Concerns Within Europe

Concerns within Europe have grown
As surveys this morning have shown
Small businesses think
That many will sink
If Covid is not overthrown

The world seems a bit gloomier this morning as negative stories are gaining a foothold in investors’ minds.  Aside from the ongoing election and stimulus dramas in the US, and the ongoing Brexit drama in the UK/EU, concern was raised after a report was released by McKinsey this morning with results of a survey of SME’s in Germany, France, Italy, Spain and the UK.  Those results were not promising at all, as more than half of the 2200 companies surveyed in August expected to file for bankruptcy in the next year if revenues don’t increase.  More than 80% of those companies described the economy as weak or very weak.  If this survey is representative of SME’s throughout Europe, this is a very big deal.  SME’s (defined here as companies with less than 250 employees) employ over 90 million people in the EU.  Losing a large portion of those companies would be a devastating blow to the EU economy.  In fact, the IMF, which in its past had been the high priest of austerity for troubled nations, is now urging European (really all) countries to continue to spend any amount necessary to prevent businesses from collapsing.

This report serves as a fresh reminder of the remarkable contrast between market behavior and economic activity worldwide.  Not only is the current business situation tenuous, but prospects for the immediate future remain terrible as well.  And yet, equity markets worldwide have been able to look past the current economic devastation and rally on expectations of; 1) a blue wave in the US which will prompt massive stimulus spending; and 2) the quick and successful completion of Covid vaccine trials which will restore confidence in people’s everyday activities.  After all, if you were no longer concerned about getting infected with a deadly disease by a stranger, going to a movie, or taking a train or any one of a thousand different normal behaviors could be resumed, and the economy would truly start to rebound in earnest.

The question, of course, is how realistic are these assumptions underlying the market behavior?  Anecdotally, I have seen too many things to disrupt the idea of a blue wave and would question the accuracy of many of the polls.  Again, in 2016, Hillary Clinton was given a 98.4% probability of winning the election the day before voting, and we know how that worked out.  My point is, this race is likely significantly tighter than many polls reflect, yet markets do not seem to be taking that into account.  Secondly, vaccines typically take between four and five years to be created and approved, so expecting that a safe and effective vaccine will be widely available in a twelve-month timeline seems quite the stretch as well.  I understand technology has improved dramatically, but this timeline is extremely aggressive.  And this doesn’t even answer the question of how many people will take the vaccine, if it becomes available.  Remember, the flu vaccine, which is widely available, generally safe and constantly advertised, is only taken by 43% of the population.

The bigger point is that the market narrative has been very clear but could well be based on fallacious assumptions.  And looking at market behavior yesterday and today, it seems as though some of those assumptions are finally being questioned.

For instance, equity markets, after falling in the US afternoon on the back of worries that the Pelosi/Mnuchin stimulus talks are stalling, fell in Asia (Nikkei -0.7%, Shanghai -0.4%) ) although early losses in Europe have since been pared back to essentially flat performance.  US futures are pointing slightly lower, but only on the order of 0.1%-0.2%.  Aside from the negative tone of the McKinsey survey discussed above, GfK Consumer Confidence in Germany fell to -3.1, a bit worse than expected, and French Business Confidence indices all turned out lower than expected.  Again, evidence of a strong recovery in Europe remains hidden.

Bond markets remain disconnected from the equity sphere, at least from traditional correlations when discussing risk appetite.  While today has more characteristics of a risk-off session, and in fairness, 10-year Treasury yields have fallen 1 basis point, European government bond markets are selling off, with yields rising across the board.  Once again, the PIGS lead the way as Greece has seen its 10-year yield rise 20bps in the past week.  For a little perspective on 10-year yields, which have become a very hot topic as they traded through 0.80% two days ago, looking at a 5-year chart, the range has been 3.237%, in November 2018, to 0.507% this past August.  It is hard to get overly excited that yields are rising rapidly given the virtual flat line that describes the trend of the post Covid activity world.

Finally, the dollar, which has been under pressure this week overall, is seeing a little love this morning, having rallied modestly against most of the G10 as well as the EMG bloc.  Starting with emerging markets, the CE4 have been key underperformers with PLN (-0.4%), HUF (-0.4%) and CZK (-0.3%) following the euro lower.  Remember, these currencies tend to track the single currency quite closely, if with a bit more beta.  CNY (-0.4%) has also come under pressure, but given its performance over the past five months, this blip appears mostly as profit taking.  The only EMG currency in the green today is ZAR (+0.2%) which is most likely driven by ongoing interest in South African bond yields.

In the G10, SEK (-0.4%) is the laggard, although both GBP (0.3%) and EUR (-0.3%) are not far behind.  Swedish krona price action looks to be purely position related, as it has been among the best performers in the past week, so a little profit-taking seems in order.  As to the euro, we have already discussed the weak data and survey results.  And finally, the pound remains beholden to the Brexit negotiations, which while heavily hyped yesterday, seem to have found a few more doubters this morning, with a positive outcome not nearly so clear.

On the data front, this morning brings weekly Initial Claims (exp 870K) and Continuing Claims (9.625M) as well as Leading Indicators (0.6%) and Existing Home Sales (6.30M).  Last week’s Initial Claims data was disappointingly high, so this week’s results should get extra scrutiny with respect to the pace of any economic recovery.  As to the Home Sales data, Starts and Permits earlier in the week were solid, and record low mortgage rates, thanks to the Fed’s QE, continue to support housing, as does the flight to the suburbs from so many major urban areas.

From the Fed, it can be no surprise that uber-dove Lael Brainerd virtually demanded more federal stimulus in her comments yesterday, but that has been the theme from the Chairman on down.  Today we hear from three speakers, and it is almost certain that all three will maintain the new Fed mantra of, we will do what we can, but stimulus is necessary.

And that’s really it for the day.  If I had to guess, I expect there to be some positive stimulus headlines, although I doubt a deal will actually be reached.  But all the market needs is headlines, at least that’s all the algos need, so look for the dollar to give up its early gains on some type of positive news like that.

Good luck and stay safe
Adf

Deeper Downturn

There once was a virus that spread
Worldwide, leaving too many dead
Its summer vacation
Has led to frustration
That governments, people, misled

Now lockdowns have made a return
From London to Paris to Bern
And ECB voices
All highlight the choices
More QE or deeper downturn

As another week draws to a close, market activity has been relatively muted.  It seems that participants are biding their time waiting for an outcome on at least one of the big current stories.  Will Brexit talks continue and be successful or will Boris decide there is no chance and simply prepare for a no-deal outcome?  Will the second wave of Covid infections running rampant in Europe slow down, or will this wave be even larger than the first with a bigger negative impact on the economy?  And finally, what is going to happen in the US presidential election?

And let’s face it, those are three really big questions with no clear answers at this time.  But let’s quickly try to address them in order and see if we can discern potential market responses.

Brexit – we have already passed the deadline Boris had originally issued for a deal, although he has since recanted and said if the EU demonstrates they are interested in “intensifying” the talks, the UK will work even harder to reach a deal.  Unfortunately, the indications from the EU are less promising as French President Macron remains adamant that French fishing vessels have unfettered access to UK waters in any deal.  While there are signs the rest of Europe are annoyed with Macron over this stance, his unwillingness to compromise, as of yet, means there has been no movement.  The other sticking point, the level of UK state aid to its companies, seems much more tractable to solve. However, right now, no deal is in sight.

Trying to game out the market impact of this binary outcome is dependent on an estimate of what is currently priced into the market.  Several indicators, including CFTC positioning and some proprietary bank positioning indicators, show that the market remains net long Sterling.  As the pound appears overvalued at current levels, it seems the likelihood of a large rally in the event of a positive outcome is quite limited.  Rather, the future for the pound is likely lower.  In the event of a no-deal Brexit, a move toward 1.20 is quite realistic by year end.  Whereas, a positive outcome is more likely to see just a moderate, ‘sell the news’ response, perhaps back toward 1.25-1.28.

The second wave of infections is clearly a growing problem.  More localized lockdowns are being imposed in Germany, the Netherlands and Spain with talk of more coming in Italy and throughout Eastern Europe.  This is in addition to the curfew in Paris which is equally problematic.  Not surprisingly, ECB members have been vocal about the need and ability of the central bank to do even more, implying that the PEPP is going to get quite a boost by December.  Once again, I will highlight that the Fed has made it quite clear they have limited ability to do anything else, although they will certainly try, which means that on a relative basis, other countries are going to ease their monetary policy further.  In this case, that bodes ill for the future direction of the euro, which I think has every possibility of drifting back to 1.15 in the short run and 1.10 over time, ceteris paribus.

But the big ceteris is the US presidential election.  The polls point to a Biden victory, although I’m sure nobody has forgotten that the same polls pointed to a Clinton victory four years ago.  Betting markets are also leaning that way, although with far less confidence.  As to the market, based on my readings, it appears that a large majority of market participants agree with the polls and have positioned accordingly.  Remember, too, that control of Congress is a crucial point in anticipating any potential market movement.  So here goes:

Blue wave – Biden wins and Democrats retake Senate:  given the platform of much higher capital gains and corporate taxes and massive spending, equity markets seem likely to fall sharply this year as investors take profits at current tax rates, and the dollar to fall alongside them.  I would want to own gold in this scenario.

Biden win with Republican Senate:  much less impact as divided government gets less done.  Arguably, we will fund the budget on continuing resolutions for four years, rather than any big new programs getting enacted.  The market response here is likely to be far more benign, with range trading rather than steep trends.

Trump win with Democratic House:  No change to current situation means further efforts at tax cuts and deregulation, but unlikely to see tax hikes.  The US has the chance to be the cleanest shirt in the dirty laundry basket and draw in more investment and prop up dollar strength.

Trump win and Republican House (admittedly low probability):  dollar strength as US continues to focus on as much economic growth as possible, with more stimulus and more tax cuts.

At this point, all these questions remain open, but by New Year’s Eve, we will have answered at least two of the three for sure.

As to markets today, there is really very little to tell.  Equities in Asia were mixed (Nikkei -0.4%, Hang Seng +0.9%) but are performing well in Europe (DAX +1.1%, CAC +1.8%) as the ECB comments seem to have investors believing more stimulus is on its way.  US futures have edged higher in the past hour, but are still only pointing to gains of 0.2% or so.

Interestingly, bond markets are rallying with yields continuing their recent downtrend.  Treasury yields are lower by 1bp after having backed up a few yesterday afternoon.  European markets are seeing roughly 2 basis point declines across the board.  In fact, bunds are back at their lowest level (-0.635%) since the panic of late March when Covid first struck Europe.  Bonds there are certainly pricing in a slowing economy in the Eurozone.

Finally, the dollar is mixed.  Against its G10 counterparts, it is +/-0.2% with the Brexit story by far the most impactful.  GBP (-0.2% as I write) was higher by 0.3% just minutes ago, as it wiggles on each headline.  But the bloc is generally uninteresting.  As to emerging markets, it is largely the same story, with a pretty even mix of gainers and losers.  Here, though, the movement has been a bit larger with ZAR (+0.5%) the best performer, perhaps on strength in the metals markets, followed by CNY (+0.4%) where everyone is looking for strong GDP numbers on Monday.  On the downside, KRW (-0.4%) is bottom of the barrel today after a higher than expected Unemployment rate was reported.

Data this morning brings Retail Sales (exp 0.8%, 0.4% ex autos), IP (0.5%), Capacity Utilization (71.8%) and Michigan Sentiment (80.5).  Yesterday’s Initial Claims data was quite disappointingly high and bodes ill for the growth story here.  But in the end, the ongoing uncertainty and confusion over the three issues raised above imply a lack of direction in the near term, although choppiness could well be on the menu.

Good luck, good weekend and stay safe
Adf

Covid Comebacking

Investors are lately concerned
That risk is what needs to be spurned
With stimulus lacking
And Covid comebacking
The bulls are afraid they’ll get burned

Risk is starting to get a bad name for itself lately as we are heading into our third consecutive day of equity market selling and haven asset buying.  The twin stories of the resurgence in coronavirus cases throughout the world and the terminal diagnosis for additional US fiscal stimulus has many people rethinking the bullish case.  Perhaps the recovery won’t be V-shaped after all.

On the Covid front, as an example of new measures taken, the French government has set a 9:00pm – 6:00am curfew in Paris while the UK is imposing a ban on families from one household mixing with those from another as both nations try to cope with the increase in Covid cases.  (Yesterday, both countries reported 20,000 or more new cases).  And it’s not just those two nations, but the increase in numbers throughout the world is substantial.  India (68K), the US (60K), Brazil (27K) and Russia (14K) are all seeing higher reported infections with most of the rest of Europe also seeing increase in the 5K-10K region.  The data is certainly beginning to look like we are in the midst of a second wave of the disease.  Of course, the one truly noteworthy exception is Sweden, which never went through the lockdown phase, and has not reported any new cases in weeks.

Nonetheless, the fact that the virus is on the march again means that less economic activity will be taking place going forward, and that bodes ill for investors.  Adding to the Covid concerns are the recent announcements by several pharma companies that they are halting trials of their Covid vaccines as recipients got sick from various things. Overall, the Covid story is starting to weigh on investors’ (as well as politicians’) minds and that is undermining some of the previous bullishness on risk assets.

As to fresh fiscal stimulus from the US, it ain’t happening, at least not before the election.  Despite (because of?) all the rhetoric we continue to receive from the central banking and supranational communities about how crucial it is for more US stimulus aid to be injected into the economy, the politics at this point are quite clear.  Neither the Democrats nor the Republicans want to allow the other side to have a victory ahead of the election for fear it might help the other side in the election.  This is why the bills proposed by both the House and the Senate were so far apart; they were simply pandering to their respective political bases.  At the same time, the central bankers have essentially admitted that they have done all they can, and any further action on their part will help only at the very margins of the economy.  Although, further central bank stimulus would likely find its way into equity markets, it wouldn’t help Main Street in any way.

With these as the evolving narratives, it should be no surprise that risk is being shed.  It should also be no surprise that these losses are starting to gain some momentum.  For instance, European equities, as measured by the Eurostoxx 600, fell 0.6% on Tuesday, 0.25% yesterday, but are down a hefty 2.65% today.  And that pattern has been repeated across equity markets around the world.  In fact, Europe bourses today are all lower by between 2.0% and 3.0%.  US futures are also pointing to the same phenomenon, after seeing declines of between 0.6% and 0.8% yesterday, they are currently trading at levels between -1.0% (Dow) and -1.5% (NASDAQ).

Bond markets, which many believe have far better predictive capacity than equity markets with respect to the economy, are in a complete risk-off stance.  10-year Treasury yields, which just Friday appeared to be heading above 0.80%, are back down to 0.70%, having fallen 2.5 basis points overnight.  But it is even clearer in the European markets where the PIGS have each seen their bonds sold today with yields rising between 1 and 4 basis points, while Bunds (-3.8bps), Oats (-2.5bps) and Gilts (-4.1bps) are all seeing significant haven demand.  As I have written before, the reality is that government bonds issued by the PIGS are risk assets, not havens.  After all, do you think any of those four nations will ever be able to repay their debt?

Turning to the dollar, in true risk off fashion, it is the leading light in the currency market today.  In the G10 space, the best performers are CHF and JPY, both of which are essentially unchanged, while we are seeing NOK (-1.1%), AUD (-1.1%) and NZD (-0.75%) lead the way lower.  You will not be surprised to know that oil prices are lower this morning, with WTI and Brent both down by 1.6%, hence NOK’s troubles.  Too, other commodity prices, including the precious metals, are lower, which is clearly undermining the latter two.

One of the interesting things is the recent behavior of Aussie.  Historically, AUD has been almost a proxy on the Chinese economy, given the strong reliance on China for Australia’s economic growth.  Essentially, all the commodities Australia produced were ship north to the mainland.  But lately, there is a great deal of tension between the two nations as the Australians have called out the Chinese on issues like human rights and Hong Kong, and the Chinese have responded by imposing quotas on Australian goods and preventing state-owned companies from purchasing there.  Thus, despite the more positive economic data from China (last night saw CPI rise a less than expected 1.7% and expectations for Monday’s Q3 GDP data have risen to 5.5%), AUD has not been able to benefit. Adding to the Aussie’s woes were comments from the RBA regarding extending the tenor of QE purchases to the 10-year bucket and driving rates lower there.  Naturally, the market did the RBA’s work for it, and yields there fell 7.5 basis points.

Meanwhile, the euro and pound are both under pressure as well, just not as much, as investors continue to reduce exposures to both areas.

As to the EMG bloc, in a bit of a surprise, PLN (-1.1%) is the worst performer of the day, which seems to be on the back of a story about no additional Covid fiscal stimulus (and you thought that was a uniquely US phenomenon).  But ZAR (-1.0%) and MXN (-0.7%) are next in line, with both obviously feeling the pain of weaker commodity prices as well as increases in their Covid case count.  The rest of the bloc is also under pressure, just not quite to the same extent.  And as long as fear reigns, it will be difficult for these currencies to regain a bid.

On the data front, this morning brings Initial Claims (exp 825K), Continuing Claims (10.55M), Empire Manufacturing (14.0) and Philly Fed (14.8).  The Initial Claims data, while obviously well off the worst (highest) levels, has really started to plateau at much higher levels than the economy has ever seen before, which suggests that any rebound remains uneven and modest at best.  But while economic activity is clearly under pressure in the US, and we will see that spelled out in Q3 earnings data which has just started coming in, investor risk appetites, or lack thereof, will be the key driver for now, and that points to further gains in the dollar.  Maybe not huge, but that is the direction most likely.

Good luck and stay safe
Adf

Macron’s Pet Peeve

Each day from the UK we learn
The data implies a downturn
Infections keep rising
Yet what’s so surprising
Is Sterling, no trader will spurn

Investors, it seems, all believe
That fishing rights, Macron’s pet peeve
Will soon be agreed
And both sides proceed
Towards Brexit come this New Year’s Eve

Since the last day of September, the pound has been a top performer in the G10 space, rallying 2.0% despite the fact that, literally, every piece of economic data has fallen short of expectations.  Whether it was GDP, PMI, IP or Employment, the entire slate has been disappointing.  At the same time, stories about Brexit negotiations continue to focus on the vast gap between both sides on fishing rights for the French fleet as well as state aid limits for UK companies.  And yet the pound continues to grind higher, trading back to its highest levels in a month.  Granted this morning it has ceded a marginal -0.2%, but that is nothing compared to this steady climb higher.

It seems apparent that traders are not focusing on the macro data right now, but instead are looking toward a successful conclusion of the Brexit negotiations.  Granted, Europe’s history in negotiations is to have both (or all) sides agree at the eleventh hour or later, but agree, nonetheless.  So, perhaps the investor community is correct, there will be no hard Brexit and thus the UK economy will not suffer even more egregiously than it has due to Covid.  But even if a deal is agreed, does it make sense that the pound remains at these levels?

At this stage, the economic prospects for the UK seem pretty awful.  This morning’s employment report showed the 3M/3M Employment change (a key measure in the UK) falling 153K.  While that is not the worst reading ever, which actually came during the financial crisis in June 2009, it is one of the five worst in history and was substantially worse than market expectations.  Of greater concern was that the pace of job cuts rose to the most on record, with 114K redundancies reported in the June-August period.  Adding it all up leaves a pretty poor outlook for the UK economy, especially as further lockdowns are contemplated and enacted to slow the resurgence in Covid infections seen throughout various parts of the country.  And yet the pound continues to perform well.

Perhaps the rally is based on monetary policy expectations.  Alas, the last we heard from the Old Lady was that they were discussing how banks would handle negative interest rates, something which last year Governor Carney explained didn’t make any sense, but now, under new leadership, seems to have gained more adherents.  If history is any guide, the fact that the BOE is talking to banks about NIRP is a VERY strong signal that NIRP is coming to the UK in the next few months.  Again, it strikes me that this is not a positive for the currency.

In sum, all the information I see points to the pound having more downside than upside, and yet upside is what we have seen for the past several weeks.  As a hedger, I would be cautious regarding expectations that the pound has much further to rally.

Turning to the rest of the market, trading has been somewhat mixed, with no clear direction on risk assets seen.  Equity markets in Asia saw gains in the Hang Seng (+2.2%) although the Nikkei (+0.2%) and Shanghai (0.0%) were far less enthusiastic.  Interestingly, the HKMA was forced to intervene in the FX market last night, selling HKD6.27 billion to defend the strong side of the peg.  Clearly, funds are flowing in that direction, arguably directly into the stock market there, which after plummeting 27.5% from January to March on the back of Covid concerns, has only recouped about 42% of those losses, and so potentially offers opportunity.  Perhaps more interestingly, last night China reported some very solid trade data, with imports rising far more than expected (+13.2% Y/Y) and the Trade Balance falling to ‘just’ $37.0B.  Export growth was a bit softer than expected, but it seems clear the Chinese economy is moving forward.

European bourses, however, are all in the red with the DAX (-0.4%) and CAC (-0.3%) representative of the general tone of the market.  Aside from the weak UK employment data, we also saw a much weaker than expected German ZEW reading (56.1 vs. 72.0 expected), indicating that concerns are growing regarding the near-term future of the German economy.

In keeping with the mixed tone to today’s markets, Treasuries have rallied with yields falling 2 basis points after yesterday’s holiday.  Perhaps that is merely catching up to yesterday’s European government bond markets, as this morning, there is no rhyme or reason to movement in this segment.  In fact, the only movement of note here is Greece, which has seen 10-year yields decline by 3bps and which are now sitting almost exactly atop 10-year Treasuries.

As to the dollar, mixed is a good description here as well.  In the G10 space, given the German data, it is no surprise that the euro has edged lower by 0.2% nor that the pound has crept lower as well.  AUD (-0.24%) is actually the worst performer, which looks a response to softness in the commodity space.  SEK (+0.3%) is the best performer after CPI data turned positive across the board, albeit not rising as much as had been forecast.  You may recall the Swedes are the only country that had moved to NIRP and then raised rates back to 0.0%, declaring negative rates to be a bad thing.  The previous few CPI readings, which were negative, had several analysts calling for Swedish rates to head back below zero, but this seems to support the Riksbank’s view that no further rate cuts are needed.

Emerging market currencies are under a bit more pressure, with the CE4 leading the way lower (CZK -0.8%, PLN -0.7%, HUF -0.65%) but the rest of the bloc has seen far less movement, generally +/- 0.2%.  Regarding Eastern Europe, it seems there are growing concerns over a second wave of Covid wreaking further havoc on those nations inspiring more rate cuts by the respective central banks.  Yesterday’s Czech CPI data, showing inflation falling into negative territory was merely a reminder of the potential for lower rates.

Speaking of CPI, that is this morning’s lead data point, with expectations for a 0.2% M/M gain both headline and ex food and energy, which leads to 1.4% headline and 1.7% core on a Y/Y basis.  Remember, these numbers have been running higher than expectations all summer, and while the Fed maintains that inflation is MIA, we all know better.  I see no reason for this streak of higher than expected prints to be broken.  In addition, we hear from two Fed speakers, Barkin and Daly, but we already know what they are likely going to say; we are supporting the economy, but Congress needs to enact a fiscal support package, or the world will end (and it won’t be their fault.)

US equity futures are a perfect metaphor for the day, with DOW futures down 0.4% and NASDAQ futures higher by 0.9%.  In other words, it is a mixed picture with no clear direction.  My fear is the dollar starts to gain more traction, but my sense is that is not in the cards for today.

Good luck and stay safe
Adf

Some Despair

In Germany, data revealed
That growth there’s apparently healed
But data elsewhere
Implied some despair
As problems, porcine, are concealed

Risk is back in vogue this morning as the market appears to be responding positively to a much better than expected PMI reading from Germany (Services PMI 50.6, up from 49.1 Flash reading, Composite 54.7, up from 53.7 Flash) and a modestly better outcome for the Eurozone (48.0 vs. 47.6 for Services, 50.4 vs. 50.1 for Composite) as a whole.  At least that’s the surface story I keep reading.  The problem with this version is that markets in Asia were also highly risk-centric and that was well before the PMI data hit the tape.  Which begs the question, what is really driving the risk narrative today?

When President Trump was infected
The thing that most people expected
Was two weeks before
He’d walk out the door
Explaining he wasn’t affected

A different, and timelier, explanation for today’s positive risk sentiment stems from the ongoing story of President Trump’s covid infection and his ability to recuperate quickly.  While the standing assumption had been that there is a two-week timeline from infection to recovery, the President has consistently indicated that he feels fine, as have his doctors, and the story is that he will be released today from his weekend stay at Walter Reed Memorial Hospital.  In other words, any concerns that attended the announcement of his illness from Friday, when we did see equity markets suffer, is in the process of being unwound this morning.  The rationale here seems to be twofold.  First, the President is set to be back at the White House and in control, something which matters greatly from a national security perspective.  But second, the fact that he, as a 74-year-old man, was able to recover so quickly from the infection speaks to the reduced impact covid is likely to have on the population as a whole.  And arguably, that may even have a bigger impact.  While we continue to hear of new lockdown’s being announced in certain places, NYC, Spain and France to name just three, if the potency of the infection is waning such that it is a short-term event with limited side effects, that could well lead to an increase in confidence amongst the population.  And, of course, confidence is the one thing that the economy is searching for desperately.

The problem is that since virtually everything has become political theater lately, it is difficult to discern the facts in this situation.  As such, it seems hard to believe that overall confidence has been lifted that significantly, at least as of this morning.  However, if President Trump remains active and vigorous this week, it will certainly put a dent into the thesis that covid is incredibly debilitating.  We will need to watch how things evolve.

Interestingly, there is one issue that seems to be getting short shrift this morning, the growing concern that there will be no Brexit deal reached in the next ten days.  Recall that Boris and Ursula had a virtual lunch date on Saturday, and both claimed that a deal was close, but there were a couple of issues left to address.  The two key differences remain the issue of acceptable state aid by the UK government and, the big one, the type of access that European (read French) fishing vessels will have to UK waters.  It seems that French President Macron is adamant that the UK give the French a (large) annual quota and be done with it, while Boris is of the mind that they should agree to meet annually and discuss the issue based on the available fish stocks and conditions.  It also seems that the rest of Europe is getting a bit annoyed at Macron as for them, the issue is not that significant.  This fact is what speaks to an eventual climb-down by Macron, but, as yet, he has not been willing to budge on the matter.  Based on the price of the pound and its recent performance (+0.2% today, +1.0% in the past week), the market clearly believes a deal will be reached.  However, that also foretells a more significant decline in the event both sides fail to reach said agreement.

So, now let’s take a look at the bullishness in markets today.  Asia saw strength across the board with the Nikkei(+1.25%) and Hang Seng (+1.3%) nicely higher and Australia (+2.6%) really showing strength.  (China remains closed virtually all week for a series of national holidays).  European indices are all green as well, albeit not quite as enthusiastic as Asia.  Thus, we have seen solid gains from the three major indices, DAX, CAC and FTSE 100, all higher by 0.7%.  And finally, US futures are pointing to a stronger opening, with current pricing showing gains of between 0.7% and 1.0%.

It should be no surprise that bond marks are under some pressure with 10-year Treasury yields up to 0.71% this morning, higher by 1 basis point on the session and 6 bps in the past week.  In fact, yields are back at their highest level in a month.  European bonds are also broadly softer (higher yields) but the movement remains muted as well, about 1bp where they have risen.  And it should also not be surprising that Italy, Portugal and Greece have seen yields decline, as those three certainly qualify as risk assets these days.

Oil prices are firmer, again taking their cue from the confidence that is infusing markets overall, while precious metals prices are flat.  And finally, the dollar is definitely softer, except against the yen, which continues to be one of the best risk indicators around.  So, in the G10 space, NOK (+0.7%) is the leader, following oil as well as benefitting from the general dollar weakness.  Next on the list is CHF (+0.5%) where data showed ongoing growth in sight deposits, an indication that capital flows continue to enter the country, despite today’s risk attitude.  But broadly speaking, the whole space is firmer.

As to EMG currencies, ZAR (+0.7%) is the leader today, with firmer commodity prices and still the highest real interest rates around keeping the rand attractive in a risk-on environment.  But it is almost the entire bloc with the CE4 (CZK +0.55%, PLN +0.45%, HUF +0.45%) showing their high EUR beta characteristics and MXN (+0.45%) also performing well, again benefitting from both firmer oil prices as well as a weaker dollar.  The one exception here is RUB (-0.5%), which appears to be suffering from the effects of the ongoing conflict in Nagorno-Karabakh and how much it is going to cost Russia to maintain its support for Armenia.

On the data front, it is a relatively quiet week with only a handful of numbers to be released:

Today ISM Services 56.2
Tuesday Trade Balance -$66.2B
JOLTs Job Openings 6.5M
Wednesday FOMC Minutes
Thursday Initial Claims 820K
Continuing Claims 11.4M

Source: Bloomberg

However, what we lack in data we make up for with Fedspeak, as eight different speakers, including Chairman Powell tomorrow, speak at 13 different events.  What we have heard lately is there is a growing difference of opinion by some FOMC members regarding the robustness of the US economic rebound.  However, despite those differences, the universal request is for further fiscal stimulus.  Given the dearth of data this week, I expect that Chairman Powell’s speech tomorrow morning is likely to be the most important thing we hear, barring a Brexit breakthrough or something else from the White House.

Good luck and stay safe
Adf

Growth Has Now Faltered

The working assumption had been
That governments soon would begin
To lift their restrictions
Across jurisdictions
From Lisbon to well past Berlin
 
But Covid had other designs
By spreading, despite strict guidelines
So, growth has now faltered
And views have been altered
Regarding recovery times
 
Remember how smug so many publications around the world seemed when comparing the spread of Covid in the US and throughout Europe?  The narrative was that despite a devastating first wave in Italy and Spain, nations on the Continent handled the situation significantly better than the chaos occurring in the US.  Much was blamed on the different types of healthcare systems, and of course, there was significant opprobrium set aside for the US president. But a funny thing has happened to that narrative lately, and it was reinforced this morning by the preliminary PMI data that was released.  Suddenly, the growth in Covid cases throughout Europe is expanding to what seems very much like a true second wave, with France and Spain leading the way, each reporting more than 10,000 cases yesterday, while in the US, we continue to see a true flattening of the curve.  The discussion in many European countries is whether or not to impose a second lockdown, as governments there try to decide if their economies and budgets can withstand such an outcome.  (I don’t envy them their choice as no matter the outcome, some people will suffer and scream loudly about the decision.)
 
But a funny thing seems to be happening within economies, despite this government wariness to act, people are making the decisions for themselves.  And so, service businesses are seeing real declines in activity as people naturally avoid restaurants, travel and entertainment companies.  And that’s just what the data shows.  PMI Services surveys showed significantly worse outcomes in France (47.5 vs. 51.5 expected), Germany (49.1 vs. 53.0) and the Eurozone as a whole (47.6 vs. 50.6).  In other words, it appears that people are pretty good at self-preservation, and will not put themselves knowingly at risk without a good reason.  Getting a pint at the local pub is clearly not a good enough reason.
 
For elected policymakers, however, this is the worst of all worlds.  Not only does economic activity contract, for which they will be blamed, but they are not making the decisions for the people, which appears to be their primary motivation in so many cases.  Of course, there is a class of policymakers to whom this outcome is seen as a pure benefit…central bankers.  It is this group who gets to continue to preen about all they have done to support the markets economy, and while the Fintwit community blasts them regularly, the bulk of the population sees them as saviors.  Central banking continues to be a pretty good gig.  Lots of power, no responsibility.
 
Meanwhile, the investment community, including those blasting the central bankers on Fintwit, continue to take advantage of the ongoing central bank largesse and pump asset prices ever higher.  While there was a very short correction back at the beginning of the month, now that merely seems like a bad dream.  And if the data continues to turn lower, the one thing we know is that central banks will step further on the accelerator, announcing greater asset purchase programs, and potentially dragging a few more countries (is the UK next?) into the negative rate world.
 
But that is the world in which we live, whether or not we like it, or agree with the policies.  And as our focus is on markets, we need to be able to describe them and try to understand the evolving trends.  Today, and really this week, that trend continues to see the dollar grind higher despite the fact that we have seen both up and down equity market activity.  In other words, this does not appear to be simply a risk-off related USD rally.  Rather, this appears to be a USD rally built on short-term economic fundamentals.  Remember, FX is a relative game, and even if things in the US are not great, if they are perceived as better than elsewhere, that is sufficient to help drive the value of the dollar higher.  One other thing to note regarding the current market activity is that the hysteria over the dollar’s ‘imminent collapse’, which was all the rage throughout the summer, seems to have completely disappeared. 
 
So, turning to this morning’s session, we find equity markets in the green around the world.  Yesterday’s US rally was followed by a fairly dull Asian session (Nikkei -0.1%, Hang Seng +0.1%) but Europe has really exploded higher.  It seems that the weakening economic data has convinced investors the ECB will be even more active in their policy mix, thus adding more support to equity markets there.  Hence today’s gains (DAX +1.6%, CAC +1.8%, FTSE 100 +2.3%) are a direct response to the weaker data.  It appears we are in the bad news is good phase for investors.  Not to worry, US futures are also pointing higher, albeit not quite as aggressively as we are seeing in Europe.
 
Bond markets remain somnolent as 10-year Treasury yields are at 0.675%, essentially unchanged from yesterday and right in the middle of the tiny 7 basis point range we have seen since September 1st.  (For those of you who were disappointed the Fed did not announce yield curve control, the reason is that they already have it, there is no need to announce it!)  At the same time, German bunds are unchanged on the day, and also mired within a fairly tight, 10bp range.  But the ongoing winners are Italy and Greece, who have seen their 10-year yields decline by 2 and 3 basis points, respectively today, with Italy’s down more than 25 basis points since the beginning of the month.
 
The strong dollar is having a deleterious impact in one market, gold, which has fallen 0.4% today and is now lower by nearly 10% from the highs seen in early August.  The driving forces of the rally remain in place, with real rates still under pressure and inflation still percolating, but it was a very overcrowded trade that seems to be getting unwound lately.
 
Finally, a look at the dollar vs. its G10 brethren shows that commodity currencies are the worst performers today with AUD and NZD both lower by -0.6%, while NOK (-0.5%) and CAD (-0.2%) complete the list.  However, at this hour, the entire bloc is softer vs. the dollar.  In the emerging markets, one needn’t be prescient to have guessed that MXN (-0.85%) and ZAR (-0.75%) are the leading decliners given the combination of their recent volatility and connection to commodity prices.  RUB (-0.6%) is also a leading decliner, suffering from the commodity market malaise, but frankly, APAC and CE4 currencies are also somewhat softer this morning.  This is all about USD strength though, not specific currency story weakness.
 
On the data front, yesterday’s Existing Home Sales were right on the button at 6.0M, as I mentioned, the highest reading since the middle of 2007.  Today the only thing to see is Markit’s US PMI data, expected to print at 53.5 for Manufacturing and 54.5 for Services.  Given the European readings, it will be quite interesting to see if the same pattern is evolving here.
 
Yesterday we also heard from Chairman Powell, but all he said was that the Fed has plenty of ammo and has done a great job, but things would be better if Congress passed another fiscal stimulus bill.  No surprises there.
 
This morning’s USD strength, while broad-based, is shallow.  Perhaps the biggest thing working in the dollar’s favor right now is the size of the short-USD positioning and the fact that recent price action is starting to warm up the technicians for a more sustained move higher.  I think that trend remains but believe we will need to see some real confirmational data to help it extend.
 
Good luck and stay safe
Adf
 
 

A Tiny Tsunami

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
Adf

Hard to Believe

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Quite Sordid

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe

Adf

 

Struck by the Flu

If you think that Jay even thought
‘bout thinking ‘bout thinking he ought
To raise interest rates
He’ll not tempt the fates
Despite all the havoc ZIRP’s wrought

Meanwhile, ‘cross the pond what we learned
Is Germany ought be concerned
Their growth in Q2
Was struck by the flu
As exports, their customers, spurned

(Note to self; dust off “QE is Our Fate” on September 16, as that now seems a much more likely time to anticipate how the Fed is going to adjust their forward guidance.) Yesterday we simply learned that rates are going to remain low for the still indeterminate, very long time. Clearly, the bond market has gotten the message as yields along the Treasury curve press to lows in every tenor out through 7-year notes while the 10-year sits just 1.5 bps above the lows seen in March at the height of the initial panic. This should be no surprise as the FOMC statement and ensuing press conference by Chairman Powell made plain that the Fed is committed to use all their available tools to support the economy. Negative rates are not on the table, yield curve control is already there, effectively, so the reality is they only have more QE and forward guidance left in their toolkit. Powell promised that QE would be maintained at least at the current level, and the question of forward guidance is tied up with the internal discussions on the Fed’s overall policy framework. Those discussions have been delayed by the pandemic but are expected to be completed by the September meeting. Perhaps, at that time, they will let us know what they plan to do about their inflation mandate. The smart money is betting on a commitment to allow inflation to overshoot their target for an extended period in order to make up for the ground lost over the past decade, when inflation was consistently below target. I guess you need to be a macroeconomist to understand why rising prices helps Main Street, because, certainly from the cheap seats, I don’t see the benefit!

The market response was in line with what would be expected, as yields fell a bit further, the dollar fell a bit further and stocks rallied a bit further. But that is soooo yesterday. Let’s step forward into today’s activities.

Things started on a positive note with Japanese Retail Sales jumping far more than expected (+13.1%) in June which took the Y/Y number to just -1.2%. That means that Japanese Retail Sales are almost back to where things were prior to the outbreak. Unfortunately, this was not enough to help the Nikkei (-0.3%) and had very little impact on the yen, which continues to trade either side of 105.00. Perhaps it was the uptick in virus cases in Japan which has resulted in further restrictions being imposed on bars and restaurants that is sapping confidence there.

Speaking of the virus, Australia, too, is dealing with a surge in cases, as Victoria and Melbourne have seen significant jumps. As it is winter in the Southern Hemisphere, there is growing concern that when the weather cools off here, we are going to see a much bigger surge in cases as well, and based on the current government response to outbreaks, that bodes ill for economic activity in the US come the fall.

But then, Germany reported their Q2 GDP data and it was much worse than expected at -10.1%. Analysts had all forecast a less severe decline because Germany seemed to have had a shorter shutdown and many fewer unemployed due to their labor policies where the government pays companies to not lay-off workers. So, if the shining star of Europe turned out worse than expected, what hope does that leave us for the other major economies there, France, Italy and Spain, all of which are forecast to see declines in Q2 GDP in excess of 15%. That data is released tomorrow, but the FX market wasted no time in selling the euro off from its recent peak. This morning, the single currency is lower by 0.35%, although its short-term future will also be highly dependent on the US GDP data due at 8:30.

Turning to this morning’s US data, today is the day we get the most important numbers, as the combination of GDP (exp -34.5%), to see just how bad things were in Q2, and Initial (1.445M) and Continuing (16.2M) Claims, to see how bad things are currently, are to be released at 8:30. After the combination of weak German data and resurgence in virus cases in areas thought to have addressed the issue, it should be no surprise that today is a conclusively risk-off session.

We have seen that in equity markets, where both the Hang Seng (-0.7%) and Shanghai (-0.25%) joined the Nikkei lower in Asia while European bourses are all in the red led by the DAX (-2.3%) and Italy’s FTSE MIB (-2.2%). And don’t worry, US futures are all declining, with all three major indices currently pointing to 1% declines at the open.

We have already discussed the bond market, where yields are lower in the US and across all of Europe as well with risk being pared around the world. A quick word on gold, which is lower by 0.8%, and which may seem surprising to some. But while gold is definitely a long-term risk aversion asset, its day to day fluctuations are far more closely related to the movement in the dollar and today, the dollar reigns supreme.

In the G10 bloc, NOK is the laggard, falling 1.0% as oil prices come under pressure given the weak economic data, but we have seen substantial weakness throughout the entire commodity bloc with AUD (-0.6%) and CAD (-0.57%) also suffering. In fact, the only currency able to hold its own this morning is the pound, which is essentially unchanged on the day. In the EMG bloc, there are several major declines with ZAR (-1.6%), RUB (-1.4%) and MXN (-1.0%) leading the way down. The contributing factor to all three of these currencies is the weakness in the commodity space and corresponding broad-based dollar strength. But the CE4 are all lower by between 0.3% and 0.6%, and most Asian currencies also saw modest weakness overnight. In other words, today is a dollar day.

And that is really the story. At this point, we need to wait for the data releases at 8:30 to get our next cues on movement. My view is that the Initial Claims data remains the single most important data point right now. Today’s expectation is for a higher print than last week, which the market may well read as the beginning of a reversal of the three-month trend of declines. A higher than expected number here is likely to result in a much more negative equity day, and correspondingly help the dollar recoup even more of its recent losses.

Good luck and stay safe
Adf