Tag Archives: #dollar

On the Spot

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This morning, it’s Core PCE

That markets are waiting to see

If it keeps on falling

More folks will be calling

For rate cuts ere end ‘Twenty-three

But what if the data is hot

That could put the Fed on the spot

Instead of a pause

That reading may cause

At least one more hike than was thought

As we head into the Memorial Day weekend, the market is awaiting some more key data points for the Fed’s calculus on inflation.  Today brings a plethora of things as follows (median expectations from Bloomberg):

  • Personal Income (exp 0.4%)
  • Personal Spending (0.5%)
  • Core PCE Deflator (0.3%, 4.6% Y/Y)
  • Durable Goods (-1.0%)
  • -ex Transport (-0.1%)
  • Michigan Sentiment (58.0)

Given the Fed’s preference for the Core PCE as their key inflation indicator, this data point is always a critical feature of the monthly slate.  However, since the FOMC Minutes were released on Wednesday, the market has already adjusted its views on the Fed’s future path.  Since the release, the market has removed another full 25bp cut from the medium-term outlook, with pricing for January 2024 rising from 4.50% to 4.735%.  It appears that the market is truly beginning to believe the Fed that it is going to remain higher for longer.

So, let’s look at the consequences of that policy stance and the market’s grudging acceptance.  Over the course of the past 3 weeks, 10-year Treasury yields have risen from 3.38% to 3.78% after giving up 3bps this morning. Meanwhile, 2-year Treasury yields have risen from 3.89% to 4.49%, increasing the curve inversion again, and highlighting the market view that a recession remains in the not-too-distant future.

Generally speaking, the combination of higher interest rates and recessionary indicators tends to undermine the equity market, but that picture is more nuanced these days as the incredibly narrow breadth of the price leaders has been able to overcome a more general malaise.  For instance, yesterday’s S&P 500 gain of 0.88% was largely the result of just three key tech names, NVDA, MSFT and AVGO, with the rest of the group mostly thrashing around.  This continues the trend of a handful of companies driving the value of the “broad” market indices, a situation that cannot go on forever, but for now, it seems fine.  Of course, the NASDAQ is even doing better since all those high performers are NASDAQ names.

However, one needs to ask, if the Fed continues to tighten policy further, and the market is now pricing a one-third probability that they hike another 25bps next month, and the result is a further slowdown in the economy, can these companies continue to perform?  Maybe they can, but history is not on their side.

Other markets, too, have been impacted by the slow realization that the Fed means what they have been saying all along, higher for longer.  While oil prices (+0.5%) are edging higher today, they have been significant underperformers along with base metals as concerns over future economic growth weigh on the sector.  Both copper and oil have been falling for the last several months as the largest importer of both, China, seems to find itself with its own economic malaise.  This is merely another input into the recession story.

Weakening growth in China and higher interest rates in the West to fight still too-high inflation do not bode well for economic activity for now.  Add to these factors the potential outcome from the debt ceiling negotiations, reduced Federal spending in the US, and you have a trifecta of reasons for a negative equity and risk market outlook.

Speaking of the debt ceiling, this morning’s headlines indicate that the two sides are getting closer, but that spending cuts are part of the process.  Naturally, this is controversial on the left side of the aisle, but the fact that not all the spending cuts included in the bill already passed by the House are going to be seen is controversial on the right side of the aisle.  If anything, this sounds like an excellent outcome, where neither side is happy, but both agree something must be done.  It is certainly no surprise to me that they are getting closer to agreement as this all has been part of the Congressional Kabuki that we regularly see on critical issues.  Remember, though, avoiding a debt default is not a huge positive sign, it is merely the absence of a negative one.

Where does this leave us?  Overall, the data remains mixed at best, with manufacturing indicators weakening, service indicators holding up, inflation remaining stickily high and the Fed continuing to pound its one main tool, the hammer of interest rate hikes on the economy.  Perhaps the most interesting data situation is that of Initial Claims, which yesterday printed at a much lower than expected 229K.  The fairly steady increases in layoffs that had been seen since the beginning of the year seem to be abating now.  In fact, the 4-week moving average of claims data has fallen back sharply to 231.8K, an indicator that the trend higher may be ending.  If this is the case, and the NFP data going forward remains robust, the Fed will have every reason to continue to tighten policy further, much further than is currently priced into the market.  As I have written in the past, I continue to believe that NFP is the most important data point.  As long as Unemployment remains low and jobs are created, the Fed will have all the cover it needs to maintain tight monetary policy.  Just be prepared for some other things to break, à la SVB and First Republic.

Finally, a word about the dollar, which while modestly softer today remains in a clear uptrend off the lows seen early in the month.  As long as the Fed maintains its current policy stance, one which is still being priced into the market, the dollar has further to rally.  Although other central banks have been tightening policy as well, notably the ECB and BOE, the Fed remains the leader of the pack.  Until the Fed finally halts, those two will lag and the dollar should remain strong.  It is only when the Fed finally reverses course, which may not be until the middle of next year on current pace, when we should see any substantial dollar weakness.  I would not hold my breath.

In the end, it all comes back to inflation.  Until the central banks believe that they have defeated inflation’s threats, barring a calamitous economic collapse, I would look for bond yields around the world to continue to drift higher, for equity markets to struggle, although further gains cannot be ruled out, and for the dollar to maintain its overall strength.

Good luck and good weekend

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Widened the Spread

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Twixt ceilings for debt and the Fed

The market has widened the spread

Of rates here at home

Despite what Jerome

Last weekend ostensibly said

Thus, dollars remain to the fore

As traders want so many more

The megacaps rise

But in a surprise

There’s less and less talk of the war

The debt ceiling negotiations remain at the top of the market’s list of concerns as the ostensible X-date of June 1stapproaches.  Certainly, the positive aspect is that both sides are talking as opposed to merely grandstanding, but as is always the case in a political standoff with a non-political impact, it is clear no deal will be reached until the Nth hour.  The other thing to remember is that the June 1st date is not a hard deadline, it is the current estimate by Secretary Yellen and subject to change.  In the end, nothing has changed my view that a deal will be reached as both sides desperately want one, but also, no deal will be reached until both sides can explain to their supporters that they did everything possible to achieve their agendas.

However, this process is clearly having an impact on the markets, especially in the interest rate space as we have seen 10-year Treasury yields, which are higher today by 3.3bps, rise 36 basis points in the past two weeks.  In addition, the yield curve inversion, which at one point had fallen to as low as -41bps, is back to a -64bp difference.  Not only that, but the 4-week T-bill, the nearest expiry past the X-date, is now yielding 5.47%, far above Fed funds and the highest spot on the yield curve.  That is clearly a direct response to fears over a possible default.  My sense is this process will go on right through Memorial Day and US interest rates may well have further to rise between now and then.

But this begs the question, are US rates dragging up rates around the world?  I would argue the answer is yes.  Looking at European sovereigns, which have all seen yields rise by around 3bps-4bps today (Gilts are actually +8bps), they have all risen in concert with Treasury yields.  During the same time frame that Treasuries rose 36bps, Bunds are +28bps, OATS +25bps and Gilts +43bps.  Yet during that period, the dollar has gained more than 1% vs. both the euro and the pound (and all the other G10 currencies as well). 

Perhaps what we are seeing is a new safe haven asset being born, the US megacap tech stock.  The likes of Apple, Microsoft and Alphabet have seen steady strength, helping to drive the NASDAQ 100 Index up nearly 5% during this same two-week period.  In fact, a quick look at YTD performance in US equity markets shows that the Dow Jones Industrials are +0.4% YTD while the NASDAQ is up 21.5%.  In the past, there was a concept during bouts of USD strength that investors were buying dollars to buy Treasuries.  I think right now investors are buying dollars to buy Apple!  In fairness, one can see the premise as regardless of the debt ceiling outcome or timing, the belief that Apple (or Microsoft or Alphabet) shares will react to that news rather than their own positive stories generates no concerns.

Of course, those names are the exceptions to the rule as the bulk of the rest of the market has been under pressure recently on the back of all the catastrophic predictions if the debt ceiling isn’t raised and the US defaults on its debt.  This can be seen in the fact that the other major indices have seen almost no movement, just sideways trading, during the recent period in question.

Turning to the Fed, it appears that we are reaching an inflection point in the tightening process, or at least in the rate hiking cycle.  While prior to the last FOMC meeting, virtually every speaker was on the same message, we are starting to see some differences.  Most importantly, Powell, last weekend, hinted that there was some concern that the continued rate hikes were starting to impact financial stability (seriously, after 4 major bank failures it is now a concern?). But the implication is that while inflation remains job number one, there are other issues on the agenda.  That seems to be the dovishness that was attributed to Powell over the weekend.

Meanwhile, yesterday we heard from two regional Fed presidents.  James Bullard from St Louis, who said that he saw at least two more rate hikes (50bps total) as necessary to be certain they have slain the inflation dragon.  As per Bloomberg news, “I think we’re going to have to grind higher with the policy rate in order to put enough downward pressure on inflation and to return inflation to target in a timely manner,” Bullard said at an event in Florida on Monday.  “I’m thinking two more moves this year — exactly where those would be this year I don’t know — but I’ve often advocated sooner rather than later.”

However, we also heard from Minneapolis President Neel Kashkari with a different message, “I think right now it’s a close call, either way, versus raising another time in June or skipping.  What’s important to me is not signaling that we’re done.”  I guess the Eccles Building will be rocking in June when they next meet.

As it stands currently, at least according to the Fed funds futures market, the market is pricing in a 23% probability of a 25bp rate hike on June 14th.  Remember, though, between now and then we see a lot of critical data including this week’s Core PCE release, next week’s NFP data and finally the May CPI data, scheduled to be released the day before the FOMC announcement.  In the meantime, all eyes seem to be on the debt ceiling negotiations, and reasonably so, given the fallout could begin before the big data comes. 

Looking at today, the big movers overnight were the bond markets with equity markets mildly in the red in both Asia and Europe.  US futures are also edging lower, but barely -0.1% at this hour (7:45).  As to commodities, oil (+0.5%) is edging higher on word that the Saudis are going to push for another production cut, while gold (-0.5%) is sliding on the back of the strong dollar and the base metals are falling again, clearly anticipating a recession.

As to the dollar, it remains king of the hill, continuing to rally vs. virtually all its G10 counterparts with only the yen (+0.1%) managing to hold its own.  In the emerging market space, the story is similar with HUF (-1.0%) the laggard on expectations of a rate cut today and the bulk of the bloc lower.  The one outlier seems to be KRW (+0.4%) which saw substantial equity inflows as the driver.  I would be remiss if I didn’t mention that CNY has rallied substantially in my absence and is now well above 7.0500 as there is a growing belief the PBOC will continue to ease policy to support the Chinese economy.

On the data front today, we see preliminary PMI data (exp 50.0 Mfg, 52.5 Services) and New Home Sales (665K).  The European flash PMI data was slightly soft, but pretty close to expectations.  Meanwhile, only Dallas Fed President Lorie Logan is on the docket today, but don’t be surprised to hear from others on CNBC or BBG as they basically cannot shut up.

In the wake of the Silicon Valley Bank failure, I was convinced the Fed was going to be finished and accordingly, changed my views on the dollar.  I had been bullish until a clear pivot was seen and I thought that was the case.  However, it increasingly appears that no pivot is coming and that higher for longer is the future.  In that case, I have to revert to my original stance and look for continued dollar strength until we get that signal.

Good luck

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Covid Comes Calling

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The German economy’s stalling
In Q1, as Covid comes calling
But still there’s belief
That fiscal relief
Will stop it from further snowballing

Consensus is hard to find this morning as we are seeing both gains and losses in the various asset classes with no consistent theme.  Perhaps the only significant piece of news was the German IFO data, which disappointed across the board, not merely missing estimates but actually declining compared with December’s data.  This is clearly a response to the renewed lockdowns in Germany and the fact that they have been extended through the middle of February.  The item of most concern, is that the manufacturing sector, which up until now had been the brightest spot, by far, is also seeing softness.  Now part of this problem has to do with the fact that shipping has been badly disrupted with insufficient containers available to ship products.  This has resulted in higher shipping costs and reduced volumes, hence reduced sales.  But part of this issue is also the fact that since virtually all of Europe is in lockdown, economic activity on the continent is simply slowing down.  It is the latter point that informs my view of the ECB’s future activities, namely non-stop monetary ease for as far as the eye can see.

When combining that view, the ECB will continue to aggressively ease policy, with the fact that the Fed is also going to continue to ease policy, it becomes much more difficult to estimate which currency is going to underperform.  Heading into 2021, the strongest conviction trade across markets was that the dollar was going to decline sharply, continuing the descent from its March 2020 highs.  And that’s exactly what we saw…for the first week of the year.  However, since then, the dollar has reversed those losses and currently sits higher on the year vs. most currencies.  My point is, and has consistently been, that in the FX market, the dollar is a relative game, and the policies of both nations are critical in establishing its value.  Thus, if every nation is aggressively easing policy, both monetary and fiscal, then the magnitude of those policy efforts are critical.  Perhaps, the fact that Congress has yet to pass an additional stimulus bill, especially given the strong belief that the Blue Wave would quickly achieve that, has been sufficient to change some views of the dollar’s future strength (weakness?).  Regardless, the one thing that is clear is that the year has just begun and there is plenty of time for more policy action as well as more surprises.  In the end, I do believe that as inflation starts to climb in the US, and real interest rates fall to further negative levels, the dollar will ultimately fall.  But that is a Q2-Q3 outcome, not really a January story.

And remarkably, that is basically the biggest piece of news from overnight.  At this point, traders and investors are turning their attention to the FOMC meeting on Wednesday, although there are no expectations for policy shifts yet.  However, the statement, and Chairman Powell’s press conference, will be parsed six ways to Sunday in order to try to glean the future.  Based on what we heard from a majority of Fed speakers before the quiet period began, there is no current concern over the backup in Treasury yields, and there is limited sentiment for the Fed to even consider tapering their policy of asset purchases, with just four of the seventeen members giving it any credence.  One other thing to remember is that the annual rotation of voting regional presidents has turned more dovish, with Cleveland’s Loretta Mester, one of the two most hawkish members, being replaced by Chicago’s Charles Evans, a consistent dove.  The other changes are basically like for like, with Daly for Kashkari (two extreme doves) and Barkin and Bostic replacing Harker and Kaplan.  These four are the minority who discussed the idea that tapering purchases could be appropriate by the end of the year, so, again, no change in voting views.

With this in mind, we can see the lack of consistent message from overnight activity.  Asian equity markets were all firmer, led by the Hang Seng (+2.4%), with the Nikkei (+0.7%) and Shanghai (+0.5%) trailing but in the green.  However, Europe has fared less well after the soft IFO data with all three major markets (DAX, CAC and FTSE 100) lower by -0.6%.  As to US futures, they are the perfect embodiment of a mixed session with NASDAQ futures higher by 0.8% while DOW futures are lower by 0.2%,

Bond markets, though, have shown some consistency, with yields falling in Treasuries (-1.0bp) and Europe (Bunds -1.7bps, OATs -1.5bps, Gilts -2.2bps).  The biggest winner, though, are Italian BTPs, which have rallied more than half a point and seen yields decline 5.3 basis points.  It seems that concerns over the government falling have abated.  Either that or the 0.70% yield available is seen as just too good to pass up.

On the commodity front, oil prices have edged up by the slightest amount, just 0.1%, as the consolidation of the past three months’ gains continues.  Gold has risen 0.4%, but there is a great deal of discussion that, technically, it has begun a downtrend and has further to fall.  Again, consistent with my view that real interest rates are likely to decline sharply in Q2, when inflation really starts to pick up, we could easily see gold slide until then, before a more emphatic recovery.

And lastly, the dollar, where both G10 and EMG blocs show a virtual even split of gainers and losers.  Starting with the G10, NZD (+0.3%) is today’s “big” winner, with SEK (+0.25%) next in line.  Market talk is about the reduction of restrictions in Australia’s New South Wales state as a reason for optimism in AUD (+0.15%) and NZD.  As for SEK, this is simply a trading move, with no obvious catalysts present.  On the flip side, the euro (-0.1%) is the worst performer, arguably suffering from that German IFO data, with other currencies showing little movement in either direction.

The EMG bloc is led by TRY (+0.4%), as it seems discussions between Turkey and Greece to resolve their competing claims over maritime boundaries is seen as a positive.  After the lira, though, no currency has gained more than 0.2%, which implies there is nothing of note to describe.  On the downside, ZAR (-0.4%) is the worst performer, which appears to be a positioning move as long rand positions are cut amid concerns over the spread of Covid and the lack of effective government response thus far.

On the data front, the week is backloaded with Wednesday’s FOMC clearly the highlight.

Tuesday Case Shiller Home Prices 8.65%
Consumer Confidence 89.0
Wednesday Durable Goods 1.0%
-ex transport 0.5%
FOMC Meeting 0.00%-0.25% (unchanged)
Thursday Initial Claims 880K
Continuing Claims 5.0M
GDP Q4 4.2%
Leading Indicators 0.3%
New Home Sales 860K
Friday Personal Income 0.1%
Personal Spending -0.4%
Core PCE 1.3%
Chicago PMI 58.0
Michigan Sentiment 79.2

Source: Bloomberg

So, plenty of stuff at the end of the week, and then Friday, two Fed speakers hit the tape.  One thing we know is that the housing market continues to burn hot, meaning data there is assumed to be strong, so all eyes will be on the PCE data on Friday.  After all, that is the Fed’s measuring stick.  The other thing that we have consistently seen during the past six months is that inflationary pressures have been stronger than anticipated by most analysts.  And it is here, where the Fed remains firmly of the belief that they are in control, where the biggest problems are likely to surface going forward.  But that is a story for another day.  Today, the dollar is wandering.  However, if the equity market in the US can pick up its pace, don’t be surprised to see the dollar come under a little pressure.

Good luck and stay safe
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Over the Moon

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Investors are over the moon
And singing a happy new tune
As Pfizer’s vaccine
Has come on the scene
And raised hope we’ll soon be immune

The market responded with glee
As pundits now seem to agree
With gridlock ahead
The vaccine, instead
Will rescue our economy

Frankly, it is hard to keep up with the narrative shifts between yesterday and today as there have been so many new opinions about how the future will unfold.  As I was completing this missive yesterday morning the Pfizer vaccine news hit the tape.  Certainly, the market was unprepared for an announcement that a vaccine with 90% efficacy was in late stage trials, implying that it could soon be approved, and distribution begun.  Hopes for a vaccine had been a key driver of markets on many days in the past several months, although market rallies were ostensibly keyed by hopes for many things like a blue wave, gridlock, and if you go back far enough, a trade deal.  However, the news of the success triggered a stupendous rally in equity markets and risk assets in general while haven assets, especially Treasuries, Bunds and Gilts, along with the yen, Swiss francs and gold, all sold off sharply.  Yesterday, I was cynical regarding the end of the pandemic being at hand, but this morning, that outcome has far more promise.

Of course, the real question is, if this vaccine truly does work, and is distributed widely enough to instill confidence in the general population, how much has the economy actually changed and to what degree are those changes permanent?

Clearly, the biggest change has been the recognition that working from home, for many jobs, is quite viable.  Technology has reached the point where meetings via Webex or Zoom or Partners seem to be quite productive (at least as productive as any meetings ever are.)  My personal experience is that I have gone from driving nearly 2000 miles per month, largely for commuting, to having driven 3000 miles in the past seven months.  Not only have I used significantly less fuel, but my car has seen dramatically less wear and tear, and thus any replacement has been postponed accordingly.  And that is just one facet of the changes.  Commercial real estate and office buildings will likely need to be repurposed going forward as the requirement for corporate staffs to all gather in a single premise has been shown to be unnecessary.

But what about travel and entertainment?  With a vaccine, does that mean people will be jumping back on airplanes to visit clients or relatives or go on vacation again?  Is the movie theater experience ever going to be as desirable again?  After all, given the remarkable array of streaming entertainment services, and the fact that TV’s have grown so remarkably large, watching at home has many advantages over going out, so what percentage of the population will be heading back out soon?  In truth, the one segment I expect to really benefit is restaurants, as while it appears people embraced preparing food at home, I expect the ability to go out, eat and not have to wash the dishes has real appeal to a majority of the population.

My point is the dynamics of economic activity going forward are likely to be very different than that which we remember from before the pandemic and its attendant lockdowns and disruptions.

Of more importance to our discussion here, what does this mean for the central banks going forward.  Remember, Chairman Powell has essentially promised not to raise interest rates until 2023, a minimum of 2+ years from now.  But what if economic activity takes off, as people find a new mix of activities and regain the confidence to gather when desired.  If growth rebounds and inflation (which is already picking up) continues to rise, will they stand pat because of that promise?  Will the ECB?  The BOJ?  The BOE?  Quite frankly, I believe the central bank community was quite happy with the current situation.  They were largely lauded as heroes for preventing even worse outcomes, they had significantly increased their power and sway within governments, and the playbook was easy, print lots of money and buy bonds (or other assets) to support market functioning.  Not only that, they could carp at governments for not implementing fiscal stimulus and the intelligentsia all agreed!

But if this vaccine really is the difference maker, and people return to some semblance of their pre-covid activities, suddenly, central bank largesse may no longer be needed.  And if they continue their current policies and inflation starts to really pick up, they will be the ones being lambasted for their actions or delayed reactions.  While it is very early day(s) in this new story, it is the first time since before the financial crisis where central bankers may find themselves the targets of wrath, rather than the saviors of the world.  (People wonder whether Chairman Powell will be reappointed; quite frankly he may not want the job!)

With all that in mind, how have markets behaved since the news hit the tape?  Yesterday’s equity market performance was quite interesting, as the early euphoria (DOW 29933) reversed and stocks wound up closing much lower, with the NASDAQ actually falling 1.5% on the day.  There was also a huge rotation from the previous winners (Mega cap tech companies) into the previous losers (value and transportation stocks).  Asia followed suit with a mixed session (Nikkei +0.25%, Hang Seng +1.1%, Shanghai -0.5%) and Europe has also lacked some direction.  For instance, the DAX is unchanged on the day while the CAC has rallied 1.1% despite horrific IP and Labor data.  Spain is much firmer (+2.2%) and Italy has fallen (-0.25%).  In other words, this is not a vaccine driven market, rather it has to do with some pretty lousy data out of Europe.  The US dichotomy continues with DOW futures higher by 0.6%, SPX futures basically unchanged and NASDAQ futures lower by -1.6%. Perhaps there was a bubble in some of those stocks after all.

Bond markets continue to sell off everywhere, except Greece, as the narrative here is quite clear; vaccine => rebounding economic growth => less central bank policy ease => higher rates.  So, this morning 10-year Treasury yields are up to 0.94%, 2 basis points higher than yesterday after a 10-basis point rise yesterday.  But we are seeing yields higher between 1 and 3 basis points throughout Europe as well.  The question to ask is, Is the ‘new vaccine makes everything better’ narrative realistic or overdone, and just how long before economic activity actually starts to rebound?

Finally, the dollar can only be described as mixed, but leaning stronger.  Ignoring TRY (-2.0%) which is what we should always be doing, the EMG markets have more losers than winners with ZAR (-0.7%) and PLN (-0.6%) leading the way.  On the flip side, THB (+0.5%) and CNY (+0.3%) are both performing reasonably well.  If anything, it is hard to cobble together a consistent story as to why any of these currencies are moving in their current direction given the inconsistencies.

As to the G10 space, there have been two gainers of note, GBP (+0.65%) and NOK (+0.5%), with only CHF (-0.3%) showing any real weakness.  The rest of the bloc is little changed overall.  NOK is benefitting from the ongoing rally in oil prices, up another 1.5% this morning, which takes the move since Thursday to a 5% gain.  As to the pound, comments from the BOE’s Chief Economist, Andy Haldane yesterday seemed to change the market’s view as to the possibility of negative rates in the future.  By calling the vaccine a “game changer” he implied future central bank actions were likely to be less aggressive.

On the data front, the NFIB Small Business indicator was released right on expectations of 104.0.  Beyond that, we only see the JOLT’s Job Openings data, but that is for September, so has very limited appeal in a market that is seeing massive changes daily.  As mentioned above, Eurozone data was generally lousy, with both French (-6.0% Y/Y) and Italian (-5.1% Y/Y) Industrial Production disappointing and French Unemployment rising to 9.0%, its highest level since 2018.  As well, German ZEW Surveys were quite weak, with Expectations falling to 39.0, far lower than expected.

And so we have a market that needs to look through worsening recent data to the potential for a dramatic change regarding the vaccine and its ability to help economic activity find a new normal.  My view is we have seen significant excesses in many markets during the past several months and years, and there is every chance a significant amount gets unwound.  I do believe volatility will remain with us for a while, as there are many possible outcomes.  But in the end, while the dollar will have bouts of both strength and weakness, the one thing that will not happen is a collapse.

Good luck and stay safe
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Waiting for Jay

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Investors are waiting for Jay
Their fears, about rates, to allay
They want it made clear
That rates will be here
From now ‘til we reach judgement day

From the market’s perspective, the world has essentially stopped spinning, at least until we finally hear the words of wisdom due from Chairman Powell beginning at 9:10 this morning.  Trading volumes across products are currently running at 50%-70% of recent average activity, highlighting just how little is ongoing.  And remember, too, as it is the last week of August, summer holidays are in full swing with most trading desks, on both the buy and sell sides, more lightly staffed than usual.  In other words, liquidity is clearly impaired right now, although by 10:00 this morning I expect that things will be back closer to normal.

As discussed yesterday, the working assumption of most analysts and investors is that Jay is going to explain the benefits of targeting average inflation over time.  The implication being that the Fed’s new policy framework, when officially announced later this year, is going to include that as a KPI.  Of course, the big question about this policy is the average over exactly which period.

Consider, it has been 102 months since then-Chairman Bernanke established the target for core PCE at 2.0%.  During that time, core PCE has been between 1.9% and 2.1% just 12 times with 89 of the other 90 readings below 1.9% and a single print above 2.1%, which happens to have been the first print after the announcement.  Meanwhile, this past April’s reading of 0.931% is the lowest reading.  The average of the two extremes is 1.53%.  Is the Fed going to be happy if core PCE jumps to 2.47% and stays there for a while?  The average of all periods since January 2012 is 1.633%, does that mean we can expect the Fed to target 2.367% core PCE readings for the next eight plus years? The point is, without some specificity on what average inflation means, it is very difficult to understand how to incorporate the idea into investment and trading decisions.

But what if Chairman Powell does not bring clarity to the discussion, merely saying that average inflation over time seems like a good future benchmark.  How might different markets react to such a lack of specificity?

Starting with equity markets, certainly those in the US will rally because…well that’s all they do these days.  Good news, bad news, no news, none of that matters.  The rationale will be stocks are a good inflation hedge if inflation goes higher (they’re not) or stocks will benefit from ongoing low interest rates if inflation remains below target.  Parabolic markets are frightening, but there is no indication that Powell’s comments are going to change that situation.  We need a different catalyst here.

Now let’s look at the bond market and what might happen there.  Specificity on how much higher the Fed is going to target inflation is going to be a pretty distinct negative.  If you own 10-year Treasuries that are yielding 0.68% (today -1bp), and the Fed explains that they are going to push inflation above 2.0%, there is going to be a pretty spectacular decline in the price of your bond should they achieve their goal.  Will investors be willing to hold paper through that type of decline?  It would not be a surprise to see a pretty sharp sell-off in Treasuries on that type of news.  Remember, too, that Treasury yields have backed up nearly 20 basis points in the past three weeks, perhaps in anticipation of today’s comments.  If Powell delivers, there is likely far more room to run.  If he doesn’t, and there is no clarity, bond investors will be back to reading the economic tea leaves, which continues to be remarkably difficult at this time.

How about the gold market?  Well, here I think the case is quite straight forward.  Clarity as to the Fed’s efforts to drive inflation higher will result in anticipation of lower real yields, and that will be an unalloyed benefit (pun intended).  A lack of clarity and gold will likely continue to consolidate its recent gains.

And finally, what about the dollar?  How will it respond to the Chairman’s speech?  Consider that despite the dollar’s recent rebound, short dollar positions remain at near record levels against both the euro and the DXY futures.  The market scuttlebutt is that the hedge fund community, which was instrumental in the dollar’s recent modest strength as they pared short dollar positions, is ready and raring to buy euros on the idea that higher US inflation will lead to a weaker dollar à la economic theory.  Certainly, if Treasuries sell off, the dollar will see some downward pressure, but one of the things that does not get as much press in the FX market is the equity market impact.  Namely, as long as US equity indices continue to set records, international investors are going to continue to buy them, which will underpin the dollar.

But what if the speech is a dud?  If there is no clarity forthcoming, then the dollar story will revert to its recent past. The bear case continues to be that the Fed’s largesse will dwarf all other nations’ policy easing and so the dollar should resume its decline.  The bull case is that the US economy, at least by recent data, appears to continue to be outperforming its major counterparts, and thus inward investment flows will continue.  That current account deficit is only a problem if international investors don’t want to fund it, and with US equity markets amongst the best performing asset classes globally, that funding is easy to find.  I know I’m not a technician, but recent price action certainly appears to have created a top at the highs from last week, and a further pullback toward 1.1650 seems quite viable.

It is difficult to draw many conclusions from today’s market activity, which is why I have largely ignored it.  Equity markets are leaning a bit lower, although the movement is not large, less than 1%, and the dollar is mixed against both the G10 and EMG blocs.

Arguably, the biggest market risk is that Powell doesn’t tip his hand at all, and that we are no wiser at 10:10 than we are now.  If that is the case, I think the dollar’s consolidation will continue, and by the end of the day, I imagine stock prices will have recouped their early losses.

But for today, it is all about Jay.

Good luck and stay safe
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Deep-Sixed

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This morning the UK released
Fresh data that showed growth decreased
By quite an extent
(Some twenty percent)
Last quarter. Boy, Covid’s a beast!

But really the market’s transfixed
By gold, where opinions are mixed
It fell yesterday
An awfully long way
With shorts praying it’s been deep-sixed

Two stories are vying for financial market headline supremacy this morning; the remarkable collapse in gold (and silver) prices, and the remarkable collapse in the UK economy in Q2. And arguably, they are sending out opposite messages.

Starting with the gold price, yesterday saw the yellow metal fall nearly 6%, which translated into $114/oz decline. On a percentage basis, silver actually fell far further, -14.7%, although for now let’s simply focus on gold. The question is, what prompted such a dramatic decline? Arguably, gold’s rally has been based on two key supports, the increasingly larger negative real yield in US interest rate markets and an underlying concern over the impact of massive monetary stimulus by the Fed and other central banks undermining all fiat currencies. These issues drove a speculative frenzy where gold ETF’s were trading above NAV and demand for physical metal was increasing faster than production.

Looking at the real yield story, last Thursday saw the nadir, at least so far, in that metric, with real10-year Treasury yields falling to -1.08%. However, as risk appetite recovered a bit, nominal yields rebounded by 10bps, and real yields did the same, now showing at ‘just’ -0.99%. At this point, it is important to remember that markets move at the margin, so even though real yields remain highly negative, the modest rebound changed the tone of the trade and encouraged a bout of profit-taking in gold. Simultaneously, we saw a much more positive risk environment, especially after Germany’s ZEW survey showed much better than forecast Expectations, pumping up European equity markets and US ones as well. This simply added to the rationale to take profits on what had been a very sharp, short-term increase in the precious metals markets. As these things are wont to do, the selling begat more selling and bingo, a major correction resulted.

Is this the end of the gold story? I sincerely doubt it, as the underlying drivers are likely to continue their original trend. If anything, what we continue to see from central banks around the world is additional stimulus driving ever lower nominal and real yields. We saw this last night in New Zealand, where the RBNZ increased their QE program and openly discussed NIRP, pushing kiwi (-0.5%) lower. But in this context, the important issue is that, yet another G10 central bank is leaning closer to negative nominal yields, which will simply drive real yields even lower. Simultaneously, additional QE is exactly the issue driving concern over the ultimate value of fiat currencies, so both key factors in gold’s rise are clearly still relevant and growing today. Not surprisingly, gold’s price has rebounded about 1.0% this morning, although it did fall an additional 2.5% early in the Asian session.

As to the other story, wow is all you can say. Q2 GDP fell 20.4% in the UK, more than double the US decline and the worst G10 result by far. Social distancing is a particularly damaging policy for the UK economy because of the huge proportion of services activity that relies on personal contact. But the UK government’s relatively slow response to the outbreak clearly did not help the economy there, and the situation on the ground indicates that there are still several pockets of rampant infection. One thing working in the UK’s favor, and thus the pound’s as well, is that despite the depths of the Q2 data, recent activity reports on things like IP and capital formation have actually been better than expected. The point is, this data, while shocking, is old news, as is evidenced by the fact that the pound is unchanged on the day while the FTSE 100 is higher by more than 1% as I type.

So, what are the mixed messages? Well, the collapse in gold prices on the back of rising yields would ordinarily be an indication of a stronger than expected economic result, as increased activity led to more credit demand and higher yields. But the UK GDP result is just the opposite, a dramatic decline that has put even more pressure on both PM Johnson’s government as well as the BOE to increase fiscal and monetary stimulus, thus driving yields lower and debasing the currency even further. So which story will ultimately dominate? That, of course, is the $64 trillion question, but for now, my money is on weaker growth, lower yields and a gold rebound.

Not dissimilar to the mixed messages of those two stories, today’s session has seen a series of mixed outcomes. For instance, equity markets are showing no consistency with both gainers (Nikkei +0.4%, Hang Seng +1.4%) and losers (Shanghai -0.6%) in Asia with similar mixed action in Europe (CAC +0.4%, DAX 0.0%, Stockholm -0.5%). Not to worry, US futures are pointing higher across the board by roughly 0.75%.

Bond markets, however, are pretty consistent, with 10-year yields higher in virtually every market (New Zealand excepted), as Treasuries rise 2.5bps, UK gilts a similar amount and German bunds a bit more than 3bps. In fact, Treasury yields, now at 0.67%, are 17bps higher in the past 6 sessions, the largest move we have seen since May. But again, I see no evidence that the big picture stories have changed nor any reason for US yields, at least in the front end, to rebound any further. One can never get overly excited by a single day’s movement, especially in as volatile an environment as we currently sit.

Finally, the dollar, too, is having a mixed session, with kiwi the leading decliner, but weakness also seen in JPY (-0.45%) and AUD (-0.25%). Meanwhile, the ongoing rally in oil prices continues to support NOK (+0.55%), with SEK (+0.45%) rising on the back of firmer than expected CPI data this morning. (As an aside, the idea that we are in a massively deflationary environment is becoming harder and harder to accept given that virtually every nation’s inflation data has been printing at much higher than expected levels.)

EMG currencies, keeping with the theme of the day, are also mixed, with TRY (-1.3%) the worst in the world as investors and locals continue to flee the currency and the country amid disastrous monetary policy activity. IDR (-0.55%) is offered as Covid cases continue to rise and despite the central bank’s efforts to contain its weakness, and surprisingly, RUB (-0.25%) is softer despite oil’s rally. On the plus side, the gains are quite modest, but CZK (+0.3%) and ZAR (+0.3%) lead the way with the former simply adding to yesterday’s gains while the rand seemed to benefit from a positive economic survey result.

This morning brings US CPI (exp 0.7%, 1.1% ex food & energy) on an annual basis, but as Chairman Powell and his minions have made clear, inflation is not even a top ten concern these days. However, if we see a higher than expected print, it is entirely realistic to see Treasury yields back up further.

Overall, the dollar remains under modest pressure, but one has to wonder if yesterday’s gold price action is a precursor to a correction here as well. Remember, positioning is extremely short the dollar, so any indication that the Fed will be forced to address inflation could well be a signal for position reductions, and hence a dollar rebound.

Good luck and stay safe
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Risk Assets Betray

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There once was a time in the past
Ere Covid, when risk was amassed
But now every day
Risk assets betray
That fear is still growing quite fast

It is awfully hard to find the bright side of the current situation, whether discussing markets, the economy or the general state of the world. Volatility remains the watchword in markets as yesterday saw the largest US equity decline since Black Monday in October 1987. Globally, economic data that is remotely current continues to show the disastrous impact of Covid-19. The latest print is this morning’s German ZEW Survey where the Expectations reading fell to -49.5, its lowest level since the middle of the Eurozone crisis in 2011. And finally, one need only listen to the number of government pronouncements and edicts including border closures, business closures and curfews to recognize that it will be quite some time before our lives, as we knew them just a few months ago, return to some semblance of normal.

And while it is virtually certain that this situation will ebb over time, we continue to get estimates that are further and further into the future as to when that time will arrive. What had been assumed to be a six-week process is now sounding an awful lot like a six-month process.

But consider this, it is events of this nature that change the zeitgeist and will have much further reaching effects on every industry. For example, given how much of the US (and global) economy has become service oriented, outside of things like food service, I expect that we will see a much greater reliance on telecommuting going forward. Even in bank dealing rooms, a place that I always considered the last bastion of the importance of proximity of workers, we are seeing a pretty effective adjustment to working from remote locations. And you can be sure that whatever issues are currently still impeding the workflow, they will be addressed by technological fixes in short order.

But what does that do to automobile manufacturers and all their supply chains? And while fossil fuels aren’t going to disappear anytime soon, in fact given how much cheaper they have become, they will be able to supplant alternatives for now, at some point, all those industries are going to suffer as well. Ironically, the move toward urbanization that we have seen during the last decade may find itself halted as people decide that not cramming themselves into small apartments with hundreds of other people (mostly strangers) in close proximity, is really a healthier way to live. And certainly, leisure activities are likely to change their nature as well. While the future remains unknown, it certainly does appear that it will look very little like the recent past. Food for thought.

Turning to the markets more specifically, we continue to see a combination of central bank and government activity in increasingly strident efforts to ameliorate the negative economic impacts of Covid-19. So last night the BOJ bought a record amount (¥121.6 billion) of equity ETF’s to help support the stock market. To their credit, the action was able to prevent a further decline in prices there, as the Nikkei closed unchanged on the day. However, it is still lower by 32% since early February’s recent high. In addition, we have seen equity short-selling bans by France, Italy, Spain, South Korea and Belgium as of this morning in an effort to prevent further market declines. Spain is the only market that seems happy about it, rising 2.6% this morning, with the rest of Europe little changed generally. Risk assets are still on the block for sale, its simply a question of the available liquidity for positions to be unwound.

Of greater interest to me are global government bond markets, which are quickly losing their status as haven assets. Despite rate cuts from all over the globe, yields are rising virtually everywhere, even in the US this morning with 10-year Treasuries seeing a 9bp jump. But Bunds have been underperforming for more than a week, with yields on the 10-year there up nearly 50bps in that time. While it makes perfect sense that the PIGS are seeing yields rise in this environment, what I think we are seeing is a combination of two things for ‘safer’ bonds. First, when yields fall this low, a key haven characteristic, limited probability of losing principal, is put at risk, because any reversal in yields will result in very sharp price declines. And second, with the spending commitments that are being made by governments on a daily basis, I think bond investors are starting to price in the idea that there is going to be a massive increase in the supply of bonds starting pretty soon. And asset managers don’t want to get caught in that blitz either. It is the second of these reasons that will continue to drive central banks to promulgate QE measures, and you can be sure we will continue to see those programs coming. In fact, I think the MMTer’s have won the debate, as that is likely to be a very accurate description of monetary policy in the future.

Finally, this morning the dollar has regained its crown and is, by far, the strongest currency around. It has rallied vs. all the G10, and pretty sharply as well. For instance, CAD is the best performer of the bunch today, and it is lower by 0.75%, having found a new home with the dollar above 1.40. SEK and AUD are the worst performers, both down around 1.7%, as the krona is seeing increased speculative betting that they will be forced to go back to negative rates, while Down Under, the Lucky Country has run out of luck with a collapsing Chinese economy crushing commodity prices, and the RBA promising to do more to stop the economy’s slowdown.

In the EMG space, the dollar is also reigning supreme this morning with EEMEA currencies under the most pressure. Given their relative outperformance lately, it cannot be too surprising that we are seeing this type of price action. HUF is today’s laggard, down 2.1%, but PLN (-2.0%), RON (-1.6%) and BGN (-1.2%) are all feeling the pain. Asian currencies are also lower, but generally not by quite as much, although IDR and KRW are both lower by around 1.5%.

Ultimately, the dollar’s strength today is probably best attributed to the absolute blowout in the basis swaps market, where borrowing dollars vs. other currencies has become hugely expensive. Given the way economic activity is contracting so rapidly, and so revenues everywhere are shrinking, all those non-US companies that need to repay dollar debt are desperate to get hold of the buck. Once financing charges rise high enough, the next step is generally outright purchases of dollars on the FX market. And that is what we are seeing this morning. Look for more of that going forward.

It’s ironic, Retail Sales is released this morning (exp 0.2%, 0.1% ex autos) on the same day I received emails that Nordstrom is closing its stores for the next two weeks along with a myriad of other smaller retailers. We also see IP (0.4%), Capacity Utilization (77.1%) and the JOLT’s Jobs Report (6.40M). But again, this data looks backward and in the quickly evolving world today, I doubt it will have an impact. Rather, while risk stabilized somewhat overnight, my sense is this is a temporary situation, and that we are going to see another wave of risk reduction, certainly before the week is over. So, for now, the dollar will continue to find a lot of demand.

Good luck
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Times of Trouble

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In times of trouble
The yen continues to be
Mighty like an oak

Pop quiz! What percentage of the workforce is working at their primary site vs. home or an alternate site? Please respond with where you’re working and your guesstimates. Will publish results of this (completely unscientific) survey on Monday, March 16.

As markets around the world continue to melt down, investors everywhere are looking for a haven to retain capital. For the past 100 years, US Treasuries have been the number one destination in markets. Interestingly, the past two days saw Treasuries sell off aggressively. I think the move was initially based on the relief rally seen on Tuesday, but at this point, the fact that Treasury prices fell alongside yesterday’s stock rout can only be explained by the idea that institutions that need cash are selling the only liquid assets they have, and Treasuries remain quite liquid. And to be clear, 10-year yields are lower by 18bps this morning as that bout of selling seems to have passed and the haven demand has returned in spades.

But since the financial crisis, the second most powerful haven asset has been the Japanese yen. Despite the fact that the nation has basically been in an economic funk for two decades, it continues to run a significant current account surplus. As a consequence, Japanese external investment is huge and when fear is in the air, that money comes running back home. The evolution of the coronavirus spread can be seen in the yen’s movement as in the middle of February, when Japan itself was dealing with the growth in infections, the yen weakened to a point not seen in nearly a year. Since then, however, the yen has strengthened 7.5% (with a peak gain of 9.8% seen Monday) as flows have been decidedly one way. This morning the yen has appreciated 0.7% from yesterday’s close and quite frankly, until the pandemic starts to ebb, I see no reason for it to stop appreciating. Par will pose a short-term psychological support for the dollar, but if this goes on for another two months, 95 is in the cards. With that in mind, though, for all yen receivables hedgers, zero premium collars are looking awfully good here. Let’s talk, at the very least you should be apprised of the pricing.

Interestingly, the Swiss franc has had a somewhat less impressive performance despite its historic haven characteristics. While it has appreciated 4.5% in the same time frame, it has been having much more trouble during the latest equity market decline. And I think that is the reason why. Famously, the Swiss National Bank has 20% of its balance sheet invested in individual equities. This is a very different investment philosophy than virtually every other central bank. The genesis of this came about when the SNB was intervening on a daily basis while trying to cap the franc and ultimately needed a place to put the dollars and euros they were buying. I guess the view was stocks only go up, so let’s make some money too. Whatever the reason, as of December 31 the USD value of their equity portfolio was about $97.6 billion. I’m pretty confident that number is a lot lower today, and perhaps the idea about Swiss franc strength is being called into question. The franc is unchanged today and has been generally unimpressive for the past week.

Meanwhile, all eyes this morning are on Madame Lagarde and the ECB who will be announcing their latest policy initiatives shortly. While it is clearly expected they will do something, other than a 10bp cut in the deposit rate, to -0.60%, there is a great deal of uncertainty. Expectations range from expanding the TLTRO program with much more aggressive rates, as low as -2.00%, to a significant increase in QE to capping government bond yields. All of that would be remarkably dramatic and likely have a short-term positive impact on markets. But will it last? My sense is that until the Fed announces next week, and at this point I think they cut 100bps, markets will still be on edge. After all, the world continues to revolve around USD funding, and in times of crisis, foreign entities need access to USD liquidity. Look for more repo, more swap lines and maybe even a lending scheme although I don’t think the Fed can do something like that within their mandate.

Overall, the dollar is performing as the number two currency haven, after the yen, and has rallied sharply against commodity currencies in both the G10 and EMG spaces. For example, with oil down 5% this morning, NOK has fallen 3.6%, but both AUD and SEK are lower by 1.5% as well. In the emerging markets, Mexican peso continues to be the market’s whipping boy, falling a further 3.2% as I type, which takes its decline since the beginning of the month to 12.2%. meanwhile, the RUB is in similarly dire straits (-2.75% today, -11.5% in March) and we are seeing every single EMG currency lower vs. the dollar today. These are the nations that are desperate for USD liquidity and you can expect their currencies to continue to decline for the foreseeable future.

At this point, data is an afterthought, but it is still being released. Yesterday saw CPI rise a tick more than expected but the more interesting data point was Mortgage Applications, which jumped 55.4% as mortgage rates collapse alongside Treasury yields. This morning brings Initial Claims (exp 220K) and PPI (1.8%, 1.7% core) with far more interest in the former than the latter. Consider, given the enormous economic disruptions, it would be easy to see that number jump substantially, which would just be another signal for the Fed to act as aggressively as possible.

At this point, as the equity meltdown continues, the dollar should remain well supported vs. everything except the yen.

Good luck
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Those Doves

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The dollar continues as king
Of currencies and that’s the thing
The Fed really loves
Especially those doves
Who want to cut rates before spring

It’s not really clear to me what else to discuss these days as everything runs through the following chain of thought: how long before the Covid-19 pandemic epidemic passes its peak; what will be the ultimate economic impact; and when will we see more aggressive monetary intervention by central banks, notably the Fed.

Since the Lunar New Year holiday (and coronavirus scare) began, back on January 24, the dollar has rallied vs. every other currency on the planet. I think it is worthwhile to consider just how big this move has been:

Swiss franc -0.70%
Japanese yen -0.95%
Canadian dollar -1.28%
British pound -1.40%
Danish krone -1.62%
Euro -1.63%
Swedish krona -2.10%
Australian dollar -4.03%
Norwegian krone -4.12%
New Zealand dollar -4.84%

Source: Bloomberg

A look at this list of currencies reveals pretty much what you would expect; those with the highest beta to China’s economy, Australia and New Zealand, have fallen the furthest, along with the currency most closely linked to the price of oil, Norway. Of course, since that day, the price of WTI has tumbled nearly 15%, on significantly reduced demand, so it is no surprise NOK has suffered. Perhaps more interestingly is that both the Swiss franc and Japanese yen, considered the two safest currencies, have both given up solid ground vs. the greenback as well. Any idea that the dollar has lost its haven status is simply incorrect. Granted, one of the key reasons the dollar is a haven is due to US Treasuries, which nobody denies as the safest of havens, and which have seen yields tumble in this same time period amidst substantial demand. In fact, 10-year Treasury yields are down by 37bps in the past month.

The emerging market picture is no different, with even HKD, the pegged currency, lower by 0.25% since the Lunar New year began. While a chart here would be too long, the highlights are as follows: commodity producing countries have seen the worst performance with ZAR (-5.6%, RUB (-5.6%), BRL (-5.0%) and CLP (-4.7%) leading the way. After those come the currencies from those nations most closely linked to China’s economy; notably THB (-4.4%), KRW (-4.0%), MYR (-3.7%) and SGD (-3.3%). The renminbi itself is down 1.1%, which all things considered is a pretty good performance, but also one that is being strictly controlled by the PBOC. As to the rest of the EMG bloc, every one of them has weakened in this time frame, many despite local central bank intervention, and quite frankly, all of their prospects are directly dependent on how the Covid-19 epidemic plays out.

Yesterday’s halting efforts at a rebound were quashed when the CDC revealed the truth that Covid-19 was coming to a city near you at some point and would likely result in significant disruptions in daily life. And of course, the market reactions to comments like these are the reason that officials, especially central bank and FinMin types, routinely lie about conditions. The truth often results in unfavorable outcomes, especially for elected officials.

So a quick recap of the overnight news is that there were more cases highlighted in Italy, South Korea, and Iran, with Brazil finally getting its first confirmed infection. The death toll continues to climb, currently at 2,715 as the official count of infections is well over 80K. As well, in the past twenty-four hours we have heard from central bank officials around the world explaining that it is too soon to react, but they are carefully monitoring the situation and primed and ready to adjust policy if it is deemed necessary. FWIW my view is that if we see US equities fall another 5% this week, we are going to see an emergency rate cut, even before the March 18 meeting. Too, futures markets are now pricing in the first Fed cut in June with two cuts by September. When all this started back at the Lunar New Year, the probability of a June cut was just 19% and a full cut wasn’t priced in until December. One important thing to remember is that the Fed has never disappointed the market on a policy move when it was fully priced by the futures market. It will take a great deal of both positive news and serious discussion by Fed speakers to avoid a real mess come the middle of March if they really don’t want to cut rates.

There was virtually no economic news overnight and this morning brings only New Home Sales (exp 718K), which is the one part of the economy that should continue to benefit from the remarkably low interest rate structure. Currently we are seeing European equity markets continuing their sell-off although US futures have stopped hemorrhaging for the time being and are essentially flat as I type. But until we see some positive news, like a cure has been found, it is difficult to expect the current momentum will change. With that in mind, I expect that equities will remain under pressure, Treasuries will remain well bid and the dollar will continue to find adherents.

Good luck
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All Stressed

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It started in China’s Great Plains
Where factories for supply chains
Were built wall to wall
But now they have all
Been shuttered to stop Covid’s gains

However, the sitch has regressed
While China, their data’s, repressed
Thus Covid’s now spreading
And everywhere heading
No shock, stocks worldwide are all stressed

I know each and every one of you will be incredulous that the G20 meeting of FinMins and central bankers this weekend in Saudi Arabia was not enough to stop Covid-19 in its tracks. I certainly was given the number of statements that we have heard in recent weeks by central bankers explaining that if the virus spreads, they will save the day!

But clearly, whatever power monetary or fiscal power has, it is not well placed to solve a healthcare crisis that is rapidly spreading around the world. This weekend may well have been the tipping point that shakes equity investors out of their dream-induced state. While the steady growth in numbers of infections and fatalities in China remains constant, something which seems to have been accepted by investors everywhere, the sudden jump in Covid cases in South Korea and, even more surprisingly, in Italy looks to have been just the ticket to sow doubt amongst the bullish investment set. And just like that, as markets are wont to do, fear is the primary sentiment this morning.

A quick market recap shows that equity markets worldwide have been decimated, although Europe (DAX -3.5%, CAC -3.5%, FTSE 100 -3.2%, FTSE MIB (Italy) -4.6%) has felt the brunt more than Asia (Nikkei -0.4%, Hang Seng -1.8%, Kospi -3.9%, Shanghai -0.3%). And US futures? Not a pretty picture at this point, with all three down more than 2.5% as I type.

Benefitting from the risk-off sentiment are Treasury bonds (yields -8bps to 1.39%) and bunds (-6bps to -0.50%), while the barbarous relic itself is up 2.4% to $1682/oz. And you thought gold was no longer important!

Finally, in the currency markets, the dollar is king once again, gaining against all comers but one, quite sharply in some cases. The yen has regained some of its haven status, rallying 0.25% this morning, although it remains far lower than just last Thursday. But the rest of the G10 is under pressure with NOK (-1.0%) falling the most as oil prices (WTI -4.0%) are getting crushed today. By contrast, CAD (-0.45%) seems almost strong in the face of the weakness in oil. But aside from the yen, the rest of the bloc is lower by at least 0.25%, and there is nothing ongoing in any of these nations that is driving the story, this is pure risk aversion.

In the EMG space, the story is more of the same, with the entire space lower vs. the dollar today although the biggest losers may be a bit of a surprise. Pesos are feeling the heat with both Mexico (-1.2%) and Chile (-1.1%) the worst performers in the space. The latter is a direct response to the weakness in copper prices, while the former has multiple problems, with oil’s decline just the latest. In fact, since last Thursday morning, the peso has fallen nearly 3.0% as we are beginning to see the very large long MXN carry position start to be unwound. It seems that long MXN had the same perception amongst currency investors as long the S&P had for equity investors. The thing is, at least according to the CFTC figures from last week, there is still a long way to go to reach neutrality. We are still more than 12% from the peso’s all-time lows of 22.03 set in early 2017, but if Covid continues to evade control, look for that level to be tested in the coming months (weeks?).

And that’s today’s story really. There are some political issues in Germany, as the ruling CDU finds itself in the middle of a leadership contest with no clear direction, while Italy’s League leader, Matteo Salvini, is hurling potshots at the weakened Giuseppe Conti government. But even under rock solid leadership, the euro would be lower this morning as would each nation’s stock market. Perhaps of more concern is the news that China, despite the ongoing spread of Covid-19, was relaxing some of its quarantine restrictions as it has become clearer by the day that the economic impact on the mainland is going to be quite substantial. President Xi cannot afford to have GDP growth slow substantially as that would break his tacit(?) deal with the people of more government control for continued material improvement. It has been a full month since virtually anything has been happening with respect to manufacturing throughout China and we are seeing more and more factories elsewhere (South Korea, Eastern Europe) shut down as supply chains have broken. Shipping rates have collapsed with more than 25% of pre-Covid activity having disappeared. This will not be repaired quickly I fear.

Turning to the data, which is arguably still too early to really reflect the impact of the virus, this week brings mostly secondary numbers, although we do see core PCE, which is forecast to have increased by a tick.

Tuesday Case-Shiller Home Prices 2.85%
  Consumer Confidence 132.1
Wednesday New Home Sales 715K
Thursday Q4 GDP 2.1%
  Durable Goods -1.5%
  -ex transport 0.2%
  Initial Claims 211K
Friday Personal Income 0.4%
  Personal Spending 0.3%
  Core PCE 0.2% (1.7% Y/Y)
  Chicago PMI 46.0
  Michigan Sentiment 100.7

Source: Bloomberg

Of course, the Fed has made it quite clear that they have an entirely new view on inflation, namely that 2.0% is the new 0.0%, and that they are going to try to force things higher for much longer to make up for their internally perceived failures of reaching this mythical target. We all know that the cost of living has risen far more rapidly than the measured inflation statistics, but that does not fit into their models, nor does it given them an excuse to continue to pump more liquidity into markets. In fact, it would not be that surprising to see them double down if today’s declines continue for several days. After all, that would imply tightening financial conditions.

But for now today is the quintessential risk-off day. Look for the dollar to remain king while equities fall alongside Treasury yields.

Good luck
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