Quickly Fading

With stimulus hopes quickly fading
And Covid, more countries pervading
Most risk appetites
Have been read last rites
Thus traders, to buy, need persuading

Well, yesterday was no fun, at least if you owned equities in your portfolio, as we saw sharp declines throughout European and US markets.  And frankly, today is not shaping up to be much better.  Risk assets are still being jettisoned around the world as investors run to havens.  Perhaps the only place this is not true is China, where recent data releases show the economy there moving back toward trend growth.  The question at hand, then, seems to be, Is this the beginning of the widely anticipated sell-off/correction?  Or is this simply a short-term blip in an otherwise strong uptrend in risk asset pricing?

Evidence on the side of the broader sell-off comes in the form of; a) the lack of a stimulus bill, which seems officially impossible before the election, and to which may hopes were pinned; and b) the increasing spread of Covid-19, forcing governments worldwide to reimpose restrictions on dining, drinking and many in-person services.  Without the stimulus to offset the economic activity that is being halted, the prospects of economic growth are fading quickly.  And unless the Fed or ECB starts to give money directly to citizens, rather than simply purchase securities, there is very little either one can do to prevent a more serious economic downturn.

Worryingly, the evidence for the short-term blip thesis is entirely technical, as yesterday’s price action halted at a key trend line, thus did not ‘officially’ break lower.  Certainly, it is exceedingly difficult to find a good reason to believe that, after a remarkable runup since the March lows, there is much left in the tank of this rally.  On what basis does one become bullish from here?  After all, the hopes for stimulus have been dashed, at least in the near-term.  Hopes for a vaccine have taken a back seat as well, with much less discussion as numerous candidates continue to go through phase 2 and 3 trials, but nothing has been approved.  The problem with the hopes for a vaccine being approved quickly is that a key part of the approval process is to ensure that there are no long-term side effects for those that prove efficacious.  And that simply takes time and cannot be accelerated.

Meanwhile, as the US election nears, investors appear to be taking their cues from the polls and expectations for a Biden victory are growing.  It is interesting to me that given the Democratic platform of higher taxes, more government intrusion into the economy and an attack on the mega-cap tech companies with an eye toward breaking them up, that investors believe a Blue wave will be positive for equities.  It seems to me, all of those would be decidedly negative outcomes for shareholders as we would transition from one of the most openly business-friendly presidencies to what, on the surface, would shape up as one of the least business-friendly administrations.  Yet, nearly everything that has been published, or at least that I have seen, comes down on the side of a Biden victory as being positive for risk assets.  While this appears to be entirely on the strength of expectations for a massive new stimulus bill, for an institution that prides itself on its forward-looking abilities, one would think the negatives of even larger increases in the budget deficit and the public debt required to fund those, would be recognized as distinctly negative.

But for now, the narrative remains if the polls are correct, risk assets will perform well, the yield curve will steepen, and the dollar will decline.  While I would argue the first two are unlikely, the dollar’s behavior will depend on what happens elsewhere in the world, thus seems impossible to call at this time.

And that seems to be the state of play this morning.  So, let’s take a look around markets at this hour.  Overnight equity action saw a mixed bag with the Nikkei essentially unchanged, the Hang Seng (-0.5%) softening and Shanghai (+0.1%) marginally higher.  As an aside, Australia’s ASX 200 fell 1.7%, despite the relatively positive news about China.  In Europe, while the FTSE 100 is back to flat on the session, the Continent remains under water led by the CAC (-1.0%) but with solid declines elsewhere (DAX -0.4%, Italy’s MIB -0.55%).  These readings, though, are actually better than from earlier in the session.  Finally, US futures have also improved in the past hour and are now pointing higher by roughly 0.5%.

Bond markets are showing modest risk-off tendencies this morning, at least throughout Europe, with Bund yields lower by 1bp, as are French OAT’s.  Treasuries, on the other hand are unchanged in the session, trading right at 0.80%, which represents about a 7-basis point decline (bond rally) from last week’s levels.  There remains a huge amount of sentiment that the yield curve is going to steepen dramatically after the election as traders and investors anticipate a tsunami of bond issuance to fund the new Administration’s platform.  Of course, if the polls prove to be wrong, as they were in 2016, my sense is we could see a very sharp bond rally as the record short interest in bond futures gets quickly unwound.

Commodity prices, which yesterday were under pressure, and have seen oil trade well back below the $40/bbl level, are bouncing this morning, up ~1.0%, but looking through the rest of the complex, in base metals and ags, movement has been very modest and is mixed.

Finally, the dollar has turned from a dull opening, to some modest weakness overall.  NOK (+0.65%) is leading the way higher in the G10 space as it benefits from oil’s bounce.  However, after that, CAD (+0.3%) is the next biggest mover, also being helped by oil, and the rest of the bloc is +/- 0.2%, with no real stories to tell.  The pound, which has really done very little this month, continues to be whipsawed by Brexit headlines, although there is some positivity as both sides are meeting right now in London.

Emerging market currencies have two outliers this morning, ZAR (+0.75%) and TRY (-0.8%), with the rest of the bloc +/- 0.2% and very little of news to discuss.  If I had to characterize the market, it would be slightly dollar bearish, but in truth, the modesty of movement makes any judgement hard to offer.  As to the big movers, Turkey’s lira continues to suffer (-3.5% this week) as investors flee the country amid concerns the central bank has completely lost control of markets there, while President Erdogan continues his war of words with Europe and feels the sting of further sanctions.  On the flipside, ZAR is actually the leading gainer in the past week, as well as today, with hopes for positive budget news bolstering the demand for very high real yields.

Data today brings Durable Goods (exp 0.5%, 0.4% ex transport), Case Shiller Home Prices (4.20%) and Consumer Confidence (102.0).  With the Fed meeting next week, we have entered into the quiet period, so will not be hearing them castigate Congress for failing to pass a spending bill, although they all will be thinking it!  Across the pond, the ECB meets Thursday, and analysts are anticipating a strong signal that the ECB is going to increase monetary ease in December, yet another reason to be suspect of the collapsing dollar theory.  As for today, if the bulls can get the upper hand, then the dollar’s modest retreat thus far today can certainly extend.  But I don’t really see that happening, and think we see a bit of dollar strength before the session ends.

Good luck and stay safe
Adf

Naught Left to Wield

The PMI data revealed
The Continent’s yet to be healed
The second wave’s crest
Must still be addressed
And Christine has naught left to wield

It appears as though the market reaction function has returned to ‘bad news is good.’  This observation is based on the market response this morning, to what can only be described as disappointing PMI data from Europe and Japan, while we have seen equity markets higher around the world, bond yields generally declining and the dollar under pressure.  The working assumption amongst the investment community seems to be that as economic weakness, fostered by the much discussed second wave of Covid infections, spreads, it will be met with additional rounds of both fiscal and monetary stimulus.  And, this stimulus, while it may have only a marginal impact on economies, is almost certainly going to find its way into investment portfolios driving asset prices higher.

Unpacking the data shows that France is suffering the most, with Manufacturing PMI declining to 51.0 and Services PMI declining to 46.5, with both of those falling short of market expectations.  Germany, on the other hand, saw Manufacturing PMI rise sharply, to 58.0, on the back of increased exports to China, but saw its Services data decline more than expected to 48.9.  And finally, the Eurozone as a whole saw Manufacturing rise to 54.4 on the back of German strength, but Services fall to 46.2, as tourism numbers remain constrained, especially throughout southern Europe.

This disappointment has analysts reconfirming their views that the ECB is going to increase the PEPP by €500 billion come December, with many expecting Madame Lagarde to basically promise this at the ECB meeting next week.  The question is, will that really help very much?  The ECB has been hoovering up huge amounts of outstanding debt and there is no indication that interest rates on the Continent are going to rise one basis point for years to come.  In fact, Euribor rates fell even further, indicating literally negative concern about rates increasing.  And yet, none of that has helped the economy recover.  While the ECB will offer counterfactuals that things would be worse if they didn’t act as they have been, there is no proof that is the case.  Except for one thing, stock prices would be lower if they hadn’t acted, that much is true.  However, in their counterfactual world, they are focused on the economy, not risk assets.

The message to take away from this information is that the second wave of infections is clearly on the rise in Europe, (>217K new cases reported yesterday), and correspondingly as governments react by imposing tighter restrictions on activities, specifically social ones like dining and drinking, economic activity is going to slow.  At this point, estimates for Q4 GDP are already sliding back toward 0.0% for the Eurozone as a whole.

One last thing, the weakening growth and inflation impulses in Europe is a clear signal to…buy euros, which is arguably why the single currency is higher by 0.25% this morning.  Don’t even ask.

A quick look at the UK story shows PMI releases were also slightly worse than expected, but all well above the critical 50.0 level (Mfg 53.3, Services 52.3, Composite 52.9).  While these were softer than September’s numbers, they do still point to an economy that is ticking over on the right side of flat.  Retail Sales data from the UK was also better than expected in September, rising 1.6% in the month and are now up 6.4% Y/Y.  Despite all the angst over Brexit and the mishandling of the pandemic by Boris, the economy is still in better shape than on the Continent.  One other positive here is that the UK and Japan signed a trade deal last night, the UK’s first with a major country since Brexit.  So, it can be done.  Ironically, in keeping with the theme that bad news is good, the pound is the one G10 currency that has ceded ground to the dollar this morning, falling a modest 0.15%, despite what appear to be some pretty good headlines.

And that is pretty much the story this morning.  Last night’s debate, while more civil than the first one, likely did nothing to change any opinions.  Trump supporters thought he won.  Biden supporters thought he won.  Of more importance is the fact that the stimulus discussions between Pelosi and Mnuchin seem to be failing, which means there will be nothing coming before the election, and quite frankly, my guess is nothing coming until 2021 at the earliest.  If this is the case, the stock market will need to refocus on hopes for a vaccine, as hopes for stimulus will have faded.  But not to worry, there is always hope for something (trade deal anyone?) to foster buying.

So, let’s quickly tour markets.  Asian equities were generally on the plus side (Nikkei +0.2%, Hang Seng +0.5%), but Shanghai didn’t get the memo and fell 1.0%.  European indices have been climbing steadily all morning, with the DAX (+1.2%), CAC (+1.55%) and FTSE 100 (+1.7%) all now at session highs.  Meanwhile, US futures, which had basically been unchanged earlier in the session, are now higher by 0.3% to 0.5%.

Bond markets are actually mixed at this time, with Treasury yields edging ever so slightly higher, less than 1bp, with similar increases in France and Germany.  The PIGS, however, are seeing demand with yields there lower by between 1bp and 3bps.  As an aside, S&P is due to release their latest ratings on Italian debt, which currently sits at the lowest investment grade of BBB-.  If they were to cut the rating, there could be significant forced selling as many funds that hold the debt are mandated to hold only IG rated paper.  But it seems that the market, in its constant hunt for yield, is likely to moderate any impact of the bad news.

As to the dollar, it is broadly, but not steeply, weaker this morning.  AUD (+0.35%) is the leading gainer in the G10 bloc as copper prices have been rising on the back of increased Chinese demand for the metal.  Otherwise, movement in the bloc remains modest, at best, although clearly, this week’s direction has been for a weaker dollar.

In the emerging markets, most currencies are stronger, but, here too, the gains are not substantial.  HUF and CZK (+0.35% each) are the leaders, following the euro, although there is no compelling story behind either move.  The rest of the bloc is generally higher although we have seen some weakness in TRY (-0.35%) and MYR (-0.3%).  The lira is still suffering the aftereffects of the central bank’s surprise policy hold as many expected them to raise rates.  Rationale for the ringgit’s decline is far harder to determine.  One last thing, there was a comment from the PBOC last night indicating they were quite comfortable with the renminbi’s recent strength.  This helped support further small gains in CNY (+0.2%) and seems to give free reign for investors to enter the carry trade here, with Chinese rates substantially higher than most others around the world.

On the data front here, yesterday saw the highest Existing Home Sales print since 2005, as record low mortgage rates encourage those who can afford it, to buy their homes.  This morning brings the US PMI data (exp 53.5 Mfg, 54.6 Services), but recall, that gets far less traction than the ISM data which is not released until Monday, November 2nd.  As to Fed speakers, we are mercifully entering the quiet period ahead of the next FOMC meeting.  But the message has been consistent, more fiscal stimulus is desperately needed.

As the weekend approaches, I would not be surprised to see the dollar’s recent losses moderated as short-term traders take risk off the table ahead of the weekend.  At this point, having broken through a key technical level in EURUSD, I expect an eventual test of 1.20, but once again, I see no reason for a break there, nor expect that if the dollar does fall to that level, it will be the first steps toward the end of its status as a reserve currency.

Good luck, good weekend and stay safe
Adf

Boris Has Gotten His Way

The EU will change what they say
To get a deal with the UK
They’ll now make believe
(The Brits, to deceive)
That Boris has gotten his way

The other thing that’s worth your note
Is guesstimates of next month’s vote
Investors are betting
A Blue Wave is heading
Our way, so bond prices they smote

This morning brings a little more clarity on one issue, and a little more hope on another, with both of these discussions driving market prices.

The hope stems from comments by the EU’s chief Brexit negotiator, Michel Barnier, who finally admitted that both sides will need to make compromises in order for a deal to be reached in time to prevent a hard Brexit.  While that may seem obvious to an outsider, we don’t have the benefit of the conceit that forms the EU negotiating stance. Interestingly, it seems the new ‘secret sauce’ for the EU is to make believe that Boris is getting his way in the negotiations for his home audience, while not actually ceding any ground.  Of course, what’s a bit odd about this tactic is their willingness, nay eagerness, to publicize the concept.  After all, this seems better left unsaid, to help perpetuate the story.  If the British people read about this, they may question the value of any concessions and demand more.  Of course, I am no politician, so would never presume to claim I understand the political machinations required to achieve a deal this complex with so many different constituencies to satisfy.

Nonetheless, today’s price action clearly demonstrates that, despite already crowded long GBP positions in the trading and investor community, there is further appetite for pounds on the assumption that a Brexit deal will give the currency an immediate boost.  As such, cable is leading the G10 higher versus the dollar with a 0.8% rally and taking the pound back to its highest level in more than a month.  what is even more surprising about the cable move is the fact that yet another BOE member, Gertjan Vlieghe, was on the tape discussing the need for further stimulus and the fact that negative rates are very much on the table.  You may recall yesterday when the RBA made the same comments, the Aussie dollar fell.  But today, those comments are insignificant compared to the renewed hope for a Brexit deal.  My final thought here is for hedgers to beware this movement.  The pound’s rally ahead of any deal implies that a ‘sell the news’ event is increasingly likely.  Regardless of the Brexit outcome, I believe the next leg in cable is lower.

On to the clarity, which has seen the US yield curve, and in fairness most major curves, steepen further with 10-year Treasuries now yielding 0.80% and 30-year Treasuries up to 1.61%.  According to pretty much everyone, the new narrative is as follows: the polls show not merely a Biden victory in the presidential election, but that the Democrats will be retaking the Senate as well.  This means that not only will there be a much larger pandemic stimulus response, but that spending will be much higher across the board, with much larger budget deficits, significantly more Treasury issuance and inflationary expectations increasing accordingly.  The outcome will be a much steeper yield curve, as the Fed is able to maintain control of the front end, between QE and forward guidance but will have much more difficulty controlling the back end of the curve.  In fact, I have consistently read that curve steepeners are now the most crowded trade out there.  Of course, the most common market reaction to an overcrowded trade is to go the other way, at least in the short run, but given the assumptions, the logic behind the trade seems sound.

Of course, the key is that the assumptions are accurate.  Any outcome other than a Blue Wave will arguably not result in the same type of government spending, Treasury issuance and subsequent inflationary outcomes.  So, while there does not appear to be a clear idea of what will happen to the dollar given potential election outcomes, there is certainly a strong view as to what will occur in the bond market.  We should know more in two weeks’ time.

Meanwhile, today is difficult to characterize in terms of risk appetite.  Equity markets, bond markets and FX markets seem to each be dancing to their own tune, rather than listening to the same music.  For instance, Asian equity markets were modestly positive in general (Nikkei +0.3%, Hang Seng +0.75%, Shanghai -0.1%) but European bourses are all in the red (DAX -0.65%, CAC -0.8%, FTSE 100 -1.05%).  US futures have managed to unwind earlier losses but are generally unchanged on the day.  Yesterday’s deadline, as set by Speaker Pelosi, apparently was as hard as Boris’s Brexit negotiating deadline of last Thursday.  But in the end, I would say there is more risk aversion than risk accumulation here.

The bond market, as discussed above, is under more pressure this morning, with today’s 1.7 basis point rise in yields taking the week’s movement to a 6.0 basis point gain since Monday morning.  Europe is seeing generally higher yields as well, although German bunds are little changed.  UK gilts have seen yields rise 2.5bps and Italy (+2.5bps) and Greece (+6.5bps) especially, are seeing movement.  But the point is, bonds selling off are more consistent with risk-on than risk-off.  So, as stocks and bonds are both selling off today, I wonder what people are buying!

As to the dollar, it is broadly lower, with the pound in the lead, but strong gains by NOK (+0.75%), NZD (+0.75%) and JPY (+0.6%).  One might assume that oil is rallying given the move in NOK, but that is not the case, as WTI is lower by 1.7% this morning.  Once again, there is no obvious catalyst for this movement as there have been neither data nor comments regarding the krone.  One thing to keep in mind is that NOK has been the worst performing G10 currency vs. the dollar this year, so unwinding of medium-term positions, especially if there are concerns over a dollar “collapse” is certainly realistic.  As to kiwi, it is possible that modestly higher bond yields there has encouraged some buying, but the movement appears to largely be an unwinding of yesterday’s sharp decline.  Finally, the yen’s strength is in keeping with equity market activity, but at odds with bonds.  Comments from BOJ member Sakurai indicated no rush to add additional monetary stimulus in response to the resurgence in Covid infections, so perhaps that is helping underpin the currency.

Interestingly, EMG currencies have seen less movement than their G10 counterparts, with the biggest gainer KRW (+0.7%) and the rest of the bloc generally rising in the 0.3% range.  Here, at least, there is a cogent explanation, as early export data showed a 5.9% rise in October compared to a 9.8% decline in September.  While the Y/Y data were still weak (-5.8%) that was more a function of the number of days in the period than actual performance.

On the data front, the only thing released in the US today is the Fed’s Beige Book at 2:00pm.  But, six more Fed speakers are on tap for the day, starting with Cleveland’s Loretta Mester at 10:00 this morning.  A broad summary of recent comments would indicate that virtually every FOMC member is willing to implement further monetary stimulus, but all are begging for a fiscal package to really help the economy.  Who knows, maybe today is the day that Mnuchin and Pelosi agree to one.

As the dollar has broken some key technical levels, there is room for a bit more of a decline.  But I wouldn’t be looking for a collapse.  Hedgers, take advantage of these levels.

Good luck and stay safe
Adf

Hope Springs Eternal

The White House and Congress have talked
‘Bout stimulus but both sides balked
Still, hope springs eternal
That both sides infernal
Intransigence will get unblocked

Throughout 2019, it seemed every other day was a discussion of the trade deal with China, which morphed into the Phase one trade deal, which was, eventually, signed early this year.  But each day, the headlines were the market drivers, with stories about constructive talks leading to stock rallies and risk accumulation, while the periodic breakdowns in talks would result in pretty sharp selloffs.  I’m certain we all remember those days.  I only bring them up because the stimulus talks are the markets’ latest version of those trade talks.  When headlines seem positive that a deal will get done, stock markets rally in the US, and by extension, elsewhere in the world.  But, when there is concern that the stimulus talks will break down, investors head for the exits.  Or at least algorithms head for the exits, its not clear if investors are following yet.

Yesterday was one of those breakdown days, where despite reports of ongoing discussions between Treasury Secretary Mnuchin and House Speaker Pelosi, the vibes were negative with growing concern that no deal would be reached ahead of the election.  Of course, adding to the problem is the fact that Senate Majority Leader McConnell has already said that the numbers being discussed by the House and Congress are far too large to pass the Senate.  Handicapping the probability of a deal being reached is extremely difficult, but I would weigh in on the side of no action.  This seems far more like political posturing ahead of the election than an attempt to address some of the current economic concerns in the country.

Yet, despite yesterday’s negativity, and the ostensible deadline of today imposed by Speaker Pelosi (we all know how little deadlines mean in politics, just ask Boris), this morning has seen a return of hope that a deal will, in fact get done, and that the impact will be a huge boost to the economy, and by extension to the stock market.  So generally, today is a risk-on session, at least so far, with most Asian markets performing nicely and most of Europe in the green, despite rapidly rising infection counts in Europe’s second wave.  Remember, though, when markets become beholden to a political narrative like this, it is extremely difficult to anticipate short-term movements.

Down Under, the RBA said
We’re thinking, while looking ahead
A negative rate
Is still on the plate
So traders, their Aussie, did shed

While the politics is clearly the top story, given the risk-on nature of markets today, and the corresponding general weakness in the dollar, it was necessary to highlight the outliers, in this case, AUD (-0.4%) and NZD (-0.5%), which are clearly ignoring the bigger narrative.  However, there is a solid explanation here.  Last night, between the RBA’s Minutes and comments from Deputy Governor Kent, the market learned that the RBA is now considering negative interest rates.  Previously, the RBA had been clear that the current overnight rate level of 0.25% was the lower bound, and that negative rates did not make sense in Australia (in fairness, they don’t make sense anywhere.)  But given the sluggish state of the recovery from the initial Covid driven recession, the RBA has decided that negative rates may well be just the ticket to goose growth once covid lockdowns are lifted.  It is no surprise that Aussie fell, and traders extended the idea to New Zealand as well, assuming that if Australia goes negative, New Zealand would have no choice but to do so as well.  Hence the decline in both currencies overnight.

But really, those are the only stories of note this morning, in an otherwise dull session.  As I mentioned, risk is ‘on’ but not aggressively so.  While the Nikkei (-0.4%) did slip, we saw modest gains in Shanghai (+0.5%) and Hong Kong (+0.1%).  Europe, too, is somewhat higher, but not excessively so.  Spain’s IBEX (+0.85%) is the leader on the continent, although we are seeing gains in the CAC (+0.4%) and the FTSE 100 (+0.3%) as well.  The DAX (-0.3%), however, is unloved today as Covid cases rise back to early April levels and lockdowns are being considered throughout the country.  Finally, the rose-tinted glasses have been put back on by US equity futures traders with all three indices higher by a bit more than 0.5% at this hour.

Bond markets, however, are following the risk narrative a bit more closely and have sold off mildly across the board.  Well mildly except for the PIGS, who have seen another day with average rises in yield of around 3 basis points.  But for havens, yields have risen just 1 basis point in the US, Germany and the UK.

Commodity prices are little changed on the session, seemingly caught between hopes for a stimulus deal and fears over increased covid cases.

And lastly, the dollar is arguably a bit softer overall, but not by that much.  Aside from Aussie and Kiwi mentioned above, only the yen (-0.15%) is lower vs. the dollar, which is classic risk-on behavior.  On the plus side, SEK and NOK (both +0.5%) are leading the way higher, although the euro has been grinding higher all session and is now up 0.4% compared to yesterday’s close.  There has been no news of note from either Sweden or Norway to drive the gains, thus the most likely situation is that both currencies are simply benefitting from their relatively high betas and the general trend of the day.  As to the euro, the technicians are in command today, calling for a move higher due to an expected (hoped for?) break of a symmetrical triangle position.  Away from these three, though, gains are extremely modest.

In the emerging markets, CZK (+0.7%) is the outlier on the high side, although there is no obvious driver as there have been neither comments by officials nor new data released.  In fact, given that Covid infections seem to be growing disproportionally rapidly there, one might have thought the Koruna would have fallen instead.  But the rest of the CE4 are also firmer, simply tracking the euro this morning as they are up by between 0.3%-0.4%.  There have been some modest losers in the space as well, with THB (-0.25%) leading the charge in that direction.  The Thai story is a combination over concerns about further stimulus there not materializing and anxiety over the political unrest and student protests gaining strength throughout the nation.

On the data front, this morning brings Housing Starts (exp 1465K) and Building Permits (1520K), as well as four more Fed speakers.  Yesterday, Chairman Powell was not focused on monetary policy per se, but rather on the concept of digital currencies, and specifically, central bank digital currencies.  This is something that is clearly coming our way, but the timing remains unclear.  One thing to keep in mind is that when they arrive, interest rates will be negative, at least in the front end, forever.  But that is a story for another day.

Today, we are beholden to the stimulus talks.  Positive news should see further risk accumulation, while a breakdown will see stocks fall and the dollar rebound.

Good luck and stay safe
Adf

Willing to Meet

The latest from 10 Downing Street
Is Boris is willing to meet
Midway twixt the stance
Of England and France
In order, the talks, to complete

Meanwhile, from the Far East we heard
That growth was strong in, quarter, third
They’re now set to be
The only country
Where year on year growth has occurred

The weekend has brought a few stories of note, all of them with bullish overtones, and so it should be no surprise that the week is starting with a risk-on tone.  The first place to look is in China, which released its Q3 GDP data last night at a slightly worse than expected 4.9% Y/Y.  While the market was looking for 5.5%, given that China is the first nation to achieve positive year over year growth, it was still seen as a market plus.  At least to the broad market. Interestingly, the Shanghai stock market fell 0.7%.  But, between the GDP data, Retail Sales rising 3.3% Y/Y and the Surveyed Jobless Rate falling a bit more than expected to 5.4%, the Chinese are painting a picture of a solid recovery.  And while this is well below the levels seen prior to the pandemic, it is still well ahead of the rest of the world.

Next up is the UK, where optimism has grown that a Brexit deal will, in fact, be reached. Boris, playing to both his constituents and the Europeans, has said that the UK is preparing for a no-deal outcome, but is happy to continue to talk if the Europeans would consider some compromises.  As well, in the House of Lords, word is they are prepared to remove the offending language from the UK government’s proposed Internal Market Bill, the one that caused all the concern since it was published in July.  In this bill, the UK sets out the relationship between the four nations in the UK; England, Scotland, Wales and Northern Ireland.  However, it was written in such a way as to render part of the Withdrawal Agreement moot, essentially overturning international law unilaterally.  Hence the issue.  In fact, the EU has sued the UK in the ICJ to prevent the law from being enacted.  This has been a major sticking point for the EU and has undermined a great deal of trust between the two sides.  Hence, the removal of that language is seen as a clear positive.  Certainly, FX traders saw it that way as the pound has rallied 0.75% since the news first was reported and is now back to 1.30.  While I believe the probability of a deal being completed remains above 50% (neither side wants a no-deal outcome), I also believe that the pound will fall after a deal is reached.  Sell the news remains the most likely situation in my view.

Adding to these two positive stories, the never-ending US stimulus talks continue to garner headlines despite a distinct lack of progress.  Yet, optimism on a stimulus bill seems to be a key driver in US equity markets, and in fact, in global ones as they are all, save Shanghai, propelled higher.  Given the proximity to the election, it seems unlikely that either side will allow the other to have a political victory, and so I remain skeptical a deal will be reached soon.  Of course, that merely means we can have a whole bunch of rallies on optimism that one will be reached!

With all that in mind, let’s take a look at the markets this morning.  Aside from Shanghai’s negative outcome in Asia, we saw strength with the Nikkei (+1.1%) and Hang Seng (+0.65%) both rallying nicely.  Europe as seen modest strength with the CAC (+0.6%) leading the way although the rest of the continent has seen far less love with the DAX (+0.1%), for instance, barely positive.  In fact, as I write, the FTSE 100 is actually slightly lower, down -0.15%.  US futures, though, have taken the stimulus story to heart and are much higher, between 0.8% (DOW) and 1.1% (NASDAQ).

Bond markets are feeling the risk-on mood as well, as they have fallen across the board with yields rising in every developed market.  Treasury yields are higher by 3.2 basis points, while bunds have seen a more modest 1.2 basis point rise.  Interestingly, the PIGS are seeing their bonds tossed overboard with an average rise of 4.5 basis points in their 10-year yields.

Oil prices (WTI -0.35%) are little changed, surprisingly, as one would expect commodities to rally on a positive risk day, while gold (+0.7%) and silver (+2.6%) are both quite strong, again somewhat surprising given higher yields and positive risk.  There are still many market relationships which have broken down compared to long-term trends.

Finally, the dollar is under pressure across the board this morning, with every G10 currency higher led by NOK (+0.95%) despite oil’s decline.  One of the drivers appears to be the unwinding of some large short positions in commodity currencies, a view that had been gaining credence amongst the leveraged community set.  This has helped SEK (+0.6%) and NZD (+0.55%) today as well.  The rest of the bloc, while higher, has been far less interesting.

On the EMG front, ZAR (+0.65%) is the leader with KRW (+0.5%) next in line.  After that, the gains are far less significant.  Korea’s won clearly benefitted from the Chinese GDP news, as China remains South Korea’s largest export destination.  Meanwhile, any gain in gold is likely to help support the rand given the gold mining industry’s importance to the economy there.  And as you consider the fact that the dollar is weak against virtually every currency, it is far more understandable that gold and silver have rallied as well.

On the data front, this week is not terribly interesting with only a handful of releases:

Tuesday Housing Starts 1455K
Building Permits 1506K
Wednesday Fed’s Beige Book
Thursday Initial Claims 865K
Continuing Claims 9.85M
Leading Indicators 0.7%
Existing Home Sales 6.30M
Friday Manufacturing PMI 53.5
Services PMI 54.6

Source: Bloomberg

However, despite a lack of data, there is no lack of Fedspeak this week, with six speeches just today, led by Chairman Powell at 8:00 on an IMF panel.  One of the themes of this week seems to be the discussion of central bank digital currencies, an idea that seems to be gaining traction around the world.  The other central bank tidbit comes from Madame Lagarde, who, not surprisingly, said she thought it made sense the PEPP (Pandemic EMERGENCY Purchase Program) be made a permanent vehicle.  This is perfectly in keeping with central bank actions where policies implemented to address an emergency morph into permanent policy tools as central bank mandates expand.  Once again, I will point out that the idea that other G10 central banks will allow the Fed to expand their balance sheet and undermine the dollar’s value without a response is categorically wrong. Every central bank will respond to additional Fed ease with their own package, thus this argument for a weaker dollar is extremely short-sighted.

But with all that said, there is no reason to believe the positive risk attitude will change today, unless there is a categorical denial by one of the parties discussing the stimulus bill.  As such, look for the dollar to continue to slide on the session.

Good luck and stay safe
Adf

Can’t Stop the Pain

While central banks worldwide compete
To broaden their own balance sheet
They also complain
They can’t stop the pain
Lest more money reaches Main Street

Fiscal policy is the topic du jour as not only are there numerous stories about the ongoing theatrics in Washington, but we continue to hear virtually every member of the Fed calling for more fiscal stimulus.  Starting from the top, where in a speech on Tuesday, Chairman Powell excoriated Congress for not acting more quickly, and on through a dozen more speeches this week, there is one universal view; the Fed has done everything in its power to support the economy but it is up to the government to add more money to the mix to make up for the impact of the government shutting down businesses.  And while this is not just a US phenomenon, we hear the same thing from the ECB, BOE, BOC and BOJ, it appears that the market is coming to believe that the US is going to be the nation that acts most aggressively on this front going forward.

There is a conundrum here, though, as this view is seen as justification for a weaker dollar.  And frankly, I am confused as to the logic behind that view.  It appears there is a growing belief, based on polling data, that President Trump will lose the election, and that there will be a Democratic sweep taking back the Senate.  With that outcome in mind, investors expect a huge fiscal stimulus will quickly be enacted, perhaps as much as $4 trillion right away.  Now, if this is indeed the case, and if fiscal stimulus is what is required to get the economy growing again, and if the US is going to be the country taking the biggest steps in that direction, wouldn’t it make sense that the dollar would be in demand?  After all, if US data improves relative to that in Europe or elsewhere, doesn’t it stand to reason that the dollar will benefit?

Adding to this conundrum is the fact that we are hearing particularly dovish signals from other central banks (in addition to their calls for more fiscal stimulus) with the Bank of Canada the latest to explain that negative interest rates could well be appropriate policy if the government doesn’t spend more money.  So now, NIRP has the potential to become policy in virtually every G10 nation except the US, where the Fed has been consistent and explicit in saying it is not appropriate.  So, I ask, if US rates remain positive across the curve, while other nations all turn negative, is that really a dollar bearish signal?  It doesn’t seem so to me, but then I’m just a salesman working from home.

And yet, dollar weakness is certainly today’s theme, with the greenback lower vs. every one of its major counterparts today.  For example, the euro is higher by 0.4% this morning despite the fact that production data from the three largest economies point to a renewed slowdown in activity.  French IP has fallen -6.2% since August of last year, rising a less than forecast 1.3% on a M/M basis.  Monday, we saw German IP data fall -0.2% in August, taking its Y/Y results to -9.6%.  hardly the stuff of bullishness.  And while it is true that Italy’s data was better than expected (+7.7% in August, though still -0.3% Y/Y), looking at that suite of outcomes does not inspire confidence in the Eurozone economy.  And recall, too, that the ECB Minutes released Wednesday were clear in their concern over a rising euro, implying they would not allow that to come to pass.  But here we are, with the euro back at 1.1800 this morning.  Go figure.

The pound, too, seems to be defying gravity as despite much worse than forecast monthly GDP data (2.1% vs. 4.6% expected) and IP data (0.3% M/M, -6.4% Y/Y), the pound, which has been a strong performer lately, is slightly higher this morning, up 0.1%.  Again, this data hardly inspires confidence in the future economic situation in the UK.

But as they say, you can’t fight city hall.  So, for whatever reason, the current narrative is that the dollar is due to fall further because the US is going to enact more stimulus.  There is, however, one market which seems to understand the ramifications of additional stimulus, the Treasury market.  10-year Treasury yields, which had found a home near 0.65% for a long time, look very much like they are heading higher.  While this morning, bonds have rallied slightly with the yield declining 1.5 bps, we are still at 0.77%, and it seems only a matter of time before we are trading through this level and beyond.  Because, remember, if the narrative is correct and there is a huge stimulus coming, that’s $4 trillion in new paper to be issued.  That cannot be a positive for bond prices.

The European government bond market is also having a good day, with yields declining between 2 and 3 basis points everywhere.  At least here, if the ECB is to be believed, the idea of additional QE driving bond yields lower makes sense, especially since we are not looking at the prospect of multiple trillions of euros of additional issuance.

Looking at those two markets, it is hard to come up with a risk framework for today, and the equity markets are not helping.  Asian markets overnight were generally slightly softer (Nikkei -0.1%, Hang Seng -0.3%) but we did see Shanghai rally nicely, +1.6%, after having been closed all week long.  That seems like it was catching up to the week’s price action.  Europe, on the other hand is mixed, with strength in some markets (CAC +0.35%, FTSE 100 +0.45%) and weakness in others (DAX 0.0%, Spain -0.6%, Italy -0.3%).  I find it interesting that the UK and France, the nations that released the weakest IP data are the best performers.  Strange things indeed.  US futures, though, are pointing higher, somewhere on the order of 0.4%-0.5%.

And as I mentioned, the dollar is weaker across the board.  The best performers in the G10 are NZD (+0.6%) and NOK (+0.5%), with the former looking more like a technical rebound after some weakness earlier this week, while the krone has benefitted from its CPI data.  Earlier this year, as NOK weakened, Norwegian CPI rose sharply, to well over 3.0%, but it appears that the krone’s recent strength (it has rallied back to levels seen before the pandemic related market fluctuations) is starting to have a positive impact on inflation.

EMG currencies are also entirely in the green this morning with CNY (+1.35%) the biggest gainer.  In fairness, this appears to be a catch-up move given China had been closed since last Thursday.  But even CNH, which traded throughout, has rallied 0.7% this morning, so clearly there is a lot of positivity regarding the renminbi.  This also seems to be politically driven, as the assumption is a President Biden, if he wins, will be far less antagonistic to China, thus reducing sanctions and tariffs and allowing the country to resume its previous activities. But the whole bloc is higher with the CE4 showing strength on the order of 0.5%-0.7% and MXN, another politically driven story, rising 0.5%.  The peso is also assumed to be a big beneficiary of an impending Biden victory as immigration restrictions are expected to be relaxed, thus helping the Mexican economy.

And that’s really it for the day.  There is no data to be released and only one Fed Speaker, Richmond’s Barkin, but based on what we have heard this week, we already know he is going to call for more fiscal stimulus and not much else.  Also, as Monday is the Columbus Day holiday, look for things to slow down right around lunch, so if you have things to get done, get them done early.

Good luck, good weekend and stay safe
Adf

Some Despair

In Germany, data revealed
That growth there’s apparently healed
But data elsewhere
Implied some despair
As problems, porcine, are concealed

Risk is back in vogue this morning as the market appears to be responding positively to a much better than expected PMI reading from Germany (Services PMI 50.6, up from 49.1 Flash reading, Composite 54.7, up from 53.7 Flash) and a modestly better outcome for the Eurozone (48.0 vs. 47.6 for Services, 50.4 vs. 50.1 for Composite) as a whole.  At least that’s the surface story I keep reading.  The problem with this version is that markets in Asia were also highly risk-centric and that was well before the PMI data hit the tape.  Which begs the question, what is really driving the risk narrative today?

When President Trump was infected
The thing that most people expected
Was two weeks before
He’d walk out the door
Explaining he wasn’t affected

A different, and timelier, explanation for today’s positive risk sentiment stems from the ongoing story of President Trump’s covid infection and his ability to recuperate quickly.  While the standing assumption had been that there is a two-week timeline from infection to recovery, the President has consistently indicated that he feels fine, as have his doctors, and the story is that he will be released today from his weekend stay at Walter Reed Memorial Hospital.  In other words, any concerns that attended the announcement of his illness from Friday, when we did see equity markets suffer, is in the process of being unwound this morning.  The rationale here seems to be twofold.  First, the President is set to be back at the White House and in control, something which matters greatly from a national security perspective.  But second, the fact that he, as a 74-year-old man, was able to recover so quickly from the infection speaks to the reduced impact covid is likely to have on the population as a whole.  And arguably, that may even have a bigger impact.  While we continue to hear of new lockdown’s being announced in certain places, NYC, Spain and France to name just three, if the potency of the infection is waning such that it is a short-term event with limited side effects, that could well lead to an increase in confidence amongst the population.  And, of course, confidence is the one thing that the economy is searching for desperately.

The problem is that since virtually everything has become political theater lately, it is difficult to discern the facts in this situation.  As such, it seems hard to believe that overall confidence has been lifted that significantly, at least as of this morning.  However, if President Trump remains active and vigorous this week, it will certainly put a dent into the thesis that covid is incredibly debilitating.  We will need to watch how things evolve.

Interestingly, there is one issue that seems to be getting short shrift this morning, the growing concern that there will be no Brexit deal reached in the next ten days.  Recall that Boris and Ursula had a virtual lunch date on Saturday, and both claimed that a deal was close, but there were a couple of issues left to address.  The two key differences remain the issue of acceptable state aid by the UK government and, the big one, the type of access that European (read French) fishing vessels will have to UK waters.  It seems that French President Macron is adamant that the UK give the French a (large) annual quota and be done with it, while Boris is of the mind that they should agree to meet annually and discuss the issue based on the available fish stocks and conditions.  It also seems that the rest of Europe is getting a bit annoyed at Macron as for them, the issue is not that significant.  This fact is what speaks to an eventual climb-down by Macron, but, as yet, he has not been willing to budge on the matter.  Based on the price of the pound and its recent performance (+0.2% today, +1.0% in the past week), the market clearly believes a deal will be reached.  However, that also foretells a more significant decline in the event both sides fail to reach said agreement.

So, now let’s take a look at the bullishness in markets today.  Asia saw strength across the board with the Nikkei(+1.25%) and Hang Seng (+1.3%) nicely higher and Australia (+2.6%) really showing strength.  (China remains closed virtually all week for a series of national holidays).  European indices are all green as well, albeit not quite as enthusiastic as Asia.  Thus, we have seen solid gains from the three major indices, DAX, CAC and FTSE 100, all higher by 0.7%.  And finally, US futures are pointing to a stronger opening, with current pricing showing gains of between 0.7% and 1.0%.

It should be no surprise that bond marks are under some pressure with 10-year Treasury yields up to 0.71% this morning, higher by 1 basis point on the session and 6 bps in the past week.  In fact, yields are back at their highest level in a month.  European bonds are also broadly softer (higher yields) but the movement remains muted as well, about 1bp where they have risen.  And it should also not be surprising that Italy, Portugal and Greece have seen yields decline, as those three certainly qualify as risk assets these days.

Oil prices are firmer, again taking their cue from the confidence that is infusing markets overall, while precious metals prices are flat.  And finally, the dollar is definitely softer, except against the yen, which continues to be one of the best risk indicators around.  So, in the G10 space, NOK (+0.7%) is the leader, following oil as well as benefitting from the general dollar weakness.  Next on the list is CHF (+0.5%) where data showed ongoing growth in sight deposits, an indication that capital flows continue to enter the country, despite today’s risk attitude.  But broadly speaking, the whole space is firmer.

As to EMG currencies, ZAR (+0.7%) is the leader today, with firmer commodity prices and still the highest real interest rates around keeping the rand attractive in a risk-on environment.  But it is almost the entire bloc with the CE4 (CZK +0.55%, PLN +0.45%, HUF +0.45%) showing their high EUR beta characteristics and MXN (+0.45%) also performing well, again benefitting from both firmer oil prices as well as a weaker dollar.  The one exception here is RUB (-0.5%), which appears to be suffering from the effects of the ongoing conflict in Nagorno-Karabakh and how much it is going to cost Russia to maintain its support for Armenia.

On the data front, it is a relatively quiet week with only a handful of numbers to be released:

Today ISM Services 56.2
Tuesday Trade Balance -$66.2B
JOLTs Job Openings 6.5M
Wednesday FOMC Minutes
Thursday Initial Claims 820K
Continuing Claims 11.4M

Source: Bloomberg

However, what we lack in data we make up for with Fedspeak, as eight different speakers, including Chairman Powell tomorrow, speak at 13 different events.  What we have heard lately is there is a growing difference of opinion by some FOMC members regarding the robustness of the US economic rebound.  However, despite those differences, the universal request is for further fiscal stimulus.  Given the dearth of data this week, I expect that Chairman Powell’s speech tomorrow morning is likely to be the most important thing we hear, barring a Brexit breakthrough or something else from the White House.

Good luck and stay safe
Adf

Spring Remains Distant

From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
Adf

All Doom and Gloom

As talks over Brexit resume
The headlines are all doom and gloom
But pound traders seem
To think that the dream
Is real, helping cable to zoom

Once again, the overnight session has been uninspiring, although there seem to be a few conundrums this morning.  The most interesting one is the dichotomy between the pound’s recent performance (+0.2% today, +1.0% this week), and the headlines regarding the difficulty in reaching a Brexit deal.  Time is clearly running short as the two sides get together once again to hash out issues as wide-ranging as access to UK waters for fishing to questions over the application of state aid for companies.  Clearly, there are no easy answers, and in the end, at least one side is going to need to adjust their current views for a deal to be reached.  And arguably, this is a two-week drill, as the details need to be agreed in time for the EU summit, to be held on October 15th, in order to allow enough time for all 27 other EU members to ratify the deal.

The question at hand, though, is what is priced into the market given the pound’s current level of 1.2850.  A quick look at the pound’s price history since the historic vote back in June 2016 shows that the range of trading has been 1.1412 (reached during the initial Covid panic) to 1.5018 (reached in the first minutes after the Brexit vote when the belief was Bremain had won.)  However, if we remove the Covid panic, which was clearly an exogenous event, then the low was 1.1841, reached in October 2016 during the leadership change in the UK.

With this as our framework, it is then worthwhile looking at valuation models, none of which really line up, but perhaps offer some modest insight.  For instance, a PPP valuation based on CPI shows the pound is undervalued by less than 4%, but based on the Big Mac index, Sterling is cheap by 28.5%.  When looking at Effective Exchange rates (REER and NEER), the evidence points to the Big Mac index being a better indicator, with measures for both showing the pound is roughly 24% undervalued.  However, it hardly seems likely that the true value of the pound is near 1.70, which is what those adjustments would imply.  Finally, simply taking a longer term look at the pound’s value (1983-2020) shows that the average price is around 1.5850.  Of course, during all of this time, the UK has been a member of the EU so upon its exit, there will be a significant change in its terms of trade, even if there is a deal.

What conclusions can be drawn from this information?  No matter the backdrop, the pound is in the lowest quartile of its historic price levels, which implies the market is anticipating some bad news.  In the event of a hard Brexit, will the pound trade to new lows, below those seen in 1985?  That seems unlikely.  After all, the UK is not going to sink into the North Sea, it is simply going to change the terms on which it deals with the EU.  Rather, a hard Brexit seems more likely to see a movement toward 1.15-1.20, in my view, as long positions get squeezed and a general gloom settles over the economy, at least initially.  On the other hand, successful negotiations may well see a move toward 1.40-1.45, still undervalued based on some of the indicators, but moving back toward its long-term average.  All in all, I would estimate the market has priced in a two-thirds probability of a hard Brexit, so while further declines are possible, parity with the dollar seems unlikely.  Parity with the euro, however, could well arrive in that scenario.

Turning to the rest of the market, though, shows the entire FX complex appears out of sync with the risk framework.  Equity markets are lower throughout Europe (DAX -0.4%, CAC -0.2%, FTSE 100 -0.5%) after an uninspiring session in Asia (Nikkei +0.1%, Hang Seng -0.85%, Shanghai -0.2%).  US futures are essentially flat, although have spent the bulk of the evening session modestly lower.  Bond prices are a bit firmer this morning, at least in Europe, where Bunds, OATs and Gilts have all seen yields edge 1basis point lower on the day.  Treasury yields, however, are essentially unchanged, still right around 0.65%,

Commodity markets show oil prices softer (WTI -0.65%) but precious metals slightly firmer (Gold +0.4%).  In fact, all metals prices are a bit higher, but agricultural prices are softer.  In other words, signals here are mixed as well.

Finally, the dollar, despite what appears to be a mild risk-off session, is weaker pretty much vs. all its G10 brethren with only the JPY (-0.1%) the outlier.  Arguably, that looks more like a risk-on day than a risk-off one.  The leading gainer in the bloc is AUD (+0.7%) which has been the beneficiary of demand for AGB’s, a slightly higher confidence index reading and a change in view regarding further RBA stimulus by Westpac, one of the big four Australian banks. It should be no surprise that NZD (+0.55%) has followed the Aussie higher, but the rest of the bloc is having a solid day amidst broad-based dollar weakness.

EMG currencies are starting to show more strength at this hour, led by PLN (+1.15%), although gains in MXN (+0.9%), HUF (+0.7%) and CZK (+0.65%) are solid as well.  The zloty has been responding to comments from one of the central bank’s members, Eugeniusz Gatnar, describing near zero interest rates as hurting the economy and calling for normalization by next year.  Meanwhile, MXN seems to be benefitting from an increase in the carry trade, where despite recent volatility, the search for yield is forcing many investors to areas they would not have previously considered.  Overall, the only currencies that have been under pressure remain RUB and TRY as the escalation of fighting between Armenia and Azerbaijan weighs on their sponsors.

On the data front, there was precious little overnight, Tokyo CPI ex Fresh Food fell -0.2%, while European data was all second tier.  This morning we see Case Shiller Home Prices (exp 3.60%) as well as Consumer Confidence (90.0), however, neither of these seem likely to change views.  Of more importance, we have four more Fed speakers, although yesterday’s had little impact.  Arguably, the thing which has the market’s attention is tonight’s first presidential debate, but at this point, it is difficult to determine what type of impact it may have.  Ultimately, a change in the White House is likely to have some significant market implications, with the dollar’s value being clearly impacted.  But it is far too early to discuss this issue.

For today, it appears that the FX market is leading the equity markets, a highly unusual situation, but I expect that we will continue to see modest USD weakness while equity markets edge higher.

Good luck and stay safe
Adf

Signs of Dissension

In China they claim that firms grew
Their profits and gross revenue
Encouraged by this
The bulls added risk
While bears had to rethink their view

Quite frankly, it has been a fairly dull session overnight with virtually no data and only a handful of comments.  Risk appetite is in the ascension after the Chinese reported, Saturday night, that Industrial Profits rose 19.1% Y/Y.  What’s truly remarkable about that statistic, and perhaps what makes it difficult to accept, is that throughout most of 2019, those numbers were negative.  In other words, prior to the outbreak of Covid-19, Chinese firms were struggling mightily to make money.  But since the very sharp dip in March, the rebound there, at least in this statistic, has been substantial.  While it is certainly possible that organic growth is the reason for this sharp rebound, it seems far more likely that PBOC support has been a key factor.  Remember, while they don’t get as much press as the Fed or ECB, they are extremely involved in the economy as well as financial markets.  After all, there is no semblance of independence from the government.

According to those in the know
The ECB’s starting to show
Some signs of dissension
Amid apprehension
The rate of inflation’s too low

In one camp the PIGS all believe
More money they ought to receive
But further up north
The hawks have put forth
The view PEPP should end New Year’s Eve

Meanwhile, the other story that is building is the growing split in the ECB between the hawks and doves regarding how to react to the evolving situation.  The breakdown is exactly as expected, with Italian, Spanish and Portuguese members calling for more support, via an expansion of the PEPP by December, latest, in order to assure those economies still suffering the aftereffects of the Covid shutdowns, that the ECB will prevent borrowing costs from rising.  Meanwhile, the hawkish set, led by Yves Mersch, the Luxembourgish ECB governor, sees the glass half full and has explained there is no need for further action as the economy looks much better.  Naturally, German, Dutch and Austrian members are on board with the latter view.  Madame Lagarde, the consensus builder, certainly has her work cut out to get policy agreement by the next meeting at the end of October.

Adding to the difficulty for the ECB is the apparent strength of the second wave of the virus that is truly sweeping the Continent.  While France has been the worst hit, with more than 11,000 new cases reported yesterday, the Netherlands, Belgium, Italy and Germany are all seeing caseloads as high, or higher, than the initial wave back in March.  European governments are reluctant to force another shutdown as the economic consequences are too severe, but they feel the need to do something that will demonstrate they are in control of the situation.  Look for more rules, but no mandatory shutdowns.

And remarkably, those are the only economically focused stories of the session.  The ongoing US presidential campaigns, especially now that the first debate is nearly upon us, has captured the bulk of the US press’s attention, although the angst over the Supreme Court nomination of Judge Amy Coney Barrett has probably been the cause of more spilled digital ink in the past several days.

So, a turn toward markets shows that Asian markets generally performed well (Nikkei +1.3%, Hang Seng +1.0%) although interestingly, despite the Chinese profits data, Shanghai actually fell -0.1%.  Europe, on the other hand, is uniformly green, led by the DAX (+2.7%) and CAC (+2.0%), with the FTSE 100 higher by a mere 1.5%.  US futures have taken their cues from all this and are currently pointing to openings nearly 1.5% higher than Friday’s closing levels.

Bond markets continue to offer little in the way of price signals as central bank activity continues to be the dominant force.  I find it laughable that Fed members are explaining they don’t want to increase QE because they don’t want to have an impact on the bond market.  Really?  Between the Fed and the ECB, the one thing in which both have been successful is preventing virtually any movement, up or down, in yields.  This morning sees the risk-on characteristic of a rise in Treasury and Bund yields, but by just 1.5bps each, and both remain well within their recent trading ranges.  Yield curve control is here in all but name.

As to the dollar, it is softer vs. its G10 counterparts with the pound (+1.25%) rising sharply in the past few minutes as the tone leading up to the restart of Brexit negotiations tomorrow has suddenly become quite conciliatory on both sides.  But we have also seen solid gains in SEK (+0.7%), NOK (+0.6%) and AUD (+0.5%).  The Stocky story has to do with the fact that the Riksbank did not receive any bids for credit by the banking community, implying the situation in the economy is improving.  As to NOK and AUD, a reversal in oil and commodity prices has been seen as a positive in both these currencies.

In the emerging markets, the picture is a bit more mixed with ZAR (+0.3%) as the leading gainer, although given the relative movement in the G10 space, one would have expected something more exciting.  On the downside, TRY (-1.65%) and RUB (-0.85%) are outliers as the declaration of war between Armenia (Russian-backed) and Azerbaijan (Turkish-backed), has raised further concerns about both nations’ financial capabilities to wage a hot war at this time.

On the data front, while the week has started off slowly, we have a lot to absorb culminating in Friday’s NFP numbers.

Tuesday Case Shiller Home Prices 3.60%
Consumer Confidence 90.0
Wednesday ADP Employment 630K
Q2 GDP -31.7%
Chicago PMI 52.0
Thursday Initial Claims 850K
Continuing Claims 12.25M
Personal Income -2.5%
Personal Spending 0.8%
Core PCE 0.3% (1.4% Y/Y)
Construction Spending 0.7%
ISM Manufacturing 56.3
ISM Prices Paid 59.0
Friday Non Farm Payrolls 850K
Private Payrolls 850K
Manufacturing Payrolls 38K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Michigan Sentiment 78.9
Factory Orders 1.0%

Source: Bloomberg

On top of the data, we have thirteen Fed speeches by eight different Fed speakers, although the Chairman is mute this week.  It seems unlikely that we will get a mixed message from this group, but it is not impossible.  After all, we have both the most hawkish (Mester today) and the most dovish (Kashkari on Wednesday) due, so the chance for some disagreement there.  As to the data, it would appear that the payroll data will be most important, but do not ignore the PCE data.  Remember, both PPI and CPI have been surprising on the high side the past two months, so a surprise here might get some tongues wagging, although I wouldn’t expect a policy change, that’s for sure.

Net, with a positive risk backdrop, it is no surprise to see the dollar under pressure.  However, I expect that we are more likely to see a modest reversal than a large extension of the move unless stocks can go up sharply from their already elevated levels.

Good luck and stay safe
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