Ephemeral

Inflation remains
Ephemeral in Japan
Will Suga as well?

Leadership in Japan remains a fraught situation as highlighted this week.  First, three by-elections were held over the weekend and the governing LDP lost all three convincingly.  PM Yoshihide Suga is looking more and more like the prototypical Japanese PM, a one-year caretaker of the seat.  Previous PM, Shinzo Abe, was the exception in Japanese politics, getting elected and reelected several times and overseeing the country for more than 8 years.  But, since 2000, Suga-san is the 9th PM (counting Abe as 1 despite the fact he held office at two different times).  In fact, if you remove Abe-san from the equation, the average tenor of a Japanese PM is roughly 1 year.  Running a large country is a very difficult job, and in the first year, most leaders are barely beginning to understand all the issues, let alone trying to address whichever they deem important.  In Japan, not unlike Italy, the rapid turnover has left the nation in a less favorable position than ought to have been the case.

Of course, long tenure is no guarantee of success in a leadership role, just ask BOJ Governor Haruhiko Kuroda.  He was appointed to the role in February 2013 and has been a strong proponent of ultra-easy monetary policy as a means to stoke inflation in Japan.  The stated target is 2.0%, and for the past 8 years, the BOJ has not even come close except for the period from March 2013-March 2014 when a large hike in the Goods and Services Tax raised prices on everyday items and saw measured inflation peak at 3.7% in August.  Alas for Kuroda-san, once the base effects of the tax hike disappeared, the underlying lack of inflationary impulse reasserted itself and in the wake of the Covid-19 pandemic lockdowns, CPI currently sits at -0.2%.

Last night, the BOJ met and left policy on hold, as expected, but released its latest economic and inflation forecasts, including the first look at their views for 2023.  Despite rapidly rising commodity prices as well as a slightly upgraded GDP growth forecast, the BOJ projects that even by 2023, CPI will only rise to 1.0%.  Thus, a decade of monetary policy largesse in Japan will have singularly failed to achieve the only target of concern, CPI at 2.0%.

Personally, I think the people of Japan should be thankful that the BOJ remains unsuccessful in this effort as the value of their savings remains intact despite ZIRP having been in place since, essentially, 1999.  While they may not be earning much interest, at least their purchasing power remains available.  But the current central bank zeitgeist is that 2.0% inflation is the holy grail and that designing monetary policy to achieve that end is the essence of the job.  The remarkable thing about this mindset is that every nation has a completely different underlying situation with respect to its demographics, debt load, fiscal accounts and growth capabilities, which argues that perhaps the one size fits all approach of 2.0% CPI may not be universally appropriate.

In the end, though, 2.0% is the only number that matters to a central banker, and for now, virtually everyone worldwide is trying to design their policy to achieve it.  As I have repeatedly discussed previously, here at home I expect that soon enough, Chairman Powell and friends will find themselves having to dampen inflation to achieve their goal, but for now, pretty much every G10 central bank remains all-in on their attempts to push price increases higher.  That means that ZIRP, NIRP and QE will not be ending anytime soon.  Do not believe the tapering talk here in the US, the Fed is extremely unlikely to consider it until late next year, I believe, at the earliest.

Delving into Japanese monetary policy seemed appropriate as central banks are this week’s story line and we await the FOMC outcome tomorrow afternoon.  In addition to the BOJ, early this morning Sweden’s Riksbank also met and left policy unchanged with their base rate at 0.0% and maintained its QE program of purchasing a total of SEK 700 billion to help keep liquidity flowing into the market.  But there, too, the inflation target of 2.0% is not expected to be achieved until 2024 now, a year later than previous views, and there is no expectation that interest rates will be raised until then.

What have these latest policy statements done for markets?  Not very much.  Overall, risk appetite is modestly under pressure this morning as Japan’s Nikkei (-0.5%) was the worst performer in Asia with both the Hang Seng and Shanghai indices essentially unchanged on the day.  I would not ascribe the Nikkei’s weakness to the BOJ, but rather to the general tone of malaise in today’s markets.  European equity markets have also been underwhelming with red numbers across the board (DAX -0.35%, CAC -0.2%, FTSE 100 -0.2%) albeit not excessively so.  Here, too, apathy seems the best explanation, although one can’t help but be impressed with the fact that yet another bank, this time UBS, reported significant losses ($774M) due to their relationship with Archegos.  As to US futures, their current miniscule gains of 0.1% really don’t offer much information.

Bond prices are also under very modest pressure with 10-year Treasury yields higher by 1.1bps and most of Europe’s sovereign market seeing yield rises of between 0.5bps and 1.0bps.  In other words, activity remains light as investors and traders await the word of god Powell tomorrow.

Commodity prices, on the other hand, are not waiting for anything as they continue to march higher across the board.  Oil (+0.8%) is leading the energy space higher, while copper (+1.1%) is leading the base metals space higher.  Gold and silver have also edged slightly higher, although they continue to lag the pace of the overall commodity rally.

The dollar, which had been uniformly higher earlier this morning is now a bit more mixed, although regardless of the direction of the move, the magnitude has been fairly small.  In the G10 space, the leading decliner is AUD (-0.2%) which is happening despite the commodity rally, although it is well off its lows for the session.  That said, it is difficult to get too excited about any currency movement of such modest magnitude.  Away from Aussie, JPY (-0.2%) is also a touch softer and the rest of the G10 is +/- 0.1% changed from yesterday’s closing levels, tantamount to unchanged.

EMG currencies have seen a bit more movement, but only TRY (+0.75%) is showing a substantial change from yesterday.  it seems that there is a growing belief that the tension between the US and Turkey regarding the Armenian genocide announcement by the Biden administration seems to be ebbing as Turkish President Erdogan refrained from escalating things.  This has encouraged traders to believe that the impact will be small and return their focus to the highest real yields around.  But away from the lira, gainers remain modest (KRW +0.25%, TWD +0.2%) with both of these currencies benefitting from equity inflows.  On the downside, ZAR (-0.35%) is the laggard as despite commodity price strength, focus seems to be shifting to the broader economic problems in the nation, especially with regard to a lack of power generation capacity.

Data this morning brings Case Shiller Home Prices (exp 11.8%) and Consumer Confidence (113.0), neither of which is likely to have a big impact although the Case Shiller number certainly calls into question the concept of low inflation. With the FOMC tomorrow, there are no Fed speakers today, so I anticipate a relatively dull session.  Treasury yields continue to be the underlying driver for the dollar in my view, so keep your eyes there.

Good luck and stay safe
Adf

His New Paradigm

No longer will we
Buy stocks every month.  Instead
We will surprise you

Last night, the final major central bank meeting of the week was held, and in it the BOJ announced the results of its policy review.  The two most notable features of this review were the scrapping of the annual ¥6 trillion target of equity ETF purchases, although they did explain that if they felt it necessary and conditions warranted, they could purchase up to ¥12 trillion, and a formalized range of the targeted yield in 10-year JGB’s at 0.25% either side of 0.00%.  As an addendum, they also indicated that any equity purchases going forward would be linked to the TOPIX Index, which tracks the entire first section of the Japanese stock market, rather than the Nikkei 225, which is far more concentrated.  Remember, one of the concerns registered by investors has been that the BOJ is not only the largest holder of JGB’s, but also the largest holder of Japanese equities in the country/world.  Regarding the JGB market, the market’s working assumption has been the acceptable trading range was +/- 0.20%, so this is a bit wider despite Kuroda-san’s insistence that nothing had changed.

In what cannot be a terribly surprising outcome, the Nikkei 225 fell on the news, -1.4%, although the TOPIX actually edged higher by 0.2%.  I guess when the biggest, and least price sensitive, buyer shifts from one index to another, this outcome is to be expected.  As to the JGB market, pretty much nothing happened with yields rising a scant 0.5bps and well within the new formal range at +0.10%.  Finally, the yen is essentially unchanged on the day as well, although the dollar’s broad-based strength of the past several weeks has really helped the BOJ here as the yen has declined more than 5% year-to-date, something the BOJ had been singularly unable to engineer on its own.

The bond market wasted no time
In forcing a major yield climb
Responding to Jay
And all he did say
Defining his new paradigm

While Treasury yields have backed off a touch this morning, the damage has clearly been done by Chairman Powell.  His Wednesday press conference, where he doubled down on just how dovish he was going to remain regardless of the bond market’s performance, has set the stage for what will ultimately be his biggest test.  After all, as a policy response, it is not a great leap to dramatically cut interest rates in the face of a pandemic driven economic collapse. However, once a policymaker insists that they are unconcerned with inflation and they are going to allow the economy to “run hot” for a while, it is a MUCH harder problem to determine when too much movement has occurred and to rein in potential excesses that can prevent the ultimate goals from being reached.

It is this set of conditions in which we currently find ourselves and which will be the lead story for months to come.  If history is any guide, the bond market will continue to sell off, ostensibly on the back of stronger economic data, but in reality, as an ongoing test of Powell and the new Fed stance.  Jay was extremely clear on Wednesday that he was unconcerned with the movement in the bond market, describing financial conditions as very accommodative.  Starting next month, the inflation data is going to be rising much more rapidly as the comparison from 2020 will show much stronger price pressures on a Y/Y basis.  This is THE battle for the next six months, with all other markets destined to react to the outcome.

The two possible outcomes shape up as follows: the Fed will be forced to respond to rising yields as the pressure on the Treasury grows and financing costs increase too rapidly thus resulting in expanded QE, Operation Twist, or YCC; or Powell stays true to his word and allows 10-year yields to rise much higher (think 2.8%-3.0%) with a corresponding steepening in the yield curve which drives the equity bus over a cliff and forces a Fed response to a cratering stock market under the guise of tightening financial conditions that need to be addressed.  Through our FX lens, the first will result in the dollar topping out much sooner than the second, as it will cap real yields and ultimately send them farther into negative territory.  But in either case, it appears that the dollar has room to run for the time being.  It will be an epic battle and my money is on the market forcing the Fed to blink before they would like.

Now to today’s markets.  After yesterday’s tech led US sell-off, we already saw that Japanese stocks were under pressure, but there was weakness across the board in Asia (Hang Seng -1.4%, Shanghai -1.7%) and we are entirely red in Europe as well (DAX -0.4%, CAC -0.4%, FTSE 100 -0.6%).  US futures, on the other hand, are pointing higher at this hour, up between 0.2%-0.5%.  We shall see if that holds up.

Bonds have reversed some of yesterday’s declines (higher yields) with Treasuries 1 basis point lower and European sovereigns seeing larger yield declines (Bunds -3bps, OATs -3bps, Gilts -4.5bps).  However, if the Treasury market resumes its decline, I would expect European yields to track higher as well, albeit at a slower pace.

Oil prices got smoked yesterday, falling more than 10% at one point before closing down 7.5% on the day.  That puts this morning’s modest 0.6% rise into context.  It appears that the oil market had gotten a bit ahead of itself.  As to the rest of the commodity bloc, metals are generally lower this morning although most ags are firmer.

Finally, the dollar is beginning to edge higher as New York walks in, with SEK (-0.3%) and NOK (-0.25%) leading the way down, although the entire G10 bloc in negative territory.  As neither nation had new news, these moves appear to be simple follow-ons to the resuming dollar trend of modest strength.  The EMG space is a bit different, with several currencies faring well this morning, notably TRY (+1.15%) on continued buying after the surprising rate hike, and MXN (+0.65%) as traders start to bet on Banxico raising rates more aggressively, following in the footsteps of Brazil.  On the downside, KRW (-0.6%) essentially gave up yesterday’s gains on the broad risk-off sentiment in Asia, which also dragged TWD (-0.5%) lower.  After that, the bulk of the movement in this space has been modest, at best, in either direction.

There is no US data to be released today, and no Fed speakers either.  Rather, the big story in the market is the triple witching in equities (expiration of options, futures and futures options), which oftentimes has a significant market impact.  And meanwhile, all eyes will remain on the Treasury market, as it is currently the single most important signal available.

Good luck, good weekend and stay safe
Adf

Not On His Watch

Rumors were rampant
Kuroda would let yields rise
Oops! Not on his watch
 
Perhaps Chairman Powell should look east for clues on how to manage bond market expectations, as his efforts yesterday can only be termed a disaster.  However, Haruhiko Kuroda was quite successful in talking down the back end of the JGB curve, and the BOJ didn’t have to spend a single dime yen. 
 
Last night, Kuroda-san was speaking to parliament on a number of issues when he was asked, point blank, if the BOJ was considering widening the yield band on 10-year JGB’s.  He replied, “Personally, I believe it’s neither necessary nor appropriate to expand the band.  There’s no change in the importance of keeping the yield curve stable at a lower level.”  And just like that, JGB yields tumbled across the board with 10-year yields falling 5bps to 0.05%.  The genesis of the question came about as rumors have been constant that during the ongoing BOJ policy review, with conclusions set to be announced later this month, the BOJ would allow a wider band around their 10-year YCC target of 0.0% as a means of steepening the yield curve to help the banking sector.  But clearly, that is not on the cards, so whatever changes may be announced next month, it seems that portion of the current policy is remaining unchanged. The market response was immediate in bond markets, but also in FX as the yen quickly fell 0.5% and is now trading at its weakest level since last June.  Perhaps what is more interesting about the yen’s move is the trajectory of its declines, which are starting to go parabolic.  Beware a much weaker yen, with a short-term test of 110 seemingly on the cards.
 
Chair Jay tried quite hard to explain
That joblessness is still the bane
Of policy goals
Thus, rising payrolls
Are needed ere rates rise again
 
But what he said, and markets heard
Was different and that is what spurred
A bond market rout
And stock buying drought
While dollar buys were undeterred
 
Meanwhile, back at the ranch…Chairman Powell made his last comments yesterday before the quiet period begins ahead of the mid-March FOMC meeting.  In an interview he explained that the FOMC remains quite far from its goals of maximum employment and stable (2% inflation) prices and that they would not be altering policy until those goals are achieved.  However, he did not indicate that they would be expanding their current easy money stance, either by expanding QE or extending the tenor of purchases, and he remained sanguine when asked about the steepening of the yield curve, explaining that it was a positive sign of growth expectations.
 
Alas, it is not that simple for the Fed as they have put themselves in a very difficult position.  Financial conditions, while seemingly an amorphous term, actually has some precision.  The Chicago Fed has an index with 105 variables but Goldman Sachs has created a much simpler version with just 4 variables; riskless interest rates (10-year yields), equity valuations (S&P 500), Credit Spreads (CDX) and the exchange rate (DXY).  Directionally, conditions are tightening when yields rise, stocks fall, credit spreads widen and the dollar rises, which is exactly what is happening right now!  In fact, in the wake of the Powell comments, they all got tighter.  Now, I’m pretty sure that was not Powell’s intention, but nonetheless, it was the result. 
 
The problem Powell and the Fed have is that, like Pavlov’s dogs, markets begin to drool at the sound of a Powell speech in anticipation of further easy money to prop things up.  But the market has extended this concept to the back end of the curve, not just the front, and the Fed, unless they change policy, has far less control out there.  It was this setup that put the pressure on Powell to ease policy further, and when he did not change his tune, the market had a little fit. 
 
Now, remember, the Fed is in its quiet period for the next 12 days, 8 of which will see markets open and trading.  Markets have a history of testing the Fed when they want something, and the Fed’s reaction function, ever since Maestro Alan Greenspan was Fed Chair in 1987 during the Black Monday stock market rout, has been to flood the market with more liquidity when markets sell off.  With that in mind, I would not be surprised to see 10-year yields test 2.0% in the next two weeks as the market tries to force the Fed’s hand.  Be prepared for more volatility and tighter financial conditions as defined by the index I described above.
 
Which leads us to today’s market activity, where risk is clearly under some pressure ahead of the payroll report this morning.  In Asia, equities were broadly, but not deeply, lower (Nikkei -0.25%, Hang Seng -0.5%, Shanghai -0.1%) while in Europe, early losses every where have eased and the picture is now mixed (DAX -0.6%, CAC -0.3%, FTSE 100 +0.4%).  US futures, which had been in negative territory all evening have turned higher and are currently up by roughly 0.15%.
 
Bonds, however, are universally softer with yields rising everywhere (except JGB’s last night).  So, Bunds (+1.2bps), OATs (+1.5bps) and Gilts (+4.2bps) lead the yield parade higher with Treasuries currently unchanged, although this is after yesterday’s 8bp rout.  Australian ACGBs continue to sell off sharply with yields higher by another 6bps overnight which takes that move to 63bps in the past month.
 
On the commodity front, OPEC+ surprised markets yesterday by leaving production unchanged vs. an expectation that they would increase it by 1 million bpd, which resulted in a sharp rally in oil prices which has continued this morning.  WTI (+2.5%) is now above $65/bbl for the first time since October 2018.  Base metals have rallied as well while precious metals are still suffering from the higher real yields attached to higher nominal yields.
 
And finally, the dollar, which is higher vs. almost every one of its counterparts this morning, with only NOK (+0.2%) and RUB (+0.3%) benefitting from the oil rally enough to overcome the dollar’s yield effect.  But elsewhere in the G10, AUD (-0.7%) and NZD -0.75%) are leading the way lower with GBP (-0.55%) also under the gun.  Now, we are seeing yields rise in all these currencies, but a big part of this move is clearly position unwinding as the massive short dollar positions that have been evident since Q4 2020 are starting to feel more pressure and getting unwound.  The euro, too, is softer, -0.3%, which has taken it below its previous correction lows, and technically opens up a test of the 200-day moving average at 1.1825.
 
In the EMG bloc, the weakness is widespread with CE4 currencies leading the euro lower, LATAM currencies (CLP -0.65%, MXN -0.6%, BRL -0.25%) all under pressure and most APAC currencies having performed poorly overnight, including CNY (-0.3%) which fell despite the new Five Year plan forecasting GDP growth above 6.0% this year.
 
And finally, the data story where we have payrolls this morning:
 

Nonfarm Payrolls

198K

Private Payrolls

195K

Manufacturing Payrolls

15K

Unemployment Rate

6.3%

Participation Rate

61.4%

Average Hourly Earnings

0.2% (5.3% Y/Y)

Average Weekly Hours

34.9

Trade Balance

-$67.5B


Source: Bloomberg
 
The thing is, while this number usually means a lot, I think there is asymmetric risk attached today.  A weak number will not do anything, while a strong number could well see the next leg of the bond market rout and ensuing stock market weakness.  Traders, when they are in the mood to test the Fed, will jump on any excuse, and this would be a good one.
 
For right now, the dollar has the upper hand, and I see no reason for that to change until we hear something different from the Fed.  And that is two weeks away!
 
Good luck, good weekend and stay safe
Adf
 
 
 
 
 
 
 

Was It Ever?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Less Than Two Weeks

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

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

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

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

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

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

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

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

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

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

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

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

Prices Keep Falling

Suga-san’s ascent
Has not altered the landscape
Prices keep falling

The distance between stated economic goals and actual economic outcomes remains wide as the economic impact of the many pandemic inspired government ordered lockdowns continues to be felt around the world.  The latest example comes from Japan, where August’s CPI readings fell, as expected, to 0.2% Y/Y at the headline level while the ex-fresh food measure (the one the BOJ prefers) fell to -0.4%.  Although pundits in the US have become fond of ridiculing the Fed’s efforts at raising inflation to 2.0%, especially given their inability to do so since defining that level as stable prices in 2012, to see real ineptitude, one must turn east and look at the BOJ’s track record on inflation.  In the land of the rising sun, the favored measure of CPI ex-fresh food has averaged 0.5% for the last 35 years!  The point is the Fed is not the first, nor only, central bank to fail in its mission to generate inflation via monetary policy.

(As an aside, it is an entirely different argument to discuss the merits of seeking to drive inflation higher to begin with, as there is a strong case to be made that limited inflation is a necessary condition for economic success at the national level.)  But 2.0% inflation has become the global central banking mantra. And though the favored inflation measure across nations often differs, the one key similarity is that every G10 nation, as well as many in the emerging markets, has been unable to achieve their goal.  The few exceptions are those nations like Venezuela, Argentina and Turkey that have the opposite problem, soaring inflation and no ability to control that.

But back to Japan, where decades of futility on the inflation front have put paid to the idea that printing money is all that is needed to generate rising prices.  The missing ingredient for all central banks is that they need to pump money into places that result in lending and spending, not simply asset purchases, or those excess funds will simply sit on bank balance sheets with no impact.

Remember, GDP growth, in the long run, comes from a combination of population growth and productivity growth.  Japan has the misfortune, in this case, of being one of the few nations on earth where the population is actually shrinking.  It is also the oldest nation, meaning the average and median age is higher there than any other country on earth (except Monaco which really doesn’t matter in this context).  The point here is that as people age, they tend to consume less stuff, spending less money and therefore driving less growth in the economy.  It is these two factors that will prevent Japan from achieving a much higher rate of inflation until such time as the country’s demographics change.  A new Prime Minister will not solve this problem, regardless of what policies he supports and implements.

Keeping this in mind, the idea that Japan is far more likely to cope with ongoing deflation rather than rising inflation, if we turn our attention to how that impacts the Japanese yen, we quickly realize that the currency is likely to appreciate over time.  Dusting off your Finance 101 textbooks, you will see that inflation has the side effect of weakening a nation’s currency, which quickly feeds into driving further inflation.  Adding to this impact is if the nation runs a current account deficit, which is generally the case when inflation is high and rising.  Harking back to Argentina and Venezuela, this is exactly the behavior we see in those economies.  The flip side of that, though, is that deflation should lead to a nation’s currency appreciating.  This is especially so when that nation runs a current account surplus.  And of course, you cannot find a nation that fits that bill better than Japan (well maybe Switzerland).  The upshot of this is, further JPY appreciation seems to be an extremely likely outcome.  Therefore, as long as prices cease to rise in Japan, there will be upward pressure on the currency.  We have seen this for years, and there is no reason for it to stop now.

Of course, as I always remind everyone, FX is a relative game, so it matters a great deal what is happening in both nations on a relative basis.  And in this case, when comparing the US, where prices are rising and the current account has been in deficit for the past two decades, and Japan, where prices are falling and the current account has been in surplus for the past four decades, the outcome seems clear.  However, the market is already aware of that situation and so the current level of USDJPY reflects that information.  However, as we look ahead, either negative surprises in Japanese prices or positive surprises in the US are going to be important drivers in the FX market.  This is likely to be seen in interest rate spreads, which have narrowed significantly since March when the Fed cut rates aggressively but have stabilized lately.  If the Fed is, in fact, going to put forth the easiest monetary policy around, then a further narrowing of this spread is quite possible, if not likely, and further JPY appreciation will ultimately be the result.  This is what we have seen broadly since the middle of 2015, a steady trend lower in USDJPY, and there is no reason to believe that is going to change.

Whew!  That turned out to be more involved than I expected at the start.  So let me quickly survey the situation today.  Risk is under modest pressure generally, although there were several equity markets that put in a good performance overnight.  After a weak US session, Asia saw modest gains in most places (Nikkei +0.2%, Hang Seng +0.5%) although Shanghai (+2.1%) was quite strong.  European markets are far less convinced of the positives with the DAX (+0.4%) and CAC (-0.1%) not showing much movement, and some of the fringe markets (Spain -1.3%) having a bit more difficulty.  US futures are mixed, although the top performer is the NASDAQ (+0.4%).

Bond markets continue to trade in a tight range, as central bank purchases offset ongoing issuance by governments, and we are going to need some new news or policies to change this story.  Something like an increase in the ECB’s PEPP program, or the BOE increasing its purchases will be necessary to change this, as the Fed is already purchasing a huge amount of paper each month.

And finally, the rest of the FX market shows that the dollar is broadly, but not universally under pressure.  G10 activity shows that NZD (+0.4%) is the leader, although JPY (+0.3%) is having another good day, while NOK (-0.25%) is the laggard.  But as can be seen by the modest movements, and given the fact it is Friday, this is likely position adjustments rather than data driven.

In the EMG space, KRW (+1.2%) was the biggest gainer overnight, which was hard to explain based on outside influences.  The KOSPI rose 0.25%, hardly a huge rally, and interest rates were unchanged.  The best estimate here is that ongoing strength in China is seen as a distinct positive for the won, as South Korea remains highly dependent on the mainland for economic activity.  Beyond the won, though, while there were more gainers than losers, the size of movement was not that significant.

On the data front, speaking of the current account, we see the Q2 reading this morning (exp -$160.0B), as well as Leading Indicators (1.3%) and Michigan Sentiment (75.0).  We also hear from three Fed speakers (Bullard, Bostic and Kashkari) but having just heard from Powell on Wednesday, it seems unlikely they will give us any new information. Rather, today appears to be a consolidation day, with marginal movements as weak positions get unwound into the weekend.

Good luck, good weekend and stay safe
Adf

The Real Threat

Around the world, government’s fret
Is it safe to reopen yet?
As growth worldwide slows
Each government knows
Elections are now the real threat

The common theme in markets today, the one that is driving asset prices higher, is that we are beginning to see a number of countries, and in the US, states, schedule the easing of restrictions on activity. Notably, in Italy, the European epicenter of the virus, PM Conte is trying to reschedule the return to some sense of normality with the first relief to occur one week from today in the manufacturing and construction industries, followed by retailers two weeks later. Personal services and restaurants, alas, must wait until June 1 at the earliest. While that hardly seems like an aggressive schedule, the forces arrayed on both sides of the argument grow louder with each passing day, neither of which has been able to convince the other side. (This sounds like the Democrats and Republicans in Congress.) But the reality is, there is no true playbook as to the “right” way to do this as we still know remarkably little about the disease, and its true infectiousness. Of course, collapsing the global economy in fear is likely to result in just as many, if not more, victims.

But it’s not just Italy that is starting. In the US, Georgia is under close scrutiny as it begins easing restrictions as of today. New York’s Governor Cuomo is now talking about a phased in reopening of certain areas, mostly upstate NY, beginning on May 15. And the truth is that many states in the US are preparing to reopen sections of their respective economies. The same is true throughout Europe and Asia, as the rolling lockdowns globally have essentially inflicted as much pain as governments can tolerate.

Of course, the real question is, what exactly does it mean to reopen the economy? I think it is fair to say that the immediate future will not at all resemble the pre-virus situation. Even assuming that most personal financial situations were not completely disrupted (and they truly were), how many people are going to rush out to sit in a movie theater with 200 strangers? How many people are going to jump on an enclosed metal tube with recirculated air for a quick weekend getaway? In fact, how many are going to be willing to go out to their favorite restaurant, assuming it reopens? After all, you cannot eat dinner while wearing an N95 mask!

My point is, the upcoming recovery of this extraordinary economic disruption is likely to be very slow. In fact, history has shown that traumatic events of this nature (think the Depression in the 1930’s) result in significant behavioral changes, especially regarding personal financial habits. The virus has highlighted the fragility of many job situations. It has exposed just how many people worldwide live close to the edge with almost no ability to handle a situation that interrupts their employment cashflow. And these lessons are the type that stick. They will almost certainly result in reduced consumption and increased personal savings. And that is almost the exact opposite of what built the global economy since the end of WWII.

With this in mind, it strikes me that the dichotomy we continue to see in markets, where equity investors are remarkably bullish, while bond and commodity investors seem to be planning for a very long period of slow/negative growth, is going to ultimately be resolved in favor of the bond market. No matter how I consider the next several months, no scenario results in that fabled V-shaped recovery.

But perhaps I am just a doom monger who only sees the negatives. After all, a quick look at markets today shows that the bulls are ascendant. Equity markets around the world are firmer this morning as the combination of prospective reopening of economies and additional central bank stimulus have convinced investors that the worst is behind us. Last night, the BOJ, as widely expected, promised unlimited JGB buying going forward. In addition, they increased their corporate bond buying to ¥20 trillion, essentially following in the Fed’s footsteps from two weeks ago. If their goal was to prop up the stock market, then it worked as the Nikkei closed higher by 2.7% helping the rest of Asia (Hang Seng +1.9%, Australia +1.5%) as well. Europe took the baton, and with more policy ease expected from the ECB on Thursday, has seen markets rise between 1.4% (FTSE 100) and 2.4% (DAX). Meanwhile, the euphoria continues to seep westward as US futures are all higher by roughly 1% this morning.

Bond markets, too, are feeling a bit better with Treasuries and bunds both seeing yields edge higher, 2bp and 1bp respectively, while the risky bonds from the PIGS, all see yields fall sharply. Interestingly, commodity markets don’t seem to get the joke, as oil (-15.8%) is under significant pressure. Finally, the dollar is under pressure across the board, falling against all its G10 counterparts with AUD (+1.4%) leading the way on a combination of today’s positivity and some short-term positive technicals. Even NOK (+0.75%) is firmer today despite oil’s sharp decline, showing just how much the big picture is overwhelming market idiosyncrasies.

In EMG space, pretty much the entire bloc is firmer vs. the dollar with ZAR (+1.15%) and HUF (+0.85%) on top of the list. The rand seems to be the beneficiary of the idea that South Africa is set to receive $5 billion from the IMF and World Bank to help them cope with Covid-19 related disruptions. Meanwhile, the forint is seeing demand driven by expectations of the country easing its lockdown restrictions this week. One quick word about BRL, which has not opened as yet. Last week saw some spectacular movement with the real having fallen nearly 10% at its worst point early Friday afternoon as President Bolsonaro’s most important ally, Justice Minister Moro, resigned amid allegations that Bolsonaro was interfering with a corruption investigation into his own son. The central bank stepped in to stem the tide, and successfully pushed the real higher by nearly 3%, but the situation remains tenuous and as Bolsonaro’s popularity wanes, it seems like there is a lot of room for further declines.

On the data front this week, the first look at Q1 GDP will be closely scrutinized, as well as the FOMC meeting on Wednesday and Thursday’s Claims data.

Tuesday Case Shiller Home Prices 3.13%
  Consumer Confidence 87.9
Wednesday Q1 GDP -3.9%
  FOMC Rate Decision 0.00% – 0.25%
Thursday Initial Claims 3.5M
  Continuing Claims 19.0M
  Personal Income -1.6%
  Personal Spending -5.0%
  Core PCE -0.1% (1.6% Y/Y)
  Chicago PMI 38.2
Friday ISM Manufacturing 36.7
  ISM Prices Paid 28.9

Source: Bloomberg

Obviously, the data will be nothing like any of us have ever seen before, but the real question is just how much negativity is priced into the market. In addition, while the Fed is not expected to change any more policies, you cannot rule out something new to goose things further.

In the end, there is no economic evidence yet that the situation is improving anywhere in the world. And while measured cases of Covid-19 infections may be dropping in places, human behaviors are likely permanently altered. This crisis is not close to over, regardless of what the stock markets are trying to indicate. My money is on the bond market view that things are going to be very slow for a long time to come. And that implies the dollar is going to retain its bid as well.

Good luck and stay safe
Adf

Infinite Buying

Is infinite buying
Kuroda-san’s new mantra
If so, will it help?

An interesting lesson was learned, for those paying attention, yesterday after a headline hit the tape about the BOJ. The headline, BOJ Considering Unlimited JGB Purchases, had an immediate impact on the yen’s value, driving it lower by 0.7% in minutes. After all, logic dictates that a central bank that will buy all the government debt available will drive rates, no matter where they are, even lower, and that the currency would suffer on the back of the news. But, as is often the case, upon further reflection, the market realized that there was much less here than met the eye, and the yen recouped all those losses by early afternoon. In fact, over the past two sessions, the yen is essentially unchanged overall.

But why, you may ask, would that headline have been misleading. The key is to recognize that the BOJ’s current policy describes their QQE (Qualitative and Quantitative Easing) as targeting ¥80 trillion per year, equivalent in today’s market to approximately $740 billion. But they haven’t come close to achieving that target since 2017, actually only purchasing about ¥15 trillion last year. That’s a pretty big miss, but a year after they created that target, they began Yield-Curve Control (YCC), which states that 10-year JGB’s will be kept at around a 0.0% yield, +/-0.2%. Now, given that the BOJ already owns nearly 50% of all JGB’s outstanding, there is very little actual trading ongoing in the JGB market, so it doesn’t really move very much. The point is, the BOJ doesn’t need to buy many JGB’s to keep yields around 0.0%. However, they have been concerned over the optics of reducing that ¥80 trillion target, as reducing it might seem a signal that the BOJ was tightening policy. But now, in the wake of the Fed’s announcement that they will be executing unlimited QE, the BOJ has the perfect answer. They can get rid of a target that no longer means anything, while seeming to expand their program. At the same time, when pressed, they will point to their successful YCC and claim they are purchasing everything necessary to keep rates low. And in fairness, they will be right.

Next week it’s the central bank three
Who meet and they’ll try to agree
On proper next steps
(Increasing the PEPP?)
And printing cash like it was free

This was merely a prelude to what the next several days are going to hold, anticipation of the next central bank actions as the three major central banks, BOJ, Fed and ECB, all meet next week. At this point, we have already seen all the excitement regarding the BOJ, and as to the Fed, while they may well announce more details on their efforts to get funds flowing to SME’s, they are already at unlimited QE (and they are active, buying $75 billion/day) and so it seems unlikely that there will be anything else new to be learned.

The ECB, however, is the place where all the action is going to be. Remember, Madame Lagarde was a little slow off the mark, when back in March she stated that the ECB’s job was not to worry about spreads in the government bond market. Granted, within two weeks, after the market crushed Italian BTP’s and called into question Italy’s ability to fund its Covid-19 response, she realized that was, in fact, her only role. And so subsequently we got a €750 billion PEPP program that included Greek debt for the first time. But clearly, based on the recent PMI data, as well as things like this morning’s Ifo Expectations Survey (69.4 vs. exp 75.0), more is needed. So, speculation is now rampant that PEPP will be increased by €250 billion, and that the Capital Key will be explicitly scrapped. The latter is important because that is the driver of which nation’s debt they purchase and is based on the relative size of each economy. But the main problem is Italy, and so you can be sure that the ECB is going to wind up with a lot more Italian debt than would be allowed under the old rules.

Turning back to this week, though, we still have a whole day to traverse before the weekend arrives. Overall, markets are beginning to quiet down, with actual volatility a bit softer than we had seen recently. For example, though equity markets in Europe are lower, the declines are between 0.7% (FTSE 100) and 1.1% (Spain’s IBEX), with the CAC and DAX in between. If you recall, we were seeing daily movement on the order of 2%-5% not that long ago. The same was true overnight, with the Nikkei (-0.9%), Hang Seng (-0.6%) and Shanghai (-1.1%) all softer but by less dramatic amounts. As to US futures, while they were negative earlier, they are actually currently higher by about 0.5%, although we have a long way to go before the opening.

Bond markets are uninspiring, with Treasuries basically unchanged. European markets are a bit firmer (yields lower) across the board as investors try to anticipate the mooted increase in PEPP. And JGB’s are yielding -0.026%, right where the BOJ wants them.

The dollar this morning is now ever so slightly softer, with CAD actually the leading gainer up 0.2%, while the rest of the G10 is +/-0.1%. The Ifo data was the only release of note, although we have seen oil prices rebound slightly, currently higher by about 1.0% helping both CAD and NOK. In the EMG bloc, the story is a bit more mixed, although gainers have had a better day than losers. By that I mean, CZK (+1.35%), HUF (+1.1%) and RUB (+1.0%) have seen stronger gains than the worst performers (INR and KRW both -0.5%). As always, there are idiosyncratic drivers, with CZK seeming to benefit from word that lockdowns are about to ease, while HUF is gaining on the imminent beginning of QE purchases by the central bank. As to RUB, the combination of oil’s continuing rally off its worst levels earlier this week, and the Bank of Russia’s 50bp rate cut, to 5.50%, has investors looking for better times ahead. Ironically, that stronger oil seems to be weighing on the rupee, while the won fell as foreign equity selling dominated the market narrative.

Yesterday’s Claims data was pretty much as expected, granted that was 4.4M, still horrific, but the market absorbed the news easily. This morning brings Durable Goods (exp -12.0%, -6.5% ex transport) and then at 10:00 Michigan Sentiment (68.0). Not surprisingly, expectations are for some of the worst readings in history, but the way the market has been behaving, I think the risk is actually for a less negative data print and a sharp risk rally. Eventually, unless there really is a V-shaped recovery, I do see risk being shed, but it doesn’t seem like today is the day to get started.

Good luck, good weekend and stay safe
Adf

 

All the PIGS in Her Fief

Said Madame Lagarde, ‘Well I guess
Things really are in quite a mess’
And so up we’ll step
To introduce PEPP
As we try to deal with the stress

The market’s response was relief
That Europe’s new central bank chief
Has realized at last
The time is long past
To help all the PIGS in her fief

Another day, another bunch of new programs! First, though, a quick observation about the overall situation right now. There is no panic in the streets (after all the streets are mostly empty due to shelter-in-home and self-quarantining) but there is panic in… Washington DC, London, Bonn, Frankfurt, Paris, Madrid, etc. And that panic emanates from the fact that all those elected politicians are facing the biggest crisis of all…they might not get reelected because of Covid-19. I believe it is the belated realization that their jobs are on the line that has seen a significant acceleration in the number of new programs being proposed and introduced around the world.

Central banks, which had borne the brunt of the heavy lifting, are starting to get help from fiscal policy actions, but those central banks are still on the front lines. To wit, in an unprecedented intermeeting action, last night the ECB unveiled a new QE program called the Pandemic Emergency Purchase Program (PEPP) which will authorize the purchase of €750 billion of public and private assets for the rest of the year, or longer if deemed necessary. This time they are including Greek government bonds, which the ongoing QE program would not touch due to the credit rating, they are ignoring the capital key, which means they can purchase far more Italian debt than Italy’s share of the Eurozone economy would dictate, and they are expanding the corporate purchases to non-financial CP. And the market liked what they heard with European government bonds rallying sharply pushing 10-year benchmark yields down by 47bps in Portugal, 71bps in Italy, 167bps in Greece and 45bps in Spain. Equity markets in Europe have stopped collapsing, but we still see pressure in Germany and the UK, while the PIGS are all higher. One other thing about Germany was the release of the IFO Expectations Index which fell to 82.0, its lowest point since the financial crisis in 2008. Certainly short-term prospects seem dire there.

And what about the euro you may ask? Well, it continues to slide, down 1.0% this morning, but is actually about middle of the pack in the G10. If you want to see real carnage, look no further than Norway, where the krone has fallen another 2.75% as I type, but that is only after it had been lower by nearly 7.5% at 6:00 this morning, which forced a response from the Norgesbank that they would be intervening if things got worse. Looking over price action during the past month, when oil prices collapsed from $53.78 to as low as $20.06 (currently $22.88), which has been a 57% decline, the worst performing currencies have been; MXN (-23.8%), RUB (-21.2%), NOK (-19.7%) and COP (-17.3%). Two caveats on this list are Norway was down much further earlier this morning, and Colombia hasn’t opened yet today, so has room for a further decline. The only positive I can take from this is that the correlation between the currencies of oil producers and the price of oil remains intact. At least we know what to expect!

But there was plenty of other activity as well. For instance, the RBA cut rates again, by 25bps, taking their base rate to a historic low of 0.25%. In addition they have implemented their first QE plan where they are targeting the yield on 3-year AGB’s at 0.25%. The problem is that the 10-year bond got hammered on the news with yields there jumping 23bps overnight, taking the move since Monday to 57bps. Look for the RBA to do more, and probably soon. And the Aussie dog dollar? Down a further 1% this morning, which takes the decline in the past month to 14.3% and it is now trading at levels not seen since 2003.

And let’s not forget South Korea, which is stepping into the market to buy KRW 1.5 trillion (~$1.1 billion) of government bonds, as it prepares both bond and stock stabilization funds to help support markets there. In other words, the government is going to be buying equities to stop the slide. The KRW response? -3.2%!

Japan would not be left out of this parade, buying a new record ¥201.6 billion of ETF’s last night while injecting ¥5.3 trillion yen in new liquidity to the money markets. Unfortunately, the Nikkei continued its decline, although fell only 1.0%, arguably an improvement over recent performance. The yen has no haven characteristics this morning, falling 1.50%, which is actually now the worst performing currency as NOK continues to rebound as I type on the back of Norgesbank activity.

Finally, I would be remiss if I didn’t mention that the Fed has unveiled yet another program, this time to backstop money market funds, a key part of the US financial plumbing system, and one that when it broke in 2008 after Lehman’s bankruptcy, resulted in financial markets seizing up entirely. The fund is there to make liquidity available to funds to meet increased redemptions without having to sell their holdings. Instead, they will pledge them as collateral and receive cash from the Fed.

This note is too short to go through every action taken, but we continue to see other central bank rate cuts and we continue to see fiscal packages starting to get enacted. In fact, President Trump signed into law the latest yesterday, to support paid sick leave and increased unemployment benefits, and now Congress turns to the MOAS (mother of all stimuli) packages which may include helicopter money as well as bailouts of airlines and hospitality businesses that have been decimated by the virus response. Mooted price tag…$1.3 trillion, but my bet is it winds up larger than that.

Meanwhile, the dollar remains the single place to be. It has rallied against everything yet again as holding cash is seen as the only response to the current situation. And the cash everyone wants to hold is green. Foreign borrowers are scrambling and struggling as their local currencies collapse and swap spreads blow out. And domestic borrowers are wondering how they are going to repay or roll over their debt given the absolute collapse in economic activity.

For now, this is likely to continue to be the situation, as there is no obvious end in site. However, the growing sense of urgency in those national capitals leads me to believe that we are going to start to see much bigger fiscal packages and a newfound belief that printing money and giving it out is a better solution than allowing economic activity to seize up completely. As I said last week, the MMT proponents have won the day. It has just not yet been made explicit.

Good luck and stay safe
Adf

 

Still Aren’t Buying

The market continues to fear
The virus, as it’s become clear
Whatever they try
Recession is nigh
And coming worldwide late this year

But Jay and his friends keep on trying
To help us all so they’re supplying
A hundred beep cut
Which might aid somewhat
Investors, though, still aren’t buying

It is getting hard to keep up with all the policy actions being undertaken by the world’s central banks and governments as every nation tries to address the Covid-19 outbreak. By now, I am sure you are all aware that the Fed, in an unprecedented Sunday night move, cut the Fed funds rate by 100bps, back to the zero bound. But here is what else they did:

• They committed to QE4, which involves purchasing $500 billion in Treasury coupon bonds as well as $200 billion in mortgage-backed securities.
• They cut the interest rate at the discount window to 0.25% and will allow borrowings there for up to 90 days (it had been an overnight facility prior to this).
• And perhaps the most interesting thing, they cut bank reserve requirements to 0.0%, essentially allowing infinite leverage for banks to encourage them to lend.
• Finally, they reinstituted USD swap lines with other major central banks around the world to help everyone else get access to USD liquidity.

The Bank of Japan, meanwhile, pulled their monthly meeting forward to last night so they could act in concert with the rest of the world. With interest rates already negative, they did not touch those, but doubled their target for ETF and corporate bond purchases to ¥12 trillion and they introduced a new zero-rate lending program to help businesses hit by the pandemic. Kuroda-san also made clear there was more they can do if necessary.

The PBOC in a somewhat lukewarm response offered 100 billion yuan of liquidity via the medium-term lending facility at an unchanged rate of 3.15%. Given they are one of the few central banks with room to cut rates, that was somewhat of a surprise. It was also surprising given just how incredibly awful the economic data releases were last night:

Retail Sales -20.5%
Industrial Production -13.5%
Fixed Asset Investment -24.5%
Unemployment Rate 6.2%

The RBNZ cut its base rate by 0.75%, taking it down to 0.25%, and promised to maintain that rate for at least 12 months. They also indicated they would be starting QE if they needed to do anything else. (And to think, New Zealand historically had been considered a ‘high-yielder’!)

The Bank of Korea cut its base rate by 0.50%, taking it to 0.75% in an unscheduled emergency meeting. Analysts are looking for another 50bps at their regular meeting on April 9.

The RBA offered further liquidity injections via repurchase agreements (repos) extending their tenor and indicated it “stands ready” to purchase government bonds (i.e. start QE) with further announcements due Wednesday.

In addition, we saw the Philippines, Hong Kong, Turkey and Sri Lanka act last night. This is clearly a global effort, but one that has not yet gained traction amid the investment community.

Speaking of the investment community, equity markets worldwide are getting crushed, with Asia falling sharply and Europe in even worse shape, as all markets are down at least 6%. Meanwhile, US equity futures are limit down at -5.0% after Friday’s remarkable late day short-covering rally. Again, the only constant here is that volatility is extremely elevated!

Treasury yields have fallen sharply again, down 20bps as I type, but were lower earlier. Interestingly, other than Treasuries, Bunds and Gilts, the rest of the government bond markets have lost their appeal to investors. Instead, we are seeing them sold off alongside equity markets with French yields higher by 4bps, Italian yields +16bps and Greek yields +26bps. In fact, pretty much every other country is seeing yields rise today. I think part of this is the fact that as equity markets decline and margin calls come in, investors must sell the only thing that has any liquidity, and that is government bonds. This behavior could go on for a while.

And lastly, turning to the dollar, it is a mixed picture this morning. The haven currencies, JPY (+1.6%) and CHF (+0.7%) are doing what they are supposed to. The euro, too, has rallied a bit, up 0.5% in what arguably is a response to the dramatically lower US interest rate picture. But NZD and NOK are both lower by 1.5%, the former on the back of its surprise central bank actions while the krone is suffering because oil has collapsed 5.6% this morning amid the ongoing oil war. CAD and AUD, the other G10 commodity currencies are also under pressure, down 0.8% and 0.5% respectively.

Turning to the EMG space, the bright spot is Central Europe, which has seen gains in PLN, RON and BGN. But otherwise, these currencies are under pressure again, some more extreme than others. RUB is the leading decliner, -2.9%, along with oil’s decline, and MXN is also getting hammered, -2.6%. ZAR (-2.4%) and CZK (-1.8%) are the next in line, but basically all APAC currencies have suffered by at least 0.5%, and one can only imagine what will happen to LATAM when it opens. It is not likely to be pretty.

We do see some data this week, but it is not clear how important it will be. Arguably, these will be the last data points prior to the onset of the epidemic.

Today Empire Manufacturing 4.9
Tuesday Retail Sales 0.2%
  -ex autos 0.1%
  IP 0.4%
  Capacity Utilization 77.1%
  JOLT’s Job Openings 6.401M
Wednesday Housing Starts 1502K
  Building Permits 1500K
Thursday Initial Claims 219K
  Philly Fed 10.0
  Leading Indicators 0.1%
Friday Existing Home Sales 5.50M

Source: Bloomberg

At this point, the Fed has canceled their meeting this week, having acted yesterday, which means that we will be able to hear from Fed speakers as they try to massage their message. But the essence of the problem is this is not a financially driven crisis, it is a global health crisis, and all the central banks can do is adjust monetary policy. Fiscal policy adjustments as well as government actions directed at ameliorating the impacts of Covid-19 are much harder, especially in large democratic nations, and so I fear that it will be a number of weeks before things even begin to return to a semblance of normal. Only then will we learn how effective all this monetary policy action will be. In the meantime, I see further declines in equity markets and continued volatility. In fact, the only positive catalyst I could see coming up is the announcement of successful testing of a vaccine for Covid-19, and its immediate production. Alas, nobody knows when that will come.

In the meantime, while bid-ask spreads will be wider, and based on what we have seen in the CDS markets, credit spreads are wider as well, the FX market is still operating, and hedgers should be able to get most everything they need done.

Good luck
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