A Vaccine’s Required

Mnuchin and Powell explained
That Congress ought not be restrained
In spending more cash
Or else, in a flash
The rebound might not be maintained

Meanwhile, as the quarter expired
The data show growth is still mired
Within a great slump
And hopes for a jump
Are high, but a vaccine’s required

I continue to read commentary after commentary that explains the future will be brighter once a Covid-19 vaccine has been created. This seems to be based on the idea that so many people are terrified of contracting the disease they they will only consider venturing out of their homes once they believe the population at large is not contagious. While this subgroup will clearly get vaccinated, that is not likely to be majority behavior. If we consider the flu and its vaccine as a model, only 43% of the population gets the flu shot each year. Surveys regarding a Covid vaccine show a similar response rate.

Consider, there is a large minority of the population who are adamantly against any types of vaccines, not just influenza. As well, for many people, the calculation seems to be that the risk of contracting the flu is small enough that the effort to go and get the shot is not worth their time. Ask yourself if those people, who are generally healthy, are going to change their behavior for what appears to be a new form of the flu. My observation is that human nature is pretty consistent in this regard, so Covid is no scarier than the flu for many folks. The point is that the idea that the creation of a vaccine will solve the economy’s problems seems a bit far-fetched. Hundreds of thousands of small businesses have already closed permanently because of the economic disruption, and we are all well acquainted with the extraordinary job loss numbers. No vaccine is going to reopen those businesses nor bring millions back to work.

And yet, the vaccine is a key part of the narrative that continues to drive risk asset prices higher. While we cannot ignore central bank activities as a key driver of equity and bond market rallies, the V-shaped recovery is highly dependent on the idea that things will be back to normal soon. But if a vaccine is created and approved for use, will it really have the impact the market is currently anticipating? Unless we start to see something akin to a health passport in this country, a document that certifies the holder has obtained a Covid-19 shot, why would anyone believe a stranger is not contagious and alter their newly learned covid-based behaviors. History shows that the American people are not fond of being told what to do when it comes to restricting their rights of movement. Will this time really be different?

However, challenging the narrative remains a difficult proposition these days as we continue to see the equity bulls in charge of all market behavior. As we enter Q3, a quick recap of last quarter shows the S&P’s 20% rally as its best quarterly performance since Q4 1998. Will we see a repeat in Q3? Seems unlikely and the risk of a reversal seems substantial, especially if the recent increase in Covid cases forces more closures in more states. In any event, uncertainty appears especially high which implies price volatility is likely to continue to rise across all markets.

But turning to today’s session, equity markets had a mixed session in Asia (Nikkei -0.75%, Hang Seng +0.5%) despite the imposition of the new, more draconian law in Hong Kong with regard to China’s ability to control dissent there. Meanwhile, small early European bourse gains have turned into growing losses with the DAX now lower by 1.5%, the CAC down by 1.4% and the FTSE 100 down by 1.0%. While PMI data released showed that things were continuing on a slow trajectory higher, we have just had word from German Chancellor Merkel that “EU members [are] still far apart on recovery fund [and the] budget.” If you recall, there is a great deal of credence put into the idea that the EU is going to jointly support the nations most severely afflicted by the pandemic’s impacts. However, despite both German and French support, the Frugal Four seem to be standing their ground. It should be no surprise that the euro has turned lower on the news as well, as early modest gains have now turned into a 0.3% decline. One of the underlying supports for the single currency, of late, has been the idea that the joint financing of a significant budget at the EU level will be the beginning of a coherent fiscal policy to be coordinated with the ECB’s monetary policy. If they cannot agree these terms, then the euro’s existence can once again be called into question.

Perhaps what is more interesting is that as European equity markets turn lower, and US futures with them, the bond market is under modest pressure as well this morning. 10-year Treasury yields are higher by more than 2bps and in Europe we are seeing yields rise by between 3bps and 4bps. This is hardly risk-off behavior and once again begs the question which market is leading which. In the long run, bond investors seem to have a better handle on things, but on a day to day basis, it is anyone’s guess.

Finally, turning to the dollar shows that early weakness here has turned into broad dollar strength with only two currencies in the G10 higher at this point, the haven JPY (+0.4%) and NOK (+0.2%), which has benefitted from oil’s rally this morning with WTI up by about 1% and back above $40/bbl. In the emerging markets, only ZAR has managed any gains of note, rising 0.4%, after its PMI data printed at a surprisingly higher 53.9. On the flip side, PLN (-0.6%) is the laggard, although almost all EMG currencies are softer, as PMI data there continue to disappoint (47.2) and concerns over a change in political leadership seep into investor thoughts.

On the data front, we start to see some much more important data here today with ADP Employment (exp 2.9M), ISM Manufacturing (49.7) and Prices Paid (44.6) and finally, FOMC Minutes to be released at 2:00. Yesterday we saw some thought provoking numbers as Chicago PMI disappointed at 36.6, much lower than expected, while Case Shiller House Prices rose to 3.98%, certainly not indicating a deflationary surge.

Yesterday we also heard the second part of Chairman Powell’s testimony to Congress, where alongside Treasury Secretary Mnuchin, he said that the Fed remained committed to doing all that is necessary, that rates will remain low for as long as is deemed necessary, and that it would be a mistake if Congress did not continue to support the economy with further fiscal fuel. None of that was surprising and, quite frankly, it had no impact on markets anywhere.

At this point, today looks set to see a little reversal to last quarter’s extremely bullish sentiment so beware further dollar strength.

Good luck and stay safe
Adf

 

Overthrow

Health data are starting to show
A second wave might overthrow
The rebound we’ve seen
From Covid-19
Which clearly will cause growth to slow

Risk is under pressure this morning as market participants continue to read the headlines regarding the rising rate of Covid infections in some of the largest US states, as well as throughout a number of emerging market nations. While this is concerning, in and of itself, it has been made more so by the fact that virtually every government official has warned that a second wave will undermine the progress that has been made with respect to the economic rebound worldwide. However, what seems to be clear is that more than three months into a series of government ordered shut downs that have resulted in $trillions of economic damage around the world, people in many places have decided that the risk from the virus is not as great as the risk to their personal economic well-being.

And that is the crux of the matter everywhere. Just how long can governments continue to impose restrictions on people without a wholesale rebellion? After all, there have been many missteps by governments everywhere, from initially downplaying the impact of the virus to moving to virtual marital law, with early prognostications vastly overstating the fatality rate of the virus and seemingly designed simply to sow panic and exert government control. It cannot be surprising that at some point, people around the world decided to take matters into their own hands, which means they are no longer willing to adhere to government rules.

The problem for markets, especially the equity markets, is that their recovery seems to be based on the idea that not only is a recovery right around the corner, but that economies are going to recoup all of their pandemic related losses and go right back to trend activity. Thus, a second wave interferes with that narrative. As evidence starts to grow that the caseload is no longer shrinking, but instead is growing rapidly, and that governments are back to shutting down economic activity again, those rosy forecasts for a sharp rebound are harder and harder to justify. And this is why we have seen the equity market rebound stumble for the past three weeks. In that time, we have seen twice as many down sessions as up sessions and the net result has been a 5.5% decline in the S&P500, with similar declines elsewhere.

So, what comes next? It is very hard to read the news about the growing list of bankruptcies as well as the significant write-downs of asset values and order cancelations without seeing the bear case. The ongoing dichotomy between the stock market rally and the economic distress remains very hard to justify in the long run. Of course, opposing the real economic news is the cabal of global central banks, who are doing everything they can think of collectively, to keep markets in functioning order and hoping that, if markets don’t panic, the economy can find its footing. This is what has brought us ZIRP, NIRP and QE with all its variations on which assets central banks can purchase. Alas, if central bankers really believe that markets are functioning ‘normally’ after $trillions of interference, that is a sad commentary on those central bankers’ understanding of how markets function, or at least have functioned historically. But the one thing on which we can count is that there is virtually no chance that any central bank will pull back from its current policy stance. And so, that dichotomy is going to have to resolve itself despite central bank actions. That, my friends, will be even more painful, I can assure you.

So, on a day with ordinary news flow, like today, we find ourselves in a risk-off frame of mind. Yesterday’s US equity rally was followed with modest strength in Asia. This was helped by Chinese PMI data which showed that the rebound there was continuing (Mfg PMI 50.9, Non-mfg PMI 54.4), although weakness in both Japanese ( higher Jobless Rate and weaker housing data) and South Korean (IP -9.6% Y/Y) data detracted from the recovery story. Of course, as we continue to see everywhere, weak data means ongoing central bank largesse, which at this point still leads to equity market support.

Europe, on the other hand, has not seen the same boost as equity markets there are mostly lower, although the DAX (+0.4%) and CAC (+0.2%) are the two exceptions to the rule. UK data has been the most prevalent with final Q1 GDP readings getting revised a bit lower (-2.2% Q/Q from -2.0%) while every other sub-metric was slightly worse as well. Meanwhile, PM Johnson is scrambling to present a coherent plan to support the nation fiscally until the Covid threat passes, although on that score, he is not doing all that well. And we cannot forget Brexit, where today’s passage without an extension deal means that December 31, 2020 is the ultimate line in the sand. It cannot be a surprise that the pound has been the worst performing G10 currency over the past week and month, having ceded 2.0% since last Tuesday. With the BOE seriously considering NIRP, the pound literally has nothing going for it in the short run. Awful economic activity, questionable government response to Covid and now NIRP on the horizon. If you are expecting to receive pounds in the near future, sell them now!

Away from the pound, which is down 0.3% today, NOK (-0.6%) is the worst performer in the G10, and that is really a result of, not only oil’s modest price decline (-1.3%), but more importantly the news that Royal Dutch Shell is writing down $22 billion of assets, a move similar to what we have seen from the other majors (BP and Exxon) and an indication that the future value (not just its price) of oil is likely to be greatly diminished. While we are still a long way from the end of the internal combustion engine, the value proposition is changing. And this speaks to just how hard it is to have an economic recovery if one of the largest industries that was adding significant value to the global economy is being downgraded. What is going to take its place?

The oil story is confirmed in the EMG space as RUB is the clear underperformer today, down 1.4% as Russia is far more reliant on oil than even Norway. However, elsewhere in the EMG bloc, virtually the entire space is under pressure to a much more limited extent. The thing is, if we start to see risk discarded and equity markets come under further pressure, these currencies are going to extend their declines.

This morning’s US data is second tier, with Case Shiller Home Prices (exp +3.8%), Chicago PMI (45.0) and Consumer Confidence (91.4). The latter two remain far below their pre-covid levels and likely have quite some time before they can return to those levels. Meantime, Fed speakers are out in force today, led by Chair Powell speaking before a Congressional panel alongside Treasury Secretary Mnuchin. His pre-released opening remarks harp on the risk of a second wave as well as the uncertainty over the future trajectory of growth because of that. As well, he continues to promise the Fed will do whatever is necessary to support the economy. And in truth, we have continued to hear that message from every single Fed speaker for the past two months’ at least. What we know for sure is that the Fed is not going to change its tune anytime soon.

For today, unless Powell describes yet another new program, if he remains in his mode of warning of disaster unless the government does more, it is hard to see how investors get excited. Risk is currently on the back foot and I see nothing to change that view today.

Good luck and stay safe
Adf

A New Paradigm

As mid-year approaches, it’s time
To ponder the central bank clime
Will negative rates
Appear in the States
And welcome a new paradigm?

With the end of the first half of 2020 approaching, perhaps it’s time to recap what an extraordinary six months it has been as well as consider what the immediate future may hold.

If you can recall what January was like, the big story was the Phase One trade deal, which was announced as almost completed at least half a dozen times, essentially every time the stock market started to decline, before it was finally signed. In hindsight, the fact that it was signed right at the beginning of the Lunar New Year celebrations in China, which coincided with the recognition that the novel coronavirus was actually becoming a problem, is somewhat ironic. After all, it was deemed THE most important thing in January and by mid-February nobody even cared about it anymore. Of course, by that time, Covid-19 had been named and was officially declared a pandemic.

As Covid spread around the world, the monetary responses were impressive for both their speed of implementation and their size. The Fed was the unquestioned leader, cutting rates 150bps in two emergency meetings during the first half of March while prepping the market for QE4. They then delivered in spades, hoovering up Treasuries, mortgage-backed bonds, investment grade corporate bonds and junk bonds (via ETF’s) and then more investment grade bonds, this time purchasing actual securities, not ETF’s. Their balance sheet has grown more than $3 trillion (from $4.1 trillion to $7.1 trillion) in just four months and they have promised to maintain policy at least this easy until the economy can sustainably get back to their inflation and employment goals.

On the fiscal front, government response was quite a bit slower, and aside from the US CARES act, signed into law in late March, most other nations have been less able to conjure up enough spending to make much of a difference. There was important news from the EU, where they announced, but have not yet enacted, a policy that was akin to mutualization of debt across the entire bloc. If they can come to agreement on this, and there are four nations who remain adamantly opposed (Sweden, Austria, Denmark and the Netherlands), this would truly change the nature of the EU and by extension the Eurozone. Allowing transfers from the richer northern states to the struggling Mediterranean countries would result in a boon for the PIGS as they could finally break the doom-loop of their own nation’s banks owning the bulk of their own sovereign debt. But despite the support of both France and Germany, this is not a done deal. Now, history shows that Europe will finally get something along these lines enacted, but it is likely to be a significantly watered-down version and likely to take long enough that it will not be impactful in the current circumstance.

Of course, the ECB, after a few early stumbles, has embraced the idea of spending money from nothing and is in the process of implementing a €1.35 trillion QE program called PEPP in addition to their ongoing QE program.

Elsewhere around the world we have seen a second implementation of yield curve control (YCC), this time by Australia which is managing its 3-year yields to 0.25%, the same level as its overnight money. There is much talk that the Fed is considering YCC as well, although they will only admit to having had a discussion on the topic. Of course, a quick look at the US yield curve shows that they have already essentially done so, at least up to the 10-year maturity, as the volatility of yields has plummeted. For example, since May 1, the range of 3-year yields has been just 10bps (0.18%-0.28%) while aside from a one-week spike in early June, 10-year yields have had an 11bp range. The point is, it doesn’t seem that hard to make the case the Fed is already implementing YCC.

Which then begs the question, what would they do next? Negative rates have been strongly opposed by Chairman Powell so far, but remember, President Trump is a big fan. And we cannot forget that over the course of the past two years, it was the President’s view on rates that prevailed. At this time, there is no reason to believe that negative rates are in the offing, but in the event that the initial rebound in economic data starts to stumble as infection counts rise, this cannot be ruled out. This is especially so if we see the equity market turn back lower, something which the Fed seemingly cannot countenance. Needless to say, we have not finished this story by a long shot, and I would contend there is a very good chance we see additional Fed programs, including purchasing equity ETF’s.

Of course, the reason I focused on a retrospective is because market activity today has been extremely dull. Friday’s equity rout in the US saw follow through in Asia (Nikkei -2.3%, Hang Seng -1.0%) although Europe has moved from flat to slightly higher (DAX +0.5%, CAC +0.25%, FTSE 100 +0.5%). US futures are mixed, with the surprising outcome of Dow and S&P futures higher by a few tenths of a percent while NASDAQ futures are lower by 0.3%. The bond market story is that of watching paint dry, a favorite Fed metaphor, with modest support for bonds, but yields in all the haven bonds within 1bp of Friday’s levels.

And finally, the dollar is arguably a bit softer this morning, with the euro the leading gainer in the G10, +0.5%, and only the pound (-0.2%) falling on the day. It seems that there are a number of algorithmic models out selling dollars broadly today, and the euro is the big winner. In the EMG bloc, the pattern is the same, with most currencies gaining led by PLN(+0.65%) after the weekend elections promised continuity in the government there, and ZAR (+0.55%) which is simply benefitting from broad dollar weakness. The exception to the rule is RUB, which has fallen 0.25% on the back of weakening oil prices.

On the data front, despite nothing of note today, we have a full calendar, especially on Thursday with the early release of payroll data given Friday’s quasi holiday

Tuesday Case Shiller Home Prices 3.70%
  Chicago PMI 44.0
  Consumer Confidence 90.5
Wednesday ADP Employment 2.95M
  ISM Manufacturing 49.5
  ISM Prices Paid 45.0
  FOMC Minutes  
Thursday Initial Claims 1.336M
  Continuing Claims 18.904M
  Nonfarm Payrolls 3.0M
  Private Payrolls 2.519M
  Manufacturing Payrolls 425K
  Unemployment Rate 12.4%
  Average Hourly Earnings -0.8% (5.3% Y/Y)
  Average Weekly Hours 34.5
  Participation Rate 61.2%
  Trade Balance -$53.0B
  Factory Orders 7.9%
  Durable Goods 15.8%
  -ex transport 4.0%

Source: Bloomberg

So, as you can see, a full slate for the week. Obviously, all eyes will be on the employment data on Wednesday and Thursday. At this point, it seems we are going to continue to see data pointing to a sharp recovery, the so-called V, but the question remains, how much longer this can go on. However, this is clearly today’s underlying meme, and the ensuing risk appetite is likely to continue to undermine the dollar, at least for the day. We will have to see how the data this week stacks up against the ongoing growth in Covid infections and the re-shutting down of portions of the US economy. The latter was the equity market’s nemesis last week. Will this week be any different?

Good luck and stay safe
Adf

Money to Burn

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
Adf

Yesterday’s News

The first bit of data we’ve seen
Has shown what economists mean
When most business stops
And GDP drops
Reacting to Covid – 19

This data describes people’s fear
Another wave just might appear
But right now those views
Are yesterday’s news
And ‘buy the dip’ traders are here

The UK is an interesting study regarding GDP growth because they actually publish monthly numbers, rather than only quarterly data like the rest of the developed world. So, this morning, the UK reported that GDP activity in April declined 20.4% from March, which had declined 5.8% from February when the first impact of Covid-19 was felt. This has resulted in the UK economy shrinking back to levels last seen in 2002. Eighteen years of growth removed in two months! Of course, when things recover, and they will recover as the lockdowns are eased around the world, we will also get to see the fastest growth numbers in history. However, we must remember that a 20% decline will require a 25% rebound to get back to where we started. Keep that in mind when we start to see large positive numbers in the summer (hopefully) or the autumn if people decide that the risks of Covid outweigh the benefits of returning to previous activities.

Needless to say, this has been an unprecedented decline, on a monthly basis, in the economy for both its depth and speed. But the more remarkable thing, is that despite this extraordinary economic disruption, a look at financial markets shows a somewhat different story. For example, on February 28, the FTSE 100 closed at 6580.61 and the pound finished the session at 1.2823. On April 30, after the worst two-month economic decline in the UK’s history, its main stock market had declined 10.3% while the pound had fallen just 1.8%. Granted, both did trade at substantially lower levels in the interim, bottoming in the third week of March before rebounding. But it seems to me that those are pretty good performances given the size of the economic dislocation. And since then, both the FTSE 100 and the pound have rallied a bit further.

The question is, how can this have occurred? Part of the answer is the fact that on a contemporaneous basis, investors could not imagine the depths of the economic decline that was taking place. While there were daily stories of lockdowns and death counts, it is still hard for anyone to have truly understood the unprecedented magnitude of what occurred. And, of course, part of the answer was this did not happen in a vacuum as policymakers responded admirably quickly with the BOE cutting rates by a total of 0.65% in the period while expanding their balance sheet by £150 billion (and still growing). And the UK government quickly put together stimulus packages worth 5% of then measured GDP. Obviously, those measures were crucial in preventing a complete financial market collapse.

Another thing to remember is that the FTSE 100 was trading at a P/E ratio of approximately 15 ahead of the crisis, which in the long-term scheme of things was actually below its average. So, stock prices in the UK were nowhere near as frothy as in the US and arguably had less reason to fall.

As to the pound, well, currencies are a relative game, and the same things that were happening in the UK were happening elsewhere as well to various degrees. March saw the dollar’s haven status at its peak, at which point the pound traded below 1.15. But as policymakers worldwide responded quite quickly, and almost in unison, the worst fears passed and the ‘need’ to own dollars ebbed. Hence, we have seen a strong rebound since, and in truth a very modest net decline.

The questions going forward will be all about how the recovery actually unfolds, both in timing and magnitude. The one thing that seems clear is that the uniformity of decline and policy response that we saw will not be repeated on the rebound. Different countries will reduce safety measures at different paces, and populations will respond differently to those measures. In other words, as confusing as data may have been before Covid, it will be more so going forward.

Now, quickly, to markets. Yesterday’s equity market price action in the US was certainly dramatic, with the Dow falling nearly 7% and even the NASDAQ falling 5.25%. The best explanation I can offer is that reflection on Chairman Powell’s press conference by investors left them feeling less confident than before. As I wrote in the wake of the ECB meeting last week, the only way for a central banker to do their job (in the market’s eyes) these days is to exceed expectations. While analysts did not expect any policy changes, there was a great deal of talk on trading desks floors chatrooms about the next step widely seen as YCC. The fact that Jay did not deliver was seen as quite disappointing. In fact, it would not be surprising to me that if stock markets continued to decline sharply, the Fed would respond.

But that is not happening as buying the dip is back in fashion with European markets higher by roughly 1.5% and US futures also pointing higher. Meanwhile, with risk back in favor, Treasury yields have backed up 3bps and the dollar is under pressure.

On the FX front, the G10 is a classic depiction of risk-on with the yen (-0.5%) and Swiss franc (-0.3%) both declining while the rest of the bloc is higher led by CAD and AUD, both up 0.5%. In truth, this has the feeling of a bounce from yesterday’s dollar strength, rather than the beginning of a new trend, but that will depend on the broader risk sentiment. If equity market ebullience this morning fades as the session progresses, look for the dollar to take back its overnight losses.

Meanwhile, EMG markets are having a more mixed session with APAC currencies all having fallen last night in the wake of the US equity rout. APAC equities were modestly lower to unchanged but had started the session under far more pressure. At the same time, the CE4, with the benefit of the European equity rebound and higher US futures are mostly firmer led by PLN (+0.6%). But the biggest winner today in this space is MXN, which has rebounded 0.7% from yesterday’s levels, although that represented a nearly 4% decline! In other words, the defining characteristic of the peso these days is not its rate but its volatility. For example, 10-day historic volatility in the peso is currently 28.37%, up from 13.4% last Friday and 21.96% in the middle of May when we were looking at daily 3% moves. Do not be surprised if we see another bout of significant peso volatility, especially given the ongoing concerns over AMLO’s handling of Covid.

On the data front, only Michigan Sentiment (exp 75.0) is on the docket today, which may have an impact if it is surprisingly better than expected, but I don’t anticipate much movement. Rather, FX remains beholden to the overall risk sentiment as determined by the US equity markets. If the rebound continues, the dollar will remain under pressure. If the rebound fails, look for the dollar to resume yesterday’s trend.

Good luck, good weekend and stay safe
Adf

 

Yesterday’s Mess

As riots engulf the US
The stock market’s feeling no stress
The bond market’s flat
The dollar’s gone splat
And Covid is yesterday’s mess

Risk is on this morning, and it appears that neither riots across most major cities in the US nor increased tensions between the US and China will do anything to dissuade investors from that mantra. I guess TINA is alive and well and living in every major financial center around the world. Of course, she does have a sugar daddy, the central bank community, who continue to spend on her by pumping massive amounts of liquidity into markets while cutting interest rates ever lower. Since April 1st, when lockdowns were beginning to spread rapidly around the world and social distancing became the watchword for personal interactions, every major equity market worldwide is higher, most by double digit percentages. Even Hong Kong’s Hang Seng Index is higher by 0.5% in that time, despite the fact that China has changed the law regarding the island’s quasi-independent status and certainly undermined a great deal of trust in the sanctity of private property there.

So why should today be any different than what we have seen for the past two months? One thought was all the rioting in the US. While there is absolutely no justification for the behavior of the Minneapolis policeman whose actions triggered this situation, there is also no justification for the looting and destruction of private property across the country. And, consider the timing; just as many businesses were starting to prepare to reopen, along comes a mob with the result being massive destruction of private property. This will certainly slow down the reopening of the economy to everyone’s detriment. I guess using the ‘broken windows’ theory of economics, the repair of all that damage and destruction will increase economic activity and be a net positive. (Alas, in 1850, Frederic Bastiat showed the fallacy in that theory by simply asking what those resources could have been used for had they not been needed to repair something that was perfectly fine beforehand.) The point is, the riots are a clear net negative to the economy.

And yet, after nearly two months of an incapacitated economy, which brought with it record unemployment levels along with record low readings across almost every economic statistic, the idea that equity markets around the world have recouped nearly two-thirds of the losses seen when the impact of Covid-19 was just beginning to be recognized is remarkable. Add to that equation the increasing tensions between the US and China, not merely the Hong Kong situation but also word that China is now halting purchases of US agricultural products and the potential death knell of the phase one trade agreement, and one is left scratching their head as to exactly what basis investors are using to make decisions. Since economic activity is clearly not the current driver, the only other choice is an unshakeable belief that the central banks, notably the Fed, will never allow the stock markets to decline substantially.

But that is where we are this morning, with equity markets in Asia having rallied after Friday’s presidential press conference made only vague threats about US retaliation for China’s actions regarding Hong Kong. In fact, the Hang Seng was the leading gainer, up 3.35%, but Shanghai (+2.2%) and the Nikkei (+0.85%) also enjoyed gains. Europe has generally followed along with both the CAC and FTSE 100 higher by 1.1% this morning. However, the DAX is having a more difficult session, falling 1.6% after final May PMI data showed Germany is lagging the Eurozone’s overall growth response. Meanwhile, US futures are basically flat on the day although they have rallied back from earlier losses in the overnight session.

Bond markets are behaving as one would expect in a risk-on session, with yields generally higher (Treasury +1bp, Bunds +3bps) but risk bonds, like Italian BTP’s seeing buying interest and declining yields (-3bps). In fact, another possible explanation for the DAX’s difficulties is the growing realization that Germany is going to be supporting all of the rest of Europe financially, which likely means that German companies may see less government support.

Finally, FX markets are really showing the diminished concerns regarding risk across all markets. Remember, during the peak of the concerns in March, foreign companies and countries were desperate to get access to dollars to continue servicing the trillions of dollars of USD denominated debt they had outstanding. As the basis moved further against them, they ultimately simply bought dollars in the FX market to satisfy those claims. Naturally, the dollar rallied strongly on all that demand. But to the rescue rode Jay Powell and his $4 trillion of liquidity and, voilá, the need to hoard dollars disappeared. So, with that in mind, one cannot be surprised that the dollar is softer across the board this morning.

Starting with the G10, Aussie is leading the way higher, up 0.95%, after its PMI data printed slightly better than expected and the market turns its attention to the RBA’s meeting this evening, where expectations are for no further policy ease for the time being. But we are also seeing strength in CAD (+0.5%), NZD (+0.4%) and GBP (+0.3%), as a combination of firming commodity prices and modest upward revisions to PMI data have helped underpin sentiment. The rest of the bloc is actually higher, but by 0.1% or less, and hardly worth mentioning.

In the EMG bloc, KRW (+1.1%) leads the way after announcing a $62 billion economic support package to help further mitigate the impact of Covid on the economy. That news was seen as far more important than the fact that their export data continues to crater amid ongoing slowdowns in global trade. But we are also seeing strength in RUB (+0.9%) and MXN (+0.75%) with the ruble benefitting from government encouragement for citizens to vacation in Russia rather than traveling abroad (thus reducing supply of RUB on the market) while the peso seems to simply be following its recent strengthening trend (+11.5% in May) amid an overall sense of dollar weakness. But here, too, the entire bloc is in the green, with the dollar simply under pressure universally.

Turning to the data front, this will be a big week as Friday brings the latest employment picture. But leading up to that, we have plenty to see as follows:

Today ISM Manufacturing 43.7
  ISM Prices Paid 42.0
Wednesday ADP Employment -9.0M
  Factory Orders -14.2%
  ISM Non- Manufacturing 44.5
Thursday Initial Claims 1.8M
  Continuing Claims 19.04M
  Trade Balance -$49.1B
Friday Nonfarm Payrolls -8.0M
  Private Payrolls -7.65M
  Manufacturing Payrolls -400K
  Unemployment Rate 19.6%
  Average Hourly Earnings 0.9% (8.5% Y/Y)
  Average Weekly Hours 34.3

Source: Bloomberg

In addition to this data, tonight we hear from the RBA and Thursday brings the ECB, where expectations are for a €500 billion increase in the PEPP program to go along with the EU’s €750 billion spending program. Meanwhile, the Fed is in their quiet period ahead of the June 10th meeting, so, mercifully, we will not hear from any Fed speakers all week. Obviously, all eyes will be focused on Friday’s employment report in the US, but I sense that the ECB is really this week’s biggest event. Until then, the momentum certainly seems to be in favor of more risk, and accordingly, a softer dollar this week.

Good luck and stay safe
Adf

‘Twas Nothing At All

Does anyone here still recall
When Covid had cast a great pall
On markets and life
While causing much strife?
Me neither, ‘twas nothing at all!

One can only marvel at the way the financial markets have been able to rally on the same story time and again during the past two years. First it was the trade talks. After an initial bout of concern that growing trade tensions between the US and China would derail the global economy led to a decline in global equity market indices, about every other day we heard from President Trump that talks were going very well, that a Phase One deal was imminent and that everything would be great. And despite virtually no movement on the subject for months, those comments were sufficient to drive stock prices higher every time they were made. Of course, we all know that a phase one deal was, in fact, reached and signed, but it occurred a scant week before the outbreak of the novel coronavirus.

What has been truly remarkable is that the market’s reaction to the virus has followed almost the exact same pattern. Once it became clear that Covid-19 was going to be a big deal, causing significant disruption throughout the world, stock prices tumbled in a series of extraordinary sessions in March and early April. But since then, we have seen a powerful rally back to within a few percent of the all-time highs set in February. And these days, every rally is based on the exact same story; to wit, some company [insert name here] is on the cusp of creating a successful Covid vaccine and things will be back to normal soon.

So, as almost all of us continue to work from home, shelter in place and maintain our social distance, investors (gamblers?) have discerned that everything is just fine, and that economic recovery is on the way. And maybe they are right. Maybe history is going to look back on this time and show it was an extremely large disruption, but an extremely short-term one that had almost no long-term impact. But, boy, that seems like a hard picture to paint if you simply look at the data and understand how economies work.

Every day we see data that describes how extraordinary the impact of government lockdown policies has been, with rampant unemployment, virtual halts in manufacturing, complete halts in group entertainment and bankruptcies of erstwhile venerable companies. And every day the global equity markets rally on the prospect of a new vaccine being discovered. I get that markets are forward looking, but they certainly seem blind to the extent of damage already inflicted and what that means for the future. Even if activities went back to exactly the way they were before the outbreak, the fact remains that many businesses are no longer in existence. They could not withstand the complete absence of revenues for an extended period of time, and so have been permanently shuttered. And while new businesses will rise to take their place, that is not an overnight process. It seems thin gruel to rally on the fact that Germany’s IFO Expectations Index rallied from its historically worst print (69.4) to its second worst print (80.1), but slightly higher than expected. Or that the GfK Consumer Confidence managed the same feat (-23.4 to -18.9). Both of these data points are correlated with extremely deep recessions.

And yet, that is the situation in which we find ourselves. The dichotomy between extremely weak economic activity and a strong belief that not only is the worst behind us, but that the damage inflicted has been modest, at best. Today is a perfect example of that situation with risk firmly in the ascendancy after the long holiday weekend.

Equity markets are on fire, rallying sharply in Asia (Nikkei +2.5%, Hang Seng +1.9%, Shanghai +1.0%) despite the fact that there is evidence that a second wave of infections is growing in China and may once again force the government there to shut down large swathes of the economy. Europe, too, is rocking with the FTSE 100 (+1.2%) leading the way although gains seen across the board (DAX +0.6%, CAC +1.1%). And US futures would not dare to be left out of this rally, with all three indices up around 2.0%. Meanwhile, Treasury yields are higher by 3.5 basis points with German bund yields higher by 6bps. Of course, Italy, Portugal and Greece have all seen their yields slide as those bond markets behave far more like risk assets than havens.

I would be remiss to ignore the commodity markets which have seen oil rally a further 2.25% this morning, back to $34/bbl and the highest point since the gap down at the beginning of this process back in early March. Gold, on the other hand, is a bit softer, down 0.3%, but remains firmly above $1700/oz as many investors continue to look at central bank activity and register concern over the future value of any fiat currency.

And then there is the dollar, which has fallen almost across the board overnight, and is substantially lower than where we left it Friday afternoon. In the G10 space, AUD (+1.3%) and NZD (+1.5%) are the leaders on the back of broadly positive risk sentiment helped by a better than expected Trade Surplus in New Zealand along with a larger than expected rebound in the ANZ Consumer Confidence Index, to its second lowest reading in history. But the pound is higher by 1.1% on prospects of an end to the nationwide lockdown in the UK. And in fact, other than the yen, which is unchanged, the rest of the bloc is firmer by 0.5% or more, largely on the positive risk sentiment.

In the emerging markets, the runaway winner is the Mexican peso, up 2.7% since Friday’s close as a combination of higher oil prices, a more hawkish Banxico than expected and growing belief that the US, its major export partner, is reopening has led to a huge short-squeeze in the FX markets. In the past week, the peso has recouped nearly 7% of its losses this year and is now down a mere 14.5% year-to-date. Helping the story is the just released GDP number for Q1, which showed a decline of only -1.2%, better than the initially reported -1.6%. But we are also seeing strength throughout the EMG bloc, with PLN (+1.8%), BRL (+1.6%) and ZAR (+1.2%) all putting in strong performances. Risk sentiment is clearly strong today.

Into this voracious risk appetite, we will see a great deal of data this holiday-shortened week as follows:

Today Case Shiller Home Prices 3.40%
  New Home Sales 480K
  Consumer Confidence 87.0
Wednesday Fed’s Beige Book  
Thursday Initial Claims 2.1M
  Continuing Claims 25.75M
  Q1 GDP -4.8%
  Q1 Personal Consumption -7.5%
  Durable Goods -19.8%
  -ex transport -15.0%
Friday Personal Income -6.5%
  Personal Spending -12.8%
  Core PCE Deflator -0.3% (1.1% Y/Y)
  Chicago PMI 40.0
  Michigan Sentiment 74.0

Source: Bloomberg

In addition to the plethora of data, we hear from six different Fed speakers, including Chairman Powell on Friday morning. On this front, however, the entire FOMC has been consistent, explaining that they will continue to do what they deem necessary, that they have plenty of ammunition left, and that the immediate future of the economy will be awful, but things will improve over time.

In the end, risk is being snapped up like it is going out of style this morning, as both investors and traders continue to look across the abyss. I hope they are right…I fear they are not. But as long as they continue to behave in this manner, the dollar will remain under pressure. It rallied a lot this year, so there is ample room for it to decline further.

Good luck and stay safe
Adf

Trade is the Word

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

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

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

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

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

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

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

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

Here are the most recent median expectations according to Bloomberg:

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

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

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

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

Good luck, good weekend and stay safe
Adf

Somewhat More Bold

The Old Lady left rates on hold
But Norway was somewhat more bold
They cut rates to nil
And won’t move them til
The virus is fin’lly controlled

Once again, central banks are sharing the headlines with Covid-19 as they attempt to address the havoc the virus is causing throughout the world. The latest moves come from the Bank of England, which while leaving policy unchanged, hinted at further stimulus to come next month, and the Norgesbank.

The base rate in the UK is currently at a record low level of 0.10%, and they have been adamant that there is no place for negative rates in the island nation. This means that QE is the only other serious tool available, and while they did not increase the amount of purchases at this meeting, it seems the current guidance, to reach a total of £465 billion, will be exhausted in July. Hence, two MPC members voted to increase QE today with the rest indicating that is a more appropriate step next month. In sum, expectations are now for a £100 billion increase at the June meeting. The other noteworthy thing from the meeting was the BOE’s economic forecast, which forecast a 14% decline in GDP in 2020 before a sharp rebound in 2021. This is by far the most dire forecast we have seen for the UK. Through it all, though, the pound has held its own, and is actually modestly higher this morning, although it remains lower by nearly 2% this month.

Meanwhile, the Norgesbank surprised almost every analyst by cutting its Deposit rate to 0.0%, a new record low for the country. With oil prices having rebounded so sharply over the past two weeks, one might have thought that prospects in Norway were improving. However, the commentary accompanying the cut indicated that the council members are trying to ensure that there will be no liquidity constraints when the economy starts to reopen post-virus, and so sought to stay ahead of the curve. They also indicated that there was virtually no chance that interest rates would move into negative territory, although we have heard that song before. The market is now expecting the Deposit Rate to remain at 0.0% for another two years. As to the krone, it is actually the strongest currency in the G10 (and the world) this morning, having risen by 1.6% vs. the dollar as I type, although it was even stronger prior to the Norgesbank action.

Today’s news simply reinforces that central banks remain the first line of defense for nearly every nation with regard to economic support during this period. As much as fiscal stimulus is critical for helping support any rebound going forward, central banks are still best positioned to adjust policies as necessary on a timely basis. Just remember how long and hard the process was for the US congress to write, debate, vote on and implement the CARES act. The same is true throughout the developed world, where legislative bodies don’t move at the speed of either the virus or markets. And so, for the foreseeable future, central banks will remain the primary tool for virtually every nation in seeking to mitigate the impact of Covid-19.

The biggest problem with this circumstance is that most central banks, and certainly the major ones, have nearly exhausted their ammunition in this fight. In the G10, the highest overnight rate currently is 0.25%, with the US, Canada, Australia and New Zealand all at that level. While QE was clearly a powerful tool when first widely introduced in 2010, it has lost some of its strength. At least with respect to aiding Main Street as opposed to Wall Street. That is why QE has evolved from government bond purchases to central bank purchases of pretty much any asset available. And yet, despite their collective efforts, monetary policy remains an extremely inefficient instrument with which to fight a viral outbreak. However, you can be sure that there will be many distortions to the economy for years to come as a result of all this activity. And that has much longer-term implications, likely slowing the pace of any recovery and future growth significantly.

Meanwhile, markets this morning are in fairly fine fettle, with equity indices in Europe all higher by something under 1%. And this is despite some pretty awful data releases showing French IP fell 16.2% in March and 17.3% Y/Y. Germany’s data, while better than that, was still awful (IP -9.2% in March and -11.6% Y/Y) and Italy regaled us with collapsing Retail Sales data (-21.3% in March). But no matter, investors are now looking into 2021 and the prospects of a strong recovery for their investment thesis. The only problem with this theory is that the potential for a non-V-shaped recovery is quite high. If this is the case, I would look for markets to reprice valuations at some point. Earlier, APAC equity markets were mixed, with the Nikkei edging higher by 0.3%, but Hang Seng (-0.6%) and Shanghai (-0.2%) both a bit softer. Finally, US futures are looking pretty good at this hour, higher by nearly 1.5% across the board.

Bond prices have edged a bit lower this morning, but movement has been modest to say the least. Yesterday saw Treasury yields rise from 10-years on out as the Treasury announced a surprisingly large 20-year auction of $20 billion. It seems that we are about to see more significant Treasury issuance going forward, and if the Fed does not continue to expand its balance sheet, we are likely to see the back end continue to sell off with correspondingly higher interest rates and a steeper yield curve. But that is a story for another day.

Elsewhere in the FX markets, Aussie (+0.9%) and Kiwi (+0.7%) have been the next best performers after NOK, as both are benefitting from the current narrative of reopening economies leading to the bottom of the economic peril. On the flip side, the yen (-0.4%) has given back some of its recent gains as risk appetite grows.

In the EMG space, the major loser is TRY, which has fallen 1.0% this morning, to a new historic low, after the central bank enacted rules to try to prevent further speculation against the currency. Alas, as long as it is freely traded, those rules will have a tough time stopping the rout. On the plus side, the three main movers have been RUB (+0.9%), ZAR (+0.8%) and MXN (+0.65%), all of which are benefitting from this morning’s positive risk attitude. One other thing to note is BRL, which while not yet open, fell another 2.5% yesterday and is back pushing its historic low levels vs. the dollar. The story there continues to be political in nature, with increasing pressure on President Bolsonaro as his most popular cabinet members exit and markets lose confidence in his presidency. My take is 6.00 is coming soon to a screen near you.

On the data front, yesterday’s ADP print of -20.236M was pretty much on the money and didn’t seem to have much impact. This morning we see Initial Claims (exp 3.0M), Continuing Claims (19.8M), Nonfarm Productivity (-5.5%) and Unit Labor Costs (4.5%). At this stage, we will have to see much worse than expected data to have a market impact, something which seems a bit unlikely, and beyond that, given tomorrow is the NFP report, I expect far more attention will be focused there than on this morning’s releases.

Overall, risk is in the ascendancy and so I would look for the dollar to generally remain under pressure for today, but I would not be surprised to see it recoup some of its early losses before the session ends.

Good luck and stay safe
Adf

 

The First Battlefield

The data from China revealed
This bug, is in fact, the windshield
It splattered the hope
That ‘war’ was a trope
Instead ‘twas the first battlefield

China released its main grouping of March data last night and the picture was not pretty. Q1 GDP fell 9.8% Q/Q and was 6.8% below Q1 2019. Those are staggeringly large contractions of economic activity and likely portend what we will begin to see throughout the rest of the world over the next several weeks. The other key data points were Retail Sales (-15.8%), Fixed Asset Investment (-16.1%), both with record declines, and then surprisingly, Industrial Production, which fell just 1.1% in March from last year’s results, though has declined 8.4% thus far in 2020. The official spin of the data was that while February was abysmal, given the nation was essentially completely closed that month, things have started to pick up again and the future is bright. While Q2 seems likely to be better than Q1, bright may overstate the case a bit. After all, the Chinese economy remains highly dependent on its export industries, and the last I checked, most of its major western markets like the US and Europe remain closed for business. So even if Chinese factories are restarting and producing goods again, their client base is not yet in the market for consuming most things.

Excitement is starting to build
And President Trump’s clearly thrilled
That plans are afoot
To increase output
In states where Covid has been chilled

But as important as that data is, and despite the harbingers it brings regarding the rest of the world in Q1 and Q2, market focus is clearly on an even more important subject, the timing of the reopening of the US economy. Last evening, in his daily press conference, the President explained that there will be a three-step approach outlined for individual states to follow in order to try to return to more normal conditions. The idea is that when reported infections show a downward trend over a two-week period, that would be an appropriate time to allow certain businesses (e.g. restaurants, movie theaters, gyms and places of worship) to reopen amid strict social distancing guidelines. Assuming no relapse in the data, phase two would include the allowance of non-essential travel with bars and schools reopening, while phase three, also assuming a continued downward slope of the infection curve, would allow the bulk of the remaining economy to reopen, while observing ongoing social distancing.

At least, that is the gist of the idea. Each state will be able to decide for itself when it reaches appropriate milestones to expand allowable activities with the Federal government not imposing any specific restrictions. While the exact timing of these activities remains uncertain, there are likely some states that will be ready to start phase one before the end of April, while others will take much longer to get there.

Investors, though, see one thing only, that the worst is behind us and that if the US is going to reopen, then so, soon, will the rest of the world. After all, Europe was inundated with the virus earlier than the US. Thus, the prospect of restarting economic activity combined with the extraordinary stimulus measures undertaken by governments around the world has encouraged the investment community to race back into equity markets before they get too rich! At least that is what it seems like this morning.

Fear has taken a back seat to greed and stock markets around the world are higher. So, we saw Asian markets (Nikkei +3.1%, Hang Seng +1.6%, Shanghai +0.7%) all perform well despite the Chinese data. Europe has been even better, with the DAX +4.2%, CAC +4.0% and FTSE 100 + 3.4%, and US futures are closely following Europe with all three indices up well more than 2.0% at this point in the session. In other words, earnings collapses are now seen to be one-time impacts and will soon be reversed. At the same time, pent-up demand will restore much of the luster to so many beaten down stocks, especially in the retail and consumer space.

This seems a tad aggressive for two reasons. First, though undoubtedly reopening the economy will result in better outcomes, it is not clear that the future will resemble the past that closely. After all, are we going to see a much greater use of telecommuting, thus less need for daily transport? Will restaurant and bar business pick up in the same way as prior to the virus’s onset? Will shopping malls ever recover? All these questions are critical to valuations, and answers will not be known for many months. But second, the one thing of which we can be pretty certain, at least in the short run, is that share repurchase programs are going to be thin on the ground for quite a while, and given the more than $1 trillion of spending that we have been seeing in that space, it seems that a key pillar of equity market support will have gone missing. So, while today is clearly all about risk being acquired, it will be a bumpy ride at best.

Speaking of risk-on, a quick look at the FX market shows that the dollar, for the first time in a week is under pressure this morning, having fallen against all its G10 peers. NZD is the leading gainer today, up 0.75%, as kiwi appears to be the highest beta currency in the group and is responding to the US reopening story. Aussie is next on the list, +0.45%, with its beta second only to kiwi, and then the rest of the bloc is higher but in a more limited fashion.

EMG currencies, too, are showing life this morning with IDR in the lead, having rallied 1.1% alongside TRY up a similar amount. The rupiah seems to be the beneficiary of the announcement by the central bank there that they are going to begin direct purchases of government bonds, i.e. monetizing the debt, on Monday, which is apparently a positive statistic in the beginning of the process. Meanwhile, on this risk-on day, Turkey’s 8%+ yields remain extremely attractive for investors, drawing funds into the country. But essentially, the entire bloc is firmer today, even the Mexican peso, which has been one of the absolutely worst performing currencies around. It has rallied 0.25%, its first gain in more than a week.

Today’s narrative is clearly that whatever damage has been incurred by Covid-19, the worst is behind us. Investors are looking forward and anxious to take part in the next up cycle. Alas, the curmudgeon in me sees a scenario where it will take far longer to regain previous levels of activity than the market currently seems to be pricing, and so risk attitudes have room to reverse, yet again, in the not too distant future. But as long as the narrative is the future is bright, the dollar should soften while equity markets rally.

Good luck, good weekend and stay safe
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