The UK’s Current Plight

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In England, the doves are in flight
Explaining that NIRP is alright
But hawks keep maintaining
That zero’s restraining
Despite the UK’s current plight

What we’ve learned thus far in 2021 is that Monday is risk-off day, at least, so far.  Yesterday, for the second consecutive week, risk was under pressure as equity markets everywhere fell, while the dollar rallied sharply.  But just like last week, where risk was avidly sought once Monday passed, this morning has seen a rebound in many equity markets, as well as renewed pressure on the dollar.

But aside from a very early assessment of a potential pattern forming, this morning brings a dearth of market-moving news.  Perhaps the most interesting is the battle playing out inside the BOE, where Silvana Tenreyo, one of the more dovish MPC members, has been making the case that in the current situation, the UK should cut the base rate into negative territory.  Her analysis, as well as that of other central banks like the ECB, SNB and Danish central bank, have shown that there are many benefits to the policy and that it has been quite effective.  Of course, those are three of four central banks (the BOJ is the other) that currently maintain negative rates, so it would be pretty remarkable if those studies said NIRP was a failure.  The claim is that NIRP increases the amount of lending that banks extend, thus encouraging spending and investment as well as weakening the currency to help the export industries in the various countries.  And the studies go on to explain that all these factors help drive inflation higher, a key goal of each of those central banks.

Now, there is no question that those are the theoretical underpinnings of NIRP, alas, it is hard to find the data to support this.  Rather, these studies tend to give counterfactual analyses, that indicate if the central banks had not gone negative, things would have been worse.  For instance, let’s look at CPI in the Eurozone (-0.3%), Switzerland (-0.8%) and Denmark (+0.5%).  Not for nothing, but those hardly seem like data that indicate inflation has been supported.  In fact, in each of these countries, inflation was going nowhere fast before the pandemic, although I will grant that Covid has depressed the numbers further to date.  And how about the currency?  Well, one of the biggest stories of the past six months has been how the dollar has declined nearly 10% against these currencies.  Once again, the concept of a weaker currency seems misplaced.

The point here is that the discussion is heating up in the UK, with the independent MPC members pushing for a move below zero, while the BOE insiders are far more reluctant, explaining that the banking system would see serious harm.  (I think if one looks at the banking system in Europe, it is a fair statement that the banks there are not performing all that well, despite (because of?) 6 years of NIRP.  The BOE counterpoint was made this morning by Governor Bailey who explained there were still many issues to be addressed and implied NIRP was not likely to be implemented in the near future.  With all this as background, it should be no surprise that the pound has been the best performer in the G10 today, rising 0.6%, after Bailey’s comments squashed ideas NIRP was on its way soon.

But the dollar, overall, is softer today, not nearly reversing yesterday’s gains (except vs. the pound), but generally under pressure.  However, there is precious little that seems to be driving markets this morning, other than longer term stories regarding fiscal stimulus and Covid-19.

So, a quick tour of markets shows that Asian equity markets shook off the weakness in the US yesterday and rallied nicely.  The Nikkei (+0.1%) was the laggard, as the Hang Seng (+1.3%) and Shanghai (+2.1%) showed real strength.  Europe, on the other hand, is showing a much more mixed picture, wit the DAX (+0.1%) actually the best performer of the big 3, while the CAC (0.0%) and FTSE 100 (-0.6%) are searching for buying interests.  The FTSE is likely being negatively impacted by the pound’s strength, as there is a narrative that the large exporters in the index are helped by a weak pound and so there is a negative correlation between the pound and the FTSE.  The problem with that is when running the correlation analysis, over the past two years, the correlation is just 0.08% and the sign is positive, meaning they move together, not oppositely.  But it is a nice story!  And one more thing, US futures are green, up about 0.25% or so.

Bond markets are selling off this morning as yields continue to rise on expectations that the future is bright.  10-year Treasury yields are up to 1.16%, which is a new high for the move, having rallied a further 1.2bps this morning.  But we are seeing the same type of price action throughout Europe, with yields higher by between 1.7 bps (Bunds) and 4.0bps (Italian BTP’s), with Gilts (+2.3bps) and OATs (+2.0bps) firmly in between.  What I find interesting about this movement is the constant refrain that H1 2021 is going to be much worse than expected, with the Eurozone heading into a double dip recession and the US seeing much slower than previously expected growth as many analysts have downgraded their estimates to 1.0% from 4.0% before.  At the same time, the message from the Fed continues to be that tighter policy is outcome based, and there is no indication they are anywhere near thinking about raising rates.  With that as background, the best explanation I can give for higher yields is concerns over inflation.  Remember, CPI is released tomorrow morning, and since the summer, almost every release was higher than forecast.  As I have written before, the Fed is going to be tested as to their tolerance for above target inflation far sooner than they believe.

The inflation story is supported, as well, but this morning’s commodity price moves, with oil higher by 1.3% and gold higher by 0.8%.  In fact, I believe that inflation is going to become an increasingly bigger story as the year progresses, perhaps reaching front page news before the end of 2021.

Finally, as mentioned above, the dollar is under broad-based, but generally modest pressure this morning.  After the pound, AUD (+0.35%) and CAD (+0.25%) are the leading gainers, responding to the firmer commodity prices, although NOK (0.0%) is not seeing any benefit from oil’s rise.  In the EMG space, it is also the commodity linked currencies that are leading the way, with ZAR (+0.9%), RUB (+0.8%) and MXN (+0.5%) topping the list.  Also, of note is the CNY (+0.3%) which is back to levels last seen in June 2018, as the strengthening trend their continues.

On the data front, the NFIB Small Business Optimism index showed less optimism, falling to 95.9, well below expectations, again pointing to a slowing growth story in H1.  The only other data point from the US is JOLT’s Job Openings (exp 6.4M), which rarely has any impact.  I would like to highlight, in the inflation theme, that Brazilian inflation was released this morning at a higher than expected 4.52% in December, which is taking it back above target and to levels last seen in early 2019.  If this continues, BRL may become a high yielder again.

Finally, we hear from 6 different Fed speakers today, but again, unless they all start to indicate tighter policy, not just better economic outcomes, in H2, while the dollar may benefit slightly, it will not turn the current trend.  And that’s really the story, the medium-term trend in the dollar remains lower, but for now, absent a catalyst for the next leg (something like discussion of YCC or increased QE), I expect a bit of choppiness.

Good luck and stay safe
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Compelled

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Just last week the narrative spoke
And told us the world would soon choke
On dollars they held
Thus, would be compelled
To sell them, ere they all went broke

But funnily, this week it seems
The selling had reached its extremes
So, shorts are now squeezed
And traders displeased
As they now must look for new themes

It had been the number one conviction trade entering 2021, that the dollar would sell off sharply this year.  In fact, there were some who were calling for a second consecutive year of a 10% decline in the dollar versus its G10 counterparts, with even more gains in some emerging market currencies.  The market, collectively, entered the new year short near record amounts of dollars, riding the momentum they had seen in Q4 of last year and looking for another few percentage points of decline.  Alas, one week into the year and things suddenly seem quite different.

The first thing to highlight is that while a few percent doesn’t seem like much of a move, certainly compared to equities or bitcoin, the institutional trading community, consisting of hedge funds and CTA’s, lever up their positions dramatically.  In fact, 10x capital is quite common, with some going even further.  So, that 2% move on a 10x leverage position results in a 20% gain, certainly very respectable.  The second thing to highlight is that if a short-term trading reversal is able to cause this much angst in the trading community, conviction in the trade must not have been that high after all.

But let us consider what has changed to see if we can get a better understanding of the market dynamics.  Clearly, the biggest change was the run-off election in Georgia, which had been expected to result in at least one seat remaining in Republican hands, and thus a Republican majority in the Senate.  This outcome of a split government was seen to be a general positive for risk, as it would prevent excessive increases in debt financed stimulus, thus force the Fed to maintain low US interest rates.  And of course, we all know, that low rates should undermine the currency.

But when the Democrats won both seats, and the Senate effectively flipped, the new narrative was that there would be massive stimulus forthcoming, encouraging the reflation trade.  The thing is, the reflation trade is part and parcel of the steepening yield curve trade based on the significant amount of new Treasury debt that would need to be absorbed by the market, with the result being declining prices and higher Treasury yields.  (One thing that I never understood about the weak dollar trade in this narrative was the idea that a steeper yield curve would lead to a weaker dollar, when historically it was always the other way around; steep curve => strong dollar.)

Last week, of course, we saw Treasury yields back up 20 basis points in the back end of the curve, exactly what you would expect in a reflation trade.  And so, it cannot be surprising that the dollar has found a bottom, at least in the short-term, as higher yields are attracting investors.  But what does this say about the future prospects for the dollar?

My thesis this year has been the dollar will decline on the back of declining real yields in the US, which will be driven by rising inflation and further Fed support.  Neither the US, nor any G10 country for that matter, can afford for interest rates to rise as they continue to issue massive amounts of debt, since higher rates would ultimately bankrupt the nation.  However, inflation appears to be making a comeback, and not just in the US, but in many places around the world, specifically China.  Thus, the combination of higher inflation and capped yields will result in larger negative real rates, and thus a decline in the dollar.  Last week saw real yields rise 15 basis points, so the dollar’s rally makes perfect sense.  But once the Fed makes it clear they are going to prevent the back end of the curve from rising, the dollar will come under renewed pressure.  However, that may not be until March, unless we see a hiccup in the equity market between now and then.  For now, though, as long as US yields rise, look for the dollar to go along for the ride.

Of course, higher US yields and a stronger dollar do not encourage increased risk appetite, so a look around markets today shows redder screens than that to which we have become accustomed.  The exception to the sell-off rule was Tokyo, where the Nikkei (+2.35%) rallied sharply as the yen continues to weaken.  Remember, given the export orientation of the Japanese economy, a weaker yen is generally quite positive for stocks there.  The Hang Seng (+0.1%) managed a small gain, but Shanghai (-1.1%), fell after inflation data from China showed a much larger rebound than expected with CPI jumping from -0.5% to +0.2%.  Obviously, that is not high inflation, but the size and direction of the move is a concern.

European markets, however, are all underwater this morning, with the DAX, CAC and FTSE 100 all lower by 0.5%.  US futures are pointing down as well, between 0.4%-0.6% to complete the sweep.  Bond markets are modestly firmer this morning, with Treasury yields slipping 1.5 bps, while Bunds, OATS and Gilts have all seen yields fall just 0.5bps.  Do not be surprised that yields for the PIGS are rising, however, as they remain risk assets, not havens.

In the commodity space, oil is under modest pressure, -0.65%, while gold is essentially unchanged, although I cannot ignore Friday’s 2.5% decline, and would point out it fell another 1.5% early in today’s session before rebounding.  Since I had highlighted Bitcoin’s remarkable post-Christmas rally, I feel I must point out it is down 17% since Friday, with some now questioning if the bubble is popping.

Finally, the dollar continues its grind higher, with commodity currencies suffering most in the G10 (NOK -1.1%, NZD -0.7%, AUD -0.6%) as well as the pound (-0.6%) which is feeling the pain of Covid-19 restrictions sapping the economy.  In the EMG space, we are also seeing universal weakness, with the commodity focused currencies under the most pressure here as well.  So, ZAR (-1.0%), MXN (-0.85%) and BRL (-0.8%) are leading the pack lower, although there were some solid declines out of APAC (IDR -0.75%, KRW -0.7%) and CE4 (PLN -0.75%, HUF -0.7%).

On the data front, this week brings less info than last week, with CPI and Retail Sales the highlights:

Tuesday NFIB Small Biz 100.3
JOLTs Job Openings 6.5M
Wednesday CPI 0.4% (1.3% Y/Y)
-ex food & energy 0.1% (1.6% Y/Y)
Fed’s Beige Book
Thursday Initial Claims 785K
Continuing Claims 5.0M
Friday Retail Sales 0.0%
-ex autos -0.2%
PPI 0.3% (0.7% Y/Y)
-ex food & energy 0.1% (1.3%)
Empire Manufacturing 5.5
IP 0.4%
Capacity Utilization 73.5%
Business Inventories 0.5%
Michigan Sentiment 80.0

Source: Bloomberg

Aside from that, we also will hear a great deal from the Fed, with a dozen speakers this week, including Powell’s participation in an economics webinar on Thursday.  Last week, you may recall that Philadelphia’s Patrick Harker indicated he could see a tapering in support by the end of the year, but the market largely ignored that.  However, if we hear that elsewhere, beware as the low rates forever theme is likely to be questioned, and the dollar could well find a lot more support.  The thing is, I don’t see that at all, as ultimately, the Fed will do all they can to prevent higher yields.  For now, the dollar has further room to climb, but over time, I do believe it will reverse and follow real yields lower.

Good luck and stay safe
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Perfect Right Here

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Said Harker, by end of this year
A taper could be drawing near
But Mester explained
No cash would be drained
As policy’s perfect right here

Ahead of this morning’s payroll report, I believe it worthwhile to recap what we have been hearing from the FOMC members who have been speaking lately.  After all, the Fed continues to be the major force in the market, so maintaining a clear understanding of their thought process can only be a benefit.

The most surprising thing we heard was from Philadelphia Fed president Harker, who intimated that while he saw no reason to change things right now, he could see the Fed beginning to taper their asset purchases by the end of 2021 or early 2022.  Granted, that still implies an additional $1 trillion plus of purchases, but is actually quite hawkish in the current environment where expectations are for rates to remain near zero for at least the next three years.  Given what will almost certainly be a significant increase in Treasury issuance this year, if the Fed were to step back from the market, we could see significantly higher rates in the back end of the curve.  And, of course, it has become quite clear that will not be allowed as the government simply cannot afford to pay higher rates on its debt.   As well, Dallas Fed President Kaplan also explained his view that if the yield curve steepened because of an improved growth situation in the US, that would be natural, and he would not want to stop it.

But not to worry, the market basically ignored those comments as evidenced by the fact that the equity market, which will clearly not take kindly to higher interest rates in any form, rallied further yesterday to yet more new all-time highs.

At the same time, three other Fed speakers, one of whom has consistently been the most hawkish voice on the committee, explained they saw no reason at all to adjust policy anytime soon.  Regional Fed presidents from Cleveland (Loretta Mester), Chicago (Charles Evans) and St Louis (James Bullard) were all quite clear that it was premature to consider adjusting policy as a response to the Georgia election results and the assumed increases in fiscal stimulus that are mooted to be on the way.

Recapping the comments, it is clear that there is no intention to adjust policy, meaning either the Fed Funds rate or the size of QE purchases, anytime soon, certainly not before Q4.  And if you consider Kaplan’s comments more fully, he did not indicate a preference to reduce support, just that higher long-term rates ought to be expected in a well-performing economy.  Vice-Chairman Clarida speaks this morning, but it remains difficult to believe that he will indicate any changes either.  As I continue to maintain, the government’s ability to withstand higher interest rates on a growing amount of debt is limited, at best, and the only way to prevent that is by the Fed capping yields.  Remember, while the Fed has adjusted its view on inflation, now targeting an average inflation rate, they said nothing about allowing yields to rise alongside that increased inflation.  Again, the dollar’s performance this year will be closely tied to real (nominal – inflation) yields, and as inflation rises in a market with capped yields, the dollar will decline.

Turning to this morning’s payroll release, remember, Wednesday saw the ADP Employment number significantly disappoint, printing at -123K, nearly 200K below expectations.  As of now, the current median forecasts are as follows:

Nonfarm Payrolls 50K
Private Payrolls 13K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

These numbers are hardly representative of a robustly recovering economy, which given the cresting second wave of Covid infections and the lockdowns that have been imposed in response, ought not be that surprising.  The question remains, will administration of the vaccine be sufficient to change the trajectory?  While much has been written about pent up demand for things like travel and movies, and that is likely the case, there has been no indication that governments are going to roll back the current rules on things like social distancing and wearing masks.  One needs to consider whether those rules will continue to discourage those very activities, and thus, crimp the expected recovery.  Tying it together, a slower than expected recovery implies ongoing stimulus

But you don’t need me to explain that permanent stimulus remains the basic premise, just look at market behavior.  After yesterday’s US equity rally, we have seen a continuation around the world with Japan’s Nikkei (+2.35%) leading the way in Asia, but strength in the Hang Seng (+1.2%) and Australia (+0.7%), although Shanghai (-0.2%) didn’t really participate.  Europe, too, is all green, albeit in more measured tones, with the DAX (+0.8%) leading the way but gains in the CAC (+0.5%) and FTSE 100 (+0.2%) as well as throughout the rest of the continent.  And finally, US futures are all pointing higher at this hour, with all three indices up by 0.25%-0.35%.

The Treasury market, which has sold off sharply in the past few sessions, is unchanged this morning, with the yield on the 10-year sitting at 1.08%.  In Europe, haven assets like bunds, OATs and gilts are little changed this morning, but the yields on the PIGS are all lower, between 1.6bps (Spain) and 3.9bps (Italy).  Again, those bonds behave more like equities than debt, at least in the broad narrative.

In the commodity space, oil continues to rally, up another 1.3% this morning, and we continue to see strength in base metals and ags, but gold is under the gun, down 1.1%, and clearly in disfavor in this new narrative of significant new stimulus and growth.  Interestingly, bitcoin, which many believe as a substitute for gold has continued to rally, vaulting through $41k this morning.

And lastly, the dollar, which everyone hates for this year, is ending the week on a mixed note.  In the G10, NOK (+0.3%) is the best performer, as both oil’s rise and much better than expected IP data have investors expecting continued strength there.  But after that, the rest of the bloc is +/- 0.2% or less, implying there is no driving force here, rather that we are seeing position adjustments and, perhaps, real flows as the drivers.

In the emerging markets, ZAR (+1.2%) and BRL (+0.6%) are the leading gainers, while IDR (-0.8%) and CLP (-0.6%) are the laggards.  In fact, other than those, the bloc is also split, like the G10, with winners and losers of very minor magnitude.  Looking first at the rand, today’s gains appear to be position related as ZAR has been under pressure all week, declining more than 5.6% prior to today’s session.  BRL, too, is having a similar, albeit more modest, correction to a week where it has declined more than 5% ahead of today’s opening.  Both those currencies are feeling strain from weakening domestic activity, so today’s gains seem likely to be short-lived.  On the downside, IDR seems to be suffering from rising US yields, as the attractiveness of its own debt starts to wane on a relative basis.  As to Chile, rising inflation seems to be weighing on the currency as there is no expectation for yields to rise in concert, thus real yields there are under pressure.

And that’s really it for the day.  We have seen some significant movement this week, as well as significant new news with the outcome of the Georgia election, so the narrative has had to adjust slightly.  But in the end, it is still reflation leads to higher equities and a lower dollar.  Plus ça change, plus ça meme chose!

Good luck, good weekend and stay safe
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Chaos Prevailed

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In Washington, chaos prevailed
As Congress’s job was derailed
Investors, though, thought
‘Twas nothing, and bought
More stocks with the 10-year was assailed

One of the more remarkable aspects of the chaotic events in Washington, DC yesterday was the fact that the market reaction was completely benign.  On the one hand, given the working assumption that the theatrics would not affect the ultimate outcome, it is understandable.  On the other hand, the fact that there continues to be this amount of discord in the nation in the wake of a highly contentious election bodes ill for the ability of things to quickly return to normal.  In the end, though, market activity indicates the investment community firmly believes there will be lots more fiscal stimulus as the new Biden administration tries to address the ongoing pandemic driven economic issues.  Hence, the idea behind the reflation trade remains the current narrative, with more stimulus leading to faster economic growth, while increased Treasury supply to fund that stimulus leads to higher long end yields and a steeper yield curve.

However, now that the formalities of the electoral vote counting have concluded, focus has turned back to the narrative on a full-time basis, with the ongoing argument over whether inflation or deflation is in our future, as well as the question of whether assets, generally, are fairly valued or bubblicious.  The thing is, away from the politics, nothing has really changed very much lately.

Covid-19 continues to spread and the resultant lockdowns around the world continue to be expanded and extended.  Just last night, for instance, Japan declared a limited state of emergency in Tokyo and three surrounding prefectures in an effort to stem the spread of Covid.  That nation has been dealing with its highest caseload since April, and the Suga government was responding to requests for help from the local governments.  Meanwhile, in Germany, on Tuesday lockdowns were extended through the end of January and restrictions tightened to prevent travel of more than 15km from one’s home.  And yet, this type of news clearly does not dissuade investors as last night saw the Nikkei rally 1.6% while the DAX, this morning, is higher by 0.4% after a 1.75% rally yesterday.  In the end, the narrative continues to highlight the idea that the worse the Covid situation, the greater the probability of further fiscal and monetary stimulus, and therefore the bigger the boost to growth.

At the same time, the reflation piece of the narrative continues apace with Treasury yields continuing to climb, edging higher by one more basis point so far this morning after an eight basis point rise yesterday.  Something that has received remarkably little attention overall is the fact that oil prices have been rallying so steadily of late, having climbed more than 40% since the day before the Presidential election, and given the pending supply reductions, showing no signs of backing off.  This, along with the ongoing rallies in most commodities, is part and parcel of the reflation trade, as well as deemed a key piece of the ultimate dollar weakness story.

Regarding this last observation, there is, indeed, a pretty strong negative correlation between the dollar’s value and the price of oil.  Of course, the question to be answered is the direction of causality.  Do rising oil prices lead to a weaker dollar?  Or is it the other way round?  If it is the former, then the dollar’s future is likely to be one of weakness as the supply reductions in US shale production alongside the Saudi cuts can easily lead to further gains of $10-$15/bbl.  However, the dollar is impacted by many things, notably Fed policy, and if the dollar is the driver of oil movement, the future of the black, sticky stuff is going to be far less certain.  If, for example, inflation rises more rapidly than currently anticipated, and forces the market to consider that the Fed may react by reducing policy ease, the dollar could easily find support, especially given the massive short positions currently outstanding.  Would oil continue to rise into that circumstance?  The point is, correlations are fine to recognize, but as a planning tool, they leave something to be desired.  Understanding the fundamentals underlying price action remains critical to plan effectively.

As to today’s session, the risk picture has turned somewhat mixed.  As mentioned above, Asian equity prices had a pretty good day, with Shanghai (+0.7%) rising alongside the Nikkei, although the Hang Seng (-0.5%) struggled.  European bourses are mixed, with the DAX (0.4%) leading and the CAC (+0.1%) slightly higher although the FTSE 100 (-0.5%) is under pressure.  There is one outlier here, Sweden, where the OMX has rallied 2.1% this morning, although there is no general news driving the movement.  In fact, PMI Services data was released at its weakest level since the summer, which hardly heralds future strength.

We’ve already discussed Treasury weakness but the picture in Europe is more mixed, with bunds (-1bps) and OATs (-0.5bps) rallying slightly while Gilts (+1.7bps) are under pressure alongside Treasuries.

And finally, the dollar is showing some solid gains this morning, higher against all its G10 counterparts and most of the EMG bloc.  Despite ongoing strength in the commodity space, AUD (-0.75%) leads the way lower with NZD (-0.6%) next in line.  Clearly, the market did not embrace the Japanese news on the lockdown, as the yen has declined 0.6% as well.  As to the single currency, it has fallen 0.5%, with a very strong resistance level building at 1.2350.  It will take quite an effort to get through that level in the short run.

Emerging markets declines are led by CLP (-1.85%) and ZAR (-1.0%), although the weakness is nearly universal.  Interestingly, the Chile story is not about copper, which continues to perform well, but rather seems to be a situation where the currency is being used as a funding currency for carry trades in the EMG bloc.  ZAR, on the other hand, is suffering alongside gold, which got hammered yesterday and is continuing to soften.

On the data front, today brings Initial Claims (exp 800K), Continuing Claims (5.2M), the Trade Balance (-$67.3B) and ISM Services (54.5).  Remember, tomorrow is payrolls day, so there may be less attention paid to these numbers this morning.  One cautionary tale comes from the Challenger Job Cuts number, which is released monthly but given limited press.  Today, it jumped 134.5% from one year ago, a significant jump on the month, and a bad omen for the employment picture going forward.  With this in mind, it seems highly unlikely the Fed will do anything but ease policy further in the near term.  One other thing, yesterday the December FOMC Minutes were released but had no market impact.  Recall, the December meeting occurred prior to the stimulus bill or the Georgia run-off election, so was missing much new information.  But in them, the FOMC made clear that the bias was for a dovish stance for a long time to come.  Based on what we heard from Chicago’s Evans on Tuesday, it doesn’t seem that anything has changed since then.

Given the significant short dollar positions that are outstanding in the investment and speculative communities, the idea that the dollar could rally in the near term is quite valid.  While nothing has changed my longer-term view of rising inflation and deeper negative real yields undermining the dollar, that doesn’t mean we can’t jump in the near term.

Good luck and stay safe
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Blue Wave at Last

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Psephologists have now decided
The run-off election provided
A blue wave at last
So laws can be passed
Republicans view as misguided

The market responded by sellin’
The 10-year, with traders foretellin’
Inflation to come
As Powell stays mum
While financing Treasury’s Yellen

While the election results from Georgia are not yet final, the indications at this time are that the Democratic party won one of the seats with the second one still too close to call.  However, the market has already made its decision, that both seats flipped to the Democrats and that the Senate will now be split 50:50, which means that the Vice President will be able to cast the deciding vote.  The clear implication is that, while hardly a mandate, the Democrats will control both the executive and legislative branches and be able to implement a great deal of their agenda.  In other words, the blue wave high tide has finally crested.

The initial reaction to this news has been seen in the sell-off of the 10-year Treasury, where the yield has risen to 1.02% as I type, its first foray above 1.00% since March 19th, during the first days of the Covid-19 market panic.  The reflation trade is back in vogue, with expectations now that the new administration will be aggressively adding fiscal stimulus, thus increasing Treasury issuance significantly and ultimately steepening the yield curve as demand for long-dated Treasuries will not be able to keep pace with the new supply.  However, given the already record levels of debt outstanding, the government simply cannot afford for interest rates to rise too far, as if they do, interest payments will soak up an ever-increasing proportion of available revenues.  It is for this reason that I continue to believe the Fed will increase their current activity, and whether tacitly, by expanding QE and extending the maturity of purchases, or explicitly, by setting a yield target, implement Yield Curve Control (YCC).

At the same time, the Fed has made it abundantly clear that higher inflation is of no concern to the committee.  The latest proof comes from Chicago Fed President Charles Evans, who explained to us yesterday, “Frankly, if we got 3% inflation, that would not be so bad.  It is very difficult to imagine out of control inflation, even with the large debt that fiscal authorities have been running up.”   Perhaps, as a Regional Fed President, he simply lacks imagination.  After all, just yesterday, almost at the same time he was recounting his views, the ISM Prices Paid index printed at 77.6, well above expectations and at a level seen only twice, briefly, in the past decade.  There is a strong correlation between this index and PPI, so the idea that inflation pressures are building is hardly unimaginable.

Which brings us back to the prospects for the dollar, as well as other markets.  While yields have climbed today, the prospect of inflation rising more rapidly and real rates falling further into negative territory still informs my view that the dollar has further to decline.  This will become more obvious when the Fed steps in to prevent the rise in nominal yields, which I am confident will occur sooner rather than later.  Again, while I don’t anticipate a dollar collapse, as other central banks will fight to prevent such an outcome, further dollar weakness is in the cards.

Speaking of other central banks fighting the dollar’s weakness, last night the PBOC started to do just that by establishing the CNY fix at a weaker renminbi rate than anticipated.  Since August 1st, CNY has appreciated by nearly 8% vs. the dollar, which for an economy that remains heavily reliant on exporting for GDP growth, is a growing problem.  As the PBOC makes no bones about directing the value of the currency, you can expect that they will be actively managing the renminbi’s value going forward in an effort to prevent too much further strength.  But, as long as both nominal and real yields remain positive in China, that will attract significant capital flows and continue to pressure the renminbi higher.

So, what has all this news done to other markets?  Well, most of Europe is ecstatic at the election outcome, at least that seems to be the case based on the rallies seen in equity markets there.  The FTSE 100 (+2.3%) is leading the way, but we are seeing strong gains in the DAX (+0.9%) and CAC (+0.8%) as well, despite the fact that the PMI Services data disappointed across the board.  The story in Asia was more mixed with the Nikkei (-0.4%) and Australia (-1.1%) underwhelmed by the outcome, although the Hang Seng (+0.2%) and Shanghai (+0.6%) both wound up in the green.  As to US futures, as I type, they are a mixed bag, with DOW futures higher by 0.2%, SPU’s lower by 0.4% while NASDAQ futures are down 2.0%.  The latter’s decline are a response to the election results as concerns grow that Big Tech will now be in the crosshairs of Congress for more regulation if not outright dismemberment.

While we have already discussed the Treasury market, European government bonds are mostly softer today as well, with yields rising as much as 4bps in the UK, although German bunds are unchanged on the session.

Another inflationary impulse comes from oil, where yesterday the Saudis surprised the market by unilaterally cutting production by 1 million barrels/day helping to take WTI above $50/bbl for the first time since late February.  If this rally continues, look for gasoline prices to creep higher, one of the key sentiment indicators regarding the perception of inflation.

And finally, the dollar remains broadly under pressure this morning, with NOK (+0.75%) the leading gainer in the G10 on the back of the oil rally, although both AUD (+0.6%) and NZD (+0.65%) are also having a good day as both commodity prices gain and they serve as a proxy for Asian growth.  Meanwhile, the euro (+0.35%) is trading at new highs for the move and back to levels not seen since April 2018.

Emerging market currencies are universally higher this morning, led by PLN (+0.85%), MXN (+0.8%) and HUF (+0.8%).  Those stories are easy to see, with oil helping the peso, while the CE4 currencies are tracking the euro’s strength.  Asian currencies, while all firmer, did not show nearly the enthusiasm, with gains between 0.1% and 0.2%, but of course, the election results were not fully known during their session.

On the data front, this morning brings ADP Employment (exp 75K) as well as Factory Orders (0.7%) and the PMI Services index (55.2).  Then, this afternoon, we see the FOMC Minutes of the December meeting, one where they disappointed many folks by not easing further. The first thing to note is that after yesterday’s ISM data, the ADP forecast increased from 50K.  Clearly, the manufacturing sector remains in better shape than expected.  At the same time, the Minutes ought to be interesting as perhaps we will learn more about attitudes regarding any prospects for what could change policy.  Of course, given the world was a different place then, and as Evans explained, inflation is of no concern, the real question from the Minutes will be what will the Fed do next to ease further.

As to the dollar, it is hard to see a short-term path in any direction other than lower, but I continue to expect the decline to be slow and orderly.

Good luck and stay safe
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No Antidote

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In Georgia, today’s runoff vote
For Senate is no antidote
To nationwide fears
The quartet of years
To come, more unease, will promote

Investors expressed their dismay
By selling stocks all yesterday
As well, though, they sold
The buck and bought gold
Uncertainty’s with us to stay

Markets certainly got off to an inauspicious start yesterday as a number of concerns regarding upcoming events, as well as the possibility that some markets are overextended, combined to induce a bit of risk reduction.  Clearly, the top story is today’s runoff election in Georgia, where both US Senate seats are up for grabs.  The Republicans currently hold a 50-48 majority, but if both seats are won by the Democratic candidates, the resulting 50-50 tie will effectively give the Democrats control of the Senate as any tie votes will be broken by the Vice-President.  In that event, the Democrats should be able to institute their platform which, ostensibly, includes infrastructure spending, the Green New Deal, or parts thereof, and more substantial stimulus to address the impact of the coronavirus.

This blue wave redux has been a key topic in markets of late.  You may recall that heading into the election in November, when the polls were calling for the original blue wave, the market anticipated a huge amount of fiscal stimulus driving significantly larger Federal budget deficits.  The ensuing Treasury bond issuance required to fund all this spending was expected to result in a much steeper yield curve, a continuing rally in the stock market as the economy recovered (and this was before the vaccine) and a declining dollar.  As the runoff election approached, markets started to replay that scenario which has, until yesterday, led to successive new all-time high closes in equity indices as well as a steeper Treasury yield curve.  As well, the dollar has remained under pressure, as that remains one of the strongest conviction trades of 2021.

But yesterday, and so far this morning, we are seeing a potential change of heart, or perhaps just a note of caution.  Because if the Republicans retain one of the two seats, that will put paid to the entire blue wave hypothesis.

Of course, there is another possibility that is driving investor caution, and that is the idea that markets, especially equity markets, remain extremely frothy at current levels.  Certainly, on a historical basis, valuation indicators like P/E or Shiller’s CAPE, or Price/Book or even Total Market Cap/GDP are at historically high extremes.  Is it possible that the market has already priced in every conceivable positive event to come?  There are those who would make that argument, and if they are correct, then the required catalyst for a correction of some sorts is likely not that large.  For instance, if the Republicans win even one seat, the entire stimulus bandwagon may never get going, let alone any of the more widescale projects.  And that could well be enough to force a rethinking of the endless stimulus theory with a resultant revaluation of investment risks.

One of the things that always bothered me about the blue wave hypothesis was the idea that the Treasury yield curve would steepen, and the dollar would decline.  Historically, a steeper yield curve has indicated a strengthening US economy which has drawn investment and strengthened the dollar.  I don’t believe that relationship will change, however, a weaker dollar does make sense if you consider how the Fed is likely to respond to rising Treasury yields; namely with Yield Curve Control (YCC).  The US government cannot afford for interest rates to rise substantially, especially as the amount of debt issued continues to grow rapidly.  In fact, the only way it can continue to pay interest on the growing pile of debt is to make sure that interest rates remain at historically low levels.  The implication is that if the Treasury continues to flood the market with issuance, the Fed will be required to buy all of it, and then some, in order to prevent yields from rising.  And whether it is explicit, or implicit, that YCC is going to result in increasingly negative real yields in the US (as inflation is almost certainly going higher).  Now, if you wanted a catalyst to drive the dollar lower, increasing negative real yields is a perfect solution.  While that may not be such a benefit for investors and savers, it will help the Fed retain the upper hand in the global policy ease race, and with it, help undermine the value of the dollar.  It is, in fact, the basis for my views this year.  All that from the Georgia run-off elections!  Who would have thunk?

As to markets this morning, yesterday’s weakness remains fairly widespread in the equity space, as all European bourses are lower (DAX -0.4%, CAC -0.5%, FTSE 100 -0.1%) after a mixed Asian session (Nikkei -0.4%, Hang Seng +0.6%, Shanghai +0.7%).  In fact, Shanghai reached its highest level since August 2015, the previous bubble we saw there.  US futures, meanwhile, are little changed at this hour as traders await the first indications from the Georgia elections.

Bond markets are broadly lower this morning, with Treasury yields higher by 1.3bps and most European bonds showing similar rises in their yields.  On the one hand this is unusual, as bonds generally benefit from a risk off mood.  On the other hand, if I am correct about the move toward negative real yields, bonds will not be a favored investment either and could well underperform going forward, at least until the central banks increase their purchases.

Another beneficiary of negative real yields in the US is gold, which rallied sharply yesterday, more than 2%, and is up a further 0.3% this morning, back at $1950/oz.  Oil, meanwhile, is starting to move higher as well, up 1.8%, as some optimism over the outcome of the OPEC+ meeting is adding to the broad commodity rally.

And finally, the dollar is generally weaker this morning, down against all its G10 counterparts and many of its EMG counterparts as well.  In the G10, SEK (+0.6%) is the leader, which appears to simply be an example of its higher beta relative to the euro or pound vs. the dollar. But we are also seeing the commodity bloc perform well (AUD +0.5%, CAD +0.3%, NOK +0.3%) alongside their main exports.  However, this is clearly a dollar weakness story as the yen (+0.25%) is rallying alongside the rest of the bloc.

Interestingly, in the EMG group, ZAR (-1.35%) is the worst performer, followed by RUB (-0.6%), neither of which makes sense based on the G10 performance as well as that of commodities.  However, it is important to remember that short dollar is one of the most overindulged positions in markets, and the carry trade has been a favorite with both these currencies benefitting from that view.  This looks like a bit of position unwinding more than anything else.  On the positive side in this bloc, the CE4 remain solid and are leading the way, while LATAM currencies are little changed on the open.

On the data front, this week brings a lot of new information culminating in the payroll report on Friday.

Today ISM Manufacturing 56.7
ISM Prices Paid 65.0
Wednesday ADP Employment 50K
Factory Orders 0.7%
FOMC Minutes
Thursday Initial Claims 803K
Continuing Claims 5.1M
Trade Balance -$67.3B
ISM Services 54.5
Friday Nonfarm Payrolls 50K
Private Payrolls 50K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

Last Thursday saw a stronger than expected Chicago PMI and yesterday’s PMI data was strong as well, so the economy remains a bit enigmatic, with manufacturing still robust, but services in the dumps.  The payroll expectations are hardly inspiring, and with lockdowns growing in the States, as well as worldwide, it doesn’t bode well for Q1 at least, in terms of GDP growth.  We also hear from seven Fed speakers this week, which could well be interesting if anyone is set to change their tune regarding how long easy money will remain the norm.  However, I doubt that will happen.

The dollar remains on its back foot here, and I see no reason for it to rebound in the short run absent a change in the underlying framework.  By that I mean, something that will imply real yields in the US are set to rise.  Alas, I don’t see that happening in the near future.

Good luck and stay safe
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The Dollar’s Fate (In the Coming Year)

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With apologies to Henry Wadsworth Longfellow

Listen, my children, and you shall hear
Of the dollar’s fate in the coming year
In the wake of a time that’s ne’er been seen
Since the Spanish Flu of Nineteen Eighteen
Perhaps Twenty-One will bring joy, not fear

Recapping Twenty shows that despite
A plague of biblical magnitude
The printing press revealed its might
As governments everywhere, debt, accrued
And flooded the markets with cash untold
(The better their citizens be controlled)
But all of that money was used, not for,
Increased production of goods onshore
Instead, for the purchase of stocks galore

Thus, equity markets at home rose higher
With Asia, too, on proverbial fire
Though Europe lagged, as the ECB
Was late to the party with more QE
Risk was embraced with a multiplier
Government bonds, though falling of late
Had seen yields tumble, year-to date
And lastly, the dollar, is now descending
As traders await this trend extending

Looking ahead, what can we expect?
Has Covid passed? Will ‘normal’ return?
Or are there surprises we’ve yet to learn?
Will stocks continue their flights of fancy?
Will bonds, inflation, at last detect?
Will dollars, everyone, start to spurn?
Will gold and bitcoin still seem chancy?

Regarding the virus, it’s not dead yet
Though hope springs eternal, and at last
The vaccines imply the worst has passed
But life, as we knew it, has been reset
Working from home (or living at work)
Is mainstream now, and not just a quirk
Office demand will certainly slide
And travel for business will lessen worldwide
Normal has changed, for boss and for clerk

Let us now speak of growth and inflation
Will growth improve on last year’s “success”?
Or will it instead fall flat and regress
Lockdown renewals bode ill for salvation
Policymakers constantly flail
As policy efforts constantly fail
Stimulus, fiscal, continues to flow
Interest rates are now forevermore low
Central banks tell us that this combination
Is perfect to counter a fearful stagnation
But in their efforts, good times to hail
The rising of prices will bypass their gaze
Leading to many more difficult days
GDP this year will struggle to One
Inflation, however, at Four, will not stun

How, then, will markets respond to this fate?
Equity prices at first will inflate
By spring, though, ‘twill be clear something’s amiss
Traders, their holdings, will start to truncate
While we shall not tumble into the abyss
Do not be shocked if the market does fall
Some twenty percent, at the least, is my call
What about bonds? How will they react?
Powell will ne’er let their prices contract
Yield Curve Control is the future we’ll see
Alongside the horror of pure MMT
Hence, ten-year bonds when December arrives
Will keep up their value, a cat with nine lives
One percent will be the height they attain
Implying the real yield most certainly dives
And so, the dollar will suffer great pain

Starting in Europe where Madame Lagarde
Is trying to keep up with Fed Chairman Jay
Sadly, what’s clear, at the end of the day
The ECB’s structure will make it too hard
While Fed and the Treasury work hand in hand
Pushing more money throughout all the land
Treaties in Europe have outcomes, unplanned
PEPP’s not enough for a rebound unscarred

Even though growth throughout Europe will sag
Even though prices will still be a drag
Nothing Lagarde can create will impact
The outcome, a euro that’s sure to move higher
Thus, if it’s something you need to acquire
At year-end, One-Thirty, you’ll need, that’s a fact

Tumultuous best describes last year’s UK
Twixt Covid and Brexit, the nation felt pain
Unhappily, this year, to Johnson’s dismay
Could worsen for every old bloke on the street
With growth in the toilet while prices show heat
It doesn’t seem much like Pound Sterling could gain

But real rates keep diving throughout the US
Offsetting those troubles, so if you need quid
Come Christmas, One-Fifty, if I had to guess
Is what they will cost as the dollar’s declined
Looking elsewhere, perhaps north of the border
Canada still seems a bit out of order
Oil’s rebounded but still seems confined
Meanwhile, housing there is quite well bid

However, again, it is Fed Chairman Jay
Who’s promised support for considerable time
Thus, when we get to our next Boxing Day
One-Fifteen for Loonies you’ll see on your screen
Eastward now, let’s turn our gaze as we glean
Whether the yen can continue its climb
Long-term, the dollar, its trend has been clear
Even before the debasement of late
Several percent, like a clock every year
Why would this year, something new, demonstrate?

Frankly, it won’t, as the Fed’s in control
Rather, the yen, will continue to roll
So, Winter Solstice this year will reveal
Dollar-Yen, Ninety-Six, where you can deal
Let us turn now to both future and past
Bitcoin and gold, which have both been amassed
Can both their prices continue to rise?
Certainly, as they’ve restricted supplies

For centuries, gold has defined what’s secure
Its glitter unblemished while paper’s debased
So, don’t be surprised if the relic’s embraced
As buyers pay Three Grand their wealth to insure
But youth has ideas which to many seem odd
And bitcoin is one such that’s been called a fraud
So, is it? Or is Bitcoin digital gold?
An updated version important to hold
As fiat debasement continues apace
This digital token gains further allure
And this year it seems Bitcoin’s making its case
As something that everyone needs to procure

It’s starting this year right around thirty grand
And hodlers believe that ‘tween here and the sky
Unless countries call for Bitcoin to be banned
A doubling or tripling’s the gain they’ll apply
One last thing I’ll highlight in digital space

The DCEP is now leading the race
This digital yuan, the first CBDC
Is coming soon courtesy of Mr Xi
It’s impact initially is quite unclear
But I guarantee that inside of a year
Nations worldwide will each roll out their own
And each will define a DC trading zone

While last year was filled with surprises galore
This year we’re likely to see many more
And finally, thank you, my readers and friends
For listening to all the twists and the bends
Now looking ahead to Twenty Twenty-One
Let’s all keep perspective and try to have fun.

Good luck, stay safe and have a wonderful new year
Adf

DCEP = Digital Currency / Electronic Payment
CBDC = Central Bank Digital Coin

Less Than Two Weeks

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There once was a tow-haired PM
Who rallied supporters ‘gainst ‘them’
At first ‘them’ was Labour
But now it’s their neighbor,
The EU, they need to condemn

With less than two weeks to agree
A deal leaving much of trade free
It’s come down to fish
Which both sides do wish
Were subject to their own decree

Today will be the last poetry of 2020.  Come January 4, 2021, FXPoetry will return with prognostications for 2021.  As such, let me wish all my readers a happy and healthy New Year.

One of the biggest benefits of 2020 coming to an end is the fact that the Brexit story should finally be put to bed.  Whether or not a trade deal is agreed by December 31st, it is unambiguous that the UK will have a changed relationship with the EU going forward.  As such, there will be no more histrionics regarding negotiations and investors and traders will return to valuing UK assets and the pound based on more fundamental views.  But we are not there yet, and so the ongoing Brexit negotiations continue to have a significant impact on markets.  If you recall, just one week ago, rumors were flying that the talks were going to collapse, and the UK was going to walk away.  Of course, that didn’t happen, and now it appears that fishing rights are the last remaining issue to be agreed.

In a nutshell, the EU want unfettered access to the UK’s fishing grounds, which are amongst the richest in the world, and which they have enjoyed for the past 47 years, ever since the UK joined the EU in 1973.  At the same time, the UK wants to control its sovereign waters, which was part of the entire rationale for Brexit in the first place, for the nation to regain its sovereignty.  It is also important to remember that from an economic perspective, fishing represents 0.1% of the UK economy and even less of the EU’s economy.  The point is, this is a symbolic issue, as opposed to a critical economic outcome.  Apparently, the UK has offered a 3-year transition period with no changes, and then want to review/renew licenses every 3 years thereafter.  The EU, meanwhile, wants no change in the current situation.  It seems to me, that of all the issues that have been addressed, this would be one of the easier ones to solve, and I remain confident it will be solved.  Perhaps 5 years or 7 years will be agreed, but some number will be agreed.

However, with both sides still full of bluster on the issue, threats of the talks breaking down are daily events, and today, it seems the market is in a more credulous mood.  As such, after a week where the pound, along with almost every other currency, rallied pretty sharply, we are seeing some profit-taking that has seen the pound retreat 0.45%, making it the worst performer in the G10.  None of this, however, has changed my view that a deal will be reached before the end of the year.

On a different note, the BOJ completed their last meeting of the year and surprised the market by explaining they were going to conduct yet another review of their policies, to be completed in March.  While leaving interest rates and asset purchase targets unchanged, they did extend their special pandemic related support programs by an additional six months.  But the news of the review is the talk of the market, with initial speculation that they may adjust their yield curve control policy to target a different tenor (currently they target 10-year yields at 0.00% +/- 0.20%) in their efforts to stoke inflation.  Alas, as demonstrated by last night’s data, they continue to fail miserably in this task.  CPI was released at -0.9% on both a headline and ex fresh food basis.  While a review may well be a good idea, it will only be useful if they actually define a policy that helps them achieve their goal of 2.0% inflation.  Unfortunately, for the past twenty-eight years, they have not really come close.  As to the yen, which has been strengthening this week along with most currencies, it too has softened overnight, down by 0.25%.

And those are really the stories of note this morning.  Risk sold off across Asia (Nikkei -0.2%, Hang Seng -0.7%, Shanghai -0.3%) although European bourses are marginally higher at this time (DAX, CAC and FTSE 100 all +0.1%).  US futures, meanwhile, are essentially flat on the day, as traders prepare for triple witching day today, when stock options, stock index futures and stock index options all expire.  Historically, they have been known to see some large moves, but right now, that doesn’t seem the case.

Bond markets, despite the lackluster stock performance, are under pressure as well, with most European bonds seeing yields rise (Bunds and OAT’s +1bp, PIGS +2bps to+6bps), although with the concern over Brexit, Gilts have seen haven demand and yields have decline 2bps.  Treasuries, meanwhile, are essentially unchanged, and continue to hover just below the 1.0% yield level that so many expect to be breeched shortly.

Both oil and gold prices are little changed on the day while the dollar is benefitting from what is almost certainly profit-taking and position adjustment heading into the weekend.  As such, it is higher vs. most of the G10, albeit only marginally, and firmer vs. most of the EMG bloc.  The noteworthy moves in EMG are RUB (-1.1%), which fell ahead of the central bank meeting, where they left policy unchanged, and has not seen any recovery since, and HUF (-0.6%) which has seen selling interest after the budget deficit there topped expectations.

Data-wise, yesterday’s Initial Claims data was a bit worse than expected, which doesn’t bode well for Q4 GDP in the US, but Housing Starts and Building Permits remain strong.  Philly Fed also disappointed, another indication that growth here is moderating.  This morning’s only number is Leading Indicators (exp 0.5%), but that seems unlikely to have an impact.  Rather, consolidation is today’s theme, and while the trend remains firmly for a lower dollar, it would not be surprising if it finishes the week on a high note.

Until 2021…good luck, good weekend and stay safe
Adf

Infinite Easing

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Until “further progress” is made
On joblessness, Jay won’t be swayed
From infinite easing
Which stocks should find pleasing
Explaining how he will get paid

As well, one more time he inferred
That Congress was being absurd
By not passing bills
With plenty of frills
So fiscal relief can be spurred

“We’re going to keep policy highly accommodative until the expansion is well down the tracks.”  This statement from Chairman Powell in yesterday’s post-meeting press conference pretty much says it all with respect to the Fed’s current collective mindset.  While the Fed left the policy rate unchanged, as universally expected, they did hint at the idea that additional QE is still being considered with a subtle change in the language of their statement.  Rather than explaining they will increase their holdings of Treasuries and mortgage-backed securities “at least at the current pace”, they now promise to do so by “at least $80 billion per month” in Treasuries and “at least $40 billion per month” in mortgages.  And they will do this until the economy reaches some still unknown level of unemployment alongside their average 2% inflation target.

What is even more interesting is that the Fed’s official economic forecasts were raised, as GDP growth is now forecast at 4.2% for 2021 and 3.2% for 2022, each of these being raised by 0.2% from their September forecasts.  At the same time, Unemployment is expected to fall to 5.0% in 2021 and 4.2% in 2022, again substantially better than September’s outlook of 5.5% and 4.6% respectively.  As to PCE Inflation, the forecasts were raised slightly, by 0.1% for both years, but remain below their 2% target.

Put it all together and you come away with a picture of the Fed feeling better about the economy overall, albeit with some major risks still in the shadows, but also prepared to, as Mario Draghi declared in 2012, “do whatever it takes” to achieve their still hazy target of full employment and average inflation of 2%.  For the equity bulls out there, this is exactly what they want to hear, more growth without tighter policy.  For dollar bears, this is also what they want to hear, a steady supply increase of dollars that need to wash through the market, driving the value of the dollar lower.  For the reflatonistas out there, those who are looking for a steeper yield curve, they took heart that the Fed did not extend the duration of their purchases, and clearly feel better about the more upbeat growth forecasts, but the ongoing lack of inflation, at least according to the Fed, means that the rationale for higher bond yields is not quite as clear.

After all, high growth with low inflation would not drive yields higher, especially in the current world with all that liquidity currently available.  And one other thing argues against much higher Treasury yields, the fact that the government cannot afford them.  With the debt/GDP ratio rising to 127% this year, and set to go higher based on the ongoing deficit spending, higher yields would soak up an ever increasing share of government revenues, thus crowding out spending on other things like the entitlement programs or defense, as well as all discretionary spending.  With this in mind, you can be sure the Fed is going to prevent yields from going very high at all, for a very long time.

Summing up, the last FOMC meeting of the year reconfirmed what we already knew, the Fed is not going to tighten monetary policy for many years to come.  For their sake, and ours, I sure hope inflation remains as tame as they forecast, because in the event it were to rise more sharply, it could become very uncomfortable at the Mariner Eccles Building.

In the meantime, this morning brings the last BOE rate decision of the year, with market expectations universal that no changes will be forthcoming.  That makes perfect sense given the ongoing uncertainty over Brexit, although this morning we heard from the EU’s top negotiator, Michel Barnier, that good progress has been made, with only the last stumbling blocks regarding fishing to be agreed.  However, in the event no trade deal is reached, the BOE will want to have as much ammunition as possible available to address what will almost certainly be some major market dislocations.  As I type, the pound is trading above 1.36 (+0.8% on the day) for the first time since April 2018 and shows no signs of breaking its recent trend.  I continue to believe that a successful Brexit negotiation is not fully priced in, so there is room for a jump if (when?) a deal is announced.

And that’s really it for the day, which has seen a continuation of the risk-on meme overall.  Looking at equity markets, Asia saw strength across the board (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +1.1%), although Europe has not been quite as universally positive (DAX +0.8%, CAC +0.4%, FTSE 100 0.0%).  US futures markets are pointing higher again, with all three indices looking at 0.5%ish gains at this time.

The bond market is showing more of a mixed session with Treasuries off 2 ticks and the yield rising 0.7bps, while European bond markets have all rallied slightly, with yields declining across the board between 1 and 2 basis points. Again, if inflation is not coming to the US, and the Fed clearly believes that to be the case, the rationale for higher Treasury yields remains absent.

Commodity markets are feeling good this morning with gold continuing its recent run, +0.7%, while oil prices have edged up by 0.3%.  And finally, the dollar is on its heels vs. essentially all its counterparts this morning, in both G10 and EMG blocs.  Starting with the G10, NOK (+1.0%) is the leader, although AUD and NZD (+0.8% each) are benefitting from their commodity focus along with the dollar’s overall weakness.  In fact, the euro (+0.3%) is the laggard here, while even JPY (+0.4%) is rising despite the risk-on theme.  This simply shows you how strong dollar bearishness is, if it overcomes the typical yen weakness attendant to risk appetite.

In the emerging markets, it is also the commodity focused currencies that are leading the way, with ZAR (+0.9%) and CLP (+0.75%) on top of the leaderboard, but strong gains in RUB (+0.7%), BRL (+0.6%) and MXN (+0.5%) as well.  The CE4, have been a bit less buoyant, although all are stronger on the day.  But this is all of a piece, stronger commodity prices leading to a weaker dollar.

On the data front, I think we are in an asymmetric reaction function, where strong data will be ignored while weak data will become the rationale for further risk appetite.  This morning we see Initial Claims (exp 815K), Continuing Claims (5.7M), Housing Starts (1535K), Building Permits (1560K), and Philly Fed (20.0).  Yesterday saw a much weaker than expected Retail Sales outcome (-1.1%, -0.9% ex autos) although the PMI data was a bit better than expected.  But now that the Fed has essentially said they are on a course regardless of the data, with the only possible variation to be additional easing, data is secondary.  The dollar downtrend is firmly entrenched at this time, and while we will see reversals periodically, and the trend is not a collapse, there is no reason to believe it is going to end anytime soon.

Good luck and stay safe
Adf

Much Bluer Skies

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Ahead of the Fed, PMI’s
From Europe were quite a surprise
It seems that despite
The lockdowns in sight
The future has much bluer skies

Preliminary PMI data from around the world this morning is the market’s key focus, at least until 2:00 this afternoon when we hear from the Fed.  But, in the meantime, the much better than expected readings surprised the market and are driving yet another increase in risk appetite.  (One wonders if that appetite will ever be sated!)

Starting in Asia, Australian data was considerably stronger than last month, with the Composite figure printing at 57.0, its second highest print in the (short) history of the series.  On the other hand, Japanese data was the sole disappointment, with the Composite slipping 0.1 to 48.0, still pointing to a contracting economy.  The European numbers, however, were all much better than expected with Germany printing 2 points higher than expected at 52.5 on the Composite while France (49.6 Composite) actually beat expectations by 6.6 points.  As such, the Eurozone Composite PMI printed at 49.8, significantly better than expectations of a 45.7 print.  The point here is that while the Eurozone economy is hardly booming (other than German manufacturing), there is a clear sense that the worst may be behind it.

Of course, what makes this so surprising is that the German government has shuttered non-essential businesses until January 10th, with hints that could be extended, after the largest single day fatality count was recorded yesterday.  We are also hearing from other European countries, (France and Italy), that further lockdowns and restrictions on gatherings are being considered as the second (third?) wave of Covid-19 sweeps across the continent.  Yet, not only markets, but businesses have clearly grabbed hold of the idea that the vaccine is going to lead to a swift end to the government intervention in virtually every economy and allow economic activity to resume as it was before.

The spanner in the works, as it were, is that governments are loathe to cede power and control once it is obtained.  If this holds true again, then businesses need to be prepared to have far more rules and restrictions imposed on their operations, something which is typically not associated with an economic boom.  However, for now, it appears that the prospect of the tightest restrictions being lifted outweighs the potential longer-term negative impacts of intrusive government.  So, as Timbuk 3 explained back in 1986, “The Future’s So Bright (I Gotta Wear Shades).

With that in mind, a quick turn to the FOMC meeting today shows us that the market consensus is for no policy changes in scope or size, but rather, more clarity on what is required for the Fed to consider tighter policy in the future.  Expectations continue to center on achieving a specific Unemployment Rate or Inflation Rate or, probably, both in combination.  Perhaps Chairman Powell will resurrect the Misery Index (not the current show on TBS, but the original one defined by Ronald Reagan, when he was running for president in 1980, as the sum of inflation and unemployment.)  For instance, a target of 3.5% Unemployment and 2.0% Inflation would seem to be right where policymakers would be thrilled.  Alas, today we are looking at a reading of 7.9%, with a poor mixture to boot (Unemployment 6.7%, CPI 1.2%).  However, as long as Congress fails to pass a new fiscal stimulus bill, do not be too surprised if the Fed does change the program, with my bet being on Operation Twist redux, where they extend the maturities of their current purchases.  We will find out at 2.

Turning to the markets, all that hunger for risk has shown up in all markets today, with equities and commodities broadly firmer while bonds and the dollar are broadly weaker.  Last night, following the strong equity performance in the US yesterday, we saw less impressive, but still positive price action in Asia with the Nikkei (+0.3%) and Hang Seng (+1.0%) both rallying although Shanghai was flat on the day.  Europe, however, has embraced the PMI data, as well as word that a Brexit deal is approaching (told ya so!) and markets there are all much firmer; DAX (+1.6%), CAC (+0.7%), FTSE 100 (+1.0%).  Finally, US futures are actually the laggards this morning, with all three in the green but the magnitude of those gains more muted than one might have expected, in the 0.2%-0.3% range.

Bond markets have come under pressure as there is certainly no case to own a low yielding haven asset when one can be gorging on risk, but the price declines are far larger in Europe (Bunds and OATs +3.7bps, Gilts +2.7bps) than in the US (Treasuries +1.0bp).  Interestingly, even the PIGS bonds are selling off as it appears Portugal is not quite so interesting a place to hold your cash when the yield there is -0.04% on 10-year paper!

Commodities are firmer, with gold having a second strong performance in a row, up 0.4% this morning, and oil prices are also drifting higher, albeit barely so at this hour.  And finally, the dollar is under significant pressure this morning after breaking through several key technical levels, with only CAD (-0.4%) underperforming in the G10.  And in truth, I cannot find a good reason for the decline as there don’t appear to be either technical or fundamental reasons evident.  On the other side, though, NOK (+0.45%) and GBP (+0.4%) are the leading gainers, although the rest of the space is higher by about 0.3%.  Aside from the Brexit hopes, this is all really about the dollar and the ever-growing conviction that it has much further to fall as 2021 approaches and unfolds.

As to the emerging markets, the CE4, taking their cues from the euro, are leading the way with CZK (+0.75%) and PLN (+0.6%) at the head of the pack.  Beyond those, the gains are less impressive, on the order of 0.2%-0.3%, with APAC currencies little changed overnight and LATAM currencies opening with less oomph than we are seeing in Europe.

On the data front, ahead of the FOMC this afternoon, we see Retail Sales (exp -0.3%, +0.1% ex autos) and then the preliminary PMI data as well (55.8 Manufacturing, 55.9 Services).  My sense is stronger than expected data would have only a limited impact on the dollar, but if the data is weak, another wave lower seems quite possible.

And that is really what we have today.  For now, the dollar is under pressure and likely to remain so.  At 2:00, there is potential for an additional leg lower, if the Fed opts to increase QE or extend maturities, but I cannot make a case for the dollar to benefit from their announcement.  In fact, for now, the only thing that can help the dollar is the fact that it has already moved a long way, and it could be due for a simple trading correction.

Good luck and stay safe
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