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

Tremors of Dread

This weekend we learned nothing new
‘Bout what central bankers will do
As they look ahead
With tremors of dread
That QE’s a major miscue

There is a bit of a conundrum developing as headlines shout about a surge in new cases of the coronavirus at the same time that countries around the world continue to reopen from their previous lockdowns. It has become increasingly apparent that governments everywhere have determined that the economic damage of the shutdown in response to Covid now outweighs the human cost of further fatalities from the disease. Of course, three months on from when the epidemic really began to rage in the West, there is also a much better understanding of who is most vulnerable and how to maintain higher levels of safe behavior, notably social distancing and wearing masks. And so, while there are still extremely vocal views on both sides of the argument about the wisdom of reopening, it is very clear economies are going to reopen.

Meanwhile, central banks continue to bask in the glow of broadly positive press that their actions have been instrumental in propping up the stock market preventing an even greater contraction of economic activity than what has actually played out. The constant refrain from every central bank speaker has been that cutting rates and expanding their balance sheets has been very effective. Oh, they are also prepared to do even more of both if they deem such action necessary because it turns out it wasn’t effective.

However, despite these encomiums about central bank perspicacity, investors find themselves at a crossroads these days. Risk assets continue to perform extremely well overall, with stocks having recouped most of their losses from March, but haven assets continue to demonstrate significant concern over the future as long-term government bond yields continue to point to near-recessionary economic activity over the medium and long term. At the end of the day, however, I think the only universal truth is that the global economy, and certainly financial markets, have become addicted to QE, and the central banks are not about to stop providing that liquidity no matter what else happens.

On this subject, this morning we had two very different visions espoused, with BOE Governor Bailey explaining that when things get better, QT will be the first response, not a raising of rates. Of course, we all remember the “paint drying” effect of QT in the US in 2018, and how it turns out removing that liquidity is really hard without causing a financial earthquake. At the same time, the ECB’s Madame Lagarde and her minions have been enthusiastically describing just how proportionate their QE purchases have been in response to the German Constitutional Court ruling from last month. Frankly, it would be easy for the ECB to point out the proportionality of buying more Italian debt given there is much more Italian debt than any other type in the EU. But I don’t think that was the German court’s viewpoint. At any rate, there is no reason to expect anything but ongoing QE for the foreseeable future. In fact, the only thing that can stop it is a significant uptick in measured inflation, but that has not yet occurred, nor does it seem likely in the next couple of quarters. So, the presses will continue to roll.

With this as background, a turn to the markets shows a fairly benign session overall. Equity market in Asia were very modestly lower (Nikkei -0.2%, Hang Seng -0.5%, Shanghai flat) while European markets are also a touch softer (DAX -0.1%, CAC -0.2%, FTSE 100 flat) although US futures are pointing higher, with all three indices up about 0.75% as I type. Meanwhile, bond markets are also showing muted price action, although the tendency is toward slightly lower yields as Treasuries have decline 1bp and Bunds 2bps. While the direction here is consistent with a risk off session, the very slight magnitude of the moves makes it less convincing.

As to the dollar, it is definitely on its back foot this morning, falling against most G10 and many EMG currencies. Kiwi is atop the leaderboard this morning, rallying 0.6% with Aussie just behind at 0.5%, as both currencies recoup a bit of the past two week’s losses. In fact, that seems to be the story behind most of the G10 today, we are seeing a rebound from the dollar’s last two weeks of strength. The only exception is the yen, which is essentially unchanged, after its own solid recent performance, and NOK, which has edged lower by 0.15% on the back of a little oil price weakness.

In the EMG bloc, the picture is a bit more mixed with APAC currencies having suffered last night, led by KRW (-0.5%) as tensions with the North increase, and IDR (-0.35%) as the market demonstrated some concern over the future trajectory of growth and interest rates there. On the positive side, it is the CE4 that is showing the best gains today with PLN (+0.8%) far and away the best performer after posting a much better than expected Retail Sales number of +14.5%, which prompted the government to highlight the opportunity for a v-shaped recovery.

Looking ahead to data this week, nothing jumps out as likely to have a big impact.

Today Existing Home Sales 4.09M
Tuesday PMI Manufacturing 50.8
  PMI Services 48.0
  New Home Sales 635K
Thursday Initial Claims 1.35M
  Continuing Claims 19.85M
  Durable Goods 10.9%
  -ex transport 2.3%
  GDP Q1 -5.0%
Friday Personal Income -6.0%
  Personal Spending 8.8%
  Core PCE 0.0% (0.9% Y/Y)
  Michigan Sentiment 79.0

Source: Bloomberg

The thing about the PMI data is that interpretation of the data is more difficult these days as a rebound from depression levels may not be indicative of real strength, rather just less weakness. In fact, the bigger concern for policymakers these days is that the Initial Claims data is not declining very rapidly. After that huge spike in March, we have seen a substantial decline, but the pace of that decline has slowed alarmingly. It seems that we may be witnessing a second wave of layoffs as companies re-evaluate just how many employees they need to operate effectively, especially in a much slower growth environment. And remember, if employment doesn’t rebound more sharply, the US economy, which is 70% consumption based, is going to be in for a much longer period of slow or negative growth. I assure you that is not the scenario currently priced into the equity markets, so beware.

As to the dollar today, recent price activity has not been consistent with the historic risk appetite, and it is not clear to me which is leading which, stocks leading the dollar or vice versa. For now, it appears that the day is pointing to maintaining the overnight weakness, but I see no reason for this to extend in any major way.

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

Revert to the Mean

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

 

Depression’s Price In

As cities continue to burn
The stock market bears never learn
Depression’s priced in
And to bears’ chagrin
Investors have shown no concern

Once again risk is on fire this morning as every piece of bad news is seen as ancient history, riots across the US are seen as irrelevant and the future is deemed fantastic based on ongoing (permanent?) government economic support and the continued belief that Covid-19 has had its day in the sun and will soon retreat to the back pages. And while the optimistic views on government largesse and the virus’s retreat may be well founded, the evidence still appears to point to an extremely long and slow recovery to the global economy. Just yesterday, the Congressional Budget Office, released a report indicating it will take nearly ten years before GDP in the US will return to its previous trend growth levels. That hardly sounds like they type of economy that warrants ever increasing multiples in the stock market. But hey, I’m just an FX guy.

A look around the world allows us to highlight what seem to be the driving forces in different regions. There are two key assumptions underpinning European asset performance these days; the fact that the EU has finally agreed to joint financing of a budget and mutualized debt issuance and the virtual certainty that the ECB is going to increase the PEPP in their step tomorrow. The flaws in these theories are manifest, although, in fairness, despite themselves the Europeans have generally found a way to get to the goal. However, the EU financing program requires unanimous approval of all 27 members, something that will require a great deal of negotiation given the expressed adamancy of the frugal four (Austria, the Netherlands, Sweden and Denmark) who are not yet convinced that they should be paying for the spendthrift habits of their southern neighbors. And the problem with this is the amount of time it will take to finally agree. Given the urgent need for funding now, a delay may be nearly as bad as no support at all.

At the same time, the ECB, despite having spent only €250 billion of the original €750 billion PEPP monies are now assumed to be ready to announce a significant increase to the size of the program. Not surprisingly, members of the governing council who hail from the frugal four have expressed reluctance on this matter as well. However, after Madame Lagarde’s gaffe in March, when she declared it wasn’t the ECB’s job to protect peripheral nation bond markets (that’s their only job!) I expect that she will steamroll any objections and look for a €500 billion increase.

Clearly, traders and investors are on the same page here as the euro continues to rally, trading higher by 0.3% this morning (+4.2% since mid-May) and back above 1.12 for the first time since March. European equity markets are rocking as well, with the DAX once again leading the way, up 2.4%, despite a breakdown in talks between Chancellor Merkel’s CDU and its coalition partner SPD over the nature of the mooted €100 billion German support program. But the rest of Europe is flying as well, with the CAC up 2.0% and both Italy’s and Spain’s main indices higher by about 2.0%. European government bonds are sliding as haven assets are simply no longer required, at least so it seems.

Meanwhile, in Asia, we have seen substantial gains across most markets with China actually the laggard, essentially flat on the day. But, for example, Indonesia’s rupiah has rallied another 2.2% this morning after a record amount of bidding for a government bond auction showed that investors are clearly comfortable heading back to the EMG bloc again. The stock market there jumped 2.0% as well, and a quick look shows the rupiah has regained almost the entirety of the 22% it lost during the crisis and is now down just 1.6% on the year. What a reversal. But it is not just Indonesia that is seeing gains. KRW (+0.7%, -5.0% YTD), PHP (+0.5%, +1.1% YTD) and MYR (+0.35%, -4.0% YTD) are all gaining today as are their stock markets. And while both KRW and MYR remain lower on the year, each has recouped more than half of the losses seen at the height of the crisis.

So, the story seems great here as well, but can these nations continue to support their economies to help offset the destruction of the shutdowns? That seems to vary depending on the nation. South Korea is well prepared as they announced yet another extra budget to add stimulus, and given the country’s underlying finances, they can afford to do so. But the Philippines is a different story, with far less resources to support themselves, although they have availed themselves of IMF support. And Indonesia? Well, clearly, they have no problem selling bonds to investors, so for the short term, things are great. The risk to all this is that the timeline to recovery is extended far longer than currently perceived, and all of that support needs to be repaid before economic activity is back.

The point of all this is that while there is clearly a bullish story to be made for these markets, there are also numerous risks that the bullish case will not come to fruition, even with the best of intentions.

And what about the US? Looking at the stock market one would think that the economy is going gangbusters and things are great. But reading the news, with every headline focused on the ongoing riots across the nation and the destruction of property and businesses, it is hard to see how the latter will help the economy return to a strong pace of growth in the short run. If anything, it promises to delay the reopening of many small businesses and restaurants, which will only exacerbate the current economic malaise.

The other thing that seems out of step with the politics is the underlying belief that there will be another stimulus bill passed by Congress soon. While the House passed a bill several weeks ago, there has been no action in the Senate, nor does there seem to be appetite in the White House for such a bill at this time with both seeming to believe that enough has been done and ending the lockdowns and reopening businesses will be sufficient. But if there are riots in the streets, will ordinary folks really be willing to resume normal activities like shopping and eating out? That seems a hard case to make. While the cause of the riots was a tragedy, the riots themselves have created their own type of tragedy as well, the delay and destruction of an economic rebound. And that will not help anybody.

So, on a day where the dollar is under pressure across the board, along with all haven assets, we have a bit of data to absorb starting with the ADP Employment number (exp -9.0M) and then ISM Non-Manufacturing (44.4) and Factory Orders (-13.4%). The Services and Composite PMI data from Europe that was released earlier showed still awful levels but marginally better results than the preliminary reports. However, it is hard to look at Eurozone PMI at 31.9 and feel like the economy there is set to rebound sharply. Those levels still imply a deep, deep recession.

However, today is clearly all about adding risk to the portfolio, and that means that equities seem likely to continue their rally while the dollar is set to continue to decline. For receivables hedgers, I think we are getting to pretty interesting levels. If nothing else, leave some orders a bit above the market to take advantage.

Good luck
Adf

 

Undeterred

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

Good luck and stay safe
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Overkill

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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To Aid and Abet

The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
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A Bit Out of Sorts

The ECB stepped to the plate
Effectively cutting the rate
At which it will lend
To help countries spend
As well, to help prices inflate

But last night some earnings reports
Put traders a bit out of sorts
And too, from Down Under
It’s really no wonder
The data inspired some shorts

With many markets globally closed today for the May Day holiday, one would have expected fairly limited price action overall. One would have been wrong. In fact, despite the best efforts of the ECB yesterday to demonstrate further support for the European economies, it turns out that disappointing data has suddenly been recognized. This data story started last evening with key Tech earnings reports from two of the FAANG stocks, both disappointing on the profit side and calling into question the ability of even these companies to be able to withstand the remarkable demand shrinkage caused by Covid-19.

Then, though most of Asia was closed for the holiday, Australia (Manufacturing Index) and New Zealand (Consumer Confidence) both reported weaker than expected economic data. Suddenly, it seems that data was an important issue for markets, a change of recent heart. And there is one more thing to remember, the calendar turned the page. The calendar matters because, especially given the remarkable price action in April, there was a significant amount of month-end rebalancing in institutional portfolios. Remember, we saw a sharp rally in stocks, so it should be no surprise that they were sold off in order for portfolios to get back to desired asset allocations.

Taking it all together resulted in some serious equity market declines in the few markets open overnight, with the Nikkei (-2.85%) and Australia’s ASX 200 (-5.0%) putting in truly awful performances. Meanwhile, in Europe, only the FTSE 100 is trading today, and it is lower by 2.1%. US futures are following suit, currently down around 2.0% across the board.

So, what of the ECB’s actions? Well, they effectively cut interest rates by lowering the rate at which TLTRO funds are borrowed by 0.25%, to -0.25%. That means that Eurozone banks which lend new money to companies can earn to fund themselves. A pretty sweet deal if they charge a positive rate on the loans. In addition, they created yet another loan program, the PELTRO, which has even lower rates, as low as -1.0% funding costs for banks lending under this criterion. Of course, the problem remains that while many companies may borrow in order to try to get through the current ceasing of activity, future growth opportunities will simply be further hindered by the additional debt on corporate balance sheets. Two other things of note from the ECB are that they did not increase their QE programs as there remains considerable concern that the German Constitutional Court may rule next week that QE is illegal, essentially funding governments throughout the Eurozone, and that will call into question everything they have done. The second was the dire forecast from Madame Lagarde that Eurozone growth could see GDP shrink 12% in 2020, which if you consider yesterday’s Q1 data (-3.8% Q/Q) implies a modest rebound by year end.

Turning to the FX markets, it can be no surprise that both AUD (-1.0%) and NZD (-0.8%) are the worst performing currencies in the G10 space. Not only did both report lousy data, but both (AUD +17%, NZD +13%) have been rallying pretty steadily since their nadir on March 19. Thus, if the paradigm is changing back to the future is not as bright, I would look for both these currencies to give up much of last month’s rally. Meanwhile, the oil proxies, CAD (-0.6%) and NOK (-0.7%) are both suffering from oil’s modest declines this morning, with WTI ceding about 2.0% of its recent spectacular gains. After all, even ignoring the odd dip into negative territory two weeks ago, oil has rallied more than 200% since that fateful day, based on the June WTI contract. On the plus side, we see JPY (+0.35%) on what appears to be a modest risk-off trade, leading the way higher, with the rest of the bloc +/- 0.2% and lacking any new information.

EMG currencies have been largely spared movement overnight as the APAC bloc was closed for the holiday although CNH has managed to fall 0.6% in the absence of a domestic market. The three main deliverable EMG currencies, MXN (-1.4%), ZAR (-1.4%) and TRY (-0.7%) have a decidedly risk-off tone to their price action, with the peso being truly impressive. Since Tuesday, we have seen MXN first rally 5.0% then decline 4.1% from its peak. Net it is stronger, but the current trend seems to point to further weakness. Again, if the risk appetite from April begins to wane further, these currencies have the opportunity to fall significantly.

On the data front, this morning brings Construction Spending (exp -3.5%) and ISM Manufacturing (36.0) with the Prices Paid (33.0) and New Orders (30.0) indices looking equally dire. Yesterday we learned that Personal Income fell sharply, and Personal Spending fell even more sharply, a record-breaking 7.5% decline. Initial Claims data was a touch weaker than the median forecast at 3.84M with Continuing Claims (which lag the Initial claims data by a week) not rising quite as much as expected, to ‘just’ 18.0M.

Ultimately, the history of Covid-19’s impact will be written as the most extraordinary destruction of demand in history. The US (and global) economy had evolved from a manufacturing base a century ago, to a service-based economy par excellence. Nobody considered what shelter-in-place and social distancing would do to that construct. It is becoming increasingly clear that the answer to that is those restrictions will cause extreme economic damage that is likely to take several years to recoup. Alas, we are not done with this disease, and the restrictions will continue to wreak havoc on the global economy, and asset values, for a while yet. We have not seen the last of risk-off, nor the last of the dollar’s strength.

Good luck, good weekend and stay safe
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Riven By Obstinacy

Said Jay, in this challenging time
Our toolkit is truly sublime
It is our desire
More bonds to acquire
And alter the Fed’s paradigm

In contrast, the poor ECB
Is riven by obstinacy
Of Germans and Dutch
Who both won’t do much
To help save Spain or Italy

Is anybody else confused by the current market activity? Every day reveals yet another data point in the economic devastation wrought by government efforts to control the spread of Covid-19, and every day sees equity prices rally further as though the future is bright. In fairness, the future is bright, just not the immediate future. Equity markets have traditionally been described as looking forward between six months and one year. Based on anything I can see; it is going to take far more than one year to get global economies back to any semblance of what they were like prior to the spread of the virus. And yet, the S&P is only down 9% this year and less than 13% from its all-time highs set in mid-February. As has been said elsewhere, the economy is more than 13% screwed up!

Chairman Powell seems to have a pretty good understanding that this is going to be a long, slow road to recovery, especially given that we have not yet taken our first steps in that direction. This was evidenced by the following comment in the FOMC Statement, “The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” (My emphasis.) And yet, we continue to see equity investors scrambling to buy stocks amid a great wave of FOMO. History has shown that bear markets do not end in one month’s time and I see no reason to believe that this time will be different. I don’t envy Powell or the Fed the tasks they have ahead of them.

So, let’s look at some of the early data as to just how devastating the response to Covid-19 has been around the world. By now, you are all aware that US GDP fell at a 4.8% annualized rate in Q1, its sharpest decline since Q4 2008, the beginning of the GFC. But in truth, compared to the European data released this morning, that was a fantastic performance. French Q1 GDP fell 5.8%, which if annualized like the US reports the data, was -21.0%. Spanish Q1 GDP was -5.2% (-19.0% annualized), while Italy seemed to have the best performance of the lot, falling only 4.8% (-17% annualized) in Q1. German data is not released until the middle of May, but the Eurozone, as a whole, printed at -3.8% Q1 GDP. Meanwhile, German Unemployment spiked by 373K, far more than forecast and the highest print in the history of the series back to 1990. While these were the highlights (lowlights?), the story is uniformly awful throughout the continent.

With this in mind, the ECB meets today and is trying to determine what to do. Last month they created the PEPP, a €750 billion QE program, to support the Eurozone economy by keeping member interest rates in check. But that is not nearly large enough. After all, the Fed and BOJ are at unlimited QE while the BOE has explicitly agreed to monetize £200 billion of debt. In contrast, the ECB’s actions have been wholly unsatisfactory. Perhaps the best news for Madame Lagarde is the German employment report, as Herr Weidmann and Frau Merkel may finally recognize that the situation is really much worse than they expected and that more needs to be done to support the economy. Remember, too, that Germany has been the euro’s biggest beneficiary by virtue of the currency clearly being weaker than the Deutschemark would have been on its own and giving their export industries an important boost. (I am not the first to notice that the euro’s demise could well come from Germany, Austria and the Netherlands deciding to exit in order to shed all responsibility for the fiscal problems of the PIGS. But that is a discussion for another day.)

The consensus is that the ECB will not make any changes today, despite a desperate need to do more. One of the things holding them back is an expected ruling by the German Constitutional Court regarding the legality of the ECB’s QE programs. This has been a bone of contention since Signor Draghi rammed them through in 2012, and it is not something the Germans have ever forgiven. With debt mutualization off the table as the Teutonic trio won’t even consider it, QE is all they have left. Arguably, the ECB should increase the PEPP by €1 trillion or more in order to have a truly positive impact. But thus far, Madame Lagarde has not proven up to the task of forcing convincing her colleagues of the necessity of bold action. We shall see what today brings.

Leading up to the ECB announcement and the ensuing press briefing, Asian equity markets followed yesterday’s US rally higher, although early gains from Europe have faded since the release of the sobering GDP data. US futures have also given back early gains and remain marginally higher at best. Bond markets are generally edging higher, with yields across the board (save Italy) sliding a few bps, and oil prices continue their recent rebound, although despite some impressive percentage moves lately, WTI is trading only at $17.60/bbl, still miles from where it was at the beginning of March.

The dollar, in the meantime, remains under pressure overall with most G10 counterparts somewhat firmer this morning. The leaders are NOK (+0.45%) on the strength of oil’s rally, and SEK (+0.4%) which seems to simply be continuing its recent rebound from the dog days of March. Both Aussie and Kiwi are modestly softer this morning, but both of those have put in stellar performances the past few days, so this, too, looks like position adjustments.

In the EMG bloc, IDR was the overnight star, rallying 2.8% alongside a powerful equity rally there, as investors who had been quick to dump their holdings are back to hunting for yield and appreciation opportunities. As markets worldwide continue to demonstrate a willingness to look past the virus’s impact, there are many emerging markets that could well see strength in both their currencies and stock markets. The next best performers were MYR (+1.0%) and INR (+0.75%), both of which also responded to a more robust risk appetite. As LATAM has not yet opened, a quick look at yesterday’s price action shows BRL having continued its impressive rebound, higher by 3.0%, but strength too in CLP (+2.9%), COP (+1.2%) and MXN (2.5%).

We get more US data this morning, led by Initial Claims (exp 3.5M), Continuing Claims (19.476M), Personal Income (-1.5%), Personal Spending (-5.0%) and Core PCE (1.6%) all at 8:30. Then, at 9:45 Chicago PMI (37.7) is due to print. As can be seen, there is no sign that things are doing anything but descending yet. I think Chairman Powell is correct, and there is still a long way to go before things get better. While holding risk seems comfortable today, look for this to turn around in the next few weeks.

Good luck and stay safe
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