Macron’s Pet Peeve

Posted on by

Each day from the UK we learn
The data implies a downturn
Infections keep rising
Yet what’s so surprising
Is Sterling, no trader will spurn

Investors, it seems, all believe
That fishing rights, Macron’s pet peeve
Will soon be agreed
And both sides proceed
Towards Brexit come this New Year’s Eve

Since the last day of September, the pound has been a top performer in the G10 space, rallying 2.0% despite the fact that, literally, every piece of economic data has fallen short of expectations.  Whether it was GDP, PMI, IP or Employment, the entire slate has been disappointing.  At the same time, stories about Brexit negotiations continue to focus on the vast gap between both sides on fishing rights for the French fleet as well as state aid limits for UK companies.  And yet the pound continues to grind higher, trading back to its highest levels in a month.  Granted this morning it has ceded a marginal -0.2%, but that is nothing compared to this steady climb higher.

It seems apparent that traders are not focusing on the macro data right now, but instead are looking toward a successful conclusion of the Brexit negotiations.  Granted, Europe’s history in negotiations is to have both (or all) sides agree at the eleventh hour or later, but agree, nonetheless.  So, perhaps the investor community is correct, there will be no hard Brexit and thus the UK economy will not suffer even more egregiously than it has due to Covid.  But even if a deal is agreed, does it make sense that the pound remains at these levels?

At this stage, the economic prospects for the UK seem pretty awful.  This morning’s employment report showed the 3M/3M Employment change (a key measure in the UK) falling 153K.  While that is not the worst reading ever, which actually came during the financial crisis in June 2009, it is one of the five worst in history and was substantially worse than market expectations.  Of greater concern was that the pace of job cuts rose to the most on record, with 114K redundancies reported in the June-August period.  Adding it all up leaves a pretty poor outlook for the UK economy, especially as further lockdowns are contemplated and enacted to slow the resurgence in Covid infections seen throughout various parts of the country.  And yet the pound continues to perform well.

Perhaps the rally is based on monetary policy expectations.  Alas, the last we heard from the Old Lady was that they were discussing how banks would handle negative interest rates, something which last year Governor Carney explained didn’t make any sense, but now, under new leadership, seems to have gained more adherents.  If history is any guide, the fact that the BOE is talking to banks about NIRP is a VERY strong signal that NIRP is coming to the UK in the next few months.  Again, it strikes me that this is not a positive for the currency.

In sum, all the information I see points to the pound having more downside than upside, and yet upside is what we have seen for the past several weeks.  As a hedger, I would be cautious regarding expectations that the pound has much further to rally.

Turning to the rest of the market, trading has been somewhat mixed, with no clear direction on risk assets seen.  Equity markets in Asia saw gains in the Hang Seng (+2.2%) although the Nikkei (+0.2%) and Shanghai (0.0%) were far less enthusiastic.  Interestingly, the HKMA was forced to intervene in the FX market last night, selling HKD6.27 billion to defend the strong side of the peg.  Clearly, funds are flowing in that direction, arguably directly into the stock market there, which after plummeting 27.5% from January to March on the back of Covid concerns, has only recouped about 42% of those losses, and so potentially offers opportunity.  Perhaps more interestingly, last night China reported some very solid trade data, with imports rising far more than expected (+13.2% Y/Y) and the Trade Balance falling to ‘just’ $37.0B.  Export growth was a bit softer than expected, but it seems clear the Chinese economy is moving forward.

European bourses, however, are all in the red with the DAX (-0.4%) and CAC (-0.3%) representative of the general tone of the market.  Aside from the weak UK employment data, we also saw a much weaker than expected German ZEW reading (56.1 vs. 72.0 expected), indicating that concerns are growing regarding the near-term future of the German economy.

In keeping with the mixed tone to today’s markets, Treasuries have rallied with yields falling 2 basis points after yesterday’s holiday.  Perhaps that is merely catching up to yesterday’s European government bond markets, as this morning, there is no rhyme or reason to movement in this segment.  In fact, the only movement of note here is Greece, which has seen 10-year yields decline by 3bps and which are now sitting almost exactly atop 10-year Treasuries.

As to the dollar, mixed is a good description here as well.  In the G10 space, given the German data, it is no surprise that the euro has edged lower by 0.2% nor that the pound has crept lower as well.  AUD (-0.24%) is actually the worst performer, which looks a response to softness in the commodity space.  SEK (+0.3%) is the best performer after CPI data turned positive across the board, albeit not rising as much as had been forecast.  You may recall the Swedes are the only country that had moved to NIRP and then raised rates back to 0.0%, declaring negative rates to be a bad thing.  The previous few CPI readings, which were negative, had several analysts calling for Swedish rates to head back below zero, but this seems to support the Riksbank’s view that no further rate cuts are needed.

Emerging market currencies are under a bit more pressure, with the CE4 leading the way lower (CZK -0.8%, PLN -0.7%, HUF -0.65%) but the rest of the bloc has seen far less movement, generally +/- 0.2%.  Regarding Eastern Europe, it seems there are growing concerns over a second wave of Covid wreaking further havoc on those nations inspiring more rate cuts by the respective central banks.  Yesterday’s Czech CPI data, showing inflation falling into negative territory was merely a reminder of the potential for lower rates.

Speaking of CPI, that is this morning’s lead data point, with expectations for a 0.2% M/M gain both headline and ex food and energy, which leads to 1.4% headline and 1.7% core on a Y/Y basis.  Remember, these numbers have been running higher than expectations all summer, and while the Fed maintains that inflation is MIA, we all know better.  I see no reason for this streak of higher than expected prints to be broken.  In addition, we hear from two Fed speakers, Barkin and Daly, but we already know what they are likely going to say; we are supporting the economy, but Congress needs to enact a fiscal support package, or the world will end (and it won’t be their fault.)

US equity futures are a perfect metaphor for the day, with DOW futures down 0.4% and NASDAQ futures higher by 0.9%.  In other words, it is a mixed picture with no clear direction.  My fear is the dollar starts to gain more traction, but my sense is that is not in the cards for today.

Good luck and stay safe
Adf

QE’s Not Constrained

Posted on by

For everyone who seems to think
The dollar will steadily sink
This weekend disclosed
The world is opposed
To letting the buck’s value shrink

In China they eased the restrictions
On short sales in all jurisdictions
While Europe explained
QE’s not constrained
And further rate cuts are not fictions

It cannot be a surprise that we are beginning to see a more concerted response to dollar weakness from major central banks.  As I have written consistently, at the current time, no nation wants their currency to be strong.  Each is convinced that a weak currency will help obtain the twin goals of improved export performance leading to economic growth and higher inflation.  While financial theory does show that, in a closed system, those are two natural consequences of a weak currency, the evidence over the past twelve years has been less convincing.  Of course, as with every economic theory, a key assumption is ‘ceteris paribus’ or all else being equal.  But all else is never equal.  A strong argument can be made that in addition to the global recession undermining pricing power, the world is in the midst of a debt deflation.  This is the situation where a high and rising level of overall debt outstanding directs cash flow to repayment and reduces the available funding for other economic activity.  That missing demand results in price declines and hence, the debt deflation.  History has shown a strong correlation between high levels of debt and deflation, something many observers fail to recognize.

However, central banks, as with most large institutions, are always fighting the last war.  The central bank playbook, which had been effective from Bretton Woods, in 1944 until, arguably, sometime just before the Great Financial Crisis in 2008-09, explained that the reflexive response to economic weakness was to cut interest rates and ease financing conditions.  This would have the dual effect of encouraging borrowing for more activity while at the same time weakening the currency and making the export community more competitive internationally, thus boosting growth further.  And finally, a weaker currency would result in imported inflation, as importers would be forced to raise prices.

The Great Financial Crisis, though, essentially broke that model, as both the economic and market responses to central bank activities did not fit that theoretical framework.  Instead, adhering to the playbook saw interest rates cut to zero, and then below zero throughout Europe and Japan, additional policy ease via QE and yet still extremely modest economic activity.  And, perhaps, that was the problem.  Every central bank enacted their policies at the same time, thus there was no large relative change in policy.  After all, if every central bank cut interest rates, then the theoretical positive outcomes are negated.  In other words, ceteris isn’t paribus.

Alas, central banks have proven they are incapable of independent thought, and they have been acting in concert ever since.  Thus, rate cuts by one beget rate cuts by another, sometimes explicitly (Denmark and Switzerland cutting rates after the ECB acts) and sometimes implicitly (the ECB, BOE and BOC cutting rates after the Fed acts).  In the end, the results are that the relative policy settings remain very close to unchanged and thus, the only beneficiary is the equity market, where all that excess money eventually flows in the great hunt for positive returns.

Keeping the central bank mindset at the fore, we have an easy time understanding the weekend actions and comments from the PBOC and the ECB.  The PBOC adjusted a reserve policy that had been aimed at preventing rampant selling speculation against the renminbi.  For the past two plus years, all Chinese banks had been required to keep a 20% reserve against any short forward CNY positions they executed on behalf of customers.  This made shorting CNY prohibitively expensive, thus reducing the incentive to do so and helped support the currency.  However, the recent price action in CNY has been strongly positive, with the renminbi having appreciated nearly 7% between late May and Friday.  For a country like China, that sells a great many low margin products to the rest of the world, a strong currency is a clear impediment to their economic plans.  The PBOC action this weekend, removing that reserve requirement completely, is perfectly in keeping with the mindset of a weaker currency will help support exports and by extension economic growth.  Now there is no penalty to short CNY, so you can expect more traders to do so.  Especially since the fixing last night was at a weaker CNY level than expected by the market.  Look for further CNY (-0.8% overnight) weakness going forward.

As to the ECB, their actions were less concrete, but no less real.  ECB Chief Economist Philip Lane, the member with the most respected policy chops, was on the tape explaining that the Eurozone faces a rocky patch after the initial rebound from Covid.  He added, “I do not see that the ECB has a structurally tighter orientation for monetary policy[than the Federal Reserve].  Anyone who pays attention to our policies and forward guidance knows that we will not tighten policy without inflation solidly appearing in the data.”  Lastly, he indicated that both scaling up QE purchases and further rate cuts are on the table.

Again, it should be no surprise that the ECB is unwilling to allow the euro to simply rally unabated in the current environment.  The playbook is clear, a strong currency needs to be addressed, i.e. weakened. This weekend simply demonstrated that all the major central banks view the world in exactly the same manner.

Turning to the markets on this holiday-shortened session, we see that Chinese equities were huge beneficiaries of the PBOC action with Shanghai (+2.65%) and the Hang Seng (+2.0%) both strongly higher although the Nikkei (-0.25%) did not share the market’s enthusiasm.  European markets are firming up as I type, overcoming some early weakness and now green across the board.  So, while the FTSE 100 (+0.1%) is the laggard, both the DAX (+0.45%) and CAC (+0.75%) are starting to make some nice gains.  As to US futures, they, too, are now all in the green with NASDAQ (+ 1.3%) far and away the leader.  Despite the federal holiday in the US, the stock market is, in fact, open today.

Banks, however, are closed and the Treasury market is closed with them.  So, while there is no movement there, we are seeing ongoing buying interest across the European government bond markets as traders prepare for increased ECB QE activity.  After all, if banks don’t own the bonds the ECB wants to buy, they will not be able to mark them up and sell them to the only price insensitive buyer in the European government bond market.  So, yields here are lower by about 1 basis point across the board.

As to the dollar, it is broadly, but mildly stronger this morning.  Only the yen (-0.15%) is weaker in the G10 space as the rest of the block is responding to the belief that all the central banks are going to loosen policy further, a la the ECB.  As to the EMG bloc, CZK is actually the biggest loser, falling 0.9% after CPI there surprised the market by falling slightly, to 3.2%, rather than extending its recent string of gains.  This has the market looking for further central bank ease going forward, something that had been questioned as CPI rose.  Otherwise, as we see the prices of both oil and gold decline, we are seeing MXN (-0.6%), ZAR (-0.5%) and RUB (-0.5%) all fall in line.  On the flip side, only KRW (+0.55%) has shown any strength as foreign investors continue to pile into the stock market there on the back of Chinese hopes.

We do get some important data this week as follows:

Tuesday CPI 0.2% (1.4% Y/Y)
-ex food & energy 0.2% (1.7% Y/Y)
Wednesday PPI 0.2% (0.2% Y/Y)
-ex food & energy 0.2% (0.9% Y/Y)
Thursday Empire Manufacturing 14.0
Initial Claims 825K
Continuing Claims 10.4M
Philly Fed 14.0
Friday Retail Sales 0.8%
-ex autos 0.4%
IP 0.6%
Capacity Utilization 71.9%
Michigan Sentiment 80.5

Source: Bloomberg

Remember, we have seen five consecutive higher than expected CPI prints, so there will be a lot of scrutiny there, but ultimately, the data continues to point to a slowing recovery with job growth still a major problem.  We also hear from nine more Fed speakers, but again, this message is already clear, ZIRP forever and Congress needs to pass stimulus.

In the end, I find no case for the dollar to weaken appreciably from current levels, and expect that if anything, modest strength is the most likely path going forward, at least until the election.

Good luck and stay safe
Adf

Can’t Stop the Pain

Posted on by

While central banks worldwide compete
To broaden their own balance sheet
They also complain
They can’t stop the pain
Lest more money reaches Main Street

Fiscal policy is the topic du jour as not only are there numerous stories about the ongoing theatrics in Washington, but we continue to hear virtually every member of the Fed calling for more fiscal stimulus.  Starting from the top, where in a speech on Tuesday, Chairman Powell excoriated Congress for not acting more quickly, and on through a dozen more speeches this week, there is one universal view; the Fed has done everything in its power to support the economy but it is up to the government to add more money to the mix to make up for the impact of the government shutting down businesses.  And while this is not just a US phenomenon, we hear the same thing from the ECB, BOE, BOC and BOJ, it appears that the market is coming to believe that the US is going to be the nation that acts most aggressively on this front going forward.

There is a conundrum here, though, as this view is seen as justification for a weaker dollar.  And frankly, I am confused as to the logic behind that view.  It appears there is a growing belief, based on polling data, that President Trump will lose the election, and that there will be a Democratic sweep taking back the Senate.  With that outcome in mind, investors expect a huge fiscal stimulus will quickly be enacted, perhaps as much as $4 trillion right away.  Now, if this is indeed the case, and if fiscal stimulus is what is required to get the economy growing again, and if the US is going to be the country taking the biggest steps in that direction, wouldn’t it make sense that the dollar would be in demand?  After all, if US data improves relative to that in Europe or elsewhere, doesn’t it stand to reason that the dollar will benefit?

Adding to this conundrum is the fact that we are hearing particularly dovish signals from other central banks (in addition to their calls for more fiscal stimulus) with the Bank of Canada the latest to explain that negative interest rates could well be appropriate policy if the government doesn’t spend more money.  So now, NIRP has the potential to become policy in virtually every G10 nation except the US, where the Fed has been consistent and explicit in saying it is not appropriate.  So, I ask, if US rates remain positive across the curve, while other nations all turn negative, is that really a dollar bearish signal?  It doesn’t seem so to me, but then I’m just a salesman working from home.

And yet, dollar weakness is certainly today’s theme, with the greenback lower vs. every one of its major counterparts today.  For example, the euro is higher by 0.4% this morning despite the fact that production data from the three largest economies point to a renewed slowdown in activity.  French IP has fallen -6.2% since August of last year, rising a less than forecast 1.3% on a M/M basis.  Monday, we saw German IP data fall -0.2% in August, taking its Y/Y results to -9.6%.  hardly the stuff of bullishness.  And while it is true that Italy’s data was better than expected (+7.7% in August, though still -0.3% Y/Y), looking at that suite of outcomes does not inspire confidence in the Eurozone economy.  And recall, too, that the ECB Minutes released Wednesday were clear in their concern over a rising euro, implying they would not allow that to come to pass.  But here we are, with the euro back at 1.1800 this morning.  Go figure.

The pound, too, seems to be defying gravity as despite much worse than forecast monthly GDP data (2.1% vs. 4.6% expected) and IP data (0.3% M/M, -6.4% Y/Y), the pound, which has been a strong performer lately, is slightly higher this morning, up 0.1%.  Again, this data hardly inspires confidence in the future economic situation in the UK.

But as they say, you can’t fight city hall.  So, for whatever reason, the current narrative is that the dollar is due to fall further because the US is going to enact more stimulus.  There is, however, one market which seems to understand the ramifications of additional stimulus, the Treasury market.  10-year Treasury yields, which had found a home near 0.65% for a long time, look very much like they are heading higher.  While this morning, bonds have rallied slightly with the yield declining 1.5 bps, we are still at 0.77%, and it seems only a matter of time before we are trading through this level and beyond.  Because, remember, if the narrative is correct and there is a huge stimulus coming, that’s $4 trillion in new paper to be issued.  That cannot be a positive for bond prices.

The European government bond market is also having a good day, with yields declining between 2 and 3 basis points everywhere.  At least here, if the ECB is to be believed, the idea of additional QE driving bond yields lower makes sense, especially since we are not looking at the prospect of multiple trillions of euros of additional issuance.

Looking at those two markets, it is hard to come up with a risk framework for today, and the equity markets are not helping.  Asian markets overnight were generally slightly softer (Nikkei -0.1%, Hang Seng -0.3%) but we did see Shanghai rally nicely, +1.6%, after having been closed all week long.  That seems like it was catching up to the week’s price action.  Europe, on the other hand is mixed, with strength in some markets (CAC +0.35%, FTSE 100 +0.45%) and weakness in others (DAX 0.0%, Spain -0.6%, Italy -0.3%).  I find it interesting that the UK and France, the nations that released the weakest IP data are the best performers.  Strange things indeed.  US futures, though, are pointing higher, somewhere on the order of 0.4%-0.5%.

And as I mentioned, the dollar is weaker across the board.  The best performers in the G10 are NZD (+0.6%) and NOK (+0.5%), with the former looking more like a technical rebound after some weakness earlier this week, while the krone has benefitted from its CPI data.  Earlier this year, as NOK weakened, Norwegian CPI rose sharply, to well over 3.0%, but it appears that the krone’s recent strength (it has rallied back to levels seen before the pandemic related market fluctuations) is starting to have a positive impact on inflation.

EMG currencies are also entirely in the green this morning with CNY (+1.35%) the biggest gainer.  In fairness, this appears to be a catch-up move given China had been closed since last Thursday.  But even CNH, which traded throughout, has rallied 0.7% this morning, so clearly there is a lot of positivity regarding the renminbi.  This also seems to be politically driven, as the assumption is a President Biden, if he wins, will be far less antagonistic to China, thus reducing sanctions and tariffs and allowing the country to resume its previous activities. But the whole bloc is higher with the CE4 showing strength on the order of 0.5%-0.7% and MXN, another politically driven story, rising 0.5%.  The peso is also assumed to be a big beneficiary of an impending Biden victory as immigration restrictions are expected to be relaxed, thus helping the Mexican economy.

And that’s really it for the day.  There is no data to be released and only one Fed Speaker, Richmond’s Barkin, but based on what we have heard this week, we already know he is going to call for more fiscal stimulus and not much else.  Also, as Monday is the Columbus Day holiday, look for things to slow down right around lunch, so if you have things to get done, get them done early.

Good luck, good weekend and stay safe
Adf

Nary a Tear

Posted on by

The Ides of October are near
The date by which Boris was clear
If no deal’s agreed
Then he will proceed
To (Br)exit with nary a tear

We are but one week away from the date widely touted by UK PM Johnson as the deadline to reach a deal with the EU on the terms of the post-Brexit relationship between the two.  It seems the date was set with several issues in mind.  First, there is an EU summit to be held that day and the next, and the idea was that any agreed upon deal could be reviewed at the summit and then there would be sufficient time for each of the remaining 27 EU members to enact legislation that would enshrine the deal in their own canon of laws.

On the other hand, if no deal is reached by then, the Johnson government would have the ensuing two- and one-half months to finalize their Brexit plans including such things as tariff schedules and customs procedures.  At the same time, while Boris has been adamant that October 15 is the deadline, the EU has been clear that they see no such artificial deadline and are perfectly willing to continue the negotiations right up until December 31.  The idea here is that if an agreement comes that late, a temporary measure can be put in place while each member enacts the appropriate legislation.

Back on September 29, in All Doom and Gloom, I posited that the market was pricing in a two-thirds probability of a hard Brexit.  The analysis was based on the level of the pound relative to its longer-term valuations and historical price action.  But clearly there is far more to the discussion in these uncertain times than simply historical price action.  And in the ensuing days I have reconsidered my views of both the probability of a hard Brexit and my estimation of the market’s anticipation.

For what it’s worth, I have come to the belief that a hard Brexit remains an unlikely event, less than a 20% probability.  Intransigence in international negotiations is the norm, not an exception, so all of Boris’s huffing and puffing is likely just that, hot air.  And in the end, it is not in either side’s interest to have the UK leave with no deal in place.  Too, the ongoing pandemic has distracted most people from the potential impacts of a hard Brexit, and my understanding is that the subject is hardly even newsworthy on the Continent.  The point is, on the EU side, other than the French fishermen, Brexit is not something of concern to the population.  After all, they are far more concerned with whether or not they will remain employed, be able to feed their families and pay rent, and who will win the UEFA Cup.  For most of Europe, the UK is an abstract thought, although not for all of it.  (An interesting statistic is that German exports to the UK have already fallen 40% since immediately after the Brexit vote four years ago.)  As such, if the EU were to soften their stance on some of the last issues, virtually nobody would notice, certainly not their constituents so, there is likely little price for EU politicians to pay electorally, with that outcome.

The UK, on the other hand, remains highly focused on Brexit, and Boris would certainly suffer in the event that any eventual deal is not widely perceived as beneficial to the UK.  The UK, of course has other problems, notably that the virus is spreading more widely again, and the government response has been to reimpose restrictions and lockdowns in the hardest hit areas.  Of course, this is exactly the thing to halt a recovery in its tracks, which if added to the potential harm from a no-deal Brexit, may be too much for Boris to withstand.  But it is the other problems which are a key driver of the pound’s exchange rate, and the main reason I don’t expect any significant rally from current levels.  Instead, I believe the odds are for a retreat to the 1.20-1.25 level, regardless of the Brexit outcome.  A signed deal would merely delay the achievement of that target for a few months, at best.  The combination of growing fiscal deficits, additional BOE policy ease and a sluggish economic recovery all point to the pound weakening over time.  While a hard Brexit will accelerate that outcome, even a deal will not prevent it from occurring.  Hedgers beware.

On to markets.  Yesterday’s US equity rally begat the same in Asia (Nikkei +1.0%, Australia +1.1%) and Europe, after a slow start, has turned higher as well (DAX +0.7%, CAC +0.55%).  China’s weeklong holiday is ending today, and their markets will reopen tonight.  US futures are also pointing higher, roughly 0.5% across the board.  It seems that the market remains entirely beholden to the US stimulus talks, and yesterday, after the President said negotiations would cease until after the election, that tune changed as there was talk of stand-alone bills on airline support or a second round of $1200 checks for previous recipients.  I have to admit that the market response to the stimulus talks reminds me of the response to the trade talks with China at the beginning of last year, with each positive headline worth another 0.5% in gains despite no net movement.

Bond markets are in vogue this morning as yields are lower in Treasuries and throughout Europe.  Of course, 10-year Treasury yields have been trending higher for the past week and a half and are now more than 25 basis points higher than their nadir seen on August 4th.  Yesterday’s 10-year auction went off without a hitch, with the yield right on expectations and solid investor demand.  Meanwhile, yesterday’s FOMC Minutes explained that several members would consider even more bond buying going forward, which cannot be a surprise given what we have heard from the most dovish members since then.  Just this week, Minneapolis Fed President Kashkari
said just that.  But with that in mind, remember that despite the prospect of more bond buying, Treasury yields are at the high end of their recent range and look like they have further to climb.  Again, this appears to be a market commentary on inflation expectations, and one that I presume the Fed is encouraging!

As to the dollar, it is very slightly softer at this point of the session, although not universally so.  Looking at the G10 space, the biggest mover is AUD, with a gain of just 0.25%.  Meanwhile, both EUR and CHF have edged lower by 0.1%.  The point is there is very little activity or movement as there have been few stories or data of note overnight. EMG currencies have shown a bit more strength led by RUB (+0.7%) and MXN (+0.6%), both benefitting from oil’s modest gains this morning. The rest of the bloc has seen much less positivity, with only KRW (+0.4%) on the back of a widening trade surplus and HUF (+0.3%) after CPI data today showed a modest decline, thus allowing the central bank to maintain its current policy settings.

On the US calendar we get Initial Claims (exp 820K) and Continuing Claims (11.4M), still the timeliest economic information we receive.  The issue here is that after the initial post-Covid spike, the decline in these numbers has really slowed down.  In other words, there are still many layoffs happening, hardly the sign of a robust economy.  In addition, we hear from three more Fed speakers, but their message is already clear.  ZIRP for years to come, and they will buy bonds the whole time.

Investors remain comfortable adding risk these days, as the central banking community worldwide continues to be seen as willing to provide virtually unlimited support.  If risk continues to be “on”, I see little reason for the dollar to rally in the short term.  But neither do I see much reason for it to decline at this stage.

Good luck and stay safe
Adf

Not So Amused

Posted on by

While Covid continues to spread
Chair Jay, for more stimulus pled
But President Trump
Said talks hit a bump
And ‘til the election they’re dead

The market was not so amused
With stock prices terribly bruised
So, as of today
Investors must weigh
The odds more Fed help is infused

Although nobody would characterize today as risk-on, the shock the market received yesterday afternoon does not seem to have had much follow through either.  Of course, I’m referring to President Trump’s tweet that all stimulus negotiations are off until after the election.  One need only look at the chart of the Dow Jones to know the exact timing of the comment, 2:48 yesterday afternoon.  The ensuing twenty minutes saw that index fall more than 2%, with similar moves in both the S&P 500 and the NASDAQ.  And this was hot on the heels of Chairman Powell pleading, once again, for more fiscal stimulus to help the economy and predicting dire consequences if none is forthcoming.

At this point, it is impossible to say how this scenario will play out largely because of the political calculations being made by both sides ahead of the presidential election next month.  On the one hand, it seems hard to believe that a sitting politician would refuse the opportunity to spend more money ahead of an election.  On the other hand, the particular politician in question is unlike any other seen in our lifetimes, and clearly walks to the beat of a different drummer.  The one thing I will say is that despite the forecasts of impending doom without further stimulus, the US data continues to show a recovering economy.  For instance, yesterday’s record trade deficit of -$67.2 billion was driven by an increase in imports, not something that typically occurs when the economy is slowing down.  One thing we have learned throughout the Covid crisis is that the econometric models used by virtually every central bank have proven themselves to be out of sync with the real economy.  As such, it is entirely possible that the central bank pleas for more stimulus are based on the idea that monetary policy has done all it can, and central bankers are terrified of being blamed for the economic problems extant.

Speaking of central bank activities and comments, the Old Lady of Threadneedle Street has been getting some press lately as the UK economy continues to deal with not merely Covid-19, but the impending exit from the EU.  Last month, the BOE mentioned they were investigating negative interest rates, but comments since then seem to highlight that there are but two of the nine members of the MPC who believe there is a place for NIRP.  That said, the Gilt market is pricing in negative interest rates from two to five years in maturity, so there is clearly a bigger community of believers.  While UK economic activity has also rebounded from the depths of the Q2 collapse, there is a huge concern that a no-deal Brexit will add another layer of difficulty to the situation there and require significantly more government action.  The BOE will almost certainly increase its QE, with a bump from the current £745 billion up to £1 trillion or more.  But, unlike the US, the UK does not have the advantage of issuing debt in the world’s reserve currency, and at some point, the cost of further fiscal stimulus may prove too steep.  As to the probability of a Brexit deal, it seems that much rides on French President Macron’s willingness to allow the French fishing fleet to sink shrink and allow the UK to manage their own territorial waters.

With this as the backdrop, a look at markets this morning shows a mixed bag on the risk front.  Asian equity markets saw the Nikkei (-0.05%) essentially unchanged although the Hang Seng (+1.1%) got along just fine.  Shanghai remains closed for holidays.  European bourses seem to be taking their cues from the Nikkei, as modest declines are the rule of the day.  The DAX (-0.35%) and the CAC (-0.2%) are both edging lower, and although the FTSE 100 is unchanged, the rest of the continent is following the German lead.  Interestingly, US futures are higher by between 0.3%-0.5%, not necessarily what one would expect.

Bond markets, once again, seem to be trading based on different market cues than either equities or FX, as this morning the 10-year Treasury yield has risen 4 basis points, and is trading back to the recent highs seen Monday.  One would be hard-pressed to characterize today as a risk-on session, where one might typically see investors sell bonds as they rotate into equities, so clearly there is something else afoot.  Yesterday’s 3-year Treasury auction seemed to be pretty well-received, so there is, as yet, no sign of fatigue in buying US debt.  There is much discussion here about the possibility of a contested election, yet I would have thought that is a risk scenario that would drive Treasury buying.  To my inexpert eyes, this appears to be driven by more inflation concerns.  Next week we see CPI again, and based on the recent trend, as well as personal experience, there has been no abatement in price pressures.  And unless the Fed starts buying the long end of the Treasury curve (something Cleveland’s Loretta Mester suggested yesterday), or announces yield curve control, there is ample room for the back end to sell off further with yields moving correspondingly higher, regardless of Fed activity.  And that would bring a whole set of new problems for the US.

Finally, one would have to characterize the dollar as on its back foot this morning.  While not universally lower, there are certainly more gainers than losers vs. the greenback.  In the G10 space, NOK (+0.5%) and SEK (+0.4%) are leading the way, which given oil’s 2.5% decline certainly seems odd for the Nocky.  As for the Stocky, there is no news nor data that would have encouraged buying, and so I attribute the movement to an extension of the currency’s recent modest strength which has seen the krona gain about 2% in the past two weeks.  Meanwhile, JPY (-0.4%) continues to sell off, much to the delight of Kuroda-san and new PM Suga.  Here, too, there is no news or data driving the story, but rather this feels like position adjustments.  It was only a few weeks ago where there was a great deal of excitement about the possibility of the yen breaking out and heading toward par.  That discussion has ended for now.

Emerging markets are generally better this morning as well, led by MXN (+0.85%) which is gaining despite oil’s decline and the landfall of Hurricane Delta, a category 3 storm.  If anything, comments from Banxico’s Governor De Leon, calling for more stimulus and explaining that the recovery will be uneven because of the lack of fiscal action, as well as the IMF castigating AMLO for underspending on stimulus, would have seemed to undermine the currency.  But apparently not.  Elsewhere, the gains are less impressive with HUF (+0.5%) and ZAR (+0.35%) the next best performers with the former getting a little love based on increased expectations for tighter monetary policy before year end, while ZAR continues to benefit, on days when fear is in the background, from its still very high real interest rates.

The only data of note today is the FOMC Minutes this afternoon, but are they really going to tell us more than we have heard recently from virtually the entire FOMC?  I don’t think so.  Instead, today will be a tale of the vagaries of the politics of stimulus as the market will await the next move to see if/when something will be agreed.  Just remember one thing; the Fed has already explained pretty much all the easing it is going to be implementing, but we have more to come from both the ECB and BOE.  That divergence ought to weigh on both the euro and the pound going forward.

Good luck and stay safe
Adf

I’m Concerned

Posted on by

Said Madame Lagarde, ‘I’m concerned
That strength in the euro’s returned
If that is the case
We’ll simply debase
The currency many have earned

Christine Lagarde, in a wide-ranging interview last week, but just released this morning, indicated several things were at the top of her agenda.  First is the fact that the containment measures now reappearing throughout the continent, notably in France, Spain and Germany, will weaken the recovery that started to gather steam during the summer. This cannot be a surprise as the key reason for the economic devastation, to begin with, was the dramatic lockdowns seen throughout Europe, and truthfully around the world.  But her second key concern, one about which I have written numerous times in the past, is that the euro’s recent strength is damaging the ECB’s efforts to support a recovery.  The new euphemism from ECB members is they are “very attentive” to the exchange rate.  The implication seems to be that if the euro starts to head back to the levels seen in early September, when it touched 1.20, they might act.  Clearly, the preferred action will be more verbal intervention.  But after that, I expect to see an increase in the PEPP program followed by a potential cut in the deposit rate and lastly actual intervention.

To be fair, most economists are already anticipating the PEPP will be expanded in December, when the ECB next publishes its economic forecasts.  Currently, the program has allocated €1.35 trillion to purchase assets on an unencumbered basis.  Recall, one of the issues with the original QE program, the APP, was that it followed the capital key, meaning the ECB would only purchase government bonds in amounts corresponding with a given economy’s size in the region.  So German bunds were the largest holdings, as Germany has the largest economy.  The problem with this was that Italy and Spain were the two large nations that needed the most help, and the ECB could not overweight their purchases there.  Enter PEPP, which has no such restrictions, and the ECB is now funding more purchases of Italian government bonds than any other nation’s.  Of course, there are more Italian government bonds than any other nation in Europe, and in fact Italy is the fourth largest issuer worldwide, following only the US, Japan and China.

As to further interest rate cuts, the futures market is already pricing in a 0.10% cut next year, so in truth, for the ECB to have an impact, they would need to either surprise by cutting sooner, or cut by a larger amount.  While the former is possible, the concern is it would induce fear that the ECB knows something negative about the economy that the rest of the market does not and could well induce a sharp asset sell-off.  As to cutting by a larger amount, European financial institutions are already suffering mightily from NIRP, and some may not be able to withstand further downward pressure there.

What about actual intervention?  Well, that would clearly be the last resort.  The first concern is that intervention tends not to work unless it is a concerted effort by multiple central banks together (think of the Plaza Agreement in 1985), so its efficacy is in doubt, at least in the medium and long term.  But second, depending on who occupies the White House, ECB intervention could be seen as a major problem for the US inspiring some type of retaliation.

In the end, for all those dollar bears, it must be remembered that the Fed does not operate in a vacuum, and in the current global crisis, (almost) every country would like to see their currency weaken on a relative basis in order to both support their export industries as well as goose inflation readings.  As such, nobody should be surprised that other central banks will become explicit with respect to managing currency appreciation, otherwise known as dollar depreciation.

Keeping this in mind, a look at markets this morning shows a somewhat mixed picture.  Yesterday’s strong US equity performance, ostensibly on the back of President Trump’s release from the hospital, was enough to help Asian markets rally with strength in the Nikkei (+0.5%) and Hang Seng (+0.9%).  China remains closed until Friday.  European markets started the day a bit under the weather, as virtually all of them were lower earlier in the session, but in the past hour, have climbed back toward flat, with some (Spain’s IBEX +0.95%) even showing solid gains.  However, the DAX (+0.1%) and CAC (+0.3%) are not quite following along.  Perhaps Madame Lagarde’s comments have encouraged equity investors that the ECB is going to add further support.  As to US futures markets, only NASDAQ futures are showing any movement, and that is actually a -0.4% decline at this time.

The bond market, on the other hand, has been a bit more exciting recently, as yesterday saw 10-year Treasury yields trade to their highest level, 0.782%, since June.  While this morning’s price action has seen a modest decline in yields, activity lately speaks to a trend higher.  Two potential reasons are the ever increasing amount of US debt being issued and the diminishing appetite for bonds by investors other than the Fed; and the potential that the recent trend in inflation, which while still below the Fed’s targeted level, has investors concerned that there are much higher readings to come.  After all, core PCE has risen from 0.9% to 1.6% over the past five months.  With the Fed making it clear they will not even consider responding until that number is well above 2.0%, perhaps investors are beginning to become a bit less comfortable that the Fed has things under control.  Inflation, after all, has a history of being much more difficult to contain than generally expected.

Finally, looking at the dollar, it is the least interesting market this morning, at least in terms of price action.  In the G10, the biggest mover has ben AUD, which has declined 0.4%, as traders focus on the ongoing accommodation of the RBA as stated in their meeting last night.  But away from Aussie, the rest of the G10 is +/- 0.2% or less from yesterday’s closing levels, with nothing of note to discuss.  In the emerging markets. THB (+0.7%) was the big winner overnight as figures showed an uptick in foreign purchases of Thai bonds.  But away from that, again, the movement overnight was both two-way and modest at best.  Clearly, the FX market is biding its time for the next big thing.

On the data front, this morning brings the Trade Balance (exp -$66.2B) and JOLTS Job Openings (6.5M).  Yesterday’s ISM Services number was a bit better than expected at 57.8, indicating that the pace of growth in the US remains fairly solid.  In fact, the Atlanta Fed GDPNow forecast is up to 34.6% for Q3.  But arguably, Chairman Powell is today’s attraction as he speaks at 10:40 this morning.    I imagine he will once again explain how important it is for fiscal stimulus to complement everything they have done, but as data of late has been reasonably solid, I would not expect to hear anything new.  In the end, the dollar remains range-bound for now, but I expect that the bottom has been seen for quite a while into the future.

Good luck and stay safe
Adf

Some Despair

Posted on by

In Germany, data revealed
That growth there’s apparently healed
But data elsewhere
Implied some despair
As problems, porcine, are concealed

Risk is back in vogue this morning as the market appears to be responding positively to a much better than expected PMI reading from Germany (Services PMI 50.6, up from 49.1 Flash reading, Composite 54.7, up from 53.7 Flash) and a modestly better outcome for the Eurozone (48.0 vs. 47.6 for Services, 50.4 vs. 50.1 for Composite) as a whole.  At least that’s the surface story I keep reading.  The problem with this version is that markets in Asia were also highly risk-centric and that was well before the PMI data hit the tape.  Which begs the question, what is really driving the risk narrative today?

When President Trump was infected
The thing that most people expected
Was two weeks before
He’d walk out the door
Explaining he wasn’t affected

A different, and timelier, explanation for today’s positive risk sentiment stems from the ongoing story of President Trump’s covid infection and his ability to recuperate quickly.  While the standing assumption had been that there is a two-week timeline from infection to recovery, the President has consistently indicated that he feels fine, as have his doctors, and the story is that he will be released today from his weekend stay at Walter Reed Memorial Hospital.  In other words, any concerns that attended the announcement of his illness from Friday, when we did see equity markets suffer, is in the process of being unwound this morning.  The rationale here seems to be twofold.  First, the President is set to be back at the White House and in control, something which matters greatly from a national security perspective.  But second, the fact that he, as a 74-year-old man, was able to recover so quickly from the infection speaks to the reduced impact covid is likely to have on the population as a whole.  And arguably, that may even have a bigger impact.  While we continue to hear of new lockdown’s being announced in certain places, NYC, Spain and France to name just three, if the potency of the infection is waning such that it is a short-term event with limited side effects, that could well lead to an increase in confidence amongst the population.  And, of course, confidence is the one thing that the economy is searching for desperately.

The problem is that since virtually everything has become political theater lately, it is difficult to discern the facts in this situation.  As such, it seems hard to believe that overall confidence has been lifted that significantly, at least as of this morning.  However, if President Trump remains active and vigorous this week, it will certainly put a dent into the thesis that covid is incredibly debilitating.  We will need to watch how things evolve.

Interestingly, there is one issue that seems to be getting short shrift this morning, the growing concern that there will be no Brexit deal reached in the next ten days.  Recall that Boris and Ursula had a virtual lunch date on Saturday, and both claimed that a deal was close, but there were a couple of issues left to address.  The two key differences remain the issue of acceptable state aid by the UK government and, the big one, the type of access that European (read French) fishing vessels will have to UK waters.  It seems that French President Macron is adamant that the UK give the French a (large) annual quota and be done with it, while Boris is of the mind that they should agree to meet annually and discuss the issue based on the available fish stocks and conditions.  It also seems that the rest of Europe is getting a bit annoyed at Macron as for them, the issue is not that significant.  This fact is what speaks to an eventual climb-down by Macron, but, as yet, he has not been willing to budge on the matter.  Based on the price of the pound and its recent performance (+0.2% today, +1.0% in the past week), the market clearly believes a deal will be reached.  However, that also foretells a more significant decline in the event both sides fail to reach said agreement.

So, now let’s take a look at the bullishness in markets today.  Asia saw strength across the board with the Nikkei(+1.25%) and Hang Seng (+1.3%) nicely higher and Australia (+2.6%) really showing strength.  (China remains closed virtually all week for a series of national holidays).  European indices are all green as well, albeit not quite as enthusiastic as Asia.  Thus, we have seen solid gains from the three major indices, DAX, CAC and FTSE 100, all higher by 0.7%.  And finally, US futures are pointing to a stronger opening, with current pricing showing gains of between 0.7% and 1.0%.

It should be no surprise that bond marks are under some pressure with 10-year Treasury yields up to 0.71% this morning, higher by 1 basis point on the session and 6 bps in the past week.  In fact, yields are back at their highest level in a month.  European bonds are also broadly softer (higher yields) but the movement remains muted as well, about 1bp where they have risen.  And it should also not be surprising that Italy, Portugal and Greece have seen yields decline, as those three certainly qualify as risk assets these days.

Oil prices are firmer, again taking their cue from the confidence that is infusing markets overall, while precious metals prices are flat.  And finally, the dollar is definitely softer, except against the yen, which continues to be one of the best risk indicators around.  So, in the G10 space, NOK (+0.7%) is the leader, following oil as well as benefitting from the general dollar weakness.  Next on the list is CHF (+0.5%) where data showed ongoing growth in sight deposits, an indication that capital flows continue to enter the country, despite today’s risk attitude.  But broadly speaking, the whole space is firmer.

As to EMG currencies, ZAR (+0.7%) is the leader today, with firmer commodity prices and still the highest real interest rates around keeping the rand attractive in a risk-on environment.  But it is almost the entire bloc with the CE4 (CZK +0.55%, PLN +0.45%, HUF +0.45%) showing their high EUR beta characteristics and MXN (+0.45%) also performing well, again benefitting from both firmer oil prices as well as a weaker dollar.  The one exception here is RUB (-0.5%), which appears to be suffering from the effects of the ongoing conflict in Nagorno-Karabakh and how much it is going to cost Russia to maintain its support for Armenia.

On the data front, it is a relatively quiet week with only a handful of numbers to be released:

Today ISM Services 56.2
Tuesday Trade Balance -$66.2B
JOLTs Job Openings 6.5M
Wednesday FOMC Minutes
Thursday Initial Claims 820K
Continuing Claims 11.4M

Source: Bloomberg

However, what we lack in data we make up for with Fedspeak, as eight different speakers, including Chairman Powell tomorrow, speak at 13 different events.  What we have heard lately is there is a growing difference of opinion by some FOMC members regarding the robustness of the US economic rebound.  However, despite those differences, the universal request is for further fiscal stimulus.  Given the dearth of data this week, I expect that Chairman Powell’s speech tomorrow morning is likely to be the most important thing we hear, barring a Brexit breakthrough or something else from the White House.

Good luck and stay safe
Adf

More Sales Than Buys

Posted on by

The virus has found a new host
As Trump has now been diagnosed
Investors reacted
And quickly transacted
More sales than buys as a riposte

While other news of some import
Explained that Lagarde’s come up short
Seems prices are static
Though she’s still dogmatic
Deflation, her ideas, will thwart

Tongues are wagging this morning after President Trump announced that he and First Lady Melania have tested positive for Covid-19.  The immediate futures market response was for a sharp sell-off, with Dow futures falling nearly 500 points (~2%) in a matter of minutes.  While they have since recouped part of those losses, they remain lower by 1.4% on the session.  SPU’s are showing a similar decline while NASDAQ futures are down more than 2.2% at this time.

For anybody who thought that the stock markets would be comfortable in the event that the White House changes hands next month, this seems to contradict that theory.  After all, what would be the concern here, other than the fact that President Trump would be incapacitated and unable to continue as president.  As vice-president Pence is a relative unknown, except to those in Indiana, investors seem to be demonstrating a concern that Mr Trump’s absence would result in less favorable economic and financial conditions.  Of course, at this time it is far too early to determine how this situation will evolve.  While the President is 74 years old, and thus squarely in the high-risk age range for the disease, he also has access to, arguably, the best medical attention in the world and will be monitored quite closely.  In the end, based on the stamina that he has shown throughout his tenure as president, I suspect he will make a full recovery.  But stranger things have happened.  It should be no shock that the other markets that reacted to the news aggressively were options markets, where implied volatility rose sharply as traders and investors realize that there is more potential for unexpected events, even before the election.

Meanwhile, away from the day’s surprising news we turn to what can only be considered the new normal news.  Specifically, the Eurozone released its inflation data for September and, lo and behold, it was even lower than quite low expectations.  Headline CPI printed at -0.3% while Core fell to a new all-time low level of 0.2%.  Now I realize that most of you are unconcerned by this as ECB President Lagarde recently explained that the ECB was likely to follow the Fed and begin allowing inflation to run above target to offset periods when it was ‘too low’.  And according to all those central bank PhD’s and their models, this will encourage businesses to borrow and invest more because they now know that rates will remain low for even longer.  The fly in this ointment is that current expectations are already for rates to remain low for, essentially, ever, and business are still not willing to expand.  While I continue to disagree with the entire inflation targeting framework, it seems it is becoming moot in Europe.  The ECB has essentially demonstrated they have exactly zero influence on CPI.  As to the market response to this news, the euro is marginally softer (-0.25%), but that was the case before the release.  Arguably, given we are looking at a risk off session overall, that has been the driver today.

Finally, let’s turn to what is upcoming this morning, the NFP report along with the rest of the day’s data.  Expectations are as follows:

Nonfarm Payrolls 875K
Private Payrolls 875K
Manufacturing Payrolls 35K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Factory Orders 0.9%
Michigan Sentiment 79.0

Source: Bloomberg

Once again, I will highlight that given the backward-looking nature of this data, the Initial Claims numbers seem a much more valuable indicator.  Speaking of which, yesterday saw modestly better (lower) than expected outcomes for both Initial and Continuing Claims.  Also, unlike the ECB, the Fed has a different inflation issue, although one they are certainly not willing to admit nor address at this time.  For the fifth consecutive month, Core PCE surprised to the upside, printing yesterday at 1.6% and marching ever closer to their (symmetrical) target of 2.0%.  Certainly, my personal observation on things I buy regularly at the supermarket, or when going out to eat, shows me that inflation is very real.  Perhaps one day the Fed will recognize this too.  Alas, I fear the idea of achieving a stagflationary outcome is quite real as growth seems destined to remain desultory while prices march ever onward.

A quick look at other markets shows that risk appetites are definitely waning today, which was the case even before the Trump Covid announcement.  The Asian markets that were open (Nikkei -0.7%, Australia -1.4%) were all negative and the screen is all red for Europe as well.  Right now, the DAX (-1.0%) is leading the way, but both the CAC (-0.9%) and FTSE 100 (-0.9%) are close on its heels.  It should be no surprise that bond markets have caught a bid, with 10-year Treasury yields down 1.5 basis points and similar declines throughout European markets.  In the end, though, these markets remain in very tight ranges as, while central banks seem to have little impact on the real economy or prices, they can manage their own bond markets.

Commodity prices are softer, with oil down more than $1.60/bbl or 4.5%, as both WTI and Brent Crude are back below $40/bbl.  That hardly speaks to a strong recovery.  Gold, on the other hand, has a modest bid, up 0.2%, after a more than 1% rally yesterday which took the barbarous relic back over $1900/oz.

And finally, to the dollar.  This morning the risk scenario is playing out largely as expected with the dollar stronger against almost all its counterparts in both the G10 and EMG spaces.  The only exceptions are JPY (+0.35%) which given its haven status is to be expected and GBP (+0.15%) which is a bit harder to discern.  It seems that Boris is now scheduled to sit down with EU President Ursula von der Leyen tomorrow in order to see if they can agree to some broad principles regarding the Brexit negotiations which will allow a deal to finally be agreed.  The market has taken this as quite a positive sign, and the pound was actually quite a bit higher (+0.5%) earlier in the session, although perhaps upon reflection, traders have begun to accept tomorrow’s date between the two may not solve all the problems.

As to the EMG bloc, it is essentially a clean sweep here with the dollar stronger across the board.  The biggest loser is RUB (-1.4%) which is simply a response to oil’s sharp decline.  But essentially all the markets in Asia that were open (MYR -0.3%, IDR -0.2%) fell while EEMEA is also on its back foot.  We cannot forget MXN (-0.55%), which has become, perhaps, the best risk indicator around.  It is extremely consistent with respect to its risk correlation, and likely has the highest beta to that as well.

And that’s really it for the day.  The Trump story is not going to change in the short-term, although political commentators will try to make much hay with it, and so we will simply wait for the payroll data.  But it will have to be REALLY good in order to change the risk feelings today, and I just don’t see that happening.  Look for the dollar to maintain its strength, especially vs. the pound, which I expect will close the day with losses not gains.

Good luck, good weekend and stay safe
Adf

Spring Remains Distant

Posted on by

From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
Adf

We Won’t Acquiesce

Posted on by

Said Madame Lagarde to the press
In Frankfurt, we won’t acquiesce
To prices not rising
So, it’s not surprising
That average inflation we’ll stress

Raise your hand if you had, ‘the ECB will copy the Fed’s average inflation framework’ when announcing their own policy initiatives.  That’s right folks, I’m sure you are all shocked to learn that the ECB is now considering (read has already decided) to follow in the Fed’s footsteps and target an average inflation rate over an indeterminate time in their own policy review.  As Lagarde pointed out, “If credible, such a strategy can strengthen the capacity of monetary policy to stabilize the economy when faced with the lower bound.”  Perhaps the key words to this statement are the first two, if credible.  After all, given the ECB’s demonstrated futility at achieving their targeted inflation rate since its creation in 1997, why would it be credible that the ECB is going to generate inflation now that will run above target.  In fact, over the entire history of ECB policymaking, there was a single stretch of 15 months (October 2001 – December 2002) where their favorite measure, Core CPI, rose above 2.0%.  Otherwise, during the other 270 months, they have seen inflation below their target, oftentimes well below.  The average inflation rate since the ECB’s founding has been 1.4%.  But now we are supposed to believe that because they claim they will allow inflation to run hot, suddenly that makes policy easier.  Personally, I don’t find their claim credible.

But from the market perspective, the importance of her comments, as well as agreement by other ECB members on the subject, is that the Fed has ceased to be the central bank with the easiest money around.  With the ECB and the Fed now both following the same path on inflation targeting, there is not much to choose between the two.  This is especially so given that neither one has been able to approach their current target, let alone exceed it in more than a decade.  But for dollar bears, this is bad news because a key part of the bearish thesis was the idea that the Fed was the easiest money around.  Average inflation targeting meant interest rates would remain near zero for at least three more years.  Well I have news for you, ECB rates will remain negative far longer than that.  Just as a man with a hammer sees every problem as a nail, a central bank with a single policy tool (QE) sees every problem solvable by more bond purchases.

Adding to the euro’s medium-term woes is the situation in Italy, where despite more than €209 billion euros of EU aid, the debt/GDP ratio is destined to head ever higher, rising to 158% this year.  That cements its current third place worldwide status (Japan 234%, Greece 182%) and starts to bring Greece’s number two slot into sight.  With a history of slow growth and a rapidly aging population, it becomes ever harder to envision a solution to Italy’s macroeconomic woes that doesn’t include either debt relief or debt monetization.  And I assure you, that is not a currency positive for the euro.  The point here is that the many negatives that underlie the euro’s construction are likely to become a greater topic of market conversation going forward, and it appears the odds of a significant rally from current levels has greatly diminished, regardless of your views of US policies.

Speaking of US policies, I will admit that I could only tolerate a few minutes of last night’s presidential debate, as the name-calling and interruptions became far too annoying.  Equity futures declined, seemingly on the view that Biden cemented his lead, at least so that’s what the punditry is explaining this morning.  Perhaps equity futures declined as investors decided that no outcome is positive for the US.  But while clearly the presidential campaign will have some market impact over the next five weeks, at this point, it seems unlikely the polls will change much, nor the betting markets.  And yet, we cannot forget that in 2016, the polls and betting markets were pointing to the exact same outcome and turned out to be spectacularly wrong.  In the end, regardless of who wins the election, the Fed is going to continue their current policy mix and more fiscal stimulus is destined to arrive.  As such, I am hard-pressed to say it will impact the dollar.

One other thing of note overnight was Chinese PMI data (Mfg 51.5, Services 55.9), which showed that growth on the mainland continued to expand moderately on the strength of increases across both manufacturing and services sectors.  Even the Caixin PMI (53.0), which focuses on small companies, put in a solid performance.  Interestingly, neither the Shanghai Composite (-0.2%) nor the renminbi (unchanged) reflected any positivity in the outcome.  And neither was that news sufficient to generate any risk taking elsewhere in the world, at least on any sustained basis.

Looking at the rest of the equity markets, we see the Nikkei (-1.5%) fell sharply although the Hang Seng (+0.8%) managed to show the only rise amongst major equity indices.  European bourses are all in the red (DAX -0.5%, CAC -0.6%, FTSE 100 -0.3%) and US futures continue to point lower, with all three indices down about -0.6% at this hour.  Bond market movement continues to largely be absent as 10-year Treasury yields are still 0.65%, unchanged, and both Bunds and Gilts are less than 1 basis point different than yesterday’s levels.  Even Italian BTP’s are unchanged despite the increasing concerns over their fiscal situation.  In other words, the central banks have done an excellent job in controlling yield curves and thus preventing the bond market from offering any economic signals.

As to the dollar, it is broadly, albeit mildly, stronger this morning against its G10 counterparts.  NOK and SEK (both -0.5%) are the leading decliners with Norway suffering from oil’s slide back below $40/bbl, while SEK is simply demonstrating its higher beta to broad movements.  But the whole space is feeling it today, with the exception of CAD, which is essentially unchanged.  Clearly, the Lagarde comments have served to soften the euro (-0.3%) at the margin.

As to the emerging market bloc, things are a bit more mixed.  The notable movers include RUB (+0.9%) and TRY (+0.5%) on what appears to be the first attempts by both nations to de-escalate the Armenian-Azerbaijani conflict.  As well, we see MXN (+0.8%) and ZAR (+0.7%) on the positive side, which is more difficult to justify given the lack of risk appetite, but is likely related to the calendar, as investors rebalance positions into month-end, and so are reducing shorts in those currencies.  On the negative side sits the CE4, following the euro’s decline with their usual ability to outpace the single currency.  Interestingly, APAC currencies have done little overnight, with most movement less than 10 basis points.

On the data front this morning we get ADP Employment (exp 649K), Q2 GDP’s final revision (-31.7%) and Chicago PMI (52.0).  Arguably, the market will be more concerned with the ADP data than anything else as investors try to get a picture of the employment situation.  We also have three more Fed speakers, Kashkari, Bowman and Bullard, but based on yesterday’s outcome, where the message is that the Fed is moderately optimistic that growth will continue but that more fiscal support would be useful, it seems unlikely that these comments will interest many people.

Overall, the big story remains the indication that the ECB is going to match the Fed every step of the way going forward, as will, eventually, every other key central bank, and so the dollar’s value will need to be determined by other means.  But for now, it points to a bit more dollar strength as short positions start to get unwound.

Good luck and stay safe
Adf