They’re Still Exposed

Though merely a few angstroms wide
The pressure that Covid’s applied
To all politicians
Has led to conditions
That many find unjustified

For instance, New Zealand has closed
Its borders, and rights they’ve bulldozed
To help in prevention
Of viral retention
Unfortunately, they’re still exposed

While the major headlines around the world continue to focus on the ongoing events in Afghanistan, at this point, they have had limited, if any, impact on markets in general.  And let’s face it, if for some reason there was a negative market impact traced to the Afgahi government collapse, it is pretty clear that the global central bank response would simply be to print more money thus supporting markets more completely.  But so far, that has not been the case (I just hope you weren’t long Afghani, interestingly the name of their currency as well, as it has fallen about 4.5% in the past 72 hours.)

This means we must turn our attention elsewhere for market moving information.  Asia continues to be the region with the most interesting issues, although Oceania is making a run for the money there in the following way; PM Ardern of New Zealand has imposed a level 4 lockdown for the next three days because a single case of the delta variant of Covid-19 has been found in the entire country!  This has resulted in a significant reevaluation of the RBNZ’s next move.  Prior to this devastating outbreak, the punditry had largely concluded that the RBNZ would be the first developed country to raise rates at their meeting tonight.  But now, second thoughts have crept in and a number of economists have changed their view and are calling for no change.  You would have thought that Covid was the most powerful force in the universe based on the (over)reaction of policymakers.  A single case!  At any rate, this change in view has resulted in NZD (-1.4%) falling sharply along with the local equity market, while NZ government bonds rallied almost a full point with yields declining by 9.7bps to 1.70%.  A single case! 

Meanwhile, in Australia, the government is proposing rounding up 24,000 unvaccinated children in a stadium to insure they are vaccinated as half that nation remains under lockdown.  The economic data Down Under has clearly rolled over with Consumer confidence the latest number to fall, while the RBA minutes, released last night, indicated that they were “prepared to act” in the event a further outbreak had a significant impact on the economy.  Not surprisingly, the market understood that to be a more dovish stance than the comments immediately following their meeting two weeks ago when they promised to start taper asset purchases next month.  AUD (-0.7%) is correspondingly under pressure as well today.

As to Asia, the big news continues to come from China where the government continues its relentless attack on its tech behemoths as President Xi has become more focused on removing any sources of power that do not emanate from his office.  Chinese equity markets sold off once again (Shanghai -2.0%, Hang Seng -1.7%) as investors read about the newest competition rules that were to come into force there and would break down the walls between financial networks run by Alibaba and Tencent.  It appears that capitalism with Chinese characteristics actually means, government-controlled businesses…full stop.

And so, before Europe even walked in, risk was under severe pressure and continues that way as I type.  Markets remain amazingly resilient with respect to business failures, but when it comes to potential policy failures, investors have less confidence that everything will work out well.  Remember, too, that it has been many months since we have even seen a 5% drawdown in the S&P 500, so do not be surprised if this is the catalyst for some further risk mitigation.

Thus far, today is definitely in the risk-off column with not just the Chinese markets declining, but the Nikkei (-0.4%) also sliding, albeit not nearly as drastically.  European markets are generally weak (Dax -0.24%, CAC -0.55%, FTSE MIB -1.0%, IBEX -0.95%) although the UK (FTSE 100 +0.1%) is holding its own after much better than expected employment data was released earlier.  It seems the combination of a highly vaccinated population and massive fiscal and monetary stimulus is helping the UK economy recover quite nicely.

It can be no surprise that bond markets are rallying sharply on this risk-off day, with Treasuries seeing yields fall by 3.7 basis points while all of Europe (Bunds -2.1bps, OATs -2.1bps, Gilts -3.8bps) are also seeing demand for haven assets.  This is even true for the PIGS where yields have fallen between 1 and 2 basis points.

On the commodity front, oil (-0.8%) continues to respond to concerns over slowing economic growth worldwide amid the spread of the delta variant, as does copper (-0.9%).  Both of these commodities are seen as the most sensitive to economic expectations.  Gold (+0.4% today, +6.2% from last week’s low) is performing the way many believe it should in times of stress.  As to the rest of the bloc, there are gainers and losers amid both base metals and agricultural products.

Finally, the dollar is on top of the world this morning, rallying against 9 of its G10 counterparts with only CHF (+0.1%) maintaining its status as a world haven.  Granted, the commodity currencies are the worst off, with CAD (-0.35%) also under pressure.  Interestingly, despite the positive UK data, the pound (-0.45%) is feeling the weight of the dollar today.

Emerging market currencies continue to struggle in general, although there are a couple of positive stories.  First up is PHP (+0.45%) which saw equity inflows as bargain hunters were seen following several days of equity market declines, and the central bank indicated no policy change was upcoming, an upgrade from concerns over further easing.  THB (+0.45%) was also stronger on the back of comments from the central bank governor as well as the fact that it had fallen so far lately, more than 6% in the past two months and back to 3-year lows, that there was a bout of profit taking.  On the downside, KRW (-0.65%) continues to be the region’s laggard as ongoing concern over chip stocks has encouraged more equity market selling (KOSPI -0.9%) and seen funds flow out of the country.  Adding to this pressure is the continued increase in Covid infections and that has been enough for the won to fall 3.4% in the past two weeks.

On the data front, this morning brings Retail Sales (exp -0.3%, +0.2% ex autos) as well as IP (0.5%) and Capacity Utilization (75.7%).  The Retail Sales data has been quite volatile lately, as each wave of Federal stimulus money has quickly found uses, but when that money has not been forthcoming, sales decline sharply.  I have seen estimates that we could see a MUCH worse than expected outcome here, something on the order of -2.5%, which would be of a piece with the weaker Michigan and Philly Fed data that we have seen lately.

This afternoon, Chairman Powell hosts a town hall meeting with educators, which does not seem like a venue for new information.  We also hear from the uber dove, Neel Kashkari.

While I understand tapering talk remains all the rage, I cannot help but look at what clearly appears to be a weakening economic impulse and wonder if by the time the Fed says they want to start tapering, the data are pointing in the wrong direction and it never comes to pass.  In that event, I feel the dollar, which has greatly benefitted from tapering talk, is likely to fall back, maybe quite a bit.  But that is still a few months away.  For now, it feels like the dollar remains numero uno.

Good luck and stay safe
Adf

Havoc Our Way

It’s been fifty years to the day
Since Nixon brought havoc our way
He slammed down the sash
Where gold swapped for cash
That’s led to today’s disarray

Given the importance of this event, although it is often overlooked, I felt I had to mention the anniversary.  In truth, it was yesterday, August 15, 1971, when President Nixon closed the gold window, ending the Bretton Woods agreement that insured (allowed?) every nation to convert their dollars to gold and ushered in the current framework of fiat currencies.  Prior to his action, the global monetary system was based on the value of gold, which was exchangeable into US dollars (or perhaps the other way around) at $35.00/oz.  Each nation’s gold sat in cages in the vault at the Federal Reserve Bank of NY and would literally be physically moved from cage to cage in order to satisfy national debts amongst the countries. The problem for the US was that most of the movement was out of the US cage into other countries’, which represented the massive trade and current account deficits the US was running.  So, Nixon essentially told the world, holding dollars was the only choice.

Of course, the fiat currency regime has evolved into the current situation where the ability to print money is endless, and every government is happy for it to never end.  The strictures of a gold-backed currency are far too confining for the social programs deemed essential by virtually every government in the world today, which is why we will never go back.  The real question is, what lies ahead?

The ructions in China persist
As data last night, forecasts, missed
And President Xi
Continues to see
More targets that he can blacklist

As to the markets today, the single biggest story has been the release of Chinese data at significantly worse than expected levels.  The key figures showed Retail Sales (8.5%, exp 10.9%), IP (6.4%, exp 7.9%) and Fixed Asset Investment (10.3%, exp 11.3%).  The disappointing outcome has been attributed to the spread of the delta variant of Covid which has not only resulted in the closure of some key infrastructure points, notably two busy ports, but also weighed on many peoples’ willingness to travel during the typically busy summer vacation season.  Given the Chinese propensity for draconian measures in their effort to stop the spread of the virus, people are concerned they will get stuck some place with no ability to return home if there is a sudden lockdown.

The Wall Street response was immediate, with a number of economic forecasts for China taken lower by between 0.5%-0.7% for 2021 as a whole.  In addition, greater attention has been paid to the Chinese credit impulse (the amount of credit that is flowing into the economy from the banking system) which has been slowing rapidly since a peak in October.  This statistic tends to lead the Chinese economy’s performance by between 6 and 12 months, so it should be no surprise we are starting to see reduced output there.

Interestingly, despite the slowing growth story, the Xi government continues to attack its bellwether tech firms, the ones that have been growing the fastest.  It is becoming increasingly evident that President Xi is perfectly willing to sacrifice economic growth in an effort to consolidate his power even further.  Last night we again saw key government editorials about the evils of online gaming and how it should be curtailed even further.  Alibaba, one of the largest and most successful Chinese internet companies, remains squarely in Xi’s sights as he brings every potential threat to heel.  In the end, this is unlikely to help the Chinese economy writ large which from this poet’s perspective means we are likely to see a very gradual depreciation in the yuan as the currency market becomes a relief valve for domestic economic pressures.

The only other headline news has been the fall of Kabul to the Taliban in a remarkably swift 72 hours, with numerous stories about the evacuation as well as the political failures that led to this outcome.  Perhaps this is the impetus for today’s risk reduction, or perhaps it is the China story, or simply the ongoing spread of the delta variant; but whatever the reason, we are definitely seeing a bit of risk-off attitude across markets.

For instance, equity screens are all red with Asia ((Nikkei -1.6%, Hang Seng -0.8%, Shanghai 0.0%) and Europe (DAX -0.6%, CAC -1.0%, FTSE 100 -1.1%) clearly under pressure.  I’m sure Friday’s very weak Michigan Sentiment number (70.2, weakest since 2011) did not help anyone’s mood, and despite the fact that all three major US indices crept higher on the day Friday, by 0.1% or less, to new record highs, this morning all three are pointing lower by about -0.3%.

Bonds though are a bit more circumspect here, as while Treasury yields have edged lower by 0.3bps, all of Europe’s sovereign markets are selling off with yields rising.  Perhaps, investors have decided that the situation is so dire they don’t want any European paper at all!  So, bunds (+1.0bps), OATs (+1.4bps) and Gilts (+1.2bps) are all lower along side their respective equity markets.

Commodities, too, are softer this morning led by oil (-1.35%) and gold (-0.2%) with base metals (Cu -1.6%, Al -0.2%, Sn -0.3%) falling as well.  In fact, the only part of this bloc holding up is foodstuff, where the big three, corn, wheat and soybeans are all firmer.

Where, you may ask, is everybody putting their money if they are selling both stocks and bonds?  It seems the dollar is finding support against most currencies, except for the havens of JPY (+0.25%) and CHF (+0.2%).  Otherwise, the rest of the G10 is softer vs. the dollar, notably the commodity bloc where AUD (-0.5%), NOK (-0.45%) and CAD (-0.3%) are the laggards.  Similarly, in the EMG bloc, it is the commodity currencies that are under the most pressure with RUB (-0.3%), ZAR (-0.2%) and PHP (-0.35%).  In fact, the only currency with gains is TRY (+0.6%) which continues to benefit from the highest real yields on the planet.

The data story this week brings Retail Sales and Housing data as well as the FOMC Minutes on Wednesday.

Today Empire Manufacturing 28.5
Tuesday Retail Sales -0.2%
-ex autos 0.2%
IP 0.5%
Capacity Utilization 75.7%
Wednesday Housing Starts 1600K
Building Permits 1610K
FOMC Minutes
Thursday Initial Claims 365K
Continuing Claims 2800K
Philly Fed 24.0
Leading Indicators 0.7%

Source: Bloomberg

Retail Sales and the FOMC Minutes are likely to get the most attention, although any really big miss, like Friday’s Michigan data, could lead to further movements, so beware.  As well we hear from a few Fed speakers, with Chairman Powell talking tomorrow, but the subject does not appear to be the economy, then uber-dove Kashkari and his counterpart, the hawkish Kaplan later in the week.

At this point, risk remains under pressure and I sense that it has some room to run lower.  It has been more than 9 months since there has been a 5% drawdown in the equity market, an inordinately long period of time for pressures to build up.  This is not to say that a drawdown is coming, just that there is real instability underlying the market, so one is very possible.  And I sense that this risk-off event would be classic with the dollar gaining real ground against virtually everything.

Good luck and stay safe
Adf

Some Water to Tread

The quickening pace of the spread
Of delta means looking ahead
The prospects for both
Inflation and growth
Seem likely, some water, to tread

The upshot is central bank staff
Will trot out some chart or some graph
Highlighting that rates
In all nation states
Should once more be cut, least in half

The talk of the markets is the pace of the spread of the delta variant of Covid and how the latest wave of lockdowns and other measures has reduced growth forecasts for the second half of the year.  This is especially true throughout Asia as nations that had seemingly weathered the initial wave of Covid with aplomb find themselves woefully unprepared for the current situation.  A combination of less widespread vaccinations and less effective health infrastructure has resulted in the fast spreading virus wreaking havoc.  China, for instance, finds itself in this position as half of its 32 provinces are reporting cases and officials there have closed major tourist destinations because of the spread.  This is a far cry from their earlier claims of having controlled the virus better than anyone else.  But the same situation exists throughout Europe and the Americas as the delta variant runs its course.

The clearest market response to this situation has been from bond markets where yields continue to fall around the world on the weaker prospects for growth.  The amount of negative yielding debt worldwide has risen back to $16.7 trillion, up from $12.9 trillion at the end of June, although still below the $18.3 trillion reached in December of last year.  However, the trajectory of this move, which is approaching vertical, offers the possibility that we could easily take out those old highs in the next week or two.

The problem is that rapidly declining bond yields do not accord easily with higher inflation or inflation expectations.  Yet higher inflation continues to be present and inflation expectations continue to rise.  This is the great conundrum in markets right now.  How can markets be anticipating slower growth while inflation measures continue to rise?  Shouldn’t slower growth lead to lower inflation?

In ordinary economic environments, there has certainly been a strong relationship between growth and inflation, but I challenge anyone to describe this economic situation as ordinary.  Rather, as a result of collective government responses to the pandemic, with whole swaths of various economies around the world being closed, along with massive fiscal and monetary stimulus being added to those same economies, a series of supply shocks have been created.  Thus, when the artificially stoked demand (from the stimulus) meets the constrained supply (from the lockdowns) the natural response is for prices to rise in order to achieve a new equilibrium.  The point is that the supply constraints continue to drive much of the pricing behavior, and therefore the inflation story, while the central banks can only really affect the demand side of the equation.  After all, while they may be able to print lots of money, they cannot print chickens, toilet paper or semiconductors, all things that have seen supply reduced.

A large part of the central banks’ transitory inflation theme stems from the fact that their models tell them that supply will be replenished and therefore prices will ease.  Alas, there has been little indication that the real world is paying attention to central bank models, as we continue to see shipping delays, manufacturing delays and higher raw materials prices as the supply infrastructure remains under significant strain.

Perhaps the most telling feature regarding the current views on inflation, even more than the rise in economic statistics, is the growth in the number of stories in the mainstream media regarding why different ordinary products and services have become more expensive.  Just this morning, the WSJ explained why both vacations and patio furniture are more expensive, and a quick Google trends search shows the term “more expensive” is being searched at near peak levels virtually daily.  The central bank community has put themselves in a significant bind, and while some nations are beginning to respond, the big 3, Fed, ECB and BOJ, show absolutely no signs of changing their behavior in the near term.  As such, the outlook is for more printed money, the same or few available goods and higher prices across the board.

Turning to markets, all that money continues to be a positive for equity investors as a great deal of that liquidity keeps finding its way into equity markets.  While Japan (Nikkei -0.2%) lagged last night, the rest of Asia rebounded with both the Hang Seng and Shanghai indices rising 0.9%.  Europe, too, continues to perform well with the DAX (+0.8%), CAC (+0.4%) and FTSE 100 (+0.4%) all in the green after PMI Services indices were released.  While all of those data points were strong, they all missed expectations and were slightly softer than last month.  In other words, the trajectory continues to be lower, although the absolute readings remain strong.  Perhaps despite what Timbuk 3 explained, you won’t need shades for the future after all.

As to the bond market, we continue to see demand as yields are lower almost everywhere.  Treasury yields have fallen 1 basis point, with European sovereigns even stronger (Bunds -1.7bps, OATs -2.0bps, Gilts -1.3bps).  In fact, the only bond market to sell off overnight was in New Zealand (+5bps) as comments from the central bank indicated they are likely to raise rates next week, and as many as 3 times by the end of the year as inflation continues to rise while the unemployment rate fell to a surprisingly low 4.0%.

Commodity prices continue to lack direction, although the negativity on the economy has impacted oil prices which are down 1.1% this morning.  However, gold (+0.4%) is looking up, as are agricultural prices with the big three products all higher by between 0.3%-0.6%.  Base metals, though, are under pressure (Cu -0.4%, Sn -0.3%) which given the evolving economic sentiment makes some sense.

Finally, the dollar is ever so slightly softer this morning with only NZD (+0.7%) showing real movement and dragging AUD (+0.3%) along with it.  Otherwise, the rest of the G10 is +/- 0.1% from yesterday’s closing levels.  The EMG picture is a bit more mixed with gainers and losers on the order of 0.4%, although even that is only a few currencies.  The leader today is KRW (+0.4%) which responded to increased expectations that the BOK would be raising interest rates soon, perhaps later this month, with some analysts even floating the idea for a 50bp hike.  We have seen a similar gain in HUF (0.4%) as the market continues to digest hawkish commentary from the central bank there, but after those two, gainers have been far less impressive.  On the downside, TRY (-0.4%) is the laggard du jour as the market grows increasingly concerned that the central bank will not be able to keep up with rising inflation there.  Elsewhere, THB (-0.35%) fell on weakening growth prospects and the rest of the space was less interesting.

Two notable data points are to be released today with ADP Employment (exp 683K) early and then the ISM Services (60.5) index released at 10:00. The ADP number will be seen by many as a harbinger of Friday’s NFP, so could well have a big impact if it surprises in either direction.

Interestingly, the dollar continues to hold its own lately despite declining yields as it appears investors are buying dollars to buy Treasuries.  After all, as more and more debt turns into negative yields, Treasuries look that much more attractive.  At least until the Fed admits that inflation is going to be more persistent than previously discussed.

Good luck and stay safe
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