Tag Archives: #Boris

Unrequited

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It cannot be very surprising
That Boris and friends keep devising
More reasons to talk
Yet both sides still balk
At genuinely compromising

For now, though, the market’s delighted
With risk appetite reignited
Pound Sterling has soared
With stocks ‘cross the board
Though bond love has been unrequited

Aahh, sweet temptation.  I’m sure most of us know, firsthand, how difficult it can be to impose self-control when it comes to something we really want, but know we shouldn’t have, like that extra cookie after dinner.  Or perhaps, it is the situation of something we really don’t want, but know we need, like that trip to the dentist.  In either case, getting ourselves to do the right thing can be an extraordinary struggle.  That is the best analogy I can find for the countless Brexit trade talk deadlines that have been made and passed since the actual Brexit agreement was signed on January 31, 2020.

You may recall last Thursday’s dinner date between Boris and Ursula, where the outcome was a declaration that if a deal could not be reached by the weekend’s close (yesterday), none would ever come.  The thing about Brexit deadlines, however, is that they only exist in the mind of the individual setting them.  It appears to be a tool designed to impose self-control on the speaker.  However, like so many of us, when we claim we will eat only one cookie, we find the temptation to eat another too great to ignore.  This appears to be the same situation when it comes to establishing Brexit talk deadlines, both sides really want a deal, and hope that a deadline will be the ticket to finding one that can be agreed.  But in the end, the only true deadline is the one inscribed in the Brexit agreement, which is December 31, 2020.  And with that as prelude, it is quite clear that the latest deadline has been ignored, and both sides have explained that a deal is within reach and they will continue talking, right up until New Year’s Eve if necessary.

This past Friday, there were rumors rampant that the whole situation would fall apart, and that risk would be jettisoned as soon as markets opened in Asia last night.  Expectations were for a huge Treasury rally, with sharp declines in stock markets.  But for now, that situation remains on hold, and the good news has inspired further risk acquisition, with most equity markets solidly higher along with oil while bonds are selling off along with the dollar.

As I have maintained for the past several months, despite all the rhetoric on both sides, the most likely outcome remains a successful conclusion to the talks.  It is unambiguously in both sides’ interest to agree a deal, and everything that we have seen has been for each sides’ domestic constituents as proof they fought to the last possible second and got the best deal possible.  In fact, part of me believes a deal has already been agreed, it just hasn’t yet been revealed as the timing is not propitious for both sides.  Whatever the situation, though, for now, the market has been satisfied that there is nothing imminent that is going to stop the risk rally.

And that pretty much sums up the session, there is nothing imminent that is going to stop the risk rally.  Looking ahead for the week, Retail Sales on Wednesday morning is arguably the most important data point, but of more importance is the FOMC meeting that same day, with the afternoon statement and press conference.  We will focus on that tomorrow and Wednesday, but as of now, there is no change expected in either the interest rate structure or quantity of QE, but there is some discussion of a change in tenor of QE purchases.

With all that in mind, then, let us look at markets overnight.  As discussed, risk appetite is growing as a combination of the positive Brexit story and the first rollouts of the Covid vaccine encourage the outlook that the timeline for reigniting economic growth is nearing.  Adding to this story is the news that a US fiscal stimulus bill may be close to being agreed, and, naturally, we know that every central bank will continue to add liquidity to the markets for as long as they deem fit, which currently seems to be indefinitely.  Interestingly, this is all occurring despite Germany imposing renewed harsh lockdowns through January, and word that we are going to see the same in Italy, Spain and the UK.

But here’s what we have seen.  Asian equity markets were generally positive (Nikkei +0.3%, Shanghai +0.7%) although the Hang Seng (-0.4%) lagged.  European markets are all higher, with some pretty good gains (DAX +1.25%, CAC +1.1%) although the FTSE 100 (+0.4%) is lagging on the strength of the pound, which negatively impacts so many companies in the index.  And finally, US futures are all green with gains between 0.6% and 0.9%.

Bond markets are selling off, which should be no surprise, with Treasury yields higher by 2.5 bps, although most of Europe has seen more moderate price declines, with yields higher by less than 2 basis points across the board.  With one exception, UK gilts have seen yields rise 6.7 basis points, as hopes for a Brexit deal have led to a lot of unwinding of Friday’s rally.

Meanwhile, oil prices are firmer (WTI +1.1%) but gold is actually softer (-0.7%) despite the dollar’s broad weakness.  In the G10 space, GBP (+1.5%) is the leader by far, as renewed hope has forced some short covering.  But the entire bloc is firmer with NOK (+1.1%) benefitting from oil’s rise, while the rest of the group has gained on a more general risk appetite with gains between 0.2% (CAD) and 0.6% (SEK).  The surprise here is JPY (+0.3%) which given the risk attitude, would have been expected to decline as well.

EMG currencies are mostly firmer, but the move seems to have ignored peripheral APAC currencies, where a group have seen very modest declines of 0.1% or so.  On the plus side, however, ZAR (+1.0%) leads the way, despite weaker gold prices, as Consumer Confidence data was released at a strong gain compared to Q3.  Elsewhere, BRL (+0.7%) and PLN (+0.7%) are the next best performers, with broad dollar sentiment the clear driver.  In fact, the entire CE4 is strong, as they demonstrate their ongoing high beta performance compared to the euro (+0.35%).

Data this week is really concentrated on Wednesday, but is as follows:

Tuesday Empire Manufacturing 6.9
IP 0.3%
Capacity Utilization 70.3%
Wednesday Retail Sales -0.3%
-ex autos 0.1%
FOMC Rate Decision 0.00% – 0.25%
Thursday Initial Claims 823K
Continuing Claims 5.7M
Philly Fed 20.0
Housing Starts 1533K
Building Permits 1558K
Friday Leading Indicators 0.4%

Source: Bloomberg

So, really, all eyes will be turned toward Washington and Chairman Powell as we await any indication that the Fed is going to change policy further.  Expectations are growing around new forward guidance, for explicit economic targets to be achieved before adjusting rates, but in any case, there is no expectation for rates to rise before the end of 2023.  Perhaps new forecasts and the new dot plot will add some new information, but I doubt it.

For now, risk remains in vogue, and as long as that remains the case, the dollar will remain under pressure.  But don’t expect a collapse, instead a modest decline, at least vs. the G10.  Certainly, there are some emerging currencies, notably BRL, which I think have room to run a bit more.

Good luck and stay safe
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Grovel and Kneel

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Said Boris, prepare for the worst
Despite all our efforts, the first
Of Jan may result
In quite a tumult
If Europe’s stance isn’t reversed

Said Ursula, we want a deal
But England must grovel and kneel
If French boats can’t fish
Wherever they wish
This rift will have no chance to heal

Brexit remains the top story in the markets as we have heard from both sides that preparations for a no-deal outcome are necessary.  From what I can glean, it appears the fishing rights issue is the final sticking point.  And, in fairness, it is pretty easy to see both sides’ point of view.  From the UK’s perspective, these are their territorial waters, and if Brexit was about nothing else, it was about regaining complete sovereignty over itself, including its canon of laws, and the disposition of its territory.  I’m pretty confident that had the roles been reversed, and British fishing boats were making their living in French waters, the French would be equally adamant about controlling access.  On the flip side, given the UK has been a member of the EU since 1973, there are two generations of French fishermen who have only known unfettered access to UK waters, and assumed it was their birthright.  Losing that access will obviously be a devastating blow to their livelihoods, and one in which they played no part of the decision.  Of course, with that in mind, it still seems like a periodic review of access would be able to satisfy both sides.  Alas, that has not yet been agreed.

The upshot of this change in tone is that the market has begun to price in a more serious probability of a no-deal outcome.  This is obviously evident in the pound, which has fallen a further 0.8% this morning and is now back to levels last seen a month ago.  In fact, versus the euro, the pound is at its weakest since mid-September, although still several percent below the pandemic lows, and more than 6% from its all-time lows seen in the wake of the GFC.  But we are seeing this change in the interest rate markets as well, where UK debt yields are tumbling across the curve. For instance, 10-year Gilt yields have fallen 4.5 basis points today and now sit at 0.15%, just a few ticks above their all-time lows seen in August.  And all shorter maturities have turned negative, with 7-year breaking below 0.0% this morning.  As to the short end, the market is now pricing a base rate cut to 0.0% by the February meeting latest, and a further cut, into negative territory by next summer.

This Brexit gloom also seems to be seeping into other markets as we are seeing a pretty widespread risk-off move today, with European equity markets all pretty substantially lower and US futures pointing in the same direction. Perhaps part of this gloom is the fact that the ECB arguably disappointed markets yesterday.  While Madame Lagarde lived up to her word regarding recalibrating the ECB programs, there was no shock or awe, something markets learned to anticipate under the previous regime.  The PEPP was increased, but by exactly the amount expected.  It was also extended in time, but all that was offset by the comment that it may not need to be fully utilized.  But there was no addition to the asset mix, no junk bonds or equities, anything to demonstrate that the ECB was going to continue to support the markets aggressively.  And with that missing, and growing concern over Brexit, it appears investors are deciding to hunker down a bit going into the weekend.

At this point, both sides in the Brexit talks claim Sunday is the final deadline, so perhaps we will see something this weekend to move markets on Monday.  But right now, there is a palpable air of despair in the markets.

Touring all markets this morning shows that Asian equities were mostly lower (Nikkei -0.4%, Shanghai -0.8%) although the Hang Seng (+0.35%) managed a gain.  However, that is really the only green number on the boards this morning as every European exchange is lower, led by the DAX (-2.0%) and followed by the CAC (-1.3%) and FTSE 100 (-1.1%).  The idea that the FTSE 100 will benefit from a no-deal Brexit seems sketchy, at best, given whatever benefit may come from a weaker pound Sterling, it would seem to be offset by the larger economic hit to the UK economy as well as the thought that many of those companies may find their export markets crimped without a deal, and therefore their profits negatively impacted.  As to the US, futures markets have been trending lower all evening and are now pointing down about 0.8% across the board.

Bond markets are on the same page, with rallies everywhere as yields decline.  Treasury yields are lower by 2 basis points, and all of Europe has seen yield declines of between 1 and 4 basis points, with the PIGS the laggards here.  You may notice I never discuss JGB’s but that is only because the BOJ has effectively closed that market, now owning nearly 50% of outstanding securities, and thus yields there never really move as almost no volume transacts on any given day.

Commodity markets are showing very minor declines with both oil and gold looking at dips of just 0.2% or so.  In other words, this is more about financial issues than economic ones.

And finally, the dollar is definitely stronger this morning, with only the yen (+0.15%) outperforming in the G10 space.  While the pound is the leading decliner, NOK (-0.8%) is right there with it.  This is a bit surprising, as not only has oil not really moved today, but Brent crude rose back above $50/bbl yesterday for the first time since the initial Covid panic in March and remains there this morning.  Given growing expectations that next year is going to bring a lot of growth, it would seem that NOK has a lot of positives on its side.  As to the rest of the bloc, the losses are more moderate, ranging from AUD (-0.15%) to SEK (-0.35%), and all simply following the risk story.

Emerging market currencies are also largely weaker, led by BRL (-0.95%) which really appears to be a reaction to yesterday’s remarkable 3.0% rally.  With spot approaching 5.00, there seems to be a lot of two-way activity in the currency.  But the other laggards are all commodity based, which fits with the overall risk-off theme.  So, ZAR (-0.8%) and MXN (-0.65%) are leading the pack while the bulk of the bloc has declined a more manageable 0.2%-0.3%.  On the flip side TWD (+0.7%) is the biggest gainer despite modest foreign equity outflows.  This is especially odd given the ongoing decline in TWD bond yields.  But whatever the driver, demand for TWD remains robust.

Yesterday’s CPI data was a tick higher than expected, which has become the norm for the second half of the year.  This morning we get PPI (exp 0.7%, 1.5% ex food & energy) although given CPI has already been released, it will largely be ignored.  Perhaps the 10:00 preliminary Michigan Confidence (76.0) reading will garner more interest.  but in the end, neither seems likely to move the needle.  Rather, with risk appetite waning, and concerns over Brexit growing, it does feel like the dollar has further room to run today.

Good luck, good weekend and stay safe
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The Table is Set

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In Brussels, the table is set
As Boris and Ursula bet
That dinner together
Will be the bellwether
To ending the hard Brexit threat

So, appetite for risk is whet
With central banks sure to abet
More equity buying
As they keep on trying
To buy every last piece of debt

There hasn’t been this much interest in a meal in Europe since the one painted by DaVinci some 530 years ago.  Clearly, the big story is this evening’s dinner date between UK PM Boris Johnson and European Commission President Ursula von der Leyen, where they will make what appears to be the final attempt to get some political agreement on the last issues outstanding in order to complete the Brexit trade deal.  With just over three weeks before the UK exits the EU, time is clearly of the essence at this stage.  I remain confident that an agreement will be reached as it is in both sides’ collective interest to do so.  Rather, the current political theater is seen as necessary, again for both sides, in order to demonstrate they did everything they could to achieve the best possible outcome.  After all, Boris is going to have to cede some portion of UK sovereignty, and the EU is going to have to cede some adherence to their extraordinarily large canon of laws.

The FX market seems to share my opinion as the pound has rallied more than 1% since I wrote yesterday and is currently firmer by 0.7% since yesterday’s close.  As I wrote last week, I remain convinced that the market has not actually priced in a successful completion of a deal, rather that the pound’s performance over the past several months, a nearly 10% rise since July 1st, has simply been reflective of the broad dollar decline and not a bet on a positive Brexit outcome.  As such, I believe there is a good amount of upside potential for the pound in the event of a positive result, perhaps as much as 3% right away, and 5%-6% over time.  Similarly, if a deal is not reached, a 5% decline is in the cards.  But, for now, all we can do is wait to hear the outcome.  Dinner is at 8pm in Brussels, so likely there will be little news before 4pm this afternoon.

Away from the Brexit story, however, the market discussion continues to revolve around prospects for a quick implementation of the Covid-19 vaccine and the resumption of pre-pandemic economic activity.  One of the conundrums in this regard is that despite what appears to be a growing belief that the vaccine will solve the covid crisis, thus enabling a return to economic growth, the central banking community will continue to inject unfathomable sums of liquidity into banks, (and by extension markets and maybe even the economy), to support economic growth.  It seems a bit duplicative to me, but then I’m just an FX salesman sans PhD.  After all, if the vaccine will allow people to revert to their former selves, what need is there for central banks to keep buying bonds?  (And in some cases, equities.  As an aside, yesterday the BOJ reached a milestone as the largest equity holder in Japan, outstripping the government pension fund, GPIF, and now in possession of nearly 8% of the entire market there.)

The thing is, there is no prospect that this behavior is going to change.  For instance, tomorrow the ECB’s final meeting of the year will conclude, and they are expected to expand the PEPP by at least €500 billion and extend the tenor of the program between six months and a year.  In addition, they are expected to expand the TLTRO III program (targeted long-term refinancing operations) by another year, and there were even some hints at a rate cut there.  The latter would be extraordinary as the current rate is -1.0%.  This means that European banks that borrow funds in this program pay -1.0% (receive 1.0% pa) as long as they lend these funds on to corporate and business clients, with no restrictions on what they can charge.  Balances in this program have fallen from €1.3 trillion to just €180 billion since the summer, so it is believable that the rate will change.  The ECB particularly likes this program as they believe it really encourages business loans.

Something else to watch in tomorrow’s meeting is whether either the statement, or Madame Lagarde in her press conference opening, discusses the exchange rate.  Since the euro first traded above 1.20 back in September, which brought an immediate response from the ECB via some jawboning, the single currency had really done very little, until November, when the latest move higher began.  Now, after a 4% rally, it would not be surprising for the ECB to once again mention the importance of a “competitive” (read: weak) euro.  With inflation in the Eurozone remaining negative, Lagarde and company simply cannot afford for the euro to rise much further.  And none of this discussion includes what may well come from the FOMC next week!

But on to today’s activity.  Risk appetite continues to be strong where equity markets in Asia (Nikkei +1.3%, Hang Seng +0.75%) and Europe (DAX +0.8%, CAC +0.2%, FTSE 100 +0.4%) are all continuing yesterday’s modest gains.  The one exception here is Shanghai (-1.3%) which seemed to respond to inflation data overnight (CPI -0.5%).  The cause here seems to be declining pork prices (remember last year the Asian Swine Flu resulted in the culling of Chinese herds and dramatic price rises) but also the expectation that the PBOC is not going to change course with respect to forcing the deleveraging of the real estate sector and concomitant bubble there.

Bond markets are behaving as one would expect in a risk-on scenario, with Treasury yields reversing yesterday’s 2bp decline, while Bunds and OATs have both seen yields edge higher by 1 basis point.  Oil prices have rallied 1.5%, partly on risk attitude and partly on the story of an attack on Iraqi oil assets disrupting supply.  Finally, gold, which has really been rebounding since the end of last month, has given up 0.65% this morning.

Lastly, the dollar is generally softer today, against most G10 and EMG currencies.  AUD (+0.9%) is the leader this morning after the Westpac Consumer Confidence Survey printed at a much higher than expected 112.0.  For reference, that was the highest print since October 2010!  But as mentioned, the pound is firmer, as is virtually the entire bloc, albeit with less impressive moves.

In emerging markets, HUF (+0.8%) is the leading gainer, followed by PLN (+0.7%) and CZK (+.4%), all of which are far outperforming the euro (+0.1%).  It seems that the EU Stimulus deal, which was being held up by Hungary and Poland over language regarding the rule of law, has finally been agreed by all parties, with those three nations set to receive a significant boost when it is finally implemented next year.  On the flip side, TWD (-0.4%) was the worst performer as a late session sell-off wiped out early gains.  At this point, there is no obvious catalyst for the move, which looks very much like a large order going through an illiquid market onshore.

There is no data of note this morning and no speakers either.  Risk appetite remains the driver, with not only vaccine euphoria, but also hopes for a US stimulus bill rising as well.  In other words, everything is fantastic!  What could possibly go wrong?

As long as equities continue to rally, the dollar is likely to remain under pressure, but with the ECB on tap for tomorrow, I don’t expect a breakout, unless something really positive (or negative) comes out of dinner in Brussels.

Good luck and stay safe
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Still a Threat

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For Boris, and all Brexiteers
They can’t wait for this, Eve, New Year’s
Alas, as of yet
There is still a threat
That no deal might bring both sides tears

Investors, however, seem sure
The UK, a deal, will secure
That’s why Britain’s pound
Is robustly sound
Let’s hope that view’s not premature

EU official sees UK trade deal “imminent” barring last-minute glitch

This Reuters News headline from this morning, aside from being inane, is a perfect example of the market narrative in action.  The broad view is that a deal will be reached, despite the fact that deadline after deadline has been missed during these negotiations.  The pound has rallied nearly 10% since the only deadline of consequence on June 30.  That was the date on which both sides would have been able to extend the current negotiations.  However, no extension was sought by the UK and none granted, so we are heading into the last four weeks of the year with nothing concrete completed.  And yet, markets on the whole continue to trade under the assumption a deal will be reached and there will be no meaningful disruption to either the UK or EU economy on January 1st.

And that is the point of the headline.  It is essentially telling us a deal is a given, and both sides are now just playing to their domestic constituencies to show how hard they are working to achieve a ‘good’ deal.  In fact, once again today, the French held out the possibility that they would veto a deal as French European Affairs Minister, Clement Beaune, told us, “If there is a deal which is not good, then we would oppose it.  We always said so.”  This comment appears to be just another part of the ongoing theater.  A senior UK official, meanwhile, claimed talks had regressed because of a change in the EU’s position regarding the fishing issue.

But let’s go back to the pound.  A 10% rally in five months is a pretty impressive outcome.  Can this movement be entirely attributed to Brexit beliefs?  At this stage, I think not.  Consider, that during that same period, both SEK and NOK have rallied nearly 11%.  And even the laggard of the G10, JPY, has rallied 3.5% in the second half of the year.  The point is that perhaps the market has not priced in as high a probability of a successful outcome as many, including me, had thought likely.  After all, if the other nine G10 currencies have rallied an average of 8.0% in a given time frame, at the margin, the additional 1.6% that cable has rallied does not seem that impressive after all.

What are the potential ramifications of this line of thinking?  Well, assuming that a deal is actually reached on time, and I believe that is the most likely outcome, it seems possible that the pound has considerably more upside than the rest of the G10.  Looking back to the original referendum in the summer of 2016, the pound touched 1.50 the night of the vote, before it became clear that Brexit was going to be the outcome.  Since then, in Q1 2018, the pound traded above 1.40, but that too, was simply a reflection of the times as the euro was trading above 1.25.  In other words, the Brexit impact on the pound, other than in the immediate aftermath of the vote, seems to have been remarkably modest.  Certainly, month-to-month movement has been in lockstep with all the other G10 currencies, and it is only the level of the pound, which adjusted back in June 2016, which is different.  The implication is that the announcement of a successful deal is likely to see the pound outperform higher.  This is opposite my previous views but appears to account for the historical price action more effectively.  Remember, within two days of the Brexit vote, the pound fell 11%.  While a deal seems unlikely to recoup that entire amount, perhaps half of that is available, which from current levels means that a move above 1.40 is viable without a corresponding rise in the euro.  At that point, the pound will revert to being just another G10 currency, with price movement locked into the dollar narrative, not the Brexit narrative.  Food for thought.

As to today’s session, it is payrolls day with the following expectations according to Bloomberg:

Nonfarm Payrolls 470K
Private Payrolls 540K
Manufacturing Payrolls 45K
Unemployment Rate 6.7%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%
Trade Balance -$64.8B
Factory Orders 0.8%

The question, of course, is has this data yet returned to its prior place of importance in investors’ minds.  And arguably, the answer is no.  There continues to be a strong market narrative that the current data is unimportant because everyone knows that the ongoing lockdowns are going to make things look worse.  This is true all over the world (except, perhaps, China).  But given the near universal central bank promises of low rates forever for the foreseeable future, investors continue to add risk to their portfolios with abandon.  In order to change that mindset, I believe we would need to see a number so shocking, something like -1000K, that it could indicate the impact of Covid might not be temporary.  But barring that, my sense is the payroll number has lost its luster.

It will be interesting to see if that luster returns in the post-Covid environment, or perhaps some other statistic will embody the zeitgeist in the future.  Remember, NFP has not always been that important.  When Paul Volcker was Fed Chair, M2 money supply was the only number that mattered.  Once Alan Greenspan took over, it was the trade data that drove markets.  Perhaps inflation will be deemed “THE” number going forward, especially in the event that MMT becomes the norm.

Ahead of the data, a tour of markets shows that risk appetite is positive, if modest.  European equity markets are generally firmer (CAC +0.3%, FTSE 100 +0.8%) although the DAX just gave up its earlier gains and is now lower by 0.2%.  Overnight, things were also fairly dull as the Nikkei (-0.2%) slipped modestly while both the Hang Seng (+0.4%) and Shanghai (+0.1%) edged higher.  In fact, the best performer overnight was South Korea with the KOSPI (+1.3%) rallying on continued strong data and KRW (+1.35%) rallying on the back of inflows to the KOSPI as well as market technicals.  Meanwhile, US futures are higher by roughly 0.3% at this hour.

The bond market has slipped a bit with yields rising by 2bps in Treasuries, but European govvies, which had been softer (higher yields) earlier in the session, have found support with yields now edging lower by about 0.5bps.  It seems a Bloomberg story released a short time ago indicated that the ECB is likely to extend their PEPP by a full year, not the 6 months mooted by most analysts.

As to the dollar, it is actually mixed in the G10, but movement has been modest in both directions.  So, CHF (+0.25%) and GBP (+0.2%) are leading the way, but realistically don’t tell us much given how insignificant the moves have been.  On the downside, NZD (-0.4%) and AUD (-0.2%) are lagging, but neither has released data of note.  Essentially, this all seems like position adjustments.

Emerging markets, however, have seen a bit more demand with the commodity bloc supported after OPEC+ reached a compromise and helped oil prices back above $46/bbl.  This is the highest they have been since before the Covid panic, so it is quite important from a market technical perspective.  In the meantime, RUB (+0.55%) and MXN (+0.5%) are leading the way (after KRW of course) with most others in this space higher by much lesser amounts.

And that’s where we stand heading into payrolls and then the weekend.  Nothing has changed the dollar weakening narrative, and the pound remains the true wildcard.  Despite my change of heart regarding the pound’s upside, that does not change my view that if the negotiations fall apart and no Brexit deal is reached, the pound can decline 5%-7%.  Arguably, we are looking at some symmetry there.  In any event, a case for a larger move in the pound is very viable, one way or the other.

Good luck, good weekend and stay safe
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Boris Has Gotten His Way

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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
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The Story of Boris

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Today it’s the story of Boris
A man who commands a thesaurus
When speaking of foes
To prove that he knows
More things than the Press’s Greek chorus

Tell me if you’ve heard this one before…a politician makes a bold promise to achieve something by a specific date.  As the date approaches, and it is clear that promise will not be fulfilled, he changes his tune blaming others for the problems.

I’m certain you recognize this situation, and of course, today it is the story of Boris.  Back on September 7, Johnson was adamant that if a deal was not completed by October 15, the day an EU summit was scheduled to begin, that there would be no deal at all.  It appears that he believed he had the upper hand in the negotiations and wanted to get things done.  As well, the EU had indicated that if a deal was not agreed by the middle of October, it would be nearly impossible for all of the 27 member nations to approve the deal in their respective parliaments.

Alas for Boris, things have not worked out as well as he might have hoped.  Instead, two major issues remain; EU access to fishing in UK waters and the limits on UK state aid for companies, and neither one seems on the verge of a breakthrough.  Yet the calendar pages keep turning and here we are, one day before the ‘deadline’ and nothing has been agreed.  In fact, as the EU prepares for its summit starting tomorrow, this is the statement that has been released, “progress on the key issues of interest to the union is still not sufficient for an agreement to be reached.”

Though Boris’s deadline grows near
It seems that he might not adhere
As now the UK
Will not walk away
From Brexit discussions this year

With this as a backdrop, one would not be surprised to see the pound start to lose some of its recent luster.  Clearly, that was a major part of yesterday’s price action, where the pound declined 1.0% and the rest of the G10 saw an average decline of only 0.4%.  In other words, while the dollar was strong against virtually all comers yesterday, the pound was at the bottom of the barrel.  Apparently, some investors are beginning to get cold feet with respect to their view that despite all the bluster, a Brexit deal will be reached.  It is also not surprising that comments from Number 10 Downing Street this morning indicate the UK will not walk away from Brexit talks immediately.  So, the EU effectively called Johnson’s bluff, and Boris backed down.  It is also important to note that while the EU would like to get a deal agreed as soon as possible, they see no hard deadline with respect to when things need to be completed before the end of the year.

The overnight session saw a follow on from yesterday, with the pound falling another 0.55% before the comments about continuing the discussions hit the tape.  The ensuing rebound now has the pound higher by 0.25% on the session, and actually the best performer in the G10 today.  The bigger point is that the Brexit saga is not nearly done, and there is still plenty of opportunity for more volatility in the pound.  I read one bank claimed the probability of a no-deal Brexit has fallen to 20%.  Whether that is accurate or not, a no-deal Brexit is likely to see the pound fall sharply, with a move to 1.20 entirely realistic.  Hedgers take note.

As to the rest of the market/world, yesterday’s risk reducing session seems to have ended, although risk is not being readily embraced either.  Overnight saw equity markets either little changed (Nikkei and Hang Seng +0.1%) or lower (Shanghai -0.55%).  Chinese Money Supply and lending data showed that the PBOC continues to push funds into the economy to support things, and the renminbi’s price action shows that there continue to be inflows to the country.  CNY (+0.2%) has consistently been a strong performer, even after the PBOC relaxed short selling restrictions at the beginning of the week.

European markets have also proven to be mixed, with the CAC, DAX and FTSE 100 all lower by -0.2%, but Spain and Italy both higher by 0.3%.  Earlier in the session, all markets were higher, so perhaps some concerns are growing, although there have been no comments on the tape of note.  US futures have also given up earlier gains and currently sit essentially unchanged.

Bond markets had a strong performance yesterday, with 10-year Treasury yields declining 5 basis points and a further 1.5 basis points this morning.  We have seen the same type of price action across European government bond markets, with virtually all of them rallying and yields declining by 2-3 bps.

Finally, as we turn to the dollar, yesterday’s broad strength is largely continuing in the EMG bloc, save CNY’s performance, but against its G10 counterparts, it is, arguably, consolidating.  Aside from the pound, the rest of the G10 is +/- 0.15%, with only slightly weaker than expected Eurozone IP data as a guide.  As to the EMG bloc, there is weakness in RUB (-0.6%), HUF (-0.5%) as well as the two highest beta currencies, MXN and SAR (-0.3%).  Russia has the dubious distinction of the highest number of new cases of Covid today, more than 14K, (wait a minute, don’t they have a vaccine?) and Hungary, with nearly 1000 is also feeling the crunch based on population size.  It appears that investors are concerned over economic prospects as both nations see the impending second wave and are considering lockdowns to help stem the outbreak.  As to MXN and SAR, they are simply the most popular vehicles for investors to play emerging markets generally, and as risk seems to be falling out of favor, their decline is no surprise.

On the data front, PPI (exp 0.2%, core 0.2%) is today’s event, but given yesterday’s CPI release was spot on, this will largely be ignored.  The inflation/deflation discussion continues but will need to wait another month for the next installment as yesterday taught us little.

One of the positives of the virtual society is that things like the World Bank / IMF meetings, which had been such big to-dos in Washington in past years, are now held virtually.  As such, they don’t generate nearly the buzz as in the past.  However, it should be no surprise that there is a single thesis that is making the rounds in this virtual event; governments need to spend more money on fiscal stimulus and not worry about increased debt.  Now, while this has been the central bank mantra for the past six months, ever since central banks realized they had run out of ammunition, it is still remarkable coming from two organizations that had made their names hectoring countries about having too much debt.  Yet that is THE approved message of the day, governments should borrow more ‘free’ money and spend it.  And it should be no surprise that is the message from the chorus of Fed speakers as well.  Alas, in the US, at least, the politics of the situation is far more important to the players than the potential benefits of passing a bill.  Don’t look for anything until after the election in my view.

As to the session, I see no reason for the dollar to do much at all.  The dollar bears have been chastened and lightened their positions, while the dollar bulls no longer like the entry point.  It feels like a choppy day with no direction is on the cards.

Good luck and stay safe
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Nary a Tear

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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No Reprieve

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Said Boris to Angela, Hon
When this year is over and done
There’ll be no reprieve
The UK will leave
The EU and start a great run

Will somebody please explain to me why every nation seems to believe that if they do not have a trade deal signed with another nation that they must impose tariffs.  After all, the WTO agreement merely defines the maximum tariffs allowable to signatories.  There is no requirement that tariffs are imposed.  And yet, to listen to the discussion about trade one would think that tariffs are mandatory if trade deals are not in place.

Consider the situation of the major aircraft manufacturer in Europe, a huge employer and key industrial company throughout the EU.  As it happens, they source their wings from the UK, which, while the UK was a member of the EU, meant there were no tariff questions.  Of course, Brexit interrupted that idea and now their wing source is subject to a tariff.  BUT WHY?  The EU could easily create legislation or a regulation that exempts airplane wings from being taxed upon importation.  After all, there’s only one buyer of wings.  This would prevent any further disruption to the manufacturer’s supply chain and seem to be a winning strategy, insuring that the airplanes manufactured remain cost competitive.  But apparently, that is not the direction that the EU is going to take.  Rather, in a classic example of cutting off one’s nose to spite their face, the EU is going to complain because the UK is not willing to cut a deal to the EU’s liking while imposing a tariff on this critical part for one of their key industrial companies.  And this is just one of thousands of situations that work both ways between the UK and the EU.  I never understand why the discussion is framed in terms of tariffs are required, rather than the reality that they are voluntarily imposed by the importing country for political reasons.

This was brought to mind when reading about the meeting between British PM Johnson and German Chancellor Merkel, where ostensibly Boris explained that he would like a deal but the EU will need to compromise on key areas like fishing rights and the influence, or lack thereof, of EU courts in UK laws, or the UK is prepared to walk with no deal.  Negotiations continue but the clock is well and truly ticking as the deadline for an extension to be agreed has long passed.

It cannot be surprising that this relatively negative news has resulted in the pound giving up some of its recent gains, although at this point of the session it is only lower by 0.2% compared to yesterday’s closing levels, a modest rebound from its earlier session lows.  The euro, on the other hand is essentially unchanged at this hour as traders look over the landscape and determine that there is very little to drive excitement for the day.

dol·drums

/ˈdōldrəmz,ˈdäldrəmz/

noun

  1. a state or period of inactivity, stagnation, or depression.

In the late 1700’s, sailors would get stuck crossing the Atlantic at the equator during the summer as the climactic conditions were of high heat and almost no wind.  This time became known as the summer doldrums, a word that came into use as a combination of dull and tantrums, or, essentially, unpredictable periods of dullness.

Well, the doldrums have arrived.  And, as the summer progresses, it certainly appears that, despite the ongoing Covid-19 emergency, the FX market is heading into a period of even greater quiet.  This is somewhat ironic as one of the favored analyst calls for the second half of the year is increasing volatility across markets.  And while that may well come to pass in Q4, right now it seems extremely unlikely.

Let’s analyze this idea for a moment.  First off, there is one market that is very unlikely to see increased volatility, Treasury notes and bonds.  For the past month, the range on 10-year yields has been 10 basis points, hardly a situation of increased volatility.  And given the Fed’s ever-increasing presence in the market, there is no reason to believe that range will widen anytime soon.  Daily movement is pretty much capped at 3 basis points these days.

Equity markets have shown a bit more life, but then they have always been more volatile than bonds historically.  Even so, in the past month, the S&P has seen a range of about 7% from top to bottom and historic volatility while higher than this time last year, at 25% is well below (and trending lower) levels seen earlier this year.  After the dislocations seen in March and April, it will take some time before volatility levels decline to their old lows, but the trend is clear.

Meanwhile, FX markets have quickly moved on from the excitement of March and April and are already back in the lowest quartile of volatility levels.  Again, looking at the past month, the range in EURUSD has been just over 2 big figures, and currently we are smack in the middle.  Implied volatility, while still above the historic lows seen just before the Covid crisis broke out, are trending back lower and have fallen in a straight line for the past month.  And this pattern has played out even in the most volatile emerging market currencies, like MXN, which while still robustly in the mid-teens, have been trending lower steadily for the past three months.

In other words, market participants are setting aside their fears of another major dislocation in the belief that the combination of fiscal and monetary stimulus so far implemented, as well as the promise of more if deemed ‘necessary’ will be sufficient to anesthetize the market.  And perhaps they are correct, that is exactly what will happen, and market activity will revert to pre-Covid norms.  But risk management is all about being prepared for the unlikely event, which is why hedging remains of critical importance to all asset managers, whether those assets are financial or real.  Do not let the lack of current activity lull you into the belief that you can reduce your hedging activities.

If you haven’t already figured this out, the reason I waxed so long on this issue is that the market is doing exactly nothing at this point.  Overnight movement was mixed and inconclusive in equities, although I continue to scratch my head over Hong Kong’s robust performance, while bond markets remain with one or two basis points of yesterday’s levels.  And the dollar is also having a mixed session with both gainers and losers, none of which have even reached 0.5%.  In fact, the only true trend that I see these days is in gold, which as breeched the $1800/oz level this morning and has been steadily climbing higher since the middle of 2018 with a three-week interruption during March of this year.  I know that the prognosis is for deflation in our future, but I would be wary of relying on those forecasts.  Certainly, my personal experience shows that prices have only gone higher since the crisis began, at least for everything except gasoline, and of course, working from home, I have basically stopped using that.

Not only has there been no market movement, there is essentially no data today either, anywhere in the world.  The point is that market activity today will rely on flows and headlines, with fundamentals shunted to the sidelines.  While that is always unpredictable, it also means that another very quiet day is the most likely outcome.

Good luck and stay safe

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Tough Sledding

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The Minister, Prime, has declared
Come June, the UK is prepared
To tell the EU
If no deal’s in view
He’ll walk. Sterling bulls should be scared!

Meanwhile as the virus keeps spreading
Investors have found it’s tough sledding
There’s no end in sight
For this terrible blight
Thus, risk assets, most holders keep shedding

While Covid-19 remains the top story across all markets, this morning we did get to hear about something else that mattered, the UK position paper on their upcoming negotiations with the EU regarding trade terms going forward. The EU insists that if a nation wants to trade with them, that nation must respect (read adhere) to the EU’s rules on various issues, notably competition and state aid, but also things like labor conditions. (Funnily enough, China doesn’t seem to need to adhere to these rules). However, Boris has declared, “At the end of this year we will regain, in full, our political and economic independence.” Those are two pretty different sentiments, and while I believe that this is just tough talk designed to level set the negotiations, which begin next week, there is every chance that the UK does walk without a deal. Certainly, that is a non-zero probability. And the FX markets have taken it to heart as the pound has suffered this morning with the worst G10 performance vs. the dollar, falling -0.3%.

In fact, it is the only currency falling vs. the dollar today, which some have ascribed to the dollar’s waning status as a haven asset. However, I would argue that given the dollar’s remarkable strength this year, as outlined yesterday, the fact that some currencies are rebounding a bit should hardly be surprising. Undoubtedly there are those who believe that as Covid-19 starts to be seen in the US, it will have a deleterious impact on the US economy, and so selling dollars makes sense. But remember, the US economy is the world’s largest consumer, by a long shot, so every other country will see their own economies suffer further in that event.

A more salient argument is that the US is the only G10 country (except Canada which really is too small to matter) that has any monetary policy room of note, and in an environment where further monetary policy ease seems a given, the US will be able to be more aggressive than anyone else, hence, lower rates leading to a softer dollar. While that is a viable argument, in the end, as the ongoing demand for Treasuries continues to show, people need dollars, and will buy them, even if they’re expensive. Speaking of Treasuries, the 10-year yield has now fallen another 4bps to 1.29%, a new all-time low yield. And you can’t buy Treasuries using euros or yen!

So as things shape up this morning, it is another risk-off session with most equity markets around the world in the red (Nikkei -2.3%, Kospi -1.1%, DAX -2.5%, CAC -2.4% FTSE 100 -2.2%) and most haven assets (CHF +0.55%, JPY, +0.3%, Gold + 0.4%) performing well. The Covid-19 virus and national responses to the infection continues to be the lead story pretty much everywhere. In fact, last night’s US Presidential press conference was seen to be quite the fiasco as President Trump was unable to convince anyone that the US is on top of the situation. And while I’ve no doubt that things here will not run smoothly, it is not clear to me that things are going to run smoothly anywhere in the world. Fast moving viral epidemics are not something that large governments are very good at addressing. As such, I would look for things to get worse everywhere before they get better.

Looking at some specific FX related stories, perhaps the biggest surprise this morning is the euro’s solid rally, +0.5%, which was underpinned by surprisingly strong Economic Sentiment data for the month of February. This is in spite of the fact that growth figures throughout the major economies on the continent have been turning lower and the unknown consequences of Covid-19. And the euro’s strength has been sufficient to underpin the CE4 currencies, all of which are up by even greater amounts, between 0.6% and 0.85%. Again, these are currencies that have been under pressure for the best part of 2020, so a rebound is not that surprising.

Elsewhere in the EMG bloc, we continue to see weakness in the commodity producers, with oil falling more than 2% this morning and base metals also in the red. MXN (-0.7%), CLP (-0.45%), RUB (-0.3%) and ZAR (-0.3%) remain victims of the coming economic slowdown and reduced demand for their key exports.

This morning’s US session brings us a lot of data including; Initial Claims (exp 212K), Q4 GDP (2.1%) and Durable Goods (-1.5%, +0.2% ex transport). Yesterday’s New Home Sales data was much better than forecast (764K), which given the historically low mortgage rates in the US cannot be that surprising. We also continue to hear from Fed speakers, with each one explaining they are watching the virus situation closely and are prepared to act (read cut rates) if necessary, but thus far, the economic situation has not changed enough to justify a move. It is comments like these that highlight just how much of a follower the Fed has become, unwilling to lead a situation.

Speaking of the foibles of the Fed, I must mention one other thing that serves to demonstrate how out of touch they are with reality. Economists from the SF Fed released a paper explaining that, as currently constructed, the Fed will not be able to achieve their inflation goals because in the next downturn, with rates so low, the public worries that the Fed will not be able to add more support to the economy (my emphasis). Now, I think about the Fed constantly as part of my job, but I am willing to wager that a vanishingly small number of people in this country, far less than 1%, think about the Fed at all…ever! To think that the Fed’s inability to hit their target has anything to do with public sentiment about their power is extraordinary, and laughable!

At any rate, today’s session looks set to continue the risk-off stance, with equity futures down 0.75% or so, and while the dollar has been under pressure overnight, I expect that will be short-lived.

Good luck
Adf

 

Wind At His Sails

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In England and Scotland and Wales
Young Boris has wind at his sails
A thumping great win
To Labour’s chagrin
Has put Brexit back on the rails

As well, from the US, the news
Is bears need start singing the blues
The trade deal is done
At least for phase one
Thus more risk, investors did choose

An historic victory for PM Boris Johnson yesterday has heralded a new beginning for the UK. Historic in the sense that it is the largest majority in Parliament for either party since Margret Thatcher’s second term, and historic in the sense that the Labour party won the fewest seats since 1935. One can only conclude that Jeremy Corbyn’s vision of renationalization of industry and high taxes was not the direction in which the UK wants to head. Perhaps the only concern is the Scottish National Party winning 49 of the 58 seats available and will now be itching to rerun the Scottish independence referendum. But that is an issue for another day, and today is all about a huge relief rally in equities as the threat of a hard Brexit essentially disappears, while the pound has also benefitted tremendously, rising 1.7% from yesterday’s closing level and having traded almost a full percent higher than that in the early aftermath of the results. So here we are this morning at 1.3390, right at my forecast for the initial move in the event of a Johnson victory. The question of course, is where do we go from here?

Before I answer, I must also mention the other risk positive story, about which I’m sure you are already aware, the news that President Trump has signed off on terms of a phase one trade deal with China. The details thus far released indicate China has promised to buy $50 billion of agricultural products from the US, and will be more vigilant in protection of IP rights, while the US is set to reduce the tariff rates already imposed and delay, indefinitely, the tariffs that were due to come into effect this Sunday. Not surprisingly, equity markets around the world rallied sharply on this news as well while haven investments like Treasuries, Bunds and the yen (and the dollar) have all fallen.

So everyone is feeling good this morning and with good reason, as two of the major political uncertainties that have been hanging over the market have been resolved. With this in mind, we can now try to answer the question of what’s next in the FX markets.

History has shown that while macroeconomic factors have some impact on the relative value of currencies, that impact is driven by the corresponding interest rates in each nation. So a nation that has strong economic growth and relatively tighter monetary policy is likely to see a strong currency while the opposite is also true. Now this correlation is hardly perfect, and financial theory cannot be completely ignored regarding a country’s fiscal balances (current account, trade and budget), where deficits tend to lead to a weaker currency, at least in theory, and surpluses the opposite. Obviously, one need only look at the dollar these days to recognize that despite the US’s significant negative fiscal position, the dollar remains relatively quite strong.

But ever since the financial crisis, there has been another part of monetary policy that has had a significant impact on the FX market, namely QE. As I’ve written before, when the US was implementing QE’s 1, 2 and 3, the dollar fell markedly each time, by 22%, 25% and 17% over a period of 9 months, 11 months and 22 months respectively. Clearly that pattern demonstrates the law of diminishing returns, where a particular action has a weaker and weaker effect the more frequently it is used. Of course, in each of these cases, the Fed funds rate was at 0.00%, so QE was the only tool in the toolbox. This brings us to the current situation; positive interest rates but the beginning of QE4. I know that none of us think 1.5% is a robust return on our savings, but remember, US interest rates are the highest in the G10, by a lot. In addition, the economy seems to be doing pretty well with GDP ticking over above 2.0%, Unemployment at 50 year lows and wage gains solidly at 3.0% or higher. Equity markets in the US make new highs on a regular basis and measured inflation is running right around 2.0%. And yet…the Fed is clearly looking at QE despite all their protestations. Buying $60 billion per month of T-bills with the newly stated option of extending those purchases to coupons is clearly expanding the balance sheet and driving risk accumulation further. And that is QE!

So with the knowledge that the Fed is engaged in QE4, and the history that shows the dollar has fallen pretty significantly during each previous QE policy, my view is that we are about to embark on a reasonable weakening of the US dollar for the next year or so. Now, clearly the initial conditions this time are different, with positive growth and interest rates, but while that will likely limit the dollar’s decline to some extent, it won’t prevent it. If pressed, I would say that we are likely to see the dollar fall by 10% or so over the next 12-18 months. And that is regardless of the outcome of the US elections next year. In the event that we were to see a President Warren or President Sanders, I think the dollar would suffer far more aggressively, but right now, removing the effect of the election still points to a slow decline in the buck. So for receivables hedgers, it is likely to be a situation where patience is a virtue.

Turning to the data story, last night we saw the Japanese Tankan report fall to 0, below expectations of 3 and down from its previous reading of 5. But the yen’s 0.35% decline overnight has more to do with risk appetite than that particular number. However, I’m sure PM Abe and BOJ Governor Kuroda are not thrilled with the implications for the economy. Otherwise, there has been precious little else of note released leaving us to ponder this morning’s Retail Sales data (exp 0.5%, 0.4% ex Autos) and wait to hear pearls of wisdom from NY Fed President Williams at 11:00. Of course, given the fact the Fed just finished meeting and there appears very little uncertainty over their immediate future course, my guess is the only thing he can try to defend is ‘not QE’ and how they are on top of the repo situation. But today is a risk on day, so while we may not extend these movements much further, I feel we are likely to maintain the gains vs. the dollar across the board.

In a final note, this will be the last poetry until January as I will be on vacation and then will return with my prognostications for 2020 to start things off.

Good luck, good weekend and happy holidays to all
Adf