Forecasts to Hell

The company named like a fruit
Said Covid was going to shoot
Its forecasts to hell
So risk assets fell
And havens all rallied to boot

Essentially, since the beginning of the Lunar New Year, there have been two competing narratives. First was the idea that the spread of the Covid virus would have a significantly detrimental impact on the global economy, reducing both production, due to the interruption of supply chains, and consumption, as the world’s second largest economy went into lockdown. This would result in a risk-off theme with haven assets in significant demand. The second was that, just like the SARS virus from 2003, this would be a temporary phenomenon and the fact that central banks around the world have been ramping up policy support by cutting rates and buying assets means that risk assets would continue their relentless march higher. And quite frankly, while there were a handful of days where the first thesis held sway, generally speaking, equity markets at least, are all-in on the second thesis.

At least that was true until today, when THE bellwether stock in the global equity markets explained that Q1 sales would miss forecasts due not only to production delays caused by supply chain interruptions, but to reduced sales as well. This news certainly put a crimp in the bull theory that the virus impact will be temporary and we have seen equity markets around the world suffer, while Treasuries rally, as fears are reignited over the ultimate impact of the CoVid virus.

While this author is no virologist, and does not pretend to have any special insight into how things with Covid evolve from here, long experience informs me that government efforts have been far more focused on controlling the message than controlling the virus. Confidence plays such an important part in today’s economy, and if the first narrative above is the one that takes hold, then there is very little that governments will be able to do to prevent a more substantial downturn and likely recession. Remember, at least in the G10, most central banks are basically out of ammunition with respect to their abilities to pump up the economy, so if the populace hunkers down because of fear, things could get ugly pretty quickly. And with that cheerful thought, let’s take a tour of the markets this morning.

It turns out the tax
On goods and services was
A growth disaster

During the US holiday weekend, we received a stunningly bad Q4 GDP report from Japan, with a -1.6% Q/Q result which turned into a -6.3% annualized number. Not only was that significantly worse than expected, but it was the worst outturn since the last time the Japanese government raised the GST in 2014. So, in their effort to be fiscally prudent, they blew an even bigger hole in their budget! But the yen didn’t really mind, as it remains a key safe haven, and while it weakened ever so slightly yesterday, this morning’s fear based markets has allowed it to recoup those losses and then some. So as I type, the yen is stronger by 0.15% today. Certainly, selling yen is a fraught operation in a market with as big a potential fear catalyst as currently exists.

Meanwhile, that other erstwhile growth engine, Germany, once again demonstrated that the idea of a rebound this year is on extremely shaky ground. Early this morning the ZEW surveys were released with the Expectations reading falling sharply to 8.7, while Current Situations fell to -15.7. While the numbers themselves have no independent meaning, both results were far worse than expected and crushed the modest rebound that had been seen in December. The euro has been under pressure since the release of the data, falling to a new low for the move and continuing its streak of down days, now up to 10 of the past twelve sessions, with the other two sessions closing essentially flat. The euro story has shown no signs of turning around on its own, and for the euro to stop declining we will need to see the dollar story change. Right now, that seems unlikely.

And generally speaking, the dollar is simply outperforming all other currencies. Versus the EMG bloc, the dollar is higher across the board, with not a single one of these currencies able to rally against the greenback. Today’s biggest decliners are the RUB (-0.6%) as oil prices fall, KRW (-0.5%) as concerns grow over Covid, and ZAR (-0.45%) as both commodity prices decline and global growth fears increase. In the G10 space, it should be no surprise that both AUD (-0.5%) and NZD (-0.7%) are the worst performers (China related) as well as NOK (-0.7%) as oil suffers over concerns of slowing global growth. It seems like we’ve heard this story before.

The one currency doing well today, other than the yen, is the British pound (+0.2%) as UK Employment data, released early this morning, was generally better than expected, with the 3M/3M Employment Change slipping a much less than expected 28K to 180K, a still quite robust number. Interestingly, yesterday saw the pound under pressure as PM Johnson’s Europe Advisor, David Frost, laid out the UK’s goals as ditching all EU social constructs and simply focusing on trade. That is at odds with the hinted at EU view, which is they want the UK to follow all their edicts even though they are no longer in the club. Look for more fireworks as we go forward on this subject.

Looking ahead to this week, the US data is generally second-tier, although we will see FOMC Minutes tomorrow.

Today Empire Manufacturing 5.0
Wednesday Housing Starts 1420K
  Building Permits 1450K
  PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.1% (1.3% Y/Y)
  FOMC Minutes  
Thursday Initial Claims 210K
  Philly Fed 11.0
Friday Leading Indicators 0.4%
  Existing Home Sales 5.45M

Source: Bloomberg

So lots of housing data, which given the interest rate structure should be pretty decent. Of course, the problem is the reason the interest rate structure is so attractive to home buyers is the plethora of problems elsewhere in the economy. In addition, we have seven Fed speakers during the rest of the week with a nice mix of hawks and doves. Although it seems unlikely that anybody will change their views, be alert to Dallas Fed President Kaplan’s comments tomorrow and Friday as he is the only FOMC member who has admitted that continuing to pump up the balance sheet could cause excesses in risk taking.

At this point, there is nothing on the horizon that indicates the dollar’s run is over. Regarding the euro, technically there is nothing between current levels and the early 2017 lows of 1.0341 although I would expect some congestion at 1.0500.

Good luck
Adf

Simply Too Fraught?

The question whose answer is sought
‘Bout what should be sold or be bought
Is will GDP
Rebound like a V
Or are things just simply too fraught?

Risk is neither on nor off this morning as investors and traders continue to sift through both the recent changes in coronavirus news from China and the economic releases and choose a direction. Thus far this morning, that direction is sideways.

In one way, it is a bit surprising there is not a more negative viewpoint as on top of the surge in reported cases of Covid-19 (the coronavirus’s official name), we have heard of more companies closing operations outside of China for lack of parts. The latest is Fiat Chrysler, which closed a manufacturing facility in Serbia due to its inability to source parts that are built in China. While the Chinese government is seemingly trying to get everyone to believe that things are going to be back to normal soon, manufacturers on the ground there who have reopened, are running at fractions of capacity due to an inability of workers to get to the plant floor. Huge swaths of the country remain in effective lockdown, and facemasks, which are seen as crucial to getting back to work, are scarce. Apparently, the capacity to make face masks in China is just 22 million/day. While that may sound like a lot, given everyone needs a new one every day, and that there are around 100 million people under quarantine (let alone 1.3 billion in the country), there just aren’t enough to go around. I remain skeptical that this epidemic will come under any sense of control for a number of weeks yet, and that ultimately, the hit to global economic growth will be far more severe than the market is currently pricing.

Another sign of trouble came from Germany this morning, where Q4 GDP was released at 0.0% taking the annual growth rate to 0.6% in 2019. Eurozone GDP turned out to be just 0.9% in 2019, and that was before the virus was even discovered. In other words, it appears that both those numbers are going to be far worse in Q1 as the Eurozone remains highly reliant on exports to grow, and as the Fiat news demonstrates, exports are going to be reduced.

Keeping this in mind, it is easy to understand why the euro remains under so much pressure. While its decline this morning is just 0.1%, to 1.0830, the euro is trading at its lowest level vs. the dollar since April 2017. The single currency has fallen in 9 of the past 10 sessions and is down 2.4% this month. And let’s face it, on the surface; it is awfully difficult to make a case for the euro to rebound on its own. Any strength will require help from the dollar, meaning either weaker US economic data, or more aggressive Fed policy ease. At this point, neither of those looks likely, but the impact of Covid-19 remains highly uncertain and can easily derail the US economy as well.

But for now, the narrative remains that Chinese GDP growth in Q1 will be hit, but that by Q2 things will be rebounding and this will all fade from memory akin to the SARS virus in 2003. Just remember, China has effectively been closed since January 23, three full weeks, or 6% of a full year. While manufactured goods demand will certainly rebound, there are many services that simply will never be performed and cannot be recouped. The PBOC is already tweaking leverage policies on property lending in an effort to help further support growth going forward, and there is discussion of allowing banks to live with a greater proportion of non-performing loans that are due to the coronavirus. One can only imagine all the garbage loans that will receive that treatment!

Switching to a view of the markets, equity markets are +/- 0.2% generally speaking with US futures in a similar position. Treasury yields have fallen back a few bps, giving up yesterday’s modest gains, and the FX market, on the whole, is fairly benign. Away from the euro’s small decline this morning, we are seeing slight weakness in the pound, Aussie and Kiwi, with the rest of the G10 doing very little. The one gainer today is CAD, +0.15%, which seems to be benefitting from WTI’s ongoing bounce from Monday’s low levels, with the futures contract there higher by 1.4%.

In the EMG space, ZAR is today’s big winner, up 0.65%, in response to President Cyril Ramaphosa’s State of the Nation speech, where he outlined steps to help reinvigorate growth and fix some of the bigger problems, like the state-owned power producer Eskom’s debt issues. Of course, speeches are just that and the proof will be in what policies actually get implemented. The other key gainers here are BRL (+0.6%), which saw the central bank (finally) intervene yesterday to try to stop the real’s dramatic recent plunge (it had fallen more than 4% in the past 10 days and nearly 10% in 2020 so far). After announcing $1 billion in swaps, the market turned tail and we are seeing that continue this morning. HUF also continues to benefit, rallying a further 0.55% this morning, as the market continues to price in growing odds of a rate hike to help rein in much higher than expected inflation.

On the data front, this morning brings Retail Sales (exp 0.3%, 0.3% ex autos) as well as IP (-0.2%), Capacity Utilization (76.8%) and Michigan Sentiment (99.5). Yesterday’s CPI data was a touch firmer than forecast, simply highlighting that the Fed’s measure of inflation does not do a very good job. Also yesterday, we heard from NY Fed President Williams who told us the economy is in a “very good place”, while this morning we hear from uber-hawk Loretta Mester. This week the doves have all cooed about letting inflation run hot and cutting if necessary. Let’s hear what the hawks think.

So as we head into the weekend, I expect traders to reduce positions that have worked as the potential for a weekend surprise remains quite large, and nobody wants to get caught. That implies to me that the dollar can soften ever so slightly as the day progresses.

Good luck
Adf

Burdened With Shame

There once was a president, Xi
Who ruled with a fist of F E
But there’s now a nit
That cares not a whit
‘Bout politics while running free

So mandarins now take the blame
For playing along with Xi’s game
Their jobs they have lost
And soon they’ll be tossed
In jail, as they’re burdened with shame

Apparently, at least some of the rumors of undercounting coronavirus infections seem to have been true as last night the latest data showed an extraordinary jump in total cases to nearly 60,000 with a regrettable mortality rate of 2.3%, meaning more than 1350 people have passed away from its effects. Last week, much was made about how this was not very different than the simple flu, but that is just not the case. The mortality rate of the flu is 0.1%, an order of magnitude lower. At any rate, officials in Hubei Province revised the way they were calculating cases (i.e. they started admitting to higher numbers) and suddenly there were nearly 15,000 more cases just like that. In typical dictatorial fashion, the previous Hubei leadership, whose job was to prevent the truth from escaping, has been summarily sacked, and President Xi has a new man on the job, with a clean(er) slate. Talk about a thankless job!

At this point, what has become clear is that the dynamics of the spread of the virus remain uncertain and despite significant efforts by the Chinese, it appears premature to declare the situation under control. Recent market activity, where risk assets were aggressively acquired leading to record high stock prices, may now need to be rethought. Consider that the narrative that had been developing, especially after it appeared the growth of the virus was slowing, was that any impact would be temporary and confined to Q1. If that were the case, then it certainly was reasonable to think that ongoing central bank largesse would continue to push risk assets ever higher. But today it seems as though the definition of temporary may need to be adjusted somewhat, and investors are treading more cautiously. This is a terrible human tragedy and the most concerning aspect is that due to the politics in China, efforts to address it using the broadest array of expertise from the WHO and CDC is not being utilized. The likely outcome of these decisions is that many more will die from the coronavirus’s effects, and economic growth worldwide will be pretty significantly impacted.

And that is the background for this morning’s market across all assets. Risk is very definitely off today as can be seen in equity markets in Europe (DAX -1.1%, CAC -1.2%, FTSE100 -1.6%) and US equity futures, all of which are down between 0.7% and 0.9%. Treasury bonds have been in demand, rising half a point with yields falling 4bps to 1.59% while gold is higher by 0.5%. In the FX markets, the yen is today’s top performer, rallying 0.35% while the dollar outperforms virtually every other currency. And finally, oil prices have been slumping again as the IEA has just issued a report estimating that oil demand would actually shrink in 2020, the first time that has happened since the financial crisis and global recession of 2008-09. The latter certainly makes sense given that China has been the largest user of petroleum and its products. Consider that not only has travel to and from China fallen dramatically, over 100 million people are on lockdown in the country, and industrial output has slowed dramatically given there are no factory workers available to get to the factories.

The initial estimates of Chinese Q1 GDP were reduced to 4.5%-5.0%, but lately I have seen estimates falling to 0.0% for Q1 which would have a pretty severe impact on the global economy. And one of the problems is that data from China doesn’t come out quite as regularly as it does here in the US or in Europe, so there are long periods with no new information. Consider also that the Chinese simply didn’t release the January trade figures (they must be AWFUL) and it would not be surprising if they delay the release of much important data going forward. My point here is that we will have an increasingly difficult time understanding the actual situation on the ground in China, although it will become more apparent as those companies and countries that do the most business there report their data. The greater the deterioration of that data, the greater the problem on the mainland.

Turning to individual currency movers this morning, RUB and NOK, the two currencies most closely linked to the price of oil, are the biggest laggards in the EMG and G10 spaces respectively. Aside from the yen’s gains, the pound just jumped 0.3% after reports that Chancellor of the Exchequer, Sajid Javid, has resigned. Apparently the market was unimpressed with his performance. Boris is actively reshuffling his cabinet today, so there are other moves as well, but this was the only one that moved the market. But elsewhere in the G10, the dollar reigns supreme.

In the EMG space, HUF is today’s biggest winner, rising 0.45% after January’s CPI data jumped to 4.7% annually, well above their 3.0% target, and the central bank said they are ready to use all tools to rein it in. Clearly that implies rate hikes are coming to Hungary. (As an aside, I wonder if Powell, Lagarde or Kuroda are going to be ringing up the central bank there asking how they were able to create inflation.) But away from HUF, any gainers have moved so little as to be effectively unchanged, while the rest of the space, notably LATAM, is under pressure on the back of the weaker China story.

Data this morning brings Initial Claims (exp 210K) and CPI (2.4%, 2.2% ex food & energy), with the latter likely to be closely watched. Weakness in this print will only increase the odds of a rate cut here in the US, likely driving the market to price one in by July (currently a 72% probability). Chairman Powell didn’t teach us anything new yesterday, simply rehashing Tuesday’s testimony and no Senators raised anything noteworthy. Today we get two more Fed speakers, Kaplan and Williams, with Kaplan needing to be closely watched. After all, he is the only FOMC member who has admitted that the growth of the Fed’s balance sheet is having an impact on markets, and could prove to be problematic over time.

But it is a risk off day, which means that further yen strength is likely, and the dollar should continue to perform well overall.

Good luck
Adf

Rate Cuts They May Soon Espouse

The Chairman explained to the House
The virus could truthfully dowse
Their growth expectation
As well as inflation
Thus rate cuts they may soon espouse

Chairman Powell testified before the House Financial Services Committee yesterday and there were absolutely no surprises. According to him, the economy remains in a “good place” and current policy settings are appropriate. He did, however, explain that the coronavirus outbreak in China did pose a new risk to their forecasts and has added significant uncertainty overall. He also left no doubt that in the event the economic data started to turn lower due to virus linked issues (or arguably any other issues), the Fed was ready to act as appropriate to support the economy. In other words, they will cut rates in a heartbeat if they think their targets are in danger of being missed. In the meantime, they continue to buy $60 billion of T-bills each month and will do so at least until April, and they continue to expand the balance sheet further via term repos, pumping ever more liquidity into the system and ultimately supporting global equity markets.

If you think about it, that is really what defines the market these days. It is the battle between questions and fears over the spread of the coronavirus and its negative impacts on Chinese and global economic activity vs. central bank largesse and the positive impacts of ever more cash being created and seeking a home by investors. And let’s face it, up until now; except for two days in late January, bookending the Lunar New Year when equity markets fell sharply, the central banks have been dominant.

Will they continue to have success? At this point, there is no reason to believe they won’t in the short run, but ultimately, it will depend on just how deep the shock to China’s economy actually turns out to be. Remember, a key discussion point about China prior to the virus outbreak was the fragility of a large swathe of Chinese industries given their highly leveraged stance. While I imagine we will never learn the true extent of how much the economy there slows, analysts will infer a great deal based on how many companies wind up failing, or at least restructuring their debt. As I have said before, interest remains due even when revenues cease to occur. But for now, the market is backing Powell and his central bank comrades and thus risk appetite continues to grow.

Thus, turning out attention to this morning’s market activity, equity markets are in the green everywhere after solid overnight performance in Asia. Haven assets, notably Treasuries and the yen, are under pressure, and overall, the dollar is on its back foot.

Last night, the RBNZ left rates on hold at 1.0% and explained that while the virus could well have a longer term negative impact, for now, they see no reason to cut rates any time soon. Interest rate markets, which had been pricing in a 40% probability of a rate cut this year, rebalanced to no rate changes and the kiwi dollar jumped 1.2%. Not surprisingly, Aussie is also performing well, up 0.5%, as investors recognize that the two nations are inextricably linked economically, and if New Zealand is feeling better, odds are Australia will be soon as well.

Last night the Swedish Riksbank also left rates on hold, at 0.0%, as widely expected, despite lowering their inflation expectations. You may recall Sweden raising rates by 25bps in December as they sought to exit the NIRP world after concluding it was doing more harm than good. While lowered inflation expectations might seem a reason to reduce rates, the fact that the catalyst for that has been the sharp decline in energy prices due to the virtual closure of China’s economy, allows Riksbank members to cogently make the case that this is a temporary shock, and they need to look through it. This morning, SEK is firmer by 0.2% vs. the dollar after the Riksbank announcement. NOK is higher by 0.4% as oil prices firm up again on a more positive general tone, and the pound is higher by 0.2% as it continues its rebound from last week’s sharp decline, and there was nothing new from the PM regarding a hard Brexit.

You may have noticed that I failed to mention the euro, which is essentially flat on the day, arguably the second biggest underperformer vs. the dollar. Early in the session, it too was firmer as the dollar has few friends during a risk-on session, but then they released Eurozone IP at -2.1%, worse than expected and the worst print in four years. Subsequent trade saw more sellers emerge, weighing on the single currency, which has been under pretty steady pressure for the past week and a half. Madame Lagarde testified to the European Parliament yesterday and basically begged countries to step up their fiscal response as it becomes ever clearer that the ECB has no more bullets.

In the emerging markets, the Russian ruble is the leader of the pack, up 0.5%, also benefitting from oil’s rebound from the lows seen earlier this week. Away from this, there are far more gainers in the space (CLP +0.4%, THB +0.35%, ZAR +0.3%) than losers (TRY -0.4%, HUF -0.3%), but as you can see by the magnitude of the movements, there is not much of interest ongoing. Ultimately, as long as the risk-on attitude prevails, I expect the higher yielding currencies (ZAR, MXN, INR, etc.) should perform well as investors continue to hunt for yield.

There is no data to be released today, but we do hear Chairman Powell in front of the Senate, as well as some comments from Philly Fed President Patrick Harker, arguably one of the more centrist FOMC members. Yesterday’s comments from the bevy of doves who were on the tape were just as expected. Things are fine, but more accommodation is available and if inflation were to rise, they would be comfortable with letting it run hot for a while before acting.

And that’s really all there is. I see no reason for the dollar to change its current trajectory, which is modestly lower this morning. And since we already know what Powell is going to say, unless some Senator pins him down on something, I suspect we will see yet another day of limited movement overall.

Good luck
Adf

 

Til All Is Clear

There’s certainly no need to fear
A global pandemic is here
Cause central banks will
Continue to fill
Their balance sheets ‘til all is clear

Once again, investors and traders (and algorithms) have surveyed the landscape, read the government reports, and determined that there’s nothing to see in China and that any impact on economic output from the still spreading coronavirus is diminishing and unimportant in the long run. And who knows, maybe that is the correct attitude. Perhaps all the worrywarts are just that, hanging their hat on the latest potential problem while ignoring how fantastic things are right in front of them.

Or…maybe things are not quite as rosy as government officials would have you believe and the impact on economic output is going to be much more severe than anyone is willing to admit at this time. In fairness, ruling governments are pretty unlikely to release bad news to their constituents for obvious reasons. In fact, this is what causes cover-ups all the time, and why the fallout, when the truth eventually does reveal itself, is so devastating for that government. Added to this reality is that the veracity of information that emanates from China has been called into question for many years, so it is quite easy to believe that the official coronavirus figures are not accurate.

With that in mind, I urge everyone to read the attached link (https://www.epsilontheory.com/body-count/) as Dr. Ben Hunt does a very effective job (far more effective than I ever could) of explaining just how the numbers can be massaged to indicate a slowing rate of infection that ‘seems’ believable, but is in fact complete hogwash. However, as long as this is the official line, and it defines the data that is reported, then trading algorithms will utilize the data and trade accordingly. Right now, any slowdown in reported deaths is clearly seen as a sign that the worst is behind us and with all the monetary stimulus still sloshing around the system, risk needs to be acquired. And that is what we are seeing again today. Clearly, last Friday was an aberration, though when it comes to equities these days, caveat emptor!

Taking this into account, let’s take a tour of markets this morning to see how things are doing. Risk is clearly in favor as equity markets around the world continue to rally following yesterday’s record-setting session in the US. While Japan was closed for National Foundation Day, the rest of Asia rallied pretty nicely with the Hang Seng rising 1.25% and Shanghai + 0.4%. European markets have followed suit (DAX +0.85%, CAC +0.45%, FTSE100 +0.85%) and US futures are all pointing higher as well. Bond markets are on the soft side, although hardly collapsing as 10-year yields in the US are trading at 1.58% as I type, and the dollar is arguably a bit softer rather than firmer this morning. In fact the only two currencies weaker than the dollar this morning are the Swiss franc and Japanese yen, although each has declined by less than 0.10%.

The UK has been the source of the most new information as there was a significant data dump, almost all of which was seen as a positive for the UK, and by extension the pound. Q4 GDP printed at 0.0%, as expected, but the December number was a better than expected 0.3% and the Y/Y number did not fall as expected, but instead printed unchanged at 1.1%. Now, while these are hardly stellar numbers in the broad scheme of things, they are substantially better than the Eurozone story, and more importantly, better than expectations. Exports rose 4.1%, the Trade Balance ticked into a ₤845M surplus, which is actually the largest surplus in the series’ history dating back to 1955! While IP was a little softer than expected at +0.1%, the overall picture was of a UK that is prepared to weather Brexit quite well. And the pound is slightly higher on the day, but just 0.15%.

Rather, the two biggest gainers in the G10 today are NOK (+0.4%) and AUD (+0.3%). The former is benefitting from the rebound in oil on the back of the idea that the coronavirus problem has passed its peak, and the latter is benefitting on the same idea. In fact, all the currencies that have been negatively impacted by the coronavirus story, mostly commodity exporting countries like Australia, Brazil and South Africa, are higher this morning on this idea that things are going great in China. I sure hope that’s the case, but I remain a skeptic.

Today’s other noteworthy event will be the testimony by Chairman Powell to the House Financial Services Committee, starting at 10:00. I’m sure his prepared remarks will simply rehash that the economy is in a good place and that the Fed remains vigilant. He is also likely to mention that the virus is a potential risk to the economy, but one that they feel confident they can handle. (After all, cutting rates and printing money seems to be the cure for everything under the sun.) However, given the distinct lack of financial and economic nous that our duly elected Representatives have continuously shown they possess, I think the Q&A will be more interesting, although ultimately I imagine that Powell will simply have to explain his opening statement in more simplistic terms for them to understand.

We have already seen the NFIB Small Business Optimism Index rise to 104.3, a better than expected outcome and certainly a positive fillip to the risk attitude. Right when Powell begins to speak we will see the JOLTs Jobs Report as well (exp 6.925M) which many see as an important indicator of labor market conditions. In addition to Powell, we will hear from SF Fed President Daly as well as Quarles, Bullard and Kashkari, amongst the most dovish of all Fed members, and so be prepared for more discussion of allowing inflation to run hot and the need for quick action in the event the currently reported Chinese data is not complete.

Overall, the dollar is under very modest pressure today, but it would be fair to call it unchanged in the broad scheme of things. Unless Powell makes a gaffe, something which seems less and less likely given his experience now, as long as risk is being acquired, I think EMG currencies are likely to perform well, but vs. the G10, the dollar may maintain its recent momentum.

Good luck
Adf

Sanguinity Reigns

Despite growth in Chinese infections
And turmoil in Irish elections
Sanguinity reigns
As Powell takes pains
To help prevent any corrections

Once upon a time, people used to describe the President of the United States as ‘the most powerful man in the world’, on the back of the idea that he oversaw the richest and most powerful nation in the world. But these days, it has become pretty clear that the most powerful man in the world is Fed Chairman Jerome Powell. After all, not only is he in command of the US economy, but he is tasked with shielding us all from the impacts of non-financial issues like the coronavirus and climate change. And many people believe, not only can he do that, but it is imperative that he stops both of those things in their tracks.

And yet, the coronavirus continues to spread as virologists and doctors learn more about it each day and seemingly continue to fall further behind the curve. For example, initially, it had been believed that the incubation period for the virus was 14 days, implying that was an appropriate amount of time for any quarantine of suspected cases. But now, the data is showing it may be as long as 24 days, which means that formerly quarantined individuals who were cleared, may actually be infected, and thus the spread of the disease accelerated. As of this morning, more than 40,000 cases have been documented with more than 900 deceased. The human toll continues to rise, and quite frankly, shows no signs of abating yet. Stories of complete lockdowns of cities in Hubei province, where people were literally welded shut inside their homes to enforce the quarantine, and videos showing large scale disinfectant spraying are remarkable, as well as horrifying. And none of this leads to greater trust in the official information that is published by the Chinese government. In other words, this situation is by no means coming to an end and the impacts on economies worldwide as well as financial markets are just beginning to be felt.

From an economic perspective, China has largely been shut for nearly three weeks now, since the beginning of the Lunar New Year holiday in January, which means that all those companies that had built supply chains that run through China while implementing just-in-time delivery have found themselves with major problems. Hubei province is a key center for automotive, technology, pharmaceutical and chemical production. Major global firms, like Foxconn, PSA (Peugeot), Honda and others have all seen production elsewhere impacted as parts that come from the area are no longer being delivered. In fact, Hyundai Motors has closed its operations in South Korea for lack of parts supply. My point is, the economic impact is going to be very widespread and likely quite significant. While there is no way to accurately assess that impact at this time, simple math implies that the fact China will have essentially been closed for 25% of Q1, at least, means that GDP data will be severely impacted, arguably by at least a full percentage point. And what about highly leveraged companies? Interest is still due even if they are not selling products and earning revenue. Trust me; things will get worse before they get better.

And yet…financial markets remain remarkably nonplussed over the potential ultimate impact of this. Yes, equity markets slipped on Friday, but a 0.5% decline is hardly indicative of a significant amount of fear. And overnight, while the Nikkei (-0.6%) and Hang Seng (-0.6%) both fell, somehow the Shanghai Composite rose 0.6%. Yes, the PBOC injected more stimulus, but there is a remarkable amount of faith that the impact of this virus is going to be completely transitory. That seems like a big bet to me, and one with decidedly ordinary odds.

European markets are in the same space, with very modest declines (DAX -0.25%, CAC -0.3%, FTSE -0.15%) and US futures are now little changed to higher. Apparently, economic growth is no longer an important input into the valuation of equities.

And that is the crux of the matter. Since the financial crisis in 2008-09, central banks around the world have, in essence, monetized the entire global economy. If growth appears to be slowing they simply print more cash. If things are going well, they also simply print more cash, although perhaps not quite as much as in the case of a slowdown. And companies everywhere, at least large, listed ones, borrow as much as possible to restructure their balance sheets, retiring equity and increasing leverage. Alas, that does not foster economic activity, and ultimately, that is the gist of the disconnect between financial market strength and the ongoing growth of populist and nationalist political parties. Welcome to the 2020’s.

So, with all that said, risk is modestly off this morning, but by no means universally so. Yes, Treasury yields are lower, down another basis point to 1.57%, but that does not speak to unmitigated fear. And in the currency market, the impact of the overnight story has been largely muted. In fact, the biggest mover today has been Norwegian krone, which has rallied 0.75% after its inflation data surprised on the high side (CPI +1.8% Y/Y in January) which has helped convince traders that Norway may be inclined to tighten policy going forward. While I don’t see that outcome, it likely takes any rate cuts off the table for the immediate future. But elsewhere in the G10, the pound’s modest 0.3% rally is the next largest move, and that has all the earmarks of a simple trading rebound after a 2.5% decline last week. Otherwise, this space has been dull, and looks set to remain so. In the EMG bloc, the picture is mixed as well, with CLP weakening furthest, -0.55% on the open, as traders bet on policy ease by the central bank, while we have seen a series of currencies, notably CNY, rally a modest 0.3%, as fears abate over a worsening outcome from the virus.

This week’s upcoming highlight is likely to be Fed Chair Powell’s testimony to the House and Senate, but we do see both CPI and Retail Sales data late in the week as well.

Tuesday NFIB Small Biz Optimism 103.3
JOLTS Job Openings 6.85M
Powell House Testimony
Wednesday Powell Senate Testimony
Thursday CPI 0.2% (2.4% Y/Y)
-ex food & energy 0.2% (2.2% Y/Y)
Initial Claims 211K
Friday Retail Sales 0.3%
-ex autos 0.3%
IP -0.2%
Capacity Utilization 76.8%
Michigan Sentiment 99.3

Source: Bloomberg

Aside from Powell’s two days in the spotlight, there will be eight other Fed speakers as well, with my guess being that all the interest will be regarding the impact of the virus. So far, there is no indication that the Fed is ready to react, but it also seems abundantly clear that they will not hesitate to cut rates again in the event that things rapidly deteriorate on that front. Ultimately, the dollar remains extremely well bid as the bid for Treasuries continues to drive flows, but nothing has changed my medium term view that the dollar will eventually weaken on the back of Not QE4.

Good luck
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Coming Up Short

All week what the market has said
Is fears in re China are dead
But last night it seems
The latest of memes
Showed fear is still somewhat widespread

This morning the payroll report
If strong, ought, the dollar, support
The US this week
Has been on a streak
While Europe keeps coming up short

After a week where early fears about the spread of the coronavirus morphed into a belief that any issues would be contained and have only a short term impact on the global economy, it seems that some investors and traders are having second thoughts. For the first time since last Friday, equity markets around the world have fallen, albeit not very far, and risk is starting to be unloaded. Certainly, this could well be short-term profit taking. After all, since Friday’s close on the S&P 500, the index was higher by nearly 4% as of last night, and pretty much in a straight line. The remarkable thing about the equity rally, which was truly global in nature, was that it very studiously ignored the ongoing growth of the epidemic and its economic impacts.

Last night, however, it seems the announcements by Toyota and Honda that they would extend their mainland Chinese factory shutdowns by another week, as well as the force majeure declarations by Chinese energy and copper companies have served to highlight just how severely economic activity in China is slowing. Alas, the human impact continues its steady climb higher, with more than 600 deaths now attributed to the virus and more than 31,000 cases confirmed. It certainly appears as the situation has not yet reached anything near a peak, which implies that more market impacts are still to come.

One of the things we are beginning to see is a more significant reduction in expectations for Chinese economic activity this year. Last night, several more analysts reduced their expectations for Q1 GDP growth there by more than 2%. Given the fact that China has quarantined some 90 million people at this point, which is a remarkable 6.5% of the population, I expect that before all is said and done, Q1 GDP growth in China is going to be much lower, probably on the order of 2% annualized. In fact, I would not be surprised if the Chinese don’t release a Q1 number at all. There is precedent for this as just last night, the customs administration there announced that there would be no January trade data release, and that the numbers would be merged with February’s data to smooth out the impact of the Lunar New Year. Assuming the virus situation is under control by the end of Q1, it would be well within the Chinese prerogative to do the same with that data, hopefully masking just how bad things were.

In the end, there was nothing positive to be learned from Asia last night, which was confirmed by weakness in both equity markets throughout the region as well as the FX markets, where every currency in the APAC group fell. And all of this movement is directly attributable to the virus story.

Moving westward to Europe, things are looking no better there this morning, with equity markets lower across the board and their currencies also under pressure. NOK is the worst performer, down 0.6% as fears over further weakness in the oil market are weighing on the currency. But, the euro is feeling more heat today as well; down 0.25% after IP data from everywhere in the Eurozone was markedly disappointing. Germany (-3.5%), France (-2.8%), Spain (-1.4%) and the Netherlands (-1.7%) demonstrated that a risk of a recession remains quite real on the continent. In fact, you may recall how Germany barely dodged that recession status in Q4, when GDP rose 0.1% in a bit of a surprise. Well, right now, Q1 looks like it is going to be negative again. It seems to me that if a country has three negative GDP prints in six quarters, with the other three quarters printing around +0.1%, that could easily be defined as a recession. But regardless of how it is described in print, the reality is that Germany has not come out of its funk yet, and it may be dragging the rest of Europe down with it.

But there is something else ongoing in the euro which is likely to have been a significant part of the currency’s recent weakness. Recall that LVMH has agreed to buy Tiffany’s for ~$16.5 billion. Well, LVMH issued both EUR (7.5 billion) and GBP (1.5 billion) bonds this week to pay for the purchase, which means that there was a massive conversion in both currencies that is a one-way flow. And as large as these markets are, a significant dollar purchase like that is going to have a major impact. As I wrote earlier this week, the euro is leaning heavily on support at 1.0950, and if it manages to break through, there is nothing technically in the way until 1.0850. If you are a payables hedger, this could be an excellent opportunity.

Turning to the US, this morning is payrolls day. After Wednesday’s blowout 291K number for ADP Employment, expectations are running high that things are going to be quite good. The current median forecasts are as follows:

Nonfarm Payrolls 165K
Private Payrolls 155K
Manufacturing Payrolls -2K
Unemployment Rate 3.5%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.3
Participation Rate 63.2%

Source: Bloomberg

A quick look at the revisions in NFP estimates since the ADP number shows that the average is now 180K. As I said, expectations are running high. And given the strength of US data we have seen all week, if we do get a strong number, I expect to see the dollar break higher, likely taking out technical resistance in a number of currencies.

To recap, we have a risk-off session leading up to a key economic indicator. It will be interesting to see if strong US data can offset the growing fear of further negative news from china, but ironically, I think that the dollar is likely to be in demand regardless of the outcome. A weak number implies a potential negative impact from the virus, and risk-off which helps the dollar. A strong number means that the US remains above the fray, and that US investments are poised to continue to lead the world, thus drawing in more dollar buyers. Either way, the dollar seems primed to rally further today.

Good luck and good weekend
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