Many Pains

In England and Scotland and Wales
The vaccine will soon be for sale
But Brexit remains
A source of more pains
If talks this week run off the rails

What a difference a day makes, twenty-four little hours.  Yesterday morning at this time, the bulls ruled the world.  Equity markets were rallying strongly everywhere, bond markets were under pressure, and the dollar was breaking below two-year support levels.  Although most commodity prices were having difficulty extending their recent gains, gold did manage to rebound sharply all day, and, in fact, is higher by another 0.7% this morning, its death being widely exaggerated.

However, aside from gold, this morning looks quite different on the risk front.  Perhaps, ahead of a significant amount of data coming the rest of the week (ADP this morning, NFP on Friday), as well as next week’s ECB meeting, this is, as a well-known Atlanta based beverage company first told us in 1929, the pause that refreshes.

Arguably, the biggest news this morning is that the UK has cleared the first vaccine for use against Covid-19 with the initial doses to be injected as early as next week.  I don’t think anyone can argue with the idea this is an unalloyed positive for just about everything.  If it proves as effective as the initial testing indicated, and if a sufficient percentage of the population gets inoculated, and if that leads to a rebound in confidence and the end of all the government imposed economic restrictions and lockdowns, it could open the door for 2021 to be a gangbuster-type year of growth and activity.  But boy, that sure is a lot of ifs!

And a funny thing about the market response to this news is that…nothing has happened.  The FTSE 100 is higher by a scant 0.2%, and has not shown the strength necessary to support other European markets as both the DAX (-0.3%) and CAC (-0.2%) are in the red.  Is it possible that the markets have already priced in all the ifs mentioned above?  And, if that is the case, what does it say about the future direction of risk appetite?

This being 2020, the year with imperfect hindsight, it should also be no surprise that the good news regarding the vaccine was offset with potential bad news about Brexit.  Michel Barnier, the EU’s top negotiator, indicated that while the mood was still positive in the round-the-clock negotiations, it is very possible that no deal is reached in time to be ratified by all parties.  And that time is drawing near.  After all, the previous deadlines were all artificial, to try to goose negotiations, but December 31st is written into a treaty signed by both sides.  The contentious issues remain access to UK waters by EU fishing vessels and the idea of what will constitute a level playing field between UK and EU companies given their newly different legal and regulatory masters.  In the event, GBP (-0.8%) is today’s worst G10 currency performer as it quickly fell when Barnier’s comments hit the tape.  Something else to keep in mind regarding the pound is that it feels an awful lot like a successful completion of a Brexit deal is entirely priced in.  So, if that deal is reached, the pound’s upside is likely to be quite limited.  Conversely, if no deal is agreed, look for a substantial shock to the pound, certainly as much as 5%-7% in short order.

And with that cheery thought in mind, let us peruse the overall market condition this morning, where eyeglasses are losing their tint.  Equity markets in Asia overnight were as close to unchanged as a non-holiday session would allow, with the largest movement from a main index, the Hang Seng, just +0.1%.  Both the Nikkei and Shanghai moved less, as investors seemed to be coping with a bit of indigestion after the recent sharp rally.  As mentioned above, European bourses have been no better, with only Spain’s IBEX (+0.4%) showing any hint of life, but the rest of the continental exchanges all in the red.  Even US futures markets are under modest pressure, with all three lower by about 0.2%.

The Treasury market saw an impressive decline yesterday, with yields rising 7 basis points in the 10-year, as the risk rally exploded all day long.  European bond markets also declined, but not quite like that.  Given the ECB’s reported -0.3% CPI reading, the case that bond yields on the continent should be rising is very difficult to make.  This morning, though, movement is measured in fractions of basis points, with only Italian BTP’s having recorded anything larger than a 1 basis point move today, in this case a decline in yields.  Otherwise, we are + / – 0.5 basis points or less in Treasuries, Bunds, OAT’s and Gilts.  In other words, nothing to see here.

Oil is feeling a bit toppish here, having rallied 36% during the month of November, but how ceding about 4% during the past few sessions.  OPEC+ talks remain mired in disagreement with the previous production cuts potentially to be abandoned.  However, taking a longer-term view, analysts are pointing to the changes in the US fracking community (i.e. bankruptcies there) and forecasting a significant decline in US oil production in 2021, which, if that occurs, is likely to provide significant price support.

And finally, the dollar, which fell sharply against virtually every currency yesterday, led by BRL (+2.7%) in the emerging markets and EUR (+1.2%) in the G10, has found its footing today.  Looking at the G10 first, NOK (-0.65%) is the laggard alongside the aforementioned pound and SEK (-0.5%).  The euro (-0.25%) has maintained the bulk of its gains after having finally pushed through key resistance at 1.2011-20, the levels seen in early September. Remember, short USD is the number one conviction trade for Wall Street for 2021, and EUR positions remain near all-time highs.

An aside in the euro is that markets continue to look to next week’s ECB meeting with expectations rife the PEPP will be expanded and extended.  Madame Lagarde promised us things would change, and every speaker since, including the Latvian central bank President, who this morning explained that €500 billion more in the PEPP with a timing extension to mid-2022 would be acceptable, as would an extension in the maturity of TLTRO loans to 5 years.  The point is that despite the confidence so many have that the dollar is destined to collapse next year, there is no way other central banks will allow that unimpeded.

Back to markets, on the EMG slate, the situation is similar with more losers than gainers led by ZAR (-1.1%) and PLN (-0.6%).  Of course, both these currencies saw stronger gains yesterday, so this seems to be a little catch-up price action.  Actually, CLP (+0.65%) has opened stronger this morning, simply adding to yesterday’s gains without an obvious catalyst, while KRW(+0.5%) continues to benefitt from better than expected trade and GDP data.

On the data front, this morning brings ADP Employment (exp 430K) as well as the Beige Book this afternoon.  As well, we will hear again from Chairman Powell, who in the Senate yesterday told us all that there needed to be more fiscal stimulus and that the Fed would do all they can to support the economy.  Given this has been the message for the past six months, nobody can be surprised.  However, one idea that seems to be developing is that the Fed could well announce purchases of longer dated bonds at their December meeting in two weeks’ time, which would certainly have an impact on the bond market, and would be seen as easier money, thus likely impact the dollar as well.  When he speaks to the House today, don’t look for anything new.

All told, today is a breather.  Clearly momentum is for a weaker dollar right now, but I continue to believe these are excellent levels for receivables hedgers to act.

Good luck and stay safe
Adf

Cloaked in Fog

***Moderna vaccine indicated at 94.5% effective** – 6:56am

The rebound in growth
Set records. But the future
Remains cloaked in fog

Similar to what we have seen in every major economy, Q3 GDP growth in Japan recorded the highest ever rate since statistics were first collected and calculated in 1980.  The 21.4% annualized growth in Q3 (5.0% Q/Q), however, was substantially below the levels seen in the US (7.5% Q/Q), France (18.2% Q/Q), Germany (8.2% Q/Q) and the UK (15.5%).  Perhaps the bigger concern for Japan is the fact that it has recouped barely half the economic losses derived from the onset of Covid-19.  And adding to that concern is the recent resurgence in Covid cases, both in Japan and its major export markets, means that Q4 growth is unlikely to continue this trend, and could very well fall back into negative territory, depending on just how long shutdowns are in place around the world.

Investors, however, embraced the news (or embraced some news if not this) as the Nikkei continued its recent rally, rising 2.05% overnight amidst an overall risk-on setting.  In fact, since the close on October 30, the Nikkei has rallied nearly 13% despite relatively unimpressive data.  Not only that, given the BOJ is already at max support, it is unclear what else they can be expected to do to support the economy.  And yet, the equity market would have you believe the future is bright!  The one market not participating in this is FX, where the yen remains unchanged on the session, seemingly unable to decline despite the risk rally, but unable to advance in a weak dollar environment.

As calendar pages keep turning
There’s something that is quite concerning
The Brexit morass
Has reached an impasse
With neither side, for a deal, yearning

While there is no question that deals like the one currently needed to achieve a smooth Brexit on December 31st are always pushed off until there is no more time to delay, it certainly appears that we are getting awfully close to that time.  The big news last week was that Dominic Cummings, one of PM Johnson’s key advisors and a major architect of the entire Brexit campaign, resigned from his post.  Pundits immediately expected the UK to soften their position on state aid, which along with fishing rights for EU (mainly French) fleets are the two big issues remaining to be sorted.  But so far, that is not the case, with the UK’s chief negotiator, David Frost, explaining today that the UK “will not be changing” their positions as the next round of negotiations begins in Brussels.  And yet, markets remain entirely sanguine about the results, clearly expecting a deal to be reached and approved in time.  This is evident in the fact that the pound has actually rallied slightly today, 0.1%, and remains well-ensconced in its recent uptrend.  Similarly, the FTSE 100 continues its recent rally, rising 0.7% and is 14% higher than its close at the end of October.  Gilt yields?  Essentially unchanged on the day at 0.34%.  The point is, there is very little concern that a hard Brexit is in our future.  Either that, or the market is completely convinced that if one comes, the BOE will be able to do something about it. FWIW, the latter seems a bad bet.

Ultimately, the story of today’s session is that risk is a wonderful thing, and those who seek to manage risk or exhibit prudence with their positioning will be left behind again.  In the growth vs. value debate, value still has no value, it’s all about growth.  As an aside, perhaps economist Herbert Stein said it best with his observation now known as Stein’s Law; “If something cannot go on forever, it will stop.”  Bull markets cannot go on forever, so beware!

But they continue this morning with risk everywhere rallying.  Elsewhere in Asia, the Hang Seng rose 0.9% and Shanghai 1.1% after Chinese data showed IP slightly better than expected in October (6.9% Y/Y) although Retail Sales disappointed at 4.3% (exp 5.0%).  However, not only did equity markets there rally, so did the renminbi, rising a further 0.35% overnight and back to its strongest level since June 2018.

In fact, even before the Moderna vaccine news hit the tape, equities were all in the green in Europe (DAX (+0.5%, CAC +1.2%) and US futures were jumping (DOW +1.0%, SPX +0.7%, NASDAQ +0.7%), and they have risen further in the wake of the headline.  Perhaps everything is rosy and we are set to return to some sense of normalcy.  Of course, if that’s the case, will central banks worldwide still need to provide so much support?  And if they don’t provide that support, will markets be able to continue to rally on their own?  Just something to consider.

But at this time, the good vibes are everywhere, with oil markets (+2.5%) encouraged by the idea that the return to normal lies just around the corner, while gold, which had been higher earlier, seems no longer to be necessary in this brave new world, and has fallen 0.8% on the day (1% since the headline.)

Meanwhile, FX markets are in full risk-on mode.  In the G10 bloc, NOK (+0.9%) is the leading gainer, benefitting from the combination of overall risk appetite and the rise in oil prices.  After that, there is a group of commodity currencies (AUD, NZD and CAD all +0.4%) rising on the back of stronger commodity prices.  The euro and pound have both edged higher by 0.1%, and in the wake of the Moderna news, the yen has actually fallen back, (-0.3%), with risk metrics clearly dominating the dollar story now.

In the EMG bloc, BRL has opened much stronger (+1.5%) and we are seeing strength in the commodity focused currencies here as well; RUB (+1.25%), MXN (+1.1%), ZAR (+1.0%).  The rest of the bloc, excepting the Turkish lira (-1.0%) which remains beholden to the inconsistencies of Erdogan’s policies, is also generally firmer but not quite to the same extent.  However, the entire story is risk is ON.

On the data front, Retail Sales dominate the week,:

Today Empire Manufacturing 13.8
Tuesday Retail Sales 0.5%
-ex autos 0.6%
IP 1.0%
Capacity Utilization 72.3%
Business Inventories 0.6%
Wednesday Housing Starts 1455K
Building Permits 1567K
Thursday Initial Claims 700K
Continuing Claims 6.4M
Philly Fed 22.0
Leading Indicators 0.7%
Existing Home Sales 6.45M

Source: Bloomberg

But if the risk appetite is going to be as strong as this morning indicates, none of the data is going to matter.  Nor will anything that the dozen Fed speakers upcoming this week have to say.  Instead, this is all about the vaccine, growth and FOMO.  In this environment, the dollar is likely to remain under modest pressure, but at the end of the day, there is no reason to believe it will decline sharply.

Good luck and stay safe
Adf

Boris Has Gotten His Way

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Willing to Meet

The latest from 10 Downing Street
Is Boris is willing to meet
Midway twixt the stance
Of England and France
In order, the talks, to complete

Meanwhile, from the Far East we heard
That growth was strong in, quarter, third
They’re now set to be
The only country
Where year on year growth has occurred

The weekend has brought a few stories of note, all of them with bullish overtones, and so it should be no surprise that the week is starting with a risk-on tone.  The first place to look is in China, which released its Q3 GDP data last night at a slightly worse than expected 4.9% Y/Y.  While the market was looking for 5.5%, given that China is the first nation to achieve positive year over year growth, it was still seen as a market plus.  At least to the broad market. Interestingly, the Shanghai stock market fell 0.7%.  But, between the GDP data, Retail Sales rising 3.3% Y/Y and the Surveyed Jobless Rate falling a bit more than expected to 5.4%, the Chinese are painting a picture of a solid recovery.  And while this is well below the levels seen prior to the pandemic, it is still well ahead of the rest of the world.

Next up is the UK, where optimism has grown that a Brexit deal will, in fact, be reached. Boris, playing to both his constituents and the Europeans, has said that the UK is preparing for a no-deal outcome, but is happy to continue to talk if the Europeans would consider some compromises.  As well, in the House of Lords, word is they are prepared to remove the offending language from the UK government’s proposed Internal Market Bill, the one that caused all the concern since it was published in July.  In this bill, the UK sets out the relationship between the four nations in the UK; England, Scotland, Wales and Northern Ireland.  However, it was written in such a way as to render part of the Withdrawal Agreement moot, essentially overturning international law unilaterally.  Hence the issue.  In fact, the EU has sued the UK in the ICJ to prevent the law from being enacted.  This has been a major sticking point for the EU and has undermined a great deal of trust between the two sides.  Hence, the removal of that language is seen as a clear positive.  Certainly, FX traders saw it that way as the pound has rallied 0.75% since the news first was reported and is now back to 1.30.  While I believe the probability of a deal being completed remains above 50% (neither side wants a no-deal outcome), I also believe that the pound will fall after a deal is reached.  Sell the news remains the most likely situation in my view.

Adding to these two positive stories, the never-ending US stimulus talks continue to garner headlines despite a distinct lack of progress.  Yet, optimism on a stimulus bill seems to be a key driver in US equity markets, and in fact, in global ones as they are all, save Shanghai, propelled higher.  Given the proximity to the election, it seems unlikely that either side will allow the other to have a political victory, and so I remain skeptical a deal will be reached soon.  Of course, that merely means we can have a whole bunch of rallies on optimism that one will be reached!

With all that in mind, let’s take a look at the markets this morning.  Aside from Shanghai’s negative outcome in Asia, we saw strength with the Nikkei (+1.1%) and Hang Seng (+0.65%) both rallying nicely.  Europe as seen modest strength with the CAC (+0.6%) leading the way although the rest of the continent has seen far less love with the DAX (+0.1%), for instance, barely positive.  In fact, as I write, the FTSE 100 is actually slightly lower, down -0.15%.  US futures, though, have taken the stimulus story to heart and are much higher, between 0.8% (DOW) and 1.1% (NASDAQ).

Bond markets are feeling the risk-on mood as well, as they have fallen across the board with yields rising in every developed market.  Treasury yields are higher by 3.2 basis points, while bunds have seen a more modest 1.2 basis point rise.  Interestingly, the PIGS are seeing their bonds tossed overboard with an average rise of 4.5 basis points in their 10-year yields.

Oil prices (WTI -0.35%) are little changed, surprisingly, as one would expect commodities to rally on a positive risk day, while gold (+0.7%) and silver (+2.6%) are both quite strong, again somewhat surprising given higher yields and positive risk.  There are still many market relationships which have broken down compared to long-term trends.

Finally, the dollar is under pressure across the board this morning, with every G10 currency higher led by NOK (+0.95%) despite oil’s decline.  One of the drivers appears to be the unwinding of some large short positions in commodity currencies, a view that had been gaining credence amongst the leveraged community set.  This has helped SEK (+0.6%) and NZD (+0.55%) today as well.  The rest of the bloc, while higher, has been far less interesting.

On the EMG front, ZAR (+0.65%) is the leader with KRW (+0.5%) next in line.  After that, the gains are far less significant.  Korea’s won clearly benefitted from the Chinese GDP news, as China remains South Korea’s largest export destination.  Meanwhile, any gain in gold is likely to help support the rand given the gold mining industry’s importance to the economy there.  And as you consider the fact that the dollar is weak against virtually every currency, it is far more understandable that gold and silver have rallied as well.

On the data front, this week is not terribly interesting with only a handful of releases:

Tuesday Housing Starts 1455K
Building Permits 1506K
Wednesday Fed’s Beige Book
Thursday Initial Claims 865K
Continuing Claims 9.85M
Leading Indicators 0.7%
Existing Home Sales 6.30M
Friday Manufacturing PMI 53.5
Services PMI 54.6

Source: Bloomberg

However, despite a lack of data, there is no lack of Fedspeak this week, with six speeches just today, led by Chairman Powell at 8:00 on an IMF panel.  One of the themes of this week seems to be the discussion of central bank digital currencies, an idea that seems to be gaining traction around the world.  The other central bank tidbit comes from Madame Lagarde, who, not surprisingly, said she thought it made sense the PEPP (Pandemic EMERGENCY Purchase Program) be made a permanent vehicle.  This is perfectly in keeping with central bank actions where policies implemented to address an emergency morph into permanent policy tools as central bank mandates expand.  Once again, I will point out that the idea that other G10 central banks will allow the Fed to expand their balance sheet and undermine the dollar’s value without a response is categorically wrong. Every central bank will respond to additional Fed ease with their own package, thus this argument for a weaker dollar is extremely short-sighted.

But with all that said, there is no reason to believe the positive risk attitude will change today, unless there is a categorical denial by one of the parties discussing the stimulus bill.  As such, look for the dollar to continue to slide on the session.

Good luck and stay safe
Adf

Deeper Downturn

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

The Story of Boris

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
Adf

Nary a Tear

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Spring Remains Distant

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

All Doom and Gloom

As talks over Brexit resume
The headlines are all doom and gloom
But pound traders seem
To think that the dream
Is real, helping cable to zoom

Once again, the overnight session has been uninspiring, although there seem to be a few conundrums this morning.  The most interesting one is the dichotomy between the pound’s recent performance (+0.2% today, +1.0% this week), and the headlines regarding the difficulty in reaching a Brexit deal.  Time is clearly running short as the two sides get together once again to hash out issues as wide-ranging as access to UK waters for fishing to questions over the application of state aid for companies.  Clearly, there are no easy answers, and in the end, at least one side is going to need to adjust their current views for a deal to be reached.  And arguably, this is a two-week drill, as the details need to be agreed in time for the EU summit, to be held on October 15th, in order to allow enough time for all 27 other EU members to ratify the deal.

The question at hand, though, is what is priced into the market given the pound’s current level of 1.2850.  A quick look at the pound’s price history since the historic vote back in June 2016 shows that the range of trading has been 1.1412 (reached during the initial Covid panic) to 1.5018 (reached in the first minutes after the Brexit vote when the belief was Bremain had won.)  However, if we remove the Covid panic, which was clearly an exogenous event, then the low was 1.1841, reached in October 2016 during the leadership change in the UK.

With this as our framework, it is then worthwhile looking at valuation models, none of which really line up, but perhaps offer some modest insight.  For instance, a PPP valuation based on CPI shows the pound is undervalued by less than 4%, but based on the Big Mac index, Sterling is cheap by 28.5%.  When looking at Effective Exchange rates (REER and NEER), the evidence points to the Big Mac index being a better indicator, with measures for both showing the pound is roughly 24% undervalued.  However, it hardly seems likely that the true value of the pound is near 1.70, which is what those adjustments would imply.  Finally, simply taking a longer term look at the pound’s value (1983-2020) shows that the average price is around 1.5850.  Of course, during all of this time, the UK has been a member of the EU so upon its exit, there will be a significant change in its terms of trade, even if there is a deal.

What conclusions can be drawn from this information?  No matter the backdrop, the pound is in the lowest quartile of its historic price levels, which implies the market is anticipating some bad news.  In the event of a hard Brexit, will the pound trade to new lows, below those seen in 1985?  That seems unlikely.  After all, the UK is not going to sink into the North Sea, it is simply going to change the terms on which it deals with the EU.  Rather, a hard Brexit seems more likely to see a movement toward 1.15-1.20, in my view, as long positions get squeezed and a general gloom settles over the economy, at least initially.  On the other hand, successful negotiations may well see a move toward 1.40-1.45, still undervalued based on some of the indicators, but moving back toward its long-term average.  All in all, I would estimate the market has priced in a two-thirds probability of a hard Brexit, so while further declines are possible, parity with the dollar seems unlikely.  Parity with the euro, however, could well arrive in that scenario.

Turning to the rest of the market, though, shows the entire FX complex appears out of sync with the risk framework.  Equity markets are lower throughout Europe (DAX -0.4%, CAC -0.2%, FTSE 100 -0.5%) after an uninspiring session in Asia (Nikkei +0.1%, Hang Seng -0.85%, Shanghai -0.2%).  US futures are essentially flat, although have spent the bulk of the evening session modestly lower.  Bond prices are a bit firmer this morning, at least in Europe, where Bunds, OATs and Gilts have all seen yields edge 1basis point lower on the day.  Treasury yields, however, are essentially unchanged, still right around 0.65%,

Commodity markets show oil prices softer (WTI -0.65%) but precious metals slightly firmer (Gold +0.4%).  In fact, all metals prices are a bit higher, but agricultural prices are softer.  In other words, signals here are mixed as well.

Finally, the dollar, despite what appears to be a mild risk-off session, is weaker pretty much vs. all its G10 brethren with only the JPY (-0.1%) the outlier.  Arguably, that looks more like a risk-on day than a risk-off one.  The leading gainer in the bloc is AUD (+0.7%) which has been the beneficiary of demand for AGB’s, a slightly higher confidence index reading and a change in view regarding further RBA stimulus by Westpac, one of the big four Australian banks. It should be no surprise that NZD (+0.55%) has followed the Aussie higher, but the rest of the bloc is having a solid day amidst broad-based dollar weakness.

EMG currencies are starting to show more strength at this hour, led by PLN (+1.15%), although gains in MXN (+0.9%), HUF (+0.7%) and CZK (+0.65%) are solid as well.  The zloty has been responding to comments from one of the central bank’s members, Eugeniusz Gatnar, describing near zero interest rates as hurting the economy and calling for normalization by next year.  Meanwhile, MXN seems to be benefitting from an increase in the carry trade, where despite recent volatility, the search for yield is forcing many investors to areas they would not have previously considered.  Overall, the only currencies that have been under pressure remain RUB and TRY as the escalation of fighting between Armenia and Azerbaijan weighs on their sponsors.

On the data front, there was precious little overnight, Tokyo CPI ex Fresh Food fell -0.2%, while European data was all second tier.  This morning we see Case Shiller Home Prices (exp 3.60%) as well as Consumer Confidence (90.0), however, neither of these seem likely to change views.  Of more importance, we have four more Fed speakers, although yesterday’s had little impact.  Arguably, the thing which has the market’s attention is tonight’s first presidential debate, but at this point, it is difficult to determine what type of impact it may have.  Ultimately, a change in the White House is likely to have some significant market implications, with the dollar’s value being clearly impacted.  But it is far too early to discuss this issue.

For today, it appears that the FX market is leading the equity markets, a highly unusual situation, but I expect that we will continue to see modest USD weakness while equity markets edge higher.

Good luck and stay safe
Adf

Fear Has Diminished

From Asia, last night, what we learned
Was China, the corner, has turned
The lockdowns are finished
And fear has diminished
Thus spending, in spades, has returned

The major news overnight comes from China, where the monthly release of data on IP, investment and Retail Sales showed that the Chinese economy is clearly regaining strength.  Arguably, the most noteworthy number was Retail Sales, which while still lower by -8.6% YTD, has rebounded to be 0.5% higher than August of last year.  Anecdotally, movie theaters there have seen attendance return to ~90% of pre-Covid levels, obviously far above anything seen here or in most of Europe.  In addition to the Retail Sales data, IP there rose 5.6% Y/Y and Property Investment rose a greater than forecast 4.6% on a YTD basis.  Overall, while these numbers are still well below the data China had been reporting pre-Covid, they point to Q3 GDP growth in excess of 3.0%, with some analysts now expecting GDP to grow as much as 6% in the third quarter.

With this unalloyed good economic news, it should be no surprise that the renminbi has performed well, and in fact, CNY is one of the top performers today, rising 0.5% and trading to levels not seen since May of last year.  While there are still numerous concerns regarding different aspects of China’s economy, notably that its banking sector is insolvent amid massively underreported bad loans, on the surface, things look better than almost anywhere else in the world.  Perhaps what is more surprising is that the equity market in Shanghai, which rose 0.5% overnight, did not have a better day.

Down Under, the RBA noted
That Aussie, though not really bloated
Would be better off
In more of a trough
Thus, helping growth there be promoted

Meanwhile, the Minutes of the most recent RBA meeting showed that while they couldn’t complain that the Aussie dollar was overvalued, especially given the recent rebound in commodity prices, they sure would like to see it lower to help the export sector of the economy.  However, despite reaffirming they would continue to support the economy, and that yield curve control wasn’t going anywhere, they gave no indication they were about to increase their support.  As such, AUD (+0.6%) is the top G10 performer of the session, and it is now pushing back to the 2-year highs seen earlier this month.

Turning to Europe, the two stories of note come from the UK and the ECB.  In Parliament, PM Johnson had the first reading of his bill that is set to unilaterally rewrite the Brexit deal with the EU, and it passed handily.  It appears that Boris believes he needs even more leverage to force the EU to accede to whatever demands remain in the negotiations, and he is comfortable playing hardball to achieve his ends.  The Europeans, however, continue to believe they have the upper hand and claim they are prepared to have the UK leave with no deal.  Politics being what it is, I imagine we won’t know the outcome until the last possible date, which is ostensibly next month at the EU Summit.

In the meantime, the market is starting to get concerned that a hard Brexit is back on the table and that the pound has much more to fall if that is the outcome.  While the market is not at record long GBP position levels, it is still quite long pounds.  The options market has been pricing more aggressively, with implied volatility around 12% for year-end (compared to 3-month historic volatility of just 9%) and risk reversals 2.5 points for the GBP puts.  While the pound has fallen a bit more than 4% since its peak on September 1st, it is still well above levels seen when fears of a hard Brexit were more prevalent.  As this new bill makes its way through Parliament, I suspect the pound will have further to decline.

As to the ECB, we have had yet more verbal intervention, this time from Italian Executive Board member, Fabio Panetta, who repeated that the ECB needs to remain vigilant and that though they have done a great job so far, they still may need to do more (i.e. ease further) in order to achieve their inflation goals.  The euro, however, continues to drift higher, up another 0.25% this morning, as the market appears to be preparing for a more aggressive FOMC statement and implicit further easing by the Fed.  While I believe it is too early for the Fed to more clearly outline their explicit plans on how to achieve average inflation of 2.0%, clearly there are many market participants who believe the Fed will be the most aggressive central bank going forward and that the dollar will suffer accordingly.  We shall see, but as I have repeatedly indicated, and Signor Panetta helped reiterate, the ECB will not stand idly by and allow the euro to rally unabated.

And those are really today’s stories.  Risk appetite continues to be fed by perceptions of further easy money from all central banks and we have seen equity markets continue their rebound from the short correction at the beginning of the month.  While Asia was mixed, Europe is in the green and US futures are pointing higher as well.  Treasuries are a touch lower, with yields up about 1 basis point, but the reality here is that yields have been in a very tight range for the past month.  In fact, the idea that the Fed needs to introduce yield control is laughable as it appears to already be in place.

As to the rest of the FX market, the dollar is under pressure everywhere, although Aussie and cable are the two leaders in the G10 space.  Elsewhere, there appears to be less conviction, or at least less rationale to buy the currency aggressively.  In the EMG bloc, ZAR is the leader, rising 1.2% this morning, continuing its strengthening trend that began back in August and has seen a nearly 7% appreciation in the interim.  Otherwise, there has been less excitement, with more modest gains on the back of generic USD weakness.

For today, we see Empire Manufacturing (exp 6.9) this morning as well as IP (1.0%) and Capacity Utilization (71.4%).  Alas, with the Fed meeting tomorrow and all eyes pointed to Washington, it seems unlikely that the market will respond to any of this data.  Instead, with the market clearly comfortable selling dollars right now, I see no reason for the buck to do anything but drift lower on the day.

Good luck and stay safe
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