Tag Archives: #dollarstrength

Jay Was Thinking

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If anyone thought Jay was thinking
‘Bout raising rates while growth was sinking
The chairman was clear
That long past next year
Their balance sheet will not be shrinking

The money quote: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” said Mr. Powell.  And this pretty much sums up the Fed stance for the time being.  While there are those who are disappointed that the Fed did not add to any programs or announce something like YCC or, perhaps, more targeted forward guidance, arguably the above quote is even more powerful than one of those choices.  Frequently it is the uncertainty over a policy’s duration that is useful, not the policy itself.  Uncertainty prevents investors from anticipating a change and moving markets contrary to policymakers’ goals.  So, for now, there is no realistic way to anticipate the timing of the next rate hike.  Perhaps the proper question is as follows: is timing the next hike impossible because of the lack of clear targets?  Or is it impossible because there will never be another rate hike?

What the Fed did tell us (via the dot plot) is that only two of the seventeen FOMC members believe interest rates will be above 0.0% in 2022 (my money is on Esther and Mester, the two most hawkish members), but mercifully, not a single dot in the dot plot was in negative territory.  They also expressed a pretty dour view of the economy as follows:

 

  2020 2021 2022
Real GDP -6.5% 5.0% 3.5%
Core PCE 1.0% 1.5% 1.7%
Unemployment 9.3% 6.5% 5.5%

Source: Bloomberg

It is, of course, the 11.5% gain from 2020 to 2021 that encourages the concept of the V-shaped recovery as evidenced by simply plotting the numbers (including 2019’s 2.3% to start).

Screen Shot 2020-06-11 at 9.30.05 AM

So, perhaps the bulls are correct, perhaps the stock market is a screaming buy as growth will soon return and interest rates will remain zero for as far as the eye can see.  There is, however, a caveat to this view, the fact that the Fed is notoriously bad at forecasting GDP growth over time.  In fact, they are amongst the worst when compared with Wall Street in general.  But hey, at least we understand the thesis.

Another interesting outcome of the meeting was the tone of the press conference, where Chairman Jay sounded anything but ebullient over the current economic situation, especially the employment situation.  And it is this takeaway that had the biggest market impact.  After the press conference, equity markets in the US sold off from earlier highs (the NASDAQ set another all-time high intraday) and Treasuries rallied with yields falling again.  In other words, despite the prospect of Forever ZIRP (FZ), equity investors seemed to lose a bit of their bullishness.  This price action has been in place ever since with Asian equity markets all falling (Nikkei -2.8%, Hang Seng -2.3%, Shanghai – 0.8%) and Europe definitely under pressure (DAX -2.1%, CAC -2.2%, FTSE 100 -2.0%).  US futures are also lower with the Dow (-1.9%) currently the laggard, but even NASDAQ futures are lower by 1.1% at this hour.

It should be no surprise that bond markets around the world are rallying in sync with these equity declines as the combination of risk-off and the prospect for FZ lead to the inevitable conclusion that lower long term rates are in our future.  This also highlights the fact that the Fed’s concern over the second part of its mandate, stable prices, has essentially been set aside for another era.  The belief that inflation will remain extremely low forever is clearly a part of the current mindset.  Yesterday’s CPI (0.1%, 1.2% core) was simply further evidence that the Fed will ignore prices going forward.  So, 10-year Treasury yields are back to 0.7% this morning, 20 basis points below last Friday’s closing levels.  In other words, the impact of last Friday’s NFP number has been erased in four sessions.  But we are seeing investors rotate from stocks to bonds around the world, perhaps getting a bit nervous about the frothiness of the recent rallies.  (Even Hertz, the darling of the Robinhooders, is looking like Icarus.)

With risk clearly being jettisoned around the world, it should be no surprise that the dollar has stopped falling, and in fact is beginning to rally against almost all its counterparts.  While haven assets like CHF (+0.2%) and JPY (+0.1%) are modestly higher, NOK (-0.9%) and AUD (-0.85%) are leading the bulk of the G10 lower.  Norway is suffering on, not only broad dollar strength, but oil’s weakness this morning, with WTI -3.1% on the session.  As to Aussie, the combination of weaker commodity prices, the strong dollar, and market technicals as it once again failed to hold the 0.70 level, have led to today’s decline.

Emerging market activity is also what you would expect in a risk-off session, with MXN (-1.6%), ZAR (-1.1%) and RUB (-0.7%) leading the way lower.  Obviously, oil is driving both MXN and RUB, while ZAR is suffering from the weakness in the rest of the commodity complex.  I think the reason that the peso has fallen so much further than the ruble is that MXN has seen remarkable gains over the past month, more than 13% at its peak, and so seems overdue for a correction.  One notable exception to this price action today is THB, which is higher by 0.65% on a combination of reports of a fourth stimulus package and a breach of the 200-day moving average which got technicians excited.

This morning’s data brings the latest Initial Claims data (exp 1.55M), as well as Continuing Claims (20.0M) and PPI (-1.2%, 0.4% core).  While nobody will care about the latter, there will be ongoing intense scrutiny on the former as Chairman Jay made it abundantly clear that employment is the only thing the Fed is focused on for now.  With the FOMC meeting behind us, we can expect to start to hear from its members again, but on the schedule, nothing happens until next week.

It is not hard to make the case that both the euro and pound have been a bit toppish at recent levels, and with risk decidedly off today, further declines there seem quite viable.

 

Good luck and stay safe

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Value, Nought

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In college Econ 101
Professors described the long run
As when we all died
Like Keynes had replied
Debating a colleague for fun

However, the rest that they taught
Has turned out to have, value, nought
Their models have failed
While many have railed
That people won’t do what they ought

Observing market activity these days and trying to reconcile price action with the theories so many of us learned in college has become remarkably difficult. While supply and demand still seem to have meaning, pretty much every construct more complex than that turns out to have been a description of a special case and not a general model of behavior. At least, that’s one conclusion to be drawn from the fact that essentially every forecast made these days turns out wrong while major pronouncements, regarding the long-term effect of a given policy, by esteemed economists seem designed to advance a political view rather than enhance our knowledge and allow us to act in the most effective way going forward. Certainly, as merely an armchair economist, my track record is not any better. Of course, the difference is that I mostly try to highlight what is driving markets in the very short term rather than paint a picture of the future and influence policy.

I bring this up as I read yet another article this morning, this by Stephen Roach, a former Chairman of Morgan Stanley Asia and current professor at Yale, about the imminent collapse of the dollar and the end of its status as the world’s reserve currency. He is not the first to call for this, nor the first to call on the roster of models that describe economic activity and determine that because one variable has moved beyond previous boundaries, doom was to follow. In this case growth of the US current account deficit will lead to the end of the dollar’s previous role as reserve currency. Nor will he be the last to do so, but the consistent feature is that every apocalyptic forecast has been wrong over time.

This has been true in Japan, where massive debt issuance by the government and massive debt purchases by the BOJ were destined to drive inflation much higher and weaken the yen substantially. Of course, we all know that the exact opposite has occurred. This has been true around the world where negative interest rates were designed to encourage borrowing and spending, thus driving economic growth higher, when it only got half the equation right, the borrowing increase, but it turns out spending on shares was deemed a better use of funds than spending on investment, despite all the theories that said otherwise.

Ultimately, the point is that despite the economics community having built a long list of very impressive looking and sounding models that are supposed to describe the workings of the economy, those models were built based on observed data rather than on empirical truths. Now that the data has changed, those models are just no longer up for the task. In other words, when it comes to forecasting models, caveat emptor.

Turning to the markets this morning, equity markets seem to have stopped to catch their collective breath after having recouped all of their March losses. In fact, the NASDAQ actually set a new all-time high yesterday, amid an economy that is about to print a GDP number somewhere between -20% and -50% annualized in Q2.

I get the idea of looking past the short-run problems, but it still appears to me that equity traders are ignoring long-run problems that are growing on the horizon. These issues, like the wave of bankruptcies that will significantly reduce the number of available jobs, as well as the potential for behavioral changes that will dramatically reduce the value of entire industries like sports and entertainment, don’t appear to be part of the current investment thesis, or at least have been devalued greatly. And while in the long-run, new companies and activities will replace all these losses, it seems highly unlikely they will replace them by 2021. Yet, yesterday saw US equity indices rally for the 7th day in the past eight. While this morning, futures are pointing a bit lower (SPU’s and Dow both lower by 1.2%, NASDAQ down by 0.7%), that is but a minor hiccup in the recent activity.

European markets are softer this morning as well, with virtually every major index lower by nearly 2% though Asian markets had a bit better showing with the Hang Seng (+1.1%) and Shanghai (+0.6%) both managing gains although the Nikkei (-0.4%) edged lower.

Bond markets are clearly taking a closer look at the current risk euphoria and starting to register concern as Treasury yields have tumbled 5bps this morning after a 4bp decline yesterday. We are seeing similar price action in European markets, albeit to a much lesser extent with bunds seeing yields fall only 2bps since yesterday. But, in true risk-off fashion, bonds from the PIGS have all seen yields rise as they are clearly risk assets, not havens.

And finally, the dollar is broadly stronger this morning with only the other havens; CHF (+0.3%) and JPY (+0.4%) gaining vs. the buck. On the downside, AUD is the laggard, falling 1.4% as a combination of profit taking after a humongous rally, more than 27% from the lows in March, and a warning by China’s education ministry regarding the potential risks for Chinese students returning to university in Australia have weighed on the currency. Not surprisingly, NZD is lower as well, by 1.1%, and on this risk-off day, with oil prices falling 2.5%, NOK has fallen 1.0%. But these currencies’ weakness has an awful lot to do with the dollar’s broad strength.

In the emerging markets, the Mexican peso, which had been the market’s darling for the past month, rallying from 25.00 to below 21.50 (13.5%) has reversed course this morning and is down by 1.4%. But, here too, weakness is broad based with RUB (-0.95%), PLN (-0.7%) and ZAR (-0.6%) all leading the bloc lower. The one exception in this space was KRW (+0.6%) after the announcement of some significant shipbuilding orders for Daewoo and Samsung Heavy Industries improved opinions of the nation’s near-term trade situation.

Turning to the data, although it’s not clear to me it matters much yet, we did see some horrific trade data from Germany, where their surplus fell to €3.5 billion, its smallest surplus in twenty years, and a much worse reading than anticipated as exports collapsed. Meanwhile, Eurozone Q1 GDP data was revised ever so slightly higher, to -3.6% Q/Q, but really, everyone wants to see what is happening in Q2. At home, the NFIB Small Biz Index was just released at a modestly better than expected 94.4 but has been ignored. Later this morning we see the JOLT’s Jobs data (exp 5.75M), but that is for April so seems too backward-looking to matter.

Risk is on its heels today and while hopes are growing that the Fed may do something new tomorrow, for now, given how far risk assets have rallied over the past two weeks, a little more consolidation seems a pretty good bet.

Good luck and stay safe
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Revert to the Mean

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For more than two weeks we have seen
Risk assets all polish their sheen
But now has the bar
Been raised much too far?
And will we revert to the mean?

I read today that recent price action (+42% since March 23) has been the largest 50-day rally in the S&P 500’s long history. Think about that for a moment, the economy has cratered (the Atlanta Fed GDPNow forecast is currently at -52.8% for Q2), unemployment has hit levels not seen since the Great Depression with more than 40 million Americans losing their job in the past three months and the stock market is flying. Well, at least the S&P 500 index is flying as the value of its five largest constituents continues to rise, seemingly inexorably, thus dragging the index along with them. The disconnect between the performance of risk assets and the data representing the economy is truly stunning. And while I understand that equity markets are discounting ‘instruments’ looking ahead to the future, it still beggars belief that most of the companies in the index are going to see earnings recover in anywhere near the time anticipated by the market. Remember, the CBO just published an analysis describing the most likely outcome being a 10-year timeframe before the US economy gets back to the levels seen in 2019.

Part and parcel of this movement in risk assets has been the dollar’s decline, with the Dollar Index (DXY) down more than 5% during the same period. While that is not historic in nature, it is still a very large move for such a short period of time.

And so I must ask, is this movement in risk assets sustainable? Clearly the driving force here has been central bank, (mainly the Fed) largesse as they have pumped trillions of dollars of liquidity into the economy, much of which seems to have found its way into stocks. But remember, the Fed started its unlimited QE by buying $75 billion A DAY of securities. That number is now down to less than $5 billion each day and declining on a weekly basis. In fairness, the Fed got ahead of the curve, recognizing just how devastating the situation was going to be. But the Treasury has caught up and has been issuing debt as quickly as they can. Now the Fed’s liquidity is being funneled directly to the Treasury, rather than finding a home elsewhere, and unless Powell reverses course and starts to increase daily purchases again, there is every chance for equity markets to begin to suffer instead.

One other thing that is missing from this market, and which has been a key driver of the long bull market, is share repurchases by companies. Stock buybacks represented nearly all of the net stock buying seen during the rally. And I assure you, that ship has sailed and is not likely to return to port for many years to come. In fact, it would not be surprising if new laws are enacted that limit or prohibit repurchases going forward. The point I am trying to make is that there are numerous reasons to believe that this remarkable rebound in the stock market, and risk assets in general, is overdone and due for its own correction.

Is today that correction? Well, for a start, it is not an extension of the rally as equity markets in Asia were little changed (Nikkei +0.35%, Hang Seng +0.2%, Shanghai -0.15%) and those in Europe are all in the red (DAX -0.7%, CAC -0.6%, FTSE 100 -0.3%). The DAX performance is quite interesting given the announcement by the German government that they have agreed on a €130 billion stimulus package, 30% larger than anticipated. Meanwhile, US futures are all pointing lower as well, down between 0.2% and 0.5%.

Bond markets continue to lack any informational value as they have become entirely controlled by the central bank community. While yield curve control is only explicit in Japan (for the 10-year) and Australia (for the 2-year) the reality is that every central bank is actively preventing government interest rates from rising out of necessity. After all, given how much borrowing is ongoing, governments cannot afford for interest rates to rise, they would not be able to pay the bills. Perhaps the only exception to this rule is the very long end, 30 years and beyond, where yields continue to rise as curves continue to steepen. (Remember when an inverted yield curve was seen as the death knell of the economy? The reality is the problem comes when it steepens like this! Steepening curves are not so much about future economic growth as much as about higher future inflation.)

And then there is the dollar, which is broadly higher this morning, albeit not in any dramatic fashion. As the market awaits word from Madame Lagarde and her 24 colleagues, we have seen the dollar rise modestly vs. both G10 and EMG counterparts. The biggest retreats have been seen by PLN (-1.25%), where the government just announced an expected 8.5% budget deficit, and MXN (-0.9%), which is suffering as oil sells off a bit. However, both those currencies have seen significant rallies in the past two weeks, so a little reversal is not surprising. As to the rest of the bloc, EEMEA currencies are underperforming APAC currencies, but generally they are all lower.

In the G10, the movement have been much more muted, with GBP, AUD and SEK all lower by 0.4% or so and the rest of the bloc, save the Swiss franc’s 0.1% rally, lower by smaller amounts. Again, it is difficult to point to any one thing as the cause for this movement, arguably it is simply position reductions after a long run.

At this point, all eyes are on the ECB, where expectations have built for an increase in the PEPP of as much as €500 billion. While they have not come close to using the original amount, it seems clear they will need more before the end of the year, and so the market has latched onto the idea it will be announced today. One potential problem with this action is it could reduce pressure on the EU to actually go ahead with their mooted €750 billion fiscal support program that includes joint borrowing, a key feature for the euro’s future. It is clear that as much as the frugal four don’t want to see the ECB distort markets further, they are even more disinclined to give their money to the Italians and Spanish directly. However, in the end, I believe Madame Lagarde will give the market what it wants and raise the PEPP limit.

Today’s data picture brings Initial Claims (exp 1.843M), Continuing Claims (20.0M), the April Trade Balance (-$49.2B), Nonfarm Productivity (-2.7%) and Unit Labor Costs (5.0%). With the monthly NFP report tomorrow, it seems unlikely the market will respond to today’s data in any meaningful way. Earlier we saw Eurozone Retail Sales decline 11.7%, not as bad as feared but still the worst outcome in the history of the series dating back to January 1998. And yet, as we have seen lately, the data is not the driver right now, it is the central banks and sentiment. While we have paused today, sentiment still seems to be for a further rally, but my take is that sentiment is getting old and tired. Beware the reversion to the mean!

Good luck and stay safe
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Playing Hardball

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Last night China shocked one and all
With two policy shifts not too small
They’ve now become loath
To target their growth
And in Hong Kong they’re playing hardball

It seems President Xi Jinping was pining for the spotlight, at least based on last night’s news from the Middle Kingdom. On the economic front, China abandoned their GDP target for 2020, the first time this has been the case since they began targeting growth in 1994. It ought not be that surprising since trying to accurately assess the country’s growth prospects during the Covid-19 crisis is nigh on impossible. Uncertainty over the damage already done, as well as the future infection situation (remember, they have seen a renewed rise in cases lately) has rendered economists completely unable to model the situation. And recall, the Chinese track record has been remarkable when it comes to hitting their forecast, at least the published numbers have a nearly perfect record of meeting or beating their targets. The reality on the ground has been called into question many times in the past on this particular subject.

The global economic community, of course, will continue to forecast Chinese GDP and current estimates for 2020 GDP growth now hover in the 2.0% range, a far cry from the 6.1% last year and the more than 10% figures seen early in the century. Instead, the Chinese government has turned its focus to unemployment with the latest estimates showing more than 130 million people out of a job. In their own inimitable way, they manage not to count the rural unemployed, meaning the official count is just 26.1M, but that doesn’t mean those folks have jobs. At this time, President Xi is finding himself under much greater pressure than he imagined. 130 million unemployed is exactly the type of thing that leads to revolutions and Xi is well aware of the risks.

In fact, it is this issue that arguably led to the other piece of news from China last night, the newly mooted mainland legislation that will require Hong Kong to enact laws curbing acts of treason, secession, sedition and subversion. In other words, a new law that will bring Hong Kong under more direct sway from Beijing and remove many of the freedoms that have set the island territory apart from the rest of the country. While Covid-19 has prevented the mass protests seen last year from continuing in Hong Kong, the sentiments behind those protests did not disappear. But Xi needs to distract his population from the onslaught of bad news regarding both the virus and the economy, and nothing succeeds in doing that better than igniting a nationalistic view on some subject.

While in the short term, this may work well for President Xi, if he destroys Hong Kong’s raison d’etre as a financial hub, the downside is likely to be much greater over time. Hong Kong remains the financial gateway to China’s economy largely because the legal system their remains far more British than Chinese. It is not clear how much investment will be looking for a home in a Hong Kong that no longer protects private property and can seize both people and assets on a whim.

It should be no surprise that financial markets in Asia, particularly in Hong Kong, suffered last night upon learning of China’s new direction. The Hang Seng fell 5.6%, its largest decline since July 2015. Even Shanghai fell, down 1.9%, which given China’s announcement of further stimulus measures despite the lack of a GDP target, were seen as positive. Meanwhile, in Tokyo, the Nikkei slipped a more modest 0.9% despite pledges by Kuroda-san that the BOJ would implement even more easing measures, this time taking a page from the Fed’s book and supporting small businesses by guaranteeing bank loans made in a new ¥75 trillion (~$700 billion) program. It is possible that markets are slowly becoming inured to even further policy stimulus measures, something that would be extremely difficult for the central banking community to handle going forward.

The story in Europe is a little less dire, although most equity markets there are lower (DAX -0.4%, CAC -0.2%, FTSE 100 -1.0%). Overall, risk is clearly not in favor in most places around the world today which brings us to the FX markets and the dollar. Here, things are behaving exactly as one would expect when investors are fleeing from risky assets. The dollar is stronger vs. every currency except one, the yen.

Looking at the G10 bloc, NOK is the leading decliner, falling 1.1% as the price of oil has reversed some of its recent gains and is down 6% this morning. But other than the yen’s 0.1% gain, the rest of the bloc is feeling it as well, with the pound and euro both lower by 0.4% while the commodity focused currencies, CAD and AUD, are softer by 0.5%. The data releases overnight spotlight the UK, where Retail Sales declined a remarkable 18.1% in April. While this was a bit worse than expectations, I would attribute the pound’s weakness more to the general story than this particular data point.

In the EMG bloc, every market that was open saw their currency decline and there should be no surprise that the leading decliner was RUB, down 1.1% on the oil story. But we have also seen weakness across the board with the CE4 under pressure (CZK -1.0%, HUF -0.75%, PLN -0.5%, RON -0.5%) as well as weakness in ZAR (-0.7%) and MXN (-0.6%). All of these currencies had been performing reasonably well over the past several sessions when the news was more benign, but it should be no surprise that they are lower today. Perhaps the biggest surprise was that HKD was lower by just basis points, despite the fact that it has significant space to decline, even within its tight trading band.

As we head into the holiday weekend here in the US, there is no data scheduled to be released this morning. Yesterday saw Initial Claims decline to 2.44M, which takes the total since late March to over 38 million! Surveys show that 80% of those currently unemployed expect it to be temporary, but that still leaves more than 7.7M permanent job losses. Historically, it takes several years’ worth of economic growth to create that many jobs, so the blow to the economy is likely to be quite long-lasting. We also saw Existing Home Sales plummet to 4.33M from March’s 5.27M, another historic decline taking us back to levels last seen in 2012 and the recovery from the GFC.

Yesterday we also heard from Fed speakers Clarida and Williams, with both saying that things are clearly awful now, but that the Fed stood ready to do whatever is necessary to support the economy. This has been the consistent message and there is no reason to expect it to change anytime soon.

Adding it all up shows that investors seem to be looking at the holiday weekend as an excuse to reduce risk and try to reevaluate the situation as the unofficial beginning to summer approaches. Trading activity is likely to slow down around lunch time so if you need to do something, early in the morning is where you will find the most liquidity.

Good luck, have a good holiday weekend and stay safe
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Enough Wherewithal

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The Chairman explained to us all
The Fed has enough wherewithal
To counter the outbreak
But, too, Congress must take
More actions to halt the shortfall

The US equity markets led global stocks lower after selling off in the wake of comments from Chairman Powell yesterday morning. In what was a surprisingly realistic, and therefore, downbeat assessment, he explained that while the Fed still had plenty of monetary ammunition, further fiscal spending was necessary to prevent an even worse economic and humanitarian crisis. He also explained that any recovery would take time, and that the greatest risk was the erosion of skills that would occur as a huge swathe of the population is out of work. It cannot be a surprise that the equity markets sold off in the wake of those comments, with a weak session ending on its lows. It is also not surprising that Asian markets overnight followed US indices lower (Nikkei -1.75%, Hang Seng -1.45%, Shanghai -1.0%), nor that European markets are all in the red this morning (DAX -1.6%, CAC -1.7%, FTSE 100 -2.2%). What is a bit surprising is that US futures, at least as I type, are mixed, with the NASDAQ actually a touch higher, while both the Dow and S&P 500 see losses of just 0.2%. However, overall, risk is definitely on its back foot this morning.

But the Chairman raised excellent points regarding the timeline for any recovery and the potential negative impacts on economic activity going forward. The inherent conflict between the strategy of social distance and shelter in place vs. the required social interactions of so much economic activity is not a problem easily solved. At what point do government rules preventing businesses from operating have a greater negative impact than the marginal next case of Covid-19? What we have learned since January, when this all began in Wuhan, China, is that the greater the ability of a government to control the movement of its population, the more success that government has had preventing the spread of the disease. Alas, from that perspective, the inherent freedoms built into the US, and much of the Western World, are at extreme odds with those government controls/demands. As I have mentioned in the past, I do not envy policymakers their current role, as no matter the decision, it will be called into question by a large segment of the population.

What, though, are we now to discern about the future? Despite significant fiscal stimulus already enacted by many nations around the world, it is clearly insufficient to replace the breadth of lost activity. Central banks remain the most efficient way to add stimulus, alas they have demonstrated a great deal of difficulty applying it to those most in need. And so, despite marginally positive news regarding the slowing growth rate of infections, the global economy is not merely distraught, but seems unlikely to rebound in a sharp fashion in the near future. Q2 has already been written off by analysts, and markets, but the question that seems to be open is what will happen in Q3 and beyond. While we have seen equity weakness over the past two sessions, broadly speaking equity markets are telling us that things are going to be improving greatly while bond markets continue to point to a virtual lack of growth. Reading between the lines of the Chairman’s comments, he seems to be siding with the bond market for now.

Into this mix, we must now look at the dollar, and its behavior of late. This morning had seen modest movement until about 6:30, when the dollar started to rally vs. most of its G10 counterparts. As I type, NOK, SEK and AUD are all lower by 0.5% or so. The Aussie story is quite straightforward as the employment report saw the loss of nearly 600K jobs, a larger number than expected, with the consequences for the economy seen as potentially dire. While restrictions are beginning to be eased there, the situation remains one of a largely closed economy relying on central bank and government largesse for any semblance of economic activity. As to the Nordic currencies, SEK fell after a weaker than expected CPI report encouraged investors to believe that the Riksbank, which had fought so hard to get their financing rate back to 0.00% from several years in negative territory, may be forced back below zero. NOK, however, is a bit more confusing as there was no data to see, no comments of note, and the other big key, oil, is actually higher this morning by more than 4%. Sometimes, however, FX movement is not easily explained on the surface. It is entirely possible that we are seeing a large order go through the market. Remember, too, that while the krone is the worst performing G10 currency thus far in 2020, it has managed to rally more than 7% since late April, and so we are more likely seeing some ordinary back and forth in the markets.

One other comment of note in the G10 space was from BOE Governor Andrew Bailey, who reiterated that negative interest rates currently have no place in the BOE toolkit and are not necessary. While the comments didn’t impact the pound, which is lower by 0.25% as I type, it continues to be an important distinction as along with Chairman Powell, the US and the UK are the only two G10 nations that refuse to countenance the idea of NIRP, at least so far.

In the emerging markets, what had been a mixed and quiet session earlier has turned into a pretty strong USD performance overall. The worst performer is ZAR, currently down 0.9% the South African yield curve bear-steepens amid continued unloading of 10-year bonds by investors. But it is not just the rand falling this morning, we are seeing weakness in the CE4 (CZK -0.7%, HUF -0.5%, PLN -0.4%) and once again the Mexican peso is finding itself under strain. While the CE4 appear to simply be following the lead of the euro (-0.35%), perhaps with a bit more exuberance, I think the peso continues to be one of the more interesting stories out there.

Both MXN and BRL have been dire performers all year, with the two currencies being the worst two performers in the past three months and having fallen more than 20% each. Both currencies continue to be extremely volatile, with daily ranges averaging in excess of 2% for the past two months. The biggest difference is that BRL has seen a significant amount of direct intervention by the BCB to prevent further weakness, while MXN continues to be a 100% free float. The other thing to recall is that MXN is frequently seen as a proxy for all LATAM because of its relatively better liquidity and availability. The point is, further problems in Brazil (and they are legion as President Bolsonaro struggles to rule amid political fractures and Covid-19) may well result in a much weaker Mexican peso. This is so even if oil prices rebound substantially.

Turning to data, we see the weekly Initial Claims number (exp 2.5M) and Continuing Claims (25.12M), but otherwise that’s really it. While we have three more Fed speakers, Kashkari, Bostic and Kaplan, on the calendar, I think after yesterday’s Powell comments, the market may be happier not to hear their views. All the evidence points to an overbought risk atmosphere that needs to correct at some point. As that occurs, the dollar should retain its bid overall.

Good luck and stay safe
Adf

Undeterred

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Said Christine, we are “undeterred”
By Germany’s court that inferred
QE is lawbreaking
As there’s no mistaking
Our power, from Brussels’, conferred

Thus, QE is here til we say
The ‘conomy’s finally okay
More bonds we will buy
And don’t even try
To hint there might be a delay!

Last week, when the German Constitutional Court ruled that the ECB’s original QE program, PSPP, broke EU laws about monetary financing of EU governments, there was a flurry of interest, but no clear understanding of the eventual ramifications of the ruling. This morning, those ramifications are beginning to become clear. Not surprisingly the ruling ruffled many feathers within the EU framework, as it contradicted the European Court of Justice, which is the EU’s highest court. This is akin to a State Supreme Court contradicting the US Supreme Court on a particular issue. At least, that’s what the legal difference is. But in one way, this is much more dangerous. There is no serious opportunity for any US state to leave the union, but what we have learned over the course of the past several years is that while the German people, on the whole, want to remain in the Eurozone and EU, they also don’t want to pay for everybody else’s problems. So, the question that is now being raised is, will Frau Merkel and her government be able to contain the damage?

In the end, this will most likely result in no changes of any sort by the ECB. There will be much harrumphing about what is allowed, and a great deal of technical jargon will be discussed about the framework of the EU. But despite Merkel’s weakened political state, she will likely manage to prevent a blow-up.

The thing is, this is the likely outcome, but it is certainly not the guaranteed outcome. The EU’s biggest problem right now is that Italy, and to a slightly lesser degree Spain, the third and fourth largest economies in the EU, have run are running out of fiscal space. As evidenced by the spreads on their debt vs. that of Germany, there remains considerable concern over either country’s ability to continue to provide fiscal support during the Covid-19 crisis. The ECB has been the only purchaser of their bonds, at least other than as short-term trading vehicles, and the entire premise of this ruling is that the ECB cannot simply purchase whatever bonds they want, but instead, must adhere to the capital key.

The threat is that if the ECB does not respond adequately, at least according to the German Court, then the Bundesbank would be prevented from participating in any further QE activities. Since they are the largest participant, it would essentially gut the program and correspondingly, the ECB’s current monetary support for the Eurozone economies. As always, it comes down to money, in this case, who is ultimately going to pay for the current multi-trillion euros of largesse. The Germans see the writing on the wall and want to avoid becoming the Eurozone’s ATM. Will they be willing to destroy a structure that has been so beneficial for them in order to not pick up the tab? That is the existential question, and the one on which hangs the future value of the euro.

Since the ruling was announced, the euro has slumped a bit more than 1.25% including this morning’s 0.2% fall. This is hardly a rout, and one could easily point to the continued awful data like this morning’s Italian March IP release (-28.4%) as a rationale. The thing about the data argument is that it no longer seems clear that the market cares much about data. As evidenced by equity markets’ collective ability to rally despite evidence of substantial economic destruction, it seems that no matter how awful a given number, traders’ attitudes have evolved into no data matters in the near-term, and in the longer-term, all the stimulus will solve the problem. With this as background, it appears that the euro’s existential questions are now a more important driver than the economy.

But it’s not just the euro that has fallen today, in fact the dollar is stronger across the board. In the G10 space, Aussie (-0.7%) and Kiwi (-0.8%) are the leading decliners, after a story hit the tapes that China may impose duties on Australia’s barley exports to the mainland. This appears to be in response to Australia’s insistence on seeking a deeper investigation into the source of the covid virus. But the pound (-0.65%), too, is softer this morning as PM Johnson has begun lifting lockdown orders in an effort to get the country back up and running. However, he is getting pushback from labor unions who are concerned for the safety of their members, something we are likely to see worldwide.

Interestingly, the yen is weaker this morning, down 0.6%, in what started as a risk-on environment in Asia. However, we have since seen equity markets turn around, with most of Europe now lower between 0.3% and 1.3%, while US futures have turned negative as well. The yen, however, has not caught a bid and remains lower at this point. I would look for the yen to gain favor if equity markets start to add to their current losses.

In the EMG space, the bulk of the group is softer today led by CZK (-1.1%) and MXN (-1.0%), although the other losses are far less impressive. On the plus side, many SE Asian currencies showed marginal gains overnight while the overall risk mood was more constructive. If today does turn more risk averse, you can look for those currencies to give back last night’s gains. A quick look at CZK shows comments from the central bank that they are preparing for unconventional stimulus (read QE) if the policy rate reaches 0%, which given they are currently at 0.25% as of last Thursday, seems quite likely. Meanwhile, the peso seems to be preparing for yet another rate cut by Banxico this week, with the only question being the size. 0.50% is being mooted, but there is clearly scope for more.

On the data front, to the extent this still matters, this week brings a modicum of important news:

Tuesday NFIB Small Biz Optimism 85.0
  CPI -0.8% (0.4% Y/Y)
  -ex food & energy -0.2% (1.7% Y/Y)
Wednesday PPI -0.5% (-0.3% Y/Y)
  -ex food & energy 0.0% (0.9% Y/Y)
Thursday Initial Claims 2.5M
  Continuing Claims 24.8M
Friday Retail Sales -11.7%
  -ex autos -6.0%
  IP -12.0%
  Capacity Utilization 64.0%
  Empire Manufacturing -60.0
  Michigan Sentiment 68.0

Source: Bloomberg

But, as I said above, it is not clear how much data matters right now. Certainly, one cannot look at these forecasts and conclude anything other than the US is in a deep recession. The trillion-dollar questions are how deep it will go and how long will this recession last. Barring a second wave of infections following the reopening of segments of the economy, it still seems like it will be a very long time before we are back to any sense of normalcy. The stock market continues to take the over, but the disconnect between stock prices and the economy seems unlikely to continue growing. As to the dollar, it remains the ultimate safe haven, at least for now.

Good luck and stay safe
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Overkill

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The talk in the market is still
‘Bout German high court overkill
While pundits debate
The bond program’s fate
The euro is heading downhill

Amid ongoing dreadful economic data, the top story continues to be the German Constitutional Court’s ruling on (rebuke of?) the ECB’s Public Sector Purchase Program, better known as QE. The issue that drew the court’s attention was whether the ECB’s actions to help support the Eurozone overall are eroding the sovereignty of its member states. Consider, if any of the bonds that are bought by the central banks default, it is the individual nations that will need to pay the cost out of their respective budgets. That means that the unelected officials at the ECB are making potential claims on sovereign nations’ finances, a place more rightly accorded to national legislatures. This is a serious issue, and a very valid point. (The same point has been made about Fed programs). However, despite the magnitude of the issues raised, the court gave the ECB just three months to respond, and if they are not satisfied with that response, they will bar the Bundesbank from participating in any further QE programs. And that, my friends, would be the end. The end of the euro, the end of the Eurozone, and quite possibly the end of the EU.

Remember, unlike the Fed, which actually executes its monetary policy decisions directly in the market, the ECB relies on each member nation’s central bank to enter the market and purchase the appropriate assets. So, the ECB’s balance sheet is really just a compilation of the balance sheets of all the national central banks. If the Bundesbank is prevented from implementing ECB policy on this score, given Germany’s status as the largest nation, and thus largest buyer in the program, the effectiveness of any further ECB programs would immediately be called into question, as would the legitimacy of the entire institution. This is the very definition of an existential threat to the single currency, and one that the market is now starting to consider more carefully. It is clearly the driving force behind the euro’s further decline this morning, down another 0.5% which makes 1.5% thus far in May. In fact, while we saw broad dollar weakness in April, as equity markets rallied and risk was embraced, the euro has now ceded all of those gains. And I assure you, if there is any doubt that the ECB will be able to answer the questions posed by the court, the euro will decline much further.

The euro is not the only instrument under pressure from this ruling, the entire European government bond market is falling today. Now, granted, the declines are not that sharp, but they are universal, with every member of the Eurozone seeing bond prices fall and yields tick higher. This certainly makes sense overall, as the ECB has been the buyer of (first and) last resort in government bond markets, and the idea that they may be prevented from acting in the future is a serious concern. Simply consider how much more debt all Eurozone nations are going to need to issue in order to pay for their fiscal programs. Across the entire Eurozone, forecasts now point to in excess of €1 trillion of new bonds this year, already larger than the ECB’s PEPP. And if there is a second wave of the virus, forcing a reclosing of economies with a longer period of lockdown, that number is only going to increase further. Without the ECB to absorb the bulk of that debt, yields in Eurozone debt will have much further to climb. The point is that this issue, which was initially seen as minor and technical, may actually be far more important than anything else. And while the odds are still with the ECB to continue with business as usual, the probability of a disruption is clearly non-zero.

Away from the technicalities of the German Constitutional Court, there is far less of interest in the markets overall. Equity markets are mixed, with gainers and losers in both the Asian session as well as Europe. US futures, at this time, are pointing higher, with all three indices looking toward 1% gains at the open. And the dollar is broadly, though not universally, higher.

Aside from the euro’s decline, we have also seen weakness in the pound (-0.4%) after the Construction PMI (the least impactful of the PMI measures) collapsed to a reading of 8.2, from last month’s dreadful 39.2. This merely reinforces what type of hit the UK economy is going to take. On the plus side, the yen is higher by 0.3%, seemingly on the back of position adjustments as given the other risk signals, I would not characterize today as a risk-off session.

In the EMG space, there are far more losers than gainers today, led by the Turkish lira (-1.0%) and the Russian ruble (-0.8%). The lira is under pressure after new economic projections point to a larger economic contraction this year of as much as 3.4%. This currency weakness is despite the central bank’s boosting of FX swaps in an effort to prevent a further decline. Meanwhile, despite oil’s ongoing rebound (WTI +3.6%) the ruble seems to be reacting to recent gains and feeling some technical selling pressure. Elsewhere in the space, we have seen losses on the order of 0.3%-0.5% across most APAC and CE4 currencies. The one exception to the rule is KRW, which rallied 0.6% overnight as expectations grow that South Korea is going to be able to reopen the bulk of its economy soon. One other positive there is that demand for USD loans (via Fed swap lines) has diminished so much the BOK is stopping the auctions for now. That is a clear indication that financial stress in the nation has fallen.

On the data front, this morning brings the ADP Employment number (exp -21.0M), which will be the latest hint regarding Friday’s payroll data. Clearly, a month of huge Initial Claims data will have taken its toll. Yesterday’s Fed speakers didn’t tell us very much new, but merely highlighted the fact that each member has their own view of how things may evolve and none of them are confident in those views. Uncertainty remains the word of the day.

For now, the narratives of the past several weeks don’t seem to have quite the strength that they did, and I would say that the focus is on the process of economies reopening. While that is very good news, the concern lies after they have reopened, and the carnage becomes clearer. Just how many jobs have been permanently erased because of the changes that are coming to our world in the wake of Covid-19? It is that feature, as well as the nature of economic activity afterwards, that will drive the long-term outcome, and as of now, no clear path is in sight. The opportunity for further market dislocations remains quite high, and hedgers need to maintain their programs, especially during these times.

Good luck and stay safe
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Risk Off’s Set To Soar

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Though April saw rallies galore
In equities, bonds and much more
The first days of May
Seem set to convey
A tale that risk-off’s set to soar

Last week finished on a down note for risk appetite, as we saw equities decline sharply on Friday, at least in those markets that were open, as well as the first cracks in the rebound in currencies vs. the dollar. This morning, those trends are starting to reassert themselves and we look to be heading toward a full-blown risk-off session.

A quick recap reminds us that Thursday, which was month end, saw a modest decline in equities which was easily attributed to portfolio rebalancing. After all, the April rally was impressive in any context, let alone the current situation where huge swathes of the global economy have been shuttered for more than a month. Friday, while a holiday in many markets around the world, saw far more significant equity market declines in countries that were open, with US markets falling between 2.5% and 3.2%. The weekend saw loads of stories highlighting the adage, ‘Sell in May and go away’, as an appropriate strategy this year. This was compounded by the far more bearish take by Warren Buffett regarding the US economy, where he explained that Berkshire Hathaway had exited its positions in airline stocks and instead had grown its cash pile to $138 billion. These are not the signs of confidence that investors crave, and so this morning, European equity markets are all much lower, led by the CAC (-4.0%) and DAX (-3.5%). While both China and Japan were closed for holidays, the Hang Seng had a terrible performance, falling 4.2%, and we saw sharp declines throughout the rest of Emerging Asia. Meanwhile, US futures markets are all lower by about 1% as I type.

I guess the question at hand remains the sustainability of last month’s price action. Right now, there are two key subjects where the underlying narrative is up for grabs; risk appetite and inflation. For the former, there is a large contingent who believe that the worst is over with respect to Covid-19, and its spread is abating. This means that over the course of the next few weeks and months, economies are going to reopen and that the situation will return to normal. There is much talk of a V-shaped recovery on the strength of the extraordinary efforts of central banks and governments around the world. The flip side of this argument is that despite the tentative steps toward reopening economies worldwide, the pace of recovery will be significantly slower than the pace of the decline. Concerns about how much of the economy has been irrevocably destroyed, with small businesses worldwide closing, and unemployment everywhere rising sharply, are rife. While we are still in the first half of Q1 earnings season, the data to date have not been pretty, and remember, the virus only became a significant issue in March, generally. This implies that the bearish view may have more legs, and it is the side I believe fits the fact pattern more accurately.

The inflation narrative is just as fierce, with the hard money advocates all decrying the central bank activity as opening the door to currency collapses and hyperinflation right around the corner. Meanwhile, the other side of the argument looks to the history of the past twenty years, where Japan has been printing yen and effectively monetizing its debt, while still unable to achieve any sort of inflation at all. In this case, I think the deflationistas make the best case for the near term, as the combination of unprecedented demand destruction as well as extraordinary growth in debt both point to slower growth and price declines in the short and medium term. However, that is not to ignore the fact that central banks have gone far outside the boundaries of what had traditionally been viewed as their bailiwick, and especially if we do see a debt jubilee of some type, where government debt owned by a nation’s own central bank is forgiven, then the opportunity for a significant inflationary outcome remains on the table. Just not right away.

Adding it up for today points to a reduced risk appetite as evidenced by those equity markets that are open. Bond markets have not played along as one might have expected, with Treasury yields lower by only 1bp, and Bund yields, along with the rest of Europe’s, actually higher this morning. That price action seems to be a response to concerns over the outcome of the German Constitutional Court’s ruling due tomorrow, regarding the legality of QE, the PEPP and, perhaps more critically, the necessity of the ECB to follow the Capital Key when purchasing bonds.

In the FX markets, the dollar has resumed its role as king of the world, rallying against every currency except the yen, which has essentially stayed flat. In the G10 space, NOK is the leading decliner, down 1.2% as oil prices are back on the schneid with WTI down 6.3% this morning. But we are seeing the pound (-0.8%) and Swedish krone (-0.7%) under significant pressure as well. GBP traders are looking ahead to Thursday’s BOE meeting where expectations are rising for another bout of policy ease, which fits in with the broad risk-off framework. The krone, meanwhile, is suffering as the Riksbank finds itself in a difficult spot regarding its QE program. It seems that despite its claims that it would be purchasing not only government bonds, but corporates as well, that is illegal based on the bank’s guiding legislation, and so there is some monetary policy confusion now undermining the currency.

In the EMG space, IDR (-1.45%) and RUB (-1.3%) have been the weakest performers, with the ruble suffering from both weaker oil prices as well as the recent increase in the pace of infections in Russia. While things there are already under pressure, they could well get worse before they get better. Meanwhile, Indonesia saw a reversal of half of last week’s currency gains as PMI data (27.5) highlighted just how weak the near-term looks for the island nation. While the bulk of the rest of the space has suffered on the back of the overall risk-off sentiment, there has been a later reversal in ZAR, where the rand is now higher by 0.75% after its PMI data surprised one and all by printing at 46.1, well above expectations and a very modest decline compared to March, albeit still in contractionary territory.

On the docket this week, we see a great deal of information culminating in the payroll report on Friday, and that is certain to be frightful.

Today Factory Orders -9.4%
Tuesday Trade Balance -$44.2B
  ISM Non-Manufacturing 37.8
Wednesday ADP Employment -20.5M
Thursday Initial Claims -3.0M
  Continuing Claims -19.6M
  Nonfarm Productivity -5.5%
  Unit Labor Costs 3.8%
  Consumer Credit $15.0B
Friday Nonfarm Payrolls -21.3M
  Private Payrolls -21.7M
  Manufacturing Payrolls -2.25M
  Unemployment Rate 16.0%
  Average Hourly Earnings 0.3% (3.3% Y/Y)
  Average Weekly Hours 33.5
  Participation Rate 61.6%

Source: Bloomberg

The range of expectations for the payroll number highlight the ongoing confusion, with estimates between -840K and -30.0M. Regardless, the number will be a record, of that there is no doubt.

In addition to all this data, we hear from the RBA and the BOE on Thursday, with further ease on the cards, and we get to hear from five different Fed speakers. In these unprecedented times, as policymakers struggle to keep up with the economic destruction, we will soon become inured to shocking data. But that will not make it any better, and I fear that shock or not, risk appetites will continue to diminish as the month, and year, progresses. This means that the dollar is likely to retain its bid for a while yet.

Good luck and stay safe
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Still Disrespected

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According to data last night
The future in Germany’s bright
While right now, it stinks
Most everyone thinks
By Q3, they’ll all be alright

And yet, markets haven’t reflected
The positive vibe ZEW detected
Stock markets are dire
The dollar is higher
While oil is still disrespected

The one constant in the current market and economic environment is that nothing is consistent. For example, in Germany, the lockdown measures were extended for two weeks the day before Frau Merkel said that they would start to ease some restrictions, allowing small shops to open along with some schools. Then, this morning, the ZEW surveys were released with the Current Situation index printing at a historically low -91.5, well below the already dire forecasts of a -77.5 print. And yet, the Expectations index rose to +28.2, far higher than the median forecast of -42.0. Essentially, the commentary was that while Q1 and Q2 would be awful, things would be right as rain in Q3. But here’s a contradiction to that view, Oktoberfest, due to begin in late September, has just been canceled despite the fact that it is five months away and that it is in the middle of Q3, when things are ostensibly going to be much better there. My point is that, right now, interpreting signals of future activity is essentially impossible. Alas, that is what I try to do each morning.

So, what have we learned in the past twenty-four hours? Arguably, the biggest story was oil where the May WTI futures contract closed at -$37.63/bbl. In other words, the contract buyer is paid to take delivery of oil. And that’s the rub, storage capacity is almost entirely utilized while demand destruction continues daily. The IEA reported that current global production is running around 100 million barrels/day, with current demand running around 70 million barrels per day. In other words, plenty of oil is looking for a temporary home, and more of it is coming out of the ground each day. Arguably, this is a great opportunity for the US government to take delivery for the Strategic Petroleum Reserve, especially since they would be getting paid for the oil. But that would require a nimbleness of action that is unlikely to be seen at any government level. This morning, June WTI futures are under further pressure, down by another 20% at $16.50/bbl as I type, simply indicating that there is limited hope for a rebound in the near term. But the curve remains in sharp contango, with prices at $30/bl in December and higher further out. This price action is simply the oil market’s manifestation of the current economic view; negative growth in Q1 and Q2 with a rebound coming in Q3. However, despite the logic, seeing any commodity, let alone the world’s most important commodity, trading below zero is a strange sight indeed.

With the oil market grabbing the world’s focus, it can be no surprise that the dollar has responded by rallying strongly, especially against those currencies that are seen as tightly linked to the price of oil. So, in the G10 space, NOK (-1.7%) and CAD (-0.7%) are suffering, with the Nokkie the worst performer in the group. But AUD (-0.95%), NZD (-1.25%) and GBP (-0.95%) are all under significant pressure as well. It seems that Kiwi has responded negatively to RBNZ Governor Orr’s musings regarding additional stimulus in May, while Aussie has suffered on the back of the weak pricing in energy markets as well as lousy employment data. Meanwhile, today’s pressure on the pound seems to stem from a renewal of the Brexit discussion, and how a hard exit will be deleterious. In addition, there are still those who claim the UK’s response to the pandemic has been inadequate and the impact there will be much worse than elsewhere. Interestingly, UK employment data released this morning did not paint as glum a picture as might have been expected. While we can ignore the Unemployment Rate, which is February’s number, the March Claims data was surprisingly moderate. I expect, however, that next month’s data will be far worse. And I continue to think the pound has far more downside than upside here.

Turning to the EMG bloc, we cannot be surprised to see RUB as the worst performer in the group, down 1.3%, nor, given the growing risk-off sentiment, that the entire space is lower vs. the dollar. As today is a day that ends in ‘y’, MXN is lower, falling 0.7% thus far, as the market is increasingly put off by both the ongoing oil price declines as well as the ongoing incompetence demonstrated by the AMLO administration. (As an aside here, it seems that many Mexican financial institutions see much further peso weakness in the future as they are actively selling pesos in the market.) The other underperformers are HUF (-0.85%), ZAR (-0.8%) and KRW (-0.75%). Working in reverse order, the won is suffering as questions arise about the health of North Korean leader Kim Jong-un, who according to some reports, is critically ill and close to death. The concern is there is no obvious successor in place, and no way to know what the future will hold. Meanwhile, the rand is under pressure from the weakness throughout the commodity space as well as the realization that the carry that can be earned by holding the currency has diminished to its lowest level since 2008. For a currency that has been dependent on foreign holdings, this is a real problem.

I guess, given that the euro is only lower by 0.2%, it is actually a top performer of the day, so perhaps the German data has been a support to the single currency. The thing is, given the export orientation of the German (and Eurozone) economy, unless things pick up elsewhere, growth expectations will need to be modified lower for Q3. Don’t be surprised if we see this in the survey data going forward.

Elsewhere, equity markets everywhere are in the red, with European indices down between 1.7% and 2.5%. Asian stock markets were also lower, by similar amounts, and after yesterday’s US declines, the futures this morning show losses of between 0.7% for the NASDAQ and 1.5% for the Dow. Bond yields continue to fall, with 10-year Treasuries lower by 3bps this morning, and overall, risk is being sold.

The only data this morning is Existing Home Sales from March, with the median expectation for a 9% decline to 5.25M. As to Fed speakers, the quiet period ahead of next Wednesday’s FOMC meeting has begun so there is nothing to hear there. Of course, given what they have already done, as well as the fact that every act is unanimously accepted, I don’t see any value add from their comments in the near-term.

Last week saw a net gain in the equity markets as the narrative embraced the idea that the infection curve was flattening and that we were past the worst of the impact. This week, despite the ZEW data, I would contend investors are beginning to understand that things will take a very long time to get back to normal, and that the chance for new lows is quite high. In this environment, the dollar is likely to remain well bid.

Good luck and stay safe
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The Absolute Fact

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It’s been one score years and one more
Since prices for oil hit this floor
Despite last week’s pact
The absolute fact
Is there’s no place for, it, to store

Q1 1999 was the last time the price of the front-month oil contract on the Comex was trading as low as it has this morning. As I type, it is currently at $13.55/bbl, down more than $4.70 on the session, which on a percentage basis is more than 25%! And you thought currency volatility was high. At any rate, it seems the major issue is that oil producers have no place left to store the stuff, and since demand has collapsed, the natural response is for the price to collapse as well. Now, in fairness, while this will garner the headlines, the market reality may be slightly different, because the May futures contract, which expires tomorrow, is no longer the active contract, that has moved to June. Now, the June contract is down nearly 10%, but is still trading above $22/bbl, so this morning’s excitement may have less long-term market impact than it seems at first. Nonetheless, it does point to just how disruptive the coronavirus has been to markets all around the world.

Of course, one should not be surprised by the currencies that have felt the repercussions of this oil price decline the most severely; MXN (-1.9%), RUB (-0.45%), NOK (-0.65%) and CAD (-0.7%). The peso has been one of the market’s favorite whipping boys all year, as it has declined nearly 22% thus far. ZAR (-25.7%) and BRL (-23.0%) are the only two currencies to underperform the peso. Thus, this morning’s nearly 2% decline cannot be a surprise. In fact, since March 2, truthfully before Covid was widely understood to be the threat it has become to Western economies, the average daily range in USDMXN has been 3.78% which works out to an annualized volatility of nearly 60%. The remarkable thing is how cheap MXN options are relative to actual movement. For example, this morning, 1-month implied volatility is trading on the order of 25%, clearly far less than the type of movement we have seen in the past seven weeks. And given oil’s extreme volatility, and the peso’s link to the price of oil, I expect that we are going to continue to see the peso trade like this for the foreseeable future. The implication here is that hedgers might want to consider owning some of this optionality to help manage the uncertainties of their exposures during this time.

Away from the oil story, though, we have an entirely different narrative forming regarding the virus and its impact on the broader economy. Despite a number of countries having extended their lockdown procedures into the second week of May, we are also getting the first signs that the peak of infections may have passed, and we are hearing from more and more quarters that reopening the economy is more critical given that fact. This has been a big part of the rationale behind the equity market rally we saw last week, which despite the evidence of just how awful Q1 earnings are going to be, was really remarkably robust.

There continue to be two strong storylines with bulls claiming that this is a temporary hit and given the amount of stimulus, both fiscal and monetary, that has been brought to bear on the problem, the ‘V’ shaped recovery is still a high probability outcome. The bears, on the other hand, continue to highlight that expectations for the economy going forward to look anything like it did three months ago are misguided, and that it will take far longer to achieve any real recovery. Structural changes will have been made resulting in a much higher unemployment rate, considerably less consumption and, thus, much weaker GDP growth. Earnings will suffer and stock prices alongside them. Last week’s price action, with both up and down days, was an excellent depiction of this battle. And this battle will continue until one side’s argument is borne out. In other words, equity market volatility is likely to be with us for many months to come as well.

So, turning to this morning’s session, we have actually seen equity markets somewhat softer, with most of Europe lower by a bit below 1.0% which followed Asia’s similarly modest weakness. US futures, though, are starting to come under more pressure, having only been down 0.5% early in the session, but now looking at 1.5% declines. Interestingly, Treasury yields have barely moved, with the 10-year lower by less than 1 basis point, although in Europe, the weakest economies (PIGS) have all seen their government bond yields rise by more than 8bps, a sign of risk being jettisoned. And finally, gold is little changed on the morning, although given the dollar’s broad rally since the beginning of March, it has held its value extremely well.

As to the rest of the FX market, the dollar is largely, albeit not universally stronger this morning, and has been gaining ground as risk has been selling off. NOK and CAD lead the way lower, but the pound is also feeling stress as Brexit (remember that?) comes back into view with discussions starting up again. There is a big question as to whether PM Johnson will concede to an extension of the current situation given the unprecedented disruption caused by Covid-19. Fears that he won’t, and that the UK will crash out with no deal are likely to start to come back if we don’t hear positive news on this front soon. In the EMG bloc, away from the peso, there were more losers than winners, but the magnitudes of movement this morning have been far less than what we have seen recently. Ultimately, if risk continues to be shed, I expect the dollar to remain well bid against all comers.

On the data front, we start to see a bigger range of March data, which will clearly have been impacted by the virus and response.

Tuesday Existing Home Sales 5.3M
Thursday Initial Claims 4.5M
  Continuing Claims 17.27M
  Markit Mfg PMI 38.0
  Markit Services PMI 31.3
  New Home Sales 644K
Friday Durable Goods -12.0%
  -ex Transport -6.0%
  Michigan Sentiment 68.0

Source: Bloomberg

As we have seen for the past several weeks, the Claims data is likely to be the most important, although the PMI data will be interesting as well. Of course, the question, at this point, is whether the market will have discounted what it perceives to be all the bad news and ignore this data. While we may see that again for another week or two, my sense is that at some point, investors will realize that the future is not quite so bright, and that risk is not where they want to be. That seems to be today’s short-term narrative, but it has not changed the bigger view yet.

Good luck and stay safe
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