Quite Dramatic

The Chinese report ‘bout Q2
Showed growth has rebounded, it’s true
But things there remain
Subject to more pain
Til elsewhere bids Covid adieu

The market’s response was emphatic
With Shanghai’s decline quite dramatic
Thus, risk appetite
Today is quite slight
Which means bears are now just ecstatic

It is no surprise that the Chinese reported a rebound to positive GDP growth in Q2 as, after all, the nation was the epicenter of Covid-19 and they, both shut down and reopened their economy first. The numbers, however, were mixed at best, with the GDP number rebounding a more than expected 3.2% Y/Y, but their Retail Sales data failing to keep up, printing at -1.8% Y/Y, rather than the expected 0.5% gain. The lesson to be learned here is that while Chinese industry seems to be heading back to a pre-Covid pace, domestic consumption is not keeping up. This is a problem for China for two reasons; first, they have made an enormous effort to adjust the mix of their economy from entirely export oriented to a much greater proportion of consumption led growth. Thus, weak Retail Sales implies that those efforts are now likely to restrict the nation’s growth going forward. Secondly, the fact that the rest of the world is months behind China in this cycle, with many emerging markets still in the closing process, not nearly ready to reopen, implies that while industry in China may have retooled, their export markets are a long way from robust.

The other interesting thing that came out of China last night, that had a more direct impact on markets there, was yet another round of stories published about the evils of speculation and how Chinese financial institutions would be selling more stocks. You may recall last week, when the Chinese government had an article published singing the praises of a strong stock market, encouraging retail investors to drive a more than 6.0% gain in the Shanghai Composite. Just a few days later, they reversed course, decrying the evils of speculation with a corresponding sharp decline. Well, it seems that speculators are still evil, as last night’s message was unequivocally negative pushing Shanghai lower by 4.5% and finally removing all those initial speculative gains. It seems the PBOC and the government are both concerned about inflating bubbles as they well remember the pain of 2015, when they tried to deflate their last one.

But this activity set the tone for all Asian markets, with red numbers everywhere, albeit not quite to the extent seen on the mainland. For instance, the Nikkei slipped 0.75% and the Hang Seng, fell 2.0%.

Europe has its own set of issues this morning, although clearly the weakness in Asia has not helped their situation. Equity markets throughout the Continent are lower with the DAX (-0.5%) and CAC (-0.7%) representative of the losses everywhere. While traders there await the ECB meeting outcome, the focus seems to be on the UK announcement that they will be increasing their debt issuance by £110 billion in Q3 to help fund all the fiscal stimulus. This will take the debt/GDP ratio above 100%, ending any chance of retaining fiscal prudence.

It’s remarkable how things can change in a short period of time. During the Eurozone debt crisis, less than 10 years ago, when Greece was on the cusp of leaving the euro, they were constantly lambasted for having a debt/GDP ratio of 150% or more while Italy, who was puttering along at 125% was also regularly excoriated by the EU and the IMF. But these days, those entities are singing a different tune, where suddenly, government borrowing is seen as quite appropriate, regardless of the underlying fiscal concerns, with the supranational bodies calling for additional fiscal stimulus and the borrowing that goes along with it. At any rate, there is certainly no sign that the current mantra of issuing debt and spending massive amounts of money to support the economy is about to change. Fiscal prudence is now completely passé.

With that as a backdrop, it should be no surprise that risk is being pared back across all markets. Having already discussed equities, we can look at bond markets and see yields virtually everywhere lower today as investors seek out haven assets. Interestingly, despite the new issuance announced in the UK, Gilts lead the way with a 2.5bp decline, while Treasuries and Bunds have both seen yields decline a more modest 1bp. Oil prices have fallen again, which is weighing on both NOK (-0.65%) and RUB (-0.4%) the two currencies most closely linked to its price. But of course, lower oil prices are indicative of weaker overall sentiment.

As such, it is also no surprise that every one of the currencies in the G10 and major emerging markets is weaker vs. the dollar this morning. While the trendy view remains that the dollar is going to continue to decline, and that has been expressed with near record short dollar positions in futures markets, the greenback is not playing along today.

At this point, I think it is important to remind everyone that a key part of the weak dollar thesis is the ongoing expansion of the Fed’s balance sheet adding more liquidity to the system and thus easing dollar policy further. But for the past 5 weeks, the Fed’s balance sheet has actually shrunk by $250 billion, a not inconsiderable 3.5%, as repo transactions have matured and not been replaced. It appears that for now, the market is flush with cash. So, given the combination of major short dollar positions extant and short term fundamental monetary details pointing to dollar strength, do not be surprised if we see a short squeeze in the buck over the next week or two.

This morning brings the bulk of the week’s data, certainly its most important readings, and it all comes at 8:30. Retail Sales (exp 5.0%, 5.0% ex autos), Philly Fed (20.0), Initial Claims (1.25M) and Continuing Claims (17.5M) will hopefully give us a clearer picture of how the US economy is progressing. One of the problems with this data is that it is mostly backward looking (Philly Fed excepted) and so probably does not capture the apparent second wave of infections seen in Florida, Texas and California, three of the most populous states. So, even if we do see somewhat better than expected data, it could easily slip back next week/month. In fact, this is why the Claims data is so important, it is the timeliest of all the major economic releases, and given the ongoing uncertainty surrounding the current economic situation, it is likely the most helpful. So, while the trend in Initial Claims has been lower, it remains at extremely problematic levels and is indicative of many more businesses retrenching and letting staff go. It has certainly been my go-to data point for the pulse of the economy.

Recent data points have been better than forecast, but nobody doubts that things are still in dire shape. Unfortunately, it appears we are still a long way from recouping all the lost economic activity we have suffered over the past months. But FX remains a relative game, and arguably, so is everyone else.

Good luck and stay safe
Adf

Prepare For Impact

The second wave nears
A swell? Or a tsunami?
Prepare for impact

The cacophony of concern is rising as the infection count appears to be growing almost everywhere in the world lately. Certainly, here in the US, the breathless headlines about increased cases in Texas, Florida and Arizona have dominated the news cycle, although it turns out some other states are having issues as well. For instance:

In Cali the growth of new cases
Has forced them to rethink the basis
Of easing restrictions
Across jurisdictions
So now they have shut down more places

In fact, it appears that this was the story yesterday afternoon that turned markets around from yet another day of record gains, into losses in the S&P and a very sharp decline in the NASDAQ. And it was this price action that sailed across the Pacific last night as APAC markets all suffered losses of approximately 1.0%. These losses resulted even though Chinese trade data was better than expected for both imports (+2.7% Y/Y) and exports (+0.5% Y/Y) seemingly indicating that the recovery was growing apace there. And, given the euphoria we have seen in Chinese stock markets specifically, it was an even more surprising outcome. Perhaps it is a result of the increased tensions between the US and China across several fronts (Chinese territorial claims, defense sales to Taiwan, sanctions by each country on individuals in the other), but recent history has shown that investors are unconcerned with such things. A more likely explanation is that given the sharp gains that have been seen throughout equity markets in the region lately, a correction was due, and any of these issues could have been a viable catalyst to get it started. After all, a 1% decline is hardly fear inducing.

The problem is not just in the US, though, as we are seeing all of Europe extend border closures for another two weeks. The issue here is that even though infections seem to be trending lower across the Continent, the fact that they will not allow tourists from elsewhere to come continues to devastate those economies which can least afford the situation like Italy, Spain and Greece. The result is that we are likely to continue to see a lagging growth response and continued, and perhaps increased, ECB largesse. Remember all the hoopla regarding the announcement that the EU was going to borrow huge sums of money and issue grants to those countries most in need? Well, at this point, that still seems more aspirational than realistic and the idea that there would be mutualized debt issuance remains just that, an idea, rather than a reality. While the situation in the US remains dire, it is hard to point to Europe and describe the situation as fantastic. One of the biggest speculative positions around these days, aside from owning US tech stocks, is being short the dollar, with futures in both EUR and DXY approaching record levels. While the dollar has clearly underperformed for the past several weeks, it has shown no indication of a collapse, and quite frankly, a short squeeze feels like it is just one catalyst away. Be careful.

Meanwhile, ‘cross the pond, the UK
Saw GDP that did display
A slower rebound
And thus, they have found
Most people won’t come out and play

As we approach the final Brexit outcome at the end of this year, investors are beginning to truly separate the UK from the EU in terms of economic performance.  Alas, for the pound, the latest data from the UK was uninspiring, to say the least.  Monthly GDP in May, the anticipated beginning of the recovery, rose only 1.8%, with the 3M/3M result showing a -19.1% outcome.  IP, Construction and Services all registered worse than expected results, although the trade data showed a surplus as imports collapsed.  The UK is continuing to try to reopen most of the economy, but as we have seen elsewhere throughout the world, there are localized areas where the infection rate is climbing again, and a second lockdown has been put in place.  The market impact here has been exactly what one would have expected with the FTSE 100 (-0.4%) and the pound (-0.3%) both lagging.

To sum things up, the global economy appears to be reopening in fits and starts, and it appears that we are going to continue to see a mixed data picture until Covid-19 has very clearly retreated around the world.

A quick look at markets shows that the Asian equity flu has been passed to Europe with all the indices there lower, most by well over 1.0%, although US futures are currently pointing higher as investors optimistically await Q2 earnings data from the major US banks starting today.  I’m not sure what they are optimistic about, as loan impairments are substantial, but then, I don’t understand the idea that stocks can never go down either.

The dollar, overall, is mixed today, with almost an equal number of gainers and losers in both the G10 and EMG blocs.  The biggest winner in the G10 is SEK (+0.6%), where the krona has outperformed after CPI data showed a higher than expected rate of 0.7% Y/Y.  While this remains far below the Riksbank’s 2.0% target, it certainly alleviates some of the (misguided) fears about a deflationary outcome.  But aside from that, most of the block is +/- 0.2% or less with no real stories to discuss.

On the EMG side, we see a similar distribution of outcomes, although the gains and losses are a bit larger.  MXN (+0.65%) is the leader today, as it seems to be taking its cues from the positive Chinese data with traders looking for a more positive outcome there.  Truthfully, a quick look at the peso shows that it seems to have found a temporary home either side of 22.50, obviously much weaker than its pre-Covid levels, but no longer falling on a daily basis.  Rather, the technical situation implies that by the end of the month we should see a signal as to whether this has merely been a pause ahead of much further weakness, or if the worst is behind us, and a slow grind back to 20.00 or below is on the cards.

Elsewhere in the space we see the CE4 all performing well, as they follow the euro’s modest gains higher this morning, but most Asian currencies felt the sting of the risk-off sentiment overnight to show modest declines.

On the data front, this week brings the following information:

Today CPI 0.5% (0.6% Y/Y)
  -ex food & energy 0.1% (1.1% Y/Y)
Wednesday Empire Manufacturing 10.0
  IP 4.4%
  Capacity Utilization 67.8%
  Fed’s Beige Book  
Thursday Initial Claims 1.25M
  Continuing Claims 17.5M
  Retail Sales 5.0%
  -ex auto 5.0%
  Philly Fed 20.0
  Business Inventories -2.3%
Friday Housing Starts 1180K
  Building Permits 1290K
  Michigan Sentiment 79.0

Source: Bloomberg

So, plenty of data for the week, and arguably a real chance to see how the recovery started off.  It is still concerning that the Claims data is so high, as that implies jobs are not coming back nearly as quickly as a V-shaped recovery would imply.  Also, remember that at the end of the month, the $600/week of additional unemployment benefits is going to disappear, unless Congress acts.  Funnily enough, that could be the catalyst to get the employment data to start to improve significantly, if they let those benefits lapse.  But that is a question far above my pay grade.

The dollar feels stretched to the downside here, and any sense of an equity market correction could easily result in a rush to havens, including the greenback.

Good luck and stay safe

Adf

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
Adf

Money to Burn

If Covid is back on the rise
It’s likely it will compromise
The mooted return
Of money to burn
Instead, growth it will tranquilize

For the past two or three months, market behavior has been driven by the belief that a V-shaped recovery was in the offing as a combination of massive fiscal and monetary stimulus alongside a flatter infection curve and the reopening of economies would bring everything back close to where it was prior to the outbreak of Covid-19. However, since last Thursday, that narrative has lost more than a few adherents with the growing concern that the dreaded second wave of infections was starting to crest and would force economies, that were just starting to reopen, back into hibernation.

The most recent piece of evidence for the new storyline comes from Beijing, where the weekend saw the reporting of 100 new infections after several weeks of, allegedly, zero infections in the country. This has resulted in the Chinese government re-imposing some restrictions as well as massively increasing testing again. Chinese data last night showed that the economy remains under significant pressure, although analysts fell on both sides of the bullish-bearish spectrum. The four key data points are Retail Sales (-13.5% YTD, up from April’s -16.2% and right on the economic estimates); IP (-2.8% YTD, up from -4.9% and slightly better than -3.0% expected); Fixed Asset Investment (-6.3% YTD vs. -10.3% last month and -6.0% expected); and the Jobless Rate (5.9%, as expected and down from 6.0% last month). My read is that the Chinese economy remains quite troubled, although arguably it has left the worst behind it. The PBOC continues to inject liquidity into the market and the Chinese government continues to add fiscal support. Unfortunately for President Xi, China remains an export led economy and given the complete demand destruction that has occurred everywhere else in the world, the near-term prospects for Chinese growth would seem to be muted at best.

For political leaders everywhere, this is not the story that they want to tell. Rather, the narrative of the V-shaped recovery was crucial to maintaining some level of confidence for their populations as well as for their own popularity. Remember, at the government level, everything is political, so crafting a story that people believe accept is just as important, if not more so, than actually implementing policies that work to address the problems.

Another chink in the narrative’s armor is the fact that despite the approach of the summer solstice, and the northern hemisphere warming that accompanies it, infection levels are growing in many different places; not only Beijing, but Korea, Japan, California, Texas and Florida, all locations that had begun to reopen their respective economies due to reduced infections. Remember, a key part of the narrative has been that the virus, like the ordinary flu, thrives in cold weather, and warmth would be a natural disinfectant, if you will. While it remains too early to claim this is not the case, the recent flare-ups are not helping that storyline.

Ultimately, what is abundantly clear is we still don’t know that much about the virus and its potential and weaknesses. While we will certainly see more businesses reopen over the next weeks, it is unclear how long it will take for actual economic activity to start to revert to any semblance of normal. Equity markets have been wearing rose-colored glasses for at least two months. Beware of those slipping off and haven assets regaining their bid quite quickly.

So, a quick look at markets this morning simply reinforces the changing narrative, with equity markets lower around the world, bond markets rallying and the dollar reasserting itself. Overnight, Asian markets all fell pretty sharply, led by the Nikkei’s 3.5% decline, but also seeing weakness in the Hang Seng (-2.2%) and Shanghai (-1.0%). European indices are also bleeding this morning, with the DAX (-0.9%) and CAC (-0.8%) slipping on increasing concerns over the growth of the second wave. US futures will not miss this party, with all three indices sharply lower, between 1.5% and 2.0%.

In the bond market, Treasury yields are sliding, down 3 basis points, as haven assets are in demand. We are seeing increased demand across European bond markets as well, surprisingly even in the PIGS, although that seems more in anticipation of the almost certain increase in the pace of ECB QE. What is clear, however, is that we are seeing a rotation from stocks to bonds this morning.

Finally, the dollar is feeling its oats this morning, rallying against the high-beta G10 currencies with AUD the leading decliner (-0.9%) followed by NOK (-0.6%) and CAD (-0.5%). The latter two are clearly feeling the pressure from oil’s declining price, down 1.75% as I type, although it had been even lower earlier in the session. While we do see both JPY and CHF slightly firmer, the emphasis is on slightly, with both less than 0.1% higher than Friday’s closing levels. Meanwhile the euro and pound are both slightly softer, also less than 0.1% off Friday’s levels, which simply implies a great deal of uncertainty over the next big move. This is corroborated by price action in the option market, where implied volatility continues to climb, as 1mo EURUSD volatility is up 1.3 points in the past week. Of perhaps more interest is the fact that the 1mo risk reversal has flipped from 0.5 for euro calls to 0.35 for euro puts in the same time frame. Clearly, concern is growing that all is not right with the world.

As to the EMG bloc, one would not be surprised to see the Mexican peso as the biggest laggard this morning, down 1.5% as the combination of declining oil prices, increasing infections and risk reduction all play into the move. Asian currencies did not have a good evening, led by KRW (-1.0%) which suffered from a combination of concern over the US-Korean alliance (as the US withdrew some troops unexpectedly and continues to demand more payment for protection) as well as some warmongering from the North. But we have also seen weakness across the rest of the region, with declines in the 0.2%-0.5% range nearly universal. Too, the rand is under pressure this morning, falling 1.0%, on what appears to be broad-based risk reduction as there are no specific stories to note there.

Data this week is on the light side with Retail Sales tomorrow likely to garner the most attention.

Today Empire Manufacturing -30.0
Tuesday Retail Sales 8.0%
  -ex autos 5.3%
  IP 3.0%
  Capacity Utilization 66.9%
Wednesday Housing Starts 1100K
  Building Permits 1250K
Thursday Initial Claims 1.29M
  Continuing Claims 19.65M
  Philly Fed -25.0
  Leading Indicators 2.4%

Source: Bloomberg

We also hear from six Fed speakers in addition to the Chairman’s congressional testimony on Tuesday and Wednesday. Clearly, it will be the latter that keeps everyone most interested. There are those who complain that Powell should have done more last week, starting YCC or adding more stimulus, but that remains a slight minority view. Most mainstream economists seem to believe that we are fast approaching the point where excessive central bank largesse is going to create much bigger problems down the road. In fact, ironically, I believe that is one of the reasons we are in risk-off mode overall, growing concerns that the future is not as bright as markets have priced to date.

My sense is that the dollar is set to end its slide overall and start to regain traction as the reality that the V-shaped recovery is not coming begins to hit home. Hedgers beware, and don’t miss these opportunities.

Good luck and stay safe
Adf

A Line in the Sand

The news out of Europe is grand
A virus response is now planned
Except for the fact
It’s not widely backed
It might draw a line in the sand

As well, what the data has shown
Is hope for the future has grown
Most surveys explain
The worst of the pain
Is past, though there’s much to bemoan

Equity markets continue to power ahead in most nations as the ongoing belief remains the worst of the damage from the global shutdowns is past, and that activity will quickly return to pre-virus levels given the extraordinary support promulgated by governments and central banks around the world. For example, Italian Consumer Confidence fell only to 94.3, a far better result than the 90.0 expected. Similarly, Eurozone Economic Confidence edged higher, to 67.5 from April’s revised 64.9 reading, also offering the chance that the worst is behind us. In fact, we have seen this pattern repeatedly over the past several weeks, where May readings (Empire Mfg, Philly Fed, Michigan Sentiment) rebounded from the extraordinary levels seen in March and April, although they remain at levels associated with extremely deep recessions. And maybe, hopefully, that is exactly what this data means. The bottom is in and it is straight up from here. Of course, the slope of this recovery line remains highly uncertain.

This morning we have also learned a bit more detail about the last major economy to announce a support package, as the EU’s mooted €750 billion package will be combined with €1.1 trillion of additional spending by the EU from its own budget…over the next seven years. That’s right, the EU has determined that the best way to support its member nations in the midst of a crisis is to promise to spend some additional money for nearly the next decade. And when you do the math, this stimulus adds up to less than 1% of the EU’s annual GDP, by far the smallest effort made by any major government. Adding injury to this insulting package is the fact that it remains highly uncertain as to whether even this can get enacted.

Remember, the underlying problem in Europe remains that the frugal north has been unwilling to support the profligate south. In fact, the telling comment was from a Dutch diplomat where he said, “Negotiations will take time. It’s difficult to imagine this proposal will be the end-state of those negotiations.” So, the headline spin is Europe is finally getting around to putting up some economic aid directly to those nations in greatest need. But the reality remains far from that outcome. Markets, of course, are happy to believe the words until they are proven wrong, but history suggests that the promised €1.85 trillion in total aid will actually be far less than that in the end.

Will it matter if the money never comes? Perhaps not. Perhaps, the natural course of events will see growth start to pick up again and demands for government support will fade into the background. Of course, it seems equally likely that EU support will be delivered by flying pigs. But hey, you never know!

Turning to markets now, risk remains the place to be for investors as equity rallies continue unabated. After another standout performance in the US yesterday, Asia did well (Nikkei +2.3%, Australia +1.3%), except for Hong Kong, where the Hang Seng fell 0.7% after the Chinese National People’s Congress approved (by 2,878-1) the measure allowing China to crack down directly on Hong Kong’s citizens regarding subversion, secession and terrorism, if deemed to be necessary by Beijing. This has opened yet another front of disagreement between the US and China and simply served to elevate tensions further. As yet, the situation remains a war of words and financial actions (like tariffs), but the situation appears to be edging closer to a point where a more kinetic outcome is possible. If that were the case, you can be sure that Covid headlines would become page 6 news and markets would need to reevaluate their current bullish stance.

Meanwhile, European markets have responded positively to the promise of EU support with all markets there higher by between 0.5% (DAX) and 1.7% (Italy’s FTSE MIB). This makes perfect sense as Italy will certainly be the largest beneficiary of the EU program while Germany will simply be picking up the tab. And finally, as I type, US futures are mixed with the Dow higher by 0.5% while NASDAQ futures are lower by -.4%.

Interestingly, bond markets around the world have rallied alongside stocks with yields edging lower in the US, 10-year Treasury is down 1 basis point, but seeing much greater price gains (yield declines) throughout Europe where France (-5bps), Spain (-4bps) and Greece (-3.5bps) are leading the way. Even bunds have seen yields decline, down 2.5bps, on the back of ongoing weakness in German regional CPI readings.

And what of the dollar, you may ask. In truth, today is the very definition of a mixed session. In the G10, four currencies have edged lower by about 0.1% (CHF, NOK, CAD, AUD) while two have edged higher, SEK +0.2%, NZD +0.1%, and the rest are essentially unchanged. With movement this small, there is no specific story driving things.

The EMG bloc has seen a similar split with gainers and losers, but here there has been a bit more substance to the moves. The worst performer is Turkey, with the lira down 0.6% after data showed Central bank borrowing continued to increase as the country tries to stockpile hard-currency reserves. But we also saw KRW decline 0.45% after the BOK cut rates to 0.50%, a new record low, and promised to do even more if necessary, implying that QE is on the table next. On the plus side, CZK has been the biggest gainer, up 0.4% after their government financing auction drew a bid-to-cover ratio of 10.72, demonstrating real demand for the currency.

On the data front, we see a great deal here at home as follows: Initial Claims (exp 2.1M), Continuing Claims (25.7M), Durable Goods (-19.0%, -15.0% ex transport) and Q1 GDP (-4.8%) all at 8:30. With the market clearly looking forward, not back, despite what will certainly be horrific data, it seems unlikely that there will be much reaction unless there is a real outlier from these expectations. Remember, the working assumption is already that Q2 GDP is going to be record-breaking in its depths, so will any of these really change opinions? My guess is no.

Overall, the dollar has been under pressure for the past two weeks and as long as risk appetite remains robust, I think that situation will apply.

Good luck and stay safe
Adf

Playing Hardball

Last night China shocked one and all
With two policy shifts not too small
They’ve now become loath
To target their growth
And in Hong Kong they’re playing hardball

It seems President Xi Jinping was pining for the spotlight, at least based on last night’s news from the Middle Kingdom. On the economic front, China abandoned their GDP target for 2020, the first time this has been the case since they began targeting growth in 1994. It ought not be that surprising since trying to accurately assess the country’s growth prospects during the Covid-19 crisis is nigh on impossible. Uncertainty over the damage already done, as well as the future infection situation (remember, they have seen a renewed rise in cases lately) has rendered economists completely unable to model the situation. And recall, the Chinese track record has been remarkable when it comes to hitting their forecast, at least the published numbers have a nearly perfect record of meeting or beating their targets. The reality on the ground has been called into question many times in the past on this particular subject.

The global economic community, of course, will continue to forecast Chinese GDP and current estimates for 2020 GDP growth now hover in the 2.0% range, a far cry from the 6.1% last year and the more than 10% figures seen early in the century. Instead, the Chinese government has turned its focus to unemployment with the latest estimates showing more than 130 million people out of a job. In their own inimitable way, they manage not to count the rural unemployed, meaning the official count is just 26.1M, but that doesn’t mean those folks have jobs. At this time, President Xi is finding himself under much greater pressure than he imagined. 130 million unemployed is exactly the type of thing that leads to revolutions and Xi is well aware of the risks.

In fact, it is this issue that arguably led to the other piece of news from China last night, the newly mooted mainland legislation that will require Hong Kong to enact laws curbing acts of treason, secession, sedition and subversion. In other words, a new law that will bring Hong Kong under more direct sway from Beijing and remove many of the freedoms that have set the island territory apart from the rest of the country. While Covid-19 has prevented the mass protests seen last year from continuing in Hong Kong, the sentiments behind those protests did not disappear. But Xi needs to distract his population from the onslaught of bad news regarding both the virus and the economy, and nothing succeeds in doing that better than igniting a nationalistic view on some subject.

While in the short term, this may work well for President Xi, if he destroys Hong Kong’s raison d’etre as a financial hub, the downside is likely to be much greater over time. Hong Kong remains the financial gateway to China’s economy largely because the legal system their remains far more British than Chinese. It is not clear how much investment will be looking for a home in a Hong Kong that no longer protects private property and can seize both people and assets on a whim.

It should be no surprise that financial markets in Asia, particularly in Hong Kong, suffered last night upon learning of China’s new direction. The Hang Seng fell 5.6%, its largest decline since July 2015. Even Shanghai fell, down 1.9%, which given China’s announcement of further stimulus measures despite the lack of a GDP target, were seen as positive. Meanwhile, in Tokyo, the Nikkei slipped a more modest 0.9% despite pledges by Kuroda-san that the BOJ would implement even more easing measures, this time taking a page from the Fed’s book and supporting small businesses by guaranteeing bank loans made in a new ¥75 trillion (~$700 billion) program. It is possible that markets are slowly becoming inured to even further policy stimulus measures, something that would be extremely difficult for the central banking community to handle going forward.

The story in Europe is a little less dire, although most equity markets there are lower (DAX -0.4%, CAC -0.2%, FTSE 100 -1.0%). Overall, risk is clearly not in favor in most places around the world today which brings us to the FX markets and the dollar. Here, things are behaving exactly as one would expect when investors are fleeing from risky assets. The dollar is stronger vs. every currency except one, the yen.

Looking at the G10 bloc, NOK is the leading decliner, falling 1.1% as the price of oil has reversed some of its recent gains and is down 6% this morning. But other than the yen’s 0.1% gain, the rest of the bloc is feeling it as well, with the pound and euro both lower by 0.4% while the commodity focused currencies, CAD and AUD, are softer by 0.5%. The data releases overnight spotlight the UK, where Retail Sales declined a remarkable 18.1% in April. While this was a bit worse than expectations, I would attribute the pound’s weakness more to the general story than this particular data point.

In the EMG bloc, every market that was open saw their currency decline and there should be no surprise that the leading decliner was RUB, down 1.1% on the oil story. But we have also seen weakness across the board with the CE4 under pressure (CZK -1.0%, HUF -0.75%, PLN -0.5%, RON -0.5%) as well as weakness in ZAR (-0.7%) and MXN (-0.6%). All of these currencies had been performing reasonably well over the past several sessions when the news was more benign, but it should be no surprise that they are lower today. Perhaps the biggest surprise was that HKD was lower by just basis points, despite the fact that it has significant space to decline, even within its tight trading band.

As we head into the holiday weekend here in the US, there is no data scheduled to be released this morning. Yesterday saw Initial Claims decline to 2.44M, which takes the total since late March to over 38 million! Surveys show that 80% of those currently unemployed expect it to be temporary, but that still leaves more than 7.7M permanent job losses. Historically, it takes several years’ worth of economic growth to create that many jobs, so the blow to the economy is likely to be quite long-lasting. We also saw Existing Home Sales plummet to 4.33M from March’s 5.27M, another historic decline taking us back to levels last seen in 2012 and the recovery from the GFC.

Yesterday we also heard from Fed speakers Clarida and Williams, with both saying that things are clearly awful now, but that the Fed stood ready to do whatever is necessary to support the economy. This has been the consistent message and there is no reason to expect it to change anytime soon.

Adding it all up shows that investors seem to be looking at the holiday weekend as an excuse to reduce risk and try to reevaluate the situation as the unofficial beginning to summer approaches. Trading activity is likely to slow down around lunch time so if you need to do something, early in the morning is where you will find the most liquidity.

Good luck, have a good holiday weekend and stay safe
Adf

 

Feeling the Heat

As tensions continue to flare
Twixt China and Uncle Sam’s heir
The positive feelings
In equity dealings
Could easily turn to a bear

Meanwhile down on Threadneedle Street
The Old Lady’s fairly downbeat
Thus negative rates
Are now on their plates
With bank stocks there feeling the heat

A yoyo may be the best metaphor for market price action thus far in May as we have seen a nearly equal number of up and down days with the pattern nearly perfect of gains followed by losses and vice versa. Today is no different as equity markets are on their back foot, after yesterday’s gains, in response to increasing tensions between Presidents Trump and Xi. Realistically, this is all political, and largely for each President’s domestic audience, but it has taken the form of a blame game, with each nation blaming the other for the instance and severity of the Covid-19 outbreak. What is a bit different this time is that President Trump, who had been quick to condemn China in the past, had also been scrupulous in maintaining that he and President Xi had an excellent working relationship. However, last night’s Twitter tirade included direct attacks on Mr Xi, a new tactic and one over which markets have now shown concern.

Thus, equity markets around the world are lower this morning with modest losses seen in Asia (Nikkei -0.2%, Hang Seng and Shanghai -0.5%) and slightly larger losses throughout the Continent (DAX -1.6%, CAC -1.1%, FTSE 100 -1.0%). US futures are pointing in the same direction with all three indices currently down about 0.7%. Has anything really changed? Arguably not. After all, both broad economic data and corporate earnings numbers remain awful, yet equity market prices, despite today’s dour mood, remain within sight of all-time highs. And of course, the bond market continues to point to a very different future as 10-year Treasury yields (-1bp today) continue to trade near historically low levels. To reiterate, the conundrum between a bond market that is implying extremely slow economic activity for the next decade, with no concomitant inflation seems an odd companion to an equity market where the median P/E ratio has once again moved above 20, well above its long-term average. This dichotomy continues to be a key topic of conversation in the market, and one which history has shown cannot last forever. The trillion-dollar question is, which market adjusts most?

With the increasing dissent between the US and China as a background, we also learned of the specter of the next country to move toward a negative interest rate stance, the UK. When Mark Carney was governor there, he categorically ruled out negative interest rates as an effective tool to help support the economy. He got to closely observe the experiment throughout Europe and concluded the detriments to the banking community outweighed any potential economic positives. (This is something that is gaining more credence within the Eurozone as well although the ECB continues to insist NIRP has been good for the Eurozone.) However, Carney is no longer governor, Andrew Bailey now holds the chair. And he has just informed Parliament, “I have changed my position a bit,” on the subject, and is now willing to consider negative rates after all. This is in concert with other members of the MPC, which implies that NIRP is likely soon to be reality in the UK. It should be no surprise that UK banking stocks are suffering after these comments as banks are the second victims of the process. (Individual savers are the first victims as their savings no longer offer any income, and in extreme cases decline.)

The other natural victim of NIRP is the currency. As discussed earlier this week, there is a pretty solid correlation between negative real rates and a currency’s relative value. Now granted, if real rates are negative everywhere, then we are simply back to the relative amount of negativity that exists, but regardless, this potential policy shift is clearly new, and one would expect the pound to suffer accordingly. Surprisingly, it is little changed this morning, down less than 0.1% amid a modest trading range overnight. However, it certainly raises the question of the future path of the pound.

When the Eurozone first mooted negative interest rates, in 2014, the dollar was already in the midst of a strong rally based on the view that the Fed was getting set to start to raise interest rates at that time. Thus, separating the impact of NIRP from that of expected higher US rates on the EUR/USD exchange rate is no easy task. However, there is no question that the euro’s value has suffered from NIRP as there is limited incentive for fixed income investment by foreigners. It should therefore be expected that the pound will be weaker going forward as foreign investment interest will diminish in the UK. Whether negative rates will help encourage foreign direct investment is another story entirely, and one which we will not understand fully for many years to come. With all this in mind, though, the damage to the pound is not likely to be too great. After all, given the fact that negative real rates are widespread, and already the situation in the UK, a base-rate cut from 0.1% to -0.1% doesn’t seem like that big a deal overall. We shall see how the market behaves.

As to the session today, FX markets have been as quiet as we have seen in several months. In the G10 space, Aussie and Kiwi are the underperformers, but both are lower by a mere 0.35%, quite a small move relative to recent activity, and simply a modest unwind of yesterday’s much more powerful rally in both. But away from those two, the rest of the bloc is less than 0.2% different from the close with both gainers (EUR, DKK) and losers (GBP, JPY) equidistant from those levels.

On the EMG side, there is a bit more constructive performance with oil’s continued rally (+2%) helping RUB (+0.4%) while the CE4 are also modestly firmer simply following the euro higher. APAC currencies seem a bit worse for wear after the Twitter spat between Trump and China, but the losses are miniscule.

Data this morning showed the preliminary PMI data from Europe is still dire, but not quite as bad as last month’s showing. In the US today we see Initial Claims (exp 2.4M), Continuing Claims (24.25M) and Existing Home Sales (4.22M). But as I have been writing all month, at this point data is assumed to be dreadful and only policy decisions seem to have an impact on the market. Yesterday we saw the Minutes of the Fed’s April 29 meeting, where there was a great deal of discussion about the economy’s problems and how they can continue to support it. Ideas floated were firmer forward guidance, attaching rate moves to numeric economic targets, and yield curve control, where the Fed determines to keep the interest rate on a particular tenor of Treasury bonds at a specific level. Both Japan and Australia are currently executing this, and the Fed has done so in its history, keeping long-term yields at 2.50% during WWII. My money is on the 10-year being pegged at 0.25% for as long as necessary. But that is a discussion for another day. For today, the dollar seems more likely to rebound a bit rather than decline, but that, too, is one man’s view.

Good luck and stay safe
Adf

Terribly Slow

From Germany data did show
That Q1 was terribly slow
As well, for Q2
Recession’s in view
Their hope remains Q3 will grow

Meanwhile last night China revealed
‘twill be a long time ere its healed
Despite what they’ve said
‘bout moving ahead
Consumers, their checkbooks, won’t wield

While the market has not yet truly begun to respond to data releases, they are nonetheless important to help us understand the longer-term trajectory of each nation’s economy as well as the overall global situation. So, despite very modest movement in markets overnight, we did learn a great deal about how Q1 truly fared in Europe. Remember, Covid-19’s impact really only began in the second half of March, just a small slice of the Q1 calendar. And yet, Q1 GDP was released early this morning from Germany, with growth falling at a 2.2% quarterly rate, which annualized comes in somewhere near -9.0%. In addition, Q4 data was revised lower to -0.1%, so Germany’s technical recession has already begun. Remember, prior to the outbreak, Germany’s economy was already in the doldrums, having printed negative quarterly GDP data in three of the previous six quarters. Of course, those numbers were much less dramatic, but the point is the engine of Europe was sputtering before the recent calamity. Forecasts for Q2 are even worse, with a quarterly decline on the order of 6.5% penciled in there despite the fact that Germany seems to be leading the way in reopening their economy.

For the Eurozone as a whole, GDP in Q1 fell 3.8% in Q1 as Germany’s performance was actually far better than most. Remember, Italy, Spain and France all posted numbers on the order of -5.0%. The employment situation was equally grim, as despite massive efforts by governments to pay companies to keep employees on the payroll, employment fell 0.2%, the first decline in that reading since the Eurozone crisis in 2012-13. One other highlight (lowlight?) was Italian Industrial Activity, which saw both orders and sales fall more than 25% in March. Q2 is destined to be far worse than Q1, and the current hope is that there is no second wave of infections and that Q3 sees a substantial rebound. At least, that’s the current narrative.

The problem with the rebound narrative was made clear, though, by the Chinese last night when they released their monthly statistics. Retail Sales there have fallen 16.2% YTD, a worse outcome than forecast and strong evidence that despite the “reopening” of the Chinese economy, things are nowhere near back to normal. Fixed Asset Investment printed at -10.3% with Property Investment continuing to decline as well, -3.3%. Only IP showed any improvement, rising 3.9% in April, but the problem there is that inventories are starting to build rapidly as consumers are just not spending. Again, the point is that shutting things down took mere days or weeks to accomplish. Starting things back up will clearly take months and likely years to get back close to where things were before the outbreak.

However, as I mentioned at the top, market reactions to data points have been virtually nonexistent for the past two months. At this point, investors are well aware of the troubles, and so data confirming that knowledge is just not that interesting. Rather, the information that matters now is the policy response that is in store.

The one thing we have learned over the past decade is that the stigma of excessive debt has been removed. Japan is the poster child for this as JGB’s outstanding represent more than 240% of Japan’s GDP, and yet the yield on 10-year JGB’s this morning is -0.01%. Obviously, this is solely because the BOJ continues to buy up all the issuance these days, but in the end, the lesson for every other nation is that you can issue as much debt and spend as much money as you like with few, if any consequences. Central bank reaction functions have been to support the economy via market actions like QE whenever there is a hint of a downturn in either the economy or the stock market. Both the Fed and ECB have learned this lesson well, and look set to continue with extraordinary support for the foreseeable future.

But the consequence of this in the one market that is not directly supported (at least in the case of the G10), the FX market, is what we need to consider. And as I observe central bank activity and try to discern its economic impacts, I have become persuaded that the medium-term outlook for the dollar is actually much lower.

Consider that the Fed is clearly going to continue its QE programs across as many assets as they deem necessary. Not merely Treasuries and Agencies, but Corporates, Munis and Junk bonds as well. And as is almost always the case, these ‘emergency’ measures will evolve into ordinary policy, meaning they will be doing this forever. The implication of this policy is that yields on overall USD debt are going to decline from a combination of continued reductions in Treasury yields and compression of credit spreads. After all, don’t fight the Fed remain a key investment philosophy. Thus, nominal yields are almost certain to continue declining.

But what about real yields? Well, that is where we get to the crux of the story and why my dollar view has evolved. CPI was just released on Tuesday and fell to 0.3% Y/Y. Thus, strictly speaking, 10-year Treasuries show a +0.31% real yield this morning (nominal of 0.61% – CPI of 0.3%). The thing is, while current inflation readings are quite low, and may well fall for another few months, the supply shock we have felt in the economy is very likely to raise prices considerably over time. Inflation is not really on the market’s radar right now, nor on that of the Fed. If anything, the concern is over deflation. But that is exactly why inflation remains a far more dangerous concern, because higher prices will not only crimp consumer spending, it will create a policy conundrum for the Fed of epic proportions. After all, Paul Volcker taught us all that raising interest rates was how to fight inflation, but that is directly at odds with QE. The point is, if (when) inflation does begin to rise, the Fed is certain to ignore the evidence for as long as possible. And that means we are going to see increasingly negative real rates in the US. History has shown that when US real rates turn negative; the dollar suffers accordingly. Hence the evolution in my medium- and long-term views of the dollar.

A quick look at this morning’s markets shows that yesterday’s late day equity rally in the US has largely been followed through Asia and Europe. Bonds are also in demand as yields throughout the government sector are mostly lower. And the dollar this morning is actually little changed overall, with a smattering of winners and losers across both G10 and EMG blocs, and no truly noteworthy stories.

We do see a decent amount of US data this morning led by Retail Sales (exp -12.0%, -8.5% ex autos). We also see Empire Manufacturing (-60.0), IP (-12.0%), Capacity Utilization (63.8%), JOLTs Job Openings (5.8M) and finally Michigan Sentiment (68.0). Only the Empire number is truly current, but to imply that a rise from -78.2 to -60.0 is progress really overstates the case. As I’ve pointed out, the data has not been a driver. Markets are exhausted after a long period of significant volatility. My expectation is for the dollar to do very little today, and actually until we see a new narrative evolve. So modest movement should be the watchword.

Good luck, good weekend and stay safe
Adf

Trade is the Word

Remember last year when Phase One
Was all that was needed to run
The stock market higher,
Light bears’ hair on fire
And help all the bulls to have fun?

Well, once again trade is the word
Investors are claiming has spurred
Their risk appetite
Both morning and night
While earnings and growth are deferred

Another day, another rally in equity markets as the bulls now point to revamped conversations between the US and China regarding trade as the critical feature to return the economy to a growth stance. Covid-19 was extremely effective at disrupting the phase one trade deal on two fronts. First, given a key part of the deal was the promise of substantial agricultural purchases by China, the closure of their economy in February and corresponding inability to import virtually anything, put paid to that part of the deal. Then there was the entire issue about the origin of Covid-19, and President Trump’s insistence on ascribing blame to the Chinese for its spread. Certainly, that did not help relations.

But yesterday, the White House described renewed discussions between senior officials to help ensure that the trade deal remains on track. Apparently, there was a phone conversation including Chinese Premier, Liu He, and both Treasury Secretary Mnuchin and Trade Rep Lighthizer last night. And this is the story on the lips of every buyer in the market. The thesis here is quite simple, US economic output will be goosed by a ramp up by the Chinese in buying products. Recall, they allegedly promised to purchase in excess of $50 billion worth of agricultural goods, as well as focus on the prevention of IP theft and open their economy further. Covid slowed their purchases significantly, so now, in order to meet their obligations, they need to dramatically increase their buying pace, thus supporting US growth. It’s almost as though last year’s news is driving this year’s market.

Nonetheless, that is the situation and yesterday’s US performance has carried over through Asia (Nikkei +2.6%, Hang Seng +1.0%, Shanghai + 0.8%) and on into Europe (DAX +0.9%, CAC + 0.8%). Not to worry, US futures are right in line, with all three indices currently higher by just over 1.0%.

Bond markets are rallying today as well, which after yesterday’s rally and the broader risk sentiment seems a bit out of place. But 10-year Treasury yields are down 10bps in the past two sessions, with this morning’s price action worth 3bps. Bunds have seen a similar, albeit not quite as large, move, with yields falling 5bps since Wednesday and down 1.5bps today. In the European market, though, today’s big story is Italy, where Moody’s is due to release its latest credit ratings update this afternoon. Moody’s currently has Italy rated Baa3, the lowest investment grade rating, and there is a risk that they cut Italy to junk status. However, we are seeing broad optimism in markets this morning. In fact, Italian BTP yields have fallen (bonds rallied) 8bps this morning and 14bps in the past two sessions. In other words, it doesn’t appear that there is great concern of a downgrade, at least not right now. Of course, that means any surprise by Moody’s will have that much larger of a negative impact.

Put it all together and you have the makings of yet another positive risk day. Not surprisingly, the dollar is under pressure during this move, with most G10 and EMG currencies in the black ahead of the payroll data this morning. And pretty much, the story for all the gainers is the positive vibe delivered by the trade news. That has helped oil prices to continue their recent rally and correspondingly supported CAD, RUB, MXN and NOK. And the story has helped renew hopes for a return to a pickup in international trade, which has fallen sharply during the past several months.

The data this morning is sure
To set records that will endure
For decades to come
As depths it will plumb
And question if hope’s premature

Here are the most recent median expectations according to Bloomberg:

Nonfarm Payrolls -22.0M
Private Payrolls -21.855M
Manufacturing Payrolls -2.5M
Unemployment Rate 16.0%
Average Hourly Earnings 0.5% (3.3% Y/Y)
Average Weekly Hours 33.5
Participation Rate 61.0%
Canadian Change in Employment -4.0M
Canadian Unemployment Rate 18.1%

Obviously, these are staggeringly large numbers in both the US and Canada. In fact, given the US economy is more than 12x the size of Canada, the situation north of the border looks more dire than here at home. Of course, the market has likely become somewhat inured to these numbers as we have seen Initial Claims numbers grow 30M in the past six weeks. But that does not detract from the absolute carnage that Covid-19 has caused to the economy. The question at hand, though, is whether the confirmation of economic destruction is enough to derail the idea that a V-shaped recovery is in the cards.

Once again, I look at the dichotomy of price action between the equity markets and the Treasury market in an effort to find an answer. The anticipated data this morning is unequivocal evidence of destruction of huge swathes of the US economy. We are looking at a decade’s worth of job growth disappearing in one month. In addition, it does appear likely that a significant proportion of these jobs will simply not return as they were. Instead, we are likely to see major transformations in the way business is carried out in the future. How long will it be before people are comfortable in large crowds? How long before they want to jostle each other in a bar to watch a football game? Or just go out on a Thursday night? The point is, equity markets don’t see the glass half full, they see it overflowing. However, 10-year Treasury yields at 0.60% are hardly an indication of strong economic demand. In fact, they are the opposite, an indication that future growth is going to be extremely subdued when it returns, and the fact that the entire term structure of rates is so low tells me that return is likely to take a long time. Much longer than a few quarters. To complete the analogy, the bond market sees that same glass as virtually emplty. So, stocks continue to point to a V and bonds to an L. Alas, history has shown the bond market tends to get these things right more often than the stock market.

The point is that the current robust risk appetite seems unlikely to have staying power, and that means that the current dollar weakness is likely to be fleeting. The bigger picture remains that the dollar, for the time being, will remain the ultimate haven currency. Look for its bid to return.

Good luck, good weekend and stay safe
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