Absent Demand

With Autumn’s arrival at hand
The virus has taken a stand
It won’t be defeated
Nor barely depleted
Thus, markets are absent demand

Risk is definitely on the back foot this morning as concerns grow over the increase in Covid-19 cases around the world.  Adding to the downward pressure on risk assets is the news that a number of major global banks are under increased scrutiny for their inability (unwillingness?) to stop aiding and abetting money laundering.  And, of course, in the background is the growing sense that monetary authorities around the world, notably the Fed, have run out of ammunition in their ongoing efforts to support economic growth in the wake of the government imposed shutdowns.  All in all, things look pretty dire this morning.

Starting with the virus, you may recall that one of the fears voiced early on was that, like the flu, it would fade somewhat in the summer and then reassert itself as the weather cooled.  Well, it appears that was a pretty accurate analysis as we have definitely seen the number of new cases rising in numerous countries around the world.  Europe finds itself in particularly difficult straits as the early self-congratulatory talk about how well they handled things vis-à-vis the US seems to be coming undone.  India has taken the lead with respect to the growth in cases, with more than 130,000 reported in the past two days.  The big concern is that government’s around the world are going to reimpose new lockdowns to try to stifle growth in the number of cases, but we all know how severely that can impact the economy.  So, the question with which the markets are grappling is, will the potential long-term benefit of a lockdown, which may reduce the overall caseload outweigh the short-term distress to the economy, profits and solvency?

At least for today, investors and traders are coming down on the side that the lockdowns are more destructive than the disease and so we have seen equity markets around the world come under pressure, with Europe really feeling the pain.  Last night saw the Hang Seng (-2.1%) and Shanghai (-0.6%) sell off pretty steadily.  (The Nikkei was closed for Autumnal Equinox Day.)  But the situation in Europe has been far more severe with the DAX (-3.2%), CAC (-3.1%) and FTSE 100 (-3.5%) all under severe pressure.  All three of those nations are stressing from an increase in Covid cases, but this is where we are seeing a second catalyst, the story about major banks and their money laundering habits.  A new report has been released that describes movement of more than $2 trillion in illicit funds by major (many European) banks, even after sanctions and fines have been imposed.  It can be no surprise that bank stocks throughout Europe are lower, nor that pre-market activity in the US is pointing in the same direction.  As such, US future markets showing declines of 1.5%-2.0% are right in line with reasonable expectations.

And finally, we cannot ignore Chairman Powell and the Fed.  The Chairman will be speaking before Congress three times this week, on both the need for more fiscal stimulus as well as the impact of Covid on the economy.  Now we already know that the Fed has implemented “powerful” new tools to help support the US, after all, Powell told us that about ten times last week in his press conference.  Unfortunately, the market is a bit less confident in the power of those tools.  At the same time, it seems the ECB has launched a review of its PEPP program, to try to determine if it has been effective and how much longer it should continue.  One other question they will address is whether the original QE program, APP, should be modified to be more like PEPP.  It is not hard to guess what the answers will be; PEPP has been a huge success, it should be expanded and extended because of its success, and more consideration will be given to changing APP to be like PEPP (no capital key).  After all, the ECB cannot sit by idly and watch the Fed ease policy more aggressively and allow the euro to appreciate in value, that would be truly catastrophic to their stated goal of raising the cost of living inflation on the Continent.

With all that in mind, a look at FX markets highlights that the traditional risk-off movement is the order of the day.  In other words, the dollar is broadly stronger vs. just about everything except the yen.  For instance, in the G10 space, NOK (-1.45%) is falling sharply as the combination of risk aversion and a sharply lower oil price (WTI -2.5%) has taken the wind out of the krone’s sails.  But the weakness here is across the board as SEK (-0.8%) and the big two, GBP (-0.5%) and EUR (-0.45%) are all under pressure.  It’s funny, it wasn’t that long ago when the entire world was convinced that the dollar was about to collapse.  Perhaps that attitude was a bit premature.  In fact, the euro bulls need to hope that 1.1765 (50-day moving average) holds because if the technicians jump in, we could see the single currency fall a lot more.

As to the emerging markets, the story is the same, the dollar is broadly higher with recent large gainers; ZAR (-2.0%) and MXN (-1.4%), leading the way lower.  But the weakness is broad-based as the CE4 are all under pressure (CZK -1.3%, HUF -1.1%, PLN -0.95%) and even CNY (-0.2%) which has been rallying steadily since its nadir at the end of May, has suffered.  In fact, the only positive was KRW (+0.2%) which benefitted from data showing that exports finally grew, rising above 0.0% for the first time since before Covid.

As to the data this week, it is quite light with just the following to watch:

Tuesday Existing Home Sales 6.01M
Wednesday PMI Manufacturing (Prelim) 53.3
Thursday Initial Claims 840K
Continuing Claims 12.45M
New Home Sales 890K
Friday Durable Goods 1.1%
-ex Transport 1.0%

Source: Bloomberg

The market will be far more interested in Powell’s statements, as well as his answers in the Q&A from both the House and Senate.  The thing is, we already know what he is going to say.  The Fed has plenty of ammunition, but with interest rates already at zero, monetary policy needs help from fiscal policy.  In addition to Powell, nine other Fed members speak a total of twelve times this week.  But with Powell as the headliner, it is unlikely they will have an impact.

The risk meme is today’s story.  If US equity markets play out as the futures indicate, and follow Europe lower, there is no reason to expect the dollar to do anything but continue to rally.  After all, while short dollar positions are not at record highs, they are within spitting distance of being so, which means there is plenty of ammunition for a dollar rally as shorts get covered.

Good luck and stay safe
Adf

Risk is in Doubt

The chatter before the Fed met
Was Powell and friends were all set
To ease even more
Until they restore
Inflation to lessen the debt

And while Jay attempted just that
His efforts have seemed to fall flat
Now risk is in doubt
As traders clear out
Positions from stocks to Thai baht

Well, the Fed meeting is now history and in what cannot be very surprising, the Chairman found out that once you have established a stance of maximum policy ease, it is very difficult to sound even more dovish.  So, yes, the Fed promised to maintain current policy “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”  And if you really parse those words compared to the previous statement’s “…maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, you could make the case it is more dovish.  But the one thing at which market participants are not very good is splitting hairs.  And I would argue that is what you are doing here.  Between the old statement and Powell’s Jackson Hole speech, everybody already knew the Fed was not going to raise rates for a very long time.  Yesterday was merely confirmation.

In fact, ironically, I think the fact that there were two dissents on the vote, Kaplan and Kashkari, made things worse.  The reason is that both of them sought even easier policy and so as dovish as one might believe the new statement sounds, clearly some members felt it could be even more dovish than that.  At the same time, the dot plot added virtually nothing to the discussion as the vast majority believe that through 2023 the policy rate will remain pegged between 0.00%-0.25% where it is now.  Also, while generating inflation remains the animating force of the committee, according to the Summary of Economic Projections released yesterday, even their own members don’t believe that core PCE will ever rise above 2.0% and not even touch that level until 2023.

Add it all up and it seems pretty clear that the Fed is out of bullets, at least as currently configured with respect to their Congressional mandate and restrictions.  It will require Congress to amend the Federal Reserve Act and allow them to purchase equities in order to truly change the playing field and there is no evidence that anything of that nature is in the cards.  A look at the history of the effectiveness of QE and either zero or negative interest rates shows that neither one does much for the economy, although both do support asset markets.  Given those are the only tools the Fed has, and they are both already in full use (and not just at the Fed, but everywhere in the G10), it is abundantly clear why central bankers worldwide are willing to sacrifice their independence in order to cajole governments to apply further fiscal stimulus.  Central banks seem to have reached the limit of their capabilities to address the real economy.  And if (when) things turn back down, they are going to shoulder as much blame as elected officials can give with respect to who is responsible for the bad news.

With that as background, let’s take a peek at how markets have responded to the news.  Net-net, it hasn’t been pretty.  Equity markets are in the red worldwide with losses overnight (Nikkei -0.7%, Hang Seng -1.6%, Shanghai -0.4%) and in Europe (DAX -0.7%, CAC -0.8%, FTSE 100 -1.0%).  US futures are pointing lower after equity markets in the US ceded all their gains after the FOMC and closed lower yesterday.  At this time, all three futures indices are lower by about 1.0%.

Meanwhile, bond markets, which if you recall have not been tracking the equity market risk sentiment very closely over the past several weeks, are edging higher, at least in those markets truly seen as havens.  So, Treasury yields are lower by 2bps, while German bunds and French OATS are both seeing yields edge lower, but by less than one basis point.  However, the rest of the European government bond market is under modest pressure, with the PIGS seeing their bonds sell off and yields rising between one and two basis points.  Of course, as long as the ECB continues to buy bonds via the PEPP, none of these are likely to fall that far in price, thus yields there are certainly capped for the time being.  I mean even Greek 10-year yields are 1.06%!  This from a country that has defaulted six times in the modern era, the most recent being less than ten years ago.

Finally, if we look to the FX markets, it can be no surprise to see the dollar has begun to reverse some of its recent losses.  Remember, the meme here has been that the Fed would be the easiest of all central banks with respect to monetary policy and so the dollar had much further to fall.  Combine that with the long-term theme of macroeconomic concerns over the US twin deficits (budget and current account) and short dollars was the most popular position in the market for the past three to four months.  Thus, yesterday’s FOMC outcome, where it has become increasingly clear that the Fed has little else to do in the way of policy ease, means that other nations now have an opportunity to ease further at the margin, changing the relationship and ultimately watching their currency weaken versus the dollar.  Remember, too, that essentially no country is comfortable with a strong currency at this point, as stoking inflation and driving export growth are the top two goals around the world.  The dollar’s rebound has only just begun.

Specifically, in the G10, we see NOK (-0.5%) as the laggard this morning, as it responds not just to the dollar’s strength today, but also to the stalling oil prices, whose recent rally has been cut short.  As to the rest of the bloc, losses are generally between 0.15%-0.25% with no specific stories to drive anything.  The exception is JPY (+0.2%) which is performing its role as a haven asset today.  While this is a slow start, do not be surprised to see the dollar start to gain momentum as technical indicators give way.

Emerging market currencies are also under pressure this morning led by MXN (-0.7%) and ZAR (-0.6%).  If you recall, these have been two of the best performing currencies over the past month, with significant long positions in each driving gains of 5.3% and 7.1% respectively.  As such, it can be no surprise that they are the first positions being unwound in this process.  But throughout this bloc, we are seeing weakness across the board with average declines on the order of 0.3%-0.4%.  Again, given the overall risk framework, there is no need for specific stories to drive things.

On the data front, yesterday’s Retail Sales data was a bit softer than expected, although was generally overlooked ahead of the FOMC.  This morning saw Eurozone CPI print at -0.2%, 0.4% core, both still miles below their target, and highlighting that we can expect further action from the ECB.  At home, we are awaiting Initial Claims (exp 850K), Continuing Claims (13.0M), Housing Starts (1483K), Building Permits (1512K) and the Philly Fed index (15.0).

Back on the policy front, the BOE announced no change in policy at all, leaving the base rate at 0.10% and not expanding their asset purchase program.  However, in their effort to ease further they did two things, explicitly said they won’t tighten until there is significant progress on the inflation goal, but more importantly, said that they will “engage with regulators on how to implement negative rates.”  This is a huge change, and, not surprisingly the market sees it as another central bank easing further than the Fed.  The pound has fallen sharply on the news, down 0.6% and likely has further to go.  Last night the BOJ left policy on hold, as they too are out of ammunition.  The fear animating that group is that risk appetite wanes and haven demand drives the yen much higher, something which they can ill afford and yet something which they are essentially powerless to prevent.  But not today.  Today, look for a modest continuation of the dollar’s gains as more positions get unwound.

Good luck and stay safe
Adf

Hard to Believe

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Poison Pens

The headlines all weekend have shouted
The dollar is sure to be routed
If Covid-19
Remains on the scene
A rebound just cannot be touted

But ask yourself this my good friends
Have nations elsewhere changed their trends?
Infections are rising
Despite moralizing
By pundits who wield poison pens

Based on the weekend’s press, as well as the weekly analysis recaps, the future of the dollar is bleak. Not only is it about to collapse, but it will soon lose its status as the world’s reserve currency, although no one has yet figured out what will replace it in that role. This is evident in the sheer number of articles that claim the dollar is sure to decline (for those of you with a Twitter account, @pineconemacro had a great compilation of 28 recent headlines either describing the dollar’s decline or calling for a further fall), as well as the magnitude of the short dollar positions in the market, as measured by CFTC data. As of last week, there are record long EUR positions and near-record shorts in the DXY.

So, the question is, why does everybody hate the dollar so much? It seems there are two reasons mentioned most frequently; the impact of unbridled fiscal and monetary stimulus and the inability of the US to get Covid-19 under control. Let’s address them in order.

There is no question that the Fed and the Treasury, at the behest of Congress, have expended extraordinary amounts of money to respond to the Covid crisis. The Fed’s balance sheet has grown from $4.2 trillion to $7.0 trillion in the course of four months. And of course, the Fed has basically bought everything except your used Toyota in an effort to support market functionality. And it is important to recognize that what they continue to explain is that they are not supporting asset prices per se, rather they are simply insuring that financial markets work smoothly. (Of course, their definition of working smoothly is asset prices always go higher.) Nonetheless, the Fed has been, by far, the most active central bank in the world with respect to monetary support. At the same time, the US government has authorized about $3.5 trillion, so far, of fiscal support, although there is much anxiety now that the CARES act increase in unemployment benefits lapsed last Friday and there is still a wide divergence between the House and Senate with respect to what to do next.

But consider this; while the US is excoriated for borrowing too much and expanding both the budget deficit and the amount of debt issued, the EU was celebrated for coming to agreement on…borrowing €2 trillion to expand the budget deficit and support the economies of each nation in the bloc. Debt mutualization, we have been assured, is an unalloyed good and will help the EU’s overall economic prospects by allowing the transfer of wealth from the rich northern nations to the less well-off southern nations. And of course, given the collective strength of the EU, they will be able to borrow virtually infinite sums from the market. Perhaps it is just me, but the stories seem pretty similar despite the spin as to which is good, and which is bad.

The second issue for the dollar, and the one that is getting more press now, is the fact that the US has not been able to contain Covid infections and so we are seeing a second wave of economic shutdowns across numerous states. You know, states like; Victoria, Australia; Melbourne, Australia; Tokyo, Japan; the United Kingdom and other large areas. This does not even address the ongoing spread of the disease through the emerging markets where India and Brazil have risen to the top of the worldwide caseload over the past two months. Again, my point is that despite reinstituted lockdowns in many places throughout the world, it is the US which the narrative points out as the problem.

It is fair to describe the dollar’s reaction function as follows: it tends to strengthen when either the US economy is outperforming other G10 economies (a situation that prevailed pretty much the entire time since the GFC) or when there is unbridled fear that the world is coming to an end and USD assets are the most desirable in the world given its history of laws and fair treatment of investors. In contrast, when the US economy is underperforming, it is no surprise that the dollar would tend to weaken. Well the data from Q2 is in and what we saw was that despite the worst ever quarterly decline in the US, it was dwarfed by the major European economies. At this time, the story being told seems to be that in Q3, the rest of the world will rapidly outpace the US, and perhaps it will. But that is a pretty difficult case to make when, first, Covid inspired lockdowns are popping up all around the world and second, the consumer of last resort (the US population) has lost their appetite to consume, or if not lost, at least reduced.

Once again, I will highlight that the dollar, while definitely in a short-term weakening trend, is far from a collapse, and rather is essentially right in the middle of its long-term range. This is not to say that the dollar cannot fall further, it certainly can, but do not think that the dollar is soon to become the Venezuelan bolivar.

And with that rather long-winded defense of the dollar behind us, let’s take a look at markets today. Equity markets continue to enjoy central bank support and have had an overall strong session. Asia saw gains in the Nikkei (+2.25%) and Shanghai (+1.75%) although the Hang Seng (-0.55%) couldn’t keep up with the big dogs. Europe’s board is no completely green, led by the DAX (+2.05%) although the CAC, which was lower earlier, is now higher by 1.0%. And US futures, which had spent the evening in the red are now higher as well.

Bond markets are embracing the risk-on attitude as Treasury yields back up 2bps, although are still below 0.55% in the 10-year. In Europe, the picture is mixed, and a bit confusing, as bund yields are actually 1bp lower, while Italian BTP’s are higher by 2bps. That is exactly the opposite of what you would expect for a risk-on session. But then, the bond market has not agreed with the stock market since Covid broke out.

And finally, the dollar, is having a pretty strong session today, perhaps seeing a bit of a short squeeze, as I’m sure the narrative has not yet changed. In the G10, all currencies are softer vs. the greenback, led by CHF (-0.6%) and AUD (-0.55%), although the pound (-0.5%) which has been soaring lately, is taking a rest as well. What is interesting about this move is that the only data released overnight was the monthly PMI data and it was broadly speaking, slightly better than expected and pointed to a continuing rebound.

EMG currencies are also largely under pressure, led by ZAR (-1.15%) and then the CE4 (on average -0.7%) with almost the entire bloc softer. In fact, the outlier is RUB (+0.8%), which seems to be the beneficiary of a reduction in demand for dollars to pay dividends to international investors, and despite the fact that oil prices have declined this morning on fears that the OPEC+ production cuts are starting to be flouted.

It is, of course, a huge data week, culminating in the payroll report on Friday, but today brings only ISM Manufacturing (exp 53.6) with the New Orders (55.2) and Prices Paid (52.0) components all expected to show continued growth in the economy.

With the FOMC meeting now behind us, we can look forward, as well, to a non-stop gabfest from Fed members, with three today, Bullard, Barkin and Evans, all set to espouse their views. The thing is, we already know that the Fed is not going to touch rates for at least two years, and is discussing how to try to push inflation higher. On the latter point, I don’t think they will have to worry, as it will get there soon enough, but their models haven’t told them that yet. At any rate, the dollar has been under serious pressure for the past several months. Not only that, most of the selling seems to come in the US session, which leads me to believe that while the dollar is having a pretty good day so far, I imagine it will soften before we log out this evening.

Good luck and stay safe
Adf

 

Struck by the Flu

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

Quite Dramatic

The Chinese report ‘bout Q2
Showed growth has rebounded, it’s true
But things there remain
Subject to more pain
Til elsewhere bids Covid adieu

The market’s response was emphatic
With Shanghai’s decline quite dramatic
Thus, risk appetite
Today is quite slight
Which means bears are now just ecstatic

It is no surprise that the Chinese reported a rebound to positive GDP growth in Q2 as, after all, the nation was the epicenter of Covid-19 and they, both shut down and reopened their economy first. The numbers, however, were mixed at best, with the GDP number rebounding a more than expected 3.2% Y/Y, but their Retail Sales data failing to keep up, printing at -1.8% Y/Y, rather than the expected 0.5% gain. The lesson to be learned here is that while Chinese industry seems to be heading back to a pre-Covid pace, domestic consumption is not keeping up. This is a problem for China for two reasons; first, they have made an enormous effort to adjust the mix of their economy from entirely export oriented to a much greater proportion of consumption led growth. Thus, weak Retail Sales implies that those efforts are now likely to restrict the nation’s growth going forward. Secondly, the fact that the rest of the world is months behind China in this cycle, with many emerging markets still in the closing process, not nearly ready to reopen, implies that while industry in China may have retooled, their export markets are a long way from robust.

The other interesting thing that came out of China last night, that had a more direct impact on markets there, was yet another round of stories published about the evils of speculation and how Chinese financial institutions would be selling more stocks. You may recall last week, when the Chinese government had an article published singing the praises of a strong stock market, encouraging retail investors to drive a more than 6.0% gain in the Shanghai Composite. Just a few days later, they reversed course, decrying the evils of speculation with a corresponding sharp decline. Well, it seems that speculators are still evil, as last night’s message was unequivocally negative pushing Shanghai lower by 4.5% and finally removing all those initial speculative gains. It seems the PBOC and the government are both concerned about inflating bubbles as they well remember the pain of 2015, when they tried to deflate their last one.

But this activity set the tone for all Asian markets, with red numbers everywhere, albeit not quite to the extent seen on the mainland. For instance, the Nikkei slipped 0.75% and the Hang Seng, fell 2.0%.

Europe has its own set of issues this morning, although clearly the weakness in Asia has not helped their situation. Equity markets throughout the Continent are lower with the DAX (-0.5%) and CAC (-0.7%) representative of the losses everywhere. While traders there await the ECB meeting outcome, the focus seems to be on the UK announcement that they will be increasing their debt issuance by £110 billion in Q3 to help fund all the fiscal stimulus. This will take the debt/GDP ratio above 100%, ending any chance of retaining fiscal prudence.

It’s remarkable how things can change in a short period of time. During the Eurozone debt crisis, less than 10 years ago, when Greece was on the cusp of leaving the euro, they were constantly lambasted for having a debt/GDP ratio of 150% or more while Italy, who was puttering along at 125% was also regularly excoriated by the EU and the IMF. But these days, those entities are singing a different tune, where suddenly, government borrowing is seen as quite appropriate, regardless of the underlying fiscal concerns, with the supranational bodies calling for additional fiscal stimulus and the borrowing that goes along with it. At any rate, there is certainly no sign that the current mantra of issuing debt and spending massive amounts of money to support the economy is about to change. Fiscal prudence is now completely passé.

With that as a backdrop, it should be no surprise that risk is being pared back across all markets. Having already discussed equities, we can look at bond markets and see yields virtually everywhere lower today as investors seek out haven assets. Interestingly, despite the new issuance announced in the UK, Gilts lead the way with a 2.5bp decline, while Treasuries and Bunds have both seen yields decline a more modest 1bp. Oil prices have fallen again, which is weighing on both NOK (-0.65%) and RUB (-0.4%) the two currencies most closely linked to its price. But of course, lower oil prices are indicative of weaker overall sentiment.

As such, it is also no surprise that every one of the currencies in the G10 and major emerging markets is weaker vs. the dollar this morning. While the trendy view remains that the dollar is going to continue to decline, and that has been expressed with near record short dollar positions in futures markets, the greenback is not playing along today.

At this point, I think it is important to remind everyone that a key part of the weak dollar thesis is the ongoing expansion of the Fed’s balance sheet adding more liquidity to the system and thus easing dollar policy further. But for the past 5 weeks, the Fed’s balance sheet has actually shrunk by $250 billion, a not inconsiderable 3.5%, as repo transactions have matured and not been replaced. It appears that for now, the market is flush with cash. So, given the combination of major short dollar positions extant and short term fundamental monetary details pointing to dollar strength, do not be surprised if we see a short squeeze in the buck over the next week or two.

This morning brings the bulk of the week’s data, certainly its most important readings, and it all comes at 8:30. Retail Sales (exp 5.0%, 5.0% ex autos), Philly Fed (20.0), Initial Claims (1.25M) and Continuing Claims (17.5M) will hopefully give us a clearer picture of how the US economy is progressing. One of the problems with this data is that it is mostly backward looking (Philly Fed excepted) and so probably does not capture the apparent second wave of infections seen in Florida, Texas and California, three of the most populous states. So, even if we do see somewhat better than expected data, it could easily slip back next week/month. In fact, this is why the Claims data is so important, it is the timeliest of all the major economic releases, and given the ongoing uncertainty surrounding the current economic situation, it is likely the most helpful. So, while the trend in Initial Claims has been lower, it remains at extremely problematic levels and is indicative of many more businesses retrenching and letting staff go. It has certainly been my go-to data point for the pulse of the economy.

Recent data points have been better than forecast, but nobody doubts that things are still in dire shape. Unfortunately, it appears we are still a long way from recouping all the lost economic activity we have suffered over the past months. But FX remains a relative game, and arguably, so is everyone else.

Good luck and stay safe
Adf

Out of Hand

The Chinese are starting to learn
The things for which all people yearn
A chance to succeed
Their families to feed
As well, stocks to never, down, turn

But sometimes things get out of hand
Despite how they’re carefully planned
So last night we heard
Officialdom’s word
The rally is now to be banned!

It seems like it was only yesterday that the Chinese state-run media were exhorting the population to buy stocks in order to create economic growth.  New equity accounts were being opened in record numbers and the retail investors felt invincible.  Well… it was just this past Monday, so I guess that’s why it feels that way.  Of course, that’s what makes it so surprising that last night, the Chinese government directed its key pension funds to sell stocks in order to cool off the rally!  For anyone who still thought that equity market movement was the result of millions of individual buying and selling decisions helping to determine the value of a company’s business, I hope this disabuses you of that notion once and for all.  That is a quaint philosophy that certainly did exist back in antediluvian times, you know, before 1987.  But ever since then, government’s around the world have realized that a rising stock market is an important measuring stick of their success as a government.  This is true even in countries where elections are foregone conclusions, like Russia, or don’t exist, like China.  Human greed is universal, regardless of the political system ruling a country.

And so, we have observed increasing interference in equity markets by governments ever since Black Monday, October 19, 1987.  While one can understand how the Western world would be drawn to this process, as government’s regularly must “sing for their supper”, it is far more surprising that ostensibly communist nations behave in exactly the same manner.  Clearly, part of every government’s legitimacy (well, Venezuela excluded) is the economic welfare of the population.  Essentially, the stock market today has become analogous to the Roman’s concept of bread and circuses.  Distract the people with something they like, growing account balances, while enacting legislation to enhance the government’s power, and by extension, politicians own wealth.

But one thing the Chinese have as a culture is a long memory.  And while most traders in the Western world can no longer remember what markets were like in January, the Chinese government is keenly aware of what happened five years ago, when their last equity bubble popped, they were forced to devalue the renminbi, and a tidal wave capital flowed out of the country.  And they do not want to repeat that scenario.  So contrary to the protestations of Western central bankers, that identifying a bubble is impossible and so they cannot be held responsible if one inflates and then pops, the Chinese recognized what was happening (after all, they were driving it) and decided that things were moving too far too fast.  Hence, not merely did Chinese pension funds sell stocks, they announced exactly what they were going to do ahead of time, to make certain that the army of individual speculators got the message.

And so, it should be no surprise that equity markets around the world have been under pressure all evening as risk is set aside heading into the weekend.  The results in Asia showed the Nikkei fall 1.1%, the Hang Seng fall 1.8% and Shanghai fall 2.0%.  European markets have not suffered in quite the same way but are essentially flat to higher by just 0.1% and US futures are pointing lower by roughly 0.5% at this early hour (6:30am).

Interestingly, perhaps a better indicator of the risk mood is the bond market, which has rallied steadily all week, with 10-year Treasuries now yielding just 0.58%, 10bps lower than Monday’s yields and within 4bps of the historic lows seen in March.  Clearly, my impression that central banks have removed the signaling power of bond markets needs to be revisited.  It seems that the incipient second wave of Covid infections in the US is starting to weigh on some investor’s sentiment regarding the V-shaped recovery.  So perhaps, the signal strength is reduced, but not gone completely.  European bond markets are showing similar behavior with the haven bonds all seeing lower yields while PIGS bonds are being sold off and yields are moving higher.

And finally, turning to the FX markets, the dollar is broadly, albeit mildly, firmer this morning although the biggest gainer is the yen, which has seen significant flows and is up by 0.4% today taking the movement this week up to a 1.0% gain.  Despite certain equity markets continuing to perform well (I’m talking to you NASDAQ), fear is percolating beneath the surface for a lot of people.  Confirmation of this is the ongoing rally in gold, which is higher by another 0.25% this morning and is now firmly above $1800/oz.

Looking more closely at specific currency activity shows that the commodity currencies, both G10 and EMG, are under pressure as oil prices retreat by more than 2% and fall back below $40/bbl.  MXN (-0.6%), RUB (-0.3%) and NOK (-0.2%) are all moving in the direction you would expect.  But we are also seeing weakness in ZAR (-0.5%) and AUD (-0.1%), completing a broad sweep of those currencies linked to commodity markets.  It appears that the fear over a second wave, and the negative economic impact this will have, has been a key driver for all risk assets, and these currencies are direct casualties.  But it’s not just those currencies under pressure, other second order impacts are being felt.  For example, KRW (-0.75%) was the worst performer of all overnight, as traders grow concerned over reports of increased infections in South Korea, as well as Japan and China, which is forcing secondary closures of parts of those economies.  In fact, the EMG space writ large is behaving in exactly the same manner, just some currencies are feeling the brunt a bit more than others.

Ultimately, markets continue to be guided by broad-based risk sentiment, and as concerns rise about a second wave of Covid infections spreading, investors are quick to retreat to the safety of havens like Treasuries, bunds, the dollar and the yen.

Turning to the data story, yesterday saw both Initial (1.314M) and Continuing (18.062M) Claims print at lower than expected numbers.  While that was good news, there still has to be significant concern that the pace of decline remains so slow.  After all, a V-shaped recovery would argue for a much quicker return to more ‘normal’ numbers in this series.  Today brings only PPI (exp -0.2% Y/Y, +0.4% Y/Y ex food & energy), but the inflation story remains secondary in central bank views these days, so I don’t anticipate any market reaction, regardless of the outcome.

There are no Fed speakers, but then, they have been saying the same thing for the past three months, so it is not clear to me what additional value they bring at this point.  I see no reason for this modest risk-off approach to end, especially as heading into the weekend, most traders will be happy to square up positions.

Good luck, good weekend and stay safe

Adf

 

A Wake of Debris

Investors are pining to see
A rebound that’s shaped like a “V”
But data of late
Could well extirpate
Those views midst a wake of debris

For everyone who remains convinced that a V-shaped recovery is the most likely outcome, recent data must be somewhat disconcerting. There is no question that June data will look better than May’s, which was substantially better than April’s, but if one takes a few steps back to gain perspective, the current situation remains dire. One of the features of most economic statistical series is that they tend to measure both monthly and annual changes. The idea is that the monthly data offer’s a picture of the latest activity while the annual data gives a view of the longer-term trend. The problem for the bulls to overcome right now is that while June’s monthly data is showing record-breaking monthly gains, the annual numbers remain horrific. This morning’s German IP data is a perfect example of the situation. While this was actually data from May, it is the latest reading. During the month, Industrial Production rose 7.8%, the largest monthly gain on record, and arguably good news. Alas, expectations were for an even greater 11.1% rebound, and more importantly, the annual data showed a still terrible 19.3% decline from 2019’s levels. So, while there is no question that May’s numbers were an improvement over April’s, it is hardly sounding an all-clear signal.

This has been the pattern we have seen consistently for the past two months and is likely to continue to be the case for quite a while. Ergo, it is fair to state that the economy is rebounding from its worst levels, but to imply that things are even approaching the pre-Covid economy is completely erroneous. This is especially so in the survey data, which, if you recall, simply asks if this month was better than last. We saw some incredible PMI data at the nadir, with readings in the low teens and even single digits in a few countries, indicating that more than 80% of respondents saw things decline from the previous month. As such, it is no surprise that things got better from there, but does a rebound to a reading above 50 on a monthly series, with no annual analog, actually mean the same thing today as it did in January? I contend it is not a reasonable comparison and to imply that the economy is doing anything but slowly climbing back from a historic decline is just plain wrong.

The European Commission clearly understands this issue as they reduced their outlook for the EU’s economic growth in 2020 by a full percentage point to -8.7%, with most member nations seeing a substantial downgrade. A key reason for this downgrade has been the recent uptick in infections and the sporadic second closures of areas within the economies. The second wave of infections is dreaded for exactly this reason, it is preventing economies around the world from gaining growth momentum, something that comes as confidence builds that things will get better. Every interruption just extends the timeline for a full recovery, a prospect that none of us welcome. Alas, it appears that the most likely outcome right now is a very slow, drawn out recovery with a continued high rate of unemployment and ongoing fiscal and monetary support abetting every economy on the planet while simultaneously preventing markets from clearing and thus insuring slower growth ahead when it finally returns.

With that as preamble, a look at today’s markets shows essentially a full reversal from yesterday’s price action. Yesterday was always a bit odd as there was no clear rationale for the risk rally, yet there it was, around the world. However, this morning, the data continues to demonstrate just how far things are from the pre-Covid world, and it seems the risk bulls are having a tougher time. Starting in Asia, we saw weakness in Japan (-0.45%) and Hong Kong (-1.4% and long overdue given what is happening there) although Shanghai (+0.4%) has managed to keep the positive momentum going for yet another day. While there were no articles exhorting share ownership in the papers there last night, it remains a key feature of the Chinese government’s strategy, encourage individuals to buy stocks to support both markets and confidence. We shall see how long it can continue. European bourses have reversed much of yesterday’s gains as well, down a bit more than 1.0% on average and US futures are trading at similar levels, -1.0%. Bond markets continue to prove to be irrelevant at this stage, no longer seen as haven assets given the fact that there is no yield available but unwilling to be sold by traders as central banks have promised to buy them all if they deem it necessary. So, for the time being, it is extremely difficult to gain any credible price signals from these markets.

Commodity markets are under a bit of pressure, with oil prices lower by 1.5% and gold falling 0.5%, while the dollar is today’s big winner. Yesterday it fell against all its G10 counterparts and most EMG ones as well. This morning, it is just the opposite, with only the pound, essentially unchanged on the day, not declining while AUD and NOK lead the way lower with 0.55% and 0.45% declines respectively. The data situation continues to show that the early signs of a rebound are leveling off, so investing based on a brighter outlook is not in the cards.

In the EMG space, MXN is today’s big loser, down 1.25%, but here, too, it is nearly universal as only IDR (+0.35%) has managed to eke out a gain, ostensibly on the back of views that the central bank’s debt monetization plan will draw inward investment. We shall see.

On the data front, yesterday’s ISM Non-Manufacturing number was a much better than expected 57.1, but as I discuss above, I don’t believe that is indicative of growth so much as a rebound from the worst conditions in the series history. This morning we only see the JOLTS Job Openings data, (exp 4.5M), but this is a delayed number as it represents May openings. Remember, too, this is down from more than 7.5M in early 2019 and 7.0M earlier this year.

Yesterday we heard from Atlanta Fed President Bostic who sounded a warning that the second wave, if it expands, would have a significantly detrimental impact on the US economy, and thus he was quite concerned with the future trajectory of growth. Remember, it is the Atlanta Fed that calculates the widely watched GDPNow number, which is currently reading an extremely precise -35.18% decline for Q2. It is no surprise he is worried.

Overall, risk is on the back foot today and appears set to continue this move. Barring some overly upbeat commentary from the White House, something that is always possible on a down day, I expect the dollar to drift slightly higher from here.

Good luck and stay safe
Adf

 

A Vaccine’s Required

Mnuchin and Powell explained
That Congress ought not be restrained
In spending more cash
Or else, in a flash
The rebound might not be maintained

Meanwhile, as the quarter expired
The data show growth is still mired
Within a great slump
And hopes for a jump
Are high, but a vaccine’s required

I continue to read commentary after commentary that explains the future will be brighter once a Covid-19 vaccine has been created. This seems to be based on the idea that so many people are terrified of contracting the disease they they will only consider venturing out of their homes once they believe the population at large is not contagious. While this subgroup will clearly get vaccinated, that is not likely to be majority behavior. If we consider the flu and its vaccine as a model, only 43% of the population gets the flu shot each year. Surveys regarding a Covid vaccine show a similar response rate.

Consider, there is a large minority of the population who are adamantly against any types of vaccines, not just influenza. As well, for many people, the calculation seems to be that the risk of contracting the flu is small enough that the effort to go and get the shot is not worth their time. Ask yourself if those people, who are generally healthy, are going to change their behavior for what appears to be a new form of the flu. My observation is that human nature is pretty consistent in this regard, so Covid is no scarier than the flu for many folks. The point is that the idea that the creation of a vaccine will solve the economy’s problems seems a bit far-fetched. Hundreds of thousands of small businesses have already closed permanently because of the economic disruption, and we are all well acquainted with the extraordinary job loss numbers. No vaccine is going to reopen those businesses nor bring millions back to work.

And yet, the vaccine is a key part of the narrative that continues to drive risk asset prices higher. While we cannot ignore central bank activities as a key driver of equity and bond market rallies, the V-shaped recovery is highly dependent on the idea that things will be back to normal soon. But if a vaccine is created and approved for use, will it really have the impact the market is currently anticipating? Unless we start to see something akin to a health passport in this country, a document that certifies the holder has obtained a Covid-19 shot, why would anyone believe a stranger is not contagious and alter their newly learned covid-based behaviors. History shows that the American people are not fond of being told what to do when it comes to restricting their rights of movement. Will this time really be different?

However, challenging the narrative remains a difficult proposition these days as we continue to see the equity bulls in charge of all market behavior. As we enter Q3, a quick recap of last quarter shows the S&P’s 20% rally as its best quarterly performance since Q4 1998. Will we see a repeat in Q3? Seems unlikely and the risk of a reversal seems substantial, especially if the recent increase in Covid cases forces more closures in more states. In any event, uncertainty appears especially high which implies price volatility is likely to continue to rise across all markets.

But turning to today’s session, equity markets had a mixed session in Asia (Nikkei -0.75%, Hang Seng +0.5%) despite the imposition of the new, more draconian law in Hong Kong with regard to China’s ability to control dissent there. Meanwhile, small early European bourse gains have turned into growing losses with the DAX now lower by 1.5%, the CAC down by 1.4% and the FTSE 100 down by 1.0%. While PMI data released showed that things were continuing on a slow trajectory higher, we have just had word from German Chancellor Merkel that “EU members [are] still far apart on recovery fund [and the] budget.” If you recall, there is a great deal of credence put into the idea that the EU is going to jointly support the nations most severely afflicted by the pandemic’s impacts. However, despite both German and French support, the Frugal Four seem to be standing their ground. It should be no surprise that the euro has turned lower on the news as well, as early modest gains have now turned into a 0.3% decline. One of the underlying supports for the single currency, of late, has been the idea that the joint financing of a significant budget at the EU level will be the beginning of a coherent fiscal policy to be coordinated with the ECB’s monetary policy. If they cannot agree these terms, then the euro’s existence can once again be called into question.

Perhaps what is more interesting is that as European equity markets turn lower, and US futures with them, the bond market is under modest pressure as well this morning. 10-year Treasury yields are higher by more than 2bps and in Europe we are seeing yields rise by between 3bps and 4bps. This is hardly risk-off behavior and once again begs the question which market is leading which. In the long run, bond investors seem to have a better handle on things, but on a day to day basis, it is anyone’s guess.

Finally, turning to the dollar shows that early weakness here has turned into broad dollar strength with only two currencies in the G10 higher at this point, the haven JPY (+0.4%) and NOK (+0.2%), which has benefitted from oil’s rally this morning with WTI up by about 1% and back above $40/bbl. In the emerging markets, only ZAR has managed any gains of note, rising 0.4%, after its PMI data printed at a surprisingly higher 53.9. On the flip side, PLN (-0.6%) is the laggard, although almost all EMG currencies are softer, as PMI data there continue to disappoint (47.2) and concerns over a change in political leadership seep into investor thoughts.

On the data front, we start to see some much more important data here today with ADP Employment (exp 2.9M), ISM Manufacturing (49.7) and Prices Paid (44.6) and finally, FOMC Minutes to be released at 2:00. Yesterday we saw some thought provoking numbers as Chicago PMI disappointed at 36.6, much lower than expected, while Case Shiller House Prices rose to 3.98%, certainly not indicating a deflationary surge.

Yesterday we also heard the second part of Chairman Powell’s testimony to Congress, where alongside Treasury Secretary Mnuchin, he said that the Fed remained committed to doing all that is necessary, that rates will remain low for as long as is deemed necessary, and that it would be a mistake if Congress did not continue to support the economy with further fiscal fuel. None of that was surprising and, quite frankly, it had no impact on markets anywhere.

At this point, today looks set to see a little reversal to last quarter’s extremely bullish sentiment so beware further dollar strength.

Good luck and stay safe
Adf

 

Over and Done

Our planet, third rock from the sun
Has had a remarkable run
For ten years, at least
No famine, just feast
But now that streak’s over and done

The IMF said, yesterday
This year will see growth go away
For ‘Twenty, it’s clear
While next year they fear
A second wave, growth will delay

Fear was the order of the day yesterday amid several related stories. Headlines continue to highlight the resurgence in reported Covid cases in the US, notably in those states that have begun to reopen more aggressively. So, California, Texas and Florida have all seen a big jump in infections which many are saying requires a second lockdown. While no orders of that nature have yet been issued, it is clear there is a risk they will be deemed necessary. That would be quite the body blow to the US economy, as well as to the equity markets which are pretty clearly pricing in that elusive V-shaped recovery. If we see second order lockdowns, you can be pretty confident that the equity market will suffer significantly. Simply consider yesterday’s performance, with the three US indices all falling at least 2.2% without having to deal with any actual change in regulations.

Adding insult to injury was the IMF, which released its updated global GDP forecasts and is now looking for a more severe global recession with growth falling 4.9% in 2020. That is down from the -3.0% expectation in April. As well, they reduced their forecasts for 2021, albeit not as dramatically, to +5.4%, down 0.4% from the April forecasts. However, they warned that should a second wave manifest itself, 2021 could see essentially zero growth globally as unemployment worldwide explodes and poverty levels in the emerging markets explodes with it. In other words, they don’t really think we are out of the woods yet.

With that one-two punch, it is no surprise that we saw risk jettisoned yesterday as not only did equity markets suffer, but we saw demand for bonds (Treasury yields -4bps yesterday and another 1.5bps this morning) while the dollar saw broad-based demand, with the DXY rising 0.6% on the day. If nothing else, this is strong evidence that all markets are anticipating quite a strong recovery, and that anything that may disrupt that process is going to have a negative impact on risk asset prices.

Adding to the fun yesterday was oil’s 6% decline on data showing inventories growing more than expected, which of course means that demand remains lackluster. Certainly, I know that while I used to fill up the tank of my car every week, I have done so only once in the past three months! While that is good for my budget, it is not helping support economic activity.

The point is, the risk asset rally has been built on shaky foundations. Equity fundamentals like revenues and earnings are (likely) in the process of bottoming out, but the rally is based on expectations of a V. Every data point that indicates the V is actually a U or a W or, worst of all, an L, will add pressure on the bulls to continue to act solely because the Fed keeps purchasing assets. History has shown that at some point, that will not be enough, and a more thorough repricing of risk assets will occur. Part of that process will almost certainly be a very sharp USD rally, which is, of course, what matters in the context of this note.

Looking at how today’s session has evolved shows that Asian equity markets had a down session, with the Nikkei taking its cues from the US and falling 1.2%, and Australia suffering even more, down 2.5%. China and Hong Kong were closed while they celebrated Dragon Boat Day. European bourses are in the green this morning, but just barely, with the average gain just 0.15% at this hour following yesterday’s 1.3%-2.0% declines. And US futures have turned lower at this time after spending much of the overnight session in the green.

As mentioned, bond markets are rallying with yields falling correspondingly, while the dollar continues to climb even after yesterday’s broad-based strength. So, in the G10 space, the euro is today’s worst performer, down 0.4%, amid overall growing concerns of a slower rebound. While the German GfK Consumer Confidence survey printed better than expected (-9.6), it was still the second worst print in the series history after last month’s. Aside from the euro, perhaps the most interesting thing is that both CHF and JPY have fallen 0.2%, despite the demand for havens. There is no news from either nation that might hint at why these currencies are underperforming from their general risk stance, but as I wrote last week, it may well be that the demand for dollars is leading the global markets these days, rather than acting as a relief valve like usual.

Emerging market currencies are seeing a more broad-based decline, simply following on yesterday’s price action. I cannot ignore the 3.6% fall in BRL yesterday, as the Covid situation grows increasingly out of control there. While the market has not opened there yet, indications are that the real’s decline will continue. Meanwhile, today’s worst performer is HUF, down 1.3%, although here, too, there is no obvious catalyst for the decline other than the dollar’s strength. Now, from its weakest point in April, HUF had managed to rally nearly 12% through the beginning of the month but has given back 5.3% of that since. On a fundamental basis, HUF is highly reliant on the Eurozone economies performing well as so much of their economic activity is generated directly on the back of Europe. Worries over the Eurozone’s trajectory will naturally hit all of the CE4. And that is true today with CZK (-0.7%) and PLN (-0.55%) also amongst the worst performers. APAC currencies suffered overnight, but not to the extent we are seeing this morning, and LATAM seems set to pick up where yesterday’s declines left off.

On the data front, this morning brings the bulk of the week’s important data. Initial Claims (exp 1.32M) and Continuing Claims (20.0M) remain critical data points in the market’s collective eyes. Anything that indicates the employment situation is not getting better will have a direct, and swift, negative impact on risk assets. We also see Durable Goods (10.5%, 2.1% ex transport) and the second revision of Q1 GDP (-5.0%). One other lesser data point that might get noticed is Retail Inventories (-2.8%) which has been falling after a sharp rise in March, but if it starts to rise again may also be a red flag toward future growth.

Two more Fed speakers are on the docket, Kaplan and Bostic, but there is nothing new coming from the Fed unless they announce a new program, and that will only come from the Chairman. So, at this stage, I see no reason to focus on those speeches. Instead, lacking an exogenous catalyst, like another Fed announcement (buying stocks maybe?) it feels like risk will remain on the defensive for the day.

Good luck and stay safe
Adf