Value, Nought

In college Econ 101
Professors described the long run
As when we all died
Like Keynes had replied
Debating a colleague for fun

However, the rest that they taught
Has turned out to have, value, nought
Their models have failed
While many have railed
That people won’t do what they ought

Observing market activity these days and trying to reconcile price action with the theories so many of us learned in college has become remarkably difficult. While supply and demand still seem to have meaning, pretty much every construct more complex than that turns out to have been a description of a special case and not a general model of behavior. At least, that’s one conclusion to be drawn from the fact that essentially every forecast made these days turns out wrong while major pronouncements, regarding the long-term effect of a given policy, by esteemed economists seem designed to advance a political view rather than enhance our knowledge and allow us to act in the most effective way going forward. Certainly, as merely an armchair economist, my track record is not any better. Of course, the difference is that I mostly try to highlight what is driving markets in the very short term rather than paint a picture of the future and influence policy.

I bring this up as I read yet another article this morning, this by Stephen Roach, a former Chairman of Morgan Stanley Asia and current professor at Yale, about the imminent collapse of the dollar and the end of its status as the world’s reserve currency. He is not the first to call for this, nor the first to call on the roster of models that describe economic activity and determine that because one variable has moved beyond previous boundaries, doom was to follow. In this case growth of the US current account deficit will lead to the end of the dollar’s previous role as reserve currency. Nor will he be the last to do so, but the consistent feature is that every apocalyptic forecast has been wrong over time.

This has been true in Japan, where massive debt issuance by the government and massive debt purchases by the BOJ were destined to drive inflation much higher and weaken the yen substantially. Of course, we all know that the exact opposite has occurred. This has been true around the world where negative interest rates were designed to encourage borrowing and spending, thus driving economic growth higher, when it only got half the equation right, the borrowing increase, but it turns out spending on shares was deemed a better use of funds than spending on investment, despite all the theories that said otherwise.

Ultimately, the point is that despite the economics community having built a long list of very impressive looking and sounding models that are supposed to describe the workings of the economy, those models were built based on observed data rather than on empirical truths. Now that the data has changed, those models are just no longer up for the task. In other words, when it comes to forecasting models, caveat emptor.

Turning to the markets this morning, equity markets seem to have stopped to catch their collective breath after having recouped all of their March losses. In fact, the NASDAQ actually set a new all-time high yesterday, amid an economy that is about to print a GDP number somewhere between -20% and -50% annualized in Q2.

I get the idea of looking past the short-run problems, but it still appears to me that equity traders are ignoring long-run problems that are growing on the horizon. These issues, like the wave of bankruptcies that will significantly reduce the number of available jobs, as well as the potential for behavioral changes that will dramatically reduce the value of entire industries like sports and entertainment, don’t appear to be part of the current investment thesis, or at least have been devalued greatly. And while in the long-run, new companies and activities will replace all these losses, it seems highly unlikely they will replace them by 2021. Yet, yesterday saw US equity indices rally for the 7th day in the past eight. While this morning, futures are pointing a bit lower (SPU’s and Dow both lower by 1.2%, NASDAQ down by 0.7%), that is but a minor hiccup in the recent activity.

European markets are softer this morning as well, with virtually every major index lower by nearly 2% though Asian markets had a bit better showing with the Hang Seng (+1.1%) and Shanghai (+0.6%) both managing gains although the Nikkei (-0.4%) edged lower.

Bond markets are clearly taking a closer look at the current risk euphoria and starting to register concern as Treasury yields have tumbled 5bps this morning after a 4bp decline yesterday. We are seeing similar price action in European markets, albeit to a much lesser extent with bunds seeing yields fall only 2bps since yesterday. But, in true risk-off fashion, bonds from the PIGS have all seen yields rise as they are clearly risk assets, not havens.

And finally, the dollar is broadly stronger this morning with only the other havens; CHF (+0.3%) and JPY (+0.4%) gaining vs. the buck. On the downside, AUD is the laggard, falling 1.4% as a combination of profit taking after a humongous rally, more than 27% from the lows in March, and a warning by China’s education ministry regarding the potential risks for Chinese students returning to university in Australia have weighed on the currency. Not surprisingly, NZD is lower as well, by 1.1%, and on this risk-off day, with oil prices falling 2.5%, NOK has fallen 1.0%. But these currencies’ weakness has an awful lot to do with the dollar’s broad strength.

In the emerging markets, the Mexican peso, which had been the market’s darling for the past month, rallying from 25.00 to below 21.50 (13.5%) has reversed course this morning and is down by 1.4%. But, here too, weakness is broad based with RUB (-0.95%), PLN (-0.7%) and ZAR (-0.6%) all leading the bloc lower. The one exception in this space was KRW (+0.6%) after the announcement of some significant shipbuilding orders for Daewoo and Samsung Heavy Industries improved opinions of the nation’s near-term trade situation.

Turning to the data, although it’s not clear to me it matters much yet, we did see some horrific trade data from Germany, where their surplus fell to €3.5 billion, its smallest surplus in twenty years, and a much worse reading than anticipated as exports collapsed. Meanwhile, Eurozone Q1 GDP data was revised ever so slightly higher, to -3.6% Q/Q, but really, everyone wants to see what is happening in Q2. At home, the NFIB Small Biz Index was just released at a modestly better than expected 94.4 but has been ignored. Later this morning we see the JOLT’s Jobs data (exp 5.75M), but that is for April so seems too backward-looking to matter.

Risk is on its heels today and while hopes are growing that the Fed may do something new tomorrow, for now, given how far risk assets have rallied over the past two weeks, a little more consolidation seems a pretty good bet.

Good luck and stay safe
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To Aid and Abet

The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
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A Bit Out of Sorts

The ECB stepped to the plate
Effectively cutting the rate
At which it will lend
To help countries spend
As well, to help prices inflate

But last night some earnings reports
Put traders a bit out of sorts
And too, from Down Under
It’s really no wonder
The data inspired some shorts

With many markets globally closed today for the May Day holiday, one would have expected fairly limited price action overall. One would have been wrong. In fact, despite the best efforts of the ECB yesterday to demonstrate further support for the European economies, it turns out that disappointing data has suddenly been recognized. This data story started last evening with key Tech earnings reports from two of the FAANG stocks, both disappointing on the profit side and calling into question the ability of even these companies to be able to withstand the remarkable demand shrinkage caused by Covid-19.

Then, though most of Asia was closed for the holiday, Australia (Manufacturing Index) and New Zealand (Consumer Confidence) both reported weaker than expected economic data. Suddenly, it seems that data was an important issue for markets, a change of recent heart. And there is one more thing to remember, the calendar turned the page. The calendar matters because, especially given the remarkable price action in April, there was a significant amount of month-end rebalancing in institutional portfolios. Remember, we saw a sharp rally in stocks, so it should be no surprise that they were sold off in order for portfolios to get back to desired asset allocations.

Taking it all together resulted in some serious equity market declines in the few markets open overnight, with the Nikkei (-2.85%) and Australia’s ASX 200 (-5.0%) putting in truly awful performances. Meanwhile, in Europe, only the FTSE 100 is trading today, and it is lower by 2.1%. US futures are following suit, currently down around 2.0% across the board.

So, what of the ECB’s actions? Well, they effectively cut interest rates by lowering the rate at which TLTRO funds are borrowed by 0.25%, to -0.25%. That means that Eurozone banks which lend new money to companies can earn to fund themselves. A pretty sweet deal if they charge a positive rate on the loans. In addition, they created yet another loan program, the PELTRO, which has even lower rates, as low as -1.0% funding costs for banks lending under this criterion. Of course, the problem remains that while many companies may borrow in order to try to get through the current ceasing of activity, future growth opportunities will simply be further hindered by the additional debt on corporate balance sheets. Two other things of note from the ECB are that they did not increase their QE programs as there remains considerable concern that the German Constitutional Court may rule next week that QE is illegal, essentially funding governments throughout the Eurozone, and that will call into question everything they have done. The second was the dire forecast from Madame Lagarde that Eurozone growth could see GDP shrink 12% in 2020, which if you consider yesterday’s Q1 data (-3.8% Q/Q) implies a modest rebound by year end.

Turning to the FX markets, it can be no surprise that both AUD (-1.0%) and NZD (-0.8%) are the worst performing currencies in the G10 space. Not only did both report lousy data, but both (AUD +17%, NZD +13%) have been rallying pretty steadily since their nadir on March 19. Thus, if the paradigm is changing back to the future is not as bright, I would look for both these currencies to give up much of last month’s rally. Meanwhile, the oil proxies, CAD (-0.6%) and NOK (-0.7%) are both suffering from oil’s modest declines this morning, with WTI ceding about 2.0% of its recent spectacular gains. After all, even ignoring the odd dip into negative territory two weeks ago, oil has rallied more than 200% since that fateful day, based on the June WTI contract. On the plus side, we see JPY (+0.35%) on what appears to be a modest risk-off trade, leading the way higher, with the rest of the bloc +/- 0.2% and lacking any new information.

EMG currencies have been largely spared movement overnight as the APAC bloc was closed for the holiday although CNH has managed to fall 0.6% in the absence of a domestic market. The three main deliverable EMG currencies, MXN (-1.4%), ZAR (-1.4%) and TRY (-0.7%) have a decidedly risk-off tone to their price action, with the peso being truly impressive. Since Tuesday, we have seen MXN first rally 5.0% then decline 4.1% from its peak. Net it is stronger, but the current trend seems to point to further weakness. Again, if the risk appetite from April begins to wane further, these currencies have the opportunity to fall significantly.

On the data front, this morning brings Construction Spending (exp -3.5%) and ISM Manufacturing (36.0) with the Prices Paid (33.0) and New Orders (30.0) indices looking equally dire. Yesterday we learned that Personal Income fell sharply, and Personal Spending fell even more sharply, a record-breaking 7.5% decline. Initial Claims data was a touch weaker than the median forecast at 3.84M with Continuing Claims (which lag the Initial claims data by a week) not rising quite as much as expected, to ‘just’ 18.0M.

Ultimately, the history of Covid-19’s impact will be written as the most extraordinary destruction of demand in history. The US (and global) economy had evolved from a manufacturing base a century ago, to a service-based economy par excellence. Nobody considered what shelter-in-place and social distancing would do to that construct. It is becoming increasingly clear that the answer to that is those restrictions will cause extreme economic damage that is likely to take several years to recoup. Alas, we are not done with this disease, and the restrictions will continue to wreak havoc on the global economy, and asset values, for a while yet. We have not seen the last of risk-off, nor the last of the dollar’s strength.

Good luck, good weekend and stay safe
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Manna From Heaven

On Friday, the world nearly ended
On Monday, investors felt splendid
Today the G7
Brings manna from heaven
But will rate cuts work as intended?

Of course, everyone is aware of yesterday’s remarkable equity market rally as investors quickly grasped the idea that the world’s central banks are not going to go down without a fight. While there were separate statements yesterday, this morning the G7 FinMins and Central bankers are having a conference call, led by Treasury Secretary Mnuchin, to discuss next steps in support of the global markets economy.

It is pretty clear that they are going to announce coordinated actions, with the real question simply what each bank is going to offer up. The argument in the US is will the cut be 25bps or 50bps? In the UK it is clearly 25bps. The ECB and BOJ have their own problems, although I wouldn’t be shocked to see 10bps from them as well as a pledge to increase asset purchases. And, of course, Canada remains largely irrelevant, but will almost certainly cut 25bps alongside the Fed.

But equity markets rebounded massively yesterday, so is there another move in store on this new news? That seems less probable. And remember, Covid-19 has not been cured and continues to spread pretty rapidly. The issue remains the government response, as we continue to see large events canceled (the Geneva Auto Show was the latest) which result in lost, not deferred, economic activity. The one thing that is very clear is that Q1 economic data is going to be putrid everywhere in the world, regardless of what the G7 decides. But perhaps they can save Q2 and the rest of the year.

The interesting thing is that bond markets don’t seem to be singing from the same hymnal as the stock markets. We continue to see a massive rally in bonds, with 2-year yields down to 0.87% while the 10-year is at 1.15%. That is hardly a description of a rip-roaring economy. Rather, that sounds like fears over an imminent recession. The only thing that is certain is that there are as many different views as there are traders and investors, and that has been instrumental in the significant increase in volatility we have observed.

As to the dollar, it has been under significant pressure since yesterday morning, with the euro climbing to its highest level since mid-January. I maintain the dollar’s weakness can be ascribed to the fact that the Fed is the only major central bank with room to really cut rates, and the market is in the process of pricing in 4 cuts for 2020, with more beyond. So further USD weakness ought not be too surprising, but I expect it is nearer its bottom than not, as in the end, the US remains the best place to invest in the current global economy. My point is that receivables hedgers need to be active and take advantage of the dollar’s recent decline. I don’t foresee it lasting for a long period of time.

The first actions were seen in Asia, as both Australia and Malaysia cut their base rates by 25bps while explaining that their close relationships with China require action. And that is certainly true as the extent of how far the Chinese economy will shrink in Q1 is still a huge unknown. Interestingly, AUD managed to rally 0.35% after the rate cut as investors seemed to approve of the action. The thing is, now rates Down Under are at 0.50%, so there is precious little room left to maneuver there. MYR, on the other hand, slipped slightly, -0.1%, although stocks there managed to rally 0.8% on the news.

Meanwhile, the market continues to punish certain nations that have their own domestic problems which are merely being exacerbated by Covid-19. A good example is South Africa, where the rand tumbled 1.45% this morning after Q4 GDP was released at a much worse than expected -0.5% Y/Y, which takes the nation to the edge of recession. And remember, this was before there was any concern over the virus, so things are likely to get worse before they get better. This doesn’t bode well for the rand in the near and medium term.

But overall, today has been, and will continue to be driven by expectations for, and then the response to the G7 meeting. While it is certain that whatever statement is made will be designed to offer support, given yesterday’s huge rebound in markets, there is ample chance for the G7 to disappoint. Arguably, the risks for the G7 are asymmetric as even an enormous support package of rate cuts and added fiscal spending seem mostly priced into the market. On the other hand, any disappointment could easily see the next leg down in both equity markets and bond yields as investors realize that sometimes, the only way to deal with a virus is to let it run its course.

Good luck
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Set For Stagnation

When thinking of every great nation
Regarding its growth expectation
The US alone
Is like to have grown
While others seem set for stagnation

The upshot of these circumstances
Is regular dollar advances
Within the G10
It’s euros and yen
That suffer on policy stances

Another day, another dollar rally. This simple sentiment pretty well sums up what we have been seeing for the past several weeks. And while there may be a multitude of catalysts driving individual currency movements, the reality is they all point in the same direction, a stronger dollar. Broadly speaking, data from around the world, excluding the US, has been consistently weaker than expected while the US continues to hum along nicely. Now, if China’s economy remains in its current catatonic state for another month, one has to believe that US numbers are going to suffer, if only for supply chain reasons. But right now, it is difficult for anyone to make the case that another currency is better placed than the dollar.

For example, last night we saw Australian Unemployment unexpectedly rise to 5.3% as the first measured impacts of Covid-19 make themselves felt Down Under. Traders wasted no time in selling Aussie and here we are this morning with the currency lower by 0.75%, trading to new lows for the move and touching its lowest level since March 2009. Perhaps the Lucky Country has run out of luck.

The yen keeps falling
Like ash from Fujiyama
Is an end in sight?

At this point in the session, the yen has seen its largest two-day decline since November 2016, in the immediate wake of President Trump’s election, and has now fallen more than 2.0% since Tuesday morning. It has broken through a key technical level at 111.02, which represented a very long-term downtrend line. This has encouraged short-term traders to add to what is believed to be significant outflows from Japanese investors, notably insurance companies. One of the other interesting things is that Japanese exporters, who are typically sellers of USDJPY, seem to be sitting this move out, having filled orders at the 110 level, and are now apparently waiting for 115. While it is unlikely that we will see the yen continue to decline 1% each day, I have to admit that 115 seems quite realistic by the end of the Japanese fiscal year next month.

And those are just two of the many stories that seem to be coming together simultaneously to encourage dollar buying. Other candidates are ongoing weak Eurozone economic data (Eurozone Construction output falling and reduced forecasts for tomorrow’s flash PMI data), rate cuts by EMG central banks (Indonesia cut by 25bps last night), and more confusion from China regarding Covid-19 and its spread. Last night, they changed the way they count infections for the second time in a week, and shockingly the result was a lower number indicating the spread of the disease is slowing. However, at this point, the virus count seems to be having less of a market impact than little things like the announcement that Hubei province is keeping all factories shuttered until at least March 10. Now I don’t know about you, but that hardly seems like the type of thing that indicates things are getting better there.

There is a new tacit contest in the market as well, trying to determine just how big a hit the Chinese economy is going to take in Q1. If you recall two weeks ago, the initial estimates were that GDP would grow at a 4%-5% rate in Q1. At this point 0.0% seems a given with a number of analysts penciling in negative growth for the quarter. And folks, I don’t know why anyone would think there is going to be a V-shaped recovery there. It is going to take a long time to get things anywhere near normal, and there has already been a lot of permanent demand destruction. On top of that, one of the things I had discussed last week, the idea that even if companies aren’t generating revenue, they still need to pay interest on their debt, is starting to be seen more publicly. The news overnight that HNA Group, a massively indebted conglomerate that had acquired trophy assets all around the world (stakes in Hilton Hotels and Deutsche Bank amongst others) is unable to pay interest on its debt and seems to be moving under state control. While the PBOC cut rates slightly overnight, the one-year loan prime rate is down to 4.05% from 4.15% previously, it appears that the Chinese government is going to be fighting the Covid-19 fight with more fiscal measures than monetary ones. That said, the renminbi has been falling along with all other currencies and has traded back through 7.00 to the dollar after a further 0.35% decline overnight.

The point is that you can essentially look at any currency right now and it is weaker vs. the dollar. Each may have its own story to tell, but they all point in the same direction.

I would be remiss to ignore other markets, which show that other than Chinese equity markets (Shanghai +1.85%), which rallied last night after news of further stimulus measures, risk is mostly on its back foot today. European equity markets are generally lower (DAX -0.1%, CAC -0.1%) although not by much. US futures are pointing lower by 0.2% across the board, again, not significant, but directionally the same message. Treasury yields continue to fall, down another 2bps this morning to 1.54%, and gold continues to rally, up another 0.3% this morning.

Yesterday’s FOMC Minutes explained that the Fed was pretty happy with current policy settings, something we already knew, and that they are still unsure how to change their ways to try to be more effective with respect to achieving their inflation target as well as insuring that there are no more funding crises. On the data front, yesterday’s PPI data was much firmer than expected, although most people pretty much ignore those numbers. Today we see Philly Fed (exp 11.0), Initial Claims (210K) and Leading Indicators (0.4%). Monday’s Empire Mfg data was stronger than expected and the forecasts for Philly Fed are for a solid increase. Yet again, the data picture points to a better outcome in the US than elsewhere, which in the current environment will only encourage further USD buying. For now, don’t get in front of this train, but if you need to hedge receivables, sooner is better than later as I think we could see this run for a while.

Good luck
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No Panacea

Fiscal stimulus
Is no panacea, but
Welcome nonetheless

At least by markets
And politicians as well
If it buys them votes!

Perhaps the MMTer’s are right, fiscal rectitude is passé and governments that are not borrowing and spending massive amounts of money are needlessly harming their own countries. After all, what other lesson can we take from the fact that Japan, the nation with the largest debt/GDP ratio (currently 236%) has just announced they are going to borrow an additional ¥26 trillion ($239 billion) to spend in support of the economy, and the market response was a stock market rally and a miniscule rise in JGB yields of just 1bp. Meanwhile, the yen is essentially unchanged.

Granted, despite the fact that this equates to nearly 5% of the current GDP, given JGB interest rates are essentially 0.0% (actually slightly negative) it won’t cost very much on an ongoing basis. However, at some point the question needs to be answered as to how they will ever repay all that debt. It seems the most likely outcome will be some type of explicit debt monetization, where the BOJ simply tears up maturing bonds and leaves the cash in the economy, thus reducing the debt and maintaining monetary stimulus. However, macroeconomic theory explains following that path will result in significant inflation. And of course, that’s the crux of the MMT philosophy, print money aggressively until inflation picks up.

The thing is, every time this process has been followed in the past, it basically destroyed the guilty country. Consider Weimar Germany, Zimbabwe and even Venezuela today as three of the most famous examples. And while inflation in Japan is virtually non-existent right now, that does not mean it cannot rise quite rapidly in the future. The point is that, currently, the yen is seen as a safe haven currency due to its strong current account surplus and the fact that its net debt position is not terribly large. But the further down this path Japan travels, the more likely those features are to change and that will be a distinct negative for the currency. Of course, this process will take years to play out, and perhaps something else will come along to change the trajectory of these long term processes, but the idea that the yen will remain a haven forever needs to be constantly re-evaluated. Just not today!

In the meantime, markets remain in a buoyant mood as additional comments from the Chinese that both sides remain in “close contact”, implying a deal is near, has the bulls ascendant. So Tuesday’s fears are long forgotten and equity markets are rallying while government bond yields edge higher. As to the dollar, it is generally on its back foot this morning as well, keeping with the theme that risk is ‘on’.

Looking at specific stories, there are several of note today. Overnight, Australia released weaker than expected GDP figures which has reignited the conversation about the RBA cutting rates in Q1 and helped to weaken Aussie by 0.3% despite the USD’s overall weakness. Elsewhere in the G10, British pound traders continue to close out short positions as the polls, with just one week left before the election, continue to point to a Tory victory and with it, finality on the Brexit issue. My view continues to be that the market is buying pounds in anticipation of this outcome, and that once the election results are final, there will be a correction. It is still hard for me to see the pound much above 1.34. However, there are a number of analysts who are calling for 1.45 in the event of a strong Tory majority, so be aware of the differing viewpoints.

On the Continent, German Factory Order data disappointed, yet again, falling 0.4% rather than rising by a similar amount as expected. This takes the Y/Y decline to 5.5% and hardly bodes well for a rebound in Germany. However, the euro has edged higher this morning, up 0.15% and hovering just below 1.11, as we have seen a number of stories rehashing the comments of numerous ECB members regarding the idea that negative interest rates have reached their inflection point where further cuts would do more harm than good. With the ECB meeting next Thursday, expectations for further rate cuts have basically evaporated for the next year, despite the official guidance that more is coming. In other words, the market no longer believes the ECB can will ease policy further, and the euro is likely edging higher as that idea makes its way through the market. Nonetheless, I see no reason for the euro to trade much higher at all, especially as the US economy continues to outperform the Eurozone.

In the emerging markets, the RBI surprised the entire market and left interest rates on hold, rather than cutting by 25bps as universally expected. The rupee rallied 0.35% on the news as the accompanying comments implied that the recent rise in inflation was of more concern to the bank than the fact that GDP growth was slowing more rapidly than previously expected. In a similar vein, PHP is stronger by 0.5% this morning after CPI printed a bit higher than expected (1.3%) and the market assumed there is now less reason for the central bank to continue its rate cutting cycle thus maintaining a more attractive carry destination. On the other side of the ledger, ZAR is under pressure this morning, falling 0.5% after data releases showed the current account deficit growing more rapidly than expected while Electricity production (a proxy for IP) fell sharply. It seems that in some countries, fiscal rectitude still matters!

On the data front this morning, we see Initial Claims (exp 215K), Trade Balance (-$48.5B), Factory Orders (0.3%) and Durable Goods (0.6%, 0.6% ex transport). Yesterday we saw weaker than expected US data (ADP Employment rose just 67K and ISM Non-Manufacturing fell to 53.9) which has to be somewhat disconcerting for Chairman Powell and friends. If today’s slate of data is weak, and tomorrow’s NFP report underwhelms, I think that can be a situation where the dollar comes under more concerted pressure as expectations of further Fed rate cuts will build. But for now, I am still in the camp that the Fed is on hold, the data will be mixed and the dollar will hold its own, although is unlikely to rally much from here for the time being.

Good luck
Adf

Truly Displeasing

Down Under the story’s that rates
May soon fall, which just demonstrates
That growth there is easing
Thus truly displeasing
The central bank head and his mates

The RBA Minutes were released last evening and the central bank in the lucky country is not feeling very good. Governor Lowe and his team painted two, arguably similar, scenarios under which the RBA would need to cut rates; a worsening of the employment situation or a continued lack of inflation (driven by a worsening of the employment situation). We have been hearing this tune from Lowe for the past several months and the market is already pricing in more than one full 25bp cut before the end of 2019. However, as is often the case, when these theories are confirmed the market adjusts further. And so, it should be no surprise that AUD is lower again this morning, falling 0.35% and now trading back to the lows last seen in January 2016. For a bit more perspective, the last time Aussie was trading below these levels was during the financial crisis in Q1 2009 amidst a full-on risk blowout. But the combination of slowing Chinese growth, and generic dollar strength is taking a toll on the Aussie dollar. The trend here is lower and appears to have further room to run. Hedgers take note!

In England, meanwhile, it appears
The outcome that everyone fears
A no-deal decision
Might soon be the vision
And Sterling might weaken for years

Turning to the UK, the odds of a hard Brexit seem to be increasing by the day. As the EU elections, scheduled for later this week, approach, the hardline Tories are in the ascendancy. Nigel Farage, one of the most vocal anti-EU voices, is leading his new Brexit party into the elections and they are set to do quite well. At the same time, Boris Johnson, the former Foreign Minister in PM May’s government, as well as former Mayor of London, and also a strong anti-EU voice, is now the leading candidate to replace May in the ongoing leadership struggle. The PM is still trying to push water uphill find support for her thrice defeated bill, but it should be no surprise that, so far, that support has yet to materialize. After all, it was hated three times already and not a single word in the bill has changed. At this point, her only hope is that the increasingly real threat of a PM Johnson, who has stated he will simply exit the EU quickly, may be enough to get those wavering to come to her side. Based on the FX market price action over the past three weeks, however, it is becoming clearer that her bill is going to fail yet again.

Since the beginning of the month, the pound has fallen 3.6% (-0.25% today) and is trading at levels last seen in early January. As this trend progresses, it looks increasingly likely that the market will test the post-Brexit lows of 1.1906. And, of course, if Johnson is the next PM and he does pull out of the EU without a deal, an initial move to 1.10 seems quite viable. Once again, hedgers beware. As an aside, do not think for a moment that the euro will go unscathed in a hard Brexit. It would be quite easy to see a 2%-3% decline immediately, although I suspect that would moderate far more quickly than the damage to the pound.

Turning our eyes eastward, we see that the ongoing trade war (it has clearly escalated past a spat) between the US and China continues to have ramifications in the FX markets. Not only is the yuan continuing to weaken (-0.2% today) but other currencies are starting to feel the brunt. The most obvious loser has been the Korean won (-0.15% overnight) which has fallen 5.4% in the past month. While the central bank there is clearly concerned, given the cause of the movement and the strong trend, there is very little they can do to halt the slide other than raising interest rates aggressively. However, that would be devastating for the South Korean economy, so it appears that there is further room for this to decline as well. All eyes are on the 1200 level, which last traded in the major dollar rally in the beginning of 2017.

Do you see the trend yet? The dollar is continuing its strengthening tendencies across the board this morning. Other news adding fuel to the fire was the latest revision of OECD growth forecasts, where the US data was upgraded to 2.6% for 2019 while virtually every other area (UK, China, Eurozone, Japan, etc.) was downgraded by 0.1%-0.2%. It should be no surprise that the dollar remains well-bid in this environment.

Turning to the data this week, it is quite sparse as follows:

Today Existing Home Sales 5.35M
Wednesday FOMC Minutes  
Thursday Initial Claims 215K
  New Home Sales 675K
Friday Durable Goods -2.0%
  -ex transport 0.2%

Obviously, all eyes will be on the Minutes tomorrow, but the data set is not very enticing. That said, we do hear from eight more Fed speakers across a total of ten speeches (Atlanta’s Rafael Bostic is up three times this week). Yesterday, Chairman Powell explained that while corporate debt levels are high, this is no repeat of the mortgage crisis from 2008. Of course, Chairman Bernanke was quite clear, at the time, that the mortgage situation was “contained” just before the bottom fell out. I’m not implying the end is nigh, simply that the track record of Fed Chairs regarding forecasting market and economic dislocations is pretty dismal. At this time, there is no evidence that the Fed is going to do anything on the interest rate front although the futures market continues to price for nearly 50bps of rate cuts this year. And when it comes to forecasting, the futures market has a much better track record. Just sayin’.

All told, at this point there is no reason to think the dollar is going to reverse any of its recent strength, and in fact, seems likely to add to it going forward.

Good luck
Adf

Another Bad Day

Consider Prime Minister May
Who’s having another bad day
Her party is seeking
Her ouster ere leaking
Support, and keep Corbyn at bay

The pound is now bearing the brunt
Of pressure as sellers all punt
On Brexit disaster
Occurring much faster
Thus moving back burner to front

While the rest of the world continues to focus on the US-China trade situation, or perhaps more accurately on the volatility of US trade policy, which has certainly increased lately, the UK continues to muddle along on its painfully slow path to a Brexit resolution of some sort. The latest news is that the Tory party is seeking to change their own parliamentary rules so they can bring another vote of no-confidence against PM May as a growing number in the party seek her resignation. Meanwhile, the odds of a deal with the Labour party continue to shrink given May’s unwillingness to accept a permanent membership in a customs union, a key demand for Labour. This is the current backdrop heading into the EU elections next week. The Brexit party, a new concoction of Nigel Farage, is leading the race in the UK according to recent polls, with their platform as, essentially, leave the EU now! And to top it all off, PM May is seeking to bring her much despised Brexit bill back to the floor for its fourth vote in early June. In other words, while it has probably been a month since Brexit was the hot topic, as the cracks begin to show in UK politics, it is coming back to the fore. The upshot is the pound has been under very steady pressure for the past two weeks, having fallen 2.7% during that time (0.2% overnight), and is now at its lowest point since mid-February.

When the delay was agreed by the EU and the UK, pushing the new date to October 31, the market basically assumed that either Labour would come on-board and a deal agreed, or that a second referendum would be held which is widely expected to point to Remain. (Of course, that was widely expected in the first referendum as well!) However, given that politics is such a messy endeavor, there is no clarity on the outcome. I think what we are observing is the market pricing in much higher odds of a hard Brexit, which remains the law of the land given there are no other alternatives at this time. Virtually every pundit believes that some deal will be struck preventing that outcome, but it is becoming increasingly clear that the FX market, at least, is far less certain of that outcome. For the FX market punditry, this has created a situation where not only trade politics are clouding the view, but local UK politics are doing the same.

Speaking of trade politics, while there is continued bluster on both sides of the US-China spat, the lines of communication clearly remain open as Treasury Secretary Mnuchin seems likely to head back to Beijing again soon for further discussions. At the same time, President Trump has delayed the decision on imposing 25% tariffs on imported autos from Europe and Japan while negotiations there continue, thus helping kindle a rebound in yesterday’s equity markets. As to the FX impact on this news, it was ever so mildly euro positive, with the single currency rebounding a total of 0.2% from its lows before the announcement. Of course, part of the euro’s rally could be pinned on the much weaker than expected US Retail Sales and IP data released yesterday, but given the modesty of movement, it really doesn’t matter the driver.

Stepping back a bit, the dollar’s longer-term trend remains higher. Versus the euro, it remains 5% higher than May 2018, while the broader based Dollar Index (DXY) has rallied 3.5% in that period. And the thing is, despite yesterday’s US data, the US situation appears to be far more supportive of growth than the situation virtually everywhere else in the world. Global activity measures continue to point to a slowing trend which is merely being exacerbated by the trade problems.

Turning to market specifics, Aussie is a touch lower this morning after weaker than expected employment data has helped cement the market’s view that the RBA is going to cut rates at least once this year with a decent probability of two cuts before December. While thus far Governor Lowe has been reluctant to lean in that direction, the collapse in housing prices is clearly starting to weigh elsewhere Down Under. I think Aussie has further to decline.

However, away from that news, there has been much less of interest to drive markets, and so, not surprisingly, markets remain extremely quiet. Something that gets a great deal of press lately has been the decline in volatility and how selling vol has turned into a new favorite trade. (As a career options trader, I would caution against selling when levels have reached a nadir like this. It is not that they can’t decline further, clearly they can, but in a reversal, the pain will be excruciating).
As to the data story, aside from the Australian employment situation, there has been nothing of note overnight. This morning brings Initial Claims (exp 220K) and Housing Starts (1.205M) and Building Permits (1.29M) along with Philly Fed (9.0) all at 8:30. I mentioned the weak Retail Sales and IP data above, but we also saw Empire Manufacturing which was shockingly high at 18.5, once again showing that there is no strong trend in the US data. While there are no Fed speakers today, yesterday we heard from Richmond President Barkin and not surprisingly, he said he thought that patience was the right stance for now. There is no doubt they are all singing from the same hymnal.

Arguably, as long as we continue to get mixed data, there is no reason to change the view. With that in mind, it is hard to get excited about the prospects of a large currency move until those views change. So, for the time being, I believe the longer-term trend of dollar strength remains in place, but it will be choppy and slow until further notice.

Good luck
Adf

 

Palpably Real

For Jay and his friends at the Fed
Inflation seems just about dead
So all the debate
‘bout rate hikes can wait
With focus on Brexit instead!

Thus turning to England, we learned
The deal, once again, has been spurned
Now fears of no deal
Are palpably real
Though markets seem quite unconcerned

While the headline news is arguably the second defeat of PM May’s Brexit deal in Parliament, I am going to touch on a different theme to start; namely the Fed.

Yesterday’s CPI data printed on the soft side (Headline 1.5%, Core 2.1%) with both coming in 0.1% below expectations. And while the Fed does not target this reading, it is still an important part of the discussion. That discussion continues to turn toward the idea that the Fed has already overtightened policy and that the next move will be a rate cut. Given the overall slowing in US data and highlighting that the Fed has been completely unable to achieve their inflation target of 2.0%, I expect that the next series of Fed comments, once they are past their meeting next week, will focus on greater efforts to achieve their mandate (the self-imposed 2.0% inflation target) and what needs to be done accordingly. I would look for the end of the balance sheet roll-off quite soon, perhaps in April, but in any case, by June, and I would look for futures markets to start pricing in a full rate cut by the middle of next year. I guess the only question is will the equity market continue to rally despite the weakening underlying fundamentals. Certainly, based on the past ten years of experience, the answer is yes. But can markets defy fundamentals forever? I guess we shall see.

PS. If the Fed is starting to turn more actively dovish, rather than its current passive stance, that will immediately undermine the dollar’s value. While for now I continue to see further upside potential for the buck, that is subject to change if the policies underlying that stance change as well.

Now to Brexit. Poor PM May. She really did work hard to try to find a solution as to how to avoid a hard Brexit, but the EU has literally zero interest in seeing the UK leave their bloc and thrive. If that were the case, the temptation for other unhappy countries (Italy anyone?) to also exit would be too great. As such, it was always in the EU’s long-term interest to play hardball like they did. It can also be no surprise that the widely touted adjustment to the codicil to the agreement was an attempt to bamboozle with flowery words, rather than an effort to put something legally binding in place. As such, once Attorney General Cox declared that the new language was no better than the old, which occurred just as I was getting prepared to publish my note yesterday, it was clear that there was no chance of passage. The fact that the vote lost by a smaller amount, only 149 votes vs. 230 votes the first time, is small consolation.

However, now Parliament has taken over and will have to come up with some plans on their own. It is generally much easier to howl from the peanut gallery than to take responsibility so we shall watch this with great interest. It seems that a majority in Parliament want to vote on a bill that will prevent a no-deal Brexit but given there is only one deal on the table and they handily rejected it, that implies they need a postponement from the EU. It is not enough for the UK to say they want to postpone. In fact, the other 27 members of the EU must all vote unanimously to agree. At this point, there has been no clarity on how long a delay they would like, nor what they plan to do with the time. And the EU has made it clear that those are important aspects of agreeing to a delay. For now, the debate in Parliament rages on, and I assume we will learn their answers in the next day or two, and certainly by the end of the week.

Funnily enough, the FX market has weighed the evidence and decided that there will categorically not be a hard Brexit and the odds of no Brexit are increasing. The pound, after yesterday’s wild ride, is back on an upswing and higher by 0.65% as I type. The one thing of which we can be sure is that the pound will continue to react to headline news until a definitive outcome exists. For my money, it appears as though the market is underpricing the probability of a hard Brexit. While I am pretty sure that nobody really wants one, the fact remains that it continues to be a real possibility even if only by legislative accident. One never knows who is looking at the situation there and sees a chance for personal political gain by allowing a hard Brexit. And in the end, given each MP is a politician first and foremost, that cannot be ignored!

Otherwise, the trade talks are ongoing with a positive spin put forth by the US top negotiator, Robert Lighthizer, although no deal is agreed as yet. Overnight data from Down Under showed weakening Consumer Confidence as the housing market there continues to implode, thus it is no surprise to see AUD having fallen by 0.25% and hugging recent lows. And in truth, little else of note is happening in these markets.

This morning we see Durable Goods (exp -0.5%, +0.1% ex Transport) as well as PPI (1.9%, 2.6% core) although nobody really cares about PPI with CPI just having been released. The Fed is now in their quiet period as they meet next week, so we will not get comments there. This leaves the Brexit debate as the primary focus for the FX market today. Based on all that I have read, I actually expect that the debate there will take more than one day, and that we won’t really get much new information today. Hence, I expect limited market activity for now.

Good luck
Adf

Expansion is Done

The planet that’s third from the sun
Is learning expansion is done
At least with respect
To growth that’s subject
To what politicians have done

It ought not be much of a surprise that the dollar is regaining its footing this morning and has been doing so for the past several sessions. This is due to the fact that the economic data continue to point to the US as the last bastion of hope for global growth. Yesterday’s data showed that there is still life in the US economy as both Non-Manufacturing ISM (59.7) and New Home Sales (621K) handily beat expectations. At the same time, the data elsewhere around the world continues to show slowing growth.

For example, Australian GDP growth in Q4 printed at a lower than expected 0.2%, with the annual number falling to 2.3%. While RBA Governor Lowe continues to cling to the idea that falling unemployment (a lagging indicator) is going to save the day, the fact remains that the housing bubble there is deflating and the slowdown in China’s economy is having a direct negative impact on Australian growth. In the wake of the report, analysts throughout Asia adjusted their interest rate forecasts to two rate cuts this year even though the RBA has tried to maintain a neutral policy with an eventual expectation to raise rates. Aussie fell sharply, down 0.75% this morning and >2.5% in the past week. It is once again approaching the 0.70 level which has thus far proven to be formidable support, and below which it has not traded in three years. Look for it to crack this time.

But it is not just problems Down Under. In fact, the much bigger issues are in Europe, where the OECD has just released its latest forecasts for GDP growth with much lower numbers on the table. Germany is forecast to grow just 0.7% this year, the UK just 0.8% and of course, Italy which is currently suffering through a recession, is slated to grow just 0.2% this year! Tomorrow Signor Draghi and his ECB colleagues meet again and there is a growing belief that a decision on rolling over the TLTRO bank financing will be made. I have been pounding the table on this for several months and there has certainly been nothing lately to change my view. At this point, the market is now pricing in the possibility of the first ECB rate hike only in mid 2020 and my view is it will be later than that, if ever. The combination of slowing growth throughout the Eurozone, slowing growth in China and still absent inflation will prevent any rate hikes for a very long time to come. In fact, Europe is beginning to resemble Japan in this vein, where slowing growth and an aging population are the prerequisites for NIRP forever. Plus, the longer growth remains subpar, the more call for fiscal policy ease which will require additional borrowing at the government level. As government debt continues to grow, and it is growing all around the world, the ability of central banks to guide rates higher will be increasingly throttled. When you consider these issues it become very difficult to be bullish on the euro, especially in the long-term. But even in the short run, the euro is likely to feel pressure. While the euro has barely edged lower this morning, that is after a 0.35% decline yesterday which means it is down just over 1.0% in the past week.

In the UK, meanwhile, the Brexit debate continues but hope is fading that the PM will get her bill through Parliament this time. Thus far, the EU has been unwilling to make any concessions on the language of the Irish backstop, and despite a herculean effort by May, it is not clear she can find the votes. The vote is scheduled for next Tuesday, after which, if it fails, Parliament will look to pass some bills preventing a no-deal Brexit and seeking a delay. However, even those don’t look certain to pass. Just this morning, Governor Carney said that a no-deal Brexit would not, in fact, be the catastrophe that had been earlier forecast as many companies have made appropriate plans to handle it. While the underlying thesis in the market continues to be that there will be a deal of some sort, it feels like the probability of a hard Brexit is growing somewhat. Certainly, the pound’s recent performance would indicate that is the case. This morning it is down a further 0.3% which takes the move to -1.75% in the past week.

One last central bank story is that of Canada, where the economy is also slowing much more rapidly than the central bank had believed just a few weeks ago. Last week we learned that inflation is lower than expected, just 1.4%, and that GDP grew only 0.1% in Q4, actually falling -0.1% in December. This is not a data set that inspires optimism for the central bank to continue raising rates. Rather, it should become clear that the BOC will remain on hold, and more importantly likely change its hawkish slant to neutral at least, if not actually dovish. As to the Loonie, it is lower by 0.3% this morning and 2.0% since the GDP release on Friday.

Add it all up and you have a story that explains global growth is slowing down further. It is quite possible that monetary policy has been pushed to its effective limit with any marginal additional ease likely to have a very limited impact on the economy. If this is the case, it portends far more difficulty in markets ahead, with one of the most likely outcomes a significant increase in volatility. If the global economy is now immune to the effects of monetary policy anesthesia, be prepared for a few more fireworks. It remains to be seen if this is the case, but there are certainly some indications things are playing out that way. And if central banks do lose control, I would not want to have a significant equity market position as markets around the world are certain to suffer. Food for thought.

This morning we get one piece of data, Trade Balance (exp -$57.9B) and we hear from two more Fed speakers, Williams and Mester. Then at 2:00 the Fed’s Beige Book is released. It seems unlikely that either speaker will lean hawkish, even Mester who is perhaps the most hawkish on the FOMC. Comments earlier this week from other speakers, Rosengren and Kaplan, highlighted the idea of patience in their policy judgements as well as potential concern over things like the extraordinary expansion of corporate debt in this cycle, and how in the event the economy slows, many more companies are likely to be vulnerable. While fear is not rampant, equity markets have been unable to rally the past several sessions which, perhaps, indicates that fear is beginning to grow. And when fear is in vogue, the dollar (and the yen) are the currencies to hold.

Good luck
Adf