Rule By Decree

The virus continues to be
Our number one priority
The global response
Has been to ensconce
The idea of rule by decree

Thus governments, both left and right
Expand as they all try to fight
Their total demise
And what that implies
‘Bout politics as a birthright

Covid-19 has created a new lens through which we view everything these days, from financial market activity to whether or not to answer the doorbell. And in every task, we have become more circumspect as to the potential effects of our choices. As Dorothy said, “I don’t think we’re in Kansas anymore.” But despite the major upheavals we have seen, we must still seek the best possible outcomes at our appointed tasks, be they as important caring for our loved ones, or as mundane as hedging FX risk. Of course, this note talks about the latter not the former, so while I truly wish you all to stay healthy and safe, that will not be the topic du jour.

Instead, I thought it might be worthwhile to discuss just how much firepower central banks and governments have thrown at Covid-19, or more accurately at the disruptions the spread of the virus has wrought. I have gathered from central bank websites the remarkable amount of actions that they have taken so far in just March of this year. This is not meant to be exhaustive but merely illustrative of the breadth of activity we have seen:

Central Bank Rate cuts Current rate QE  Bio USD equivalent
Fed -1.50% 0.25% 5000
BOC -1.50% 0.25% 90
Norgesbank -1.25% 0.25%
RBNZ -0.75% 0.25%
Chile -0.75% 1.00%
RBI -0.75% 4.40% 12
Bank of England -0.65% 0.10% 240
RBA -0.50% 0.25% 80
BOKorea -0.50% 0.75%
Philippines -0.50% 3.75%
BCBrazil -0.50% 3.75%
Colombia -0.50% 3.75%
Banxico -0.50% 6.50%
Thailand -0.25% 0.75%
Indonesia -0.25% 4.50%
PBOC -0.20% 2.20%
SNB 0.00% -0.75%
ECB 0.00% -0.50% 1100
BOJ 0.00% -0.10% 205
Riksbank 0.00% 0.00% 30
MASingapore 0.00% 1.26%
Russia 0.00% 6.00%
Danmark Nationalbank 0.15% -0.60%

The collective amount of rate cutting has been 10.70%! And QE that was easily confirmed now totals more than $6.75 trillion equivalent. Central banks are pulling out all the stops. Meanwhile, governments, to the extent they are separate than central banks, have been adding fiscal stimulus by the truckload as they create inventive new ways to support both businesses and individuals in this most remarkable of situations. Will it be enough to stem the tide? Only time will tell, but nobody can accuse these officials of not trying, that’s for sure.

Of course, as I have discussed previously, the biggest concern ought to be just how much of the economy is controlled by governments, especially in ostensibly free market nations, when all this finally passes. And even more importantly, how quickly they reduce that control. Alas, if history is any guide, it will require a revolution for governments to cede their grip on the economy, and by extension the power it brings. There is a book, “The Fourth Turning” by Neil Howe, which discusses the cycles of history. It is a fascinating read, and one which seems quite prescient as to the current global political situation. I highly recommend taking a look.

In the end, what seems quite certain is that what we assumed was normal just two months ago may never return. This is true of businesses as well as market behaviors. Safe havens have lost much of their luster as investors find themselves in a very difficult situation. How can getting paid just 0.6% nominally for 10 years (current 10-year treasury yield) be considered a safe place to hold your funds with inflation running at 2.3%, and after a likely short-term deflationary bout due to demand destruction, set to move to heights not seen since prior to the GFC? Of course, the answer is, it can’t. But then Treasuries have a higher return than Gilts, Bunds or JGB’s, the other nations to which one would naturally gravitate for a safe haven. Equities certainly don’t create warm and fuzzy feelings given the extraordinary situation with businesses shutting down everywhere and revenues and earnings collapsing. Commodities? Even gold has had a tough time, although it is marginally higher since all this really got going in earnest, but as a safe haven? Cryptocurrencies? (LOL). In fact, despite the ongoing depreciation of the dollar through creeping inflation, Benjamins are clearly the one thing that remain accepted as a place to maintain value. They are fungible and recognized worldwide as a store of value and medium of exchange. It is with this in mind that we should recognize the near-term outlook for the dollar should remain positive.

So what has happened overnight? The dollar is king once again, rising against all its G10 counterparts with CAD the laggard, -1.1%, after oil prices once again sold off sharply (WTI briefly traded below $20/bbl and isdown about 5.2%) this morning. But the weakness is widespread with SEK -1.0% and EUR -0.8% following closely behind the Loonie. European data released this morning showed, not surprisingly, that Economic Confidence (94.5 from 103.5) had fallen at its fastest pace ever, although it has not yet plumbed the depths of the Eurozone crisis in 2012. Give it time!

Emerging markets are also under significant pressure, with MXN today’s biggest loser, down 1.8%, as the combination of tumbling oil prices, the rapid decline of US demand and AMLO’s remarkably insouciant response to Covid-19 has investors fleeing despite the highest yields available in LATAM. But RUB (-1.3%) on the back of declining oil prices and ZAR (-1.1%) on the back of declining commodity prices as well as internal credit problems, are also suffering. In fact, just two currencies, MYR and PHP were able to rally today, each by about 0.2% as each nation announced additional fiscal and monetary support.

Looking ahead this week, aside from the ongoing virus news, we do get more data as follows:

Tuesday Case Shiller Home Prices 3.29%
  Chicago PMI 40.0
  Consumer Confidence 110.0
Wednesday ADP Employment -150K
  Construction Spending 0.5%
  ISM Manufacturing 45.0
  ISM Prices Paid 41.8
Thursday Trade Balance -$40.0B
  Initial Claims 3150K
  Factory Orders 0.2%
Friday Nonfarm Payrolls -100K
  Private Payrolls -110K
  Manufacturing Payrolls -10K
  Unemployment Rate 3.8%
  Average Hourly Earnings 0.2% (3.0% Y/Y)
  Average Weekly Hours 34.2
  Participation Rate 63.3%
  ISM Non-Manufacturing 44.0

Source: Bloomberg

Obviously, much of this is still backward looking and the real question on the NFP report is just how much of the disruption took place during the survey week, which was 3 weeks ago. I think the Initial Claims number will have more power this month, as well as the ISM data. But boy, next month’s NFP report is going to be UGLY!

At any rate, there is not going to be anything positive from the economic data set this week, or probably throughout April. Rather the next piece of positive news we will hear is when the infection curve has started to flatten and there is an end to this disruption in sight. As of now, one man’s view is we will be like this for another month at least. I sincerely hope for everyone, that it is shorter than that.

Good luck and stay safe
Adf

No Easy Fix

As fears ‘bout the virus increased
Supply and demand growth have ceased
There’s no easy fix
Or policy mix
But funding soon will be released

Words fail to describe the price action across all markets recently as volatile seems too tame a description. Turbulent? Tumultuous? I’m not sure which implies larger moves. But that is certainly what we have seen for the past two weeks and is likely to be what we see for a while longer. The confluence of events that is ongoing is so far outside what most market participants had become accustomed to over the past decade, that it seems many are simply giving up.

Consider; signing of phase one of the trade deal between the US and China was hailed as a milestone that would allow trading to return to its prior environment which consisted of ongoing monetary support by central banks helping to underpin economic growth with low inflation. As such, we saw equity markets worldwide benefit, we saw haven assets come under some pressure as havens were seen as unnecessary, and we saw the dollar rally as the US equity market led the way and investors everywhere wanted to get in on the party.

But that is basically ancient history now, as the combination of the discovery, evolution and spread of the coronavirus along with a pickup in US electoral excitement essentially destroyed that story. The past two weeks has been the markets’ collective effort to write a new narrative, and so far, they have not agreed on a theme.

The interesting point about Covid-19 economically is that it has created both a supply and a demand shock. The supply shock was the first thing really observed as China shut down throughout February and companies worldwide that relied on China as part of their supply chain realized that their own production would be impaired. So, we had a period where the focus was almost entirely on which multinational companies would be reducing Q1 earnings estimates due to the supply problems. This also encouraged the economics set to assume a “V” shaped recovery which had most investors looking through Q1 earnings warnings and remaining fully invested.

Unfortunately, as Covid-19 spread though, and I think it is now on every continent and spreading more rapidly, governments worldwide have imposed travel restrictions to the hardest hit countries (China, South Korea, Italy). But an even bigger problem is that many companies around the world are imposing their own travel and hiring restrictions, with Ford, famously, halting all business travel alongside a number of major banks (JPM, HSBC, Credit Suisse). In fact, yesterday, I was visiting a client who explained that our meeting would be their last as they are not allowing other companies to visit their headquarters starting today. The point is this is a demand shock. Travel and leisure companies will continue to suffer until an all clear is sounded. Talk of postponing or canceling the Olympics in Tokyo this summer is making the rounds. Talk of sporting events being played in empty arenas has increased. (March Madness with no crowds!) And there are the requisite stories about store shelves being emptied of things like toilet paper, paper towels and hand sanitizer.

The problem for policy makers is that the response to a supply shock and the response to a demand shock are very different. A demand shock is what policymakers have been assuming since the Great Depression, as easing monetary and fiscal policy is designed to increase demand through several different channels. But a supply shock requires a different emphasis. Neither monetary nor fiscal policy can address Covid-19 directly, curing the ill or protecting those still uninfected. The closure of manufacturing capacity as a response to trying to avoid the spread of a disease is going to have a massive negative impact on corporate finances. After all, interest is still due even if a company doesn’t make any sales. To address this, central banks will need to show forbearance on banks’ non-performing loan ratios, as well as incent banks to continue to lend to companies so impacted. It needs to be more finely targeted, something at which central banks have not shown themselves particularly adept.

And of course, after a decade of central bankers teaching markets that if there is a decline of any magnitude, the central bank will step in, policy space is already quite limited. In sum, the next market narrative remains unwritten because we have never seen this confluence of circumstances before and there are millions of different ideas as to what is the right way to behave. Volatility will be with us for a while.

So with that long preamble, turning to the markets sees that after yesterday’s remarkable risk-on rally in the US, arguably catalyzed by the fact that Senator Sanders fared more poorly than expected in Super Tuesday voting, (thus reducing the chance of his eventual election), Asia picked up the baton and rallied. But Europe has not been able to follow along with virtually every European equity market down at least 1.5%. US futures are also suffering, currently lower by 1.75% or so across all three indices. Meanwhile, 10-year yields, which yesterday managed to trade back above 1.0%, are down nearly 10bps this morning as risk is being jettisoned left and right. The yen is rocking, up by 0.6%, with the dollar trading below 107.00 for the first time since October. In fact, the dollar is generally on its back foot this morning, as the market continues to price in further significant rate activity by the Fed, something which essentially none of its counterparty central banks can implement. At this point, the market is pricing in almost 50bps more at the March meeting in two weeks, and a total of 75bps by July. The ECB doesn’t have 75 to cut, neither does the BOJ or the BOE or the RBA. So, for now, the dollar is likely to remain soft. But as the market has priced these cuts in, I would have anticipated the dollar to fall even further. This hints that the dollar’s decline is likely near its end.

On the data front, remarkably, yesterday’s ISM Non-Manufacturing print was stellar at 57.3, but nobody is certain how to interpret that and what impact Covid-19 may have had on the data. Today we see a bit more data here with Initial Claims (exp 215K), Nonfarm Productivity (1.3%), Unit Labor Costs (1.4%) and Factory Orders (-0.1%). My sense is that Initial Claims is the one to watch. Any uptick there could well be interpreted as the beginning of layoffs due to Covid-19, but also as a prelude to weaker overall growth and perhaps a recession. It is still early days, but arguably, Initial Claims data, which is weekly, will be our first look into the evolution of the economy during the virus.

For now, the dollar remains soft, and I doubt any data will change that, but the dollar will not fall forever. Layering in receivables hedges seems like a pretty good plan at this point.

Good luck
Adf

A Fig Leaf?

This morning, the market’s motif
Is central banks’ promised relief
The all-clear has sounded
And stocks have rebounded
But is this more than a fig leaf?

In case you were curious what central bank relief looked or sounded like, I have included the statements from each of the four major central banks addressing Covid-19, starting with the Fed’s statement Friday afternoon that was able to turn the equity market around (all are my emphases). Since then, we have heard from the other three major banks, as per below, and we have also been informed that G7 FinMins would be having a conference call this week to discuss a coordinated response.

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.

Global financial and capital markets have been unstable recently with growing uncertainties about the outlook for economic activity due to the spread of the novel coronavirus. The Bank of Japan will closely monitor future developments and will strive to provide ample liquidity and ensure stability in financial markets through appropriate market operations and asset purchases.”

The Bank of England is working with the UK Treasury as well as international partners to ensure all necessary steps are taken to protect financial and monetary stability amid the global outbreak of the coronavirus. The bank continues to monitor developments and is assessing its potential impacts on the global and UK economies and financial systems.

The European Central Bank is vigilant and mobilized when it comes to the fallout from the outbreak of the coronavirus. Any response needs to be calm and proportionate. ECB policy is already very accommodative.

And this has essentially been this morning’s market story, a major relief rally. Friday night, late, China released its PMI data and it was dreadful, with Manufacturing PMI at 35.7 while the Non-manufacturing figure was even worse, at 29.6! This should dispel was any doubts that growth in China has nearly ground to a halt. However, despite the promised support by central banks around the world, and you can be sure pretty much all of them, not just the big four, will be jumping in, if quarantines remain in place as the infection continues to spread, supply lines will remain broken and growth will be feeble. The OECD just released a report regarding the coronavirus with updated GDP forecasts and it is not pretty. Naturally, China is the hardest hit, with Q1 GDP now forecast to turn negative, and 2020 GDP growth to fall to 4.9% before rebounding next year. Meanwhile, global GDP growth is now forecast to fall to 2.4%, its slowest pace since the financial crisis in 2009. And the working assumption is that the virus is contained before the end of Q1. If we continue to see the virus spread, these numbers will be revised still lower.

So, with this as our backdrop, let’s turn our attention to actual market activity. Despite all the promises of support, equity investors remain uncertain as to how to proceed at this time. Support may be helpful, but if companies earnings plummet because of the disruption, then current market valuations are likely still a bit rich. Looking at Asian markets, China was the best performer, with Shanghai rising more than 3.1% as promises of support by the PBOC encouraged investors there. But we also saw the Nikkei (+0.95%) and the Hang Seng (+0.6%) rise although Australia’s ASX 200 (-0.8%) didn’t share in the enthusiasm. Europe has been far less positive with the DAX (-0.45%) and CAC (-0.25%) in the red along with Italy’s FTSE MIB (-2.25%) which is really feeling the brunt of the problems on the continent. The lone equity bright spot is the UK, where the FTSE 100 is higher by 0.5%, largely due to the fact that the pound is today’s worst performing currency, having fallen 0.5% vs. the dollar, and more than 1% vs. the euro.

The British pound story is entirely Brexit related as trade negotiations started today with concerns raised that the red lines both sides have defined may end the chance of any agreement as early as next month. Given the international nature of the FTSE 100 members, a weaker pound is usually a benefit for the stock market. But clearly, if the trade talks collapse, the impact on UK companies would be significant.

But other than the pound, the FX market is the only one that has responded in the manner the central banks were hoping, as the dollar has fallen sharply vs. pretty much every other currency. In the G10 space, SEK (+0.7%) and EUR (+0.65%) are leading the way although even AUD and NZD have managed to gain 0.3% this morning.

In the EMG space, KRW was the BIG winner, rallying 1.7% overnight, but almost every APAC currency jumped on the concerted central bank message. The two exceptions here this morning are INR and MXN, both currently lower by 0.7%, with both suffering from the same disease, new Covid-19 infections where there hadn’t been any before.

Meanwhile, bond markets continue to price in much slower growth as 10-year Treasury yields have tumbled to 1.05%, another new historic low, while German bunds fall to -0.66%, near its historic lows. There is discernment in the market though, as Italian yields have risen 7.5bps as concerns over the safety of those bonds, given Italy’s dubious distinction of being the European country worst hit by the virus, has called into question its financing capabilities.

Adding to all this enjoyment is a very busy data week culminating in the payroll report on Friday.

Today ISM Manufacturing 50.5
  ISM Prices Paid 50.5
  Construction Spending 0.6%
Wednesday ADP Employment 170K
  ISM Non-Manufacturing 55.0
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Nonfarm Productivity 1.4%
  Unit Labor Costs 1.4%
  Factory Orders -0.2%
Friday Trade Balance -$47.0B
  Nonfarm Payrolls 175K
  Private Payrolls 160K
  Manufacturing Payrolls -4K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.3
  Participation Rate 63.4%
  Consumer Credit $17.0B

Source: Bloomberg

At this point, Covid-19 stories are going to be the primary driver of market activity as investors across all markets try to figure out how to react. Havens remain in demand, although the dollar has clearly suffered. Arguably the dollar’s weakness is predicated on the fact that, of all the nations around, the US is the one with the ability to cut rates the furthest. In fact, futures markets are now pricing in 100bps of rate cuts this year, with between 25bps and 50bps for the March meeting in two weeks’ time. Nobody else has that much room, and so the dollar is definitely feeling the pressure. Of course, I continue to believe that if things get much worse, the dollar will rally regardless of the Fed funds rate, as Treasury bonds remain the single safest and most liquid asset available anywhere in the world. For today however, unless there is additional new information, the dollar is likely to remain under pressure, and in truth, that seems likely all week.

Good luck
Adf

Strength in Their Ranks

Around the world, all central banks
Are to whom we need to give thanks
By dint of their easing
All shorts they are squeezing
Who knew they’d such strength in their ranks?

Every day that passes it becomes clearer and clearer that central banks truly are omnipotent. Not only do they possess the ability to support economies (or at least stock markets), but apparently, easing monetary policy cures the coronavirus infection. Who knew they had such wide-ranging powers? At least that is certainly the way things seem if you look through a market focused lens.

Let’s recap:

Date # cases / # deceased S&P 500 Close 10-Year Treasury EURUSD USDJPY
31 Dec 1 / 0 3230 1.917% 1.1213 108.61
6 Jan 60 / 0 3246 1.809% 1.1197 108.37
10 Jan 41 / 1 3265 1.82% 1.1121 109.95
20 Jan 219 / 3 3320 1.774% 1.1095 110.18
22 Jan 500 / 17 3321 1.769% 1.1093 109.84
24 Jan 1320 / 41 3295 1.684% 1.1025 108.90
28 Jan 4515 / 107 3276 1.656% 1.1022 109.15
30 Jan 7783 / 170 3283 1.586% 1.1032 108.96
3 Feb 17,386 / 362 3248 1.527% 1.1060 108.69
4 Feb 24,257 / 492 3297 1.599% 1.1044 109.59

Sources: https://www.pharmaceutical-technology.com/news/coronavirus-a-timeline-of-how-the-deadly-outbreak-evolved/and Bloomberg

Now obviously, they are not actually creating a medical cure for this latest human affliction (I think), but once it became clear that the coronavirus was going to have a significant impact on the Chinese, and by extension, global economies, they jumped into action. While it was no surprise that the PBOC immediately eased policy to head off an even larger stock market rout upon the (delayed) return from the Lunar New Year holidays, I think there was a larger impact from Chairman Powell, who at the Fed press conference last week, made it clear that the Fed stood ready to react (read cut rates) if the coronavirus impact expanded. And then, just like that, the coronavirus was relegated to the agate type of newspapers.

What is really amazing is how the narrative has been altered from, ‘oh my gosh, we are on the cusp of a global pandemic so sell all risky assets’ to ‘the flu is actually a much bigger problem globally and this coronavirus is small potatoes and will be quickly forgotten, so buy those risky assets back’.

The point here is that market players lead very sheltered lives and really see the world as a binary function, is risk on or is risk off? And as long as the central banks continue to assure traders and investors that they will do whatever it takes to prevent stock markets from declining, at least for any length of time, those central banks will continue to control the narrative.

So, with that as preamble, what is new overnight? In a modest surprise, at least on the timing, the Bank of Thailand cut rates by 25bps to a record low 1.00%. The stated reason was as a prophylactic to prevent economic weakness as the coronavirus spreads. Too, the MAS explained that they have plenty of room to ease policy further (which for them means weakening the SGD) if they deem the potential coronavirus impacts to call for such action. It should be no surprise that SGD is today’s weakest link, having fallen 0.75% but we also saw immediate weakness in THB overnight, with the baht falling nearly 1.0% before a late day recovery on the back of flows into the Thai stock exchange. As to the rest of the EMG space, PHP is also modestly weaker after the central bank there indicated that they would cut rates as needed, but we have seen more strength across the space in general. RUB is leading the pack, up 0.8% on the back of a strong rebound in oil prices (WTI +2.3%), but we are also seeing strength throughout LATAM as CLP (+0.7%), BRL (+0.55%) and MXN (+0.4%) all rebound on renewed risk appetite. ZAR has also had a banner day, rising 0.7% on the positive commodity tone to markets.

In the G10 space, things are a bit less interesting. It should be no surprise that AUD is the top performer, rising 0.4%, as it has the strongest beta relationship to China and risk. NOK is also gaining, +0.25%, with oil’s recovery. On the other side of the blotter, CHF (-0.3%) and JPY -0.15%, but -1.0% since yesterday morning) are taking their lumps as haven assets no longer hold appeal to the investment community. This idea has been reinforced by the 10-year Treasury, which has seen its yield rise from 1.507% on Friday to 1.63% this morning.

And don’t worry, your 401K’s are all green again today with equity markets around the world back on the elevator to the penthouse.

Turning to today’s US session, we start to get some more serious data with ADP Employment (exp 157K), the Trade Balance (-$48.2B) and ISM Non-Manufacturing (55.1). Earlier this morning we saw Services PMI data from both Europe and the UK. Eurozone PMI data was mixed (France weak and Italy strong), while the UK saw a strong rebound. We also saw Eurozone Retail Sales, which were quite disappointing, falling 1.6% in December, and seemingly being the catalyst for the euro’s tepid performance today, -0.2%. Remember, Monday’s US ISM data was much better than expected, and there is no question that the market is willing to believe that today’s data will follow suit.

In sum, continued strong performance by the US economy, at least relative to its peers, as well as the working assumption that should the data start to falter, the Fed will be slashing rates immediately, will continue to support risk assets. At this point, that seems to be taking the form of buying high yield currencies (MXN, ZAR, INR) while buying the dollar to increase positions in the S&P500 (or maybe just in Tesla ). As such, I look for the dollar to hold its own vs. the bulk of the G10, but soften vs. much of the EMG bloc.

Good luck
Adf

Investors Remain Unconcerned

There once was a time in the past
When market bears quickly amassed
Positions quite short
While they would exhort
Investors, their holdings, to cast

But these days the story has turned
So bears that go short now get burned
A global pandemic?
It’s just academic
Investors remain unconcerned

One has to be impressed with the current frame of mind of global investors as they clearly feel bulletproof. Or perhaps, one has to be impressed with the job that central bankers around the world have done to allow those feelings to exist.

The coronavirus is quickly becoming back page news, where there will be a tally of cases and deaths daily, morphing into weekly, as the investment community turns its attention to much more important things, like how many new streaming customers each of the streaming services picked up in Q4. It seems the fact that China’s economy is going to feel some extreme pain in Q1 is being completely dismissed. At least from the market’s perspective. And this is where the central banks get to take a bow. It turns out that overwhelming liquidity support is all one needs to make people forget about everything else. It is truly the opioid of the market masses.

So as you sit down this morning you will see that equity markets around the world are on a tear higher, with every market that has been open today in the green, most by well more than 1%. And don’t worry; US futures are all more than 1% higher as well. Everything is clearly fantastic!

Last night, the PBOC fixed the renminbi more than 0.5% stronger than the market would have indicated, thus demonstrating they would not let things get out of hand. Then after a weak opening, where equity indices there fell more than 2%, the government stepped in along with official buyers and turned the tide higher. Once this occurred, equity markets elsewhere in Asia took their cues and everything rallied. Risk was no longer anathema and we have seen that across all assets as havens come under pressure and other risk assets, notably oil has rebounded. The lifecycle of a negative event has grown increasingly shorter as central banks continue to demonstrate their willingness to do ‘whatever it takes’ to prevent a sell-off of any magnitude in any equity market.

This is not just a US phenomenon, but a global one. To me the question is: Is this peak financialization of the global economy? By that I mean are we now in a period where the real economy, the one where cars and other stuff are manufactured and food is grown, has become completely secondary to the idea that companies that do those things need to be entirely focused on their capital structure to be sure that they are appropriately overleveraged? While I recognize that I am old-fashioned in my thoughts, I cannot help but believe that we are going to see a pretty significant repricing of assets at some point in the not too distant future. In truth, despite the market’s insouciance with regard to the ongoing coronavirus outbreak, it is entirely possible that it continues to expand for several more months and that China, the second largest economy in the world and one representing 16% of total global economic activity, does not grow at all in Q1 while supply chains are closed and manufacturing around the world grinds to a much slower pace. Many recessions have been born of less than that. Just remember, trees don’t grow all the way to the sky, and neither do economies!

So let’s turn back to the other things ongoing in this morning’s session. Broadly speaking, the dollar is under modest pressure along with Treasury bonds and the Japanese yen. After all, safe havens do not boost your returns when Tesla is rallying 20% a day! There has been limited data today (Italian CPI +0.5% Y/Y) so FX markets are watching equities. Yesterday saw a big surprise in the US ISM data, which printed above 50 for the first time since July and has a number of analysts reconsidering their forecasts for slowing growth. The dollar definitely responded to this yesterday, rallying across the board as Fed funds futures backed off taking the probability of a rate cut by the Fed in July down to 85%. Remember, Friday that was at 100%.

Yesterday also saw the pound suffer significantly as the initial saber rattling by both the UK and the EU continued, which helped push the pound back to its key support level of 1.2950-1.3000. But as I said yesterday, this is simply both sides trying to get an advantage in the negotiation. While anything is possible, I continue to believe that a deal will be reached, or at the very least that a delay agreed on a timely basis. Boris is not going to jeopardize his power on this principle, remember he’s a politician first, and principles for them are fluid.

In the EMG bloc, pretty much every currency has rallied today as investors have quickly returned to those currencies with either higher yields (ZAR +0.6%, MXN +0.5%) or the best prospects assuming the coronavirus situation quickly dissipates (KRW +0.6%, CLP +0.6%, THB +0.5%). And in truth, I don’t think it’s any more complicated than that.

In the US this morning we see December Factory Orders (exp 1.2%), generally not a major data point. There are no Fed speakers scheduled today which means that FX is going to be a secondary story. All eyes will be on equity markets and I expect that as risk assets are acquired, the dollar (and yen and Swiss franc) will continue to soften slowly.

Good luck
Adf

A True Blue Pangloss

Right now there’s a group of old men
(Though Europe has proffered a hen)
Who feel it’s their right
To hog the limelight
When talking pounds, dollars or yen

Here’s a thought for the conspiracy theorists amongst you. Do you think that the cabal of central bankers get annoyed when something other than their actions and words are responsible for moving markets? And so yesterday they determined it was Carney’s turn to make comments that would dominate the financial wires. I mean, war in the Middle East is completely out of the central bankers’ control, which means they have to be reactive in the event that market moves start to become uncomfortable (i.e. stock prices fall). When you are the leader of a G10 central bank, a key part of your role is to make sure that traders and investors jump at your every word (or so it seems) so if the investment community is worrying about something like war, the central bankers are just not very relevant. And they HATE that! While, of course, this is somewhat tongue in cheek, it is remarkable how quickly we hear from a major central banker after market activity that has been focused on non-monetary issues.

Mark Carney, the Old Lady’s boss
Explained, like a true blue Pangloss
That under the rules
They’d plenty of tools
To ease two percent at a toss

At any rate, arguably, as the relief rally continues, the biggest news overnight was a speech by BOE Governor Carney indicating that despite the fact that the base rate is currently set at 0.75%, the BOE has the capability, if necessary, to ease policy by an effective 250bps through rate cuts, more QE and forward guidance. Interestingly, if you read the speech, he doesn’t say that is what they are going to do, although two MPC members have voted for a rate cut already, he is merely responding to the critics who claim the central banks have no ammunition left to fight an eventual downturn in economic activity. Cable traders, however, must have heard the following: we are going to ease policy immediately, at least based on the fact that the pound is today’s worst performing currency, having fallen 0.65% as I type, and taking its decline thus far in 2020 to nearly 2.0%.

At the same time, the central bank cabal should be pleased because equity markets around the world are rallying aggressively, mostly on the idea that a war between the US and Iran is not imminent, and tangentially on the idea that the central banks remain adamant that they have plenty of ammunition left to keep easing monetary policy ad infinitum.

And that’s really the story, isn’t it? Markets remain almost completely beholden to central bank activity and central bank comments. As long as the prevailing view is that any decline in equity markets is an aberration and will be addressed immediately, we are going to see global equity markets rise. You cannot really fight that story. However, when it comes to the FX markets, there is slightly more opportunity for diversion amongst countries as each nation is likely to add differing amounts of stimulus, thus the relative value of one currency vs. another can react to those differences.

After all, looking at the UK, for example, the combination of the imminent Brexit deal and reduction in policy uncertainty as well as Carney’s comments that the BOE has plenty of room to ease has been more than sufficient to support the FTSE 100, which is higher by 0.6% this morning. And of course, part and parcel of that movement is the pound’s weakness. In fact, I believe this year is going to be all about relative policy ease, at least in the G10 space, with the Fed on track to ease more than any other nation via their not QE and repo programs. And that is why, as the year progresses, I continue to expect the dollar to decline. But so far this year, that has not been the narrative.

With this in mind, a look at the overnight price action shows that equity markets around the world have looked great (Nikkei +2.3%, Shanghai +0.9%, DAX +1.3%, CAC +0.45%) and haven assets have suffered (JPY -0.3%, -0.9% since Tuesday; gold -0.6%; and Treasuries +5bps since yesterday morning). A diminished chance of war and talk of easier policy have worked wonders for risk appetites. Can all this continue? As long as central banks keep playing the same tune they have for the past decade, there doesn’t seem to be any reason for it to stop.

Meanwhile, the dollar has generally been going gangbusters this year, up against all its G10 counterparts, although having a more mixed performance in the EMG space. In truth, US data so far has generally been beating expectations with yesterday’s ADP print of 202K (with a big revision higher for the previous month) the latest proof of that theory. Obviously, Friday’s payroll report will be carefully watched to see if job growth remains abundant, and perhaps more importantly, to see if wages continue to rise. So for the time being, it seems that the FX market is focused on the economic data, and the US data has generally been the best of the bunch, hence the dollar’s strength.

This morning, the only piece of data is Initial Claims (exp 220K) which during payroll week is generally ignored. This means that the dollar’s ongoing short term strength is likely to continue to manifest itself until we get a bad number, or we hear, more clearly, that the Fed is going to ease. I continue to believe that payables hedgers should be taking advantage of what, I believe, will be short term dollar strength. But there is a long way to go this year.

Good luck
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Tempting the Fates

Around the world most central banks
Have, monthly, been forced to give thanks
That tempting the fates
With negative rates
Has not destroyed euros or francs

And later today we will hear
From Draghi, the man who made clear
“Whatever it takes”
Would fix the mistakes
Investors had grown, most, to fear

With Brexit on the back burner for the day, as the UK awaits the EU’s decision on how long of a delay to grant, the market has turned its attention to the world’s central banks. Generally speaking, monetary ease remains the primary focus, although there are a few banks that are bucking the trend.

Starting with the largest for today, and world’s second most important central bank, the ECB meets today in what is Mario Draghi’s final policy meeting at the helm. Given their actions last month, where they cut the deposit rate a further 10bps to -0.50% and restarted QE to the tune of €20 billion per month, there is no expectation for any change at all. In fact, the only thing to expect is more exhortations from Draghi for increasing fiscal policy stimulus by Germany and other Northern European nations that are not overly indebted. But it will not change anything at this stage, and he has already tied Madame Lagarde’s hands going forward with their most recent guidance, so this will be the farewell tour as everybody regales him for saving the euro back in 2012.

But there have been a number of other moves, the most notable being the Swedish Riksbank, which left rates unchanged, but basically promised to raise them by 25bps in December to return them to 0.00%. Apparently they are tired of negative rates and don’t want them to become habit forming. While I admire that concept, the problem they have is growth there is slowing and inflation is falling well below their target of 2.0%. The most recent reading was 1.5%, but the average going back post the financial crisis is just 1.1%. SEK gained slightly after their comments, rallying 0.15% this morning, but the trend in the krone remains lower and I think they will need to raise a lot more than 25bps to change that.

Meanwhile, other central bank activity saw Norway leave rates unchanged at 1.50% as core inflation there remains above their 2.0% target. NOK’s response was essentially nil. Indonesia cut rates by 25bps, as widely expected, its fourth consecutive rate cut, and although the rupiah is ever so slightly softer this morning, -0.2%, its performance this year has been pretty solid, having gained 2.3% YTD. Finally, the Turkish central bank cut rates by a surprising 250bps this morning, much more than the 100bps expected. If you recall, President Erdogan has been adamant that higher interest rates beget higher inflation, and even fired the previous central bank head to replace him with someone more malleable. Interestingly, a look at Turkish inflation shows that it has been falling despite (because of?) recent rate cuts. And today, despite that huge cut, the initial currency impact was pretty modest, with the lira falling 0.5% immediately, but already recouping some of those losses. And in the broader picture, the lira’s recent trend has clearly been higher and remains so after the cut.

On the data front we saw PMI data from the Eurozone and it simply reinforced the idea that the Eurozone is heading into a recession. Germany’s numbers were worse than expected (Manufacturing 41.9, Composite 48.6) which was enough to drag the Eurozone data down as well (Manufacturing 45.7, Composite 50.2). It seems clear that when Germany reports their Q3 GDP next month it will be negative and Germany will ‘officially’ be in a recession. It is data of this nature that makes it so hard to turn bullish on the single currency. Given their economic travails, the Teutonic austerity mindset, which was enshrined in law, and the fact that the ECB is essentially out of bullets, it is very difficult to have a positive view of the euro in the medium term. This morning, ahead of the ECB policy statement, the euro is little changed, and I see no reason for it to move afterwards either.

So, there was lots of central bank activity, but not so much FX movement in response. My sense is that FX traders are now going to fully turn their attention to the FOMC meeting next week, as even though a rate cut seems assured, the real question is will the Fed call a halt to the mid-cycle adjustment, or will they leave the door open to further rate cuts. The risk with the former is that the equity market sells off sharply, thus tightening financial conditions, sowing fear in Washington and forcing a reversal. However, the risk with the latter is that the Fed loses further credibility, something they have already squandered, by being proven reactive to the markets, and less concerned with the economy writ large.

For today’s session, we have the only real data of the week, Durable Goods (exp -0.7%, -0.2% ex Transport), and Initial Claims (215K) at 8:30, then New Home Sales (702K) at 10:00. We also see the US PMI data (Manufacturing 50.9, Services 51.0) although the market generally doesn’t pay much attention to this. Instead it focuses on the ISM data which won’t be released until next week.

Without any Fed speakers on the docket, once again the FX market is likely to take its cues from equities, which are broadly higher this morning after a number of better than expected earnings announcements. In this risk-on environment, I think the dollar has room to edge lower, but unless we start to see the US data really deteriorate, I have a feeling the Fed is going to try to end the rate cuts and the dollar will benefit going forward. Just not today.

Good luck
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