and smooth things out.

Payrolls were still the focus through Chair Yellen’s term, especially since her background is as a labor economist, so the employment half of the mandate was far more important to her than the inflation half, and so, if anything, NFP took on greater importance.

Jay Powell’s turn at the Fed started amid a period where the economy was getting significant fiscal support and interest rates were trying to be normalized.  In fact, the Unemployment Rate had fallen to its lowest level in more than 50 years and seemed quite stable there, so Powell seemed to have an easy job, just don’t screw things up.  Alas, his efforts to continue normalizing interest rates (aka tightening policy) resulted in a sharp equity market correction in December 2018.  The President was none too pleased with that outcome, as the Trump administration was highly focused on the stock market as a barometer of its performance.  Thus, once again, the Fed stepped in to stabilize markets, and turned from tightening policy to easing in the Powell Pivot.  And perhaps that is the real message here, the most important data point to both the Fed and every administration is not payrolls or unemployment or inflation.  It is the S&P500.

But Covid’s shock to the market was unlike anything seen in a century, at least, and arguably, given the interconnectivity of the global economy compared to the last pandemic in 1918-20, ever.  So, the first NFP data points were shocking, but the market quickly grew accustomed to numbers that would have been unthinkable just months prior.  Instead, the numbers that mattered were the infection count, and the mortality rate.  And arguably, those are still the numbers that matter, along with the vaccination rate and the stimulus size.  All of these have been the market’s primary focus since March last year, and until the idea of the government lockdown fades, are likely to continue to be the keys for market behavior.

Which brings us back to this morning, when the payroll report is to be published.  Does it really have that much impact any longer?  Or has its usefulness as an indicator faded?  Well, it seems apparent that market participants are far more intent on hearing from Fed speakers and trying to discern when monetary accommodation is going to be reduced (never) than on the jobs number.  In fact, given virtually every major central bank has explained that rates will remain at current levels for the next 3 to 4 years, at least, the only thing the data can tell us is if that will last longer than currently expected.

Ok, ahead of payrolls we have seen a general embrasure of risk, with equity markets strong, following yesterday’s US rally.  The Nikkei (+1.5%) and Hang Seng (+0.6%) both performed well although shanghai (-0.2%) slipped slightly.  In Europe, the CAC (+1.1%) leads the way followed by the DAX (+0.3%) after weak Factory order numbers (-1.9%) and the FTSE 100 (+0.1%).  US futures are currently trading higher by about 0.5% to round things out.

Bond markets are behaving as you would expect in a risk on session, with 10-year Treasuries printing at a new high yield for the move, 1.16%, up 2.1bps.  In Europe, the bond selling is greater with Bunds (+2.5bps) and Gilts (+5.3bps) getting tossed in favor of stocks.  Commodities are still in vogue, with oil (+1.0%) and gold (+0.4%) firm alongside all the base metals and agriculturals.

Finally, the dollar, is acting a bit more like expected, softening a bit while risk is being acquired.  The dollar’s recent rally alongside the equity rally seemed unusual compared to recent history, but today, things look more normal.  S,o NOK (+0.4%) and CAD (+0.3%) lead the G10 charge while JPY (-0.15%) is today’s laggard.  Clearly these stories are commodities and risk preference.  In the EMG space, APAC currencies were under a bit of pressure overnight, led by KRW (-0.4%) and MYR (-0.25%), but this morning we are seeing strength in TRY (+1.0%), RUB (+0.8%) and MXN (+0.4%) to lead the way.  The CE4 are also performing relatively well alongside modest strength in the euro (+0.2%).

Now the data:

Nonfarm Payrolls 105K
Private Payrolls 163K
Manufacturing Payrolls 30K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B

Source: Bloomberg

Which brings us back to the question, does it really matter?  And the answer is, not to the stock market, and therefore not really to the Fed.  However, a strong number here could well hit the bond market pretty hard as well as support the dollar more fully.  We shall see.  FWIW, I don’t believe the dollar’s correction is over, and another 1%-2% is entirely viable in the short-run.

Good luck, good weekend and stay safe
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Contracted, Not Grown

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There once was a continent, grand
Whose culture and history fanned
Both science and art
Which helped to jumpstart
Expansion across all the land

But lately the data has shown
That Europe’s contracted, not grown
This bodes ill for those
Who purchased euros
As markets take on a new tone

Entering 2021, one of the highest conviction trades amongst the analyst and investment community was that the dollar would decline sharply this year.  After all, it fell broadly and steadily in 2020 from the moment it peaked in mid-March on the initial pandemic fears.  But the narrative that developed was that the Fed would be the king of all monetary easers, pumping so much liquidity into markets that the surfeit of dollars would simply drive the value of the greenback lower vs. all its main counterparts.  Adding to the tale was the election of Joe Biden as president, and the belief that he would be able to enact massive stimulus to help reflate the economy, thus adding fiscal stimulus to the Fed’s already humongous monetary efforts.  The pièce de résistance was the Georgia runoff elections, when the Democrats gained effective control of the Senate, and so all of these dreams seemed destined to come true.

However, there was always one conundrum that never made sense, at least to me, and that was the idea that the dollar would decline while the US yield curve steepened.  The thesis was that all the fiscal stimulus would result in massive Treasury issuance (check), which would result in higher yields as the market had trouble absorbing all that debt (partial check) and then the dollar would decline sharply (oops).  The problem is that historically, as the US yield curve steepens, the dollar typically rallies.

The other quibble with this narrative was that it seemed to ignore the facts on the ground in Europe.  It was never realistic to believe that the ECB would sit back and allow the euro to rally sharply without responding.  And of course, that is exactly what we have seen.  In the past three weeks, we have heard from numerous ECB speakers, including Madame Lagarde, that the exchange rate is quite important in their deliberations.  The proper translation of that comment into English is, if the euro keeps rallying, we will directly respond via further easing or even intervention if necessary.  Remember, Europe can ill afford a strong euro from both a growth and inflationary perspective, and they will do all they think they can to prevent it from coming about.

At the same time, there is another issue that the dollar bears seemed to neglect, the pathetic state of affairs in the Eurozone economy, as well as the vast incompetence displayed throughout the continent with respect to the inoculation of their populations with the new Covid vaccines. Based on current trends, the US and UK will have vaccinated 75% of their respective populations by the end of 2021.  Italy, Germany and France are looking at 2024 at the earliest to achieve the same milestone.  Ask yourself how beneficial that will be for the Eurozone economy if the current lockdowns remain in place for the next 2-3 years.

The one possible saving grace for this view is that the Fed responds more aggressively to any steepening of the yield curve.  While Europe cannot afford for the euro to rise, the US cannot afford for interest rates to rise, at least not very much.  While yields have clearly risen from their summer lows, they remain extremely accommodative.  However, if yields should start to rise further, say because inflation starts to accelerate, the Fed seems destined to stop that move, either explicitly, via YCC, or tacitly via extending and expanding QE such that they absorb all the new Treasury issuance and prevent yields from rising.  Of course, this will result in much deeper negative real yields which, in my view, will be what leads to the dollar’s eventual decline.  Given Europe’s much duller inflationary pulse, it will be much harder for the ECB to drive real yields in Europe as low as in the US.  But that is a story for the second half of 2021, not the first.

Which brings us to today’s activity.  The discussion above was prompted by the much weaker than expected Eurozone Retail Sales data released this morning, with December’s monthly growth at 2.0% and the Y/Y number at just 0.6%, half of expectations.  And this was before the extended and expanded lockdowns in January.  It is increasingly evident that the Eurozone is in its second recession in just over a year, again, hardly a rationale to buy its currency.  Which makes it completely unsurprising that the euro has declined yet again, -0.4%, and breaking below the psychological 1.20 level.  For those keeping track, this is he fourth consecutive day of declines and it is pretty easy to look at a chart and see a downtrend developing.  In fact, since its peak on January 7, the euro is down a solid 3%.

But the dollar is performing well against all its G10 brethren, and most EMG counterparts as well.  SEK (-0.6%) and NOK (-0.5%) are the worst performers with the latter somewhat surprising given that oil (+0.75%) continues to rally.  It seems that both these countries are seeing doubts over their ability to inoculate their populations from Covid similar to the Eurozone, so it should not be surprising that their currencies decline.  The same is true of CAD (-0.25%) where the current trend for vaccinations shows it will take a full ten years to vaccinate 75% of Canada’s population!  I imagine the pace will increase, but it does demonstrate the futility so far.  CAD, however, has not been as weak as the euro given the benefits from the rising oil price seem to be offsetting some of its other problems.

In the Emerging markets, ZAR (-0.8%) is the worst performer today, falling on a combination of broad dollar strength and concerns over the possibility of a debt crisis as the nation’s debt/GDP ratio has climbed rapidly to 80%, and with its still high yields, debt service ability is becoming a bigger problem.  Of course, there is also a new strain of Covid, first identified there, that has increased virulence and is working against the economy.  With the euro lower, it is no surprise that the CE4 have followed it down, and we are also seeing weakness in MXN (-0.6%), again, after central bank comments indicating possible rate cuts in the future.  On the flipside, TRY (+0.5%) is the star performer today, continuing to gather interest given its world-beating interest rate structure and promises from the central bank to maintain those yields.

While I skipped over both equity and bond markets today, it is only because there was precious little movement in most cases and certainly no discernible trend.

On the data front, yesterday saw better than expected ADP Employment and ISM Services prints, once again highlighting the differences between the US and Europe.  This morning brings a raft of data as follows: Initial Claims (exp 830K), Continuing Claims (4.7M), Nonfarm Productivity (-3.0%), Unit Labor Costs (4.0%) and Factory Orders (0.7%).  With Payrolls tomorrow, all eyes will be on the Initial Claims number, but it is hard to believe any print will change market sentiment.

Finally, the BOE met this morning and left policy unchanged, as expected.  However, they did tell banks to start preparing for negative interest rates going forward.  While they claim the policy is not imminent, it seems unlikely that they are asking banks to prepare for a low probability event.  Despite significant evidence that negative rates do not help the economy, although they do help stock prices, the BOE looks like it is going to ignore that and go there anyway.  The only analyses that showed NIRP was beneficial was produced by the central banks that are operating under NIRP.  This cannot be good for the pound over time.

For the day, the dollar is starting to gain momentum to move higher, and I think a slow continuation of this move is likely.

Good luck and stay safe
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Markets Rejoice

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He once said, “Whatever it takes”
To fix all the prior mistakes
Is what he would do
And Draghi came through
Though that was ere Covid outbreaks

But now Italy’s in a bind
As Conte, the PM, resigned
So, Draghi’s first choice
(And markets rejoice)
To lead a land that’s much maligned

***FLASH***  Mario Draghi accepts mandate to form new Italian government!

Now that GameStop fever is ebbing, far more quickly than Covid-19 I might add, it is time to look elsewhere for market drivers and sentiment.  With this in mind, we turn to the nation that puts the “I” in PIGS, Italy.  My personal experience in Italy is that it is a beautiful country, with extraordinary history and even better food.  The people are warm and welcoming, and it is truly a delightful place.  Alas, it is also, historically, one of the worst run nations on earth.  Attention to detail and a sense of urgency are two things that tend to be missing from the Italian culture, but both are necessary to be able to govern effectively.  Thus, it is not surprising that Italy has had 66 different governments since the end of WWII, with the most recent one falling two weeks ago.  The norm has been for coalitions, often fractious, to come together on short-term issues and then fall apart when longer term questions need to be addressed.

This is an apt description of the current situation, where PM Giuseppe Conte, a law professor with no previous political experience, was tapped to lead a disparate coalition of center-left and radical-left parties in an effort to prevent Matteo Salvini’s Lega Nord, a right-wing party, from taking control.  While this effort stumbled along for nearly two years, it recently foundered when a key supporter of the coalition, Matteo Renzi, withdrew his support and Conte lost a vote of no-confidence in the Italian Senate.  Conte has been unable to piece together another coalition which leaves two choices; the President, Sergio Mattarella, can appoint someone else to try to do so, or elections must be held.

Enter Mario Draghi.  Since his time as ECB President ended in 2019, he has been relatively quiet on most issues, and has not been willing to get involved in the morass of Italian politics at all.  Arguably, because of that, he remains the most popular public figure (non sports or entertainment) in the country.  And so, President Mattarella is meeting with Draghi today to ask him to form a new government with wide latitude to do “whatever it takes” to fix Italy’s many problems.  While the early word from political figures there is mixed, at best, the market thinks this is the best idea since sliced bread.  This is clear from both the equity market, where the FTSE MIB has rallied by a world-beating 2.7% today, as well as from the bond market, where BTPs have rallied sharply with yields falling 9.2 basis points and the spread to bunds has fallen to just over 100 basis points, its tightest level since 2016.

Remember, Italy has been one of the worst hit nations from Covid, as the infections appeared there early and the economy is hugely reliant on tourism and services, exactly the areas Covid destroyed.  Add to that the government’s general incompetence which has slowed the distribution of the vaccines (although in fairness, this seems to be true throughout Europe, Germany included) and you have a situation where the economy, which shrunk 9.0% in 2020, remains on course to shrink again through at least the first half of 2021.  It is not clear, by any means, that Draghi will accept the position, nor if he does, if he will be able to bring together the disparate views in the Italian congress to pass legislation that helps the situation.  But, boy, the markets are all-in on the trade!

The Draghi story has been icing on the market bullish cake this morning with risk continuing to be embraced as US stimulus talks turn away from the bipartisan idea and therefore toward a quicker passage under budget reconciliation terms (where the Senate does not have a chance to filibuster).  As well, in many nations we have seen upticks in data releases, although there are still some, notably China, where the data is falling short of estimates.

Starting with equities, Asia saw strength in the Nikkei (+1.0%) and Hang Seng (+0.2%) but Shanghai (-0.5%) fell after Caixin PMI Services data (52.0) fell short of expectations and pretty significantly from last month’s reading of 56.3.  While still above the key 50.0 level, momentum in China appears to be stalling for now.  Europe is all green, but Italy is truly the outlier.  The DAX (+0.7%) comes next and then the CAC (+0.3%) and FTSE 100 (+0.2%) are both positive, but just barely.  As to US futures, after yesterday’s strong session, with all three indices rising around 1.5%, and after some strong earnings reports yesterday afternoon, futures are higher by modest amounts, led by the NASDAQ’s 0.6% climb.

Bond markets are offering the same message, with yields higher in Treasuries (2.1bps), bunds (1.1bps) and Gilts (1.1bps).  Meanwhile, the bonds of the PIGS are all rallying on the combination of general risk attitude and the hope that good news in Italy will spread.

Oil continues its winning ways, rising another 0.5% this morning which puts WTI above $55/bbl, a level many technicians believe opens the way for a sharper rally from here.  Gold, after a dreadful day yesterday, is still under modest pressure, down 0.15%, but silver, after an even more dreadful day yesterday, having fallen more than 8%, is actually bouncing a bit, and up 0.5% as I type.

Finally, the dollar is generally stronger vs. G10 currencies, with only AUD and NZD (both +0.1%) showing any life.  The kiwi story is based on stronger than expected employment data indicating the economy is rebounding and more monetary support may not be necessary, while Aussie seems to be benefitting from strong PMI data.  But otherwise, the dollar is on top this morning, with broad-based gains although they are not substantial.  SEK (-0.4%) is the worst performer, followed by the pound (-0.25%) and euro (-0.25%), both of which saw underwhelming PMI services data. In the EMG bloc the picture is more mixed, with both gainers and losers, although it is hard to piece together a coherent story.  The CE4 are the laggards, down 0.3% on average as they track the euro.  LATAM is also underperforming, although both MXN and BRL are softer by just 0.2%.  On the plus side, RUB (+0.3%) leads the way, arguably on oil’s uptick, and then some APAC currencies eked out marginal gains as well.  However, given the modest magnitude of movement, this feels an awful lot like position adjustments.

On the data front today we see ADP Employment (exp 50K) and ISM Services (56.7).  The former will attract more attention than the latter, in my view, as the market looks ahead to Friday’s NFP data. It would also be a mistake if I did not mention that Eurozone CPI was released this morning at a much higher than expected 0.9% (1.4% core) which is hard to reconcile with the collapsing economic activity.  Although perhaps, inflation is not dependent on demand as much as supply, and central bankers have it completely wrong.  Nah.

For now, the dollar’s correction continues, and we are right at the 1.2010 level that proved the breakout point in December.  At this stage, a move to 1.1950 seems a good bet, but we will need to see many more positions unwind if we are to overcome the dollar weakness narrative.  The confusing part is the ongoing equity rally alongside the dollar rally, something we have not seen for quite a while.  But that doesn’t mean it can’t continue for a while longer.  I still like the dollar to fall in H2, but right now, momentum is building for further dollar strength.

Good luck and stay safe
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Both Need Downgrading

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Excitement in markets is fading
With GameStop and silver both trading
Much lower today
As sellers convey
The message that both need downgrading

Well, it appears that the GameStop bubble is deflating rapidly this morning, which is only to be expected.  Short interest in the stock has fallen from 140% of market cap to just 39% as of yesterday’s close.  This means that there is precious little reason for it to rally again, as, if you recall, the company’s business model remains a bad fit for the times.  The top tick, last Thursday, was $483 per share.  In the pre-market this morning it is trading at $172, and I anticipate that before the end of the month, it will be trading back to its pre-hype $17-$18 level.  But it was fun while it lasted!

Meanwhile silver, yesterday’s story, has also fallen sharply, -4.7% as I type, as the mania there seems to have been more readily absorbed by a much larger market.  The conspiracy theory that the central banks and JP Morgan have been manipulating the price lower for the past several decades has always been hard to understand but was certainly more widespread than I expected.  The major difference between silver and GME though, is that silver has a real raison d’etre as an industrial metal, as well as a traditional store of wealth and monetary metal.  Last year silver’s price rose 46.5%, leading all precious metals higher.  And, in the event that inflation does begin to show itself again, something I believe is coming soon to a screen near you, there is a strong case to be made for it to rally further.  This is especially so given the ongoing debasement of all fiat currencies by central banks around the world as they print more and more each day.

Down Under the RBA stunned
The market and every hedge fund
Increasing QE
As they want to see
The Aussie increasingly shunned

While other major central banks stood pat in their recent policy meetings, the RBA last night surprised one and all by increasing the amount of QE by A$100 billion, at A$5 billion / month, meaning they will continue the program well into 2022.  As well, they explained that they would not consider raising rates until 2024 at the earliest as they work to push unemployment lower.  This means, the overnight rate will remain at 0.1% and YCC for the 3-year bond will also remain at that level.  Interestingly, the market had tapering on its mind, as ahead of the meeting AUD had rallied nearly 0.6%, with analyst discussions of tapering rampant.  As such, it is no surprise that the currency gave up those gains immediately upon the release of the statement, and has now fallen 0.25% on the day, the worst laggard in the G10.

With the FOMC meeting behind us, Fed speakers are going to be inundating us with their views for the next month, so be prepared for a lot more discussion on this topic.  Remember, before the quiet period ahead of the January meeting, four regional presidents were talking taper, with two seeing the possibility of that occurring late in 2021.  Chairman Powell, however, tried to squelch that theory in the statement and press conference.   Yesterday, uber-dove Neel Kashkari expressed his view that it is “..key for Fed to keep foot on monetary policy gas.”  Meanwhile, Raphael Bostic and Eric Rosengren both harped on the need for additional fiscal stimulus to revive the economy, with Bostic once again explaining that tapering when economic growth picks up will be appropriate, although giving no timeline.  (He was one of the four discussing a taper ahead of the meeting.)  We have seven more speakers this week, some of them multiple times, so there will certainly be headline risk as this debate plays out in public.

But for now, markets are sanguine about the possibility of central bank tightening in any way, shape or form, as once again, risk is being embraced across the board.  Starting in Asia, we saw green results everywhere (Nikkei +1.0%, Hang Seng +1.2%, Shanghai +0.8%), with the same being true in Europe (DAX +1.1%, CAC +1.6%, FTSE 100 +0.5%).  US futures are pointing in the same direction with gains on the order of 0.75% at 7:00am.

Bond markets are also on board the risk train, with yields rising in Treasuries (+2.9 bps) and throughout Europe (Bunds +2.7bps, OATs +2.2bps, Gilts +3.1bps).  Part of this positivity seems to be coming from the release of Eurozone Q4 GDP data, which was not quite as bad, at -0.7% Q/Q (-5.1% Y/Y) as forecast.  That outcome, though, was reasonably well known ahead of time as both Germany and Spain printed Q4 GDP at +0.1% in a surprise last week.  Unfortunately, the ongoing lockdowns throughout Europe, which have been extended into March in some cases, point to another quarter of economic contraction in Q1, thus resulting in a second recession in short order on the continent.  With that in mind, while we have not heard much from ECB speakers lately, it is certainly clear that there is no taper talk in Frankfurt at this time.

Which takes us to the currency markets.  The G10 bloc is split with EUR (-0.25%) matching AUD’s futility, while the rest of the European currencies are all modestly lower.  Commodity currencies, however, are holding their own led by CAD (+0.35%) which is benefitting from oil’s rally (+1.3%), although NOK (+0.1%) has seen less benefit.  EMG currencies, however, lean toward gains this morning, with MXN (+0.8%), BRL (+0.6%) and RUB (+0.6%) leading the way, each benefitting from higher commodity prices.  Even ZAR (+0.5%) is higher despite the lagging in precious metals.  But that story is far more focused on ZAR interest rates, which are an attractive carry play in a risk on scenario.  The laggards in this bloc are basically the CE4, tracking the euro, and even those losses are minimal.

While there is no data this morning in the US, we do have important statistics coming up later in the week as follows:

Wednesday ADP Employment 50K
ISM Services 56.7
Thursday Initial Claims 830K
Continuing Claims 4.7M
Nonfarm Productivity 4.0%
Unit Labor Costs -3.0%
Factory Orders 0.7%
Friday Non Farm Payrolls 60K
Private Payrolls 100K
Manufacturing Payrolls 31K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B
Consumer Credit $12.0B

Source: Bloomberg

So, plenty to see, but will we learn that much?  Obviously, all eyes will be on the payroll data, which given the rise in Initial Claims we have seen during the past month seems unlikely to surprise on the high side.  As such, anticipating sufficient data exuberance to get the Fed doves to talk about tapering seems remote.

Adding it all up leaves the current short dollar squeeze in place, with an opportunity, I think, for the euro to trade back below 1.20 for a time, but nothing we have seen or heard has changed my view that the dollar will fall in the second half of the year.  For those of you with payables, hedging sooner rather than later should be rewarded over time.

Good luck and stay safe
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GameStop

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The company still known as GameStop
Whose model for business, a mall shop
Was heavily shorted
Has seen those shorts thwarted
By buyers whose bubble will not pop

While I recognize GameStop (GME) seems to have absolutely nothing to do with the FX markets, I have been asked by a number of people to explain what happened, so I thought I would offer a relatively short explanation of the events, which were truly remarkable.  And arguably, this is much more about markets in general, and market sentiment in particular.

As always, I think a little perspective is in order.  GME was born in 1984 as Babbage’s in Dallas, Texas.  After a series of mergers, it was acquired by Barnes & Noble in 1999, who merged it with another company, Funco, Inc. and renamed this entity GameStop.  It went public in 2002, was spun off from Barnes & Noble in 2004, and then grew as a business.  Its business model was to be the go-to place for electronic games, and it eventually opened more than 5000 sites throughout malls in the US and around the world.  The problem, of course, is that even before Covid-19, bricks and mortar retail space was suffering.  This was especially so for this business, where games can be downloaded over the internet, and disks and cartridges have lost their appeal.  Covid seemed like the last straw, as malls all over the country were closing and saw extraordinary reductions in foot traffic, thus devastating the company’s business.

Over the course of the past twelve months, short interest in GME stock skyrocketed, as a number of hedge funds expected that the company would file Chapter 11 relatively soon.  After all, revenues had fallen more than 30% on a Q/Q and Y/Y basis, and profitability had disappeared.  In truth, it seemed a pretty logical bet.  However, hedge funds, being hedge funds, and reveling in as much leverage as possible given ZIRP, actually created short positions that grew to 140% of the outstanding float of the stock!  How, you may ask, is that possible?  Well, clearly, there was some naked shorting going on, which means that some of them were selling the stock without having borrowed it to deliver.  Oh, yeah, that is illegal these days.  It is also entirely possible that some brokers holding the stock rehypothecated it, meaning they lent it out more than once, also illegal.

Fast forward to three weeks ago, where a financial analyst, whose Reddit handle is Roaring Kitty, figured out that the short positions in this stock were untenable.  He posted on the Reddit thread WallStreetBets, which picked up traction and encouraged people to buy the stock.  Hence, the stock started to rise after months, if not years, in the doldrums.

The next step came from the options market, where the several million followers of WallStreetBets figured out that the leverage available in buying out of the money call options (also known as low delta call options) was extraordinary, and so they bought millions of them.

As a former option market maker (not in stocks, but FX, bonds and commodities), I can tell you that selling low delta options is a very dangerous trade.  This is because, if the market starts to move toward the strike price, as a hedger, I am forced to buy ever more underlying to hedge my position.  This is called gamma hedging and is the bread and butter of what options traders do all day long.  But the combination of the extraordinary demand for low delta GME calls and the recognition by the hedge funds with extensive short positions fed on itself into a frenzy.  At some point, the prime brokers who were handling those hedge funds’ business had to make margin calls and close out the short positions.  And those type of buyers are completely insensitive to price, because the prime broker doesn’t pay the freight, it is the hedge fund with the short position that is getting stopped out, that takes the losses.

Now, remember, because of the size of the short position, greater than the amount of stock outstanding, this process has taken a while to unfold, and is probably not done yet.  It has, however, busted those hedge funds, who have lost billions of dollars, as well has shown that they were not all that smart after all.  Alas, I fear that all the Robinhooders who were a huge proportion of the buyers are going to find themselves in a bad state as well.  After all, GME is still a dying business with the wrong business model for today.  A $1 billion market cap is probably a lot more appropriate than the current $23 billion market cap, so look for the stock to decline going forward, although probably not as quickly as it rose.

From our perspective, though, I think the lesson of GME is more about what it says about sentiment in the markets these days.  This type of price action and market activity has historically been confined to the last stages of a mania of some sort. In other words, to my eyes, and remember, I have seen market crashes starting in 1987, Tokyo in 1989, 1999-2000, and 2008-2009, this smacks of the true “irrational exuberance” made famous by former Fed Chair Alan Greenspan in 1996.  Whether it is rising rates, disappointment in the slower than expected rollout of the vaccine, or pressure on profit margins and earnings misses, I expect that shedding risk is going to be the norm for the next two quarters at least.  This is not to say we are going to see a collapse in stock markets, just that the gains of the pasts several months and years are unlikely to be repeated.

Which brings us to this morning, where the newest target for a short squeeze by the WSB crowd is silver.  Silver has opened higher by around 8%-10% and is now pressing $30/oz.  The last time silver traded above that level was March 2013, in the wake of the Eurozone debt crisis, and the only other time it did so was in 1980, when the Hunt brothers tried to corner the market.  Understand this, in 1980, the market was smaller, there were more natural buyers of silver for industrial uses, notably Eastman Kodak for film emulsion, and the Hunt’s failed dismally once the COMEX changed the rules.  Today, in a much larger market ($1.5 trillion) with far less industrial demand, this seems destined to fail, at least with respect to achieving the same type of impact as GME.  But that doesn’t mean the price can’t go higher in the short run.

Ok, on to FX, where today is PMI day, with the most noteworthy results coming from China over the weekend.  Noteworthy in the sense that they were all worse than expected (Mfg 51.3, Services 52.4 and Caixin 51.5) and all represented pretty big declines from last month.  In addition, the forward-looking pieces, like New Orders and Employment also fell sharply, so it doesn’t bode well for February.  Recall, China has locked down much of the northern part of the country to prevent the spread of Covid and this is occurring right before the start of the Lunar New Year holiday, the busiest travel time of the year, historically, in the country.  The point is, if expectations are for China’s economy to drive global growth, we could be seeing a longer delay before things pick up.

European PMI’s were generally in line with expectations on the manufacturing side and a number of other emerging market economies saw better than anticipated results.  Again, this simply highlights that the recovery in H1 is likely to be quite uneven.

As to markets, despite early losses in Asia and US futures, equity markets have turned around and were robustly higher overnight (Nikkei +1.55%, Hang Seng +2.15%, Shanghai +0.6%) and are all higher throughout Europe (DAX +1.5%, CAC +1.5%, FTSE 100 +1.2%).  US futures, which had opened the overnight session down as much as 1% are now all higher by more than that.

Bond markets are also demonstrating risk-on characteristics, albeit on a much more subdued basis.  Treasury yields have edged higher by 1.2bps, while bunds are essentially unchanged along with OATs and Gilts.  What we are seeing is PIGS bonds rallying with yields in Italy (-3.2bps) and Greece (-2.7bps) falling the most.

With silver leading the way, gold (+0.7%), too, is higher and so is crude oil (+0.5%).  In other words, risk is in favor here.  Interestingly, the FX market is not as convinced, at least not if we believe that risk-on is synonymous with a weaker dollar.  CHF (-0.6%) is the worst performer, which as a haven makes some sense, but EUR (-0.5%) leads the rest of the European group down, after German Retail Sales fell -9.6%!  The commodity currencies have not been as badly impacted (CAD -0.3%, AUD -0.2%).  Actually, today’s best performing G10 currency, other than the dollar, is the pound, which is basically flat as the success they’ve had with their vaccine program (13% of the population has already been vaccinated, the most by far for a large nation) has investors of the belief that the UK will lead the recovery.

EMG currencies are having a more mixed session with TRY (+1.7%) the leading gainer on further hawkish comments from the new central bank head there helping convince traders that tighter monetary policy will be with us for a while.  MXN (+1.15%) is next in line, on the strength of the commodity rally, along with ZAR (+0.75%) on the same basis.  Remember, Mexico is the largest silver producing country in the world, so the big rally in silver is clearly helping the peso.  On the downside, CNY (-0.6%) suffered on its data, and the CE4 are all falling similar amounts to the euro.  The rest of the bloc is less interesting and mixed as to gainers and losers.

On the data front, ISM Manufacturing (exp 60.0) is the main release today, with Construction Spending (+0.8%) due as well.  It is a payroll week, but I will delve into that more tomorrow as this note is already exceptionally long.  We do hear from three Fed speakers today, with a mix of uber doves and regular doves, so if anything, I expect that we will see more talk of needing more stimulus.  Speaking of which, the political fight over the proposed $1.9 trillion new bill continues but, in the end, you know that they will pass another bill with a lot more money being spent.

For all the conviction as the new year began that the dollar would decline sharply, the price action through January has clearly shaken some people.  However, positioning seems to be remaining steady, and I still believe that as inflation rises, real yields will fall sharply and the dollar along with it.  But for now, the dollar continues to push out the weak shorts, and quite frankly, this move does not feel like it is ending.  At this stage, a move in the euro toward 1.1950 seems quite viable.

Good luck and stay safe
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Was It Ever?

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The BOJ asked
Is QE still effective?
Or…was it ever?

One of the constants in financial markets since 2012 has been the BOJ’s massive intervention in Japanese markets.  They were the first major central bank to utilize QE, although they call it QQE (Quantitative and Qualitative Easing – not sure what quality it brings) and have now reached a point where the BOJ owns more than 51% of the JGB market.  In fact, given their buy and hold strategy removes those bonds from trading, the liquidity in the JGB market has suffered greatly.  Remember, too, that JGB issuance is greater than 230% of the Japanese GDP, which means the BOJ’s balance sheet is larger than the Japanese economy, currently sitting at ~$6.74 Trillion or 133.2%.

But they don’t only purchase JGB’s, they are also actively buying equity ETF’s in Japan, and by using their infinite printing press have now become the largest single shareholder in the country with holdings of ~$435 Billion, or roughly 7.5% of all the equities outstanding in the country.  And you thought the Fed was pursuing an activist monetary policy!

The thing is, it is not hard to describe all these efforts as utter failures in achieving their aims.  Those aims were to support growth and push inflation up to 2.0%.  (As an aside, it is remarkable how 2.0% has become the ‘magic’ number for the right amount of inflation in central banking circles.  Thank you Donald Brash.)  However, a quick look at the history of inflation in Japan since Kuroda-san’s appointment to Governor of the BOJ in March 2013, and the latest surge in activist monetary policy, shows that the average inflation rate during his tenure as been 0.73%.  Inflation peaked in May 2014, in the wake of the GST hike (a tax rise on consumption) at 3.7%, and spent 12 months above the 2.0% level as that impact was felt, but then the baseline was permanently higher and inflation quickly fell back below 1.0%, never to consider another rise to that level.

Looking at growth, the picture is similar, with the average Q/Q GDP growth during Kuroda-san’s tenure just 0.1%.  It is abundantly clear that central bankers are no Einsteins, as they seem constantly surprised that the same strategies they have been using for years do not produce new results.  Perhaps you must be insane to become a central banker.

What makes this relevant today is that last night, it was learned that BOJ policymakers are considering some changes to their policies.   It’s current policy of YCC has short-term rates at -0.1% and a target for 10-year yields of 0.00% +/- 0.20% leeway.  They also currently purchase ¥12 Trillion ($115 Billion) of equity ETF’s per year.  However, their new plans indicate that they are going to change the mix of JGB purchases, extending the tenor and cutting back purchases of short-term bonds, while also allowing more flexibility in the movement of 10-year yields, with hints it could widen that band from the current 40bps to as much as 60bps.  While that may not seem like a lot, given the minimal adjustments that have been made to these policies over the past 8 years, any movement at all is a lot.

And the market took heed quickly, with JPY (-0.5%) falling to its weakest point vs. the dollar since mid-November.  Technically, USDJPY has broken through some key resistance levels and the prospects are for further USD appreciation, at least in the short run.

In China, the PBOC
Is worried that bubbles will key
More problems ahead
And to punters’ dread
Have drained out more liquidity

China is the other noteworthy story this morning, where the central bank has aggressively drained liquidity from the market as they remain extremely wary of inflating bubbles.  Overnight funding costs rose 29bps last night, to their highest level since March 2015.  Not surprisingly, Chinese equity markets suffered with Shanghai (-0.6%) and the Hang Seng (-0.95%) both unable to follow yesterday’s US rally.  (The Nikkei (-1.9%) also suffered as concerns were raised that the BOJ, in their revamp of policy, may choose to buy less equities.)  What is so interesting about this action is that if you ask any Western central banker about bubbles you get two general responses; first, they cannot tell when a bubble exists; and second, anyway, even if they could, it is not their job to deflate them.  Yet, the PBOC is very clear that not only can they spot a bubble, but they will address it.

I think it is fair to say that given the recent activity in certain stocks like GameStop and AMC, the US market is really exhibiting bubble-like tendencies.  Rampant speculation by individual investors is always a sign of a bubble.  We saw that in 1999-2000 during the Tech bubble, when people quit their day jobs to become stock traders and we saw that in the housing bubble of 2007-8, when people quit their day jobs to speculate in real estate and flip houses.   It also seems pretty clear that the combination of current monetary and fiscal policies has resulted in equity markets being the final repository of that cash.  Having lived, and traded, through the previous two bubbles, I can affirm the current situation exhibits all the same hallmarks, with one exception, the fact that central banks are explicitly targeting asset purchases.  However, this situation cannot extend forever, and at least one part of the financial framework will falter. When that starts, price action will become extremely volatile, similar to what we saw last March, but for a longer period of time, and market liquidity, which has already suffered, will get even worse.  All this points to the idea that hedging financial risk remains critical.  Do not be dissuaded by some volatility, because I assure you, it can get worse.

Anyway, a quick tour of markets shows some real confusion today.  Equities, which we saw fell sharply in Asia, are falling across Europe as well (DAX -0.8%), CAC (-0.9%), FTSE 100 (-1.0%) despite the fact that preliminary GDP data from the continent indicated growth in Q4 was merely flat, not negative. US futures are all pointing lower as well, between 0.5% and 0.9%.

Bonds, however, are all being sold as well, with Treasury yields rising 2.6bps, and European market seeing even greater rate rises (Bunds +3.3bps, OATs +3.3bps, Gilts +3.9bps).  So, investors are selling both stocks and bonds.  What are they buying?

Commodities are in favor this morning, with oil (+0.5%) and the ags rising, but precious metals are in even greater favor (Gold +1.1%, Silver +3.25%).  And finally, the dollar, is under broad pressure, with only the yen really underperforming today.  NOK (+0.9%) is leading the way in the G10, while the rest of the bloc, though higher, is less enthusiastic with gains ranging from 0.1%-0.3%.  Emerging market currencies are having a much better day, led by ZAR (+1.3%) on the back of the commodity rally, followed by TRY (+0.85%) and MXN (+0.45%).  CNY (+0.25%) has rallied on the back of the Chinese monetary actions and BRL (-0.1%) is the only laggard in the bloc as bets on rate hikes, that had been implemented earlier in the week, seem to be getting unwound.

There is important data this morning as well, led by Personal Income (exp 0.1%) and Personal Spending (-0.4%), but also Core PCE (1.3%), Chicago PMI (58.5) and Michigan Sentiment (79.3).  The PCE data has the best chance of being the most interesting, as a higher than expected print will get tongues wagging once more regarding the reflation trade and higher bond yields.

But, when looking at the markets in their totality, there is no specific theme.  Risk is neither on, nor off, but looks more confused.  If I had to describe things, I would say that fiat linked items are under pressure while real items are in demand.  Alas, given current monetary policy globally, I fear that is the future in a nutshell.  As to the dollar, relative to other currencies, clearly, today it is under the gun, but arguably, it is really just consolidating its recent modest gains.

Good luck, good weekend and stay safe
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No Bonds Will They Shed

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Chair Powell explained that the Fed
Cared not about bubbles widespread
Employment’s the key
And ‘til he can see
Improvement, no bonds will they shed

Meanwhile, cross the pond, Ollie Renn
Repeated the mantra again
The ECB will
Not simply stand still
And let euros outgain the yen

At the first FOMC meeting of 2021, Chairman Powell was very clear as to what was in focus, employment.  To nobody’s surprise, they left policy rates on hold and did not change the purchase metrics of the current QE program.  However, in the statement, they downgraded their outlook for the economy, which given the ongoing vaccination program seemed somewhat surprising.  However, the fact that vaccinations are taking longer to be administered than had been expected, seems to be driving their discussion.  He was also explicit that the Fed was set to continue their current program until such time as they achieve their twin goals of maximum employment and 2% average inflation.  Based on the recent rising trajectory of Initial Claims (expected today at 875K) and given even Powell described the fact that the Unemployment Rate likely significantly understates the true situation, it will be a very long time before the Fed even considers reducing their program.

When asked at the press conference following the meeting about potential bubbles in asset markets, with several questions specifically about GameStop stock (a truly remarkable story in its own right), the Chairman was also clear that employment was the thing that mattered, and the Fed was not focused on things like this.  He even explained that the Fed fully expected inflation data to rise this summer but would not waver from their course until maximum employment is achieved.  So, the message is clear, the balance sheet will continue to grow regardless of any ancillary issues that arise.

Keeping our focus on central banks, we turn to the ECB, where this morning it was Finnish Central Bank president Ollie Renn’s turn to explain to the markets that the ECB was carefully watching the exchange rate and its impact on inflation, and would use all the tools necessary to help boost inflation, including addressing a ‘too strong’ euro.  Kudos for their consistency as this was exactly the same message we heard yesterday from Klaas Knot, the Dutch central bank chief.  As well, during yesterday’s session there was an ECB statement that “markets [are] underestimating rate-cut odds.”  You may recall the Knot specifically mentioned the possibility of cutting interest rates by the ECB as well.  All told, there is a consistent message here as well, the euro is a key focus of the ECB and they will not allow it to trade higher unabated.  I have made this point for months, as the dollar bearish views became more entrenched, that the ECB would not sit idly by and allow the euro to rally significantly without responding.  This is the first response.

What are we to conclude from these two messages?  The conclusion I draw is that beggar thy neighbor policies continue to be at the forefront of monetary policy discussions within every major central bank.  While I’m sure they are not actually described in that manner, the results, nevertheless are just that, every central bank is committed to continuing to expand their balance sheet while adding accommodation to their respective economies, and so the relative impact remains muted.  In the end, nothing has changed my view that the Fed will cap yields, which right now are doing a good job of that all by themselves (10-year Treasury yields are -1bp today and back to 1.00%, their lowest level since the break higher on the Georgia election results), and that the dollar will suffer as real yields in the US plummet.  But again, that is Q2 or Q3, not Q1.

Perhaps, what is more interesting is that despite all this promised central bank largesse, yesterday was a massive risk-off session and today is following right in those footsteps.  Starting with equity markets, the bloodbath is universal.  Asia saw sharp declines (Nikkei -1.5%, Hang Seng -2.6%, Shanghai -1.9%) following the US selloff.  And it wasn’t just the main indices, literally every Asian market that was open yesterday fell, most by more than 1%.  European bourses are also all red this morning, but the magnitude of losses has been more muted.  Of course, they got to participate in yesterday’s sell-off, so perhaps that is not too surprising.  As I type, the CAC (-0.1%) is the best performer, with the DAX (-0.6%) and FTSE 100 (-1.0%) suffering more acutely.  Here, too, every market is in the red.  Interestingly, US futures are mixed, with DOW futures actually higher by 0.1%, but NASDAQ futures are down 0.7% after weaker than expected earnings and guidance from some of the Tech megacaps last night.

Bond markets are pretty much all in the green, with yields lower, but essentially, the entire space has seen yields decline just 1 basis point.  That is not really a sign of panic.  Perhaps, with yields so low, investors are beginning to understand that bonds no longer offer the hedge characteristics for risk that they have historically held.  In other words, is earning -0.64% to hold 10-year bunds really hedging negative outcomes in your equity portfolio?  A key part of the thesis that bonds are a haven is that you earn a stable return during tough times.  These days, that is just not the case, and the risk that yields normalize means the potential losses attendant to holding a bond portfolio at current yields is quite substantial.

Commodity prices are generally softer, but not by very much.  WTI (-0.4%) continues to consolidate its gains from Q4 but has basically gone nowhere for the past two weeks.  Gold (-0.2%), too, is treading water lately, although the technicians are starting to say it is in a mild downtrend.

And finally, the dollar is basically stronger once again this morning.  This is true vs. every G10 currency, with AUD (-0.7%) the worst performer, but all the commodity currencies (NZD -0.5%, CAD -0.4%) under pressure along with the havens (JPY -0.2%, CHF -0.2%).  This is simply another dollar up day, with risk still in question.  In the emerging markets, KRW (-1.35%) is by far the worst performer, suffering from the changing risk appetite as well as weaker than expected earnings from Samsung, the largest company in the country.  Capital exited the KOSPI and drove the won to its lowest level since early November.  But we are seeing weakness in the usual suspects with RUB (-0.6%), MXN (-0.4%) and BRL (-0.3%) all under some pressure.  The outlier here is ZAR (+0.2%) which after a very weak start alongside other commodity linked currencies, has rebounded on the news that the first Covid vaccines would be arriving by the end of the week.

There is a bunch of data this morning led by Initial Claims but also Q4 GDP (exp 4.2%), Leading Indicators (0.3%) and New Home Sales (870K).  This is the first reading for Q4, but the market is more intently focused on Q1 and Q2, so it is not clear the print will matter much.  Housing we know continues to perform extremely well, so the Claims data is likely the most important release, especially given Powell’s focus on employment.

As of now, risk remains on its heels, but it would not be that surprising if things turned around as Powell’s message of non-stop stimulus should encourage the bulls.  If that is the case, I would look for the dollar to cede some of its gains, but it is certainly not a signal to sell aggressively.

Good luck and stay safe
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You’d Better Think Twice

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If you thought Lagarde doesn’t care
About how her euros compare
To dollars in price
You’d better think twice
‘Cause she is acutely aware

This morning, her colleague, Klaas Knot
Was clear when explaining they’ve got
The tools they may need
To help them succeed
In cooling a euro that’s hot

With the FOMC meeting on tap for later today, the market is mostly biding its time until they hear if anything will be changing at the Mariner Eccles Building.  However, that seems highly unlikely at this time given the following factors:  first, the last we heard from Chairman Powell was that now is not the time to consider removing any policy accommodation, even if things seem to be looking up; and second, it is not clear that things are looking up.  While certainly there are some parts of the economy that are doing well, notably housing and manufacturing, the service sector remains under severe pressure as lockdowns pervade the country.  True, it appears that some of the more draconian lockdowns may be coming to an end, but the hit to the employment situation has been turning much worse.  Recall, the December NFP data printed at a much worse than expected -140K, and Initial Claims data has been running higher lately than back then.  Too, remember that the Fed modified their mandate to seek to achieve “maximum employment” which means declining NFP data is more likely to drive further policy ease than tightness.

So, in truth, today’s FOMC meeting is likely to be a pretty dull affair, with limited market expectations for any movement of any sort.  On the other hand, the ECB, which met last week and took no further action, remains concerned about the euro’s strength.  I have been quite clear in my warnings that the ECB would not allow the euro to trade higher without a response as they simply cannot afford that outcome.  Remember, the ECB’s playbook (and in truth, most central bank playbooks) defines the reaction function for specific conditions.  According to the book, too low inflation requires lower interest rates and a weaker exchange rate.  In fact, one of the primary reasons to lower interest rates is to weaken the exchange rate.  The idea is that a weak currency can help import inflation while simultaneously helping the competitive stance of that nation’s export community.  The problem with this strategy is that it was designed to be used in isolation.  So, if one country is behaving in that manner, it has a chance to succeed.  Unfortunately, the Covid pandemic has resulted in virtually every country trying to use these tools at the same time, thus canceling out each other’s efforts.

Of course, one player is much larger than the others, namely the Fed.  The Fed’s ability to ease policy seems to be outstripping that of the ECB, and every other country as well.  Adding to that has been the extraordinary fiscal policy ease we have seen here, which has been larger than elsewhere, and with the still robust expectations of another $1.9 trillion of fiscal support coming, has been one of the defining features of the bearish dollar outlook.

Which brings us to this morning’s comments from Klaas Knot, the Dutch Central Bank President and ECB Governing Council member.  He was quite clear in explaining the ECB has the necessary tools, including interest rate cuts, to prevent any further strengthening of the euro which could undermine inflation.  “That is something we, of course, monitory very, very carefully.  It’s one of the factors, not the exclusive factor, but one of the factors we take into account when arriving at our assessment of where inflation is going.”  In other words, euro bulls need to understand the ECB is not going to sit by and watch the single currency rally unabated.  It should be no surprise that the market responded to these comments by selling off the single currency, which is now down 0.4% on the day.  Adding to the bearish euro scenario was the release of the German GfK Consumer Confidence survey, which printed at -15.6, its third lowest reading in history, trailing only the May and June readings post the start of the Covid crisis last year.  Once again, I will reiterate my view, while eventually the dollar will decline more sharply as real yields in the US fall into further negative territory later this year, for now, the dollar’s decline seems to be on hold.

Ok, let’s quickly look at markets.  Risk is starting to become more suspect as the morning wears on, with European equity markets now all sharply in the red vs. their earlier little changed price action.  In the wake of the Knot comments, the DAX (-1.55%), CAC (-1.0%) and FTSE 100 (-0.8%) have all sold off hard.  Asian markets, which had closed before the comments, had a more mixed day, with the Nikkei (+0.3%) recouping a little of yesterday’s losses, but the Hang Seng (-0.3%) and Shanghai (+0.1%) doing little overall.  As to US futures, the DOW (-0.9%) and SPU (-1.0%) lead the way down with the NASDAQ (-0.25%) still outperforming after some pretty good earnings data last night from Microsoft.

It should be no surprise that bond markets have found a bid, with Treasury yields lower by 1.4bps, while Bunds (-1.4bps) and OATs (-1.0bps) are also now trading higher.  Again, earlier in the session, yields had actually crept a bit higher, so this reversal of risk attitude is growing.

Commodity markets are being impacted as well, with oil back to flat on the day from early session gains of 0.5% and gold is actually lower by 0.5%.  Only the ags remain well bid, as I guess everyone needs to eat, even during a pandemic.

Finally, the dollar is stronger across the board, with the strength becoming more evident after the Asian close.  In the G10, NOK (-0.9%) is the leading decliner as oil prices have turned, but we are seeing weakness throughout the commodity bloc (AUD -0.6%, NZD -0.4%, CAD -0.4%) as well.  In fact, even the havens are weaker today with both JPY and CHF off by 0.2%.  Today is just a dollar positive day.  In the EMG bloc, the few green spots on the chart are all APAC currencies with very modest gains (KRW +0.2%, TWD +0.1%).  On the other hand, all the markets that are currently open are showing sharp declines led by ZAR (-0.9%), MXN (-0.85%) and RUB (-0.8%).  It is remarkable how closely these three currencies trade to each other.  But really, everything else is weak as well.  There are no specific stories of note here, it is just a day to reduce risk.

On the data front, this morning brings Durable Goods (exp 1.0%, 0.5% ex transport) and then the FOMC statement at 2:00 followed by the Powell press conference at 2:30.  It seems unlikely that the market will react to the Durables data, so things seem to be shaping up as a dollar up day, at least until we hear from Jay.  However, I don’t foresee the dollar exploding higher, just continuing this drift, at least vs. the G10.  EMG is always a different story, so be careful there.

Good luck and stay safe
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