Risk Assets Betray

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
Adf

 

Times of Trouble

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
Adf

Those Doves

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
Adf

 

All Stressed

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
Adf

Set For Stagnation

When thinking of every great nation
Regarding its growth expectation
The US alone
Is like to have grown
While others seem set for stagnation

The upshot of these circumstances
Is regular dollar advances
Within the G10
It’s euros and yen
That suffer on policy stances

Another day, another dollar rally. This simple sentiment pretty well sums up what we have been seeing for the past several weeks. And while there may be a multitude of catalysts driving individual currency movements, the reality is they all point in the same direction, a stronger dollar. Broadly speaking, data from around the world, excluding the US, has been consistently weaker than expected while the US continues to hum along nicely. Now, if China’s economy remains in its current catatonic state for another month, one has to believe that US numbers are going to suffer, if only for supply chain reasons. But right now, it is difficult for anyone to make the case that another currency is better placed than the dollar.

For example, last night we saw Australian Unemployment unexpectedly rise to 5.3% as the first measured impacts of Covid-19 make themselves felt Down Under. Traders wasted no time in selling Aussie and here we are this morning with the currency lower by 0.75%, trading to new lows for the move and touching its lowest level since March 2009. Perhaps the Lucky Country has run out of luck.

The yen keeps falling
Like ash from Fujiyama
Is an end in sight?

At this point in the session, the yen has seen its largest two-day decline since November 2016, in the immediate wake of President Trump’s election, and has now fallen more than 2.0% since Tuesday morning. It has broken through a key technical level at 111.02, which represented a very long-term downtrend line. This has encouraged short-term traders to add to what is believed to be significant outflows from Japanese investors, notably insurance companies. One of the other interesting things is that Japanese exporters, who are typically sellers of USDJPY, seem to be sitting this move out, having filled orders at the 110 level, and are now apparently waiting for 115. While it is unlikely that we will see the yen continue to decline 1% each day, I have to admit that 115 seems quite realistic by the end of the Japanese fiscal year next month.

And those are just two of the many stories that seem to be coming together simultaneously to encourage dollar buying. Other candidates are ongoing weak Eurozone economic data (Eurozone Construction output falling and reduced forecasts for tomorrow’s flash PMI data), rate cuts by EMG central banks (Indonesia cut by 25bps last night), and more confusion from China regarding Covid-19 and its spread. Last night, they changed the way they count infections for the second time in a week, and shockingly the result was a lower number indicating the spread of the disease is slowing. However, at this point, the virus count seems to be having less of a market impact than little things like the announcement that Hubei province is keeping all factories shuttered until at least March 10. Now I don’t know about you, but that hardly seems like the type of thing that indicates things are getting better there.

There is a new tacit contest in the market as well, trying to determine just how big a hit the Chinese economy is going to take in Q1. If you recall two weeks ago, the initial estimates were that GDP would grow at a 4%-5% rate in Q1. At this point 0.0% seems a given with a number of analysts penciling in negative growth for the quarter. And folks, I don’t know why anyone would think there is going to be a V-shaped recovery there. It is going to take a long time to get things anywhere near normal, and there has already been a lot of permanent demand destruction. On top of that, one of the things I had discussed last week, the idea that even if companies aren’t generating revenue, they still need to pay interest on their debt, is starting to be seen more publicly. The news overnight that HNA Group, a massively indebted conglomerate that had acquired trophy assets all around the world (stakes in Hilton Hotels and Deutsche Bank amongst others) is unable to pay interest on its debt and seems to be moving under state control. While the PBOC cut rates slightly overnight, the one-year loan prime rate is down to 4.05% from 4.15% previously, it appears that the Chinese government is going to be fighting the Covid-19 fight with more fiscal measures than monetary ones. That said, the renminbi has been falling along with all other currencies and has traded back through 7.00 to the dollar after a further 0.35% decline overnight.

The point is that you can essentially look at any currency right now and it is weaker vs. the dollar. Each may have its own story to tell, but they all point in the same direction.

I would be remiss to ignore other markets, which show that other than Chinese equity markets (Shanghai +1.85%), which rallied last night after news of further stimulus measures, risk is mostly on its back foot today. European equity markets are generally lower (DAX -0.1%, CAC -0.1%) although not by much. US futures are pointing lower by 0.2% across the board, again, not significant, but directionally the same message. Treasury yields continue to fall, down another 2bps this morning to 1.54%, and gold continues to rally, up another 0.3% this morning.

Yesterday’s FOMC Minutes explained that the Fed was pretty happy with current policy settings, something we already knew, and that they are still unsure how to change their ways to try to be more effective with respect to achieving their inflation target as well as insuring that there are no more funding crises. On the data front, yesterday’s PPI data was much firmer than expected, although most people pretty much ignore those numbers. Today we see Philly Fed (exp 11.0), Initial Claims (210K) and Leading Indicators (0.4%). Monday’s Empire Mfg data was stronger than expected and the forecasts for Philly Fed are for a solid increase. Yet again, the data picture points to a better outcome in the US than elsewhere, which in the current environment will only encourage further USD buying. For now, don’t get in front of this train, but if you need to hedge receivables, sooner is better than later as I think we could see this run for a while.

Good luck
Adf

Simply Too Fraught?

The question whose answer is sought
‘Bout what should be sold or be bought
Is will GDP
Rebound like a V
Or are things just simply too fraught?

Risk is neither on nor off this morning as investors and traders continue to sift through both the recent changes in coronavirus news from China and the economic releases and choose a direction. Thus far this morning, that direction is sideways.

In one way, it is a bit surprising there is not a more negative viewpoint as on top of the surge in reported cases of Covid-19 (the coronavirus’s official name), we have heard of more companies closing operations outside of China for lack of parts. The latest is Fiat Chrysler, which closed a manufacturing facility in Serbia due to its inability to source parts that are built in China. While the Chinese government is seemingly trying to get everyone to believe that things are going to be back to normal soon, manufacturers on the ground there who have reopened, are running at fractions of capacity due to an inability of workers to get to the plant floor. Huge swaths of the country remain in effective lockdown, and facemasks, which are seen as crucial to getting back to work, are scarce. Apparently, the capacity to make face masks in China is just 22 million/day. While that may sound like a lot, given everyone needs a new one every day, and that there are around 100 million people under quarantine (let alone 1.3 billion in the country), there just aren’t enough to go around. I remain skeptical that this epidemic will come under any sense of control for a number of weeks yet, and that ultimately, the hit to global economic growth will be far more severe than the market is currently pricing.

Another sign of trouble came from Germany this morning, where Q4 GDP was released at 0.0% taking the annual growth rate to 0.6% in 2019. Eurozone GDP turned out to be just 0.9% in 2019, and that was before the virus was even discovered. In other words, it appears that both those numbers are going to be far worse in Q1 as the Eurozone remains highly reliant on exports to grow, and as the Fiat news demonstrates, exports are going to be reduced.

Keeping this in mind, it is easy to understand why the euro remains under so much pressure. While its decline this morning is just 0.1%, to 1.0830, the euro is trading at its lowest level vs. the dollar since April 2017. The single currency has fallen in 9 of the past 10 sessions and is down 2.4% this month. And let’s face it, on the surface; it is awfully difficult to make a case for the euro to rebound on its own. Any strength will require help from the dollar, meaning either weaker US economic data, or more aggressive Fed policy ease. At this point, neither of those looks likely, but the impact of Covid-19 remains highly uncertain and can easily derail the US economy as well.

But for now, the narrative remains that Chinese GDP growth in Q1 will be hit, but that by Q2 things will be rebounding and this will all fade from memory akin to the SARS virus in 2003. Just remember, China has effectively been closed since January 23, three full weeks, or 6% of a full year. While manufactured goods demand will certainly rebound, there are many services that simply will never be performed and cannot be recouped. The PBOC is already tweaking leverage policies on property lending in an effort to help further support growth going forward, and there is discussion of allowing banks to live with a greater proportion of non-performing loans that are due to the coronavirus. One can only imagine all the garbage loans that will receive that treatment!

Switching to a view of the markets, equity markets are +/- 0.2% generally speaking with US futures in a similar position. Treasury yields have fallen back a few bps, giving up yesterday’s modest gains, and the FX market, on the whole, is fairly benign. Away from the euro’s small decline this morning, we are seeing slight weakness in the pound, Aussie and Kiwi, with the rest of the G10 doing very little. The one gainer today is CAD, +0.15%, which seems to be benefitting from WTI’s ongoing bounce from Monday’s low levels, with the futures contract there higher by 1.4%.

In the EMG space, ZAR is today’s big winner, up 0.65%, in response to President Cyril Ramaphosa’s State of the Nation speech, where he outlined steps to help reinvigorate growth and fix some of the bigger problems, like the state-owned power producer Eskom’s debt issues. Of course, speeches are just that and the proof will be in what policies actually get implemented. The other key gainers here are BRL (+0.6%), which saw the central bank (finally) intervene yesterday to try to stop the real’s dramatic recent plunge (it had fallen more than 4% in the past 10 days and nearly 10% in 2020 so far). After announcing $1 billion in swaps, the market turned tail and we are seeing that continue this morning. HUF also continues to benefit, rallying a further 0.55% this morning, as the market continues to price in growing odds of a rate hike to help rein in much higher than expected inflation.

On the data front, this morning brings Retail Sales (exp 0.3%, 0.3% ex autos) as well as IP (-0.2%), Capacity Utilization (76.8%) and Michigan Sentiment (99.5). Yesterday’s CPI data was a touch firmer than forecast, simply highlighting that the Fed’s measure of inflation does not do a very good job. Also yesterday, we heard from NY Fed President Williams who told us the economy is in a “very good place”, while this morning we hear from uber-hawk Loretta Mester. This week the doves have all cooed about letting inflation run hot and cutting if necessary. Let’s hear what the hawks think.

So as we head into the weekend, I expect traders to reduce positions that have worked as the potential for a weekend surprise remains quite large, and nobody wants to get caught. That implies to me that the dollar can soften ever so slightly as the day progresses.

Good luck
Adf

Coming Up Short

All week what the market has said
Is fears in re China are dead
But last night it seems
The latest of memes
Showed fear is still somewhat widespread

This morning the payroll report
If strong, ought, the dollar, support
The US this week
Has been on a streak
While Europe keeps coming up short

After a week where early fears about the spread of the coronavirus morphed into a belief that any issues would be contained and have only a short term impact on the global economy, it seems that some investors and traders are having second thoughts. For the first time since last Friday, equity markets around the world have fallen, albeit not very far, and risk is starting to be unloaded. Certainly, this could well be short-term profit taking. After all, since Friday’s close on the S&P 500, the index was higher by nearly 4% as of last night, and pretty much in a straight line. The remarkable thing about the equity rally, which was truly global in nature, was that it very studiously ignored the ongoing growth of the epidemic and its economic impacts.

Last night, however, it seems the announcements by Toyota and Honda that they would extend their mainland Chinese factory shutdowns by another week, as well as the force majeure declarations by Chinese energy and copper companies have served to highlight just how severely economic activity in China is slowing. Alas, the human impact continues its steady climb higher, with more than 600 deaths now attributed to the virus and more than 31,000 cases confirmed. It certainly appears as the situation has not yet reached anything near a peak, which implies that more market impacts are still to come.

One of the things we are beginning to see is a more significant reduction in expectations for Chinese economic activity this year. Last night, several more analysts reduced their expectations for Q1 GDP growth there by more than 2%. Given the fact that China has quarantined some 90 million people at this point, which is a remarkable 6.5% of the population, I expect that before all is said and done, Q1 GDP growth in China is going to be much lower, probably on the order of 2% annualized. In fact, I would not be surprised if the Chinese don’t release a Q1 number at all. There is precedent for this as just last night, the customs administration there announced that there would be no January trade data release, and that the numbers would be merged with February’s data to smooth out the impact of the Lunar New Year. Assuming the virus situation is under control by the end of Q1, it would be well within the Chinese prerogative to do the same with that data, hopefully masking just how bad things were.

In the end, there was nothing positive to be learned from Asia last night, which was confirmed by weakness in both equity markets throughout the region as well as the FX markets, where every currency in the APAC group fell. And all of this movement is directly attributable to the virus story.

Moving westward to Europe, things are looking no better there this morning, with equity markets lower across the board and their currencies also under pressure. NOK is the worst performer, down 0.6% as fears over further weakness in the oil market are weighing on the currency. But, the euro is feeling more heat today as well; down 0.25% after IP data from everywhere in the Eurozone was markedly disappointing. Germany (-3.5%), France (-2.8%), Spain (-1.4%) and the Netherlands (-1.7%) demonstrated that a risk of a recession remains quite real on the continent. In fact, you may recall how Germany barely dodged that recession status in Q4, when GDP rose 0.1% in a bit of a surprise. Well, right now, Q1 looks like it is going to be negative again. It seems to me that if a country has three negative GDP prints in six quarters, with the other three quarters printing around +0.1%, that could easily be defined as a recession. But regardless of how it is described in print, the reality is that Germany has not come out of its funk yet, and it may be dragging the rest of Europe down with it.

But there is something else ongoing in the euro which is likely to have been a significant part of the currency’s recent weakness. Recall that LVMH has agreed to buy Tiffany’s for ~$16.5 billion. Well, LVMH issued both EUR (7.5 billion) and GBP (1.5 billion) bonds this week to pay for the purchase, which means that there was a massive conversion in both currencies that is a one-way flow. And as large as these markets are, a significant dollar purchase like that is going to have a major impact. As I wrote earlier this week, the euro is leaning heavily on support at 1.0950, and if it manages to break through, there is nothing technically in the way until 1.0850. If you are a payables hedger, this could be an excellent opportunity.

Turning to the US, this morning is payrolls day. After Wednesday’s blowout 291K number for ADP Employment, expectations are running high that things are going to be quite good. The current median forecasts are as follows:

Nonfarm Payrolls 165K
Private Payrolls 155K
Manufacturing Payrolls -2K
Unemployment Rate 3.5%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.3
Participation Rate 63.2%

Source: Bloomberg

A quick look at the revisions in NFP estimates since the ADP number shows that the average is now 180K. As I said, expectations are running high. And given the strength of US data we have seen all week, if we do get a strong number, I expect to see the dollar break higher, likely taking out technical resistance in a number of currencies.

To recap, we have a risk-off session leading up to a key economic indicator. It will be interesting to see if strong US data can offset the growing fear of further negative news from china, but ironically, I think that the dollar is likely to be in demand regardless of the outcome. A weak number implies a potential negative impact from the virus, and risk-off which helps the dollar. A strong number means that the US remains above the fray, and that US investments are poised to continue to lead the world, thus drawing in more dollar buyers. Either way, the dollar seems primed to rally further today.

Good luck and good weekend
Adf

Strength in Their Ranks

Around the world, all central banks
Are to whom we need to give thanks
By dint of their easing
All shorts they are squeezing
Who knew they’d such strength in their ranks?

Every day that passes it becomes clearer and clearer that central banks truly are omnipotent. Not only do they possess the ability to support economies (or at least stock markets), but apparently, easing monetary policy cures the coronavirus infection. Who knew they had such wide-ranging powers? At least that is certainly the way things seem if you look through a market focused lens.

Let’s recap:

Date # cases / # deceased S&P 500 Close 10-Year Treasury EURUSD USDJPY
31 Dec 1 / 0 3230 1.917% 1.1213 108.61
6 Jan 60 / 0 3246 1.809% 1.1197 108.37
10 Jan 41 / 1 3265 1.82% 1.1121 109.95
20 Jan 219 / 3 3320 1.774% 1.1095 110.18
22 Jan 500 / 17 3321 1.769% 1.1093 109.84
24 Jan 1320 / 41 3295 1.684% 1.1025 108.90
28 Jan 4515 / 107 3276 1.656% 1.1022 109.15
30 Jan 7783 / 170 3283 1.586% 1.1032 108.96
3 Feb 17,386 / 362 3248 1.527% 1.1060 108.69
4 Feb 24,257 / 492 3297 1.599% 1.1044 109.59

Sources: https://www.pharmaceutical-technology.com/news/coronavirus-a-timeline-of-how-the-deadly-outbreak-evolved/and Bloomberg

Now obviously, they are not actually creating a medical cure for this latest human affliction (I think), but once it became clear that the coronavirus was going to have a significant impact on the Chinese, and by extension, global economies, they jumped into action. While it was no surprise that the PBOC immediately eased policy to head off an even larger stock market rout upon the (delayed) return from the Lunar New Year holidays, I think there was a larger impact from Chairman Powell, who at the Fed press conference last week, made it clear that the Fed stood ready to react (read cut rates) if the coronavirus impact expanded. And then, just like that, the coronavirus was relegated to the agate type of newspapers.

What is really amazing is how the narrative has been altered from, ‘oh my gosh, we are on the cusp of a global pandemic so sell all risky assets’ to ‘the flu is actually a much bigger problem globally and this coronavirus is small potatoes and will be quickly forgotten, so buy those risky assets back’.

The point here is that market players lead very sheltered lives and really see the world as a binary function, is risk on or is risk off? And as long as the central banks continue to assure traders and investors that they will do whatever it takes to prevent stock markets from declining, at least for any length of time, those central banks will continue to control the narrative.

So, with that as preamble, what is new overnight? In a modest surprise, at least on the timing, the Bank of Thailand cut rates by 25bps to a record low 1.00%. The stated reason was as a prophylactic to prevent economic weakness as the coronavirus spreads. Too, the MAS explained that they have plenty of room to ease policy further (which for them means weakening the SGD) if they deem the potential coronavirus impacts to call for such action. It should be no surprise that SGD is today’s weakest link, having fallen 0.75% but we also saw immediate weakness in THB overnight, with the baht falling nearly 1.0% before a late day recovery on the back of flows into the Thai stock exchange. As to the rest of the EMG space, PHP is also modestly weaker after the central bank there indicated that they would cut rates as needed, but we have seen more strength across the space in general. RUB is leading the pack, up 0.8% on the back of a strong rebound in oil prices (WTI +2.3%), but we are also seeing strength throughout LATAM as CLP (+0.7%), BRL (+0.55%) and MXN (+0.4%) all rebound on renewed risk appetite. ZAR has also had a banner day, rising 0.7% on the positive commodity tone to markets.

In the G10 space, things are a bit less interesting. It should be no surprise that AUD is the top performer, rising 0.4%, as it has the strongest beta relationship to China and risk. NOK is also gaining, +0.25%, with oil’s recovery. On the other side of the blotter, CHF (-0.3%) and JPY -0.15%, but -1.0% since yesterday morning) are taking their lumps as haven assets no longer hold appeal to the investment community. This idea has been reinforced by the 10-year Treasury, which has seen its yield rise from 1.507% on Friday to 1.63% this morning.

And don’t worry, your 401K’s are all green again today with equity markets around the world back on the elevator to the penthouse.

Turning to today’s US session, we start to get some more serious data with ADP Employment (exp 157K), the Trade Balance (-$48.2B) and ISM Non-Manufacturing (55.1). Earlier this morning we saw Services PMI data from both Europe and the UK. Eurozone PMI data was mixed (France weak and Italy strong), while the UK saw a strong rebound. We also saw Eurozone Retail Sales, which were quite disappointing, falling 1.6% in December, and seemingly being the catalyst for the euro’s tepid performance today, -0.2%. Remember, Monday’s US ISM data was much better than expected, and there is no question that the market is willing to believe that today’s data will follow suit.

In sum, continued strong performance by the US economy, at least relative to its peers, as well as the working assumption that should the data start to falter, the Fed will be slashing rates immediately, will continue to support risk assets. At this point, that seems to be taking the form of buying high yield currencies (MXN, ZAR, INR) while buying the dollar to increase positions in the S&P500 (or maybe just in Tesla ). As such, I look for the dollar to hold its own vs. the bulk of the G10, but soften vs. much of the EMG bloc.

Good luck
Adf

Investors Remain Unconcerned

There once was a time in the past
When market bears quickly amassed
Positions quite short
While they would exhort
Investors, their holdings, to cast

But these days the story has turned
So bears that go short now get burned
A global pandemic?
It’s just academic
Investors remain unconcerned

One has to be impressed with the current frame of mind of global investors as they clearly feel bulletproof. Or perhaps, one has to be impressed with the job that central bankers around the world have done to allow those feelings to exist.

The coronavirus is quickly becoming back page news, where there will be a tally of cases and deaths daily, morphing into weekly, as the investment community turns its attention to much more important things, like how many new streaming customers each of the streaming services picked up in Q4. It seems the fact that China’s economy is going to feel some extreme pain in Q1 is being completely dismissed. At least from the market’s perspective. And this is where the central banks get to take a bow. It turns out that overwhelming liquidity support is all one needs to make people forget about everything else. It is truly the opioid of the market masses.

So as you sit down this morning you will see that equity markets around the world are on a tear higher, with every market that has been open today in the green, most by well more than 1%. And don’t worry; US futures are all more than 1% higher as well. Everything is clearly fantastic!

Last night, the PBOC fixed the renminbi more than 0.5% stronger than the market would have indicated, thus demonstrating they would not let things get out of hand. Then after a weak opening, where equity indices there fell more than 2%, the government stepped in along with official buyers and turned the tide higher. Once this occurred, equity markets elsewhere in Asia took their cues and everything rallied. Risk was no longer anathema and we have seen that across all assets as havens come under pressure and other risk assets, notably oil has rebounded. The lifecycle of a negative event has grown increasingly shorter as central banks continue to demonstrate their willingness to do ‘whatever it takes’ to prevent a sell-off of any magnitude in any equity market.

This is not just a US phenomenon, but a global one. To me the question is: Is this peak financialization of the global economy? By that I mean are we now in a period where the real economy, the one where cars and other stuff are manufactured and food is grown, has become completely secondary to the idea that companies that do those things need to be entirely focused on their capital structure to be sure that they are appropriately overleveraged? While I recognize that I am old-fashioned in my thoughts, I cannot help but believe that we are going to see a pretty significant repricing of assets at some point in the not too distant future. In truth, despite the market’s insouciance with regard to the ongoing coronavirus outbreak, it is entirely possible that it continues to expand for several more months and that China, the second largest economy in the world and one representing 16% of total global economic activity, does not grow at all in Q1 while supply chains are closed and manufacturing around the world grinds to a much slower pace. Many recessions have been born of less than that. Just remember, trees don’t grow all the way to the sky, and neither do economies!

So let’s turn back to the other things ongoing in this morning’s session. Broadly speaking, the dollar is under modest pressure along with Treasury bonds and the Japanese yen. After all, safe havens do not boost your returns when Tesla is rallying 20% a day! There has been limited data today (Italian CPI +0.5% Y/Y) so FX markets are watching equities. Yesterday saw a big surprise in the US ISM data, which printed above 50 for the first time since July and has a number of analysts reconsidering their forecasts for slowing growth. The dollar definitely responded to this yesterday, rallying across the board as Fed funds futures backed off taking the probability of a rate cut by the Fed in July down to 85%. Remember, Friday that was at 100%.

Yesterday also saw the pound suffer significantly as the initial saber rattling by both the UK and the EU continued, which helped push the pound back to its key support level of 1.2950-1.3000. But as I said yesterday, this is simply both sides trying to get an advantage in the negotiation. While anything is possible, I continue to believe that a deal will be reached, or at the very least that a delay agreed on a timely basis. Boris is not going to jeopardize his power on this principle, remember he’s a politician first, and principles for them are fluid.

In the EMG bloc, pretty much every currency has rallied today as investors have quickly returned to those currencies with either higher yields (ZAR +0.6%, MXN +0.5%) or the best prospects assuming the coronavirus situation quickly dissipates (KRW +0.6%, CLP +0.6%, THB +0.5%). And in truth, I don’t think it’s any more complicated than that.

In the US this morning we see December Factory Orders (exp 1.2%), generally not a major data point. There are no Fed speakers scheduled today which means that FX is going to be a secondary story. All eyes will be on equity markets and I expect that as risk assets are acquired, the dollar (and yen and Swiss franc) will continue to soften slowly.

Good luck
Adf

Just Look What You’ve Wrought!

On Monday it seems we all thought
That crises were sold and not bought
On Tuesday we learned
Those sellers got burned
Chair Powell; just look what you’ve wrought!

hubris: noun
hu·bris | \’hyü-brƏs \
Definition of hubris : exaggerated pride or self-confidence
Example of hubris in a sentence
//It takes remarkable hubris to survey the ongoing situation regarding the 2019-nCoV virus and decide that Monday’s 1.5% decline in the S&P 500 was a buy signal.

I saw a note on Twitter this morning that really crystalized the current market condition. All prices are based on flow, not value. It is a fool’s errand to try to determine what the underlying value of any financial asset is these days, as it has no relevance regarding the price of that asset. This is most evident in the equity markets, but is equally true in the currency markets as well. So for all of us who are trying to determine what possible future paths are for market movements, the primary focus should be on how favored they are, for whatever reason, compared to the rest of the investment universe. In fact, this is the key outcome of the financialization of the global economy. And while this is just fine, maybe even great, when flows are driving equity prices, and other assets, higher, it will be orders of magnitude worse going the other way.

But the bigger issue is the financialization of the economy. Prior to the financial crisis and recession of 2008-2009, there seemed to be a reasonable balance between finance and production within the global economy. In other words, financial questions represented a minority of the impact on how companies were managed and on how much of anything was produced. This balance, which I would have put at 80% production / 20% finance, give or take a nickel, was what underpinned the entire economics profession. Finance was simply a relatively small part of every productive endeavor with the goal of insuring production could continue.

But in the wake of that recession, the fear of allowing massively overpriced markets to actually clear resulted in central banks stepping in and essentially taking over. The initial corporate reaction was to take advantage of the remarkably low interest rates and refinance their businesses completely. The problem was that since markets never cleared, there was still a dearth of demand on an overall basis. This is what led to a decade of subpar growth. Remember, the average annual GDP growth in the decade following the GFC was about 1.5%, well below the previous decade’s 3.0%. At the same time, the ongoing shortening of attention spans, especially for investors, forced corporate management to figure out how to make more money. Unfortunately, the fact that slow GDP growth prevented an actual increase in profits forced senior management to look elsewhere. And this is when it quickly became clear that levering up corporate balance sheets, while ZIRP and NIRP were official policy, made a great deal of sense. If a company couldn’t actually make more money, it sure could make it seem that way by issuing debt and buying back stock, thus reducing the denominator in the key metric, EPS.

And that is where we are today, in an economy that continues to grow at a much slower pace than prior to the financial crisis, but at the same time allows ongoing growth in a key metric, EPS, through financial engineering.

Which brings me back to the idea of flow. It is financial flows that determine the future paths of all assets, so the more money that is made available by the central banking community (currently about $100 billion per month of new cash), the higher the price assets will fetch. Let me say that they better not stop providing that new cash anytime soon.

With that as a (rather long) preamble, today’s market discussion is all about the Fed. This afternoon at 2:00 we will get the latest communique and then Chairman Powell will meet the press at 2:30. Current expectations are for no policy changes although there seems to be a growing view that the ongoing coronavirus situation, and its likely negative impact on Chinese/global GDP growth, will force a more dovish hue to both the statement and the press conference. Remember, the Fed is currently going through a major policy review, similar to that of the ECB, as they try to determine what tools are best to manage the economy achieve their mandated goals going forward. Given that ongoing policy review, it would take a remarkable catalyst to drive a near-term policy change, and apparently a global pandemic doesn’t rise to that standard.

Oh yeah, what about that coronavirus? Well, the death toll is now above 130, and the number of cases is touching 10,000, far more than seen in the SARS outbreak of 2003. (And I ask, if so many are skeptical of Chinese economic data, why would we believe that this data is accurate, especially as it would not reflect China in a positive light?) At any rate, while the Hang Seng fell sharply last night, its first session back since last week, the rest of the global equity market seems pretty comfortable. And hey, Apple earnings beat big time (congrats), so all is right with the world!!

What will this do to flows in the FX market? Broadly speaking, the dollar continues to see small gains vs. its G10 brethren as US rates remain the highest around. Granted Canadian rates are in the same place, but with oil’s recent decline, and growing concern over the housing bubble in Canada’s main cities, it seems like the dollar is safer to earn those rates. At the same time, many emerging markets currently carry rates that are far higher than in the US, and what we saw yesterday was significant interest in owning those currencies, especially MXN, RUB, BRL and COP, all of which gained between 0.5% and 1.0% in yesterday’s session. While those currencies have edged lower this morning, the flow story remains the key driver, and if markets maintain their hubris, the carry trade will quickly return.

On the data front, yesterday’s US Consumer Confidence number was much better than expected at 131.6. This morning we saw slightly better than expected GfK Consumer Confidence in Germany (9.9 vs. 9.6 exp) and better than expected French Consumer Confidence (104 vs 102). That is certainly a positive, but it remains to be seen if the spread of the coronavirus ultimately has a negative impact here. Ahead of the Fed, there is no important US data, so we are really in thrall to the ongoing earnings parade until Chairman Powell steps up to the mic. As to the dollar, it continues to perform well, and until the Fed, that seems likely to continue.

Good luck
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