The Grand Mal

A very large family fund
Was clearly surprised and quite stunned
When bankers said, Pay
The money today
You owe, or you soon will be shunned

Turns out, though, no money was there
So bankers then went on a tear
They sold massive blocks
Of certain large stocks
And warned levered funds to beware

Meanwhile in the Suez Canal
The ship that had caused the grand mal
In trade supply chains
Is floating again
Though not near its final locale

There is a blend of good and bad news in markets today, at least with respect to broad ideas regarding risk.  On the plus side, the Ever Given is no longer completely wedged into the sand in the Suez Canal, with the stern of the ship back in the water.  While that is clearly a positive, the bow of the ship remains lodged in the bank and is the target of the salvage teams working to extract it.  Once that is accomplished, which may still take several more days, it will then need to undergo a series of tests to insure that no significant damage was done to the hull and that it won’t run into problems further along its journey.  In the meantime, more than 450 ships are waiting to pass through the canal in both directions, so it will take a few weeks, at least, for supply chains to get back to their prior working timelines.  But at least this is a step forward.

On the less positive side, stories about a remarkable liquidation of equity positions are filtering out of the market regarding a family office called Archegos, which was run by a former Tiger Investment fund manager and managed a huge long/short portfolio of equities on a highly levered basis.  (n.b. a long/short fund is a strategy where the manager typically selects specific companies in a sector, or sometimes sectors against each other, to bet on the relative performance of one vs. the other). It turns out that a number of these positions moved against the fund and margin calls were made for billions of dollars that could not be met.  The result was a massive liquidation of some individual stock positions, apparently in excess of $30 billion, with remarkable impacts on those names.

While only the funds brokers will mourn its passing, as it was a massive fee payer, it does highlight the potential disruption that can occur when leverage goes awry.  And of course, leverage going awry simply means that stock prices decline.  One of the things that central bank largesse has fomented that does not get a great deal of press, is the extraordinary growth in the amount of margin purchases that are outstanding.  According to FINRA data, since the nadir in the 2009 GFC, margin debt has grown 375% while the S&P 500 has risen just under 200% (both of these are in real terms).  While Archegos is only the first to break, do not be surprised if/when other funds run into similar problems because their particular set of investments didn’t pan out.  The takeaway here is that there is a great deal of risk embedded into the system, and much of it is hidden from view.  Risk management (aka hedging) remains a critical part of portfolio management, and that is true for corporate treasuries as well as for fund managers.

Now, on to the day’s price action.  Equity markets are mixed, though starting to look a bit better as early losses in Europe have turned around.  Asia saw modest gains (Nikkei +0.7%, Hang Seng 0.0%, Shanghai +0.5%) and now Europe is picking up, with the three main indices (DAX, CAC, FTSE 100) all higher by 0.5%.  However, in the US, there still appears to be some fallout from the Archegos mess, with futures all pointing lower by about 0.4%.

In the bond market, Treasury yields have slipped 2.5 basis points this morning as there is clearly some haven appeal, although European sovereigns, with those equity markets performing well, have seen yields edge higher, but by less than 1 basis point.  Clearly, the bond market is not a point of interest today given the activity in stocks.

Oil prices (+1.1%), which had briefly fallen on the initial reports of the refloating of the Ever Given, have since rebounded as it has become clear that ships will not be moving through the canal anytime soon.  Metals prices are mixed, with precious metals still under pressure, while base metals have shown more resilience as gains in Al and Sn offset losses in Cu and Zn.  (I’ll bet you didn’t think you would need to remember your periodic table to read about finance!)

As to the dollar, it is generally higher this morning, with gains across most currencies in both the G10 and EMG blocs.  In the developed world, SEK (-0.5%) is the laggard as concerns over the next wave of the Covid virus spread, which is becoming a theme on the Continent as well.  The euro (-0.2%) continues to slide slowly as the 3rd wave (4th wave?) of Covid makes its way through Germany and other nations, and further discussions of more restrictive lockdowns continue.  On the plus side, GBP (+0.35%) is the leading gainer as the UK takes yet another step toward reopening the economy, by relaxing a few more restrictions.

In the Emerging markets, MXN (-0.8%) and TRY (-0.75%) are the laggards with the former under pressure due to some legislative proposals that will tighten the government’s grip on PEMEX, while the lira is suffering as the market starts to build expectations for a rate cut under the new central bank governor.  But the CE4 are all weaker, showing their high beta relationship to the euro, and a number of APAC currencies, including CNY (-0.3%) are weaker as well.

On the data front, there is a great deal of info this week, culminating in the payroll report on Friday.

Tuesday Case Shiller Home Prices 11.35%
Consumer Confidence 96.8
Wednesday ADP Employment 550K
Chicago PMI 60.0
Thursday Initial Claims 680K
Continuing Claims 3775K
ISM Manufacturing 61.4
ISM Prices Paid 82.0
Friday Nonfarm Payrolls 643K
Private Payrolls 635K
Manufacturing Payrolls 37K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

So, plenty to learn and clearly, the latest stage of reopening of the economy has economists looking for a substantial amount of jobs growth.  Of course, even if this forecast is accurate, Chairman Powell is still going to be looking for the other 9 million jobs that have disappeared before he considers tightening policy.  It remains to be seen if the market will continue to tighten for him.  After a deluge of Fed speakers last week, each and every one explaining they would not be changing policy for a long time and that there was no concern over potential rising inflation, this week sees only a handful of Fed speakers, with NY’s John Williams arguably the most influential.  But I don’t expect any change of message, which has clearly been drilled into the entire committee.

While broad equity indices have not suffered greatly, I cannot help but believe that the Archegos situation will give some people pause in their ongoing accumulation of risk.  While not looking for a crash, I expect that we will see choppy markets amid reduced liquidity and would not be surprised to see a bit more risk reduction.  In that environment, the dollar should remain broadly bid.

Good luck and stay safe
Adf

Pent-Up Demand

The one thing consistently heard
Is growth in H2 will be spurred
By pent-up demand
Throughout all the land
As people buy things they’ve deferred

But what if the virus has wrought
Some changes in what people sought
Perhaps now it’s saving
That people are craving
Not spending, as routinely thought

There appears to be one universal view regarding economic activity going forward; there is an enormous amount of pent-up demand for things that people have been craving since the onset of the widespread government lockdowns as a result of the spread of Covid-19.  This includes eating out, going to the gym, going to the movies and traveling on vacation.  And it seems pretty clear that there is some truth to this idea.  But given the trauma that governments around the world inflicted on their populations via the inconsistent messaging and lockdown mania, isn’t it possible that many people have reevaluated what they deem as most important?  I know that this author has certainly reconsidered what is really necessary to live a happy and fulfilling life, and I imagine I am not the only one.

But the point is, virtually every economist’s assumption in their econometric models is that there will be a substantial pick-up in activity, especially in those service sectors that have been decimated by the ongoing restrictions, in the second half of the year.  There is no doubt that savings rates are higher now than they were before the pandemic, with the latest BEA data showing a 13.7% rate at the end of 2020 vs. a 7.3% rate at the end of 2019.  But the 2019 data was below the long-term (75 year) average savings rate of 9.0%, and two-thirds the rate seen from the end of WWII to1989.  The point is recent profligacy by the American people is something of a historical anomaly.  While Americans never saved like some other cultures, where savings rates would hover in the 20% range, historically, people really did try to save some money.

The other thing to remember is the past twelve months have been remarkably traumatic to the entire nation, if not the entire world, with a generation of children having their educations disrupted and changed significantly.  As was evident in the wake of the Great Depression, an entire generation altered their behavior, as the Roaring 20’s morphed into the Depression.  The one thing that hasn’t changed is human nature, with peoples’ response to trauma informing their future activities.  This is all a long-winded way of saying that, perhaps, there isn’t nearly as much pent-up demand for things as is currently assumed.  Perhaps, the increase in savings rate is a way for people, in general, to feel a bit more secure about their situation.  While FOMO will never completely disappear, it certainly could wane.

With this in mind, it is possible to turn a more critical eye at forecasts for GDP growth around the world going forward.  For instance, the UK reported that Q4 GDP rose 1.0%, well above forecasts of a 0.5% increase, and insuring that despite likely negative growth in Q1, there will be no double-dip recession.  But BOE Chief Economist, Andy Haldane was positively effusive in his forecasts, saying, “A year from now, annual growth could be in the double digits.”  Wow is all I can say.  That is an optimistic point of view, but it is not an isolated one.  Here in the US, forecasts now indicate that GDP will grow 4.9% in 2021, well above trend and enough to offset 2020’s 3.5% decline.  And maybe they are right.  Certainly, equity markets are all-in on the idea.  However, I would be cautious in blindly accepting these numbers as gospel given no econometric model takes into account the changes wrought in perceptions by Covid-19.  I fear growth could be much less impressive as 2021 evolves which means markets will need to adjust their thinking.  Stay nimble!

On to today’s session, which has seen another lackluster performance across markets.  With most of Asia closed for the New Year holiday, only the Nikkei (-0.15%) was trading and it displayed a general lack of interest.  European bourses are mixed with the DAX (-0.5%) a key underperformer while the CAC and FTSE 100 are both flat on the day.  Given the better than expected data from the UK, it would seem that performance is a bit disappointing, but there are ongoing Brexit travails which seem to be putting a damper on things.  US futures, meanwhile, had spent the bulk of the overnight session in the green, but are now all lower by about 0.2%.  It appears we may be seeing some risk being unloaded into the holiday weekend.

Bond markets are ever so slightly firmer this morning, with the biggest mover Italian BTP’s (-1.5bps) after the FiveStar party voted to support Super Mario for PM.  Otherwise, Treasury yields are essentially unchanged as are bunds and Gilts.

Oil (WTI -1.0%) is under pressure again today, for the second consecutive session, but the uptrend remains firmly in place.  This has all the hallmarks of a modest correction.  Gold, however, is under pressure as well, and has been lagging most other commodities.  Base metals are mixed as are agriculturals, which, again, tells you that there is no strong theme in the markets.

As to the dollar, it is broadly higher this morning, albeit not dramatically so.  In the G10, the commodity currencies are under the most pressure (NZD (-0.5%, AUD -0.3%, CAD -0.3%) but we are also seeing weakness in the two havens with both JPY and CHF softer by 0.3%.  In the emerging markets, RUB (-1.0%) is the weakest of the bunch after the central bank explained they won’t be cutting rates further amid concerns over new sanctions to be imposed by the EU as well as the ongoing spread of Covid.  But aside from the ruble, while most currencies in the bloc are softer, the movement has been relatively small, on the order of -0.1% to -0.3%, indicating this is really a dollar story.

On the data front, the only thing we see today is the preliminary Michigan Sentiment Survey (exp 80.9), which would need to be wildly different to change any views.  As well, we continue to lack Fed speakers, and the data has clearly not shown “substantial further progress” on the Fed’s efforts to support the economy, so policy changes are not in the air.

The dollar’s consolidation after a nearly year-long decline continues, although, as I mentioned yesterday, there seems little impetus for the dollar to extend its corrective rally.  Rather, it feels like we are going to see a little more market chop with no direction into the holiday weekend,

Good luck, good weekend and stay safe
Adf

Chaos Prevailed

In Washington, chaos prevailed
As Congress’s job was derailed
Investors, though, thought
‘Twas nothing, and bought
More stocks with the 10-year was assailed

One of the more remarkable aspects of the chaotic events in Washington, DC yesterday was the fact that the market reaction was completely benign.  On the one hand, given the working assumption that the theatrics would not affect the ultimate outcome, it is understandable.  On the other hand, the fact that there continues to be this amount of discord in the nation in the wake of a highly contentious election bodes ill for the ability of things to quickly return to normal.  In the end, though, market activity indicates the investment community firmly believes there will be lots more fiscal stimulus as the new Biden administration tries to address the ongoing pandemic driven economic issues.  Hence, the idea behind the reflation trade remains the current narrative, with more stimulus leading to faster economic growth, while increased Treasury supply to fund that stimulus leads to higher long end yields and a steeper yield curve.

However, now that the formalities of the electoral vote counting have concluded, focus has turned back to the narrative on a full-time basis, with the ongoing argument over whether inflation or deflation is in our future, as well as the question of whether assets, generally, are fairly valued or bubblicious.  The thing is, away from the politics, nothing has really changed very much lately.

Covid-19 continues to spread and the resultant lockdowns around the world continue to be expanded and extended.  Just last night, for instance, Japan declared a limited state of emergency in Tokyo and three surrounding prefectures in an effort to stem the spread of Covid.  That nation has been dealing with its highest caseload since April, and the Suga government was responding to requests for help from the local governments.  Meanwhile, in Germany, on Tuesday lockdowns were extended through the end of January and restrictions tightened to prevent travel of more than 15km from one’s home.  And yet, this type of news clearly does not dissuade investors as last night saw the Nikkei rally 1.6% while the DAX, this morning, is higher by 0.4% after a 1.75% rally yesterday.  In the end, the narrative continues to highlight the idea that the worse the Covid situation, the greater the probability of further fiscal and monetary stimulus, and therefore the bigger the boost to growth.

At the same time, the reflation piece of the narrative continues apace with Treasury yields continuing to climb, edging higher by one more basis point so far this morning after an eight basis point rise yesterday.  Something that has received remarkably little attention overall is the fact that oil prices have been rallying so steadily of late, having climbed more than 40% since the day before the Presidential election, and given the pending supply reductions, showing no signs of backing off.  This, along with the ongoing rallies in most commodities, is part and parcel of the reflation trade, as well as deemed a key piece of the ultimate dollar weakness story.

Regarding this last observation, there is, indeed, a pretty strong negative correlation between the dollar’s value and the price of oil.  Of course, the question to be answered is the direction of causality.  Do rising oil prices lead to a weaker dollar?  Or is it the other way round?  If it is the former, then the dollar’s future is likely to be one of weakness as the supply reductions in US shale production alongside the Saudi cuts can easily lead to further gains of $10-$15/bbl.  However, the dollar is impacted by many things, notably Fed policy, and if the dollar is the driver of oil movement, the future of the black, sticky stuff is going to be far less certain.  If, for example, inflation rises more rapidly than currently anticipated, and forces the market to consider that the Fed may react by reducing policy ease, the dollar could easily find support, especially given the massive short positions currently outstanding.  Would oil continue to rise into that circumstance?  The point is, correlations are fine to recognize, but as a planning tool, they leave something to be desired.  Understanding the fundamentals underlying price action remains critical to plan effectively.

As to today’s session, the risk picture has turned somewhat mixed.  As mentioned above, Asian equity prices had a pretty good day, with Shanghai (+0.7%) rising alongside the Nikkei, although the Hang Seng (-0.5%) struggled.  European bourses are mixed, with the DAX (0.4%) leading and the CAC (+0.1%) slightly higher although the FTSE 100 (-0.5%) is under pressure.  There is one outlier here, Sweden, where the OMX has rallied 2.1% this morning, although there is no general news driving the movement.  In fact, PMI Services data was released at its weakest level since the summer, which hardly heralds future strength.

We’ve already discussed Treasury weakness but the picture in Europe is more mixed, with bunds (-1bps) and OATs (-0.5bps) rallying slightly while Gilts (+1.7bps) are under pressure alongside Treasuries.

And finally, the dollar is showing some solid gains this morning, higher against all its G10 counterparts and most of the EMG bloc.  Despite ongoing strength in the commodity space, AUD (-0.75%) leads the way lower with NZD (-0.6%) next in line.  Clearly, the market did not embrace the Japanese news on the lockdown, as the yen has declined 0.6% as well.  As to the single currency, it has fallen 0.5%, with a very strong resistance level building at 1.2350.  It will take quite an effort to get through that level in the short run.

Emerging markets declines are led by CLP (-1.85%) and ZAR (-1.0%), although the weakness is nearly universal.  Interestingly, the Chile story is not about copper, which continues to perform well, but rather seems to be a situation where the currency is being used as a funding currency for carry trades in the EMG bloc.  ZAR, on the other hand, is suffering alongside gold, which got hammered yesterday and is continuing to soften.

On the data front, today brings Initial Claims (exp 800K), Continuing Claims (5.2M), the Trade Balance (-$67.3B) and ISM Services (54.5).  Remember, tomorrow is payrolls day, so there may be less attention paid to these numbers this morning.  One cautionary tale comes from the Challenger Job Cuts number, which is released monthly but given limited press.  Today, it jumped 134.5% from one year ago, a significant jump on the month, and a bad omen for the employment picture going forward.  With this in mind, it seems highly unlikely the Fed will do anything but ease policy further in the near term.  One other thing, yesterday the December FOMC Minutes were released but had no market impact.  Recall, the December meeting occurred prior to the stimulus bill or the Georgia run-off election, so was missing much new information.  But in them, the FOMC made clear that the bias was for a dovish stance for a long time to come.  Based on what we heard from Chicago’s Evans on Tuesday, it doesn’t seem that anything has changed since then.

Given the significant short dollar positions that are outstanding in the investment and speculative communities, the idea that the dollar could rally in the near term is quite valid.  While nothing has changed my longer-term view of rising inflation and deeper negative real yields undermining the dollar, that doesn’t mean we can’t jump in the near term.

Good luck and stay safe
Adf

Not Whether but When

The question’s not whether but when
The Fed adds more money again
With Congress unable
To reach cross the table
It’s up to Jay and his (wo)men

For the first time in months, the top stories today are simply a rehash of the top stories yesterday.  In other words, there is nothing new under the sun, at least with respect to market activities.  There has been nothing new regarding Brexit (talks continue but no word on an outcome); nothing new regarding US fiscal stimulus (talks continue but no word on an outcome);  and nothing new regarding Covid-19 (vaccines have begun to be administered, but lockdowns continue to be the primary tool to fight the spread of the infection).

True, we received some data from China overnight describing an economy that continues to recover, but one whose pace of recovery is barely accelerating and certainly not exceeding expectations.  We saw some data from the UK that described the employment situation as less dire than forecast, but still a mess.  And we saw some inflation data from both Italy and France describing the complete lack of an inflationary impulse on the Continent.  The point is, none of this could be called new information, and so investor response has been extremely muted.

Rather, the story that is developing traction seems to be the question of what the FOMC is going to do when they meet tomorrow.  There seem to be two questions of note; first, will they leave everything just as it is, reiterating their current forward guidance to continue to support the economy until it is deemed capable of recovering on its own, or will they start to attach some metrics to their views; and second, will they leave their current asset purchase program unchanged, or will they alter either the size or tenor?

The bigger picture on this issue needs to consider what we have heard from various Fed speakers prior to the quiet period.  To a (wo)man, they all explained that more fiscal stimulus was critical in helping the economy to recover, and so the fact that none has been forthcoming must be weighing on their views of the future.  This would seem to bias a call for action, not inaction.

Regarding the first question, if we learned anything from the FOMC Minutes three weeks’ ago, it was that there seemed to be movement in the direction of applying metrics to their hitherto vague statements regarding when they will act.  The concern with this approach is that in the wake of the financial crisis, they did just this, explaining that rates would remain near zero until the Unemployment Rate reached their then-current view of full employment, which initially was pegged at 5.0%.  That target was changed several times until it was finally abandoned, as it turned out their models weren’t all that accurate.  Which begs the question, do they want to put themselves in the same position of defining a position and subsequently finding out their initial assumptions were wrong, so they need to change that position?  Remember, credibility is one of a central bank’s most crucial assets and moving targets on policy because of model or forecast errors does not enhance credibility.  In the end, it seems more likely they will not apply hard numbers to their targets, rather much softer views like, full employment rather than a specific unemployment rate; or trend inflation rather than a specific average inflation rate with a timeline attached.

As to the second question, based on positioning indicators, current expectations are pretty evenly distributed as to a change (either more purchases or a Twist) or standing pat.  Again, based on the commentary that fiscal stimulus is crucial and its failure to be agreed, I would lean toward the side of more stimulus to be announced now, perhaps stoking the Christmas rally in equities.  (After all, half the time it seems stoking equity rallies is their entire focus.)

But away from that conversation, there is precious little else to discuss today.  A quick tour of markets shows that after yesterday afternoon’s US equity selloff, Asian equities followed suit with modest declines across the board (Nikkei -0.2%, Hang Seng -0.7%, Shanghai -0.1%).  European bourses, which had been modestly higher earlier, are starting to fade a bit, although the DAX (+0.6%) and CAC (+0.3%) remain in the green.  However, the FTSE 100 (-0.3%) has turned lower as the pound has recently started to edge higher.  US futures are all pointing higher, though, with gains of around 0.6% across the board.

Bond prices are mixed, with Treasuries very slightly softer and yields there higher by less than 1 basis point, but European markets starting to find a bid with yields declining modestly across the board.  The outperformers right now are the PIGS, with yield declines of between 1.5 and 4 basis points, while the rest of Europe’s markets are looking at smaller price gains.

Commodities are reversing yesterday’s price action with oil virtually unchanged while gold has rallied 1.0% this morning.  And finally, the best way to describe the dollar is modestly, but not universally, softer.  In the G10, as I write, GBP (+0.4%) has rallied in the past hour although there has been nothing on the tape that would seem to account for the price action.  But most of the bloc is modestly firmer, between 0.1% and 0.2%, with only two laggards, AUD and NZD (both lower by -0.1%) which have responded to China’s announcement they would be banning shipments of coal from Australia going forward.

EMG currencies are also somewhat firmer in general, led by LATAM (BRL, MXN and CLP all +0.50%) with two others showing similar strength (ZAR and RUB).  As to the rest of the bloc, gains and losses are less than 0.2%, which is another way of saying there is no new information there either.  Broadly speaking, this bloc is going to take its cues from the G10 space, and while the consensus for 2021 remains a much weaker dollar, today that is not taking shape.

On the data front, we see Empire Manufacturing (exp 6.3), IP (0.3%) and Capacity Utilization (73.0%) this morning, although none of these seem likely to change any views.  As such, at this point, it seems the best bet is the FX market will follow the broad risk theme, assuming one develops, or will respond to news, perhaps a fiscal stimulus breakthrough will come today, which is likely to lead to further dollar weakness.  But we will have to wait for that.

Good luck and stay safe
Adf

Post-Covid Themes

With Thanksgiving now in the past
And Christmas approaching quite fast
The only thing clear
Through end of the year
Is dollar shorts have been amassed

For many, conviction is strong
That currencies, they need be long
The idea, it seems
Is post-Covid themes
Mean risk averse views are now wrong

Having been away for a week, the most interesting thing this morning is the rising conviction in the view that the dollar has much further to decline in 2021.  Much is made of the fact that since its Covid induced highs in March, the dollar has fallen by more than 12% vs the Dollar Index (DXY) which is basically the euro.  Of course, that is nothing compared to the recoveries seen by the commodity currencies like NOK (+33.2%), AUD (+27.6%) and NZD (+23.6%) over the same period.  Yet when viewed on a year-to-date basis, the movement is far less impressive, with NOK actually unchanged on the year, and the leader, SEK, higher by 10.8%.  It is also worth remembering that the euro has rallied by a relatively modest 6.9% thus far in 2020, hardly worthy of the term dollar collapse.

In addition, as I have written before, but given the growing dollar bearish sentiment, I feel worth repeating, is that in the broad scheme of things, the dollar is essentially right in the middle of its long-term trading range.  For instance, from the day the euro came into existence, January 1, 1999, the average daily FX rate, according to Bloomberg, has been 1.1999, almost exactly where it currently trades.  It has ranged from a low of 0.8230 in October 2000 to a high of 1.6038 the summer before the GFC hit.  The point is EURUSD at 1.20 is hardly unusual, neither can it be considered weak nor strong.

Unpacking the rationale, as best I understand it, for the dollar’s imminent decline, we see that a great deal of faith is put upon the idea of a continuing risk rally over the next months as the global economy recovers with the advent of the Covid vaccines that seem likely to be approved within weeks.  The sequence of events in mind is that the distribution of the vaccine will have the dual impact of dramatically reducing the Covid caseloads while simultaneously reinvigorating confidence in the population to resume pre-Covid activities like going out to restaurants, bars and the movies, as well as resuming their travel plans.  The ensuing burst of activity will result in a return to pre-Covid levels of economic activity and all will be right with the world.  (PS  pre-Covid economic activity was a desultory 1.5% GDP growth with low inflation that caused the central bank community to maintain ultra-low interest rates for a decade!)

Equity markets, which are seemingly already priced for this utopian existence, will continue to rally based on the never-ending stream of central bank liquidity…or is it based on the massive growth in earnings given the near certainty of higher taxes and higher interest rates in the future.  No, it can’t be the second view, as higher taxes and higher interest rates are traditionally equity negatives.  So perhaps, equity markets will continue to rally as the prospect of future growth will remain just close enough to seem real, but far enough away to discourage policymakers from changing the rules now.  Perhaps this is what is meant by the Goldilocks recovery.

Of course, while commodity markets have bought into the story hook, line and sinker, it must be recalled that they have been the greatest underperforming segment of markets for the past decade.  Since December 1, 2010, the Goldman Sachs Commodity Index (GSCI) has fallen 36.5%, while the S&P500 has rallied 191%.  My point is the fact that commodity markets are performing well with the prospects of incipient economic growth ought not be that surprising.

The fly in the ointment, however, is the bond market, where despite all the ink spilled regarding the reflation trade and the steepening of the US Treasury yield curve, 10-year Treasuries refuse to confirm the glowing views of the future. At least, while they may be agnostic on growth, there is certainly little concern over a rekindling of inflation, despite the earnest promises of every central banker in the world to stoke the fires and bring measured inflation back to their targets.  As I type this morning, 10-year Treasury yields are 0.85%, right in the middle of its range since the US election.  You remember that, the event that was to usher in the great reflation?

In the end, while sentiment has clearly been growing toward a stronger recovery next year, encouraging risk appetites in both G10 and, especially, EMG economies, as yet, the data has not matched expectations, and positioning remains based on hope rather than evidence.

Now a quick tour around today’s markets shows that the equity rally has paused, at the very least, with weakness in Asia (Nikkei -0.8%, Hang Seng -2.1%, Shanghai -0.5%) despite stronger than expected economic data from both Japan (IP +3.8%) and China (Mfg PMI 52.1, non-Mfg PMI 56.4).  European markets are also mostly in the red, although the DAX (+0.2%) is the exception to the rule.  However, the CAC (-0.4%) and FTSE 100 (-0.15%) have joined the rest of the continent lower despite positive comments regarding a Brexit deal being within reach this week.  US futures have a bit of gloom about themselves as well, with both DOW and SPX futures pointing to 0.5% declines at the open, although NASDAQ futures are little changed at this hour.

Surprisingly, despite the soft tone in the equity markets, European government bond yields are all edging higher, with Bunds (+1.6bps) pretty much defining the day’s activity as most other major markets are seeing similar moves, including Treasuries (+1.8 bps).  Commodity prices are under pressure with oil (-1.3%) and gold (-0.9%) both suffering although Bitcoin seems to be regaining its footing, rallying 2.3% this morning.

Finally, the dollar, is under a modicum of pressure this morning with G10 currencies mostly a bit firmer (NOK and SEK +0.4%) GBP (+0.3%), although AUD (-0.1%) seems to be getting nosebleeds as it approaches its highest level in two years.  Potentially, word that China has slapped more tariffs on Australian wines, as the acrimony between those two nations escalates, could be removing the rose-colored tint there.  Meanwhile, in the EMG bloc, there is a mix of activity, with some gainers (HUF +0.8%) and BRL (+0.65%), and some losers (ZAR -0.3%), KRW (-0.25%).  Broadly, the commodity focused currencies here are feeling a little pressure from the underperformance in oil and metals, while the CE4 are tracking the euro nicely.

It is an important data week, and we also hear from numerous central bankers.

Today Chicago PMI 59.0
Tuesday ISM Manufacturing 58.0
Construction Spending 0.8%
Wednesday ADP Employment 420K
Fed Beige Book
Thursday Initial Claims 765K
Continuing Claims 5.81M
ISM Services 57.6
Friday Nonfarm Payrolls 500K
Private Payrolls 608K
Manufacturing Payrolls 46K
Unemployment Rate 6.8%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Trade Balance -$64.8B
Factory Orders 0.8%

Source: Bloomberg

In addition, we have seven Fed speakers this week, including most importantly, Chairman Powell’s testimony to the Senate Banking Committee tomorrow and the House Finance Panel on Wednesday.  We also hear from Madame Lagarde twice this week, and with the euro hovering just below 1.20, be prepared for her to mention that a too-strong euro is counterproductive.  You may recall in early September, the last time the euro was at these levels, that both she and Philip Lane, ECB Chief Economist, were quickly on the tape talking down the single currency.  Although since that time CNY has rallied strongly (+4%) thus removing some of the pressure on the ECB, there is still no way they want to see the euro rally sharply from here.

But do not be surprised to see the market test those euro highs today or tomorrow, if only to see the ECB response and pain threshold.  Clearly, momentum is against the greenback lately, and today is no exception, but I do not buy the dramatic decline story, if only because no other central bank will sit idly by and allow it.

Good luck and stay safe
Adf

More Money They’ll Print

While stock markets make all-time highs
The world’s central banks still advise
More money they’ll print
In case there’s a hint
That prices will simply not rise

In a chicken and egg type question, it is worth asking; is the fact that equity markets continue to rally (yet another all-time high was recorded yesterday, this time by the Dow) despite the fact that economies worldwide remain in chaos and operating at a fraction of their capacity, as governments impose another wave of lockdowns throughout Europe, the UK and many US states, logical?  Obviously, the link between those dichotomous outcomes is the support provided by the central banking community.  Perhaps the way to frame the question is, if markets have already seen past the end of the pandemic, and are willing to fund the business community right now, why do central banks feel they need to, not merely continue with their programs, but promise to increase them going forward?

This was made clear, yet again, when Fed Vice-Chair, Richard Clarida, explained that the FOMC is carefully evaluating the current situation and will not hesitate to use all available tools to help support the economy.  The punditry sees this as a code for an increase in the size of the asset purchase program, from the current $120 billion each month (split $80 billion Treasuries and $40 billion mortgages) to as much as $160 billion each month, with the new money focused on Treasuries.  At the same time, ECB Chief Economist, Philip Lane, explained that the central bank will provide enough monetary stimulus to make sure governments, companies and households have access to cheap credit throughout the coronavirus crisis.

And perhaps, that is the crux of the problem we face.  Despite investor optimism that the future is bright, and despite central banks’ proven inability to get funding to those most in need, namely individual households, those same central banks continue to do the only thing they know how to do, print more money, and by extension fund governments and large companies, who already have access to funding.  As the saying goes, the rich get richer.

The cycle goes as follows: central banks cut interest rates => investors move out the risk curve seeking returns => corporations and governments issue more debt at cheaper levels => an excess (and ultimately unsustainable) amount of debt outstanding.  Currently, that number, globally, is approaching 400% of GDP, and on current trends, has further to go.  The problem is, repayment of this debt can only be achieved in one of two ways, realistically, neither of which will be pleasant.  Either, inflation actually begins to rise sufficiently to diminish the real value of the debt or we get to a debt jubilee, where significant portions are simply written off.

If you were ever wondering why central banks are desperate for higher inflation, this is your answer.  While they are mostly economists, they still recognize that inflation is exactly the kind of debt destructive force necessary to eventually balance the books.  It will take time, even if they can manage the rate of inflation, but their firmly held belief is if they could just get inflation percolating, all that debt would become less of a problem.  At least for the debtors. Creditors may not feel the same excitement.

On the other hand, the debt jubilee idea is being bandied about in many forms these days, with the latest being the cancellation of student debt outstanding.  That’s $1.6 trillion that could be dissolved with the signing of a law.  Now, who would pay for that?  Well, I assure you it is not a free lunch.  In fact, the case could be made that it is this type of action that will lead to the central banks’ desired inflation outcome.  Consider, wiping out that debt would leave $1.6 trillion in the economy with no corresponding liabilities.  That’s a lot of spending power which would suddenly be used to chase after a still restricted supply of goods and services.  And that is just one small segment of the $100’s of trillions of dollars of debt outstanding.  The point is, there are still many hard decisions yet to be made and there are going to be winners and losers based on those decisions.  Covid-19 did not cause these issues to arise, it merely served as a catalyst to make them more widely known, and potentially, will push us toward the endgame.  Be prepared!

But that is all just background information to help us try to understand market activity a bit better.  Instead, let’s take a look at the market today, where yesterday’s risk appetite seems to have developed a bit of indigestion.  Overnight saw a mixed equity picture (Nikkei +0.4%, Hang Seng +0.1%, Shanghai -0.2%) with the magnitude of movements more muted than recent activity.  Europe, on the other hand, has been largely in the red (DAX -0.35%, CAC -0.3%, FTSE -1.15%) as apparently Mr Lane’s comments were not seen as supportive enough, or, more likely, markets are simply overbought after some enormous runs this month, and are seeing a bit of profit taking.  US futures are mixed at this point, with the DOW and S&P both down -0.5%, while the NASDAQ is up about 0.3%.  The biggest stock market story is S&P’s decision to add Tesla to the S&P500 index starting next month, which has helped goose the stock higher by another 10%.

Bond markets this morning are a tale of three regions.  Asian hours saw Australian and New Zealand bonds fall sharply with 10-year yields rising about 7 basis points, as the RBA’s YCC in the 3-year space is starting to really distort markets there.  However, in Europe, we are seeing a very modest bond rally, with yields slightly softer, about 1 basis point throughout the continent, and Treasuries have seen yields slip 1.5 basis points so far in the session. Clearly, a bit of risk-off attitude here.

FX markets, however, are not viewing the world quite the same way as the dollar, at least vs. its G10 counterparts, is somewhat softer, although has seen a more mixed session vs. EMG currencies.  Leading the way in the G10 is GBP (+0.5%) as stories make the rounds that a Brexit deal will be agreed next week.  Now, they are just stories, with no official comments, but that is the current driver.  Next in line is JPY (+0.3%) which perhaps we can attribute to a risk-off attitude, especially as CHF (+0.25%) is moving the same way.  As to the rest of the bloc, gains have been much smaller, and there has been absolutely zero data released this morning.

In the EMG bloc, EEMEA currencies have been the weak spot, with HUF (-0.5%) the worst performer, although weakness in PLN (-0.3%) and RUB (-0.25%) is also clear.  This story has to do with the Hungarian and Polish vetoes of the EU budget and virus recovery fund, as they will not accept the rule of law conditions attached by Brussels.  You may have heard about the concerns Brussels has over these two nations move toward a more nationalist viewpoint on many issues like immigration and judicial framework, something Brussels abhors.  On the positive side, BRL (+0.5%) has opened strongly, and CNY (+0.45%) led the Asian bloc higher overnight.  The China story continues to focus on the apparent strength of their economic rebound as well as the fact that interest rates there are substantially higher than elsewhere in the world and drawing in significant amounts of investor capital.  As to BRL, it seems the central bank has hinted they will be increasing the amount of dollars available to the market, thus adding to pressure on the dollar.

On the data front, yesterday saw a weaker than expected Empire Mfg number, but this morning is really the week’s big number, Retail Sales (exp 0.5%, 0.6% ex autos) as well as IP (1.0%) and Capacity Utilization (72.3%) a little later. On the Fed front, we have Chairman Powell speaking at 1:00, but not a speech, part of a panel, as well as another five Fed members on the tape at 3:00.  However, I anticipate the only thing we will learn is that the entire group will back up Vice-Chair Clarida regarding additional actions.

Despite the lack of risk appetite, the dollar is on its back foot this morning.  Ironically, I expect that we will see a rebound in risk appetite, rather than a rebound in the dollar as the session unfolds.

Good luck and stay safe
Adf

Cloaked in Fog

***Moderna vaccine indicated at 94.5% effective** – 6:56am

The rebound in growth
Set records. But the future
Remains cloaked in fog

Similar to what we have seen in every major economy, Q3 GDP growth in Japan recorded the highest ever rate since statistics were first collected and calculated in 1980.  The 21.4% annualized growth in Q3 (5.0% Q/Q), however, was substantially below the levels seen in the US (7.5% Q/Q), France (18.2% Q/Q), Germany (8.2% Q/Q) and the UK (15.5%).  Perhaps the bigger concern for Japan is the fact that it has recouped barely half the economic losses derived from the onset of Covid-19.  And adding to that concern is the recent resurgence in Covid cases, both in Japan and its major export markets, means that Q4 growth is unlikely to continue this trend, and could very well fall back into negative territory, depending on just how long shutdowns are in place around the world.

Investors, however, embraced the news (or embraced some news if not this) as the Nikkei continued its recent rally, rising 2.05% overnight amidst an overall risk-on setting.  In fact, since the close on October 30, the Nikkei has rallied nearly 13% despite relatively unimpressive data.  Not only that, given the BOJ is already at max support, it is unclear what else they can be expected to do to support the economy.  And yet, the equity market would have you believe the future is bright!  The one market not participating in this is FX, where the yen remains unchanged on the session, seemingly unable to decline despite the risk rally, but unable to advance in a weak dollar environment.

As calendar pages keep turning
There’s something that is quite concerning
The Brexit morass
Has reached an impasse
With neither side, for a deal, yearning

While there is no question that deals like the one currently needed to achieve a smooth Brexit on December 31st are always pushed off until there is no more time to delay, it certainly appears that we are getting awfully close to that time.  The big news last week was that Dominic Cummings, one of PM Johnson’s key advisors and a major architect of the entire Brexit campaign, resigned from his post.  Pundits immediately expected the UK to soften their position on state aid, which along with fishing rights for EU (mainly French) fleets are the two big issues remaining to be sorted.  But so far, that is not the case, with the UK’s chief negotiator, David Frost, explaining today that the UK “will not be changing” their positions as the next round of negotiations begins in Brussels.  And yet, markets remain entirely sanguine about the results, clearly expecting a deal to be reached and approved in time.  This is evident in the fact that the pound has actually rallied slightly today, 0.1%, and remains well-ensconced in its recent uptrend.  Similarly, the FTSE 100 continues its recent rally, rising 0.7% and is 14% higher than its close at the end of October.  Gilt yields?  Essentially unchanged on the day at 0.34%.  The point is, there is very little concern that a hard Brexit is in our future.  Either that, or the market is completely convinced that if one comes, the BOE will be able to do something about it. FWIW, the latter seems a bad bet.

Ultimately, the story of today’s session is that risk is a wonderful thing, and those who seek to manage risk or exhibit prudence with their positioning will be left behind again.  In the growth vs. value debate, value still has no value, it’s all about growth.  As an aside, perhaps economist Herbert Stein said it best with his observation now known as Stein’s Law; “If something cannot go on forever, it will stop.”  Bull markets cannot go on forever, so beware!

But they continue this morning with risk everywhere rallying.  Elsewhere in Asia, the Hang Seng rose 0.9% and Shanghai 1.1% after Chinese data showed IP slightly better than expected in October (6.9% Y/Y) although Retail Sales disappointed at 4.3% (exp 5.0%).  However, not only did equity markets there rally, so did the renminbi, rising a further 0.35% overnight and back to its strongest level since June 2018.

In fact, even before the Moderna vaccine news hit the tape, equities were all in the green in Europe (DAX (+0.5%, CAC +1.2%) and US futures were jumping (DOW +1.0%, SPX +0.7%, NASDAQ +0.7%), and they have risen further in the wake of the headline.  Perhaps everything is rosy and we are set to return to some sense of normalcy.  Of course, if that’s the case, will central banks worldwide still need to provide so much support?  And if they don’t provide that support, will markets be able to continue to rally on their own?  Just something to consider.

But at this time, the good vibes are everywhere, with oil markets (+2.5%) encouraged by the idea that the return to normal lies just around the corner, while gold, which had been higher earlier, seems no longer to be necessary in this brave new world, and has fallen 0.8% on the day (1% since the headline.)

Meanwhile, FX markets are in full risk-on mode.  In the G10 bloc, NOK (+0.9%) is the leading gainer, benefitting from the combination of overall risk appetite and the rise in oil prices.  After that, there is a group of commodity currencies (AUD, NZD and CAD all +0.4%) rising on the back of stronger commodity prices.  The euro and pound have both edged higher by 0.1%, and in the wake of the Moderna news, the yen has actually fallen back, (-0.3%), with risk metrics clearly dominating the dollar story now.

In the EMG bloc, BRL has opened much stronger (+1.5%) and we are seeing strength in the commodity focused currencies here as well; RUB (+1.25%), MXN (+1.1%), ZAR (+1.0%).  The rest of the bloc, excepting the Turkish lira (-1.0%) which remains beholden to the inconsistencies of Erdogan’s policies, is also generally firmer but not quite to the same extent.  However, the entire story is risk is ON.

On the data front, Retail Sales dominate the week,:

Today Empire Manufacturing 13.8
Tuesday Retail Sales 0.5%
-ex autos 0.6%
IP 1.0%
Capacity Utilization 72.3%
Business Inventories 0.6%
Wednesday Housing Starts 1455K
Building Permits 1567K
Thursday Initial Claims 700K
Continuing Claims 6.4M
Philly Fed 22.0
Leading Indicators 0.7%
Existing Home Sales 6.45M

Source: Bloomberg

But if the risk appetite is going to be as strong as this morning indicates, none of the data is going to matter.  Nor will anything that the dozen Fed speakers upcoming this week have to say.  Instead, this is all about the vaccine, growth and FOMO.  In this environment, the dollar is likely to remain under modest pressure, but at the end of the day, there is no reason to believe it will decline sharply.

Good luck and stay safe
Adf

Aged Like Bad Wine

While Veterans here are recalled
And politics has us enthralled
The dollar’s decline
Has aged like bad wine
With strategies soon overhauled

US markets are closed today in observance of the Veteran’s Day holiday, but the rest of the world remains at work.  That said, look for a far less active session than we have seen recently.  In the first place, with the Fed on holiday, the Treasury market is closed and price action there has been one of the biggest stories driving things lately.  Secondly, while US equity futures markets are trading, all three stock exchanges are closed for the day, so the opportunity for individual company excitement is absent.  And finally, with today being an official bank holiday, while FX staff will be available, staffing will be at skeleton levels and come noon in New York, when London goes home, things here will slow to a standstill.

However, with that as a caveat, the world continues to turn.  For instance, while last week saw meetings in three key central banks, with two of them (RBA and BOE) explaining that easier monetary policy was in store, although the Fed made no such claims, last night saw the smallest of G10 nations, New Zealand, make headlines when the RBNZ explained that they were not changing policy right now, but that the economy there has been far more resilient than expected and they would not likely need to ease monetary policy any further.  It should be no surprise that the market responded by selling New Zealand government bonds (10-year yields rose 14.5 basis points), while overnight rates rose 16 basis points and traders removed all expectations for NIRP. QED, the New Zealand dollar is today’s best performer, rising 0.8%.

Sticking with the central bank theme, and reinforcing my view that the dollar’s decline has likely run its course broadly, although certainly individual currencies can strengthen based on country specific news, were comments from the Bank of Spain’s chief economist, Oscar Arce, explaining that the ECB must do still more to combat the threat of deflation in the Eurozone and that the December meeting will bring an entirely new discussion to the table.  The takeaway from the ECB meeting two weeks ago was that they would be expanding their stimulus programs in December.  Literally every comment we have heard from a European banking official in the interim has, not merely reinforced this view, but has implied that actions then will be massive.

I will repeat my strongly held view that the ECB will not, nay cannot, allow the euro to rise very far in their efforts to reboot the Eurozone economy.  Remember, one of the major benefits expected from easing monetary policy is a weakening of the currency.  When an economy is struggling with growth and deflation issues, as the Eurozone is currently struggling, a weak currency is the primary prescription to fix things.  You can be certain that every time the euro starts to rally near 1.20, which seems to be their tolerance zone, we will hear even more from ECB members about the additional easing in store as Madame Lagarde does her level best to prevent a euro rally.  And if the euro declines, so will the CE4 as well as the pound, Swiss franc and the Scandies.  In other words, the dollar is unlikely to decline much further than we have already seen.

In truth, those are the most noteworthy stories of the session so far.  Virtually every other headline revolves around either the ongoing election questions in the US, both the contestation of the presidential outcome and the upcoming run-off elections in Georgia for two Senate seats and control of the Upper House, or the vaccine and how quickly it can be approved and then widely distributed.

So, a quick look around markets this morning shows that risk appetite is moderate, at best.  For instance, equity markets in Asia were mixed with the Nikkei (+1.8%) continuing its recent strong run, up more than 10% this month, but the Hang Seng (-0.3%) and Shanghai (-0.5%) couldn’t find the same support.  Europe, on the other hand, is all in the green, but the movement is pretty modest with the FTSE 100 (+0.7%) the leader and both the DAX and CAC up just 0.4% at this hour.  US futures, which are trading despite the fact that equity markets here will be closed today, are all higher as well, with the NASDAQ (+1.0%) leading the way after having been the laggard for the first part of the week, while the other two are showing solid gains of 0.65%.

Bond markets in Europe are rising slightly, with yields slipping between 1 and 3 basis points on prospects for further ECB policy ease courtesy of Senor Arce as highlighted above, as there was no new economic data nor other statements of note.  As I mentioned, the Treasury market will be closed today for the holiday.

But commodity markets continue to perform well, with oil prices higher yet again, this morning by 3.2% taking the gains this week to 15%!  Metals prices, both base and precious, are also firmer as the vaccine news continues to spread good cheer regarding economic prospects going forward.

And finally, the dollar is best described as mixed to stronger.  For instance, against its G10 brethren, only NZD is firmer, as explained above.  But the rest of the bloc is softer led by NOK (-0.65%) and EUR (-0.4%).  While the euro makes sense given the Arce comments and growing belief that the ECB will really be aggressive next month, with oil’s sharp rebound, one must be surprised at the krone’s performance.  In fact, this merely reinforces my view that as the euro goes (lower) it will drag many currencies along for the ride.

However, in the EMG bloc, movement has been pretty even (excepting TRY) with a few more losers than gainers, but generally speaking, no really large movement.  On the plus side we see THB (+0.5%) and KRW (+0.45%) leading while on the downside it is MXN (-0.6%) and HUF (-0.45%) in the worst shape.  Looking a bit more deeply, the baht has been rallying all quarter and we may be looking at the last hurrah as the government has asked the BOT to manage the currency’s strength in order to help export industries compete more effectively.  Meanwhile, the won was the beneficiary of a significant jump in preliminary export data, with a 20.1% Y/Y gain for the first ten days of November auguring well for the economy.  Meanwhile, on the downside, the peso, which would have been expected to rally on the back of oil prices, is actually serving as a proxy for Peruvian risk as the impeachment of the president there Monday night has thrown the nation into turmoil and investors are seeking a proxy that is more liquid than the sol.  As to HUF, it is simply tracking the euro’s decline, and we can expect to see the same behavior for the entire CE4 bloc.

And that’s really it for today.  There is no news and no scheduled speakers and the session will be short.  But the dollar is edging higher, so keep that in mind.

Good luck and stay safe
Adf

Hopes are now Dashed

Psephologists took a great hit
Their forecasts turned out to be sh*t
The blue wave has crashed
And hopes are now dashed
For Congress, more cash to commit

An astrologer, and economist and a psephologist walk into a bar
“What’s it going to be?” asks the barkeep.
“We have no idea,” they reply

While the final results of the Presidential race are not yet in, nor seem likely to be known before Friday at the earliest, what has become clear is that the Republican party is very likely to retain control of the Senate, no matter what, and that the Democratic majority in the House of Representatives has shrunk.  In other words, the idea of the blue wave, where the Democrats would not merely win the presidency, but retake the Senate and expand their control of the House has been crushed.  And with that outcome, the reflation trade that had gained so many adherents of late, is being quickly unwound.

Thus, the election results have spawned both a bull flattening of the yield curve, with 10-year yields currently lower by 11.5 basis points, while 30-year yields are 13 basis points lower and a dollar rebound, especially against most emerging market currencies.  It had seemed odd yesterday to see such significant market movement ahead of the results of what many expected to be a close, and possibly contested, election.  But clearly, there was a significant amount of enthusiasm for that mythical blue wave.

Until the Presidential results are declared, it will be extremely difficult to focus on US economic issues, as in fairness, given the diametrically opposed platforms of the two candidates, we can only surmise a future path once we know who wins.  As such, I expect the two stories that will dominate for the rest of the week will be the election results and the ongoing covid inspired lockdowns throughout Europe.

As this is not a political discussion, let us turn to the other major storyline.  As of today, it appears that Germany, France, Italy and the UK are all imposing significant restrictions on most, if not all, of their citizens for the entire month of November.  Given the rapid spread of the virus in this wave, Europe reported another 239K new cases yesterday, it is understandable that governments feel the need to act.  However, the balance between trying to maintain economic activity and trying to avoid spending so much money on healthcare save citizens’ lives is a difficult one to maintain.  After all, the EU has very strict guidelines as to what type of budget deficits its members can run, and at this point, every member is over the limit.  It is this reason that Madame Lagarde has been so clear that the ECB can, and will, do more to support the economy.  If they don’t, things will get ugly very quickly.  It is also this reason that leads me to believe the euro has limited upside for the foreseeable future.  Whatever is happening in the US, the situation in Europe is not one that inspires confidence.

Thus, let’s look at how markets are responding to the incomplete election results and the increase in Covid infections.  Equities in Asia had a mixed session, with the Nikkei (+1.7%) performing well while the Hang Seng (-0.2%) suffered on the back of the Ant Financial story.  (This story revolves around the expected IPO of the Chinese company, which was forecast to be the largest of the year, but which the Chinese government squashed.)  Shanghai equities were little changed on the session, up just 0.2%.  Europe, however, has seen early gains evaporate and at this point could best be characterized as mixed.  The DAX (-0.1%) is the laggard, while the CAC and FTSE 100 (+0.2% each) are marginally higher.  However, Spain’s IBEX (-1.1%) is feeling the pain of the lockdowns, as is Italy’s MIB (-0.25%).  US futures are quite interesting at this point, with DOW futures actually lower by 0.1%, while NASDAQ futures are 2.0% higher.  And NASDAQ futures were as much as 4.5% higher earlier in the session.  It seems that the status quo in US politics is deemed a positive for the Tech mega caps, while the cyclical companies are expected to have a much tougher time.  As well, if President Trump wins, there will be no expectation of significant tax hikes, something that would have been a virtual certainty with a President Biden.

As discussed above, Treasuries are rallying fiercely.  But we are seeing rallies throughout Europe as well, with Gilt yields leading the way, having fallen by 4.3 bps, but most of the continent looking at 2bp declines.  This appears to be either position unwinding or a renewed enthusiasm that the ECB is going to step up in a massive way next month.  Recall, yesterday, bonds fell everywhere, so a rebound is not that surprising, especially for those who were selling based on the moves in the US.  However, I suspect that given the newest lockdown announcements, investors have become increasingly convinced that the ECB is going to get perilously close to the idea of direct funding of government deficits, something that is verboten within the rules, but something that is desperately needed by the likes of Italy, Spain and Greece.

As to the dollar, yesterday’s sharp decline was puzzling for the same reason the bond market sell-off was puzzling, and so, this morning’s rebound makes perfect sense.  While earlier in the session, the dollar had seen much sharper gains, at this hour (6:52am), those gains are fairly modest.  AUD (-0.4%) is the worst G10 performer, followed closely by GBP (-0.35%) and NZD (-0.35%).  Meanwhile, both haven currencies, CHF and JPY have climbed back to unchanged on the day from earlier session losses.  With the election news still roiling markets, it is nonsensical to try to attribute these moves to anything other than position moves.

EMG currencies are also under pressure virtually across the board, and like the G10, the early declines, which in some cases were quite substantial have abated.  For instance, MXN (-4.1% last night, -1.0% now) showed the most volatility, but CNY (-1.0% last night, unchanged now) also saw substantial movement.  Again, to attribute this, or any currency movement, to anything other than position adjustment in the wake of the US election results would be a mistake.

As to the data today, the Services PMI data was released throughout Europe and was pretty much as expected.  ISM Services (exp 57.5) is out at 10:00 and expected to continue to show surprising growth.  Before that, we see the Trade Balance (exp -$63.9B), but trade policy is just not of interest these days.

Rather, the market will remain enthralled with the election results, which as I type remain decidedly unclear.  Either candidate could win the key remaining states of Pennsylvania, Michigan and Georgia, although all three are trending Trump right now.

In the end, the election result will matter because it will inform policy ideas.  If we remain status quo ante, the dollar likely has further to rise.  If Mr Biden emerges victorious, the dollar could certainly cede its recent gains, but no collapse is in sight.

Good luck and stay safe
Adf

There is Trouble

It seems that the virus mutated
In Spain, which has now complicated
The efforts by France
To alter their stance
On lockdowns, with new ones created

In Germany, too, there is trouble
With cases, this week, set to double
So, Madame Lagarde
Will simply discard
Her fears, and inflate the bond bubble

The second wave of infections, or perhaps the third, is clearly washing over Europe with Covid-19 cases surging across the continent.  The situation has deteriorated so rapidly that, in short order, both Germany and France have ordered lockdowns, closing restaurants, bars, gyms and theaters for the next month.  Public gatherings are being restricted to ten people drawn from only two families as hospital beds throughout both nations fill up quickly.  Research to be released this morning has identified a new strain of the virus that apparently originated in Spanish farm workers during the summer and has been the main version in the latest outbreak.  It seems that it was spread by people returning to their homelands from Spanish holidays.

Meanwhile, Spain and Italy are also contemplating nationwide lockdowns as infections surge there, and even countries that saw a limited outbreak last spring, like the Czech Republic, are under severe pressure now.  Add it all up and you have a recipe for a fourth quarter of negative growth on the continent.  Seemingly, the only part of the Eurozone economy that is performing well are German capital goods exporters as their main market, China, has been rebounding.

With this as background, now consider that you are Christine Lagarde and chairing the ECB policy meeting today.  While the ECB has made significant efforts to support every Eurozone nation during the current crisis, clearly the situation remains fraught.  Is there anything that she can do to shore up confidence?

The punditry is pretty united in their views at this time, not expecting any policy changes at today’s meeting in the belief that the council will want to wait for updated economic forecasts in December before adding to the PEPP. Estimates for an increase in that QE program have coalesced around €500 billion.  If anything, the only expectations for today are for Lagarde to essentially promise that the ECB will announce the expansion of their policy accommodation in December.  While this may well be the outcome, if there is one thing we should have learned from Signor Draghi’s time in Lagarde’s chair, it is that acting sooner than expected and larger than expected are the only ways for the ECB to alter the narrative.  And right now, the narrative is leaning toward the ECB is powerless to prevent the next downturn.

With this in mind, and recognizing that Lagarde, while perhaps not the most sophisticated economic mind on the council, is clearly the best politician, and with the new gloom and doom reports coming in daily, if not hourly, I think there is a decent probability that the ECB acts today.  After all, if they are certain they are going to increase the PEPP program in December, what is the advantage to waiting.  And while I don’t think that a rate cut is in the cards yet, there is a non-zero probability of that too.  News earlier this week, that didn’t get much press in the US, highlighted that small German banks, of which there are nearly 1800, have started to charge depositors to maintain deposits from the first euro.  So, savings accounts are going to be taxed subject to negative interest.  If banks are starting to pass on the costs of ECB monetary policy, then the ECB is likely to be far more comfortable in cutting rates further as they recognize that the banking system there is likely to have halted the decline in lending spreads.  Hence, my out of consensus view is we see some definitive action from the ECB this morning.

Leading up to that meeting, with the announcement to be made at 8:45 this morning (Daylight Savings time has already occurred there), markets are rebounding modestly from yesterday’s risk reducing session.  I’m sure you are all aware of he size of the decline in stock market indices yesterday, with US markets falling ~3.5%, their worst single day performance since June.  What was quite interesting about the session, though, was while equity risk was abandoned, haven assets, which had a bid early in the session, lost their luster as well.  In fact, Treasury bonds wound up the day unchanged, and yields there are actually almost a basis point higher this morning.

A quick tour of equity markets shows that Asian markets were somewhat lower (Nikkei -0.4%, Hang Seng -0.5%, Shanghai +0.1%), although they all closed well off the worst levels of the session.  European bourses are ever so slightly higher, on average, with the DAX (+0.4%), CAC (+0.1%) and FTSE 100 (+0.3%) all in the green.  The big outlier here is Spain’s MIB (-0.95%), which is feeling the pain of the latest story about the genesis of the new strain of the virus, as well as responding to the announcement by PM Sanchez that the national state of emergency has been extended for six months, meaning lockdowns are almost certainly coming there soon.  US futures, meanwhile, are currently up about 0.5%-0.7%, although that is well off the earlier session highs.  The question remains is this a modest trading bounce, or was yesterday an aberration?

Unlike the Treasury market, with a modest uptick in yields, Bunds and OATs are both rallying with 1 basis point declines.  It seems I am not the only one who thinks the ECB may act today, as any early action should see an uptick in demand for European paper.  Oil, on the other hand, is having another tough day, down 3.5%, and at $36/bbl, WTI is back to its lowest level since mid-June.  Fears over slipping demand alongside growing supply are infiltrating the market.

As to the dollar, early price activity was mixed, but it is seeing some demand in the past hour and is now largely higher on the day.  NOK (-0.95%) is the laggard again, following oil lower, but we are seeing weakness, albeit modest weakness, from SEK (-0.4%) and EUR (-0.2%).  Certainly, if I am correct in my view on the ECB, we should see the euro decline further.  On the plus side, only JPY (+0.25%) is gaining on the greenback as the BOJ’s lack of policy action combined with a background of fear over the new lockdowns and their impact on economic activity, has some Japanese investors taking their money home.  This is a trend that has legs.

EMG currencies have also turned from a mixed bag to a nearly universal decline, although the losses are not enormous.  For a change of pace, MXN (-0.7%) is the laggard today, suffering from the ongoing oil price declines, and pushing TRY (-0.6%) back to only the second worst performing currency.  But EEMEA currencies are all lower in the 0.3%-0.5% range.  In fact, the only gainer today is CNY (+0.25%) which continues to benefit from investment inflows as the Chinese economy continues to be the world’s top performer.

On the data front, today we see the most important points of the week.  Initial Claims (exp 770K) and Continuing Claims (7.775M) have been falling but remain substantially higher than even during the worst recessions in the past 75 years.  Of possibly more interest will be this morning’s first reading of Q3 GDP (exp 32.0%), which while it will be a record, will not make up for the loss in Q2.  And right after those are released, we hear from the ECB, so the 30 minutes between 8:30 and 9:00 have the chance for some fireworks.

In the end, it appears to me that risk will continue to be shed leading up to the election, and with that activity, we will see the dollar (and yen) grind higher.

Good luck and stay safe
Adf