Tag Archives: #dollarweakness

Their Siren Song

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The trend ‘gainst the dollar is strong
With bears playing their siren song
As long as real rates
Are in dire straits
‘Twould be a mistake to go long

While there is usually some interesting tidbit on which to focus regarding market behavior that is not specifically FX related, this morning that does not seem to be the case. In fact, today’s most noteworthy story is that the dollar continues to drive lower vs. almost all its counterparts. As there was no specific news or data that appears to be driving other currencies higher, I can only attribute this broad resumption of the dollar downtrend to the fact that real interest rates in the US have turned back lower.

Looking back a few weeks, 10-year US real interest rates (nominal – CPI) bottomed at -1.08% on August 6th. That coincided with the peak price in gold, as well as the euro’s local high. But then Treasury yields began to back up as the bond market started getting indigestion from the Treasury issuance schedule ($316 billion total since then, of which $112 billion were Notes and Bonds.) The problem is that not merely is the size of the issuance unprecedented, but that it shows no signs of slowing down as the government continues to run massive deficits.

At any rate, real yields backed up by 14 basis points in the ensuing week, which resulted in both a sharp correction in the price of gold, and support for the dollar. But it seems that phase of the market may be behind us as Treasury yields have been sliding on both a nominal and real basis, and we have seen gold (and silver) recoup those losses while the dollar has ceded its gains and then some.

At this point, the question becomes, what is driving real yields? Is it fears of rising inflation? Is it hope that the Fed will maintain ultra-easy monetary policy even if the economy recovers strongly? Or is it something else?

Regarding the pace of inflation, while last week’s CPI data was certainly a shock to most eyes, it doesn’t seem as though it is the driver. I only point this out because the nadir in real yields occurred a week before the CPI data was released. Now it is certainly possible that bond investors were anticipating a higher inflation print, but there was absolutely no indication it would be as high as it turned out to be. In fact, based on the CPI release, I would have anticipated real yields to fall further, as the combination of higher inflation and a Fed that is essentially ignoring inflation at the current time is a recipe for further declines there. Remember, everything we have heard from the Fed is that not merely are they unconcerned with inflation, but that they welcome it and are comfortable allowing it to run hotter than their target for a time going forward.

This latter commentary implies that there is not going to be any change in the Fed’s policy stance in the near future either. Rather, Chairman Powell has made it clear that the Fed is going to provide ongoing support and liquidity to the markets economy for as long as they deem it necessary. Oh, and by the way, they have plenty of tools left with which to do so.

If these are not viable explanations for the change in trend, one other possible driver is the vagaries of the ongoing pandemic. Perhaps there is a relationship between increases in infection rates and investor assessments of the future. Logically, that would not be far-fetched, and there is growing evidence that there is a correlation between market behavior and covid news. Specifically, when it appears that covid is in retreat, bond yields tend to rise, and so real rates have been moving in lockstep. As well, when the news indicates that the virus is resurgent, the yield complex tends to head lower. Thus, in a convoluted way, perhaps the dollar bearishness that has become so pervasive is being driven by the idea that the US continues to suffer the most from Covid-19, and as long as that remains the case, this trend will remain intact.

Now, I would not want to base all my trading and hedging decisions on this idea, but it is certainly worth keeping in mind when looking at short-term risk exposures and potential timing to manage them.

But as I said at the top, overall, there is very little of note in the financial press and not surprisingly, market activity has been fairly muted. For example, equity markets in Asia basically finished either side of unchanged on the day (Nikkei -0.2%, Hang Seng +0.1%, Shanghai +0.3%). Europe, which had been largely unchanged all morning has been on a late run and is now nicely higher (DAX +0.9%, CAC +0.6%) and US futures have also edged up from earlier unchanged levels. As discussed, Treasury yields continue to drift lower (-1.5 basis points) and gold is rocking (+1.0% and back over $2000/oz.)

And the dollar? Well, it is definitely on its back foot this morning, with the entire G10 complex firmer led by GBP (+0.5%) on the strength of optimism over the resumption of Brexit talks and JPY (+0.45%) which seems to be benefitting from the ongoing premium for owning JGB’s and swapping back to USD.

In the EMG bloc, RUB (+0.8%) is the leader today, followed by ZAR (+0.7%) and MXN (+0.65%). All of these are benefitting from firmer commodity prices which, naturally are helped by the dollar’s broad weakness. But other than TRY (-0.2%) which has fallen in nine of the past ten sessions as President Erdogan and the central bank undermine the lira, and IDR (-0.3%), which has also seen a string of suffering, but this based on difficulty dealing with Covid effectively, the rest of the bloc is modestly firmer vs. the greenback.

On the data front, this morning brings Housing Starts (exp 1245K) and Building Permits (1326K), which if wildly different than expectations could have a market impact, although are likely to be ignored by traders. Rather, the trend in the dollar remains lower, with the euro actually setting new highs for the move this morning, and until we see a change in the rate structure, either by US real rates rising, or other real rates falling more aggressively, I expect this trend will continue. Hedgers, choose your spots, but don’t miss out.

Good luck and stay safe
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Prices Bespeak

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It seems that the rate of inflation
Is rising across our great nation
Demand remains weak
But prices bespeak
The need for some new Fed mentation

Does inflation still matter to markets? That is the question at hand given yesterday’s much higher than expected, although still quite low, US CPI readings and various market responses to the data. To recap, CPI rose 0.6% in July taking the annual change to 1.0%. The core rate, ex food & energy, also rose 0.6% in July, which led to an annual gain of 1.6%. For good order’s sake, it is important to understand that those monthly gains were the largest in quite a while. For the headline number, the last 0.6% print was in June 2009. For the core number, the last 0.6% print was in January 1991!

The rationale for inflation’s importance is twofold. First, and foremost, the Fed (and in fact, every central bank) is charged with maintaining stable prices as a key part of their mandate. As such, monetary policy is directly responsive to inflation readings and designed to achieve those targets. Second, economic theory tells us that the value of all assets over time is directly impacted by the change in the price level. This concept is based on the idea that investors and asset holders want to maintain the real value of their savings (and wealth) over time so that when they need to draw on those savings, they can maintain their desired level of consumption in the future.

Of course, the Fed has made a big deal about the fact that inflation remains far too low and one of the stated reasons for ZIRP and QE is to help push the inflation rate back up to their 2.0% target. Remember, too, that target is symmetric, which means that they expect inflation to print higher than their target as well as lower, and word is, come the September meeting, they are going to formalize the idea of achieving an average of 2.0% inflation over time. The implication here is that they are going to be willing to let the inflation rate run above 2.0% in order to make up for the last decade when their preferred measure, core PCE, only touched 2.0% in 11 of the 103 months since they established the target.

Looking at the theory, what we all learned in Economics 101 was that higher inflation led to higher nominal interest rates, higher gold prices and a weaker currency. The equity question was far less clear as there are studies showing equities are a good place to be and others showing just the opposite. A quick look at the market response to yesterday’s CPI data shows that yields behaved as expected, with 10-year Treasuries seeing yields climb 3.5 basis points. Gold, on the other hand, had a more mixed performance, rallying 1.0% in the first hours after the release, but ultimately falling 1.0% on the day. And finally, the dollar also behaved as theory would dictate, falling modestly in the wake of the release, probably about 0.25% on average.

So yesterday, the theory held up quite well, with markets moving in the “proper” direction after the news came out. But a quick look at the longer-term relationship between inflation and markets tells a bit of a different story. The correlation between US CPI and EURUSD has been 0.01% over the past ten years. In the same timeframe, gold’s correlation to CPI has actually been slightly negative, -0.05%, while Treasury yields have shown the only consistent relationship with the proper sign, but still just +0.2%.

What this data highlights are not so much that inflation impacts market prices, but that we should only care about inflation, from a market perspective at least, because the Fed (and other central banks) have made it part of their mantra. Thus, the answer to the question, does inflation still matter is that only insofar as the Fed continues to care about it. And what we have gleaned from the Fed over the past five months, since the onset of the covid pandemic, is that inflation is way down their list of priorities right now. In other words, look for higher inflation readings going forward with virtually no signal from the Fed that they will respond. At least, not until it gets much higher. If you were wondering how we could get back to the 1970’s situation of stagflation, we are clearly setting the table for just such an outcome.

But on to markets today. Risk is under a bit of pressure this morning as equity markets in Asia and Europe were broadly lower, the only exception being the Nikkei (+1.8%) which saw a large tech sector rally drive the entire index higher. Europe, on the other hand, is a sea of red although only the FTSE 100 in London is down appreciably, -1.1%. And at this hour, US futures are essentially flat.

Bond markets are less conclusive today. Treasury yields are lower by 1 basis point at this hour, although that is well off the earlier session price highs, but European government bond markets are actually falling today, with yields edging higher, despite the soft equity market performance. As to gold, it is currently higher by 1.0%, which simply takes it back to the level seen at the time of yesterday’s CPI release.

Turning to the dollar, it is definitely softer as in the G10, only NZD (-0.3%), which seems to be responding to the sudden recurrence of Covid-19 cases in the country, is weaker than the greenback. But NOK (+0.6%) with oil continuing to edge higher, leads the pack, followed closely by the euro and pound, both of which are firmer by 0.5% this morning. Perhaps French Unemployment data, which showed an unemployment rate of just 7.1% instead of the 8.3% forecast, is driving the bullishness. But arguably, we are simply watching the continuation of the dollar’s recent trend lower.

In the emerging markets, the CE4 are all solidly higher as they track the euro’s movement with a bit more beta. But the rest of the space has seen almost no movement with those currency markets that are open showing movement on the order of +/- 10 basis points. In other words, there is no real story here to tell.

On the data front, we get the weekly Initial Claims (exp 1.1M) and Continuing Claims (15.8M) data at 8:30, but that is really all there is. We continue to hear from some Fed speakers, with today bringing Bostic and Brainard, but based on what we have heard from other FOMC members recently, there is nothing new we will learn. Essentially, the Fed continues to proselytize for more fiscal support and blame all the economy’s problems on Covid-19, holding themselves not merely harmless for the current situation, but patting themselves on the back for all they have done.

With this in mind, it is hard to get excited about too much activity today, and perhaps the best bet is the dollar will continue to drift lower for now. While the dollar weakening trend remains intact, it certainly has lost a lot of its momentum.

Good luck and stay safe
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Faded Away

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It started when Trump hinted that
The capital gains tax was at
A rate much too high
And cuts were close by
His words, thus, a rally begat

Then Germany joined in the fray
As data from their ZEW survey
Exploded much higher
Now stocks are on fire
While havens have faded away

It used to be that you could determine the nature of a nation’s government by their response time to major events. So, autocratic nations were able to respond extremely quickly to negative events because a single man (and it was always a man) made the decisions and those who didn’t follow orders found themselves removed from the situation. Conscientious objection was not a viable alternative. Meanwhile, democratically elected governments always took more time to react because the inherent nature of democratic debate was slow and messy, with everyone needing to make their case, and then a majority formed to move forward.

This broad view of government decision-making was generally true for as long as economies were based on the production of real goods and services. However, that economic model has been essentially retired and replaced by the new concept of financialization. This is the process by which private actors recognize there is more value to be obtained (and with less risk!) if they spend their time and effort re-engineering their balance sheet rather than investing in their underlying business.

The upshot of the financialization of economies is that government response times to crises have been shortened remarkably. (It is important to understand that in this context, central banks, despite their “independence”, are part of the government). So, now even democratically elected governments can respond with alacrity to ongoing crises. This begs the question of whether democratically elected governments have become more autocratic (lockdowns anyone?), or whether this is simply the natural evolution of the democratic process when combined with media tools like Facebook and Twitter, where responses can be formulated and disseminated in minutes.

At any rate, the key observation is that government officials everywhere have taken the combination of financialization and high-speed response quite seriously, and we now get policies floated and implemented in a fraction of the time it used to take. The main reason this can be done is because policies that address financial questions are much easier to implement than policies that address production bottlenecks. After all, it is a lot easier for the Fed to decide to buy Fallen Angels than it is for 535 people, many of whom hate each other, to agree on a package of policies that might help support small businesses and shop owners.

This has been a build-up to help understand the key theme today: risk is back!! Or perhaps, the proper statement is risk-on is back. Last evening, President Trump floated the idea that a capital gains tax cut was just the remedy to help the US economy get back on its feet. But the reality is that the only thing a capital gains tax cut will accomplish is to help boost the stock market further. After all, the S&P 500, after yesterday’s modest 0.3% rally, is still 1.0% below its all-time high. Such lagging performance cannot be tolerated apparently, hence the genesis of this idea. But it was enough to achieve its goal, a further boost in equity markets worldwide.

A quick look at markets overnight shows the Nikkei (+1.9%) and Hang Seng (+2.1%) followed the bullish sentiment, although surprisingly, Shanghai (-1.1%) could not hold onto early gains. Even with that decline, the Shanghai Composite is up more than 5% in the past two weeks, hardly a true laggard. Meanwhile, Europe has really taken the bit in its teeth and is flying this morning, getting a good start from the Asian movement and then responding extremely positively to the German ZEW survey results where the Expectations component printed at 71.5, its highest level since December 2003. So, despite the growth in Covid cases in Germany, the business community is looking forward to robust times in the near future. This was all equity traders and investors needed to see to get going and virtually every European bourse is higher by more than 2.2% this morning. Of course, it would not be a successful outcome if US markets didn’t rise as well, and futures this morning are all green, pointing to between 0.5% (NASDAQ) and 1.0% (DJIA) gains on the opening.

Naturally, the risk on environment has resulted in Treasury bond sales. After all, there is no need to own something as pedantic as a bond when not only are stocks available, but the tax rate on your gains is going to be reduced! And so, 10-year Treasury yields have risen 3bps this morning, and are back at 0.60%, 10bps higher than the new lows seen just one week ago today. And that price behavior is common amongst all European government bond markets, with German bund yields higher by 3.3bps and UK gilts nearly 4bps higher.

But the biggest victim of this move has clearly been gold, which has tumbled 2% this morning and is back below $2000/oz for the first time in a week. There is no question that precious metals markets have been getting a bit frothy, so this pullback is likely simple profit taking and not a change in any trend.

Finally, as we turn to the dollar, the risk-on attitude is playing out in its traditional fashion this morning, with the buck falling against 9 of its G10 counterparts with only the yen weaker versus the dollar. NOK (+0.8%) is the big gainer, rallying on the back of the ongoing rally in oil prices (WTI +2.5%), but we are seeing solid gains of roughly 0.4% across most of the rest of the bloc. The one laggard, aside form JPY (-0.14%), is the pound where the UK released employment data today that simply demonstrated how difficult things are there. This seems to have held the pound back as it is only higher by 0.2% this morning.

In the EMG space, RUB and ZAR (both +0.8%) are the leaders with the former clearly an oil beneficiary, while the latter, despite gold’s decline, has been the beneficiary of the hunt for yield as South Africa continues to have amongst the highest real yields in the world. But pretty much the whole bloc is in the green today as the simple concept of risk-on is the driver.

On the data front, the NFIB Small Business Index disappointed at 98.8, a clear indication that a capital gains tax cut does not seem to be the best solution for the economy. At 8:30 we get PPI (exp -0.7% Y/Y, +0.1% Y/Y core) but not only is this data backwards looking, the Fed has basically told us they don’t care about inflation at all anymore. We also hear from two Fed speakers, Barkin and Daly, but again, there is very little new that is likely to come from their comments.

Today is a risk-on day and after a brief consolidation, the dollar feels like it has further room to decline. Versus the euro, I imagine a test of 1.20 is coming soon, but it is not clear to me how much further we can go from there. As such, for receivables hedgers, adding a little to the mix at current levels is likely to be a good strategy.

Good luck and stay safe
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Quite Sordid

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For Italy, France and for Spain
The data released showed their pain
Each nation recorded
A number quite sordid
And each, Covid, still can’t contain

As awful as the US GDP data was yesterday, with an annualized decline of 32.9%, this morning saw even worse data from Europe.  In fact, each of the four largest Eurozone nations recorded larger declines in growth than did the US in Q2.  After all, Germany’s 10.1% decline was a Q/Q number.  If we annualize that, it comes to around 41%.  Today we saw Italy (-12.4% Q/Q, -50% annualized), France (-13.8% Q/Q or -55% annualized) and Spain, the worst of the lot (-18.5% Q/Q or -75% annualized).  It is, of course, no surprise that the Eurozone, as a whole, saw a Q/Q decline of 12.1% which annualizes to something like 49%.  At those levels, precision is not critical, the big figure tells you everything you need to know.  And what we know is that the depths of recession in Europe were greater than anywhere else in Q2.

The thing is, none of this really matters any more.  The only thing the Q2 GDP data did was establish the base from which future growth will occur.  We saw this in the US yesterday, where equity markets rallied, and we are seeing and hearing it today throughout Europe as the narrative is quite clear; Q2 was the nadir and things should get better going forward.  In fact, that is the entire thesis behind the V-shaped recovery.  Certainly, one would be hard pressed to imagine a situation where Q3 GDP could shrink relative to Q2, but unfortunately the rebound story is running into some trouble these days.

The trouble is making itself known in various ways.  For example, the fact that the Initial Claims data in the US has stopped declining is a strong indication that growth is plateauing.  This is confirmed by the resurgence of Covid cases being recorded throughout the South and West and the reimposition of lockdown measures and closures of bars and restaurants in California, Texas and Arizona.  And, alas, we are seeing the same situation throughout Europe (and in truth, the rest of the world) as nations that had been lionized for their ability to act quickly and prevent the spread of the virus through draconian measures, find that Covid is quite resilient and infections are surging in Spain, Italy, Germany, the UK, Japan, Singapore, South Korea and even in China.  You remember China, the origin of the virus, and the nation that explained they had eradicated it completely just last month.  Maybe eradicated was too strong a word.

So, the real question is, what happens to markets if the future trajectory of growth is much shallower than a V?  It is not difficult to argue that equity markets, especially in the US, are priced for the retracement of all the lost growth.  That seems to be at odds with the situation on the ground where thousands of small businesses have closed their doors forever.  And not just small businesses.  The list of bankruptcy filings by large, well-known companies is staggeringly long.

Can continued monetary and fiscal support from government institutions really replace true economic activity?  Of course, the answer to that question is no.  Money from nothing and excessive debt issuance will never substitute for the creation of real goods and services that are demanded by the population.  So, while equity markets trade under the assumption that government support is a stop-gap filler until activity returns to normal, the recent, high-frequency data is implying that the gap could be much longer than initially anticipated.

And as has been highlighted in many venues, the bond market is telling a different story.  Treasury yields out to 10 years are now trading at record lows.  The amount of negative yielding debt worldwide is climbing again, now back to $16 trillion, and heading for the record levels seen at the end of last August.  This price behavior is the very antithesis of expected strong growth in the future.  Rather it signals concerns that growth will be absent for years to come, and with it inflationary pressures.  At some point, these two asset classes will both agree on a story, and one of them will require a major repricing.  My money is on the stock market to change its tune.

But that is a longer term discussion.  For now, let us review the overnight session.  It is hard to characterize it as either risk-on or risk-off, as we continue to see mixed signals from different markets.  In Asia, the Nikkei was the worst performer, falling 2.8% as concerns grow that a second wave of Covid infections is going to stop the signs of recovery.  Confirming those fears, a meeting of government and central bank officials took place where they discussed what to do in just such a situation, which of course means there will be more stimulus, both monetary and fiscal, on its way soon.  The yen behaved as its haven status would dictate, rallying further and touching a new low for the move at 104.19 before backtracking and sitting unchanged on the day as I type.  The thing about the yen is that 105 had proven to be a strong support level and is now likely going to behave as resistance.  While I don’t see a collapse, USDJPY has further to fall.

The rest of Asia saw weakness (Hang Seng -0.5%, Sydney -2.0%) and strength (Shanghai +0.7%) with the latter responding to modestly better than expected PMI data, while the former two are feeling the impact of the rise in infections.  Europe, on the other hand, is green across the board, with Italy’s FTSE MIB (+1.25%) leading the way, although the DAX (+0.7%) is performing well.  Here, just like in the US, investors seem to believe in the V-shaped recovery and now that the worst has been seen, those investors are prepared to jump in with both feet.

As discussed above, bond markets continue to rally, and yields continue to fall.  That is true throughout Europe as well as in the US.  In fact, it is true in Asia as well, with China the lone exception, seeing its 10-year yield rise 4bps overnight.

And finally, the dollar can only be described as mixed.  In the G10, NZD (-0.5%) and AUD (-0.2%) are the worst performers as both suffer from concerns over growing numbers of new Covid cases, while SEK and GBP (+0.25% each) lead the way higher.  It is ironic as there is concern over the growing number of cases in those nations as well, and, in fact, the UK is locking down over 4 million people in the north because of a rise in infections.  But the pound has been on fire lately, and that momentum shows no signs of abating for now.  One would almost think that a Brexit deal has been agreed, but the latest news has been decidedly negative there.  This is simply a reminder that FX is a perverse market.

Emerging markets have also seen mixed activity, although it is even more confusing.  Even though commodities are having a pretty good day, with both oil and gold prices higher, the commodity currencies are the worst performers today, with ZAR (-1.35%), RUB (-1.0%) and MXN (-0.9%) all deeply in the red.  On the positive side, THB (+0.85%) and CNY (+0.5%) are showing solid strength.  The renminbi, we already know, is benefitting from the better than expected PMI data while the baht benefitted from ongoing equity inflows.

This morning we see another large grouping of data as follows: Personal Income (exp -0.6%), Personal Spending (5.2%), core PCE Deflator (1.0%), Chicago PMI (44.5) and Michigan Sentiment (72.9).  As inflation is no longer even a concern at the Fed, or any G10 central bank, the market is likely to look at two things, Spending data which could help cement the idea that things are rebounding nicely, or not, and Chicago PMI, as an indication of whether industrial activity is picking up again.

Overall, regardless of the data, the trend remains for the dollar to decline, at least against its G10 brethren and I see nothing that is going to change that trend for now.  At some point, it will make sense for receivables hedgers to take advantage, but it is probably still too early for that.

Good luck, good weekend and stay safe

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QE is Our Fate

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The Fed Chair, a banker named Jay
Will meet with his comrades today
Though no one expects
A change, it’s what’s next
That has traders set to make hay

Will guidance be tied to the rate
Of joblessness? Or will they state
Inflation is key
And ‘til there we see
Advances, QE is our fate

Today’s primary feature in the markets is the FOMC meeting where at 2:00 they will release their latest policy statement, and then at 2:30 Chairman Powell will hold a virtual press conference. As is often the case, market activity ahead of the meeting is muted as investors and traders are wary of taking on new positions ahead of a possible change in policy.

However, the punditry is nearly unanimous in its belief that there will be no policy changes today, and that the statement will be nearly identical to the previous version, with just some updates relating to the data that has been released since then. The big question is whether or not Chairman Powell will give an indication of what the next steps by the Fed are likely to be.

A quick review of the current policy shows that the Fed has a half dozen lending programs outstanding, which they extended to run through the end of 2020 in an announcement yesterday, and which are focused on corporate bonds, both IG and junk, municipal securities and small business loans. Of course, they continue to buy both Treasury and mortgage-backed securities as part of their more ordinary QE measures. And the Fed Funds rate remains at the zero bound. Consensus is that none of this will change.

The problem for the Fed is, short of simply writing everyone in the country a check (which is really fiscal policy) they are already buying all the debt securities that exist. While eventually, they may move on to purchasing equities, like the BOJ or SNB, at this point, that remains illegal. So, the thinking now goes that Forward Guidance is the most likely next step, essentially making a set of promises to the market about the future of policy and tying those promises to specific outcomes in the economic data. Given their mandate of full employment and stable prices, it is pretty clear they will tie rate movements to either the Unemployment Rate or the inflation rate. You may recall in the wake of the GFC, then Chairman Bernanke did just this, tying the eventual removal of policy accommodation to the Unemployment Rate. Alas, this did not work as well as the Fed had hoped. The first problem was that as the unemployment rate declined, it did not lead to the expected rise in inflation, so the Fed kept having to move its target lower. This did not inspire credibility in the central bank’s handling of the situation, nor its models. But the bigger problem is that the market became addicted to ZIRP and QE, and when Bernanke mentioned, off hand, in Congressional testimony, that some day the Fed would start to remove accommodation, he inspired what is now called the ‘Taper Tantrum’ where 10-year Treasury yields rose 1.3% in just over three months

You can be certain that Powell does not want to set up this type of situation, but, if anything, I would argue the market is more addicted to QE now than it was back then. At any rate, given the Fed’s need to show they are doing something, you can be sure that tied forward guidance is in our future. The question is, to what statistic will they tie policy? It is here where the pundits differ. There is a range of guesses as follows: policy will be unchanged until, 1) inflation is steadily trending to our 2.0% target, 2) inflation reaches out 2.0% target, or 3) inflation spends time above our 2% target in an effort to ‘catch up’ for previous low readings. This in order of most hawkish to least. Of course, they could focus on the Unemployment rate, and choose a level at which they believe full employment will be reached and thus start to pressure inflation higher.

The problem with the inflation target is that they have been trying to achieve their 2.0% target, based on core PCE, and have failed to do so consistently for the past 10 years. It is not clear why a claim they are going to continue to maintain easy money until they reach it now, let alone surpass that target, would have any credibility. On the Unemployment front, given what are certainly dramatic changes in the nature of the US economy in the wake of Covid-19, it beggars belief that there is any confidence in what the appropriate level of full employment is today. Again, it is hard to believe that their models have any semblance of accuracy in this area either.

And one other thing, most pundits don’t anticipate the announcement of new forward guidance until the September meeting, so this is all anticipation of something unlikely to occur for a while yet. But, as a pundit myself, we do need to have something to discuss on a day when markets remain uninteresting.

So, let’s take a quick look at today’s market activities. Equity markets remain mixed with both gainers (Shanghai +2.1%) and losers (Nikkei -1.2%) in Asia and in Europe (CAC +0.7%, DAX 0.0%, Italy -0.8%). US futures are edging higher, but not with any enthusiasm. Bond markets are all within a basis point of yesterday’s closing levels, although Treasuries did rally in the mild risk-off session we saw Tuesday with 10-year yields back below 0.60%. Yesterday, gold had a wild day, making new highs early in the overnight session and falling back 4% in NY before rebounding to close at $1960/oz. This morning it is little changed, but the trend remains higher.

Finally, the dollar is softer this morning, although yesterday saw a mixed session. The pound (+0.25%) has been a steady performer lately and is pressing toward 1.30 for the first time since early March, pre-Covid. While there was UK data on lending and money supply, this movement appears to be more technical in nature, with the added benefit that the dollar remains under pressure against all currencies. Elsewhere in the G10, oil’s strength this morning is helping NOK (+0.5%), while the rest of the bloc is just marginally firmer vs. the dollar.

In the emerging markets, the big winner today was THB (+0.8%) where the central bank is trying to make a change in the local gold market. Interestingly, gold traded in baht is a huge market, and one where the recent flows have resulted in excess baht strength. As such, the central bank is trying to change the market into a USD based gold market, which should remove upward pressure from the currency. But away from that, while the bulk of the bloc is firmer, the movement is 0.3% or less, hardly the stuff of dreams, and with no coherent message other than the dollar is soft.

And that’s really it for the day. There is no data of note to be released and so all eyes are on the FOMC. My money is on inflation based forward guidance, likely the most dovish type shooting for above target outcomes, but not to be put in place until September. And that means, the dollar’s recent downtrend is likely to continue to be the situation for the immediate future.

Good luck and stay safe
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Hardly a Sign

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The thing that I don’t understand
Is why people think it’s not planned
The dollar’s decline
Is hardly a sign
The FOMC’s lost command

Based on the breathless commentary over the weekend and this morning, one would have thought that the dollar is in freefall.  It’s not!  Yes, the dollar has been sliding for the past two months, but that is a blink of an eye compared to the fact that it has been trending higher since its nadir a bit more than twelve years ago.  In fact, if one uses the euro as a proxy, which many people do, at its current level, 1.1725 as I type, the single currency remains below the average rate over its entire life since January 1999.  The point is, the current situation is hardly unprecedented nor even significant historically, it is simply a time when the dollar is weakening.

It is, however, instructive to consider what is happening that has the punditry in such a tizzy.  Arguably, the key reason the dollar has been declining lately is because real US interest rates have been falling more rapidly than real rates elsewhere.  After all, the Eurozone has had negative nominal rates since 2014.  10-year German bunds went negative in May 2019 and have remained there ever since.  Given that inflation has been positive, albeit weak, there real rates have been negative for years so the world is quite familiar with negative rates in Europe.  The US story, however, is quite different.  While nominal rates have not yet crossed the rubicon, real rates have moved from positive to negative quite recently and done so rapidly.  So, what we are really witnessing is the FX market responding to this relative change in rates, at least for the most part.  Undoubtedly, there are dollar sellers who are bearish because of their concerns over the macro growth story in the US, the second wave of Covid infections in the South and West and because of the growth in US debt issuance.  But history has shown that the most enduring impacts on a currency’s value are driven by relative interest rates and their movement.  And that is what we are seeing, US rates are falling relative to others and so the dollar is falling alongside them.

In other words, the current price action is quite normal in the broad scheme of things, and not worthy of the delirium it seems to be inspiring.  As I mentioned Friday, this is also what is driving the precious metals complex, which has seen further strength this morning (XAU +$40 or 2.1%, XAG +$1.50 or 6.7%).  And it must be noted that gold is now at a new, all-time nominal high of $1943/oz.  But since we are focusing on the concept of real valuation, while the price is higher than we saw in 2011 on a nominal basis, when adjusted for inflation it still lags pretty substantially, by about 18%, and both current and 2011 levels are significantly below gold’s inflation adjusted price seen in 1980 right after the second oil crisis.

However, the fact that the current reporting of the situation appears somewhat overhyped does not mean that the dollar cannot fall further.  And in fact, I expect that to be the case for as long as the Fed continues to add liquidity, in any form, to the economy.  Markets move at the margin, and the current marginal change is the decline in US real interest rates, hence the dollar is likely to continue to fall if US rates do as well.

The current dollar weakness begs the question about overall risk attitude.  So, a quick look around equity markets globally today shows a mixed picture at best, certainly not a strong view in either direction.  For instance, last night saw the Nikkei edge lower by 0.2% (after having been closed since Wednesday) and the Hang Seng (-0.4%) also slide.  But Shanghai (+0.25%) managed to eke out small gains.  In Europe, the DAX (+0.3%) is pushing ahead after the IFO figures bounced back much further than expected, although the CAC and FTSE 100 (-0.2% each) have both suffered slightly.  A special mention needs to be made for Spain’s IBEX (-1.3%) as the sharp increase in Covid infections seen in Catalonia has resulted in several European nations, notably the UK and Sweden, reimposing a 14-day quarantine period on people returning from Spain on holiday.  Naturally, the result is holidays that had been booked are being quickly canceled.  As to US futures, they are currently in the green, with the NASDAQ up 1.0%, although the others are far less enthusiastic.

Bond markets continue to show declining yields, with Treasuries down another basis point plus and now yielding 0.57%.  Bunds, too, are seeing demand, with yields there down 3 bps, although both Spanish and Italian debt are being sold off with yields edging higher.  In other words, the bond market is not pointing to a risk-on session.

Finally, the dollar is weak across the board, against both G10 and EMG currencies.  In the latter bloc, ZAR is the leader, up 1.3% on the back of the huge rally in precious metals, but we are also seeing the CE4 currencies all keeping pace with the euro, which is higher by 0.6% this morning.  As a group, those four currencies are higher by about 0.65%.  Asian currencies also performed well, but not quite to the standards of the European set, but it is hard to find a currency that declined overnight.  In G10 space, the SEK is the leader, rising 1.0%, cementing its role as the highest beta G10 currency.  But we cannot forget about the yen, which has rallied 0.75% so far this morning, and is now back to its lowest level since the Covid spike, and before that, prices not seen since last August.  A longer-term look at the yen shows that 105 has generally been very strong support with only the extraordinary events of this past March driving it below that level for the first time in four years.  Keep on the lookout for a move toward those Covid inspired lows of 102, although much further seems hard to believe at this point.

On the data front, this week’s highlight is undoubtedly the FOMC meeting on Wednesday, but there is plenty to see.

Today Durable Goods 7.0%
  -ex Transport 3.6%
Tuesday Case Shiller Home Prices 4.10%
  Consumer Confidence 94.4
Wednesday FOMC Rate Decision 0.0% – 0.25%
Thursday GDP Q2 -35.0%
  Personal Consumption -34.5%
  Initial Claims 1.445M
  Continuing Claims 16.3M
Friday Personal Income -0.5%
  Personal Spending 5.4%
  Core PCE 0.2% (1.0% Y/Y)
  Chicago PMI 43.9
  Michigan Sentiment 72.8

Source: Bloomberg

Of course, the GDP data on Thursday will be eye opening, as a print anywhere near forecasts will be the largest quarterly decline in history.  However, that is backward looking.  Of more importance, after the Fed of course, will be the Initial Claims data, which last week stopped trending lower.  Another tick higher there and the V-shaped recovery narrative is likely to be mortally wounded.  As to the Fed, while we will discuss it at length later this week, it seems unlikely they will do or say anything that is going to change the current market sentiment.  And that sentiment continues to be to sell dollars.

Good luck and stay safe

Adf

 

 

 

About to Retrace

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The question investors must face
Is what type of risk to embrace
Are we in a movie
Where things turn out groovy?
Or are stocks about to retrace?

The risk narrative is having a harder time these days as previous rules of engagement seem to have changed. For instance, historically, when risk was ‘off’, stock prices fell, government bond markets rallied, although credit spreads would widen, the dollar and the yen, and to an extent the Swiss franc, would all out perform the rest of the currency world and gold would outperform the rest of the commodity complex. Risk on would see the opposite movement in all these markets. Trading any product successfully mostly required one to understand the narrative and then respond mechanically. Those were the days!

Lately, the risk narrative has been in flux, as a combination of massive central bank interference across most markets and evolving views on the nature of the global geopolitical framework have called into question many of the previous market assumptions.

The adjustments have been greatest within the bond markets as global debt issuance has exploded higher ever since the GFC in 2009, taking an even sharper turn up in the wake of Covid-19. Of course, central banks have been so heavily involved in the market via QE purchases that it is no longer clear what the bond market is describing. Classical economics explained that countries that issued excessive debt ultimately saw their interest rates rise and their currencies devalue amidst an inflationary spike. However, it seems that theory must be discarded because the empirical evidence has shown that massive government debt issuance has resulted in low inflation and relative currency stability for most nations.

The MMT crowd will explain this is the natural response and should be expected because government spending is an unalloyed good that can be expanded indefinitely with nary a consequence. Meanwhile, the Austrians are hyperventilating over the idea that the ongoing expansion of both government spending and debt issuance will result in a debt deflation and anemic growth for as long as that debt remains a weight on the economy.

These days, the distortion in the bond markets has rendered them unrecognizable to investors with any longevity. Central banks are actively buying not only their own government debt, but corporate debt (IG and junk) and municipal debt. Thus, credit spreads have been compressed to record low levels despite the fact that the current economic situation is one of a cataclysmic collapse in activity. Bankruptcies are growing, but debt continues to be sought by investors worldwide. At some point, this final dichotomy will reconcile itself, but for now, central banks rule the roost.

Equity markets have taken a slightly different tack; when things are positive, buy the FANGMAT group of stocks before anything else, although other purchases are allowed. But when it is time to be concerned because the economic story is in question, simply buy FANGMAT and don’t touch any other stocks. If you remove those seven stocks from the indices, the result is that the S&P and NASDAQ have done virtually nothing since the crash in March, and US markets have actually underperformed their European brethren. Of course, those stocks are in the indices, so cannot be ignored, but the question that must be asked is, based on their current valuation of >$6.8 trillion, are they really worth more than the GDP of Germany and the UK combined? While yesterday saw a modest sell-off in the US, which has continued overnight (Hang Seng -2.2%, Shanghai -3.9%, DAX -1.5%, CAC -1.3%) the fact remains stock markets continue to price in a V-shaped recovery and nothing less. And since stock markets tend to drive the overall narrative, if that story changes, beware the movement elsewhere.

It should be noted that yesterday’s Initial Claims data, printing at 1.41M, the first rise in the data point since March, bodes ill for the idea that growth is going to quickly return to pre-Covid levels. And given the uncertainty over how long that recovery will take, stocks may soon be telling us a different story. Just stay alert.

While idioms tell us what’s bold
Is brass, we must all now behold
The barbarous relic
Whose rise seems angelic
Of course, I’m referring to gold!

Turning to precious metals as risk indicators, price action in both gold and silver indicates a great deal of underlying concern in the current market framework. Gold, as you cannot have missed, is fast approaching $1900/oz and its record high level of $1921 is in sight. Silver, while still well below its all-time highs of $49.80/oz, has rallied more than 24% in July, and is gaining more and more adherents. The key unknown is whether this is due to an impending fear of economic calamity, or simply the fact that real interest rates have turned negative throughout the G10 nations and so the cost of owning gold is de minimis.

For the conspiracy theorists, the concern is that ongoing central bank money printing is going to ultimately debase the value of all currencies, so while they may remain relatively stable in the FX markets, their value in purchasing real goods will greatly diminish. In other words, inflation, that the central banks so fervently desire, will reveal itself as a much greater threat than currently imagined by most. Here, too, the geopolitics comes into play, as there is growing concern that the current tit-for-tat squabbles between the US and China will escalate into a more dangerous situation, one where shots are fired in anger, at which times gold is seen as the ultimate safe haven. Personally, I do not believe the US-China situation deteriorates into a hot war as while both presidents need to show they are strong and tough against their rivals, thus the rhetoric and diplomatic squabbles, neither can afford a war.

And finally, to the FX market, where the dollar has clearly lost its luster as the ultimate safe haven, a title it held as recently as two month’s ago. While today’s movement is relatively benign across all currencies, what we have seen this month is a dollar declining against the entire G10 bloc and the bulk of the EMG bloc as well, with several currencies (CLP +7.0%, HUF +5.4%, SEK +5.2%) showing impressive gains. If we think back to the narrative heading into the July 4th holiday, it was focused on the upcoming payroll release and the recent FOMC meeting which had everyone buying into the risk-on narrative. That came from the fact that the payroll data was MUCH better than expected and the Fed made clear they were going to stand ready to continue to add liquidity to markets forever, if they deemed it necessary. Back then, the euro was trading just above 1.12, and its future path seemed uncertain to most. But now, here we are just three weeks later, and the euro has been rising steadily despite the fact that concerns continue to grow over the growth narrative.

Is the euro becoming the new haven currency of last resort? That seems a bit premature, although the EU’s recent agreement to issue mutual debt and inaugurate a more fulsome EU-wide fiscal policy will be an important part of that story in the future. But for now, it seems that there is an almost willful blindness on the part of the investor community as they pay lip service to worries about the recovery’s shape but continue to find succor in (previous) risk-on assets.

While the dollar today is mixed with limited movement in any currency, there is no doubt the FX narrative is evolving toward ‘the dollar has much further to fall between the political chaos and the still positive view of the economy’s future. But remember this, while the dollar has traded to its weakest point in about two years, it is far away from any level that could be considered weak. Current momentum is against the dollar, and if the euro were to trade to resistance between 1.17-1.18, it would not be surprising, but already the pace of its decline has been ebbing, so I do not expect a collapse of any sort, rather a further gradual decline seems the best bet for now.

Good luck, good weekend and stay safe
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Stocks Dare Not Wane

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Can someone, to me, please explain
The reason that stocks dare not wane?
If this is to be
Then how come we see
Both silver and gold, new heights gain?

It seems like the narrative is becoming more difficult to explain these days. On the one hand, risk appetite appears to be gaining as evidenced by the ongoing rally in equity markets, the continued rebound in oil prices and the dollar’s steady decline. The rationale continues to be one where hope springs eternal for the elusive Covid vaccine and that fiscal stimulus will continue to be pumped into the global economy until said vaccine arrives driving a V-shaped recovery. Meanwhile, paying for that fiscal stimulus will be global central banks, who are printing money as quickly as possible in order to mop up all the newly issued bonds. (I would wager that the ECB will purchase at least 50% of the new EU bonds when they are finally issued.)

The potential flaw in this theory is the price behavior of haven assets, notably gold, silver and Treasuries, all of which have continued to rally right alongside risk assets. Now, it is certainly possible that the continuous flood of new money into the global economy has simply resulted in all assets rising in price, including the haven assets, but it would be a mistake to ignore the signals those haven assets are flashing. For instance, 10-year Treasury yields have fallen back below 0.60% today for the first time since establishing their historic low at 0.569% in mid-April. Historically, the message of low 10-year yields has been slow growth ahead. It seems to me that doesn’t jive very well with the V-shaped recovery story that appears to be driving equity prices. Of course, the issue here could easily be that the Fed’s purchases are simply distorting the market thus removing any signaling power from 10-year yields, but they have assured us repeatedly that is not the case. Rather, their purchases are designed to insure the opposite, that the market functions normally.

Turning to precious metals, both gold and silver have been on a tear of late, with silver really turning it on in July, rising 21%, while gold has seen steady buying and is higher by 4.3% so far this month. Granted, this could simply be part of the dollar weakness effect, where a declining dollar lifts the value of all commodities. But you cannot rule out the idea that this price movement is a signal of growing concerns over the value of all fiat currencies as central banks around the world work overtime to provide liquidity to markets.

From the perspective of the narrative, it is important to accept that this time it’s different, and that these haven asset signals are merely noise in the new world order. And maybe they are. Maybe the fact that central banks around the world have added nearly $20 trillion of liquidity to global markets without corresponding economic growth is of no real concern and will not result in consequences like rising inflation or growth in inequality. Unfortunately, the one thing that we have learned during this crisis is that central banks have a single playbook regardless of the situation…print more money. Like a man with a hammer, to whom every problem looks like a nail, central bankers see a problem and respond in one way only… turn on the presses. I certainly hope the Fed et al, know what they are doing, but the evidence is that their models are no longer reflective of reality, and that is the big problem. Any model is only as good as its data, but good data doesn’t make a bad model good, in fact it is more likely to give misinformation instead.

So, let us now turn to the market’s activities this morning to see if there is anything new under the sun. While equity markets around the world are under pressure, the losses are relatively small and arguably just a reflex response to what has been a strong run for the past several sessions. Government bonds continue to rally ever so slowly in both the US and Europe, but the truly interesting things are happening in the FX world.

To start, the euro has well and truly broken out of its range, easily taking out resistance at 1.1495 during its 0.7% climb yesterday. This morning, it has added to those gains, up another 0.4% and trading at levels last seen in October 2018. Momentum is on its side and as I mentioned yesterday, I see no real resistance until at least 1.17, meaning another 1.0%-2.0% is quite within reason. At this stage, there doesn’t need to be a narrative, just the acceptance that the current trend is strong. But yesterday saw the entire G10 space rally, led by AUD (+1.6%) and NOK (+1.3%) with the former benefitting from a serious short squeeze while the latter had oil to thank for its gains. But even the yen (+0.45% yesterday) showed real strength, despite no concern about risk.

But the real story was in the EMG space, where virtually the entire bloc was firmer, although none so impressively as BRL, which rocketed 3.1% during the day. It seems that a combination of general positivity from the EU’s announced deal and the specifics of the introduction of the long-awaited new tax reform by the Bolsonaro administration were enough to get the juices flowing. Technically, it appears that barring any significant negative news, this could continue until USDBRL tests 5.00, or even the 4.85 lows seen in mid-June.

But the entire EMG bloc was on fire, with the CE4 far outperforming the euro (CZK +1.95%, HUF +1.90%, PLN +1.6%) but also strength elsewhere in LATAM (CLP +1.75%, COP +0.75%). In fact, APAC currencies were the laggards, although most of them did rise modestly. This morning’s price action has been a bit more muted, although we have seen IDR (+0.6%) halt what has been an impressive weakening trend. It seems that a local company is planning to move into Covid vaccine trials next month which has encouraged optimists to believe the second wave of infections there may be addressed soon.

Arguably, the one truly interesting thing today is the weakness in CNY (-0.2%) which seems to be a response to the story that the US has closed the Chinese consulate in Houston. The Chinese are now threatening to close the US consulate in Wuhan (who would want to work in that office anyway?) with the real concern that the ongoing cold war between the two nations shows no signs of abating. In fact, if you want a rationale for owning haven assets, this situation offers plenty of scope.

Turning to the data today, we get our first from the US in the form of Existing Home Sales (exp 4.75M) which would represent a 21% gain from last month. Of course, the level remains far below the pre-Covid situation where 5.5M was the norm for more than 5 years. The Fed remains in its quiet period as the market will eventually turn their attention to next Wednesday’s meeting, but for now, the market doesn’t need any further impetus. The story is the dollar is falling and risk is to be acquired. While the latter idea might be a little bit of a concern, the former, a weaker dollar, seems a fait accompli for now.

Good luck and stay safe
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A Blank Check

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While much of the nation’s a wreck
The good news is there’s still Big Tech
Whose prices ne’er fall
Thus, keeping in thrall
Investors who wrote a blank check

One cannot but be impressed with the performance of the tech sector in US equity markets.  It seems that no matter what else happens anywhere in the world, a small group of companies has unearthed the secret to infinite value, or at least a never-ending rally in their share prices. Yesterday’s price action was instructive in that a group of just seven companies, all tech titans, added nearly $300 billion in value, which was greater than the entire NASDAQ’s 2.5% gain. While we all are happy to see equity markets continue to rally, it certainly is beginning to appear as though some of these valuations are unsustainable, especially if the V-shaped recovery doesn’t materialize. One other thing to consider about the values of these companies is that if there is a change in the White House, it is almost certain to bring with it significantly higher corporate taxes (39.6% anyone?), which will almost certainly result in a repricing of the future stream of earnings available to shareholders. But for now, clearly nothing matters but the fact that these companies are market darlings and are set to continue to rally…until they stop.

In Europe, those twenty plus nations
(Ahead of their summer vacations)
Have finally agreed
To help those in need
With billions in brand new donations

However, arguably the biggest story in the markets today is that the EU finally did agree to a spending plan to help those nations most severely impacted by the Covid recession. It was inevitable that this would be the result as the political imperative was too great for four smaller nations to prevent its completion. To hear the frugal four, though, is quite amusing. They seem to believe that their “principled” stand, where they each get a larger rebate from the general pool of funds (each is a net payer into the EU budget), and their demands that this is a one-time solution to an extraordinary event means that in the future, debt mutualization will not expand. If there is one thing that we know about government programs, it is that they always expand, and they never die. There is no such thing as a one-time program. Debt mutualization is now the standard in the EU, and one should expect nothing less. Redistribution from the North to the South of the continent is now a permanent feature.

The market reaction to this news is mostly what one would have expected. European equity markets have rallied, with those in Italy (+2.2%) and Spain (+1.9%) leading the way higher, although the strength is broad-based. As well, European government bond markets are also performing appropriately, with the havens seeing a modest rise in yields while the risk bonds, like Italian and Greek debt, falling as investors have greater assurances that they will now be repaid. After all, with debt mutualization, Greek and German debt are basically the same!

Finally, looking at the FX markets, we find the euro slightly softer on the session, having briefly traded higher, but now falling victim to what appears to be a buy the rumor, sell the news type event. But the euro has been a stellar performer for the past two months, rising 4.5% in that period as the market narrative has turned back to some previously discredited themes. Notably, we continue to hear a great deal about the dollar’s twin deficit issue and how that will undermine the greenback. In addition, given the ongoing risk rally, the idea of needing a safe haven currency, has simply faded from existence. In fact, this morning there is now talk that the euro, with its new solidarity, is really a haven asset. PPP models continue to point to the euro being undervalued at current levels with forecasts creeping ever higher. In fact, one large bank is out calling for 1.30 in the euro by the end of next year.

Of course, there is a great irony in the discussion of a stronger euro, the fact it is the absolute last thing Madame Lagarde and her ECB compatriots want (or need). After all, one of the key reasons for them to cut interest rates below zero was to undermine the euro in order to both import inflation and help European exporters become more price competitive. You can be sure that if the euro does start to break higher, we will hear a great deal more about the inappropriate price action of a rising euro. For now, all eyes are on 1.1495, which was the spike high seen in March, and which is currently serving as a resistance point for the technicians. A break there is likely to see a test of the 1.17-1.18 level before the end of the summer.

As to the dollar overall, it continues its recent weakening trend, with only a handful of currencies modestly softer and some decent moves the other way. For instance, Aussie is the top pick in the G10 this morning, rising 0.85%, as a combination of risk appetite and a short squeeze is doing the job nicely. But we are also seeing strength in NOK (+0.6%) and CAD (+0.5%), both of which are benefitting from oil’s rally today (WTI +2.8%). In the EMG space, it should be no surprise that RUB and ZAR (both +0.8%) are the leaders as the oil and commodity price rallies are clear supports. In fact, the bulk of this bloc is firmer this morning with only a handful of currencies (RON, CNY, SGD) in the red, and there just by a few basis points. Overall, it is fair to say the dollar is on its back foot again today.

With no data due today, and none of note released overnight, the FX market seems set to take its cues from the equity space and the broad risk themes. And it is pretty clear that the broad risk theme today is…buy more risk!

Herbert Stein, a very well-respected economist in the 1960’s was quoted as saying, “that which cannot continue, will not continue.” His point was that while exuberance may manifest itself periodically, it always ends when reality intrudes. Right now, it feels like risk assets, especially that formidable group of tech names, is completely disconnected with the economic reality and best-case prospects. The implication is this cannot go on. But that doesn’t mean it won’t go further before it ends. The narrative is risk assets are the thing to own, and as long as that is the case, the dollar is likely to remain under pressure.

Good luck and stay safe
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Second Wave

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In Q2 we learned to behave
Like primitives stuck in a cave
In order to stem
The virus mayhem
And millions of lives, try to save

But Q3 has shown that we crave
More contact than lockdown, us, gave
Thus, it’s not surprising
Infections are rising
And now we’ve achieved second wave

If I were to describe market behavior of late, the word I would use is tentative. Investors and traders are caught between wanting to believe that the nonstop stimulus efforts on both fiscal, and especially, monetary fronts will be sufficient to help the economy through the current economic crisis (conveniently ignoring the extraordinary build up in debt), and concerns that there is too much permanent damage to too many businesses to allow for a swift recovery to a pre-Covid level of activity. Adding to the fear side of the equation is the resurgence in the number of infections worldwide, especially in places that had seemed to eradicate the virus. News from Hong Kong, Australia, China and India shows that the virus is making a resurgence, with several places recording more cases now than when things started five to six months ago. And of course, we have seen the same pattern in states that were first to reopen here at home.

Meanwhile, the medical community continues its extraordinary efforts to find a vaccine, with several promising candidates making their way through trials. Perhaps the best medical news is that it seems doctors on the front line have learned how to treat the disease more effectively, which has reduced the number of critical cases and helped drive down the fatality rate. Alas, an effective vaccine remains elusive. Ironically, the vaccine’s importance in many ways is symbolic. The idea that there is a way to avoid catching the bug is certainly appealing, but if the flu vaccine is any harbinger of the outcome, a minority of people will actually get vaccinated. So, the vaccine story is more about a chance for confidence to be restored than about people’s health. Perhaps this sums up the state of human affairs these days better than anything else.

And yet, while no politician anywhere will allow confirmation, it certainly appears that we are seeing a second wave of infections spread worldwide. From the market’s perspective, this has been a key concern for the past several months as a second wave of economy-wide shutdowns would end all hopes of that elusive V-shaped recovery. And the only way to justify the current levels of asset values is by assuming this crisis will pass quickly and things will return to a more normal framework. Hence the trader’s dilemma. Is the worst behind us? Or is a second wave going to expand and delay the recovery further? Perhaps the most telling feature of this market is the changed relationship between the S&P 500 and the VIX index. Prior to the Covid-19 outbreak, an equity rally of the type seen since late March would have seen the VIX index collapse toward 15, the level at which it traded for virtually all of 2019. But this time, 30 has become the new normal for the VIX, a strong indication that investors are paying for protection, despite the cost, as there remains an underlying fear of another sharp decline beyond the horizon. Hence, my description of things as tentative.

Looking at markets this morning, tentative is an excellent descriptor. In the equity space, Asian markets were mixed, with the Nikkei (-0.3%) on the weak side with the Hang Seng (+0.5%) was the strong side. But given the type of movement we have seen lately, neither really displayed anything new at the end of the week. European markets are also mixed with the DAX (+0.5%) the best performer while Spain’s IBEX (-0.5%) is the worst. Again, a mix of performances with no evident trend. US futures are currently pointing higher although only the NASDAQ (+1.0%) is showing any real strength.

Meanwhile, Treasury yields have slipped again, with the 10-year down to 0.60%, its lowest level since mid-April and just 4bps from its historic low. That is hardly a sign of economic confidence. In Europe, the picture is mixed but yields are essentially within 1bp of where they closed yesterday as traders are unwilling to take a view.

Finally, the dollar, too, is having a mixed session, although if I had to characterize it, I would say it is slightly softer overall. The euro is higher by 0.3% this morning as there is hope that the EU Summit, which began a few hours ago, will come to an agreement on their mooted €750 billion pandemic plan that includes joint borrowing. Of course, the frugal four still need to be bought off in some manner but given the political determination to be seen to be doing something, I would look for a watered-down version of the bill to be agreed. However, the best performer today is CHF (+0.5%) in what appears to be some profit taking on EURCHF positions after the cross’s strong rally this week.

In the emerging markets, IDR is the big underperformer today, falling 0.5% overnight as traders position for future rate cuts by the central bank. While they cut 25bps yesterday, they also came across as more dovish than expected implying they are not yet done with the rate hatchet. On the plus side, ZAR (+0.6%) is top of the charts as investors have been flocking to the front end of their yield curve after a much lower than expected inflation print. The view is that the SARB has further to cut which will drive front end yields down, hence the buying. (The dichotomy between the two currencies is fascinating as both are moving on rate cut assumptions, but in opposite directions. Hey, nobody ever said FX was rational!) But we are seeing more gainers than losers as the CE4 track the euro higher and several APAC currencies also moved modestly higher overnight. Remember, one of the emerging narratives has been the dollar’s imminent decline on the back of the twin deficits and lost prestige in the world community. So, every time we see a day where the dollar declines, you can be sure you will see stories on that topic. And while the twin deficit story is certainly valid from a theoretical basis, it has never been a good short-term indicator of movement in the currency markets.

On the data front, yesterday saw US Retail Sales print at a better than expected 7.5%, but Initial Claims fall less than expected, with still 1.3 million first time claims. As I have mentioned, that number continues to be the timeliest indicator of what is happening, and it is certainly not declining very rapidly anymore. Today brings Housing Starts (exp 1189K) and Building Permits (1293K) at 8:30 and then Michigan Sentiment (79.0) at 10:00. Neither of these seem likely to have a major market impact. Rather, as earnings season progresses, I expect the ongoing reports there to drive equity markets and overall risk appetite. For now, nobody is very hungry for risk, but a few good numbers could certainly change that view, pushing stocks higher and the dollar lower.

Good luck, good weekend and stay safe
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