Fear Has Diminished

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

A Tiny Tsunami

Covid’s wrought havoc
Like a tiny tsunami
Can Japan rebound?

In what is starting off as a fairly quiet summer morning, there are a few noteworthy items to discuss. It cannot be surprising that Japan’s economy suffered greatly in Q2, given the damage to economic activity seen worldwide due to Covid-19. Thus, although the -7.8% Q2 result was slightly worse than forecast, it merely served to confirm the depths of the decline. But perhaps the more telling statistic is that, given Japan was in recession before Covid hit, the economy there has regressed to its size in 2011, right after the Tohoku earthquake and tsunami brought the nation to its knees.

Back then, the dollar had been trending lower vs. the yen for the best part of the previous four years, so the fact that it dropped sharply on the news of the earthquake was hardly surprising. In fact, it was eight more months before the dollar reached its nadir vs. the yen (75.35), which simply tells us that the trend was the driver and the singular event did not disrupt that trend. And to be clear, that trend was quite steep, averaging nearly 11% per year from its beginning in 2007. In comparison, the current trend in USDJPY, while lower, is much less dramatic. Since its recent peak in June 2015, the entire decline has been just 15.5% (~3.2% per annum). Granted, there have been a few spikes lower, most recently in March during the first days of the Covid panic, but neither the economic situation nor the price action really resembles those days immediately after Tohoku.

The point is, while the dollar is certainly on its back foot, and the yen retains haven status, the idea of a dollar collapse seems far-fetched. I’m confident that Japan’s Q3 data will show significant improvement compared to the Covid inspired depths just reported, but given the massive debt overhang, as well as the aging demographics and trend growth activity in the country, it is likely to be quite a few years before Japan’s economy is once again as large as it was just last year. Ironically, that probably means the yen will continue to trend slowly higher over time. But even getting to 100 will be a long road.

The other interesting story last night was from China, where the PBOC added substantially more liquidity to the markets than had been anticipated, RMB 700 billion in total via one-year injections. This more than made up for the RMB550 billion that is maturing over the next week and served as the catalyst for the Shanghai Exchange’s (+2.35%) outperformance overnight. This merely reinforces the idea that excess central bank liquidity injections serve a singular purpose, goosing stock market returns supporting economic activity.

There is something of an irony involved in watching the central banks of communist nations like China and Russia behave as their actions are essentially identical to the actions of central banks in democratic nations. Is there really any difference between the PBOC injecting $100 billion or the Fed buying $100 billion of Treasuries? In the end, given the combination of uncertainty and global ill will, virtually all that money finds its way into equity markets, with the only question being which nation’s markets will be favored on any given day. It is completely disingenuous for the Fed, or any central bank, to explain that their activities are not expanding the current bubble in markets; they clearly are doing just that.

But the one thing of which we can be certain is that they are not going to stop of their own accord. Either they will be forced to do so after changes in political leadership (unlikely) or the investment community will become more fearful of their actions than any possible inaction on their parts. It is only at that point when this bubble will burst (and it will) at which time central banks will find themselves powerless and out of ammunition to address the ensuing financial distress. As to when that will occur, nobody knows, but you can be certain it will occur.

And with that pleasant thought now past, a recap of the overnight activity shows that aside from Shanghai, the equity picture was mixed in Asia (Nikkei -0.8%, Hang Seng +0.6%) while European bourses are similarly mixed (DAX +0.2%, CAC 0.0%, Spain’s IBEX -0.75%). US futures are modestly higher at this point, but all well less than 1%. Bond markets are starting to find a bid, with 10-year Treasuries now down 1.5 basis points, although still suffering indigestion from last week’s record Treasury auctions. And in fact, Wednesday there is another huge Treasury auction, $25 billion of 20-year bonds, so it would not be surprising to see yields move higher from here. European bond markets are all modestly firmer, with yields mostly edging lower by less than 1bp. Commodity markets show oil prices virtually unchanged on the day while gold (and silver) are rebounding from last week’s profit-taking bout, with the shiny stuff up 0.5% (AG +2.1%).

Finally, the dollar is arguably slightly softer overall, but there have really been no large movements overnight. In G10 world, the biggest loser has been NZD (-0.3%) as the market voted no to the announcement that New Zealand would be postponing its election by 4 weeks due to the recently re-imposed lockdown in Auckland. On the plus side, JPY leads the way (+0.25%, with CAD and AUD (both +0.2%) close by on metals price strength. Otherwise, this space is virtually unchanged.

Emerging markets have had a bit more spice to them with RUB (-1.25%) the outlier in what appears to be some position unwinding of what had been growing RUB long positions in the speculative community. But away from that, HUF (-0.6%) is the only other mover of note, as investors grow nervous over the expansion of the current account deficit there.

This week’s data releases seem likely to be less impactful as they focus mostly on housing:

Today Empire Manufacturing 15.0
Tuesday Housing Starts 1240K
  Building Permits 1320K
Wednesday FOMC Minutes  
Thursday Initial Claims 915K
  Continuing Claims 15.0M
  Philly Fed 21.0
Friday Manufacturing PMI 51.8
  Services PMI 51.0
  Existing Home Sales5.40M  

Source: Bloomberg

Of course, the FOMC Minutes will be greatly anticipated as analysts all seek to glean the Fed’s intentions regarding the policy overhaul that has been in progress for the past year. Away from the Minutes, though, there are only two Fed speakers, Bostic and Daly. And let’s face it, pretty much every FOMC member is now on board with the idea that raising the cost of living inflation is imperative, and that if inflation runs hot for a while, there is no problem. Clearly, they don’t do their own food-shopping!

It is hard to get too excited about markets one way or the other today, but my broad view is that though the medium-term trend for the dollar may be lower, we continue to be in a consolidation phase for now.

Good luck and stay safe
Adf

Hard to Believe

As travel restrictions expand
And quarantines spread ‘cross the land
It’s hard to believe
That we’ll soon achieve
A surge to pre-Covid demand

Risk is having a tough day today as new travel restrictions announced by the UK, regarding travelers from France and the Netherlands, as well as four small island nations, has raised the specter of a second wave of economic closures. In fact, while the headlines are hardly blaring, the number of new infections in nations that had been thought to have achieved stability (Germany, France, Spain and New Zealand) as well as those that have never really gotten things under control (India, Brazil and Mexico) indicates that we remain a long way from the end of the pandemic. Given the market response to this news, it is becoming ever clearer that expectations for that elusive V-shaped recovery have been a key driver to the ongoing rebound in risk appetites worldwide.

However, most recent data has pointed to a slowing of economic activity in the wake of the initial bounce. Exhibit A is China, where Q2 GDP grew a surprising 3.2%, but where the monthly data released last evening showed IP (-0.4% YTD) and Retail Sales (-9.9% YTD) continue to lag other production indicators. The very fact that Retail Sales continues to slump is a flashing red light regarding the future performance of the Chinese economy. Remember, they have made a huge effort to convert their economy from a highly export-oriented one to a more domestic consumer led economy. But if everyone is staying home, that becomes a problem for growth. And the word is, at least based on several different BBG articles, that many Chinese are reluctant to resume previous activities like going out to dinner or the movies.

The upshot is that the PBOC will very likely be back adding stimulus to the economy shortly, after a brief hiatus. Since it bottomed at the end of May, the renminbi had rallied 3.35%, and engendered stories of ongoing strength as the Chinese sought to reduce USD utilization. A big part of that story has been the idea that China has left the pandemic behind and was set to get back to its days of 6% annual GDP growth. Alas, last night’s data has put a crimp in that story, halting the CNY rally, at least for the moment.

But back to the broader risk picture, which shows that equity markets in Europe are suffering across the board (DAX -1.3%, CAC -2.0%, FTSE 100 -2.1%) as not only has the UK quarantine news shocked markets, but the data continues to be abysmal. This morning it was reported that Eurozone employment had fallen 2.8% in Q2, the largest decline since the euro was born in 1999, and essentially wiping out 50% of all jobs created during the past two decades. Meanwhile, Eurozone GDP fell 12.1% in Q2 and was lower by 15% on a year over year basis last quarter. While the GDP outcome may have been forecast by analysts, it remains a huge gap to overcome for the economies in the Eurozone and seems to have forced some reconsideration about the pace of future growth.

And perhaps, that is today’s story. It seems that there is a re-evaluation of previous assumptions regarding the short-term future of the global economy. US futures are pointing lower although are off their worst levels of the overnight session. Treasury yields, after rising sharply yesterday in the wake of a pretty lousy 30-year auction, have fallen back 2.5 basis points to 0.70%, still well above the lows seen two weeks ago, but unappetizing, nonetheless. Commodity prices are slipping with both oil (-0.5%) and gold (-0.4%) a bit lower. And the dollar is modestly firmer along with the yen, an indication that risk is under pressure.

In the G10, aside from the yen, which seems clearly to be benefitting from today’s risk mood, the pound has actually edged a bit higher, 0.3%, after comments by the UK’s chief Brexit negotiator, David Frost, indicated his belief a deal could be reached by the end of September. Meanwhile, NOK (-0.5%) is the worst performer in the bloc as the decline in oil prices has combined with a strong weekly performance driving profit-taking trades and pushing the currency back down. The rest of the bloc is broadly softer, but the movement has been modest at best.

In the EMG space, there are more losers than gainers with RUB (-0.6%) not surprisingly the laggard, although TRY (-0.5%) continues to demonstrate how to destroy a currency’s value with bad policymaking. The rest of the space is generally softer by much smaller amounts and there has only been one gainer, PHP (+0.2%) which, remarkably, seems to be benefitting from the idea that the central bank is openly monetizing debt. Historically, this type of activity, especially in emerging market economies, was seen as a disaster-in-waiting and would result in a much weaker currency. But apparently, in the new Covid age, it is seen as a mark of sound policy.

A quick diversion into debt monetization and the potential consequences is in order. By this time, MMT has become a mantra to many who believe that inflation is a thing of the past and without inflation, there is no reason for governments that print their own currency to ever stop doing so, thus supporting economic activity. But I fear that view is hugely mistaken as the lessons learned from the economic response to the GFC are not applicable here. Back then, all the new liquidity that was created simply sat on bank balance sheets as excess reserves at the Fed. Very little ever made its way into the real economy. Obviously, it did make it into the stock market.

But this time, there is not merely monetary support, but fiscal support, with much of the money being spent by those recipients of the $1200 bonus check, the $600/week of topped up Unemployment benefits, and the $billions in PPP loans. At the same time, factory closures throughout the nation have reduced the production of ‘stuff’ while government restrictions have reduced the availability of many services (dining, movies, health clubs, etc.) Thus, it becomes easy to see how we now have a situation where a lot more money is chasing after a lot less stuff. Yes, the savings rate has risen, but this is a recipe for inflation, and potentially a lot of it. MMT proponents claim that inflation is the only thing that should moderate government spending. But ask yourself this question, is it realistic to expect the government to slow or stop spending just because inflation starts to rise? Elected officials will never want to derail that gravy train, despite the consequences. And while MMT is not official policy, it is certainly a pretty fair description of what the Fed is currently doing, buying virtually all the new Treasury debt issued. Do not be surprised when next month’s CPI figures are higher still! And the month after…

Anyway, this morning brings Retail Sales (exp +2.1%, +1.3% ex autos) as well as Nonfarm Productivity (1.5%), Capacity Utilization (70.3%), IP (3.0%), Business Inventories (-1.1%) and finally, Michigan Sentiment (72.0). Retail Sales will get all the press. A soft number is likely to enhance the risk-off mood and help the dollar edge a bit higher, while a strong print should give the bulls a renewed optimism with the dollar suffering as a consequence.

Good luck, good weekend and stay safe
Adf

Quite Sordid

For Italy, France and for Spain
The data released showed their pain
Each nation recorded
A number quite sordid
And each, Covid, still can’t contain

As awful as the US GDP data was yesterday, with an annualized decline of 32.9%, this morning saw even worse data from Europe.  In fact, each of the four largest Eurozone nations recorded larger declines in growth than did the US in Q2.  After all, Germany’s 10.1% decline was a Q/Q number.  If we annualize that, it comes to around 41%.  Today we saw Italy (-12.4% Q/Q, -50% annualized), France (-13.8% Q/Q or -55% annualized) and Spain, the worst of the lot (-18.5% Q/Q or -75% annualized).  It is, of course, no surprise that the Eurozone, as a whole, saw a Q/Q decline of 12.1% which annualizes to something like 49%.  At those levels, precision is not critical, the big figure tells you everything you need to know.  And what we know is that the depths of recession in Europe were greater than anywhere else in Q2.

The thing is, none of this really matters any more.  The only thing the Q2 GDP data did was establish the base from which future growth will occur.  We saw this in the US yesterday, where equity markets rallied, and we are seeing and hearing it today throughout Europe as the narrative is quite clear; Q2 was the nadir and things should get better going forward.  In fact, that is the entire thesis behind the V-shaped recovery.  Certainly, one would be hard pressed to imagine a situation where Q3 GDP could shrink relative to Q2, but unfortunately the rebound story is running into some trouble these days.

The trouble is making itself known in various ways.  For example, the fact that the Initial Claims data in the US has stopped declining is a strong indication that growth is plateauing.  This is confirmed by the resurgence of Covid cases being recorded throughout the South and West and the reimposition of lockdown measures and closures of bars and restaurants in California, Texas and Arizona.  And, alas, we are seeing the same situation throughout Europe (and in truth, the rest of the world) as nations that had been lionized for their ability to act quickly and prevent the spread of the virus through draconian measures, find that Covid is quite resilient and infections are surging in Spain, Italy, Germany, the UK, Japan, Singapore, South Korea and even in China.  You remember China, the origin of the virus, and the nation that explained they had eradicated it completely just last month.  Maybe eradicated was too strong a word.

So, the real question is, what happens to markets if the future trajectory of growth is much shallower than a V?  It is not difficult to argue that equity markets, especially in the US, are priced for the retracement of all the lost growth.  That seems to be at odds with the situation on the ground where thousands of small businesses have closed their doors forever.  And not just small businesses.  The list of bankruptcy filings by large, well-known companies is staggeringly long.

Can continued monetary and fiscal support from government institutions really replace true economic activity?  Of course, the answer to that question is no.  Money from nothing and excessive debt issuance will never substitute for the creation of real goods and services that are demanded by the population.  So, while equity markets trade under the assumption that government support is a stop-gap filler until activity returns to normal, the recent, high-frequency data is implying that the gap could be much longer than initially anticipated.

And as has been highlighted in many venues, the bond market is telling a different story.  Treasury yields out to 10 years are now trading at record lows.  The amount of negative yielding debt worldwide is climbing again, now back to $16 trillion, and heading for the record levels seen at the end of last August.  This price behavior is the very antithesis of expected strong growth in the future.  Rather it signals concerns that growth will be absent for years to come, and with it inflationary pressures.  At some point, these two asset classes will both agree on a story, and one of them will require a major repricing.  My money is on the stock market to change its tune.

But that is a longer term discussion.  For now, let us review the overnight session.  It is hard to characterize it as either risk-on or risk-off, as we continue to see mixed signals from different markets.  In Asia, the Nikkei was the worst performer, falling 2.8% as concerns grow that a second wave of Covid infections is going to stop the signs of recovery.  Confirming those fears, a meeting of government and central bank officials took place where they discussed what to do in just such a situation, which of course means there will be more stimulus, both monetary and fiscal, on its way soon.  The yen behaved as its haven status would dictate, rallying further and touching a new low for the move at 104.19 before backtracking and sitting unchanged on the day as I type.  The thing about the yen is that 105 had proven to be a strong support level and is now likely going to behave as resistance.  While I don’t see a collapse, USDJPY has further to fall.

The rest of Asia saw weakness (Hang Seng -0.5%, Sydney -2.0%) and strength (Shanghai +0.7%) with the latter responding to modestly better than expected PMI data, while the former two are feeling the impact of the rise in infections.  Europe, on the other hand, is green across the board, with Italy’s FTSE MIB (+1.25%) leading the way, although the DAX (+0.7%) is performing well.  Here, just like in the US, investors seem to believe in the V-shaped recovery and now that the worst has been seen, those investors are prepared to jump in with both feet.

As discussed above, bond markets continue to rally, and yields continue to fall.  That is true throughout Europe as well as in the US.  In fact, it is true in Asia as well, with China the lone exception, seeing its 10-year yield rise 4bps overnight.

And finally, the dollar can only be described as mixed.  In the G10, NZD (-0.5%) and AUD (-0.2%) are the worst performers as both suffer from concerns over growing numbers of new Covid cases, while SEK and GBP (+0.25% each) lead the way higher.  It is ironic as there is concern over the growing number of cases in those nations as well, and, in fact, the UK is locking down over 4 million people in the north because of a rise in infections.  But the pound has been on fire lately, and that momentum shows no signs of abating for now.  One would almost think that a Brexit deal has been agreed, but the latest news has been decidedly negative there.  This is simply a reminder that FX is a perverse market.

Emerging markets have also seen mixed activity, although it is even more confusing.  Even though commodities are having a pretty good day, with both oil and gold prices higher, the commodity currencies are the worst performers today, with ZAR (-1.35%), RUB (-1.0%) and MXN (-0.9%) all deeply in the red.  On the positive side, THB (+0.85%) and CNY (+0.5%) are showing solid strength.  The renminbi, we already know, is benefitting from the better than expected PMI data while the baht benefitted from ongoing equity inflows.

This morning we see another large grouping of data as follows: Personal Income (exp -0.6%), Personal Spending (5.2%), core PCE Deflator (1.0%), Chicago PMI (44.5) and Michigan Sentiment (72.9).  As inflation is no longer even a concern at the Fed, or any G10 central bank, the market is likely to look at two things, Spending data which could help cement the idea that things are rebounding nicely, or not, and Chicago PMI, as an indication of whether industrial activity is picking up again.

Overall, regardless of the data, the trend remains for the dollar to decline, at least against its G10 brethren and I see nothing that is going to change that trend for now.  At some point, it will make sense for receivables hedgers to take advantage, but it is probably still too early for that.

Good luck, good weekend and stay safe

Adf

 

Deferred

In Europe, despite what you’ve heard
The rebound could well be deferred
The ECB told
The banks there to hold
More capital lest they’re interred

It seems that the ECB is still a bit concerned about the future of the Eurozone economy.  Perhaps it was the news that the Unemployment rate in Spain jumped up to 15.3%.  Or perhaps it was the news that cases of Covid are growing again in various hot spots across the Continent.  But whatever the reason, the ECB has just informed the Eurozone banking community that dividends are taboo, at least for the rest of 2020, and that they need to continue to bolster their capital ratios.  Now, granted, European banks have been having a difficult time for many years as the fallout from Negative interest rates has been accumulating each year.  So, not only have lending spreads shrunk, but given the Eurozone economy has been so slothful for so long, the opportunities for those banks to lend and earn even that spread have been reduced.  It should be no surprise that the banking community there is in difficult shape.

However, from the banks’ perspective, this is a major problem.  Their equity performance has been dismal, and cutting dividends is not about to help them.  So, the cost of raising more capital continues to rise while the potential profit in the business continues to fall.  This strikes me as a losing proposition, and one that is likely to lead to another wave of European bank mergers.  Do not be surprised if, in a few years, each major country in Europe has only two significant banks, and both are partly owned by the state.  Banking is no longer a private industry, but over the course of the past decade, since the GFC, has become a utility.  But unlike utilities that make a solid return on capital and are known for their steady dividend payouts, these are going to be owned and directed by the state, with any profits going back to the state.  I foresee the conservatorship model the US Treasury used for FNMA and FHLMC as the future of European banking.

The reason I bring this up is because amidst all the cooing about how the EU has finally changed the trajectory of Europe with their groundbreaking Pandemic relief package, and how this will establish the opportunity for the euro to become the world’s favored reserve currency, there are still many fundamental flaws in Europe, and specifically in the Eurozone, which will effectively prevent this from happening.  In fact, there was a recent study by Invesco Ltd, that showed central banks around the world expect to increase their reserve allocation to USD in the next year, not reduce those allocations.  This has been a key plank for the dollar bears, the idea that the world will no longer want dollars as a reserve asset.  Whatever one thinks about the US banking community and whether they serve a valuable purpose properly, the one truth is that they are basically the strongest banks in the world from a capital perspective.  And in the current environment, no country can be dominant without a strong banking sector.

In fact, this may be the strongest argument for the dollar to remain overpriced compared to all those econometric models that focus on the current account and trade flows.  A quick look at China’s banks shows they are likely all insolvent, with massive amounts of unreported, but uncollectable loans outstanding.  China has been the most active user of the extend and pretend model, rolling loans over to insolvent state companies in order to make it appear those loans will eventually be repaid.  Only US banks have the ability to write off significant amounts of their loan portfolio (remember, in Q2 the number was $38 billion) and remain viable and active institutions.  In fact, this is one of the main reasons the US economy has outperformed Europe for the past decade.  Covid or no, European banks will continue to drag the European economy down, mark my words.  And with that, the euro’s opportunity for significant gains will be limited.

But that is a much longer-term view.  Let us look at today’s markets now.  If pressed, I would describe them as ever so slightly risk-off, but the evidence is not that convincing.  Equity markets in around the world have been mixed, with few being able to follow the US markets continued strength.  For example, last night saw the Nikkei (-0.25%) slide along with Sydney (-0.4%) while both Shanghai and the Hang Seng rallied a solid 0.7%.  Europe, on the other hand has much more red than green, with the DAX (-0.35%) and CAC (-0.75%) leading the way, although Spain’s IBEX (+0.3%) seems to be rebounding from yesterday’s losses despite the employment data.  Meanwhile US futures, which were essentially unchanged all evening, have just turned modestly lower.

The bond market, though, is a little out of kilter with the stock market, as yields throughout Europe have moved higher despite the stock market performances there.  Meanwhile, Treasury yields are a half basis point lower than yesterday’s close, although yesterday saw the 10-year yield rise 4bps as risk fears diminished.  Gold and silver are consolidating this morning, with the former down 0.85% as I type, and the latter down 5.0%.  But in the overnight session, gold did trade to a new all-time high, at $1981/oz.  The rally in gold has been extremely impressive this year, and after touching new highs, there are now a few analysts who are growing concerned a correction is imminent.  From a trading perspective, that certainly makes sense, but in the end, the underlying story remains quite positive, and is likely to do so as long as central banks believe it is their duty to print as much money as they can as quickly as they can.

As to the dollar, it is broadly firmer this morning, although the movement has not been that impressive.  In the G10, kiwi is the biggest loser, down 0.5%, as talk of additional QE is heating up there.  But other than SEK (-0.4%), the rest of the block is just a bit softer, with CHF and JPY actually 0.1% firmer at this time.  Emerging market activity shows RUB (-0.8%) as the weakest of the lot, although we are also seeing softness in TRY and ZAR (-0.6% each) and MXN (-0.5%).  Softening oil and commodity prices are clearly not helping either the rand or peso, but as to TRY, it remains unclear what is driving it these days.

On the data front, yesterday saw Durable Goods print largely as expected, showing the initial bounce in the economy.  This morning brings Case Shiller Home Prices (exp 4.05%) and Consumer Confidence (95.0), neither of which seems likely to move the needle.  With the Fed on tap for tomorrow, despite the fact they are likely to leave well enough alone, there will be much ink spilled over the meeting.

In the end, the short-term trend remains for the dollar to soften further, today notwithstanding, but I don’t believe in the dollar collapse theory.  As such, receivables hedgers should really be looking for places to step in and add to your programs.

Good luck and stay safe

Adf

 

 

 

They’ll See the Light

In China, a new rule applies
Which helped stocks close on session highs
The news was released
Insurers increased
The size of their equity buys

Meanwhile, Brussels has been the sight
Of quite a large policy fight
Four nations refuse
Their cash to misuse
But in the end, they’ll see the light

Once upon a time, government announcements were focused on things like international relations, broad economic policies and the occasional self-kudos to try to burnish their reputation with the electorate, or at least with the population.  But that ideal has essentially disappeared from today’s world.  Instead, as a result of the ongoing financialization of economies worldwide, there are only two types of government announcements these days; those designed to explain why the current government is the best possible choice, and those designed to prop up the nation’s stock market.  Policy comments are too hard for most people to understand, or at least to understand their potential ramifications, so they are no longer seen as useful.  But, do you know what is seen as useful?  Explaining that institutions should buy more stocks because a higher stock market is good for everyone!

Once again, China leads the way in this vein, with Friday night’s announcement that henceforth, Insurers should can allocate as much as 45% of their assets to equities, up from the previous cap of 30%.  Some quick math shows that this new regulation has just released an additional $325 billion of new buying power into the Chinese stock market, or roughly 4% of the total market capitalization in the country.  It cannot be a surprise that the Shanghai Exchange rallied 3.1% last night, which was, of course, exactly the idea behind the announcement.  In fact, lately, the Chinese have been really working to manipulate the stock market there, apparently seeking a steady move higher, probably something like 1% a day, but have been having trouble reining in the exuberance of the large speculative community there.  So, all of their little nudges higher result in 3%-5% gains, which they feel could be getting out of hand, and so they need to squash them occasionally.  But for now, they are back on the rally bandwagon, so look for some steady support this week.

Interestingly, however, this was clearly not seen as a global risk-on signal as equity activity elsewhere has been far more muted.  The rest of Asia was basically flat (Nikkei +0.1%, Hang Seng -0.1%) and Europe has seen a mixed session as well, with small gains by the DAX (+0.3%) and losses by the CAC (-0.3%).  In other words, investors realize this is simply Chinese activity.  PS, US futures are basically unchanged on the day as well.

At the same time, there is a critical story building out of Europe, the outcome of the EU Summit. This began with high hopes on Friday as most people expected the Frugal Four to quickly cave into the pressure to give more money away to the PIGS.  However, after three full days of talks, there is still no agreement.  Remember, their concern is that the EU plan to give away €500 billion in grants to countries most in need (read Italy, Spain and Greece), is simply delaying the inevitable as they will almost certainly waste these funds, just like they have each wasted funds for decades.  And the frugal four nations were not interested in throwing their money away.  But in the end, it was always clear that with support from Germany and France, a deal would get done in some form.  The latest is that “only” €390 billion will be given as grants, so a 22% reduction, but still a lot of free cash.

While no one has yet signed on the dotted line, you can be sure that by the end of the day, they will have announced a successful conclusion to the process.  The funny thing is that regardless of the outcome of the Summit, it seems to me that the entire package, listed at €750 billion, is actually pretty small.  After all, the CARES act here had a price tag of $3.2 trillion, four times as large, and the EU economy is going to suffer just as much as the US.  But that is not the way the market is looking at things.  Rather, they have collectively decided that this package is a huge euro positive and have been pushing the single currency higher steadily for pretty much the entire month of July (+2.5%), with it now sitting just pips below the spike high seen in March, and back to levels last seen, really, in January 2019.  How much further can it rise?  Personally, I am skeptical that it has that much more room to run, but I know the technicians are really getting excited about a big breakout here.

As to the rest of the FX market, activity has been fairly muted with the dollar slightly softer against most G10 and EMG counterparts.  On the G10 side, NOK and SEK lead the way higher, both up by 0.45%, as in a broad move, these higher beta currencies tend to have the best performance.  JPY is a touch softer on the day, and a number of currencies, CAD, NZD, CHF, are all within just basis points of Friday’s close.

We are seeing similar price action in the emerging markets, with one notable loser, IDR (-0.5%) as traders there continue to price in further policy ease by the central bank after last week’s 25bp rate cut. On the plus side, the CE4 are leading the way higher, with gains between 0.3% and 0.6%, simply tracking the euro with a bit more beta.  But really, there is not too much of note to discuss here.

On the data front, it is an extremely quiet week upcoming as follows:

Wednesday Existing Home Sales 4.80M
Thursday Initial Claims 1.293M
  Continuing Claims 16.9M
  Leading Indicators 2.1%
Friday PMI Manufacturing 52.0
  PMI Services 51.0
  New Home Sales 700K

Source: Bloomberg

In addition, there are no Fed speakers on the docket as it seems everybody has gone on holiday.  So, once again, Initial Claims seems to be the key data point this week, helping us to determine if things are actually getting better, or we have seen a temporary peak in activity.  With the ongoing spread of what appears to be a second wave of Covid, there is every chance that we start to see the rebound in data seen for the past two months start to fade.  If that is the case, it strikes me that we will see a bit more risk-off activity and the dollar benefit.  But that is a future situation.  Today, the dollar remains under modest pressure as traders respond to the perceived benefits of striking a deal at the EU.

Good luck and stay safe

adf

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