Tag Archives: #dollarstrength

The Story of Boris

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Today it’s the story of Boris
A man who commands a thesaurus
When speaking of foes
To prove that he knows
More things than the Press’s Greek chorus

Tell me if you’ve heard this one before…a politician makes a bold promise to achieve something by a specific date.  As the date approaches, and it is clear that promise will not be fulfilled, he changes his tune blaming others for the problems.

I’m certain you recognize this situation, and of course, today it is the story of Boris.  Back on September 7, Johnson was adamant that if a deal was not completed by October 15, the day an EU summit was scheduled to begin, that there would be no deal at all.  It appears that he believed he had the upper hand in the negotiations and wanted to get things done.  As well, the EU had indicated that if a deal was not agreed by the middle of October, it would be nearly impossible for all of the 27 member nations to approve the deal in their respective parliaments.

Alas for Boris, things have not worked out as well as he might have hoped.  Instead, two major issues remain; EU access to fishing in UK waters and the limits on UK state aid for companies, and neither one seems on the verge of a breakthrough.  Yet the calendar pages keep turning and here we are, one day before the ‘deadline’ and nothing has been agreed.  In fact, as the EU prepares for its summit starting tomorrow, this is the statement that has been released, “progress on the key issues of interest to the union is still not sufficient for an agreement to be reached.”

Though Boris’s deadline grows near
It seems that he might not adhere
As now the UK
Will not walk away
From Brexit discussions this year

With this as a backdrop, one would not be surprised to see the pound start to lose some of its recent luster.  Clearly, that was a major part of yesterday’s price action, where the pound declined 1.0% and the rest of the G10 saw an average decline of only 0.4%.  In other words, while the dollar was strong against virtually all comers yesterday, the pound was at the bottom of the barrel.  Apparently, some investors are beginning to get cold feet with respect to their view that despite all the bluster, a Brexit deal will be reached.  It is also not surprising that comments from Number 10 Downing Street this morning indicate the UK will not walk away from Brexit talks immediately.  So, the EU effectively called Johnson’s bluff, and Boris backed down.  It is also important to note that while the EU would like to get a deal agreed as soon as possible, they see no hard deadline with respect to when things need to be completed before the end of the year.

The overnight session saw a follow on from yesterday, with the pound falling another 0.55% before the comments about continuing the discussions hit the tape.  The ensuing rebound now has the pound higher by 0.25% on the session, and actually the best performer in the G10 today.  The bigger point is that the Brexit saga is not nearly done, and there is still plenty of opportunity for more volatility in the pound.  I read one bank claimed the probability of a no-deal Brexit has fallen to 20%.  Whether that is accurate or not, a no-deal Brexit is likely to see the pound fall sharply, with a move to 1.20 entirely realistic.  Hedgers take note.

As to the rest of the market/world, yesterday’s risk reducing session seems to have ended, although risk is not being readily embraced either.  Overnight saw equity markets either little changed (Nikkei and Hang Seng +0.1%) or lower (Shanghai -0.55%).  Chinese Money Supply and lending data showed that the PBOC continues to push funds into the economy to support things, and the renminbi’s price action shows that there continue to be inflows to the country.  CNY (+0.2%) has consistently been a strong performer, even after the PBOC relaxed short selling restrictions at the beginning of the week.

European markets have also proven to be mixed, with the CAC, DAX and FTSE 100 all lower by -0.2%, but Spain and Italy both higher by 0.3%.  Earlier in the session, all markets were higher, so perhaps some concerns are growing, although there have been no comments on the tape of note.  US futures have also given up earlier gains and currently sit essentially unchanged.

Bond markets had a strong performance yesterday, with 10-year Treasury yields declining 5 basis points and a further 1.5 basis points this morning.  We have seen the same type of price action across European government bond markets, with virtually all of them rallying and yields declining by 2-3 bps.

Finally, as we turn to the dollar, yesterday’s broad strength is largely continuing in the EMG bloc, save CNY’s performance, but against its G10 counterparts, it is, arguably, consolidating.  Aside from the pound, the rest of the G10 is +/- 0.15%, with only slightly weaker than expected Eurozone IP data as a guide.  As to the EMG bloc, there is weakness in RUB (-0.6%), HUF (-0.5%) as well as the two highest beta currencies, MXN and SAR (-0.3%).  Russia has the dubious distinction of the highest number of new cases of Covid today, more than 14K, (wait a minute, don’t they have a vaccine?) and Hungary, with nearly 1000 is also feeling the crunch based on population size.  It appears that investors are concerned over economic prospects as both nations see the impending second wave and are considering lockdowns to help stem the outbreak.  As to MXN and SAR, they are simply the most popular vehicles for investors to play emerging markets generally, and as risk seems to be falling out of favor, their decline is no surprise.

On the data front, PPI (exp 0.2%, core 0.2%) is today’s event, but given yesterday’s CPI release was spot on, this will largely be ignored.  The inflation/deflation discussion continues but will need to wait another month for the next installment as yesterday taught us little.

One of the positives of the virtual society is that things like the World Bank / IMF meetings, which had been such big to-dos in Washington in past years, are now held virtually.  As such, they don’t generate nearly the buzz as in the past.  However, it should be no surprise that there is a single thesis that is making the rounds in this virtual event; governments need to spend more money on fiscal stimulus and not worry about increased debt.  Now, while this has been the central bank mantra for the past six months, ever since central banks realized they had run out of ammunition, it is still remarkable coming from two organizations that had made their names hectoring countries about having too much debt.  Yet that is THE approved message of the day, governments should borrow more ‘free’ money and spend it.  And it should be no surprise that is the message from the chorus of Fed speakers as well.  Alas, in the US, at least, the politics of the situation is far more important to the players than the potential benefits of passing a bill.  Don’t look for anything until after the election in my view.

As to the session, I see no reason for the dollar to do much at all.  The dollar bears have been chastened and lightened their positions, while the dollar bulls no longer like the entry point.  It feels like a choppy day with no direction is on the cards.

Good luck and stay safe
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QE’s Not Constrained

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For everyone who seems to think
The dollar will steadily sink
This weekend disclosed
The world is opposed
To letting the buck’s value shrink

In China they eased the restrictions
On short sales in all jurisdictions
While Europe explained
QE’s not constrained
And further rate cuts are not fictions

It cannot be a surprise that we are beginning to see a more concerted response to dollar weakness from major central banks.  As I have written consistently, at the current time, no nation wants their currency to be strong.  Each is convinced that a weak currency will help obtain the twin goals of improved export performance leading to economic growth and higher inflation.  While financial theory does show that, in a closed system, those are two natural consequences of a weak currency, the evidence over the past twelve years has been less convincing.  Of course, as with every economic theory, a key assumption is ‘ceteris paribus’ or all else being equal.  But all else is never equal.  A strong argument can be made that in addition to the global recession undermining pricing power, the world is in the midst of a debt deflation.  This is the situation where a high and rising level of overall debt outstanding directs cash flow to repayment and reduces the available funding for other economic activity.  That missing demand results in price declines and hence, the debt deflation.  History has shown a strong correlation between high levels of debt and deflation, something many observers fail to recognize.

However, central banks, as with most large institutions, are always fighting the last war.  The central bank playbook, which had been effective from Bretton Woods, in 1944 until, arguably, sometime just before the Great Financial Crisis in 2008-09, explained that the reflexive response to economic weakness was to cut interest rates and ease financing conditions.  This would have the dual effect of encouraging borrowing for more activity while at the same time weakening the currency and making the export community more competitive internationally, thus boosting growth further.  And finally, a weaker currency would result in imported inflation, as importers would be forced to raise prices.

The Great Financial Crisis, though, essentially broke that model, as both the economic and market responses to central bank activities did not fit that theoretical framework.  Instead, adhering to the playbook saw interest rates cut to zero, and then below zero throughout Europe and Japan, additional policy ease via QE and yet still extremely modest economic activity.  And, perhaps, that was the problem.  Every central bank enacted their policies at the same time, thus there was no large relative change in policy.  After all, if every central bank cut interest rates, then the theoretical positive outcomes are negated.  In other words, ceteris isn’t paribus.

Alas, central banks have proven they are incapable of independent thought, and they have been acting in concert ever since.  Thus, rate cuts by one beget rate cuts by another, sometimes explicitly (Denmark and Switzerland cutting rates after the ECB acts) and sometimes implicitly (the ECB, BOE and BOC cutting rates after the Fed acts).  In the end, the results are that the relative policy settings remain very close to unchanged and thus, the only beneficiary is the equity market, where all that excess money eventually flows in the great hunt for positive returns.

Keeping the central bank mindset at the fore, we have an easy time understanding the weekend actions and comments from the PBOC and the ECB.  The PBOC adjusted a reserve policy that had been aimed at preventing rampant selling speculation against the renminbi.  For the past two plus years, all Chinese banks had been required to keep a 20% reserve against any short forward CNY positions they executed on behalf of customers.  This made shorting CNY prohibitively expensive, thus reducing the incentive to do so and helped support the currency.  However, the recent price action in CNY has been strongly positive, with the renminbi having appreciated nearly 7% between late May and Friday.  For a country like China, that sells a great many low margin products to the rest of the world, a strong currency is a clear impediment to their economic plans.  The PBOC action this weekend, removing that reserve requirement completely, is perfectly in keeping with the mindset of a weaker currency will help support exports and by extension economic growth.  Now there is no penalty to short CNY, so you can expect more traders to do so.  Especially since the fixing last night was at a weaker CNY level than expected by the market.  Look for further CNY (-0.8% overnight) weakness going forward.

As to the ECB, their actions were less concrete, but no less real.  ECB Chief Economist Philip Lane, the member with the most respected policy chops, was on the tape explaining that the Eurozone faces a rocky patch after the initial rebound from Covid.  He added, “I do not see that the ECB has a structurally tighter orientation for monetary policy[than the Federal Reserve].  Anyone who pays attention to our policies and forward guidance knows that we will not tighten policy without inflation solidly appearing in the data.”  Lastly, he indicated that both scaling up QE purchases and further rate cuts are on the table.

Again, it should be no surprise that the ECB is unwilling to allow the euro to simply rally unabated in the current environment.  The playbook is clear, a strong currency needs to be addressed, i.e. weakened. This weekend simply demonstrated that all the major central banks view the world in exactly the same manner.

Turning to the markets on this holiday-shortened session, we see that Chinese equities were huge beneficiaries of the PBOC action with Shanghai (+2.65%) and the Hang Seng (+2.0%) both strongly higher although the Nikkei (-0.25%) did not share the market’s enthusiasm.  European markets are firming up as I type, overcoming some early weakness and now green across the board.  So, while the FTSE 100 (+0.1%) is the laggard, both the DAX (+0.45%) and CAC (+0.75%) are starting to make some nice gains.  As to US futures, they, too, are now all in the green with NASDAQ (+ 1.3%) far and away the leader.  Despite the federal holiday in the US, the stock market is, in fact, open today.

Banks, however, are closed and the Treasury market is closed with them.  So, while there is no movement there, we are seeing ongoing buying interest across the European government bond markets as traders prepare for increased ECB QE activity.  After all, if banks don’t own the bonds the ECB wants to buy, they will not be able to mark them up and sell them to the only price insensitive buyer in the European government bond market.  So, yields here are lower by about 1 basis point across the board.

As to the dollar, it is broadly, but mildly stronger this morning.  Only the yen (-0.15%) is weaker in the G10 space as the rest of the block is responding to the belief that all the central banks are going to loosen policy further, a la the ECB.  As to the EMG bloc, CZK is actually the biggest loser, falling 0.9% after CPI there surprised the market by falling slightly, to 3.2%, rather than extending its recent string of gains.  This has the market looking for further central bank ease going forward, something that had been questioned as CPI rose.  Otherwise, as we see the prices of both oil and gold decline, we are seeing MXN (-0.6%), ZAR (-0.5%) and RUB (-0.5%) all fall in line.  On the flip side, only KRW (+0.55%) has shown any strength as foreign investors continue to pile into the stock market there on the back of Chinese hopes.

We do get some important data this week as follows:

Tuesday CPI 0.2% (1.4% Y/Y)
-ex food & energy 0.2% (1.7% Y/Y)
Wednesday PPI 0.2% (0.2% Y/Y)
-ex food & energy 0.2% (0.9% Y/Y)
Thursday Empire Manufacturing 14.0
Initial Claims 825K
Continuing Claims 10.4M
Philly Fed 14.0
Friday Retail Sales 0.8%
-ex autos 0.4%
IP 0.6%
Capacity Utilization 71.9%
Michigan Sentiment 80.5

Source: Bloomberg

Remember, we have seen five consecutive higher than expected CPI prints, so there will be a lot of scrutiny there, but ultimately, the data continues to point to a slowing recovery with job growth still a major problem.  We also hear from nine more Fed speakers, but again, this message is already clear, ZIRP forever and Congress needs to pass stimulus.

In the end, I find no case for the dollar to weaken appreciably from current levels, and expect that if anything, modest strength is the most likely path going forward, at least until the election.

Good luck and stay safe
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We Won’t Acquiesce

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Said Madame Lagarde to the press
In Frankfurt, we won’t acquiesce
To prices not rising
So, it’s not surprising
That average inflation we’ll stress

Raise your hand if you had, ‘the ECB will copy the Fed’s average inflation framework’ when announcing their own policy initiatives.  That’s right folks, I’m sure you are all shocked to learn that the ECB is now considering (read has already decided) to follow in the Fed’s footsteps and target an average inflation rate over an indeterminate time in their own policy review.  As Lagarde pointed out, “If credible, such a strategy can strengthen the capacity of monetary policy to stabilize the economy when faced with the lower bound.”  Perhaps the key words to this statement are the first two, if credible.  After all, given the ECB’s demonstrated futility at achieving their targeted inflation rate since its creation in 1997, why would it be credible that the ECB is going to generate inflation now that will run above target.  In fact, over the entire history of ECB policymaking, there was a single stretch of 15 months (October 2001 – December 2002) where their favorite measure, Core CPI, rose above 2.0%.  Otherwise, during the other 270 months, they have seen inflation below their target, oftentimes well below.  The average inflation rate since the ECB’s founding has been 1.4%.  But now we are supposed to believe that because they claim they will allow inflation to run hot, suddenly that makes policy easier.  Personally, I don’t find their claim credible.

But from the market perspective, the importance of her comments, as well as agreement by other ECB members on the subject, is that the Fed has ceased to be the central bank with the easiest money around.  With the ECB and the Fed now both following the same path on inflation targeting, there is not much to choose between the two.  This is especially so given that neither one has been able to approach their current target, let alone exceed it in more than a decade.  But for dollar bears, this is bad news because a key part of the bearish thesis was the idea that the Fed was the easiest money around.  Average inflation targeting meant interest rates would remain near zero for at least three more years.  Well I have news for you, ECB rates will remain negative far longer than that.  Just as a man with a hammer sees every problem as a nail, a central bank with a single policy tool (QE) sees every problem solvable by more bond purchases.

Adding to the euro’s medium-term woes is the situation in Italy, where despite more than €209 billion euros of EU aid, the debt/GDP ratio is destined to head ever higher, rising to 158% this year.  That cements its current third place worldwide status (Japan 234%, Greece 182%) and starts to bring Greece’s number two slot into sight.  With a history of slow growth and a rapidly aging population, it becomes ever harder to envision a solution to Italy’s macroeconomic woes that doesn’t include either debt relief or debt monetization.  And I assure you, that is not a currency positive for the euro.  The point here is that the many negatives that underlie the euro’s construction are likely to become a greater topic of market conversation going forward, and it appears the odds of a significant rally from current levels has greatly diminished, regardless of your views of US policies.

Speaking of US policies, I will admit that I could only tolerate a few minutes of last night’s presidential debate, as the name-calling and interruptions became far too annoying.  Equity futures declined, seemingly on the view that Biden cemented his lead, at least so that’s what the punditry is explaining this morning.  Perhaps equity futures declined as investors decided that no outcome is positive for the US.  But while clearly the presidential campaign will have some market impact over the next five weeks, at this point, it seems unlikely the polls will change much, nor the betting markets.  And yet, we cannot forget that in 2016, the polls and betting markets were pointing to the exact same outcome and turned out to be spectacularly wrong.  In the end, regardless of who wins the election, the Fed is going to continue their current policy mix and more fiscal stimulus is destined to arrive.  As such, I am hard-pressed to say it will impact the dollar.

One other thing of note overnight was Chinese PMI data (Mfg 51.5, Services 55.9), which showed that growth on the mainland continued to expand moderately on the strength of increases across both manufacturing and services sectors.  Even the Caixin PMI (53.0), which focuses on small companies, put in a solid performance.  Interestingly, neither the Shanghai Composite (-0.2%) nor the renminbi (unchanged) reflected any positivity in the outcome.  And neither was that news sufficient to generate any risk taking elsewhere in the world, at least on any sustained basis.

Looking at the rest of the equity markets, we see the Nikkei (-1.5%) fell sharply although the Hang Seng (+0.8%) managed to show the only rise amongst major equity indices.  European bourses are all in the red (DAX -0.5%, CAC -0.6%, FTSE 100 -0.3%) and US futures continue to point lower, with all three indices down about -0.6% at this hour.  Bond market movement continues to largely be absent as 10-year Treasury yields are still 0.65%, unchanged, and both Bunds and Gilts are less than 1 basis point different than yesterday’s levels.  Even Italian BTP’s are unchanged despite the increasing concerns over their fiscal situation.  In other words, the central banks have done an excellent job in controlling yield curves and thus preventing the bond market from offering any economic signals.

As to the dollar, it is broadly, albeit mildly, stronger this morning against its G10 counterparts.  NOK and SEK (both -0.5%) are the leading decliners with Norway suffering from oil’s slide back below $40/bbl, while SEK is simply demonstrating its higher beta to broad movements.  But the whole space is feeling it today, with the exception of CAD, which is essentially unchanged.  Clearly, the Lagarde comments have served to soften the euro (-0.3%) at the margin.

As to the emerging market bloc, things are a bit more mixed.  The notable movers include RUB (+0.9%) and TRY (+0.5%) on what appears to be the first attempts by both nations to de-escalate the Armenian-Azerbaijani conflict.  As well, we see MXN (+0.8%) and ZAR (+0.7%) on the positive side, which is more difficult to justify given the lack of risk appetite, but is likely related to the calendar, as investors rebalance positions into month-end, and so are reducing shorts in those currencies.  On the negative side sits the CE4, following the euro’s decline with their usual ability to outpace the single currency.  Interestingly, APAC currencies have done little overnight, with most movement less than 10 basis points.

On the data front this morning we get ADP Employment (exp 649K), Q2 GDP’s final revision (-31.7%) and Chicago PMI (52.0).  Arguably, the market will be more concerned with the ADP data than anything else as investors try to get a picture of the employment situation.  We also have three more Fed speakers, Kashkari, Bowman and Bullard, but based on yesterday’s outcome, where the message is that the Fed is moderately optimistic that growth will continue but that more fiscal support would be useful, it seems unlikely that these comments will interest many people.

Overall, the big story remains the indication that the ECB is going to match the Fed every step of the way going forward, as will, eventually, every other key central bank, and so the dollar’s value will need to be determined by other means.  But for now, it points to a bit more dollar strength as short positions start to get unwound.

Good luck and stay safe
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The New Weasel Word

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The bulk of the FOMC
Explained their preferred policy
More government spending,
Perhaps never ending,
Is what almost all want to see

Meanwhile, ‘cross the pond, what we heard
Is ‘bove 2% is preferred
They’ll soon change their stance
To give growth a chance
Inflation’s the new weasel word

Another day, another central bank explanation that higher inflation is just what the doctor ordered to improve the economy.  This time, Banque de France’s Governor, Francois Villeroy de Galhau, explained that the current formulation used by the ECB, “below, but close to, 2%”, is misunderstood.  Rather than 2% being a ceiling, what they have meant all along is that it is a symmetrical target.  Uh huh!  I’ve been around long enough to remember that back in 1988, when the ECB was first being considered, Germany was adamant that they would not accept a central bank that would allow inflation, and so forced the ECB to look just like the Bundesbank.  That meant closely monitoring price pressures and preventing them from ever getting out of hand.  Hence, the ECB remit, was absolutely designed as a ceiling, with the Germans reluctant to even allow 2% inflation.  Of course, for most of the rest of Europe, inflation was the saving grace for their economies.  Higher inflation begat weaker currencies which allowed France, Italy, Spain, et.al. to continue to compete with a German economy that became ever more efficient.

But twenty-some years into the experiment of the single currency, and despite the fact that the German economy remains the largest and most important in the Eurozone, the inflationistas of Southern Europe are gaining the upper hand.  These comments by Villeroy are just the latest sign that the ECB is going to abandon its price stability rules, although you can be sure that they will never say that.  Of course, the problem the ECB has is similar to that of Japan and the US, goosing measured inflation has been beyond their capabilities for the past decade (more than two decades for the BOJ), so simply changing their target hardly seems like it will be sufficient to do the job.  My fear, and that of all of Germany, is that one day they will be successful in achieving this new goal and will not be able to stop inflation at their preferred level, but instead will see it rise much higher.  But that is not today’s problem.  Just be aware that we are likely to begin hearing many other ECB members start discussing how inflation running hot for a while is a good thing.  Arguably, the only exceptions to this will be the Bundesbank and Dutch central bank.

And once again, I will remind you all that there is literally no chance that the ECB will sit back and watch, rather than act, if the Fed actually succeeds in raising inflation and weakening the dollar.

Speaking of the Fed, this week has seen a significant amount of Fedspeak already, with Chairman Powell on the stand in Congress for the past three days.  What he, and virtually every other Fed speaker explained, was that more fiscal stimulus was required if the government wanted to help boost growth.  The Fed has done all they can, and to listen to Powell, they have been extremely effective, but the next step was Congress’s to take.  The exception to this thought process came from St Louis Fed President Bullard, who explained that based on his forecasts, the worst is behind us and no further fiscal stimulus is needed.  What makes this so surprising is that he has been one of the most dovish of all Fed members, while this is a distinctly hawkish sentiment.  But he is the outlier and will not affect the ultimate outcome at this stage.

Powell was on the stand next to Treasury Secretary Mnuchin, who made the comment with the biggest impact on markets.  He mentioned that he and House Speaker Pelosi were back to negotiating on a new stimulus package, which the equity market took as a sign a deal would be reached quickly.  We shall see.  Clearly, there is a great deal of angst in Congress right now, so the ability to agree on anything across the aisle is highly questionable.

With that in mind, a look at markets shows what had been a mixed opening is turning into a more negative session.  Overnight saw Asian equity markets with minimal gains and losses (Nikkei +0.5%, Hang Seng -0.3%, Shanghai -0.2%), but Europe, which had been behaving in a similar manner early in the session has turned sharply lower.  At this time, the DAX (-1.95%) and CAC (-2.0%) are leading the way lower, with the FTSE 100 (-0.8%) having a relatively better day.  At the same time, US futures turned from flat to lower, with all three indices now pointing to -0.6% losses at the open.

It is difficult to point to a specific comment or piece of news driving this new sentiment, but it appears that the bond market is in the same camp as stocks.  Treasury yields, while they remain in a narrow range, have slipped 1bp, to 0.65%, and we are seeing Bunds (-2bps) and Gilts (-3bps) also garner demand as havens are in play.  Apparently, central bank desire for inflation is not seen as a serious situation quite yet.

Commodity prices have turned around as well, with oil falling 2% from morning highs, and gold dropping 1%.  In other words, this is a uniform risk reduction, although I would suspect that gold prices should lag the decline elsewhere.

As to the dollar, it is starting to pick up a more substantial bid with EUR (-0.3%) and GBP (-0.35%) sliding from earlier levels.  NOK (-1.15%) remains the worst performer in the G10, which given the decline in oil prices and evolving risk sentiment should be no surprise.  But at this point in the day, the entire bloc is weaker vs. the buck.  EMG currencies, too, have completely reversed some modest early morning strength, and, once again, ZAR (-1.2%) and MXN (-1.0%) lead the way lower.  One must be impressed with the increased volatility in those currencies, as they start to approach levels seen in the initial stages of the Covid crisis.  For anyone who thought that the dollar had lost its haven status, recent price action should put paid to that notion.

On the data front, today brings Durable Goods (exp 1.4%, 1.0% ex Transport) and we hear from two more Fed speakers, Williams and Esther George.  While Williams is almost certain to repeat Powell’s current mantra of more fiscal support, Ms George is one of the more hawkish Fed members and could well sound more like James Bullard than Jay Powell.  We shall see.

This has been a risk-off week, with equity markets down across the board and the dollar higher vs. every major currency in the world.  It seems highly unlikely that the Durable Goods number will change that broader sentiment, and so the ongoing equity market correction, as well as USD rebound seems likely to continue into the weekend.  Remember, short USD positions are still the rule, so there is plenty of ammunition for a further short covering.

Good luck, good weekend and stay safe
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Further To Go

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The contrast could not be more clear
Twixt Powell and Christine this year
The Fed jumped in first
But now they’ve disbursed
As much aid as like to appear

Meanwhile Ms Lagarde in Berlin
Was clearly quite slow to begin
But Europe depends
On banks to extend
Its aid, so can still underpin

More growth by increasing the flow
Of cash, through TLTRO
Thus, traders now see
The buck vis-à-vis
The euro, has further to go

It was less than two months ago when the most prominent theme in the market was the imminent demise of the dollar, not merely in the short-term, but in the long run.  The idea that was being circulated was that because of the US’s excessive and growing twin deficits (Budget and Current Account), investors would soon decide that holding dollar’s would be too risky and thus demand a different unit of account and store of value.  During this period, we did see the dollar sell off, with the greenback falling nearly 6.5% vs. the euro during the month of July.  But that was basically that.  It was a great story, and probably a good trade for some early movers, but explaining short term market volatility by referring to ultra-long-term financial theory was always destined to fail.  And fail it has.  After all, since then, the dollar has actually appreciated (+2.2% vs. the euro) and yet, if anything, the US has seen its budget and current account deficits widen further.

Rather, short-term dollar movement tends to be driven by things like relative monetary policy and relative macroeconomic performance.  Looking back at that time, the prevailing sentiment was that the Fed, despite having already implemented an unfathomable amount of monetary ease already, was preparing to do even more.  Recall, leading up to, and through, the Jackson Hole symposium, market participants were sure that the Fed was going to not merely allow inflation to run hot, but help it do so.  Meanwhile, the ECB, in its typical plodding manner, was very quiet and the punditry saw little in the way of additional ease on the horizon.  In fact, there were complaints that the ECB was not doing nearly enough.

However, as seems to happen quite frequently, the punditry turns out to have gotten things backwards.  Last week, the Fed announced their new policy goals, counting on average inflation targeting to help them achieve significantly lower unemployment, although they still couldn’t didn’t explain how they were going to achieve said higher inflation.  And then earlier this week, Chairman Powell, in as much, admitted that the Fed has done all they can and that it was up to Congress to expand fiscal stimulus in order to give the economy the support it needed to cope with the Covid inspired recession.  In other words, the Fed is out of bullets.

One of the problems the Fed has is that transmission of monetary policy is effected by banks, that is the way the system is designed.  But the bulk of the Fed programs have only supported markets, by them buying Treasuries, Mortgage-backed securities, Corporates (IG and Junk) and Munis.  But for small companies who don’t access the capital markets directly, virtually none of the Fed’s activities have had an impact as the bank’s are reluctant to lend in this environment of economic uncertainty.  Europe, on the other hand, relies on banks for the majority of capital flow to its economy, as European corporate debt markets remain much smaller and more fragmented across countries.  So, when the ECB created the TLTRO, targeted lending facility, where they PAY banks 1.00% to lend money to companies, who also pay the banks interest, it turns out to be a more efficient way to prosecute monetary policy ease.  And this morning, the latest tranche of this program saw an additional €174.5 billion taken up.  This is on top of the €1.3 trillion that was taken up last time there was a tender, three months ago.

The point is, suddenly investors and traders are figuring out that the ECB has the ability to promulgate policy ease more effectively than the Fed, and just as importantly, are doing so.  Add it all up and you have ECB policy looking easier than Fed policy at the margin, a clear recipe for the euro’s decline.  This move in the euro is just beginning, and it would not be surprising to see the single currency head back toward 1.12 before the end of the year.  As I have written in the past, there was no way the ECB would sit back and allow the dollar to fall unhindered.  They simply cannot afford that outcome to occur.

Which brings us to today’s session, where risk is being jettisoned across equity markets globally, although several European markets are starting to turn things around.  Overnight, following a very weak US session, Asia was red across the board led by the Hang Seng (-1.8%), but with weakness in Shanghai (-1.7%) and the Nikkei (-1.1%). Europe, however, while starting lower in every market has now seen a little positivity as the DAX (+0.15%) and Italy’s FTSE MIB (+0.7%) are offsetting increasingly modest weakness in the CAC (-0.1%) and FTSE 100 (-0.4%).  Finally, US futures, which had also been lower by more than 0.5% earlier in the session, have rebounded to flat.

The bond market, however, remains enigmatic lately, with yields continuing to trade in extremely tight ranges regardless of the movement in risk assets.  At this time, Treasury yields are unchanged, after remaining essentially unchanged during yesterday’s US equity sell-off.  Bunds have seen yields edge lower by 1.5 basis points, while Gilt yields have edged higher by less than a basis point.  It seems that the bond markets, globally, are unwilling to follow every twist and turn of the recent stock market manias.

As to the dollar, it is firmer vs. most of its counterparts, but just like we are seeing in European equities, we are beginning to see a bit of a rebound in some currencies as well.  In the G10, the biggest story is NOK (-0.65%) where the Norgesbank disappointed one and all by seeming to be more dovish than anticipated.  Many had come to believe they would be putting a timeline on raising interest rates, but they did no such thing, thus the krone has continued its recent poor performance (-5.8% vs. the dollar in the past month).  But we are seeing weakness elsewhere with SEK (-0.8%) actually the worst performer, albeit absent any specific news, and both NZD (-0.5%) and AUD (-0.3%) suffering at this point.

In the EMG bloc, overnight saw weakness across the Asian currencies led by KRW (-0.7%) and THB, IDR and TWD (all -0.5%) as risk was shed across the board.  But with the recent turn in events, early losses by ZAR (+0.7%) and MXN (+0.3%) have turned to gains.  It is those two currencies, however, which remain the most volatile around, so be careful if hedging there.

On the data front, yesterday’s US PMI data was right on expectations and showed continued progress in the economy, a sharp contrast to the European situation.  This morning saw modestly weaker than expected German IFO data (Expectations 97.7), which is not helping the euro.  Later today we see Initial Claims (exp 840K), Continuing Claims (12.275M) and finally New Home Sales (890K) at 10:00.  Once again, the tapes will be painted with Fedspeak, led by Powell at 10:00 in front of the Senate Banking Committee, but also hearing from six more FOMC members. While I would not be surprised if Powell tried to walk back his comments about the Fed being done, it’s not clear he will be able to do so.

For now, the dollar’s trend remains pretty solid, and I expect that it will continue to grind higher until we get a substantive change in policies.

Good luck and stay safe
Adf

Growth Has Now Faltered

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

Absent Demand

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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

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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

Posted on by

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

Posted on by

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