Fated To Burst

While here in the US the word
Is stimulus, more, is preferred
The UK is thinking
‘Bout how they’ll be shrinking
Their deficit, or so we’ve heard

Meanwhile, China, last night, explained
That excesses would be contained
The bubble inflated
By Powell is fated
To burst, as it can’t be sustained

If you look closely enough, you may be able to see the first signs of governments showing concern about the excessive policy ease, both fiscal and monetary, that has been flooding the markets for the past twelve months.  This is not to say that the end is nigh, just that there are some countries who are beginning to question how much longer all this needs to go on.

The first indication came last night from China, remarkably, when the Chairman of the China Banking and Insurance Regulatory Commission, and Party secretary for the PBOC, explained that aside from reducing leverage in the Chinese property market to stay ahead of systemic risks, he was “very worried” about the risks from bubbles in the US equity markets and elsewhere.  Perhaps bubbles can only be seen from a distance of 6000 miles or more which would explain why the PBOC can recognize what is happening in the US better than the Fed.  Or perhaps, the PBOC is the only central bank left in the world that has the ability, in the words of legendary Fed Chair William McChesney Martin “to take away the punch bowl just as the party gets going”.  We continue to hear from Fed speakers as well as from Treasury secretary Yellen, that the Fed has the tools necessary if inflation were to return, and that is undoubtedly true.  The real question is do they have the fortitude to use them (take away that punch bowl) if the result is a recession?

The second indication that free money and government largesse may not be permanent comes from the UK, where Chancellor of the Exchequer Rishi Sunak is set to present his latest budget which, while still offering support for individuals and small businesses, is now also considering tax increases to start to pay for all the previous largesse.  The UK budget deficit is running at 17% of GDP, which in peacetime is extremely large.  And, as with the US, the bulk of that money is not going toward productive investment, but rather to maintenance of the current situation which has been crushed by government lockdowns.  However, the UK does not have the world’s reserve currency and may find that if they continue to issue gilts with no end, there is a finite demand for them.  This could easily result in the worst possible outcome, higher interest rates, slowing growth and a weakening currency driving inflation higher.  The pound has been amongst the worst performers during the past week, falling 1.4% (-0.1% today), as investors start to question assumptions about the ability of the UK to continue down its current path.

But not to worry folks, here in the US, the $1.9 trillion stimulus bill is starting to get considered in the Senate, where some changes will need to be made before reconciliation with the House, but where it seems certain to get the clearance it needs for passage and eventual enactment within the next two weeks.  So, the US will not be heeding any concerns that going big is no longer the right strategy, despite what has been a remarkable run of economic data.  In the current Treasury zeitgeist, as we learned from Florence + The Machine in 2017, “Too Much is Never Enough”!

Where does that leave us today?  Well, risk struggled in the overnight session on the back of the PBOC concerns about bubbles and threats to reduce liquidity (Nikkei -0.9%, Hang Seng -1.2%, Shanghai -1.2%), but after a weak start, European bourses have decided that Madame Lagarde will never stop printing money and have all turned positive at this time (DAX +0.5%, CAC +0.5%, FTSE 100 +0.6%).  And, of course, that is a valid belief given that we continue to hear from ECB speakers that the PEPP can easily be adjusted as necessary to insure continued support.  The most recent comments come from VP Luis de Guindos, who promised to prevent rising bond yields from undermining easy financing conditions.  US futures, meanwhile, while still lower at this hour by about 0.2%, have been rallying back from early session lows of greater than -0.7%.

Treasury yields continue to resume their climb higher, up another 2.9 basis points this morning, although they remain below the 1.50% level.  In Europe, bunds (+2.0bps), OATs (+2.7bps) and Gilts (+0.6bps) are all giving back some of yesterday’s rally, as risk appetite is making a comeback.  Also noteworthy are ACGBs Down Under with a 5.2 bp rise last night although the RBA did manage to push 3-year yields, their YCC target, even lower to 0.087%.

Commodity prices seem uncertain which way to go this morning, with oil virtually unchanged, although still above $60/bbl, and gold and silver mixed.  Base metals are very modestly higher with ags actually a bit softer.  In other words, no real direction is evident here.

As to the dollar, the direction is higher, generally, although not universally.  In the G10, NOK (+0.6%) is the leading gainer followed by AUD (+0.3%) which has held its own after the RBA stood pat and indicated they would not be raising rates until 2024! That doesn’t strike me as a reason to buy the currency, but that is the word on the Street.  But the rest of the bloc is softer, although earlier declines of as much as 0.5% have been whittled down.

EMG currencies have also seen a few gainers (RUB +0.4%, INR +0.25%) but are largely softer led by BRL (-0.7%) and ZAR (-0.7%).  It is difficult to derive a theme here as the mixed commodity markets are clearly impacting different commodity currencies differently.  However, the one truism is that the dollar is definitely seeing further inflows as its broad-based strength is undeniable today.

There is no data released today in the US, although things certainly pick up as the week progresses from here.  On the speaker front we hear from two arch doves, Brainerd and Daly, neither of whom will indicate that a bubble exists or that it is time to cut back on any type of stimulus.  Perhaps at this point, markets have priced in the full impact of the stimulus bill, and the fact that the Fed is on hold, and is looking at other central bank activities as the driver of rates.  After all, if other central banks seek to expand policy, as we have heard from the ECB, then those currencies are likely to come under pressure.

Here’s the thing; investors remain net short dollars against almost every currency, so every comment by other central banks about further support is going to increase the pain level unless the Fed responds.  Right now, that doesn’t seem likely, but if yields do head back above 1.5%, don’t be surprised to see something out of the FOMC meeting later this month.  However, until then, the dollar seems likely to hold its recent bid.

Good luck and stay safe
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GameStop

The company still known as GameStop
Whose model for business, a mall shop
Was heavily shorted
Has seen those shorts thwarted
By buyers whose bubble will not pop

While I recognize GameStop (GME) seems to have absolutely nothing to do with the FX markets, I have been asked by a number of people to explain what happened, so I thought I would offer a relatively short explanation of the events, which were truly remarkable.  And arguably, this is much more about markets in general, and market sentiment in particular.

As always, I think a little perspective is in order.  GME was born in 1984 as Babbage’s in Dallas, Texas.  After a series of mergers, it was acquired by Barnes & Noble in 1999, who merged it with another company, Funco, Inc. and renamed this entity GameStop.  It went public in 2002, was spun off from Barnes & Noble in 2004, and then grew as a business.  Its business model was to be the go-to place for electronic games, and it eventually opened more than 5000 sites throughout malls in the US and around the world.  The problem, of course, is that even before Covid-19, bricks and mortar retail space was suffering.  This was especially so for this business, where games can be downloaded over the internet, and disks and cartridges have lost their appeal.  Covid seemed like the last straw, as malls all over the country were closing and saw extraordinary reductions in foot traffic, thus devastating the company’s business.

Over the course of the past twelve months, short interest in GME stock skyrocketed, as a number of hedge funds expected that the company would file Chapter 11 relatively soon.  After all, revenues had fallen more than 30% on a Q/Q and Y/Y basis, and profitability had disappeared.  In truth, it seemed a pretty logical bet.  However, hedge funds, being hedge funds, and reveling in as much leverage as possible given ZIRP, actually created short positions that grew to 140% of the outstanding float of the stock!  How, you may ask, is that possible?  Well, clearly, there was some naked shorting going on, which means that some of them were selling the stock without having borrowed it to deliver.  Oh, yeah, that is illegal these days.  It is also entirely possible that some brokers holding the stock rehypothecated it, meaning they lent it out more than once, also illegal.

Fast forward to three weeks ago, where a financial analyst, whose Reddit handle is Roaring Kitty, figured out that the short positions in this stock were untenable.  He posted on the Reddit thread WallStreetBets, which picked up traction and encouraged people to buy the stock.  Hence, the stock started to rise after months, if not years, in the doldrums.

The next step came from the options market, where the several million followers of WallStreetBets figured out that the leverage available in buying out of the money call options (also known as low delta call options) was extraordinary, and so they bought millions of them.

As a former option market maker (not in stocks, but FX, bonds and commodities), I can tell you that selling low delta options is a very dangerous trade.  This is because, if the market starts to move toward the strike price, as a hedger, I am forced to buy ever more underlying to hedge my position.  This is called gamma hedging and is the bread and butter of what options traders do all day long.  But the combination of the extraordinary demand for low delta GME calls and the recognition by the hedge funds with extensive short positions fed on itself into a frenzy.  At some point, the prime brokers who were handling those hedge funds’ business had to make margin calls and close out the short positions.  And those type of buyers are completely insensitive to price, because the prime broker doesn’t pay the freight, it is the hedge fund with the short position that is getting stopped out, that takes the losses.

Now, remember, because of the size of the short position, greater than the amount of stock outstanding, this process has taken a while to unfold, and is probably not done yet.  It has, however, busted those hedge funds, who have lost billions of dollars, as well has shown that they were not all that smart after all.  Alas, I fear that all the Robinhooders who were a huge proportion of the buyers are going to find themselves in a bad state as well.  After all, GME is still a dying business with the wrong business model for today.  A $1 billion market cap is probably a lot more appropriate than the current $23 billion market cap, so look for the stock to decline going forward, although probably not as quickly as it rose.

From our perspective, though, I think the lesson of GME is more about what it says about sentiment in the markets these days.  This type of price action and market activity has historically been confined to the last stages of a mania of some sort. In other words, to my eyes, and remember, I have seen market crashes starting in 1987, Tokyo in 1989, 1999-2000, and 2008-2009, this smacks of the true “irrational exuberance” made famous by former Fed Chair Alan Greenspan in 1996.  Whether it is rising rates, disappointment in the slower than expected rollout of the vaccine, or pressure on profit margins and earnings misses, I expect that shedding risk is going to be the norm for the next two quarters at least.  This is not to say we are going to see a collapse in stock markets, just that the gains of the pasts several months and years are unlikely to be repeated.

Which brings us to this morning, where the newest target for a short squeeze by the WSB crowd is silver.  Silver has opened higher by around 8%-10% and is now pressing $30/oz.  The last time silver traded above that level was March 2013, in the wake of the Eurozone debt crisis, and the only other time it did so was in 1980, when the Hunt brothers tried to corner the market.  Understand this, in 1980, the market was smaller, there were more natural buyers of silver for industrial uses, notably Eastman Kodak for film emulsion, and the Hunt’s failed dismally once the COMEX changed the rules.  Today, in a much larger market ($1.5 trillion) with far less industrial demand, this seems destined to fail, at least with respect to achieving the same type of impact as GME.  But that doesn’t mean the price can’t go higher in the short run.

Ok, on to FX, where today is PMI day, with the most noteworthy results coming from China over the weekend.  Noteworthy in the sense that they were all worse than expected (Mfg 51.3, Services 52.4 and Caixin 51.5) and all represented pretty big declines from last month.  In addition, the forward-looking pieces, like New Orders and Employment also fell sharply, so it doesn’t bode well for February.  Recall, China has locked down much of the northern part of the country to prevent the spread of Covid and this is occurring right before the start of the Lunar New Year holiday, the busiest travel time of the year, historically, in the country.  The point is, if expectations are for China’s economy to drive global growth, we could be seeing a longer delay before things pick up.

European PMI’s were generally in line with expectations on the manufacturing side and a number of other emerging market economies saw better than anticipated results.  Again, this simply highlights that the recovery in H1 is likely to be quite uneven.

As to markets, despite early losses in Asia and US futures, equity markets have turned around and were robustly higher overnight (Nikkei +1.55%, Hang Seng +2.15%, Shanghai +0.6%) and are all higher throughout Europe (DAX +1.5%, CAC +1.5%, FTSE 100 +1.2%).  US futures, which had opened the overnight session down as much as 1% are now all higher by more than that.

Bond markets are also demonstrating risk-on characteristics, albeit on a much more subdued basis.  Treasury yields have edged higher by 1.2bps, while bunds are essentially unchanged along with OATs and Gilts.  What we are seeing is PIGS bonds rallying with yields in Italy (-3.2bps) and Greece (-2.7bps) falling the most.

With silver leading the way, gold (+0.7%), too, is higher and so is crude oil (+0.5%).  In other words, risk is in favor here.  Interestingly, the FX market is not as convinced, at least not if we believe that risk-on is synonymous with a weaker dollar.  CHF (-0.6%) is the worst performer, which as a haven makes some sense, but EUR (-0.5%) leads the rest of the European group down, after German Retail Sales fell -9.6%!  The commodity currencies have not been as badly impacted (CAD -0.3%, AUD -0.2%).  Actually, today’s best performing G10 currency, other than the dollar, is the pound, which is basically flat as the success they’ve had with their vaccine program (13% of the population has already been vaccinated, the most by far for a large nation) has investors of the belief that the UK will lead the recovery.

EMG currencies are having a more mixed session with TRY (+1.7%) the leading gainer on further hawkish comments from the new central bank head there helping convince traders that tighter monetary policy will be with us for a while.  MXN (+1.15%) is next in line, on the strength of the commodity rally, along with ZAR (+0.75%) on the same basis.  Remember, Mexico is the largest silver producing country in the world, so the big rally in silver is clearly helping the peso.  On the downside, CNY (-0.6%) suffered on its data, and the CE4 are all falling similar amounts to the euro.  The rest of the bloc is less interesting and mixed as to gainers and losers.

On the data front, ISM Manufacturing (exp 60.0) is the main release today, with Construction Spending (+0.8%) due as well.  It is a payroll week, but I will delve into that more tomorrow as this note is already exceptionally long.  We do hear from three Fed speakers today, with a mix of uber doves and regular doves, so if anything, I expect that we will see more talk of needing more stimulus.  Speaking of which, the political fight over the proposed $1.9 trillion new bill continues but, in the end, you know that they will pass another bill with a lot more money being spent.

For all the conviction as the new year began that the dollar would decline sharply, the price action through January has clearly shaken some people.  However, positioning seems to be remaining steady, and I still believe that as inflation rises, real yields will fall sharply and the dollar along with it.  But for now, the dollar continues to push out the weak shorts, and quite frankly, this move does not feel like it is ending.  At this stage, a move in the euro toward 1.1950 seems quite viable.

Good luck and stay safe
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Was It Ever?

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
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Out of Hand

The Chinese are starting to learn
The things for which all people yearn
A chance to succeed
Their families to feed
As well, stocks to never, down, turn

But sometimes things get out of hand
Despite how they’re carefully planned
So last night we heard
Officialdom’s word
The rally is now to be banned!

It seems like it was only yesterday that the Chinese state-run media were exhorting the population to buy stocks in order to create economic growth.  New equity accounts were being opened in record numbers and the retail investors felt invincible.  Well… it was just this past Monday, so I guess that’s why it feels that way.  Of course, that’s what makes it so surprising that last night, the Chinese government directed its key pension funds to sell stocks in order to cool off the rally!  For anyone who still thought that equity market movement was the result of millions of individual buying and selling decisions helping to determine the value of a company’s business, I hope this disabuses you of that notion once and for all.  That is a quaint philosophy that certainly did exist back in antediluvian times, you know, before 1987.  But ever since then, government’s around the world have realized that a rising stock market is an important measuring stick of their success as a government.  This is true even in countries where elections are foregone conclusions, like Russia, or don’t exist, like China.  Human greed is universal, regardless of the political system ruling a country.

And so, we have observed increasing interference in equity markets by governments ever since Black Monday, October 19, 1987.  While one can understand how the Western world would be drawn to this process, as government’s regularly must “sing for their supper”, it is far more surprising that ostensibly communist nations behave in exactly the same manner.  Clearly, part of every government’s legitimacy (well, Venezuela excluded) is the economic welfare of the population.  Essentially, the stock market today has become analogous to the Roman’s concept of bread and circuses.  Distract the people with something they like, growing account balances, while enacting legislation to enhance the government’s power, and by extension, politicians own wealth.

But one thing the Chinese have as a culture is a long memory.  And while most traders in the Western world can no longer remember what markets were like in January, the Chinese government is keenly aware of what happened five years ago, when their last equity bubble popped, they were forced to devalue the renminbi, and a tidal wave capital flowed out of the country.  And they do not want to repeat that scenario.  So contrary to the protestations of Western central bankers, that identifying a bubble is impossible and so they cannot be held responsible if one inflates and then pops, the Chinese recognized what was happening (after all, they were driving it) and decided that things were moving too far too fast.  Hence, not merely did Chinese pension funds sell stocks, they announced exactly what they were going to do ahead of time, to make certain that the army of individual speculators got the message.

And so, it should be no surprise that equity markets around the world have been under pressure all evening as risk is set aside heading into the weekend.  The results in Asia showed the Nikkei fall 1.1%, the Hang Seng fall 1.8% and Shanghai fall 2.0%.  European markets have not suffered in quite the same way but are essentially flat to higher by just 0.1% and US futures are pointing lower by roughly 0.5% at this early hour (6:30am).

Interestingly, perhaps a better indicator of the risk mood is the bond market, which has rallied steadily all week, with 10-year Treasuries now yielding just 0.58%, 10bps lower than Monday’s yields and within 4bps of the historic lows seen in March.  Clearly, my impression that central banks have removed the signaling power of bond markets needs to be revisited.  It seems that the incipient second wave of Covid infections in the US is starting to weigh on some investor’s sentiment regarding the V-shaped recovery.  So perhaps, the signal strength is reduced, but not gone completely.  European bond markets are showing similar behavior with the haven bonds all seeing lower yields while PIGS bonds are being sold off and yields are moving higher.

And finally, turning to the FX markets, the dollar is broadly, albeit mildly, firmer this morning although the biggest gainer is the yen, which has seen significant flows and is up by 0.4% today taking the movement this week up to a 1.0% gain.  Despite certain equity markets continuing to perform well (I’m talking to you NASDAQ), fear is percolating beneath the surface for a lot of people.  Confirmation of this is the ongoing rally in gold, which is higher by another 0.25% this morning and is now firmly above $1800/oz.

Looking more closely at specific currency activity shows that the commodity currencies, both G10 and EMG, are under pressure as oil prices retreat by more than 2% and fall back below $40/bbl.  MXN (-0.6%), RUB (-0.3%) and NOK (-0.2%) are all moving in the direction you would expect.  But we are also seeing weakness in ZAR (-0.5%) and AUD (-0.1%), completing a broad sweep of those currencies linked to commodity markets.  It appears that the fear over a second wave, and the negative economic impact this will have, has been a key driver for all risk assets, and these currencies are direct casualties.  But it’s not just those currencies under pressure, other second order impacts are being felt.  For example, KRW (-0.75%) was the worst performer of all overnight, as traders grow concerned over reports of increased infections in South Korea, as well as Japan and China, which is forcing secondary closures of parts of those economies.  In fact, the EMG space writ large is behaving in exactly the same manner, just some currencies are feeling the brunt a bit more than others.

Ultimately, markets continue to be guided by broad-based risk sentiment, and as concerns rise about a second wave of Covid infections spreading, investors are quick to retreat to the safety of havens like Treasuries, bunds, the dollar and the yen.

Turning to the data story, yesterday saw both Initial (1.314M) and Continuing (18.062M) Claims print at lower than expected numbers.  While that was good news, there still has to be significant concern that the pace of decline remains so slow.  After all, a V-shaped recovery would argue for a much quicker return to more ‘normal’ numbers in this series.  Today brings only PPI (exp -0.2% Y/Y, +0.4% Y/Y ex food & energy), but the inflation story remains secondary in central bank views these days, so I don’t anticipate any market reaction, regardless of the outcome.

There are no Fed speakers, but then, they have been saying the same thing for the past three months, so it is not clear to me what additional value they bring at this point.  I see no reason for this modest risk-off approach to end, especially as heading into the weekend, most traders will be happy to square up positions.

Good luck, good weekend and stay safe

Adf

 

Buying With Zeal

When markets are healthy, they’ve got
Investors who’ve sold and who’ve bought
All based on their views
Of critical news
As profits are actively sought

But these days most governments feel
It’s better that they should conceal
The idea of prices
Reflecting a crisis
And so they are buying with zeal

It remains difficult to understand the enthusiasm with which investors, if it truly is investors, are chasing after stock prices these days. Last night’s version of this story took place in Asia, where the Nikkei was the laggard of the major markets, only rising 1.8%. At the same time, in Hong Kong, home to the biggest recent crackdown on personal freedoms in the world, the stock market jumped 3.8%. Of course, that is nothing compared to China’s Shanghai Index, which rose 5.7% overnight, and is now higher by more than 9% YTD. Interestingly, it appears that the key driver of the equity rally in China was the plethora of headlines essentially telling the population to buy stocks! At this point, it is no longer clear to me that equity market prices contain any information whatsoever regarding the state of the companies listed. Certainly, the idea that they reflect millions of independent views of the future has been discarded. Rather, it appears that governments around the world have come to believe that higher stock prices equate to improved confidence, regardless of how those prices came about.

It is not hard to understand why this idea has gained government adherents, as every government wants its citizens to be confident and happy. The problem is that they have the causality backwards. Historically, the process worked as follows: stock performance reflected the views of millions of individual and institutional investors views on how companies would perform in the future. Expectations about earnings were crucial and those were tied to broad economic performance. Clearly, the level of interest rates played a role in these decisions, but so did issues like the business environment, the competitive environment and government policies on taxes and regulation. At that time, if the underlying features were aligned so that stock prices were rising, it was likely a result of an underlying confidence in the economy and its overall performance. But that is essentially ancient history at this point, having largely ended in 1987.

Ever since Black Monday, October 19,1987, and more importantly, then Fed Chairman Alan Greenspan’s promise to add as much liquidity as necessary to prevent a further collapse, the fundamental ideas of what the stock market describes and explains have been inverted. Governments worldwide have learned that if they support equity markets, it can lead to better economic outcomes, at least until the bubbles burst. But this is why we first got the Tech bubble of 1999-2000, which when it burst saw governments double down to inflate the housing bubble of 2007-09, which when it burst saw governments double down again to inflate the “everything” bubble, that in many ways still exists. A decade of ZIRP and NIRP has distorted any and all signals that equity markets may have offered in the past.

And so, it should be no surprise that governments around the world, who have piled one bad decision on top of another, should look for something they can still do which they believe will have a positive impact on their constituents. Hence, government support for stock markets is likely a permanent feature of the financial markets for the future. It is, of course, ironic that the Chinese Communist Party believes that the way to control their population is through markets, but, hey, whatever works is the mantra.

This, too, will end in tears, but for now, it is the reality with which we all must deal.

With this as preamble, a look around today’s session shows that the Asian (equity) flu has infected every market around the world. In Europe, the DAX and CAC (both +1.7%) are performing nicely, but not quite as well as the FTSE 100 (+1.9%) or nearly as well as Spain’s IBEX (+2.5%). US futures, meanwhile, are just getting warmed up, with current gains of between 1.2%-1.5%. Bond markets, though, are a little less risk drunk, although the 10-year Treasury yield has risen 1.5bps to 0.68%. But in Europe, pretty much every government bond market is seeing demand as yields there fall across the board. Once again, there seems to be a risk disconnect between markets.

While WTI prices are little changed, Brent has pushed higher by 0.5%, again a risk positive. And gold, despite all the equitiphoria, continues to rise, up another $4/oz and pushing ever closer to $1800. And what of the dollar you ask? Clearly on its back foot today, down vs. almost all its G10 brethren, with only CAD and JPY a touch weaker, and both by less than 0.1%. On the positive side, NOK is the big winner, up 0.7%, as it benefits from a combination of modestly higher Brent prices, general risk appetite and the fact that it is the worst performing G10 currency this year, so has the most ground to make up. But we are seeing solid gains in the euro and Swiss franc (0.4% each) as well as Aussie and Stockie. The pound, on the other hand, which is higher, is barely so.

In the EMG bloc, CNY is today’s king, having rallied 0.6% despite the fact that the PBOC fixed the currency weaker overnight. However, given the equity rally there, it cannot be that surprising. But almost the whole bloc is rallying today with MXN (+0.6%) and the CE4 (+0.4% on average) also benefitting from increased risk appetite. In fact, there is only one outlier on the downside, RUB (-0.65%) which despite Brent’s gains, is suffering as the virus continues to run amok in the country.

On the data front this week, there is not very much to excite:

Today ISM Non-Manufacturing 50.0
Tuesday JOLTS Job Openings 4.8M
Wednesday Consumer Credit -$15.0B
Thursday Initial Claims No forecasts yet
  Continuing Claims No forecasts yet
Friday PPI 0.4% (-0.2% Y/Y)
  -ex food & energy 0.1% (0.5% Y/Y)

Source: Bloomberg

Clearly, the most surprising thing is that as of Monday morning, no economist is willing to opine on their Initial Claims views. While it could be due to the holiday, I have a feeling it is more related to the fact that most economists have lost faith in their models’ ability to accurately describe the economy. Certainly, the flattening of this curve calls into question the validity of the V-shaped recovery story, so it will be interesting to see when these estimates start to show up.

We do hear from two Fed members this week, Thomas Barkin and Mary Daly, but that story remains unchanged and will do so until at least the meeting at the end of this month, and probably until the September meeting.

So, to recap, risk is on as governments around the world encourage it as whole-heartedly as they can. And with it, the dollar remains under pressure for now.

Good luck and stay safe
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Overrun

Our planet, third rock from the sun
Has clearly now been overrun
By Covid-19
Whose spread is unseen
And cannot be fought with a gun

It is certainly difficult, these days, to keep up with the latest narrative about how quickly the virus will continue to spread and when we will either flatten the infection curve or will get past its peak. Every day brings a combination of optimistic views, that within a few weeks’ things will settle down, as well as pessimistic views, that millions will die from the virus and it will be many months before life can return to any semblance of normal. And the thing is, both sets of opinions can come from reasonably well-respected sources. Adding to the confusion is the fact that there is still a huge political divide in the US, and that many comments are politically tinged in order to gain advantage. After all, while it has not been the recent focus, there is still a presidential election scheduled for November, a scant seven plus months from now.

With this as the baseline, it cannot be that surprising that we have seen the extraordinary volatility present throughout markets in recent weeks. And while volatility may have peaked, it is not about to fall back to the levels present two months ago. In fact, the one thing of which I am certain is it will take a long time for markets to settle back into the rhythms that had seemed so pleasing and normal for so many years.

Something else to note is that while central banks seem to have been able to positively impact market behavior in recent days, the cost of doing so has gone up dramatically. For example, during the financial crisis, the widely hated TARP bill had a price tag of $700 billion, clearly a large number. And yet that is one-third of what the present stimulus bill will cost. And the Fed? Well it took them three months in 2008 to expand their balance sheet by $1 trillion. This time it took less than three weeks. And they are not even close to done!

It is the latter point that brings the greatest risk to markets, the fact that the cost of addressing market failures has grown far faster than the global economy. This is a result of the serial bubble blowing that we have seen since October 1987, when the Maestro himself, then Fed Chair Alan Greenspan, promised the Fed would support markets and not allow things to collapse. That inaugurated a pattern of central bank behavior that prevented markets of any kind from clearing excesses because the political fallout would have been too great. But as we have seen, each bubble blown since has had a larger and larger price tag to overcome. The question now is, have we reached the limits of what policymakers can do to prevent markets from clearing? Certainly, they will never admit that is the case, but much smarter people than me have made the case that their capabilities have been stretched to the limit.

It is with this as background that I think it makes sense to discuss what we have seen this week alone! Using the S&P 500 as our proxy, we saw a sharp decline on Monday, over 4%, and then a three-day rebound of nearly 18%! In fact, from its lows on Monday, the rebound has been more than 20%. Many in the financial press have been saying this is now a bull market. My view is that is bull***t. A bull market needs to be defined as a market where prices are rising on the back of strong underlying fundamentals and where long-term prospects are strong. The recent fixation on 20% movements as defining a bull or bear market are completely outdated. Instead, I think the case is far easier to make that we are ensconced in the beginning of a bear market, where the long-term, or at least medium-term, fundamentals are quite weak and prospects are uncertain, at best, and realistically quite negative for the coming quarters. Declaring a bull market on the same day that Initial Unemployment Claims printed at nearly 3.3 million, far and away the highest in history, is ridiculous! I fear that the movement this week in stocks and the dollar, is not the beginning of a new trend, but a reactive bounce to previous price action.

Turning to the dollar, after a remarkable rally in the buck throughout the month of March, it too has fallen sharply during the past several sessions. The proximate cause was the Fed, which when it announced its laundry list of new programs on Monday evening was able to calm immediate fears over a lack of USD liquidity. It appears that the dollar’s two week run of strength was driven by global fears over a shortage of dollar liquidity available coming into quarter end next week. We saw this in the movement of basis swap spreads, which blew out in favor of dollars, and we saw this in the FX forward market, where every price that encompassed the turn was no longer linearly interpolated. But the Fed has thrown $5 trillion at the problem and for now, that seems like it is enough, at least for this quarter. Markets have settled, and the fear over coming up short of dollars has abated for the time being.

But this is not over, not by a longshot. Navigating the next few months will be quite difficult as we are sure to see more negative news regarding the virus, followed by policy attempts to address that news. Until a solid case is made that globally, the peak of the infection curve is behind us, we are going to remain in a tenuous market state with significant volatility.

Finishing with a brief look at the dollar this morning, it is actually having a mixed session. In the G10, NOK continues to be the most volatile currency by far, down 1.3% this morning after an intervention led 14% rally in the past week. Of course, that was after it fell nearly 29% in the previous two weeks! And you thought only EMG currencies were volatile! But the rest of the G10 space shows JPY strength, +0.9%, as repatriation flows help the currency, and then much lesser movements in both directions from the rest of the bloc.

In the emerging markets, the story is similar, with KRW the biggest gainer, +1.8% overnight, as the BOK confirmed its recent activity qualifies as QE, and more importantly, that they will continue to do everything necessary to support the economy. Meanwhile, on the opposite end of the spectrum is the Mexican peso, which has fallen 1.5% this morning after Standard & Poor’s downgraded the country’s credit rating by a notch to BBB and left them on negative watch. The peso, too has had a wild ride this month, declining nearly 6 full pesos at its worst level, or 30%, before rallying back sharply this week by 10% at its peak, now more like 8.2%. Again, the point is that we can expect ongoing sharp movements in both directions for now.

With spot today being month-end, I realize many companies will be active in their balance sheet rolling programs. Forward bid-ask spreads continue to be wider than normal but have definitely moderated from what we saw in the past two weeks. This is the new normal though, so for the next several months, be prepared for wider pricing than we all learned to love.

Good luck, good weekend and stay safe
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