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
Adf

 

Covid’s Attacks

We’re finally going to see
The data which shows the degree
Of all the impacts
By Covid’s attacks
On life as we knew it to be

Risk assets are under pressure this morning as market participants once again reevaluate the cost-benefit analysis of government actions during the ongoing Covid-19 crisis. The question which bedevils both politicians and markets is, what is the proper balance between restricting economic activity via lockdown orders to prevent further spread of the virus vs. maintaining economic activity in order to prevent the global economy from collapsing? The problem is there is no easy answer to this dilemma, and the reality is that every nation has a different tradeoff based on the nature of its economy as well as the social and cultural mores that exist there.

And so, every nation continues to go their own way as they try to figure out the response best suited for their own circumstances. What is beginning to change as time passes is the data reports that will be released in the coming days and weeks will now be reflective of the first periods of shutdowns and will offer the best indications yet of just how severe the economic damage, thus far, has been. Remember, most data are backward looking. In fact, other than the Initial Claims data, which is both timely and has been awful, analysts are simply guessing at the economic impact so far. Thus, much will be learned this week and next as we start to see the first measurements of how significant the impact has been to date. In fact, we start with today’s Retail Sales data (exp -8.0%, -5.0% ex autos), as well as Empire Manufacturing (-35.0), IP (-4.0%), Capacity Utilization (74.0%) and then the Fed’s Beige Book at 2:00. All of this data is for March, which means that the crisis was in full swing for the bulk of the period. Expectations, as can be seen above, are for substantial declines across the board. But are econometric models based on history going to be effective in forecasting unprecedented events? My money is on no. If the first pieces of data we have seen are any indication, then today’s numbers will be much worse than currently anticipated.

However, as any economist worth their salt will explain, markets are discounting instruments, always looking some period into the future, rather than looking backwards. And that is, no doubt, just as true now as before the Covid-19 outbreak. The question of the moment then becomes, just how far ahead is the market discounting? There seems to be a significant difference of opinion between the bond and equity markets, with the latter having a far more optimistic view than the former. In fact, the bond market appears to be pricing in a significantly longer period of economic disruption, as evidenced by the 30-year yield at 1.32%, than is the stock market, which has already retraced 50% of its initial decline.

One other thing to remember is that recent government actions indicate further delays in reopening economies, rather than any speeding up of the process. This is evidenced by this morning’s German announcement that they will be extending lockdown measures to May 3, from the previously expected April 19. And the Germans have had a measure of success in slowing the spread of the virus, with today being the sixth consecutive day of a lower count of new infections. So, for those nations where the infection rate is not slowing, like the US, it becomes that much more difficult to revert to any sense of normalcy.

History has shown that when the stock and bond markets tell different stories, like they are now, it is more frequent the bond market has things right. I see no reason that this situation is any different and expect that we are coming to the end of the equity market bounce. Risk is far more likely to be shed than added in the next few weeks, and that means that haven assets like the dollar and they yen should resume their climb.

With that in mind, let’s look at markets this morning. The dollar is definitely in the ascendant vs. its G10 brethren with NOK (-1.9%) the leading decliner after the OPEC+ talks led to a disappointing outcome and oil prices have fallen to new lows for the move with WTI touching $19.20/bbl earlier this morning. But Aussie (-1.8%) and Kiwi (-1.7%) are feeling the weight of weaker commodity prices and less confidence in China’s rebound as well. Even JPY, the best performer today is lower by 0.15%, just reinforcing that in the strange new world we inhabit, the dollar remains the single most attractive currency in which to hold assets.

In the Emerging markets, the story is similar with most currencies under pressure led by ZAR (-1.8%), MXN and RUB (both -1.7%) on the back of the weak oil/commodity story. However, we did see two gainers overnight, IDR (+0.45%) and THB (+0.3%). The former seems to be benefitting from the fact that the central bank there surprised markets and did not cut rates yesterday, as well as the positive economic impact of showing a small trade surplus, thus reducing external financing pressures. Meanwhile, the baht seems to be the beneficiary of an announcement of a new fiscal stimulus totaling nearly $31 billion, which is seen as quite substantial there. Otherwise, the bulk of this bloc has seen more modest losses, somewhere between 0.2% and 1.0%.

Having already discussed today’s data, I think the real question for FX markets today will be just how equity markets perform as a better indicator of risk sentiment. Europe has been under pressure all morning, with almost all markets there lower by about 2.0%. Meanwhile, US equity futures are pointing in the same direction, with losses currently pegged between 1.1% (NASDAQ) and 1.7%(S&P 500). Of course, the Retail Sales data will be out before the equity market opening, so there is ample opportunity for either a significantly worse opening in the event the data is even worse than expected, as well as an extension of the recent rally should the data somehow surprise on the high side. I fear the worst.

So be prepared for a risk-off session as we finally start to see just how badly the US economy has been damaged by Covid-19. Ironically, this implies that the dollar is set for further gains as the rest of the world is likely to be even worse off.

Good luck
Adf

 

Until Covid-19 Is Dead

To those who had thought that the Fed
Was finished, Chair Powell just said
There’s nothing that we
Won’t do by decree
Until Covid-19 is dead

Small Caps? Check. Munis? Check. Junk bonds Fallen angels? Check. These are the latest segments in the credit market where the Fed has created new support based on yesterday’s stunning announcements. All told, the Fed has committed up to $2.3 trillion to support these areas, as well as the trillions of dollars they had already spent and committed to support the Treasury market, mortgage market, and ensure that bank finances remained sufficient for their continued operation and provision of loans and services to the economy.

While the breadth of programs the Fed has announced and implemented thus far is stunning, based on the CARES act passed last week, there is still plenty more ammunition available for the Fed to continue to be creative. Of course, the market reaction was highly positive to these announcements and served to cap off a week where the S&P 500 rose more than 12% from last Friday’s closing levels. In fact, a cynic might suggest that the Fed’s sole purpose is to prop up the equity market, but given the extraordinary events ongoing, I suppose that is merely a happy side effect. At any rate, there is no doubt that the Fed has taken its role as the world’s central bank seriously. Between swap lines and repo facilities for other central banks and purchase programs for virtually every type of domestic asset, Chairman Powell will never be able to be accused of fiddling while the economy burned. And while government programs are notoriously difficult to remove once enacted, based on the ongoing economic indicators, like yesterday’s second consecutive 6.6 million print in the Initial Claims data, it is evident that the Fed is being as aggressive as possible.

There will almost certainly be numerous longer-term negative consequences of all this activity and books will be written about all the ways the Fed overstepped its bounds, but right now, the vast majority of people around the world are hugely in favor of their actions. Anything that supports the economy and population through this period of mandated shutdown is appreciated. While they don’t run polls for popularity of central bank chiefs, I’m pretty confident Chairman Jay would be riding high these days.

In the meantime, there were two other noteworthy stories in the past 24 hours with market impact. The first was that the OPEC+ meeting did not come to agreement yesterday for production cuts totaling 10 million bbl/day as Mexico was the lone holdout, insisting that it would only cut 100,000 bbl/day of production, not the 400,000 bbl/day needed. After 16 hours of video conferencing, the energy leaders postponed any decision and decided to allow today’s G20 FinMin video conference to go forward and help try to break the impasse. It strikes me that Mexico will cave soon on this issue, but for now, nothing is agreed. It is hard to determine how oil markets have responded given essentially all cash and futures markets are closed today for the Good Friday holiday. However, oil futures had not fallen on Thursday afternoon which indicates they, too, believe a deal will be done.

And finally, the EU finally came up with a financing package to address the economic impact of the virus on its members. As was to be expected, it was significantly less than initially mooted and the construct of the deal indicates that there has not yet been any agreement by the Teutonic trio of Germany, Austria and the Netherlands to fund the PIGS. A brief overview of the deal shows the headline figure to be €540 billion made up of three pieces; a joint employment insurance fund (€100B), an EIB supported package designed to provide liquidity to impacted companies (€200B) and a ESM credit line (€240B) to backstop national spending. The problem with the latter is that the European Stability Mechanism is anathema to those nations that need it most like Spain and Italy, because it imposes fiscal conditions on the use of the funds. It is an ECB creation from the Eurobond crisis years by Mario Draghi, but it has never been used. Essentially, the rest of Europe has said to Germany, we may need your money, but we will not become your vassal. And this is exactly why the EU, and its subgroup the Eurozone, will remain dysfunctional going forward.

Thus, when compiling the newest information, the one thing that becomes clear is that the US continues to be the nation most willing to increase spending and liquidity to support its economy. And in the end, it cannot be surprising that the dollar will suffer in that scenario. Back in January, my view was the dollar would decline this year as the US was the economy with the most room to ease policy and that eventually, those much easier conditions would result in a weaker dollar. Well, that is exactly what we are seeing occur right now, as the Fed has upped the ante regarding monetary policy easing relative to the rest of the world at the same time that the broad narrative seems to be evolving into ‘the infection peak has passed and things are going to be better in the future than in the recent past’. Hence, the need to hold dollars as a haven has diminished, and the dollar has responded. For instance, this week AUD has rallied 5.7% while NOK is higher by 3.9%. Clearly both have been buoyed by the rise in oil prices as well as the generally better tone on risk. But the entire G10 bloc is higher, although the yen has gained just 0.1% on the week.

In the EMG space, we see a similar picture with MXN the leader, rallying 6.3%, followed closely by ZAR (5.6%) and HUF (5.2%) as virtually the entire bloc has gained vs. the dollar this week. And the story is identical throughout, a better risk tone and more available USD liquidity relieving pressure on USD borrowers throughout the world.

For the time being, this is very likely to remain the trend, but do not dismiss the fact that the global economy is currently in a very severe recession, and that it will take a long time to recover. During the Great Depression in 1929-1932, after a very sharp initial fall in equity markets, there was a powerful rally that ultimately gave way to a nearly 90% decline. We are currently witnessing a powerful rally, but another decline seems likely given the economic damage that will take years to fix. Meanwhile, the dollar, while under pressure right now, is likely to see renewed demand in the next wave.

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

PS. FX Poetry will return on Wednesday, April 15.

Just an Illusion

It seems there’s a bit of confusion
‘Bout whether this time of seclusion
Will actually end
The virus’ growth trend
Or if this is just an illusion

Markets have a less certain feel about them this morning than we have seen the past several days. Consider, despite continuing increases in both deaths and the caseload in the hardest hit areas, risk has been gathered up pretty aggressively. I realize that the narrative that is trying to be told is that we have passed the peak of infections and that with a little perseverance regarding all the shelter-in-place orders, we can expect the virtual halt in the global economy to end. The problem with this narrative is that the earliest infection sites in Asia; China, South Korea, Hong Kong, Singapore and Japan, have recently seen the infection data turn higher again. At the same time, we continue to hear of daily increases in the fatality count in Spain, Italy, Germany, the UK and New York, with all of those places considering extensions of their lockdowns.

And yet, US and European stock markets are higher by between 8% and 12% so far this week. I continue to be confused by this price action as it appears to imply that investors expect companies to simply pick up where they left off before the lockdowns and disruption began. The problem with that view is it appears to be complete fantasy. Consider, this morning we are going to get our third consecutive Initial Claims number that prints in the millions. Prior to two weeks ago, the largest single data point ever in the series was 695K. The median expectation on Bloomberg this morning is for 5.5M with the range of estimates 2.5M and 7.5M. The thing is, this number has the potential to be much higher than that. In fact, it would not surprise me if we saw a 10.0M print. One of the biggest problems that has consistently been reported is that most states’ employment systems have not been able to handle the crush of applications, although they have been working feverishly to catch up. Add to that the fact that over the past week we have heard an increasing number of states declare that more and more non-essential businesses need to close down for the remainder of the month, while more and more large companies are furloughing employees and only covering health care costs. Prior to the onset of the pandemic, the workforce in the US numbered about 178 million. If 25% of the economy has been shuttered, and I think that is a conservative estimate, that implies some 44 million people will eventually be applying for unemployment insurance. Three plus weeks into this process, we have only heard about 10 million. I fear there are many more to come, so don’t be surprised if today’s number is MUCH higher.

Continuing along this premise, if the claims data turns out to be much worse than expected, will that unravel the narrative that the worst is behind us? Or in fact, will markets begin to understand that even when the infection is well past its peak, economic activity will take a long time to recover. There is a great deal of discussion right now about what shape the recovery will take later this year and next. The first big assumption is that the recovery will start in Q3, which seems brave given we still don’t have an accurate representation of Covid-19’s actual pathology. But let’s work with that assumption. The bulk of the debate is whether the recovery will chart like a ‘V’ or a ‘U’. However, the more pessimistic discuss a ‘W’ or even an ‘L’. Alas, I fear we may see a ‘Harry Potter’ recovery, one that looks more like

We will learn much in a short while. However, until then, let’s take a look at the markets this morning, where the dollar remains under pressure, akin to yesterday, yet government bonds are rallying and equity markets are having a mixed performance. Aside from the Claims data, all eyes are on the tape to see what comes out of the OPEC+ meeting and whether or not they can agree on significant production cuts to help stem the extraordinary build-up in stored oil. Oil traders remain quite bullish as we are seeing Brent crude futures higher by 4.1% and WTI higher by 6.7%. That is clearly helping support the narrative that the worst is behind us. But even if they manage to agree to the mooted 10 million barrel/day production cut, will that be enough to stem the tide? Estimated usage prior to the current situation was 93 million barrels/day, so this represents a nearly 11% production cut. But again, if I go back to my 25% decline in activity, that still means there is a lot of surplus oil being pumped with fewer and fewer places to put it. This price move has all the earmarks of a buy the rumor situation. Just watch out upon the news of an agreement. And especially be careful if they cannot agree production cuts, which is likely to be a significant market negative.

Turning to FX markets, in the G10 space, NOK is the leader today, rallying 0.5% on the back of oil’s gains, and we also see the pound rallying this morning, up 0.4%, after the BOE changed its mind and explained it would be monetizing UK debt, thus expanding the government’s ability to increase stimulus. Meanwhile, a few currencies, CAD, NZD, are a bit softer, but the movement is so small as to be meaningless. Looking at the EMG bloc, IDR is today’s champ, rising 2.3%, after the government issued 50-year dollar bonds and laid out its path to help finance extraordinary stimulus. The rupiah has been under significant pressure since the beginning of March, having fallen nearly 13% before today’s rebound. Allegedly the fundamentals show the currency is still too cheap, but markets may have another take. Beyond the rupiah, RUB has rallied 1.4% on the strength of oil, while HUF and CZK are both higher by a bit more than 1.0% as both currencies seem to be benefitting from large bond financings. However, with the Easter holiday upcoming, there were a number of markets closed last night and we will see many closed tomorrow as well, so price action has been somewhat muted.

On the data front, along with Initial Claims, we see PPI (exp 1.2%, 1.3% ex food & energy), as well as Michigan Sentiment (75.0). However, it is all about the Claims data today. My expectation is that if the print is within the range of expectations, that will not derail the recent equity strength, but if we come out on the high side, especially with Good Friday tomorrow and US equity markets closed, we could easily see a significant risk-off outcome by the end of the day.

Good luck and stay safe
Adf