Tag Archives: #dollarup

Fears to Assuage

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When calendars all turned the page
To ‘Twenty-One, clearly the rage
Was bets on reflation
And more legislation
For stimulus, fears to assuage

The dollar was slated to fall
The yield curve, to grow much more tall
While stocks were to rally
And Covid’s finale
Was forecast, a popular call

But so far, while stocks have edged higher
And bond yields are truly on fire
The dollar remains
Ensconced in its gains
Its meltdown has yet to transpire

One cannot be but impressed with the dollar’s resilience so far this year amid such surety by so many that it was destined to fall sharply.  Consensus views at the beginning of January were that the vaccines would lead to significant reflation in the global economy, equity markets would benefit greatly, bond yields would rise amid trillions of dollars of new issuance, and the dollar would fall.  As I said from the start, higher bond yields and a steeper yield curve did not typically lead to dollar weakness.  And that is what we have begun to see in the past several sessions.

Global bond markets have really started to reprice the current situation.  While the US story is easy to understand; huge new stimulus bill with no tax increases means huge new Treasury issuance to pay for things and supply overwhelms demand, one needs to ask what is driving the price declines throughout Europe and Asia as well. Stimulus efforts elsewhere have been less substantial despite more severe lockdowns by most of Europe and many Asian nations.  So, perhaps it was not merely the supply-demand imbalance that had bond investors concerned, perhaps it was also inflation expectations.

Certainly, these have been rising sharply with US 5yr-5yr breakevens now at 2.40% this morning, the highest level since March 2013, and not merely trending higher, but exploding higher.  (Germany, too, has seen a sharp rise in breakeven inflation, albeit to much lower levels, rising from 0.2% at the lows last March to 1.06% today.)  While last week’s CPI readings were a touch softer than expected on a headline basis, the reality is that higher inflation remains almost assured going forward.  This is partly because of the way the data is calculated, where last year’s pandemic induced lows will fall out of the calculation to be replaced by this year’s much higher readings.  It is also evident in the rising price of commodities, specifically oil (+1.0% this morning) which is higher by 25% this year.  In fact, the entire energy sector has seen prices rise by roughly that amount, and we have seen gains across the board in both base metals and all agricultural products.  In other words, stuff costs more.

Perhaps, of more concern is the insouciance toward inflation shown by the Fed.  For example, just yesterday, SF Fed President Mary Daly, when asked about inflation getting out of hand replied, “I don’t think that’s a risk we should think about right now.  We should be less fearful about inflation around the corner and recognize that fear costs millions of jobs.”  If you think the Fed is going to respond to any inflation data, anytime soon, you are mistaken.  They have made it very clear that the only part of their mandate that currently matters is employment.

So, let’s recap; the price of stuff is going higher while the Fed is adamant that tighter policy is inappropriate at this time.  Bonds are doing their job, or perhaps that is; the bond vigilantes are doing their job.  They are forcing yields higher, and left unabated, probably have much further to go.  But will they be left unabated?  I think the definitive answer is, no, the Fed will not allow Treasury yields to rise very much further.  And this, of course, drives my view that the dollar, while strong now, will eventually reverse course, as the Fed halts the rise in Treasury yields.

But for now, those higher yields are attracting investors into dollar products, and by extension, into dollars.  And this story can play out for a while yet.  It is a mug’s game to try to guess at what point the Fed will become uncomfortable with Treasury yields, with current guesses ranging from 1.50% to 3.0% in the 10-year.  My sense is it will be toward the lower end of that range that will encourage the extension and expansion of QE, perhaps 1.75%-2.0%.  But I remain confident that at some point, they will respond.  And with inflation showing no signs of abating, it will happen sooner than you think.

What about the rest of the world?  Well, the one thing we know is that neither the ECB nor the BOJ can afford for their currencies to strengthen too much.  While Japan has shown more stoicism lately, I can easily envision Madame Lagarde, in the context of alleged lack of inflationary pressures, pushing the ECB to expand their largesse as well, at least enough to try to offset the Fed.  Will it work?  That, of course, is the $64 trillion question.

On to today’s activity.  Risk is under a bit of pressure this morning after what were truly impressive bond market declines yesterday.  but those declines were not so much risk on, as fear starting to spread.  So, a quick tour of equity markets shows that after a mixed US session, the Nikkei shed 0.6% overnight, although the Hang Seng managed a 1.1% gain.  Shanghai reopens tonight.  In Europe, screens are red wit the DAX (-0.55%) leading the way lower, although the CAC (flat) and the FTSE 100 (-0.1%) are not suffering that greatly.  Meanwhile, at this hour, US futures are essentially unchanged.

Bond yields, which rose sharply around the world yesterday (11bps in the US, 5-8bps throughout Europe) are consolidating a bit.  Treasuries are lower by 1.9 basis points, but they have already backed up from earlier levels.  In Europe, we see the same thing, where early yield declines have been virtually erased.  Bunds are flat, OATs are higher by 0.6bps and Gilts, one of the worst performers yesterday, have seen yields fall 1.0bp, but that is well off the levels earlier this morning. The point is, even if equities are under pressure, funds don’t appear to be flowing into bonds.

Rather, commodities are the market of choice, with oil now above $60/bbl (+1.0%) and base metals higher along with almost all agricultural products.  In fact, the only real laggards here are gold (-0.3%) and silver (-0.5%), which are arguably suffering from higher yields as a competitor.

Finally, the dollar is definitely feeling its oats this morning, rising against all its G10 brethren, with the weakest link SEK (-0.45%), although other than CAD (-0.1%) and JPY (-0.05%), the rest of the bloc is lower by at least 0.3%.  This is a broad dollar strength story, with virtually no idiosyncratic national issues to drive things.  In fact, the only data of note was UK inflation, which printed a tick higher than expected.

Emerging market currencies are similarly under pressure across the board, led lower by ZAR (-0.8%) and MXN (-0.8%), although there is broad weakness in APAC and CE4 currencies as well.  Again, one needn’t look too far afield to determine why these currencies are weak, it is simply a dollar strength day.

On the data front, we start the morning with Retail Sales (exp 1.1%, 1.0% ex autos), move on to IP (0.4%) and Capacity Utilization (74.8%) and finish the afternoon with the FOMC Minutes from the January meeting.  It seems hard to believe that the Minutes will have much impact as there were neither policy shifts nor even dissension in the ranks. Perhaps we will learn if YCC or QE extension has been a discussion topic, which would be hugely bond bullish and dollar bearish.  But I doubt it.

Rather, this dollar rebound, much to my surprise, seems to have a little more behind it and could well extend a bit further.  Looking at the euro, the technicians will focus on 1.2000, the 100-day moving average and 1.1950, the low touched in last week’s sell-off.  But if the Treasury curve continues to steepen, the euro could well move back to the 1.1750 level last seen prior to the US election in November.  That is not my base case, but the probability has certainly grown lately.

Good luck and stay safe
Adf

Pent-Up Demand

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The one thing consistently heard
Is growth in H2 will be spurred
By pent-up demand
Throughout all the land
As people buy things they’ve deferred

But what if the virus has wrought
Some changes in what people sought
Perhaps now it’s saving
That people are craving
Not spending, as routinely thought

There appears to be one universal view regarding economic activity going forward; there is an enormous amount of pent-up demand for things that people have been craving since the onset of the widespread government lockdowns as a result of the spread of Covid-19.  This includes eating out, going to the gym, going to the movies and traveling on vacation.  And it seems pretty clear that there is some truth to this idea.  But given the trauma that governments around the world inflicted on their populations via the inconsistent messaging and lockdown mania, isn’t it possible that many people have reevaluated what they deem as most important?  I know that this author has certainly reconsidered what is really necessary to live a happy and fulfilling life, and I imagine I am not the only one.

But the point is, virtually every economist’s assumption in their econometric models is that there will be a substantial pick-up in activity, especially in those service sectors that have been decimated by the ongoing restrictions, in the second half of the year.  There is no doubt that savings rates are higher now than they were before the pandemic, with the latest BEA data showing a 13.7% rate at the end of 2020 vs. a 7.3% rate at the end of 2019.  But the 2019 data was below the long-term (75 year) average savings rate of 9.0%, and two-thirds the rate seen from the end of WWII to1989.  The point is recent profligacy by the American people is something of a historical anomaly.  While Americans never saved like some other cultures, where savings rates would hover in the 20% range, historically, people really did try to save some money.

The other thing to remember is the past twelve months have been remarkably traumatic to the entire nation, if not the entire world, with a generation of children having their educations disrupted and changed significantly.  As was evident in the wake of the Great Depression, an entire generation altered their behavior, as the Roaring 20’s morphed into the Depression.  The one thing that hasn’t changed is human nature, with peoples’ response to trauma informing their future activities.  This is all a long-winded way of saying that, perhaps, there isn’t nearly as much pent-up demand for things as is currently assumed.  Perhaps, the increase in savings rate is a way for people, in general, to feel a bit more secure about their situation.  While FOMO will never completely disappear, it certainly could wane.

With this in mind, it is possible to turn a more critical eye at forecasts for GDP growth around the world going forward.  For instance, the UK reported that Q4 GDP rose 1.0%, well above forecasts of a 0.5% increase, and insuring that despite likely negative growth in Q1, there will be no double-dip recession.  But BOE Chief Economist, Andy Haldane was positively effusive in his forecasts, saying, “A year from now, annual growth could be in the double digits.”  Wow is all I can say.  That is an optimistic point of view, but it is not an isolated one.  Here in the US, forecasts now indicate that GDP will grow 4.9% in 2021, well above trend and enough to offset 2020’s 3.5% decline.  And maybe they are right.  Certainly, equity markets are all-in on the idea.  However, I would be cautious in blindly accepting these numbers as gospel given no econometric model takes into account the changes wrought in perceptions by Covid-19.  I fear growth could be much less impressive as 2021 evolves which means markets will need to adjust their thinking.  Stay nimble!

On to today’s session, which has seen another lackluster performance across markets.  With most of Asia closed for the New Year holiday, only the Nikkei (-0.15%) was trading and it displayed a general lack of interest.  European bourses are mixed with the DAX (-0.5%) a key underperformer while the CAC and FTSE 100 are both flat on the day.  Given the better than expected data from the UK, it would seem that performance is a bit disappointing, but there are ongoing Brexit travails which seem to be putting a damper on things.  US futures, meanwhile, had spent the bulk of the overnight session in the green, but are now all lower by about 0.2%.  It appears we may be seeing some risk being unloaded into the holiday weekend.

Bond markets are ever so slightly firmer this morning, with the biggest mover Italian BTP’s (-1.5bps) after the FiveStar party voted to support Super Mario for PM.  Otherwise, Treasury yields are essentially unchanged as are bunds and Gilts.

Oil (WTI -1.0%) is under pressure again today, for the second consecutive session, but the uptrend remains firmly in place.  This has all the hallmarks of a modest correction.  Gold, however, is under pressure as well, and has been lagging most other commodities.  Base metals are mixed as are agriculturals, which, again, tells you that there is no strong theme in the markets.

As to the dollar, it is broadly higher this morning, albeit not dramatically so.  In the G10, the commodity currencies are under the most pressure (NZD (-0.5%, AUD -0.3%, CAD -0.3%) but we are also seeing weakness in the two havens with both JPY and CHF softer by 0.3%.  In the emerging markets, RUB (-1.0%) is the weakest of the bunch after the central bank explained they won’t be cutting rates further amid concerns over new sanctions to be imposed by the EU as well as the ongoing spread of Covid.  But aside from the ruble, while most currencies in the bloc are softer, the movement has been relatively small, on the order of -0.1% to -0.3%, indicating this is really a dollar story.

On the data front, the only thing we see today is the preliminary Michigan Sentiment Survey (exp 80.9), which would need to be wildly different to change any views.  As well, we continue to lack Fed speakers, and the data has clearly not shown “substantial further progress” on the Fed’s efforts to support the economy, so policy changes are not in the air.

The dollar’s consolidation after a nearly year-long decline continues, although, as I mentioned yesterday, there seems little impetus for the dollar to extend its corrective rally.  Rather, it feels like we are going to see a little more market chop with no direction into the holiday weekend,

Good luck, good weekend and stay safe
Adf

De Minimis Sellin’

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There once was a Fed Chair named Yellen
Whose term saw di minimis sellin’
Of bonds or of stocks
As from her soapbox
She promised a balance sheet swellin’

But now she’s the Treasury Sec
And her goal’s to get a blank check
For spending, not saving
Though that might be paving
The way to a financial wreck

Investors continue to add to their risk portfolios this morning amid the never-ending hopes for yet more fiscal stimulus from the US.  This can be seen most clearly from the combination of rising stock prices and rising bond yields.  In classic risk-on fashion, the ongoing speculative mania continues to drive equity markets higher around the world.  Asia is uniformly green, with the Nikkei (+2.1%) leading the way but strength in Shanghai (+1.0%) and Hong Kong (+0.1%).  The concern for the latter has to do with the upcoming Lunar New Year holiday and the fact that the link between the mainland and Hong Kong stock markets will be turned off during that period, thus reducing inflows. Meanwhile, Europe is also firmer across the board with Italy’s FTSE MIB (+1.4%) the leader as investors gain confidence that Super Mario Draghi will be as “successful” a PM as he was an ECB President.  But the FTSE 100 (+0.95%), CAC (+0.6%) and DAX (+0.3%) are all firmer with the DAX lagging on the back of weaker than expected IP data (0.0%, exp +0.3%) indicating that the ongoing lockdowns in Germany, which are slated to continue for another 6 to 8 weeks, are taking a toll.  And don’t worry, US futures are all green too, higher by roughly 0.4% each.

The second piece of this puzzle is the bond market, which is behaving exactly as expected in a risk-on session by selling off nicely.  In fact, Treasury yields have touched new highs for the move with the 10-year at 1.19% (+2.9bps) while 30-year bonds have just traded to 2.00% for the first time since Feb 19 of last year, right as the Covid crisis was beginning.  But this is not an isolated US feature, we are seeing higher yields throughout Europe, Italy excepted, as Bunds (+2.6bps), OATs (+2.5bps) and Gilts (+3.3bps) are all under pressure today.  Why, you may ask, are European bond markets selling off if the story is US stimulus?  Because it’s one big global trade, and if the $1.9 trillion stimulus package gets passed, the idea is a faster US recovery will support European and Asian companies that sell into the US.

Of course, politics being what it is, even control of the House and Senate doesn’t mean that passing a bill this large is easy.  And this is where Ms Yellen comes in, she needs to forcefully make the case passage is critical for the nation’s economy.  The problem is that the recent data trend, which has been generally better than expected (excluding Friday’s jobs data) points to the fact that perhaps not so much stimulus is needed.  So, on the Sunday morning talk shows she was emphatic in her comments that it is critical, and that erring by spending too much is a significantly better mistake than spending too little.  Interestingly, even some left-leaning economists don’t back that view.  Notably, Larry Summers, former director of the National Economic Council for President Obama, and Olivier Blanchard, former chief economist at the IMF, have highlighted the risks to this package on two fronts; first, it could result in inflation and second, it may prevent the passage of other legislation focused on infrastructure and green investment deemed more important.

Now, the one thing we know about Congress is that virtually none of the members of either the House or Senate have any understanding of economics or finance.  As such, they take their cues from their financial backers staffers and the pronouncements of eminent economists from their side of the aisle.  And this is what makes the Summers and Blanchard comments noteworthy, they are both clearly left of center and both are arguing for less Covid stimulus. Janet has her work cut out for her to get what she wants.  Ironically, the fact that this package may not be passed until March is probably a positive for stocks, after all, that means another 4-6 weeks of stimulus hopes!

A quick look at commodity prices shows that virtually every commodity price is higher this morning led by oil (+1.3%), but with strength in precious metals (gold +0.4%, silver +1.0%) and agriculturals (wheat +0.7%, corn +0.6%).  Again, this is a risk-on market.

The one piece of the relation trade narrative that continues to fail, however, is the weak dollar story.  For now, before inflation data starts to rise sharply and real yields tumble, rising US rates are leading to a rising US dollar.  So, this morning the pound (-0.4%) is the laggard, but the weakness is across the board.  Even NOK (-0.1% and CAD (-0.15%) are softer despite the ongoing oil price rally.  In fact, the entire commodity bloc is suffering despite firmer commodity prices.  This is true in emerging markets as well which is led lower by ZAR (-1.0%) and both BRL (-0.7%) and MXN (-0.7%) today.  The rand story continues to be virus related as the vaccine rollout stalls given the realization that the new strain of virus is not responding well to the AstraZeneca vaccines they have.  In fact, the vaccine story is part of the LATAM problems, but of greater consequence is the fact that as US yields rise, the carry trade is becoming less attractive, and both these currencies are beneficiaries of carry.  On the plus side in EMG, KRW (+0.35%) is the best performing currency around after virus restrictions were eased somewhat amid declining infection statistics.

Speaking of statistics, it is a very quiet week on the data front, with CPI the marquis number on Wednesday.

Tuesday NFIB Small Biz Optimism 97.5
JOLTs Job Openings 6.4M
Wednesday CPI 0.3% (1.5% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Thursday Initial Claims 760K
Continuing Claims 4.41M
Friday Michigan Sentiment 80.9

Source: Bloomberg

Regarding the CPI data, it has printed higher than the survey in all but one month since June and given the ongoing inflationary pressures of higher commodity prices and supply chain issues, my sense is we will see that again.  On the speaking front, just three Fed speakers this week, Mester today, Bullard tomorrow and then Chairman Powell speaks Wednesday afternoon.  This makes Wednesday the day to watch.  Until then, I expect the market will focus on stimulus matters and equity prices.  If US yields continue to rise I suspect the dollar will test resistance again, with the key level in the euro at 1.1910.  Once again, nothing has changed my medium-term view about dollar weakness, and last week did see a halving of the long euro positions in the CFTC data, but for now, I feel like the dollar still has the upper hand.

Good luck and stay safe
Adf

Contracted, Not Grown

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There once was a continent, grand
Whose culture and history fanned
Both science and art
Which helped to jumpstart
Expansion across all the land

But lately the data has shown
That Europe’s contracted, not grown
This bodes ill for those
Who purchased euros
As markets take on a new tone

Entering 2021, one of the highest conviction trades amongst the analyst and investment community was that the dollar would decline sharply this year.  After all, it fell broadly and steadily in 2020 from the moment it peaked in mid-March on the initial pandemic fears.  But the narrative that developed was that the Fed would be the king of all monetary easers, pumping so much liquidity into markets that the surfeit of dollars would simply drive the value of the greenback lower vs. all its main counterparts.  Adding to the tale was the election of Joe Biden as president, and the belief that he would be able to enact massive stimulus to help reflate the economy, thus adding fiscal stimulus to the Fed’s already humongous monetary efforts.  The pièce de résistance was the Georgia runoff elections, when the Democrats gained effective control of the Senate, and so all of these dreams seemed destined to come true.

However, there was always one conundrum that never made sense, at least to me, and that was the idea that the dollar would decline while the US yield curve steepened.  The thesis was that all the fiscal stimulus would result in massive Treasury issuance (check), which would result in higher yields as the market had trouble absorbing all that debt (partial check) and then the dollar would decline sharply (oops).  The problem is that historically, as the US yield curve steepens, the dollar typically rallies.

The other quibble with this narrative was that it seemed to ignore the facts on the ground in Europe.  It was never realistic to believe that the ECB would sit back and allow the euro to rally sharply without responding.  And of course, that is exactly what we have seen.  In the past three weeks, we have heard from numerous ECB speakers, including Madame Lagarde, that the exchange rate is quite important in their deliberations.  The proper translation of that comment into English is, if the euro keeps rallying, we will directly respond via further easing or even intervention if necessary.  Remember, Europe can ill afford a strong euro from both a growth and inflationary perspective, and they will do all they think they can to prevent it from coming about.

At the same time, there is another issue that the dollar bears seemed to neglect, the pathetic state of affairs in the Eurozone economy, as well as the vast incompetence displayed throughout the continent with respect to the inoculation of their populations with the new Covid vaccines. Based on current trends, the US and UK will have vaccinated 75% of their respective populations by the end of 2021.  Italy, Germany and France are looking at 2024 at the earliest to achieve the same milestone.  Ask yourself how beneficial that will be for the Eurozone economy if the current lockdowns remain in place for the next 2-3 years.

The one possible saving grace for this view is that the Fed responds more aggressively to any steepening of the yield curve.  While Europe cannot afford for the euro to rise, the US cannot afford for interest rates to rise, at least not very much.  While yields have clearly risen from their summer lows, they remain extremely accommodative.  However, if yields should start to rise further, say because inflation starts to accelerate, the Fed seems destined to stop that move, either explicitly, via YCC, or tacitly via extending and expanding QE such that they absorb all the new Treasury issuance and prevent yields from rising.  Of course, this will result in much deeper negative real yields which, in my view, will be what leads to the dollar’s eventual decline.  Given Europe’s much duller inflationary pulse, it will be much harder for the ECB to drive real yields in Europe as low as in the US.  But that is a story for the second half of 2021, not the first.

Which brings us to today’s activity.  The discussion above was prompted by the much weaker than expected Eurozone Retail Sales data released this morning, with December’s monthly growth at 2.0% and the Y/Y number at just 0.6%, half of expectations.  And this was before the extended and expanded lockdowns in January.  It is increasingly evident that the Eurozone is in its second recession in just over a year, again, hardly a rationale to buy its currency.  Which makes it completely unsurprising that the euro has declined yet again, -0.4%, and breaking below the psychological 1.20 level.  For those keeping track, this is he fourth consecutive day of declines and it is pretty easy to look at a chart and see a downtrend developing.  In fact, since its peak on January 7, the euro is down a solid 3%.

But the dollar is performing well against all its G10 brethren, and most EMG counterparts as well.  SEK (-0.6%) and NOK (-0.5%) are the worst performers with the latter somewhat surprising given that oil (+0.75%) continues to rally.  It seems that both these countries are seeing doubts over their ability to inoculate their populations from Covid similar to the Eurozone, so it should not be surprising that their currencies decline.  The same is true of CAD (-0.25%) where the current trend for vaccinations shows it will take a full ten years to vaccinate 75% of Canada’s population!  I imagine the pace will increase, but it does demonstrate the futility so far.  CAD, however, has not been as weak as the euro given the benefits from the rising oil price seem to be offsetting some of its other problems.

In the Emerging markets, ZAR (-0.8%) is the worst performer today, falling on a combination of broad dollar strength and concerns over the possibility of a debt crisis as the nation’s debt/GDP ratio has climbed rapidly to 80%, and with its still high yields, debt service ability is becoming a bigger problem.  Of course, there is also a new strain of Covid, first identified there, that has increased virulence and is working against the economy.  With the euro lower, it is no surprise that the CE4 have followed it down, and we are also seeing weakness in MXN (-0.6%), again, after central bank comments indicating possible rate cuts in the future.  On the flipside, TRY (+0.5%) is the star performer today, continuing to gather interest given its world-beating interest rate structure and promises from the central bank to maintain those yields.

While I skipped over both equity and bond markets today, it is only because there was precious little movement in most cases and certainly no discernible trend.

On the data front, yesterday saw better than expected ADP Employment and ISM Services prints, once again highlighting the differences between the US and Europe.  This morning brings a raft of data as follows: Initial Claims (exp 830K), Continuing Claims (4.7M), Nonfarm Productivity (-3.0%), Unit Labor Costs (4.0%) and Factory Orders (0.7%).  With Payrolls tomorrow, all eyes will be on the Initial Claims number, but it is hard to believe any print will change market sentiment.

Finally, the BOE met this morning and left policy unchanged, as expected.  However, they did tell banks to start preparing for negative interest rates going forward.  While they claim the policy is not imminent, it seems unlikely that they are asking banks to prepare for a low probability event.  Despite significant evidence that negative rates do not help the economy, although they do help stock prices, the BOE looks like it is going to ignore that and go there anyway.  The only analyses that showed NIRP was beneficial was produced by the central banks that are operating under NIRP.  This cannot be good for the pound over time.

For the day, the dollar is starting to gain momentum to move higher, and I think a slow continuation of this move is likely.

Good luck and stay safe
Adf

Markets Rejoice

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He once said, “Whatever it takes”
To fix all the prior mistakes
Is what he would do
And Draghi came through
Though that was ere Covid outbreaks

But now Italy’s in a bind
As Conte, the PM, resigned
So, Draghi’s first choice
(And markets rejoice)
To lead a land that’s much maligned

***FLASH***  Mario Draghi accepts mandate to form new Italian government!

Now that GameStop fever is ebbing, far more quickly than Covid-19 I might add, it is time to look elsewhere for market drivers and sentiment.  With this in mind, we turn to the nation that puts the “I” in PIGS, Italy.  My personal experience in Italy is that it is a beautiful country, with extraordinary history and even better food.  The people are warm and welcoming, and it is truly a delightful place.  Alas, it is also, historically, one of the worst run nations on earth.  Attention to detail and a sense of urgency are two things that tend to be missing from the Italian culture, but both are necessary to be able to govern effectively.  Thus, it is not surprising that Italy has had 66 different governments since the end of WWII, with the most recent one falling two weeks ago.  The norm has been for coalitions, often fractious, to come together on short-term issues and then fall apart when longer term questions need to be addressed.

This is an apt description of the current situation, where PM Giuseppe Conte, a law professor with no previous political experience, was tapped to lead a disparate coalition of center-left and radical-left parties in an effort to prevent Matteo Salvini’s Lega Nord, a right-wing party, from taking control.  While this effort stumbled along for nearly two years, it recently foundered when a key supporter of the coalition, Matteo Renzi, withdrew his support and Conte lost a vote of no-confidence in the Italian Senate.  Conte has been unable to piece together another coalition which leaves two choices; the President, Sergio Mattarella, can appoint someone else to try to do so, or elections must be held.

Enter Mario Draghi.  Since his time as ECB President ended in 2019, he has been relatively quiet on most issues, and has not been willing to get involved in the morass of Italian politics at all.  Arguably, because of that, he remains the most popular public figure (non sports or entertainment) in the country.  And so, President Mattarella is meeting with Draghi today to ask him to form a new government with wide latitude to do “whatever it takes” to fix Italy’s many problems.  While the early word from political figures there is mixed, at best, the market thinks this is the best idea since sliced bread.  This is clear from both the equity market, where the FTSE MIB has rallied by a world-beating 2.7% today, as well as from the bond market, where BTPs have rallied sharply with yields falling 9.2 basis points and the spread to bunds has fallen to just over 100 basis points, its tightest level since 2016.

Remember, Italy has been one of the worst hit nations from Covid, as the infections appeared there early and the economy is hugely reliant on tourism and services, exactly the areas Covid destroyed.  Add to that the government’s general incompetence which has slowed the distribution of the vaccines (although in fairness, this seems to be true throughout Europe, Germany included) and you have a situation where the economy, which shrunk 9.0% in 2020, remains on course to shrink again through at least the first half of 2021.  It is not clear, by any means, that Draghi will accept the position, nor if he does, if he will be able to bring together the disparate views in the Italian congress to pass legislation that helps the situation.  But, boy, the markets are all-in on the trade!

The Draghi story has been icing on the market bullish cake this morning with risk continuing to be embraced as US stimulus talks turn away from the bipartisan idea and therefore toward a quicker passage under budget reconciliation terms (where the Senate does not have a chance to filibuster).  As well, in many nations we have seen upticks in data releases, although there are still some, notably China, where the data is falling short of estimates.

Starting with equities, Asia saw strength in the Nikkei (+1.0%) and Hang Seng (+0.2%) but Shanghai (-0.5%) fell after Caixin PMI Services data (52.0) fell short of expectations and pretty significantly from last month’s reading of 56.3.  While still above the key 50.0 level, momentum in China appears to be stalling for now.  Europe is all green, but Italy is truly the outlier.  The DAX (+0.7%) comes next and then the CAC (+0.3%) and FTSE 100 (+0.2%) are both positive, but just barely.  As to US futures, after yesterday’s strong session, with all three indices rising around 1.5%, and after some strong earnings reports yesterday afternoon, futures are higher by modest amounts, led by the NASDAQ’s 0.6% climb.

Bond markets are offering the same message, with yields higher in Treasuries (2.1bps), bunds (1.1bps) and Gilts (1.1bps).  Meanwhile, the bonds of the PIGS are all rallying on the combination of general risk attitude and the hope that good news in Italy will spread.

Oil continues its winning ways, rising another 0.5% this morning which puts WTI above $55/bbl, a level many technicians believe opens the way for a sharper rally from here.  Gold, after a dreadful day yesterday, is still under modest pressure, down 0.15%, but silver, after an even more dreadful day yesterday, having fallen more than 8%, is actually bouncing a bit, and up 0.5% as I type.

Finally, the dollar is generally stronger vs. G10 currencies, with only AUD and NZD (both +0.1%) showing any life.  The kiwi story is based on stronger than expected employment data indicating the economy is rebounding and more monetary support may not be necessary, while Aussie seems to be benefitting from strong PMI data.  But otherwise, the dollar is on top this morning, with broad-based gains although they are not substantial.  SEK (-0.4%) is the worst performer, followed by the pound (-0.25%) and euro (-0.25%), both of which saw underwhelming PMI services data. In the EMG bloc the picture is more mixed, with both gainers and losers, although it is hard to piece together a coherent story.  The CE4 are the laggards, down 0.3% on average as they track the euro.  LATAM is also underperforming, although both MXN and BRL are softer by just 0.2%.  On the plus side, RUB (+0.3%) leads the way, arguably on oil’s uptick, and then some APAC currencies eked out marginal gains as well.  However, given the modest magnitude of movement, this feels an awful lot like position adjustments.

On the data front today we see ADP Employment (exp 50K) and ISM Services (56.7).  The former will attract more attention than the latter, in my view, as the market looks ahead to Friday’s NFP data. It would also be a mistake if I did not mention that Eurozone CPI was released this morning at a much higher than expected 0.9% (1.4% core) which is hard to reconcile with the collapsing economic activity.  Although perhaps, inflation is not dependent on demand as much as supply, and central bankers have it completely wrong.  Nah.

For now, the dollar’s correction continues, and we are right at the 1.2010 level that proved the breakout point in December.  At this stage, a move to 1.1950 seems a good bet, but we will need to see many more positions unwind if we are to overcome the dollar weakness narrative.  The confusing part is the ongoing equity rally alongside the dollar rally, something we have not seen for quite a while.  But that doesn’t mean it can’t continue for a while longer.  I still like the dollar to fall in H2, but right now, momentum is building for further dollar strength.

Good luck and stay safe
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GameStop

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The company still known as GameStop
Whose model for business, a mall shop
Was heavily shorted
Has seen those shorts thwarted
By buyers whose bubble will not pop

While I recognize GameStop (GME) seems to have absolutely nothing to do with the FX markets, I have been asked by a number of people to explain what happened, so I thought I would offer a relatively short explanation of the events, which were truly remarkable.  And arguably, this is much more about markets in general, and market sentiment in particular.

As always, I think a little perspective is in order.  GME was born in 1984 as Babbage’s in Dallas, Texas.  After a series of mergers, it was acquired by Barnes & Noble in 1999, who merged it with another company, Funco, Inc. and renamed this entity GameStop.  It went public in 2002, was spun off from Barnes & Noble in 2004, and then grew as a business.  Its business model was to be the go-to place for electronic games, and it eventually opened more than 5000 sites throughout malls in the US and around the world.  The problem, of course, is that even before Covid-19, bricks and mortar retail space was suffering.  This was especially so for this business, where games can be downloaded over the internet, and disks and cartridges have lost their appeal.  Covid seemed like the last straw, as malls all over the country were closing and saw extraordinary reductions in foot traffic, thus devastating the company’s business.

Over the course of the past twelve months, short interest in GME stock skyrocketed, as a number of hedge funds expected that the company would file Chapter 11 relatively soon.  After all, revenues had fallen more than 30% on a Q/Q and Y/Y basis, and profitability had disappeared.  In truth, it seemed a pretty logical bet.  However, hedge funds, being hedge funds, and reveling in as much leverage as possible given ZIRP, actually created short positions that grew to 140% of the outstanding float of the stock!  How, you may ask, is that possible?  Well, clearly, there was some naked shorting going on, which means that some of them were selling the stock without having borrowed it to deliver.  Oh, yeah, that is illegal these days.  It is also entirely possible that some brokers holding the stock rehypothecated it, meaning they lent it out more than once, also illegal.

Fast forward to three weeks ago, where a financial analyst, whose Reddit handle is Roaring Kitty, figured out that the short positions in this stock were untenable.  He posted on the Reddit thread WallStreetBets, which picked up traction and encouraged people to buy the stock.  Hence, the stock started to rise after months, if not years, in the doldrums.

The next step came from the options market, where the several million followers of WallStreetBets figured out that the leverage available in buying out of the money call options (also known as low delta call options) was extraordinary, and so they bought millions of them.

As a former option market maker (not in stocks, but FX, bonds and commodities), I can tell you that selling low delta options is a very dangerous trade.  This is because, if the market starts to move toward the strike price, as a hedger, I am forced to buy ever more underlying to hedge my position.  This is called gamma hedging and is the bread and butter of what options traders do all day long.  But the combination of the extraordinary demand for low delta GME calls and the recognition by the hedge funds with extensive short positions fed on itself into a frenzy.  At some point, the prime brokers who were handling those hedge funds’ business had to make margin calls and close out the short positions.  And those type of buyers are completely insensitive to price, because the prime broker doesn’t pay the freight, it is the hedge fund with the short position that is getting stopped out, that takes the losses.

Now, remember, because of the size of the short position, greater than the amount of stock outstanding, this process has taken a while to unfold, and is probably not done yet.  It has, however, busted those hedge funds, who have lost billions of dollars, as well has shown that they were not all that smart after all.  Alas, I fear that all the Robinhooders who were a huge proportion of the buyers are going to find themselves in a bad state as well.  After all, GME is still a dying business with the wrong business model for today.  A $1 billion market cap is probably a lot more appropriate than the current $23 billion market cap, so look for the stock to decline going forward, although probably not as quickly as it rose.

From our perspective, though, I think the lesson of GME is more about what it says about sentiment in the markets these days.  This type of price action and market activity has historically been confined to the last stages of a mania of some sort. In other words, to my eyes, and remember, I have seen market crashes starting in 1987, Tokyo in 1989, 1999-2000, and 2008-2009, this smacks of the true “irrational exuberance” made famous by former Fed Chair Alan Greenspan in 1996.  Whether it is rising rates, disappointment in the slower than expected rollout of the vaccine, or pressure on profit margins and earnings misses, I expect that shedding risk is going to be the norm for the next two quarters at least.  This is not to say we are going to see a collapse in stock markets, just that the gains of the pasts several months and years are unlikely to be repeated.

Which brings us to this morning, where the newest target for a short squeeze by the WSB crowd is silver.  Silver has opened higher by around 8%-10% and is now pressing $30/oz.  The last time silver traded above that level was March 2013, in the wake of the Eurozone debt crisis, and the only other time it did so was in 1980, when the Hunt brothers tried to corner the market.  Understand this, in 1980, the market was smaller, there were more natural buyers of silver for industrial uses, notably Eastman Kodak for film emulsion, and the Hunt’s failed dismally once the COMEX changed the rules.  Today, in a much larger market ($1.5 trillion) with far less industrial demand, this seems destined to fail, at least with respect to achieving the same type of impact as GME.  But that doesn’t mean the price can’t go higher in the short run.

Ok, on to FX, where today is PMI day, with the most noteworthy results coming from China over the weekend.  Noteworthy in the sense that they were all worse than expected (Mfg 51.3, Services 52.4 and Caixin 51.5) and all represented pretty big declines from last month.  In addition, the forward-looking pieces, like New Orders and Employment also fell sharply, so it doesn’t bode well for February.  Recall, China has locked down much of the northern part of the country to prevent the spread of Covid and this is occurring right before the start of the Lunar New Year holiday, the busiest travel time of the year, historically, in the country.  The point is, if expectations are for China’s economy to drive global growth, we could be seeing a longer delay before things pick up.

European PMI’s were generally in line with expectations on the manufacturing side and a number of other emerging market economies saw better than anticipated results.  Again, this simply highlights that the recovery in H1 is likely to be quite uneven.

As to markets, despite early losses in Asia and US futures, equity markets have turned around and were robustly higher overnight (Nikkei +1.55%, Hang Seng +2.15%, Shanghai +0.6%) and are all higher throughout Europe (DAX +1.5%, CAC +1.5%, FTSE 100 +1.2%).  US futures, which had opened the overnight session down as much as 1% are now all higher by more than that.

Bond markets are also demonstrating risk-on characteristics, albeit on a much more subdued basis.  Treasury yields have edged higher by 1.2bps, while bunds are essentially unchanged along with OATs and Gilts.  What we are seeing is PIGS bonds rallying with yields in Italy (-3.2bps) and Greece (-2.7bps) falling the most.

With silver leading the way, gold (+0.7%), too, is higher and so is crude oil (+0.5%).  In other words, risk is in favor here.  Interestingly, the FX market is not as convinced, at least not if we believe that risk-on is synonymous with a weaker dollar.  CHF (-0.6%) is the worst performer, which as a haven makes some sense, but EUR (-0.5%) leads the rest of the European group down, after German Retail Sales fell -9.6%!  The commodity currencies have not been as badly impacted (CAD -0.3%, AUD -0.2%).  Actually, today’s best performing G10 currency, other than the dollar, is the pound, which is basically flat as the success they’ve had with their vaccine program (13% of the population has already been vaccinated, the most by far for a large nation) has investors of the belief that the UK will lead the recovery.

EMG currencies are having a more mixed session with TRY (+1.7%) the leading gainer on further hawkish comments from the new central bank head there helping convince traders that tighter monetary policy will be with us for a while.  MXN (+1.15%) is next in line, on the strength of the commodity rally, along with ZAR (+0.75%) on the same basis.  Remember, Mexico is the largest silver producing country in the world, so the big rally in silver is clearly helping the peso.  On the downside, CNY (-0.6%) suffered on its data, and the CE4 are all falling similar amounts to the euro.  The rest of the bloc is less interesting and mixed as to gainers and losers.

On the data front, ISM Manufacturing (exp 60.0) is the main release today, with Construction Spending (+0.8%) due as well.  It is a payroll week, but I will delve into that more tomorrow as this note is already exceptionally long.  We do hear from three Fed speakers today, with a mix of uber doves and regular doves, so if anything, I expect that we will see more talk of needing more stimulus.  Speaking of which, the political fight over the proposed $1.9 trillion new bill continues but, in the end, you know that they will pass another bill with a lot more money being spent.

For all the conviction as the new year began that the dollar would decline sharply, the price action through January has clearly shaken some people.  However, positioning seems to be remaining steady, and I still believe that as inflation rises, real yields will fall sharply and the dollar along with it.  But for now, the dollar continues to push out the weak shorts, and quite frankly, this move does not feel like it is ending.  At this stage, a move in the euro toward 1.1950 seems quite viable.

Good luck and stay safe
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No Bonds Will They Shed

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Chair Powell explained that the Fed
Cared not about bubbles widespread
Employment’s the key
And ‘til he can see
Improvement, no bonds will they shed

Meanwhile, cross the pond, Ollie Renn
Repeated the mantra again
The ECB will
Not simply stand still
And let euros outgain the yen

At the first FOMC meeting of 2021, Chairman Powell was very clear as to what was in focus, employment.  To nobody’s surprise, they left policy rates on hold and did not change the purchase metrics of the current QE program.  However, in the statement, they downgraded their outlook for the economy, which given the ongoing vaccination program seemed somewhat surprising.  However, the fact that vaccinations are taking longer to be administered than had been expected, seems to be driving their discussion.  He was also explicit that the Fed was set to continue their current program until such time as they achieve their twin goals of maximum employment and 2% average inflation.  Based on the recent rising trajectory of Initial Claims (expected today at 875K) and given even Powell described the fact that the Unemployment Rate likely significantly understates the true situation, it will be a very long time before the Fed even considers reducing their program.

When asked at the press conference following the meeting about potential bubbles in asset markets, with several questions specifically about GameStop stock (a truly remarkable story in its own right), the Chairman was also clear that employment was the thing that mattered, and the Fed was not focused on things like this.  He even explained that the Fed fully expected inflation data to rise this summer but would not waver from their course until maximum employment is achieved.  So, the message is clear, the balance sheet will continue to grow regardless of any ancillary issues that arise.

Keeping our focus on central banks, we turn to the ECB, where this morning it was Finnish Central Bank president Ollie Renn’s turn to explain to the markets that the ECB was carefully watching the exchange rate and its impact on inflation, and would use all the tools necessary to help boost inflation, including addressing a ‘too strong’ euro.  Kudos for their consistency as this was exactly the same message we heard yesterday from Klaas Knot, the Dutch central bank chief.  As well, during yesterday’s session there was an ECB statement that “markets [are] underestimating rate-cut odds.”  You may recall the Knot specifically mentioned the possibility of cutting interest rates by the ECB as well.  All told, there is a consistent message here as well, the euro is a key focus of the ECB and they will not allow it to trade higher unabated.  I have made this point for months, as the dollar bearish views became more entrenched, that the ECB would not sit idly by and allow the euro to rally significantly without responding.  This is the first response.

What are we to conclude from these two messages?  The conclusion I draw is that beggar thy neighbor policies continue to be at the forefront of monetary policy discussions within every major central bank.  While I’m sure they are not actually described in that manner, the results, nevertheless are just that, every central bank is committed to continuing to expand their balance sheet while adding accommodation to their respective economies, and so the relative impact remains muted.  In the end, nothing has changed my view that the Fed will cap yields, which right now are doing a good job of that all by themselves (10-year Treasury yields are -1bp today and back to 1.00%, their lowest level since the break higher on the Georgia election results), and that the dollar will suffer as real yields in the US plummet.  But again, that is Q2 or Q3, not Q1.

Perhaps, what is more interesting is that despite all this promised central bank largesse, yesterday was a massive risk-off session and today is following right in those footsteps.  Starting with equity markets, the bloodbath is universal.  Asia saw sharp declines (Nikkei -1.5%, Hang Seng -2.6%, Shanghai -1.9%) following the US selloff.  And it wasn’t just the main indices, literally every Asian market that was open yesterday fell, most by more than 1%.  European bourses are also all red this morning, but the magnitude of losses has been more muted.  Of course, they got to participate in yesterday’s sell-off, so perhaps that is not too surprising.  As I type, the CAC (-0.1%) is the best performer, with the DAX (-0.6%) and FTSE 100 (-1.0%) suffering more acutely.  Here, too, every market is in the red.  Interestingly, US futures are mixed, with DOW futures actually higher by 0.1%, but NASDAQ futures are down 0.7% after weaker than expected earnings and guidance from some of the Tech megacaps last night.

Bond markets are pretty much all in the green, with yields lower, but essentially, the entire space has seen yields decline just 1 basis point.  That is not really a sign of panic.  Perhaps, with yields so low, investors are beginning to understand that bonds no longer offer the hedge characteristics for risk that they have historically held.  In other words, is earning -0.64% to hold 10-year bunds really hedging negative outcomes in your equity portfolio?  A key part of the thesis that bonds are a haven is that you earn a stable return during tough times.  These days, that is just not the case, and the risk that yields normalize means the potential losses attendant to holding a bond portfolio at current yields is quite substantial.

Commodity prices are generally softer, but not by very much.  WTI (-0.4%) continues to consolidate its gains from Q4 but has basically gone nowhere for the past two weeks.  Gold (-0.2%), too, is treading water lately, although the technicians are starting to say it is in a mild downtrend.

And finally, the dollar is basically stronger once again this morning.  This is true vs. every G10 currency, with AUD (-0.7%) the worst performer, but all the commodity currencies (NZD -0.5%, CAD -0.4%) under pressure along with the havens (JPY -0.2%, CHF -0.2%).  This is simply another dollar up day, with risk still in question.  In the emerging markets, KRW (-1.35%) is by far the worst performer, suffering from the changing risk appetite as well as weaker than expected earnings from Samsung, the largest company in the country.  Capital exited the KOSPI and drove the won to its lowest level since early November.  But we are seeing weakness in the usual suspects with RUB (-0.6%), MXN (-0.4%) and BRL (-0.3%) all under some pressure.  The outlier here is ZAR (+0.2%) which after a very weak start alongside other commodity linked currencies, has rebounded on the news that the first Covid vaccines would be arriving by the end of the week.

There is a bunch of data this morning led by Initial Claims but also Q4 GDP (exp 4.2%), Leading Indicators (0.3%) and New Home Sales (870K).  This is the first reading for Q4, but the market is more intently focused on Q1 and Q2, so it is not clear the print will matter much.  Housing we know continues to perform extremely well, so the Claims data is likely the most important release, especially given Powell’s focus on employment.

As of now, risk remains on its heels, but it would not be that surprising if things turned around as Powell’s message of non-stop stimulus should encourage the bulls.  If that is the case, I would look for the dollar to cede some of its gains, but it is certainly not a signal to sell aggressively.

Good luck and stay safe
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