Risk is in Doubt

The chatter before the Fed met
Was Powell and friends were all set
To ease even more
Until they restore
Inflation to lessen the debt

And while Jay attempted just that
His efforts have seemed to fall flat
Now risk is in doubt
As traders clear out
Positions from stocks to Thai baht

Well, the Fed meeting is now history and in what cannot be very surprising, the Chairman found out that once you have established a stance of maximum policy ease, it is very difficult to sound even more dovish.  So, yes, the Fed promised to maintain current policy “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”  And if you really parse those words compared to the previous statement’s “…maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, you could make the case it is more dovish.  But the one thing at which market participants are not very good is splitting hairs.  And I would argue that is what you are doing here.  Between the old statement and Powell’s Jackson Hole speech, everybody already knew the Fed was not going to raise rates for a very long time.  Yesterday was merely confirmation.

In fact, ironically, I think the fact that there were two dissents on the vote, Kaplan and Kashkari, made things worse.  The reason is that both of them sought even easier policy and so as dovish as one might believe the new statement sounds, clearly some members felt it could be even more dovish than that.  At the same time, the dot plot added virtually nothing to the discussion as the vast majority believe that through 2023 the policy rate will remain pegged between 0.00%-0.25% where it is now.  Also, while generating inflation remains the animating force of the committee, according to the Summary of Economic Projections released yesterday, even their own members don’t believe that core PCE will ever rise above 2.0% and not even touch that level until 2023.

Add it all up and it seems pretty clear that the Fed is out of bullets, at least as currently configured with respect to their Congressional mandate and restrictions.  It will require Congress to amend the Federal Reserve Act and allow them to purchase equities in order to truly change the playing field and there is no evidence that anything of that nature is in the cards.  A look at the history of the effectiveness of QE and either zero or negative interest rates shows that neither one does much for the economy, although both do support asset markets.  Given those are the only tools the Fed has, and they are both already in full use (and not just at the Fed, but everywhere in the G10), it is abundantly clear why central bankers worldwide are willing to sacrifice their independence in order to cajole governments to apply further fiscal stimulus.  Central banks seem to have reached the limit of their capabilities to address the real economy.  And if (when) things turn back down, they are going to shoulder as much blame as elected officials can give with respect to who is responsible for the bad news.

With that as background, let’s take a peek at how markets have responded to the news.  Net-net, it hasn’t been pretty.  Equity markets are in the red worldwide with losses overnight (Nikkei -0.7%, Hang Seng -1.6%, Shanghai -0.4%) and in Europe (DAX -0.7%, CAC -0.8%, FTSE 100 -1.0%).  US futures are pointing lower after equity markets in the US ceded all their gains after the FOMC and closed lower yesterday.  At this time, all three futures indices are lower by about 1.0%.

Meanwhile, bond markets, which if you recall have not been tracking the equity market risk sentiment very closely over the past several weeks, are edging higher, at least in those markets truly seen as havens.  So, Treasury yields are lower by 2bps, while German bunds and French OATS are both seeing yields edge lower, but by less than one basis point.  However, the rest of the European government bond market is under modest pressure, with the PIGS seeing their bonds sell off and yields rising between one and two basis points.  Of course, as long as the ECB continues to buy bonds via the PEPP, none of these are likely to fall that far in price, thus yields there are certainly capped for the time being.  I mean even Greek 10-year yields are 1.06%!  This from a country that has defaulted six times in the modern era, the most recent being less than ten years ago.

Finally, if we look to the FX markets, it can be no surprise to see the dollar has begun to reverse some of its recent losses.  Remember, the meme here has been that the Fed would be the easiest of all central banks with respect to monetary policy and so the dollar had much further to fall.  Combine that with the long-term theme of macroeconomic concerns over the US twin deficits (budget and current account) and short dollars was the most popular position in the market for the past three to four months.  Thus, yesterday’s FOMC outcome, where it has become increasingly clear that the Fed has little else to do in the way of policy ease, means that other nations now have an opportunity to ease further at the margin, changing the relationship and ultimately watching their currency weaken versus the dollar.  Remember, too, that essentially no country is comfortable with a strong currency at this point, as stoking inflation and driving export growth are the top two goals around the world.  The dollar’s rebound has only just begun.

Specifically, in the G10, we see NOK (-0.5%) as the laggard this morning, as it responds not just to the dollar’s strength today, but also to the stalling oil prices, whose recent rally has been cut short.  As to the rest of the bloc, losses are generally between 0.15%-0.25% with no specific stories to drive anything.  The exception is JPY (+0.2%) which is performing its role as a haven asset today.  While this is a slow start, do not be surprised to see the dollar start to gain momentum as technical indicators give way.

Emerging market currencies are also under pressure this morning led by MXN (-0.7%) and ZAR (-0.6%).  If you recall, these have been two of the best performing currencies over the past month, with significant long positions in each driving gains of 5.3% and 7.1% respectively.  As such, it can be no surprise that they are the first positions being unwound in this process.  But throughout this bloc, we are seeing weakness across the board with average declines on the order of 0.3%-0.4%.  Again, given the overall risk framework, there is no need for specific stories to drive things.

On the data front, yesterday’s Retail Sales data was a bit softer than expected, although was generally overlooked ahead of the FOMC.  This morning saw Eurozone CPI print at -0.2%, 0.4% core, both still miles below their target, and highlighting that we can expect further action from the ECB.  At home, we are awaiting Initial Claims (exp 850K), Continuing Claims (13.0M), Housing Starts (1483K), Building Permits (1512K) and the Philly Fed index (15.0).

Back on the policy front, the BOE announced no change in policy at all, leaving the base rate at 0.10% and not expanding their asset purchase program.  However, in their effort to ease further they did two things, explicitly said they won’t tighten until there is significant progress on the inflation goal, but more importantly, said that they will “engage with regulators on how to implement negative rates.”  This is a huge change, and, not surprisingly the market sees it as another central bank easing further than the Fed.  The pound has fallen sharply on the news, down 0.6% and likely has further to go.  Last night the BOJ left policy on hold, as they too are out of ammunition.  The fear animating that group is that risk appetite wanes and haven demand drives the yen much higher, something which they can ill afford and yet something which they are essentially powerless to prevent.  But not today.  Today, look for a modest continuation of the dollar’s gains as more positions get unwound.

Good luck and stay safe
Adf

Gone Undetected

When Covid, last winter, emerged
Most government bond prices surged
As havens were sought
And most people thought
That price pressures would be submerged

But since then, with six months now passed
Economists all are aghast
Deflation expected
Has gone undetected
As price levels beat their forecasts

You may recall that when the coronavirus first came to our collective attention at the end of January, it forced China to basically shut down its economy for three weeks. At that time, expectations were for major supply chain disruptions, but concerns over the spread of the virus were not significant. Economists plugged that information into their models and forecast price rises due to supply constraints. Of course, over the next two months as Covid-19 spread rapidly throughout the rest of the world and resulted in lockdowns of economic activity across numerous countries, the demand destruction was obvious. Economists took this new information, plugged it into their models and declared that the deflationary pressures would be greater than the supply chain disruptions thus resulting in deflation, and more ominously, could result in a deflationary spiral like the one the US suffered during the Great Depression.

Central banks didn’t need their arms twisted to respond to that message, especially since the big three central banks, the Fed, ECB and BOJ, had all been struggling to raise inflation to their respective targets for nearly ten years. Thus began the greatest expansion of monetary stimulus in history. Throughout this period, central bankers pooh-poohed the idea that inflation would emerge by pointing to the financial crisis of 2008-9, when they implemented the previously greatest expansion in monetary policy, flooding economies with money, yet no inflation was recorded. At least, price inflation in goods and services, as measured by governments, remained subdued throughout the period.

But there is a very big difference between the current economic situation and the state of things back in 2009. During the financial crisis, banks were the epicenter of the problem, and printing money and injecting it into banks was all that was needed to prevent a further collapse in the economy. In fact, fiscal policy was relatively tight, so all that money basically sat on bank balance sheets as excess reserves at the Fed. There was no increase in buying pressure and thus no measured inflation. In fact, the only thing that inflated was financial asset prices, as the central bank response led to a decade long boom in both stock and bond prices.

In 2020 however, Covid-19 has inspired not just central bank action, but massive fiscal stimulus as well. At this point, over $10 trillion of fiscal stimulus has been implemented worldwide, with the bulk of it designed to get money into the hands of those people who have lost their jobs due to the economic shutdowns worldwide. In other words, this money has entered the real economy, not simply gone into the investment community. When combining that remarkable artificial increase in demand with the ongoing supply chain breakages, it is not hard to understand that price pressures are going to rise. And so they have, despite all the forecasts for deflation.

Just this morning, the UK reported CPI rose 1.0% Y/Y in July, 0.4% more than expected. Core CPI there rose 1.8% Y/Y, 0.6% more than expected. This outcome sounds remarkably like the US data from last week and shows this phenomenon is not merely a US situation. The UK has implemented significant fiscal stimulus as well as monetary support from the BOE. The UK has also seen its supply chains severely interrupted by the virus. The point is, prices seem far more likely to rise during this crisis than during the last one. We are just beginning to see the evidence of that. And as my good friend, @inflation_guy (Mike Ashton) explains, generating inflation is not that hard. Generating just a little inflation is going to be the problem. Ask yourself this, if the economy is still dragging and inflation starts to rise more rapidly than desired, do you really think any central bank is going to raise rates? I didn’t think so. Be prepared for more inflation than is currently forecast.

With that in mind, let us consider what is happening in markets today. Once again the picture is mixed, at least in Asia, as today the Nikkei (+0.25%) found a little support while the Hang Seng (-0.75%) and Shanghai (-1.25%) came under pressure. European exchanges are showing very modest gains (DAX +0.25%, CAC +0.1%) and US futures are all barely in the green. This is not a market that is excited about anything. Instead, investors appear to be on the sidelines with no strong risk view evident.

Turning to bond markets, we continue to see Treasury yields, and all European bond yields as well, slide this morning, with the 10-year Treasury yield down 2 basis points and similar declines throughout Europe. Commodity markets are showing some weakness, with both oil (WTI -0.9%) and gold (-0.6%) softer this morning. Add it all up and it feels like a bit of risk aversion rather than increased risk appetite.

And what of the dollar? Despite what has the feeling of some risk aversion, the dollar is slightly softer on the day, with most currencies showing some strength. In the G10 space, NZD is the outlier, rising 0.7% on the back of a massive short squeeze in the kiwi. But away from that, the movement has been far more muted, and, in fact, the pound is softer by 0.2% as traders are beginning to ask if Brexit may ultimately be a problem. In addition, while the UK inflation data was much higher than expected, there is certainly no indication at this time that the BOE is going to reverse course anytime soon. I have to say that the pound above 1.32 does seem a bit overextended.

EMG currencies are a more mixed picture with RUB (-0.3%) responding to oil’s modest decline, while ZAR has pushed higher by 0.6% on the back of strong foreign inflows for today’s local bond auctions. In what appears to be a benign environment, the hunt for yield is fierce and South Africa with its nominal yields above 9% in the 10-year and inflation running well below 3% is certainly attractive. But otherwise, movement has been uninteresting with most currencies edging higher vs. the dollar this morning.

On the data front today, the only US release is the FOMC Minutes from the July meeting where analysts will be searching for clues as to the Fed’s preferred next steps. More specific forward guidance tied to economic indicators seems to be in the cards, with the key question, which indicators?

Add it all up and we have another slow summer day where the dollar drifts lower. Arguably, the biggest unknown right now would be an agreement on the next US fiscal stimulus package, which if announced would likely result in a weaker dollar. However, I am not willing to forecast the timing of that occurring.

Good luck and stay safe
Adf

Shareholders’ Dreams

The contrast is hard to ignore
Twixt growth, which is still on the floor
And market extremes
Where shareholders’ dreams
Of gains help them come back for more

“There’s no way I can lose.  Right now, I’m feeling invincible.”

This quote from a Bloomberg article about the massive rally in the Chinese stock markets could just as easily come from a US investor as well.  It is a perfect encapsulation of the view that the current situation is one where government support of both the economy and the markets is going to be with us for quite a while yet, and so, stock prices can only go higher.  So far, of course, that view has been spot on, at least since March 23rd, when the US markets bottomed.

The question this idea raises, though, is how long can this situation endure?  There is no denying the argument that ongoing monetary support for economies is flowing into asset markets.  One need only look at the correlation between the gain in the value of global equity markets since things bottomed, and the amount of monetary stimulus that has been implemented.  It is no coincidence that both numbers are on the order of $15 trillion.  But as we watch bankruptcy after bankruptcy get announced, Brooks Brothers was yesterday’s big-name event, it becomes harder and harder to see how market valuations can maintain their current levels without central bank support.  Thus, if equity market values are important to central banks, and I would argue they are, actually, their leading indicator, it leads to the idea that central banks will continue to add liquidity to the economy forever.  In other words, MMT has arrived.

Magical Money Tree Modern Monetary Theory is the controversial idea that, as long as governments print their own money, like the US does with dollars, as opposed to how euros are created by an “independent” authority, there is nothing to stop governments from spending whatever they want, budgets be damned.  After all, they can either issue debt, and print the money needed to repay it, or skip the issuance step and simply print what they need when they need it.  The proponents explain that the only hitch is inflation, which they claim would be the moderator on overprinting.  Thus, if inflation starts to rise, they can slow down the presses.

Originally, this was deemed a left leaning strategy as their idea was to print more money to pay for social programs.  But like every good (?) idea, it has been co-opted by the political opposition in a slightly different form.  Thus, printing money to buy financial assets (which is exactly what the Fed has been doing since 2009’s first bout of QE, is the right leaning application of this view.  To date, the Fed has only purchased bonds, but you can see the evolution toward stocks is underway. At first it was only Treasuries and then mortgage-backed bonds, which was designed to aid the collapsing housing market.  But now we are on to Munis (at least they are government entities) and investment grade corporate ETF’s, then extending to junk bond ETF’s and then individual corporate bonds.  It is not hard to see that the next step will be SPYders and DIAmonds and finally individual stocks.

It is also not hard to discern the impact on equity prices as we go forward in this scenario, much higher.  But ask yourself this; is this a good long-term outcome?  Consider the classic definition of Socialism:

      noun:   a political and economic theory of social organization which advocates that the means of production, distribution, and exchange should be owned or regulated by the state.

Would it not be the case that if the central bank owns equities, they are taking ownership of the means of production?  Would the Fed not be voting their shareholder rights?  And wouldn’t they be deciding winners and losers based on political issues, not economic ones?  Is this really where we want to go?

The EU is already on the way, with a new plan to take equity stakes in SME’s, the economic sector that has been least aided by PEPP and the ECB versions of QE.  And already the discussion there is of which companies to help; only those that meet current ‘proper’ criteria, such as climate neutrality and social cohesion.  The point is that the future is shaping up to turn out quite differently than the recent past, at least when it comes to the financial/economic models that drive political decisions.  Stay alert to these changes as they are almost certainly on their way.

Once again, I drifted into a non-market discussion because the market discussion is so incredibly boring.  Equity markets continue their climb, based on ongoing financial largesse by central banks.  Bond markets remain mired in tight ranges and the dollar continues to consolidate after a massive rally in March led to a more gradual unwinding of haven asset positions.  But lately, the story is just not that interesting.

Arguably, the dollar’s recent trend lower is still intact, it has just flattened out a great deal.  So we continue to see very gradual weakness in the greenback, just not necessarily every day.  For example, in the past three weeks, the euro has climbed 1.25%, but had an equal number of up and down days during this span.  In other words, if you look hard enough, you can discern a trend, it is just not a steep one.  In fact, as I type, it has turned modest overnight gains into modest losses, but is certainly not showing signs of a breakout in either direction.  And this is a pretty fair description of the entire G10 bloc, modest movement in both directions over the course of a few weeks, but net slightly firmer vs. the dollar.

Today, the pound is the big winner, although it has only gained 0.25%, coming on the back of the government’s announcement of an additional £30 billion of fiscal support for the UK economy focused on wages, job retention and small businesses.  As to the rest of the G10, SEK is firmer by 0.2%, although there are no stories that would seem to support the movement, while the other eight currencies are less than 0.1% changed from yesterday.

In the emerging markets, the story is somewhat similar with just two outliers, RUB (+0.6% as oil is higher) and ZAR (+0.5% as gold is higher).  In fact, the currency that has truly performed best of all this year is gold, which is higher by nearly 20% YTD, and shows no signs of slowing down.  Arguably, the rand should continue to find support from this situation.

Once again, data is scarce, with today’s Initial and Continuing Claims data the highlights (exp 1.375M and 18.75M respectively).  At this stage, these are probably the most important coincident indicators we have, as any signs of increased layoffs will result in a lot more anxiety, both in markets and the White House.  Of course, if those numbers decline, look for the V-shaped recovery story to gain further traction and stronger equity markets alongside a (slightly) weaker dollar.

Good luck and stay safe

Adf

 

Overthrow

Health data are starting to show
A second wave might overthrow
The rebound we’ve seen
From Covid-19
Which clearly will cause growth to slow

Risk is under pressure this morning as market participants continue to read the headlines regarding the rising rate of Covid infections in some of the largest US states, as well as throughout a number of emerging market nations. While this is concerning, in and of itself, it has been made more so by the fact that virtually every government official has warned that a second wave will undermine the progress that has been made with respect to the economic rebound worldwide. However, what seems to be clear is that more than three months into a series of government ordered shut downs that have resulted in $trillions of economic damage around the world, people in many places have decided that the risk from the virus is not as great as the risk to their personal economic well-being.

And that is the crux of the matter everywhere. Just how long can governments continue to impose restrictions on people without a wholesale rebellion? After all, there have been many missteps by governments everywhere, from initially downplaying the impact of the virus to moving to virtual marital law, with early prognostications vastly overstating the fatality rate of the virus and seemingly designed simply to sow panic and exert government control. It cannot be surprising that at some point, people around the world decided to take matters into their own hands, which means they are no longer willing to adhere to government rules.

The problem for markets, especially the equity markets, is that their recovery seems to be based on the idea that not only is a recovery right around the corner, but that economies are going to recoup all of their pandemic related losses and go right back to trend activity. Thus, a second wave interferes with that narrative. As evidence starts to grow that the caseload is no longer shrinking, but instead is growing rapidly, and that governments are back to shutting down economic activity again, those rosy forecasts for a sharp rebound are harder and harder to justify. And this is why we have seen the equity market rebound stumble for the past three weeks. In that time, we have seen twice as many down sessions as up sessions and the net result has been a 5.5% decline in the S&P500, with similar declines elsewhere.

So, what comes next? It is very hard to read the news about the growing list of bankruptcies as well as the significant write-downs of asset values and order cancelations without seeing the bear case. The ongoing dichotomy between the stock market rally and the economic distress remains very hard to justify in the long run. Of course, opposing the real economic news is the cabal of global central banks, who are doing everything they can think of collectively, to keep markets in functioning order and hoping that, if markets don’t panic, the economy can find its footing. This is what has brought us ZIRP, NIRP and QE with all its variations on which assets central banks can purchase. Alas, if central bankers really believe that markets are functioning ‘normally’ after $trillions of interference, that is a sad commentary on those central bankers’ understanding of how markets function, or at least have functioned historically. But the one thing on which we can count is that there is virtually no chance that any central bank will pull back from its current policy stance. And so, that dichotomy is going to have to resolve itself despite central bank actions. That, my friends, will be even more painful, I can assure you.

So, on a day with ordinary news flow, like today, we find ourselves in a risk-off frame of mind. Yesterday’s US equity rally was followed with modest strength in Asia. This was helped by Chinese PMI data which showed that the rebound there was continuing (Mfg PMI 50.9, Non-mfg PMI 54.4), although weakness in both Japanese ( higher Jobless Rate and weaker housing data) and South Korean (IP -9.6% Y/Y) data detracted from the recovery story. Of course, as we continue to see everywhere, weak data means ongoing central bank largesse, which at this point still leads to equity market support.

Europe, on the other hand, has not seen the same boost as equity markets there are mostly lower, although the DAX (+0.4%) and CAC (+0.2%) are the two exceptions to the rule. UK data has been the most prevalent with final Q1 GDP readings getting revised a bit lower (-2.2% Q/Q from -2.0%) while every other sub-metric was slightly worse as well. Meanwhile, PM Johnson is scrambling to present a coherent plan to support the nation fiscally until the Covid threat passes, although on that score, he is not doing all that well. And we cannot forget Brexit, where today’s passage without an extension deal means that December 31, 2020 is the ultimate line in the sand. It cannot be a surprise that the pound has been the worst performing G10 currency over the past week and month, having ceded 2.0% since last Tuesday. With the BOE seriously considering NIRP, the pound literally has nothing going for it in the short run. Awful economic activity, questionable government response to Covid and now NIRP on the horizon. If you are expecting to receive pounds in the near future, sell them now!

Away from the pound, which is down 0.3% today, NOK (-0.6%) is the worst performer in the G10, and that is really a result of, not only oil’s modest price decline (-1.3%), but more importantly the news that Royal Dutch Shell is writing down $22 billion of assets, a move similar to what we have seen from the other majors (BP and Exxon) and an indication that the future value (not just its price) of oil is likely to be greatly diminished. While we are still a long way from the end of the internal combustion engine, the value proposition is changing. And this speaks to just how hard it is to have an economic recovery if one of the largest industries that was adding significant value to the global economy is being downgraded. What is going to take its place?

The oil story is confirmed in the EMG space as RUB is the clear underperformer today, down 1.4% as Russia is far more reliant on oil than even Norway. However, elsewhere in the EMG bloc, virtually the entire space is under pressure to a much more limited extent. The thing is, if we start to see risk discarded and equity markets come under further pressure, these currencies are going to extend their declines.

This morning’s US data is second tier, with Case Shiller Home Prices (exp +3.8%), Chicago PMI (45.0) and Consumer Confidence (91.4). The latter two remain far below their pre-covid levels and likely have quite some time before they can return to those levels. Meantime, Fed speakers are out in force today, led by Chair Powell speaking before a Congressional panel alongside Treasury Secretary Mnuchin. His pre-released opening remarks harp on the risk of a second wave as well as the uncertainty over the future trajectory of growth because of that. As well, he continues to promise the Fed will do whatever is necessary to support the economy. And in truth, we have continued to hear that message from every single Fed speaker for the past two months’ at least. What we know for sure is that the Fed is not going to change its tune anytime soon.

For today, unless Powell describes yet another new program, if he remains in his mode of warning of disaster unless the government does more, it is hard to see how investors get excited. Risk is currently on the back foot and I see nothing to change that view today.

Good luck and stay safe
Adf

A New Paradigm

As mid-year approaches, it’s time
To ponder the central bank clime
Will negative rates
Appear in the States
And welcome a new paradigm?

With the end of the first half of 2020 approaching, perhaps it’s time to recap what an extraordinary six months it has been as well as consider what the immediate future may hold.

If you can recall what January was like, the big story was the Phase One trade deal, which was announced as almost completed at least half a dozen times, essentially every time the stock market started to decline, before it was finally signed. In hindsight, the fact that it was signed right at the beginning of the Lunar New Year celebrations in China, which coincided with the recognition that the novel coronavirus was actually becoming a problem, is somewhat ironic. After all, it was deemed THE most important thing in January and by mid-February nobody even cared about it anymore. Of course, by that time, Covid-19 had been named and was officially declared a pandemic.

As Covid spread around the world, the monetary responses were impressive for both their speed of implementation and their size. The Fed was the unquestioned leader, cutting rates 150bps in two emergency meetings during the first half of March while prepping the market for QE4. They then delivered in spades, hoovering up Treasuries, mortgage-backed bonds, investment grade corporate bonds and junk bonds (via ETF’s) and then more investment grade bonds, this time purchasing actual securities, not ETF’s. Their balance sheet has grown more than $3 trillion (from $4.1 trillion to $7.1 trillion) in just four months and they have promised to maintain policy at least this easy until the economy can sustainably get back to their inflation and employment goals.

On the fiscal front, government response was quite a bit slower, and aside from the US CARES act, signed into law in late March, most other nations have been less able to conjure up enough spending to make much of a difference. There was important news from the EU, where they announced, but have not yet enacted, a policy that was akin to mutualization of debt across the entire bloc. If they can come to agreement on this, and there are four nations who remain adamantly opposed (Sweden, Austria, Denmark and the Netherlands), this would truly change the nature of the EU and by extension the Eurozone. Allowing transfers from the richer northern states to the struggling Mediterranean countries would result in a boon for the PIGS as they could finally break the doom-loop of their own nation’s banks owning the bulk of their own sovereign debt. But despite the support of both France and Germany, this is not a done deal. Now, history shows that Europe will finally get something along these lines enacted, but it is likely to be a significantly watered-down version and likely to take long enough that it will not be impactful in the current circumstance.

Of course, the ECB, after a few early stumbles, has embraced the idea of spending money from nothing and is in the process of implementing a €1.35 trillion QE program called PEPP in addition to their ongoing QE program.

Elsewhere around the world we have seen a second implementation of yield curve control (YCC), this time by Australia which is managing its 3-year yields to 0.25%, the same level as its overnight money. There is much talk that the Fed is considering YCC as well, although they will only admit to having had a discussion on the topic. Of course, a quick look at the US yield curve shows that they have already essentially done so, at least up to the 10-year maturity, as the volatility of yields has plummeted. For example, since May 1, the range of 3-year yields has been just 10bps (0.18%-0.28%) while aside from a one-week spike in early June, 10-year yields have had an 11bp range. The point is, it doesn’t seem that hard to make the case the Fed is already implementing YCC.

Which then begs the question, what would they do next? Negative rates have been strongly opposed by Chairman Powell so far, but remember, President Trump is a big fan. And we cannot forget that over the course of the past two years, it was the President’s view on rates that prevailed. At this time, there is no reason to believe that negative rates are in the offing, but in the event that the initial rebound in economic data starts to stumble as infection counts rise, this cannot be ruled out. This is especially so if we see the equity market turn back lower, something which the Fed seemingly cannot countenance. Needless to say, we have not finished this story by a long shot, and I would contend there is a very good chance we see additional Fed programs, including purchasing equity ETF’s.

Of course, the reason I focused on a retrospective is because market activity today has been extremely dull. Friday’s equity rout in the US saw follow through in Asia (Nikkei -2.3%, Hang Seng -1.0%) although Europe has moved from flat to slightly higher (DAX +0.5%, CAC +0.25%, FTSE 100 +0.5%). US futures are mixed, with the surprising outcome of Dow and S&P futures higher by a few tenths of a percent while NASDAQ futures are lower by 0.3%. The bond market story is that of watching paint dry, a favorite Fed metaphor, with modest support for bonds, but yields in all the haven bonds within 1bp of Friday’s levels.

And finally, the dollar is arguably a bit softer this morning, with the euro the leading gainer in the G10, +0.5%, and only the pound (-0.2%) falling on the day. It seems that there are a number of algorithmic models out selling dollars broadly today, and the euro is the big winner. In the EMG bloc, the pattern is the same, with most currencies gaining led by PLN(+0.65%) after the weekend elections promised continuity in the government there, and ZAR (+0.55%) which is simply benefitting from broad dollar weakness. The exception to the rule is RUB, which has fallen 0.25% on the back of weakening oil prices.

On the data front, despite nothing of note today, we have a full calendar, especially on Thursday with the early release of payroll data given Friday’s quasi holiday

Tuesday Case Shiller Home Prices 3.70%
  Chicago PMI 44.0
  Consumer Confidence 90.5
Wednesday ADP Employment 2.95M
  ISM Manufacturing 49.5
  ISM Prices Paid 45.0
  FOMC Minutes  
Thursday Initial Claims 1.336M
  Continuing Claims 18.904M
  Nonfarm Payrolls 3.0M
  Private Payrolls 2.519M
  Manufacturing Payrolls 425K
  Unemployment Rate 12.4%
  Average Hourly Earnings -0.8% (5.3% Y/Y)
  Average Weekly Hours 34.5
  Participation Rate 61.2%
  Trade Balance -$53.0B
  Factory Orders 7.9%
  Durable Goods 15.8%
  -ex transport 4.0%

Source: Bloomberg

So, as you can see, a full slate for the week. Obviously, all eyes will be on the employment data on Wednesday and Thursday. At this point, it seems we are going to continue to see data pointing to a sharp recovery, the so-called V, but the question remains, how much longer this can go on. However, this is clearly today’s underlying meme, and the ensuing risk appetite is likely to continue to undermine the dollar, at least for the day. We will have to see how the data this week stacks up against the ongoing growth in Covid infections and the re-shutting down of portions of the US economy. The latter was the equity market’s nemesis last week. Will this week be any different?

Good luck and stay safe
Adf

Looking Distressed

The market was looking distressed
So, Jay clearly thought it was best
To tell everyone
The Fed had begun
To buy corporates at his behest

Frankly, I’m stunned. Anyone who believes that the Fed is focusing on any variable other than the S&P 500 was completely disabused of that notion yesterday. While I know it seems like it was weeks ago, yesterday morning there was concern that Chairman Powell’s comments last week about a long, tough road to recovery were still top of mind to market participants. Concerns over a rising infection rate in some states and countries were growing thus driving investors to react negatively. After all, if the mooted second wave of Covid comes and the nascent economic revival is squashed at the outset, the case for the V-shaped recovery and stratospheric stock prices would quickly die. And so, Chairman Powell responded by explaining that the Fed would expand the SMCCF* program to start buying individual bonds today. Remember, the initial story was ETF’s were the only purchases to be made. Now, the Fed is effectively cherry-picking which investors it wants to help as certainly the companies whose bonds the Fed buys will not be getting any of that money. Or will they? Perhaps the hope is that if the Fed owns individual corporate bonds, in the coming debt jubilee, they will tear up those bonds as well as their Treasuries, thus reducing leverage in a trice.

A debt jubilee, for those who are unfamiliar with the term, is a government sanctioned erasure of outstanding debts. Its origins are in the book of Deuteronomy in the Old Testament, when every 50 years there was a call for the release of all debts, both monetary and personal (indenture). Of course, in the modern world it is a bit more difficult to accomplish as all creditors would be severely impacted by the concept. All creditors except one, that is, a nation’s central bank.

Now that we are in a fiat currency system where central banks create money from nothing (paraphrasing Dire Straits), any public debt that they hold on their balance sheets can simply be forgiven by decree, thus reducing the leverage outstanding. While there would seem to be some inflationary consequences to the action (after all, an awful lot of funds would be instantly freed up to chase after other goods, services and investments), the modern central bank viewpoint on inflation is that it is dangerously low and a problem at current levels, so those consequences are likely to be quickly rationalized away. Thus, if the Fed owns individual corporate bonds, especially of highly indebted companies, they will be able forgive those, reduce leverage and support those companies’ prospects to maintain a full-sized staff. You see, the rationalization is it will support employment, not help investors.

To be clear, there is no official plan for a debt jubilee, but it is something that is gaining credence amongst a subset of the economics community. Especially because of the inherent concerns over near- and medium-term growth due to Covid-19, as future consumer behavior is likely to be very different than past consumer behavior, I expect that a debt jubilee is something about which we will hear a great deal more going forward. Nonstop printing of money by the world’s central banks is not a sustainable activity in the long run. Neither is it sustainable for governments to run deficits well in excess of GDP. A debt jubilee is a potential solution to both those problems, and if it can be accomplished by simply having central banks tear up debt, other creditors will not be destroyed. Truly a (frightening) win-win.

It can be no surprise that the stock market reacted positively to the news, turning around morning losses to close higher by 0.85% in the US with the sharpest part of the move happening immediately upon the statement’s release at 2:15 yesterday. This euphoria carried over into Asia with remarkable effect as the Nikkei (+4.9%) and KOSPI (+5.3%) exploded higher while the rest of the region merely saw strong gains of between 1.4% (Shanghai) and 3.9% (Australia). And naturally, Europe is a beneficiary as well, with the DAX (+2.8%) leading the way, but virtually every market higher by more than 2.0%. US futures? Not to worry, all three indices are currently higher by more than 1.1%.

In keeping with the risk-on attitude, we also saw Treasury bonds sell off in the afternoon with yields rising a bit more than 4bps since the announcement. In Europe, bund yields are higher as are gilts, both by 2.5bps, but the PIGS are basking in the knowledge that their future may well be brighter as we are seeing Portugal (-2bps), Italy (-5.5bps), Greece (-6.5bps) and Spain (-3bps) all rallying nicely.

And finally, the dollar, which had started to show some strength yesterday, has also reversed most of those gains and is broadly, though not deeply, softer this morning. In the G10, the pound is the leader, higher by 0.45%, as the market ignored Jobless Claims in the UK falling by 529K, only the second worst level on record after last month’s numbers, and instead took heart that a Brexit deal could well be reached after positive comments from both Boris Johnson and the EU leadership following a videoconference call earlier today. While nothing is confirmed, this is the best tone we have heard in a while. However, away from the pound gains are limited to less than 0.25% with some currencies even declining slightly.

In the emerging markets, the leading gainer is KRW (+0.75%) despite the fact that North Korea blew up the Joint Office overnight. That office was the sight of ongoing discussions between the two nations and its destruction marks a significant rise in hostility by the North. In my view, the market is remarkably sanguine about the story, especially in light of its response to the news out of India, where Chinese soldiers ostensibly attacked and killed three Indian soldiers in the disputed border zone. There, the rupee fell 0.25% on the report as concerns grow over an escalation of tensions between the two nations. But aside from those two currencies, there were many more gainers in APAC currencies as funds flowed into local stock markets on the Fed inspired risk appetite.

On the data front, we see Retail Sales (exp 8.4%, 5.5% ex autos) as well as IP (3.0%) and Capacity Utilization (66.9%), with all three numbers rebounding sharply from their lows set in April. We saw a similar rebound in German ZEW Expectations (63.4 and its highest since 2006), but recall, that is based on the change of view month to month.

Chairman Powell testifies to the Senate this morning, so all ears will be listening at 10:00. Yesterday we heard from two Fed speakers, Dallas’s Kaplan and San Francisco’s Daly, both of whom expressed the view that a rebound was coming, that YCC was not appropriate at this time and that the Fed still had plenty they could do, as they made evident with yesterday afternoon’s announcement.

While equity markets continue to react very positively to the central bank activities, the dollar seems to be finding a floor. In the end, investment flows into the US still seem to be larger than elsewhere and continue to be a key driver for the dollar. Despite a positive risk appetite, it appears the dollar has limited room to fall further.

Good luck and stay safe
Adf

*Secondary Market Corporate Credit Facility

Buy With More Zeal

The stimulus story is clear
Expect more throughout the whole year
C bankers are scared
And war they’ve declared
On bears, who now all live in fear

Thus, Wednesday the Fed will reveal
They’ll not stop til they hear the squeal
Of covering shorts
While Powell exhorts
Investors to buy with more zeal!

The market is biding its time as traders and investors await Wednesday’s FOMC statement and the press conference from Chairman Powell that follows. Patterns that we have seen over the past week are continuing, albeit on a more modest path. This means that the dollar is softer, but certainly not collapsing; treasury yields are higher, and those bonds almost seem like they are collapsing; commodity prices continue to mostly move higher; and equity markets are mixed, with pockets of strength and weakness. This is all part and parcel of the V-shaped recovery story which has completely dominated the narrative, at least in financial markets.

Friday’s payroll report was truly surprising as the NFP number was more than 10 million jobs higher than estimated. This led to a surprisingly better than expected, although still awful, Unemployment Rate of 13.3%. However, this report sowed its own controversy when the Labor Department happened to mention, at the bottom of the release, that there was a little problem with the count whereby 4.9 million respondents were misclassified as still working and temporarily absent rather than unemployed. Had these people been accounted for properly, the results would have been an NFP outcome of -2.4 million while the Unemployment rate would have been about 3% higher. Of course, this immediately raised questions about the propriety of all government statistics and whether the administration is trying to cook the books. However, Occam’s Razor would point you in another direction, that it is simply really difficult to collect accurate data during the current pan(dem)ic.

What is, perhaps, more interesting is that the financial press has largely ignored the story. It seems the press is far more interested in fostering the bullish case and this number was a perfect rebuttal to all the bears who continue to highlight things like the coming wave of bankruptcies that are almost certain to crest as soon as the Fed (and other central banks) stop adding money to the pot every day. Of course, perhaps the central banking community will never stop adding money to the pot thus permanently supporting higher equity valuations. Alas, that is the precise recipe for fiat currency devaluation, perhaps not against every other fiat currency, but against real stuff, like gold, real estate, and even food. So, while FX rates may all stay bounded, inflation would become a much greater problem for us all.

At this point, the universal central bank view is that deflation remains the primary concern, and inflation is easily tamed if it should appear. But ask yourself this, if central banks have spent trillions of dollars to drive rates lower to support the economy, how much appetite will they have to raise rates to fight inflation at the risk of slowing the economy? Exactly.

So, let’s take a look at today’s markets. After Friday’s blowout performance by US equities, which helped drive the dollar lower and Treasury yields higher, Asia was actually very quiet with only the Nikkei (+1.4%) showing any life at all. And that came after a surprisingly good Q1 GDP report showing Japan shrank only 2.2% in Q1, not the -3.4% originally reported. This also represents a data controversy as Capex data appeared far more robust than originally estimated. However, this too, seems to be a case of the government having a difficult time getting accurate data with most economists expecting the GDP result to be revised lower. But the rest of Asia was basically flat in equity space.

Meanwhile, European bourses are mixed with the DAX (-0.4%) and CAC (-0.5%) leading the way lower although we continue to see strength in Spain (+0.7%) and Italy (+0.2%). The ongoing belief that the largest portion of ECB stimulus will be used to support the latter two nations remains a powerful incentive for investors to keep buying into their markets.

On the bond front, Treasury yields, after having risen 25bps last week, in the 10-year, are higher by a further 2bps this morning. 30-year yields are rising even faster, up 3.5bps so far today. This, too, is all part of the same narrative; the V-shaped recovery means that lower rates will no longer be the norm going forward. This is setting up quite the confrontation with the Fed and is seen as a key reason that yield-curve control (YCC) is on the horizon. The last thing the Fed wants is for the market to undermine all their efforts at economic recovery by anticipating their success and driving yields higher. Thus, YCC could be the perfect means for the Fed to stop that price action in its tracks.

As to the dollar, it is having a more mixed performance today as opposed to the broad-based weakness we saw last week. In the G10, SEK and NOK (+0.4% each) are the best performers although we are seeing modest 0.15%-0.2% gains across the Commonwealth currencies as well as the yen. NOK is clearly following oil prices higher, while SEK continues to benefit from the fact that its rising yields are attracting more investment after reporting positive Q1 growth last week. On the downside, the pound is the leading decliner, -0.25%, although the euro is weakening by 0.15% as well. While the pound started the session firmer on the back of easing lockdown restrictions, it has since turned tail amid concerns that this dollar decline is reaching its limits.

In the EMG bloc, RUB (+0.65%) is the clear leader today, also on oil’s ongoing rally, although there are a number of currencies that have seen very modest gains as well. On the downside, TRY and PHP (-0.25% each) are the leading decliners, but here, too, there is a list of currencies that have small losses. As I said, overall, there is no real trend here.

While this week brings us the FOMC meeting, there is actually very little other data to note:

Tuesday NFIB Small Biz Sentiment 92.2
  JPLT’s Job Openings 5.75M
Wednesday CPI 0.0% (0.3% Y/Y)
  -ex food & energy 0.0% (1.3% Y/Y)
  FOMC Rate Decision  0.25%
Thursday Initial Claims 1.55M
  Continuing Claims 20.6M
  PPI 0.1% (-1.3% Y/Y)
  -ex food & energy -0.1% (0.5% Y/Y)
Friday Michigan Sentiment 75.0

Source: Bloomberg

While we can be pretty sure the Fed will not feel compelled to change policy at this meeting, you can expect that there will be many questions in the press conference regarding the future, whether about forward guidance or YCC. As they continue to reduce their daily QE injections, down to just $4 billion/day, I fear the equity market may start to feel a bit overdone up here, and a short-term reversal seems quite realistic. For now, risk is still on, but don’t be surprised if it stumbles for a while going forward. And that means the dollar is likely to show some strength.

Good luck and stay safe
Adf

Fear of Deflation

The ECB’s fear of deflation
Inspired more euro creation
They’ll keep buying bonds
Until growth responds
In every EU member nation

Investors responded by buying
As much as they could while still trying
To claim, it’s quite clear
That early next year
Economies all will be flying

Madame Lagarde is clearly getting the hang of what it means to be a central banker these days, at least at a major central bank. The key to success is to listen to how much easing the pundits are expecting and deliver significantly more than that. In the mold of Chairman Powell back in March, Lagarde yesterday exceeded all expectations. The ECB increased its PEPP by €600 billion, extended the minimum deadline to June 2021 and explained they would be reinvesting the proceeds of all maturing purchases until at least the end of 2022. They, of course, kept their other programs on autopilot, so the APP (their first QE program) will still be purchasing €20 billion per month through at least the end of this year. And finally, they left the interest rate structure on hold, so the deposit rate remains at -0.50%, but more importantly, they didn’t adjust the tiering. Tiering is the ECB’s way of limiting the amount of bank reserves that ‘earn’ negative interest rates. So, if the ECB decides that rates need to be cut even lower, they will be able to adjust the tiering levels to help minimize the damage to bank balance sheets. This is key in Europe because banks remain far more important in the transmission of monetary policy than in the US and negative rates have been killing them.

With this increase in accommodation, the Eurozone has finally created a support structure that is in concert with the size of the Eurozone economy. Adding up the pieces shows the ECB buying €1.5 trillion in assets, the EU having already created a €500 billion cheap lending program and now close to agreeing on an additional €750 billion program with joint borrowing and grants as well as loans. Add to that the individual national support (remember Germany just plumped for €130 billion yesterday) and the total is now well over €3 trillion. That is real money and should help at least mitigate the worst impacts of the economic shutdowns across the continent.

And so, can anybody be surprised that markets responded favorably to the news. Equity markets throughout Europe are higher this morning with the DAX (+1.8%), CAC (+2.3%) and the rest of the continental bourses all looking forward to more free money. Of course, the risk-on attitude has investors swapping their haven bonds for stocks and risky bonds, so bund yields have risen 1.5bps (Dutch bonds are up 2.5bps) while Greek yields have fallen 3bps. Italy and Spain are unchanged on the day, as there is no real selling, but just more interest in equities in the two nations. Finally, the euro, although currently slightly softer on the day (-0.15%) traded to a new high for this move at 1.1384. Except for two days in early March, as the virus story was disrupting markets, this is the highest level for the single currency since last July.

Technically, it is pretty easy to make the case that the euro is breaking out of a multi-year downtrend, although that is not confirmed. When viewing fundamentals, the question at hand is whether the Fed or ECB has more accommodative monetary policy. Clearly, despite the recent EU package, the US has been far more accommodative fiscally. And while the longer end of the US yield curve continues to sell off (10-year yields are now up to 0.85%, 20 bps this week, with 30-year yields at 1.66%, also 20bps higher on the week), the 2-year T-note remains anchored at 0.2% with a real yield firmly negative. Recall, there is a strong correlation between real 2-year yields and the value of the dollar, so those negative yields are clearly weighing on the buck. While it will not be a straight line, as long as the market continues to believe that central banks will not allow a market correction, the dollar should continue to slide.

Away from the euro, the dollar is soft almost across the board again today, with only PLN (-0.5%) having fallen any distance in the EMG bloc, and the Swiss franc (-0.3%) the only real loser in the G10. The Swiss story seems to be a technical one as the EURCHF cross has broken higher technically after the ECB announcement yesterday and continued with a little momentum. Poland is a bit more mystifying as there does not appear to be any specific news that would have led to selling, although the trend for the past 3 weeks remains clearly higher.

On the plus side, the big winner today is IDR (+1.55%) after the central bank governor, Perry Warjiyo, commented that the rupiah remains undervalued amid low inflation and a declining current account deficit.

With this as a backdrop, this morning brings the US payroll report with the following forecasts:

Nonfarm Payrolls -7.5M
Private Payrolls -6.75M
Manufacturing Payrolls -400K
Unemployment Rate 19.1%
Average Hourly Earnings 1.0% (8.5% Y/Y)
Average Weekly Hours 34.3
Participation Rate 60.1%

Source: Bloomberg

Remember, Wednesday’s ADP number was much lower than expected at -2.76M, still remarkably awful, but nonetheless surprising. However, data continues to be of secondary importance to the markets. I expect this will be the case until we start to see a recovery in earnest, but for now, we seem to be trying to define the bottom. The dichotomy between the destruction of the economy via lockdowns and the ebullience of the stock markets remains a key concern. The positive spin is that we truly will see a very sharp recovery in Q3 and Q4 with unemployment rolls tumbling back to a more normal recessionary level, and the bulls will have been right. Alas, the other side of that coin is that forecasts of permanent job destruction and decimated corporate earnings will prove too much for the central banks to overcome and we will have a longer-term decline in equity prices as the recession/depression lingers far longer.

For now, the bulls remain in charge. Today’s data is unlikely to change that view, so further dollar weakness seems the best bet. However, be aware of the risk of the other side of the trade, it has not disappeared by any stretch.

Good luck, good weekend and stay safe
Adf

Until Covid-19 Is Dead

To those who had thought that the Fed
Was finished, Chair Powell just said
There’s nothing that we
Won’t do by decree
Until Covid-19 is dead

Small Caps? Check. Munis? Check. Junk bonds Fallen angels? Check. These are the latest segments in the credit market where the Fed has created new support based on yesterday’s stunning announcements. All told, the Fed has committed up to $2.3 trillion to support these areas, as well as the trillions of dollars they had already spent and committed to support the Treasury market, mortgage market, and ensure that bank finances remained sufficient for their continued operation and provision of loans and services to the economy.

While the breadth of programs the Fed has announced and implemented thus far is stunning, based on the CARES act passed last week, there is still plenty more ammunition available for the Fed to continue to be creative. Of course, the market reaction was highly positive to these announcements and served to cap off a week where the S&P 500 rose more than 12% from last Friday’s closing levels. In fact, a cynic might suggest that the Fed’s sole purpose is to prop up the equity market, but given the extraordinary events ongoing, I suppose that is merely a happy side effect. At any rate, there is no doubt that the Fed has taken its role as the world’s central bank seriously. Between swap lines and repo facilities for other central banks and purchase programs for virtually every type of domestic asset, Chairman Powell will never be able to be accused of fiddling while the economy burned. And while government programs are notoriously difficult to remove once enacted, based on the ongoing economic indicators, like yesterday’s second consecutive 6.6 million print in the Initial Claims data, it is evident that the Fed is being as aggressive as possible.

There will almost certainly be numerous longer-term negative consequences of all this activity and books will be written about all the ways the Fed overstepped its bounds, but right now, the vast majority of people around the world are hugely in favor of their actions. Anything that supports the economy and population through this period of mandated shutdown is appreciated. While they don’t run polls for popularity of central bank chiefs, I’m pretty confident Chairman Jay would be riding high these days.

In the meantime, there were two other noteworthy stories in the past 24 hours with market impact. The first was that the OPEC+ meeting did not come to agreement yesterday for production cuts totaling 10 million bbl/day as Mexico was the lone holdout, insisting that it would only cut 100,000 bbl/day of production, not the 400,000 bbl/day needed. After 16 hours of video conferencing, the energy leaders postponed any decision and decided to allow today’s G20 FinMin video conference to go forward and help try to break the impasse. It strikes me that Mexico will cave soon on this issue, but for now, nothing is agreed. It is hard to determine how oil markets have responded given essentially all cash and futures markets are closed today for the Good Friday holiday. However, oil futures had not fallen on Thursday afternoon which indicates they, too, believe a deal will be done.

And finally, the EU finally came up with a financing package to address the economic impact of the virus on its members. As was to be expected, it was significantly less than initially mooted and the construct of the deal indicates that there has not yet been any agreement by the Teutonic trio of Germany, Austria and the Netherlands to fund the PIGS. A brief overview of the deal shows the headline figure to be €540 billion made up of three pieces; a joint employment insurance fund (€100B), an EIB supported package designed to provide liquidity to impacted companies (€200B) and a ESM credit line (€240B) to backstop national spending. The problem with the latter is that the European Stability Mechanism is anathema to those nations that need it most like Spain and Italy, because it imposes fiscal conditions on the use of the funds. It is an ECB creation from the Eurobond crisis years by Mario Draghi, but it has never been used. Essentially, the rest of Europe has said to Germany, we may need your money, but we will not become your vassal. And this is exactly why the EU, and its subgroup the Eurozone, will remain dysfunctional going forward.

Thus, when compiling the newest information, the one thing that becomes clear is that the US continues to be the nation most willing to increase spending and liquidity to support its economy. And in the end, it cannot be surprising that the dollar will suffer in that scenario. Back in January, my view was the dollar would decline this year as the US was the economy with the most room to ease policy and that eventually, those much easier conditions would result in a weaker dollar. Well, that is exactly what we are seeing occur right now, as the Fed has upped the ante regarding monetary policy easing relative to the rest of the world at the same time that the broad narrative seems to be evolving into ‘the infection peak has passed and things are going to be better in the future than in the recent past’. Hence, the need to hold dollars as a haven has diminished, and the dollar has responded. For instance, this week AUD has rallied 5.7% while NOK is higher by 3.9%. Clearly both have been buoyed by the rise in oil prices as well as the generally better tone on risk. But the entire G10 bloc is higher, although the yen has gained just 0.1% on the week.

In the EMG space, we see a similar picture with MXN the leader, rallying 6.3%, followed closely by ZAR (5.6%) and HUF (5.2%) as virtually the entire bloc has gained vs. the dollar this week. And the story is identical throughout, a better risk tone and more available USD liquidity relieving pressure on USD borrowers throughout the world.

For the time being, this is very likely to remain the trend, but do not dismiss the fact that the global economy is currently in a very severe recession, and that it will take a long time to recover. During the Great Depression in 1929-1932, after a very sharp initial fall in equity markets, there was a powerful rally that ultimately gave way to a nearly 90% decline. We are currently witnessing a powerful rally, but another decline seems likely given the economic damage that will take years to fix. Meanwhile, the dollar, while under pressure right now, is likely to see renewed demand in the next wave.

Good luck, stay safe and have a good holiday weekend
Adf

PS. FX Poetry will return on Wednesday, April 15.

Growth Can Be Spurred

In England this morning we heard
From Vlieghe, the BOE’s third
Incumbent to say
That given his way
He’d cut rates so growth can be spurred

The pound is under pressure this morning after Gertjan Vlieghe became the third MPC member in the past week, after Carney and Tenreyo, to explain that a rate cut may be just the ticket at this point in time. Adding these three to the two members who had previously voted to cut rates, Haskel and Saunders, brings the number of doves to five, a majority on the committee. It can be no surprise that the pound has suffered, nor that interest rate markets have increased the probability of a 25bp rate cut at the January 30 meeting from below 25% last week to 50% now. Adding to the story was the release of worse than expected November IP (-1.2%) and GDP (-0.3%) data, essentially emphasizing the concerns that the UK economy has a long way to go to recover from the Brexit uncertainty.

However, before you turn too negative on the UK economy, remember that this is backward-looking data, as November was more than 6 weeks ago, and in the interim we have had the benefit of the resounding electoral victory by Boris Johnson. This is not to say that the UK economy cannot deteriorate further, just that there has been a palpable change in the tone of commentary in the UK as Brexit uncertainty has receded. Granted, the question of the trade deal with the EU, which is allegedly supposed to be signed by the end of 2020, remains open. But it is very difficult for market participants to look that far ahead and try to anticipate the outcome. And if anything, Boris has the fact that he was able to renegotiate the original Brexit deal in just six weeks’ time working in his favor. While previous assumptions had been that trade deals take years and years to negotiate, it is clear that Boris doesn’t subscribe to that theory. Personally, I wouldn’t bet against him getting it done.

But for now, the pound is the worst performer of the session, and given today’s news, that should be no surprise. However, I maintain my view that current levels represent an excellent opportunity for payables hedgers to add to hedges.

The other mover of note in the G10 space is the yen, which has fallen 0.4% after traders were able to take advantage of a Japanese holiday last night (Coming-of-age Day) and the associated reduced liquidity to push the dollar above a key technical resistance point at 109.72. Stop-loss orders at that level led to a quick jump at 4:00 this morning, and given the broad risk-on attitude in markets (equity markets worldwide continue to rebound from concerns over further Middle East flare ups), it certainly feels like traders are going to push the dollar up to 110, a level not seen since May. However, the other eight currencies in the G10 have been unable to generate any excitement whatsoever and are very close to unchanged this morning.

In the EMG space, Indonesia’s rupiah is once again the leader in the clubhouse, rising a further 0.7% after the central bank reiterated it would allow the currency to appreciate and following an announcement by the UAE that it would make a large investment in the nation’s (Indonesia’s) sovereign wealth fund. The resultant rally, to the rupiah’s strongest level in almost a year, has been impressive, but there is no reason to believe that it cannot continue for another 5% before finding a new home. This is especially true if we continue to hear good things regarding the US-China trade situation. Trade has also underpinned the second-best performer of the day in this space, KRW, which has rallied 0.5%, on the trade story.

While those are the key stories thus far this session, we do have a full week’s worth of data to anticipate, led by CPI, Retail Sales and Housing data.

Tuesday NFIB Small Biz Optimism 104.9
  CPI 0.3% (2.4% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday PPI 0.2% (1.3% Y/Y)
  -ex food & energy 0.2% (1.3% Y/Y)
  Empire Manufacturing 3.5
  Fed’s Beige Book  
Thursday Initial Claims 218K
  Philly Fed 3.0
  Retail Sales 0.3%
  -ex autos 0.5%
  Business Inventories -0.1%
Friday Housing Starts 1380K
  Building Permits 1460K
  IP -0.1%
  Capacity Utilization 77.0%
  Michigan Sentiment 99.3
  JOLTS Job Openings 7.264M

Source: Bloomberg

So clearly there is plenty on the docket with an opportunity to move markets, and we also hear from another six Fed speakers. While you and I may be concerned about rising prices, it has become abundantly clear that the Fed is desperate to see them rise further, so the only possible reaction to a CPI miss would be on the weak side, which would likely see an equity rally on the assumption that even more stimulus is coming. Otherwise, I think Retail Sales will be the data point of choice for the market, with weakness here also leading to further equity strength on the assumption that the Fed will add to their current policy.

And it is hard to come up with a good reason for any Fed speaker to waver from the current mantra of no rate cuts, but ongoing support for the repo market and a growing balance sheet. And of course, that underlies my thesis that the dollar will eventually fall. Just not today it seems!

Good luck
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