Hopes are now Dashed

Psephologists took a great hit
Their forecasts turned out to be sh*t
The blue wave has crashed
And hopes are now dashed
For Congress, more cash to commit

An astrologer, and economist and a psephologist walk into a bar
“What’s it going to be?” asks the barkeep.
“We have no idea,” they reply

While the final results of the Presidential race are not yet in, nor seem likely to be known before Friday at the earliest, what has become clear is that the Republican party is very likely to retain control of the Senate, no matter what, and that the Democratic majority in the House of Representatives has shrunk.  In other words, the idea of the blue wave, where the Democrats would not merely win the presidency, but retake the Senate and expand their control of the House has been crushed.  And with that outcome, the reflation trade that had gained so many adherents of late, is being quickly unwound.

Thus, the election results have spawned both a bull flattening of the yield curve, with 10-year yields currently lower by 11.5 basis points, while 30-year yields are 13 basis points lower and a dollar rebound, especially against most emerging market currencies.  It had seemed odd yesterday to see such significant market movement ahead of the results of what many expected to be a close, and possibly contested, election.  But clearly, there was a significant amount of enthusiasm for that mythical blue wave.

Until the Presidential results are declared, it will be extremely difficult to focus on US economic issues, as in fairness, given the diametrically opposed platforms of the two candidates, we can only surmise a future path once we know who wins.  As such, I expect the two stories that will dominate for the rest of the week will be the election results and the ongoing covid inspired lockdowns throughout Europe.

As this is not a political discussion, let us turn to the other major storyline.  As of today, it appears that Germany, France, Italy and the UK are all imposing significant restrictions on most, if not all, of their citizens for the entire month of November.  Given the rapid spread of the virus in this wave, Europe reported another 239K new cases yesterday, it is understandable that governments feel the need to act.  However, the balance between trying to maintain economic activity and trying to avoid spending so much money on healthcare save citizens’ lives is a difficult one to maintain.  After all, the EU has very strict guidelines as to what type of budget deficits its members can run, and at this point, every member is over the limit.  It is this reason that Madame Lagarde has been so clear that the ECB can, and will, do more to support the economy.  If they don’t, things will get ugly very quickly.  It is also this reason that leads me to believe the euro has limited upside for the foreseeable future.  Whatever is happening in the US, the situation in Europe is not one that inspires confidence.

Thus, let’s look at how markets are responding to the incomplete election results and the increase in Covid infections.  Equities in Asia had a mixed session, with the Nikkei (+1.7%) performing well while the Hang Seng (-0.2%) suffered on the back of the Ant Financial story.  (This story revolves around the expected IPO of the Chinese company, which was forecast to be the largest of the year, but which the Chinese government squashed.)  Shanghai equities were little changed on the session, up just 0.2%.  Europe, however, has seen early gains evaporate and at this point could best be characterized as mixed.  The DAX (-0.1%) is the laggard, while the CAC and FTSE 100 (+0.2% each) are marginally higher.  However, Spain’s IBEX (-1.1%) is feeling the pain of the lockdowns, as is Italy’s MIB (-0.25%).  US futures are quite interesting at this point, with DOW futures actually lower by 0.1%, while NASDAQ futures are 2.0% higher.  And NASDAQ futures were as much as 4.5% higher earlier in the session.  It seems that the status quo in US politics is deemed a positive for the Tech mega caps, while the cyclical companies are expected to have a much tougher time.  As well, if President Trump wins, there will be no expectation of significant tax hikes, something that would have been a virtual certainty with a President Biden.

As discussed above, Treasuries are rallying fiercely.  But we are seeing rallies throughout Europe as well, with Gilt yields leading the way, having fallen by 4.3 bps, but most of the continent looking at 2bp declines.  This appears to be either position unwinding or a renewed enthusiasm that the ECB is going to step up in a massive way next month.  Recall, yesterday, bonds fell everywhere, so a rebound is not that surprising, especially for those who were selling based on the moves in the US.  However, I suspect that given the newest lockdown announcements, investors have become increasingly convinced that the ECB is going to get perilously close to the idea of direct funding of government deficits, something that is verboten within the rules, but something that is desperately needed by the likes of Italy, Spain and Greece.

As to the dollar, yesterday’s sharp decline was puzzling for the same reason the bond market sell-off was puzzling, and so, this morning’s rebound makes perfect sense.  While earlier in the session, the dollar had seen much sharper gains, at this hour (6:52am), those gains are fairly modest.  AUD (-0.4%) is the worst G10 performer, followed closely by GBP (-0.35%) and NZD (-0.35%).  Meanwhile, both haven currencies, CHF and JPY have climbed back to unchanged on the day from earlier session losses.  With the election news still roiling markets, it is nonsensical to try to attribute these moves to anything other than position moves.

EMG currencies are also under pressure virtually across the board, and like the G10, the early declines, which in some cases were quite substantial have abated.  For instance, MXN (-4.1% last night, -1.0% now) showed the most volatility, but CNY (-1.0% last night, unchanged now) also saw substantial movement.  Again, to attribute this, or any currency movement, to anything other than position adjustment in the wake of the US election results would be a mistake.

As to the data today, the Services PMI data was released throughout Europe and was pretty much as expected.  ISM Services (exp 57.5) is out at 10:00 and expected to continue to show surprising growth.  Before that, we see the Trade Balance (exp -$63.9B), but trade policy is just not of interest these days.

Rather, the market will remain enthralled with the election results, which as I type remain decidedly unclear.  Either candidate could win the key remaining states of Pennsylvania, Michigan and Georgia, although all three are trending Trump right now.

In the end, the election result will matter because it will inform policy ideas.  If we remain status quo ante, the dollar likely has further to rise.  If Mr Biden emerges victorious, the dollar could certainly cede its recent gains, but no collapse is in sight.

Good luck and stay safe
Adf

Votes in the States

The second wave’s not the infection
Nor, either, is it the election
Instead, central banks
Will fire more blanks
As each makes a massive injection

But meantime, the world now awaits
The outcome from votes in the States
Most polls point toward Blue
Which many construe
As time to add risk to their plates

Election day has finally arrived, and the market is positively giddy over the prospects, or at least so it seems.  Equity markets worldwide are rising dramatically, haven assets are selling off, so Treasuries and bunds have fallen, and the dollar is under pressure versus every currency except the Turkish lira.  Most polls continue to point to a Biden victory, although there are several, interestsingly those that predicted Trump’s victory four years ago, calling for him to be reelected.  It is interesting that risk is being acquired so aggressively at this time given a key part of the narrative has been the relatively high probability of a contested election with no winner declared for weeks, if not longer driving major uncertainty in markets.  In addition, several big cities have been taking precautions against anticipated violence and rioting, with storefronts being boarded up and additional police called to duty.  Again, that hardly seems like a signal to be adding risk, but then this is the 2020’s, when everything you thought you knew turns out to have been wrong.

I guess the real question is, can the risk rally be sustained?  Well, if central banks have anything to say on the subject, and clearly they will try, the answer is a qualified yes.  Qualified because the longevity of the rally is still subject to debate.

While we all know that both the Fed and Bank of England will be meeting on Thursday, last night we got our first central bank meeting of the week, when the RBA convened Down Under.  As was widely expected, they cut their Cash Rate Target to 0.10% and they lowered the yield target on 3-year government bonds to 0.10% (that is their yield curve control program) but they also surprised the market by expanding their QE by A$100 billion.  This last is in addition to their unlimited purchases to maintain the 3-year rate at 0.10%.  The market response was quite positive, but it’s not clear whether that would have happened regardless, or whether it was dependent on the RBA’s actions.  But whatever the case, the ASX 200 rose 1.9% and AUD rose more than a penny and is higher by 0.9% at this hour.

But what of the rest of the world?  Why is risk being gobbled up so aggressively today?  For instance, despite a complete lack of new data from Europe, we are seeing broad-based strength in Continental equity markets.  The DAX (+1.75%), the CAC (+2.0%) and the FTSE 100 (+1.65%) are all firmly in the green, as are every other Eurozone market.  Perhaps they are continuing to react to last week’s ECB meeting where Madame Lagarde promised to “recalibrate” ECB policy in order to do more.  In other words, the creativity of central bankers will be on full display.  Consider, right now, all they can do is print money and buy bonds.  Perhaps they will start to buy other assets (equities anyone?), or perhaps, the frequently discussed digital euro will be announced, with every Eurozone citizen eligible to open an account at the central bank that will be replenished with cash funds regularly.  Or is it simply the European asset management crowd voting that if the polls are correct, the economy will recover quickly?  While there is no obvious catalyst, market sentiment has turned quite positive this week, especially after last week’s doom and gloom.

But it’s not just Europe.  We saw strength in Asia (Nikkei +1.4%, Hang Seng +2.0%, Shanghai +1.4%) and US futures are rocking as well with DOW (+1.5%) leading the way, though both the SPX (+1.2%) and NASDAQ (+0.75%) remain firmly positive.  Again, other than the RBA news, there was nothing out of Asia, and of course it is far too early to have anything from the US.  In fairness, yesterday did see a blowout ISM number 59.3 vs. 56.0 expected, so the data in the US continues to be impressive.  But it beggars belief that equities are rallying today based on that information.  In the end, it remains all about the election.

One thing that we have seen really build up lately is the view that the US yield curve is going to steepen dramatically.  That is evident in the record short position in long bond futures in Chicago (>260K), as well as the massive outflows the from ETF’s TLT and LQD, the biggest government bond and IG corporate bond ETF’s respectively.  The view seems to be that regardless of who wins the election, the US is going to see higher interest rates in the back end as the massive amount of Treasury issuance that will be required to fund the growing budget deficit will overwhelm the market.  And that makes perfect sense.  Of course, making sense and making money are two very different things.  If the market is excessively skewed in one direction in anticipation of an event, it is the very definition of the ‘buy the rumor, sell the news’ set-up that happens time and again.  My take here is that while a year from now, we may well see much higher Treasury yields in the 30-year, that will not be the first move once the election is over.  Not only will the Fed have something to say on the subject, but positions will get stale and unwound, and we could easily see a significant Treasury rally, especially if the economy falters.

One last thing to mention is the oil market, which saw a massive rebound yesterday on the story that the OPEC+ production cuts are likely to remain in place, rather than their expected ending.  In the end, oil prices remain a function of supply and demand, and any economic growth, for now, will still require oil.  The future may well be renewables, but in this case, the future is quite a few years away.

But that is really the story heading into the election.  It is surprising to me that we have seen as much movement as we have this morning, but since election results won’t be released until 7:00pm Eastern time, today is no different than yesterday in terms of new information.  I sincerely doubt that Factory Orders (exp 1.0%) are going to change any views, and given the Fed meeting Thursday, we still have silence from the FOMC.  While I would not fight the tape today, I still do not see the appeal of a short dollar position for the medium term.

Good luck and stay safe
Adf

Boris Has Gotten His Way

The EU will change what they say
To get a deal with the UK
They’ll now make believe
(The Brits, to deceive)
That Boris has gotten his way

The other thing that’s worth your note
Is guesstimates of next month’s vote
Investors are betting
A Blue Wave is heading
Our way, so bond prices they smote

This morning brings a little more clarity on one issue, and a little more hope on another, with both of these discussions driving market prices.

The hope stems from comments by the EU’s chief Brexit negotiator, Michel Barnier, who finally admitted that both sides will need to make compromises in order for a deal to be reached in time to prevent a hard Brexit.  While that may seem obvious to an outsider, we don’t have the benefit of the conceit that forms the EU negotiating stance. Interestingly, it seems the new ‘secret sauce’ for the EU is to make believe that Boris is getting his way in the negotiations for his home audience, while not actually ceding any ground.  Of course, what’s a bit odd about this tactic is their willingness, nay eagerness, to publicize the concept.  After all, this seems better left unsaid, to help perpetuate the story.  If the British people read about this, they may question the value of any concessions and demand more.  Of course, I am no politician, so would never presume to claim I understand the political machinations required to achieve a deal this complex with so many different constituencies to satisfy.

Nonetheless, today’s price action clearly demonstrates that, despite already crowded long GBP positions in the trading and investor community, there is further appetite for pounds on the assumption that a Brexit deal will give the currency an immediate boost.  As such, cable is leading the G10 higher versus the dollar with a 0.8% rally and taking the pound back to its highest level in more than a month.  what is even more surprising about the cable move is the fact that yet another BOE member, Gertjan Vlieghe, was on the tape discussing the need for further stimulus and the fact that negative rates are very much on the table.  You may recall yesterday when the RBA made the same comments, the Aussie dollar fell.  But today, those comments are insignificant compared to the renewed hope for a Brexit deal.  My final thought here is for hedgers to beware this movement.  The pound’s rally ahead of any deal implies that a ‘sell the news’ event is increasingly likely.  Regardless of the Brexit outcome, I believe the next leg in cable is lower.

On to the clarity, which has seen the US yield curve, and in fairness most major curves, steepen further with 10-year Treasuries now yielding 0.80% and 30-year Treasuries up to 1.61%.  According to pretty much everyone, the new narrative is as follows: the polls show not merely a Biden victory in the presidential election, but that the Democrats will be retaking the Senate as well.  This means that not only will there be a much larger pandemic stimulus response, but that spending will be much higher across the board, with much larger budget deficits, significantly more Treasury issuance and inflationary expectations increasing accordingly.  The outcome will be a much steeper yield curve, as the Fed is able to maintain control of the front end, between QE and forward guidance but will have much more difficulty controlling the back end of the curve.  In fact, I have consistently read that curve steepeners are now the most crowded trade out there.  Of course, the most common market reaction to an overcrowded trade is to go the other way, at least in the short run, but given the assumptions, the logic behind the trade seems sound.

Of course, the key is that the assumptions are accurate.  Any outcome other than a Blue Wave will arguably not result in the same type of government spending, Treasury issuance and subsequent inflationary outcomes.  So, while there does not appear to be a clear idea of what will happen to the dollar given potential election outcomes, there is certainly a strong view as to what will occur in the bond market.  We should know more in two weeks’ time.

Meanwhile, today is difficult to characterize in terms of risk appetite.  Equity markets, bond markets and FX markets seem to each be dancing to their own tune, rather than listening to the same music.  For instance, Asian equity markets were modestly positive in general (Nikkei +0.3%, Hang Seng +0.75%, Shanghai -0.1%) but European bourses are all in the red (DAX -0.65%, CAC -0.8%, FTSE 100 -1.05%).  US futures have managed to unwind earlier losses but are generally unchanged on the day.  Yesterday’s deadline, as set by Speaker Pelosi, apparently was as hard as Boris’s Brexit negotiating deadline of last Thursday.  But in the end, I would say there is more risk aversion than risk accumulation here.

The bond market, as discussed above, is under more pressure this morning, with today’s 1.7 basis point rise in yields taking the week’s movement to a 6.0 basis point gain since Monday morning.  Europe is seeing generally higher yields as well, although German bunds are little changed.  UK gilts have seen yields rise 2.5bps and Italy (+2.5bps) and Greece (+6.5bps) especially, are seeing movement.  But the point is, bonds selling off are more consistent with risk-on than risk-off.  So, as stocks and bonds are both selling off today, I wonder what people are buying!

As to the dollar, it is broadly lower, with the pound in the lead, but strong gains by NOK (+0.75%), NZD (+0.75%) and JPY (+0.6%).  One might assume that oil is rallying given the move in NOK, but that is not the case, as WTI is lower by 1.7% this morning.  Once again, there is no obvious catalyst for this movement as there have been neither data nor comments regarding the krone.  One thing to keep in mind is that NOK has been the worst performing G10 currency vs. the dollar this year, so unwinding of medium-term positions, especially if there are concerns over a dollar “collapse” is certainly realistic.  As to kiwi, it is possible that modestly higher bond yields there has encouraged some buying, but the movement appears to largely be an unwinding of yesterday’s sharp decline.  Finally, the yen’s strength is in keeping with equity market activity, but at odds with bonds.  Comments from BOJ member Sakurai indicated no rush to add additional monetary stimulus in response to the resurgence in Covid infections, so perhaps that is helping underpin the currency.

Interestingly, EMG currencies have seen less movement than their G10 counterparts, with the biggest gainer KRW (+0.7%) and the rest of the bloc generally rising in the 0.3% range.  Here, at least, there is a cogent explanation, as early export data showed a 5.9% rise in October compared to a 9.8% decline in September.  While the Y/Y data were still weak (-5.8%) that was more a function of the number of days in the period than actual performance.

On the data front, the only thing released in the US today is the Fed’s Beige Book at 2:00pm.  But, six more Fed speakers are on tap for the day, starting with Cleveland’s Loretta Mester at 10:00 this morning.  A broad summary of recent comments would indicate that virtually every FOMC member is willing to implement further monetary stimulus, but all are begging for a fiscal package to really help the economy.  Who knows, maybe today is the day that Mnuchin and Pelosi agree to one.

As the dollar has broken some key technical levels, there is room for a bit more of a decline.  But I wouldn’t be looking for a collapse.  Hedgers, take advantage of these levels.

Good luck and stay safe
Adf

Deeper Downturn

There once was a virus that spread
Worldwide, leaving too many dead
Its summer vacation
Has led to frustration
That governments, people, misled

Now lockdowns have made a return
From London to Paris to Bern
And ECB voices
All highlight the choices
More QE or deeper downturn

As another week draws to a close, market activity has been relatively muted.  It seems that participants are biding their time waiting for an outcome on at least one of the big current stories.  Will Brexit talks continue and be successful or will Boris decide there is no chance and simply prepare for a no-deal outcome?  Will the second wave of Covid infections running rampant in Europe slow down, or will this wave be even larger than the first with a bigger negative impact on the economy?  And finally, what is going to happen in the US presidential election?

And let’s face it, those are three really big questions with no clear answers at this time.  But let’s quickly try to address them in order and see if we can discern potential market responses.

Brexit – we have already passed the deadline Boris had originally issued for a deal, although he has since recanted and said if the EU demonstrates they are interested in “intensifying” the talks, the UK will work even harder to reach a deal.  Unfortunately, the indications from the EU are less promising as French President Macron remains adamant that French fishing vessels have unfettered access to UK waters in any deal.  While there are signs the rest of Europe are annoyed with Macron over this stance, his unwillingness to compromise, as of yet, means there has been no movement.  The other sticking point, the level of UK state aid to its companies, seems much more tractable to solve. However, right now, no deal is in sight.

Trying to game out the market impact of this binary outcome is dependent on an estimate of what is currently priced into the market.  Several indicators, including CFTC positioning and some proprietary bank positioning indicators, show that the market remains net long Sterling.  As the pound appears overvalued at current levels, it seems the likelihood of a large rally in the event of a positive outcome is quite limited.  Rather, the future for the pound is likely lower.  In the event of a no-deal Brexit, a move toward 1.20 is quite realistic by year end.  Whereas, a positive outcome is more likely to see just a moderate, ‘sell the news’ response, perhaps back toward 1.25-1.28.

The second wave of infections is clearly a growing problem.  More localized lockdowns are being imposed in Germany, the Netherlands and Spain with talk of more coming in Italy and throughout Eastern Europe.  This is in addition to the curfew in Paris which is equally problematic.  Not surprisingly, ECB members have been vocal about the need and ability of the central bank to do even more, implying that the PEPP is going to get quite a boost by December.  Once again, I will highlight that the Fed has made it quite clear they have limited ability to do anything else, although they will certainly try, which means that on a relative basis, other countries are going to ease their monetary policy further.  In this case, that bodes ill for the future direction of the euro, which I think has every possibility of drifting back to 1.15 in the short run and 1.10 over time, ceteris paribus.

But the big ceteris is the US presidential election.  The polls point to a Biden victory, although I’m sure nobody has forgotten that the same polls pointed to a Clinton victory four years ago.  Betting markets are also leaning that way, although with far less confidence.  As to the market, based on my readings, it appears that a large majority of market participants agree with the polls and have positioned accordingly.  Remember, too, that control of Congress is a crucial point in anticipating any potential market movement.  So here goes:

Blue wave – Biden wins and Democrats retake Senate:  given the platform of much higher capital gains and corporate taxes and massive spending, equity markets seem likely to fall sharply this year as investors take profits at current tax rates, and the dollar to fall alongside them.  I would want to own gold in this scenario.

Biden win with Republican Senate:  much less impact as divided government gets less done.  Arguably, we will fund the budget on continuing resolutions for four years, rather than any big new programs getting enacted.  The market response here is likely to be far more benign, with range trading rather than steep trends.

Trump win with Democratic House:  No change to current situation means further efforts at tax cuts and deregulation, but unlikely to see tax hikes.  The US has the chance to be the cleanest shirt in the dirty laundry basket and draw in more investment and prop up dollar strength.

Trump win and Republican House (admittedly low probability):  dollar strength as US continues to focus on as much economic growth as possible, with more stimulus and more tax cuts.

At this point, all these questions remain open, but by New Year’s Eve, we will have answered at least two of the three for sure.

As to markets today, there is really very little to tell.  Equities in Asia were mixed (Nikkei -0.4%, Hang Seng +0.9%) but are performing well in Europe (DAX +1.1%, CAC +1.8%) as the ECB comments seem to have investors believing more stimulus is on its way.  US futures have edged higher in the past hour, but are still only pointing to gains of 0.2% or so.

Interestingly, bond markets are rallying with yields continuing their recent downtrend.  Treasury yields are lower by 1bp after having backed up a few yesterday afternoon.  European markets are seeing roughly 2 basis point declines across the board.  In fact, bunds are back at their lowest level (-0.635%) since the panic of late March when Covid first struck Europe.  Bonds there are certainly pricing in a slowing economy in the Eurozone.

Finally, the dollar is mixed.  Against its G10 counterparts, it is +/-0.2% with the Brexit story by far the most impactful.  GBP (-0.2% as I write) was higher by 0.3% just minutes ago, as it wiggles on each headline.  But the bloc is generally uninteresting.  As to emerging markets, it is largely the same story, with a pretty even mix of gainers and losers.  Here, though, the movement has been a bit larger with ZAR (+0.5%) the best performer, perhaps on strength in the metals markets, followed by CNY (+0.4%) where everyone is looking for strong GDP numbers on Monday.  On the downside, KRW (-0.4%) is bottom of the barrel today after a higher than expected Unemployment rate was reported.

Data this morning brings Retail Sales (exp 0.8%, 0.4% ex autos), IP (0.5%), Capacity Utilization (71.8%) and Michigan Sentiment (80.5).  Yesterday’s Initial Claims data was quite disappointingly high and bodes ill for the growth story here.  But in the end, the ongoing uncertainty and confusion over the three issues raised above imply a lack of direction in the near term, although choppiness could well be on the menu.

Good luck, good weekend and stay safe
Adf