Growth’s Embers

Said Madame Lagarde, come December
There’s something you all must remember
It’s not ‘bout the size
But how we comprise
Our policy to fan growth’s embers

For a consensus driven institution, the ECB is, apparently, finding it pretty hard to arrive at a consensus on what the promised policy expansion should contain.  You may recall that at their meeting in late October, the ECB appeared pretty explicit that they would be increasing monetary support at the upcoming meeting.  The narrative quickly developed that another €500 billion of PEPP purchases would be appropriate, although there were some ideas that the ECB could expand the APP, their original QE program.  With this in mind, it is crucial to remember that markets typically take the most simplistic approach toward any analysis, and so respond to numbers.  Subtleties are either misunderstood or ignored by the trading community as they require far too much time to appreciate before responding.  After all, it is much easier for algorithms (and traders) to be programmed to buy on a large number and sell on a small number than to dig into the meaning of the words offered up by the ECB.

Keeping this in mind, it is quite interesting that recently, we have started to hear from numerous ECB members that the size of the program adjustments are not as important as their nature.  (Now where have we heard that before?)   Just this morning, Madame Lagarde herself was quoted as follows, “What is really important is that we make sure that the financing conditions are stable, are conducive to economic recovery as it comes.”  She also emphasized that “[market participants must] not only know that the level of financing is going to be there, but that it will be available for a period for time that will last long enough.”  Reading between the lines, this sounds like the mooted €500 billion expansion that has been the market baseline premise since the October meeting, is not going to be realized.  Looking back over the past week, comments from numerous other ECB members, including Chief Economist Philip Lane, as well as Finland’s Olli Rehn, Belgium’s Yves Mersch and Spain’s Pablo Hernandez de Cos have also highlighted that size doesn’t matter, but instead it is the nature and duration of the program that is important.

What are we to make of this change in emphasis?  Initially there are two conclusions that can be drawn.  First, some of the more hawkish members of the ECB; Germany, Austria and the Netherlands most likely, have made it clear that they don’t want to see an unlimited amount of asset purchases as those three nations still believe that central bank financing of government spending is a bad idea.  Thus, the fact that central bankers from more dovish countries are trying to temper expectations is playing to the hawks.

But there is another, more intriguing possibility, and that is that the ECB, who has been terrified of an overly strong euro, has realized that the Chinese renminbi’s consistent strength vs. the dollar (+8.6% since late May) has now been sufficient to offset the euro’s appreciation since that same time.  Essentially, the euro saw a very sharp rise from May through August but has been biding its time since then while the renminbi has been steadily climbing almost every day.  The point is, on a trade-weighted basis, the euro is no longer nearly as strong as it was in August, and so if EURUSD rises a bit further, the ECB may not be too troubled.  This is not to imply that they will be happy to see the euro go screaming up through 1.25 anytime soon, but if it trades to 1.20 or 1.21, it will probably not be ringing alarm bells.

Putting it all together leads me to believe that the ECB no longer is feeling quite as stressed about the euro’s strength vs. the dollar this summer, and so does not feel compelled to increase QE by that much in order to prevent a further rise.  The $2.2 trillion question (that is roughly the amount of EURUSD transacted each day according to the BIS) is, if the ECB disappoints the narrative, despite their claims, and the euro rallies sharply, what will they do then?  Poor Christine already has enough trouble speaking to the market effectively.  If this message gets muddled, it will really create problems, as well as the chance for an emergency program early next year.

With that in mind, let’s look at today’s activities.  After a modest sell-off in the US yesterday, Asia had another mixed session with the Nikkei (-1.1%) falling for a second day after its long run of gains, while the Hang Seng (+0.5%) and Shanghai (+0.2%) both finished with small pluses.  The European markets are all green, but the movement has been de minimis, with the DAX and CAC (+0.2% each) essentially leading the way while the FTSE 100 is simply flat.  Certainly, there is no massive risk-on attitude apparent.  Finally, US futures are all modestly higher at this hour, but 0.2% is a good description here as well.

Bond markets are also fairly muted this morning with Treasury yields essentially unchanged, having retraced half of the vaccine related movement of the past week.  European markets are similarly little changed, except for Greek bonds, where yields have fallen nearly 5 basis points.  But the rest of the curve is within one basis point of yesterday’s levels.  Again, it is hard to discern much risk attitude here.

Oil prices have pushed higher by 1% this morning but have not yet reclaimed the heights seen in the wake of the vaccine announcement.  Gold, meanwhile, has been wandering aimlessly of late, although there is a growing hubbub about Bitcoin, which has traded to $18k this morning.

Finally, to the dollar, which is clearly under pressure virtually across the board this morning.  In the G10 space, NOK (+0.55%) is the leader, following oil prices higher as ongoing enthusiasm over a vaccine driven recovery continues to be felt.  But we are seeing gains in SEK (+0.4%), once again showing its deserved status as a high beta currency, and JPY (+0.2%), which has recouped more than half of its very sharp decline seen last Monday in the wake of the first vaccine announcement.  As this doesn’t appear to be a risk-off scenario, I would attribute the yen’s gains more to the dollar’s broad weakness than anything else.  However, do not be surprised if we test, and this time break, 103.00 before too long.

Emerging market currencies are also broadly stronger, but the movement has been fairly contained.  Leading the pack is CLP (+0.7%) as copper prices are benefitting from the vaccine enthusiasm, as well as RUB (+0.6%) on the back of oil’s strength.  After that, the gains are far less impressive, but they are evident across all three major blocs.  On the downside, today’s notable loser is THB (-0.5%) as the central bank there commented on the baht’s recent strength (+3.0% in the past two weeks) and is set to unveil a package to rein in that strength.

On the data front, yesterday saw weaker than expected Retail Sales numbers here in the States, although that didn’t have much impact on things.  Overnight we have seen CPI data from Europe, which was largely in line with expectations and remains right near 0.0%.  This morning brings Housing Starts (exp 1460K) and Building Permits (1567K), which also seem unlikely to have much impact.  Four more Fed speakers are on the docket, but unlike the ECB, there doesn’t seem to be much disagreement on what needs to be done in the US (more fiscal stimulus, please!)

And that’s it really.  The dollar’s weakness feels a bit overdone in the very short term, but with this new attitude by the ECB, if I am correct, an eventual grind toward 1.21 seems possible.  However, do not mistake that for a dollar collapse in any way, shape or form.

Good luck and stay safe
Adf

More Money They’ll Print

While stock markets make all-time highs
The world’s central banks still advise
More money they’ll print
In case there’s a hint
That prices will simply not rise

In a chicken and egg type question, it is worth asking; is the fact that equity markets continue to rally (yet another all-time high was recorded yesterday, this time by the Dow) despite the fact that economies worldwide remain in chaos and operating at a fraction of their capacity, as governments impose another wave of lockdowns throughout Europe, the UK and many US states, logical?  Obviously, the link between those dichotomous outcomes is the support provided by the central banking community.  Perhaps the way to frame the question is, if markets have already seen past the end of the pandemic, and are willing to fund the business community right now, why do central banks feel they need to, not merely continue with their programs, but promise to increase them going forward?

This was made clear, yet again, when Fed Vice-Chair, Richard Clarida, explained that the FOMC is carefully evaluating the current situation and will not hesitate to use all available tools to help support the economy.  The punditry sees this as a code for an increase in the size of the asset purchase program, from the current $120 billion each month (split $80 billion Treasuries and $40 billion mortgages) to as much as $160 billion each month, with the new money focused on Treasuries.  At the same time, ECB Chief Economist, Philip Lane, explained that the central bank will provide enough monetary stimulus to make sure governments, companies and households have access to cheap credit throughout the coronavirus crisis.

And perhaps, that is the crux of the problem we face.  Despite investor optimism that the future is bright, and despite central banks’ proven inability to get funding to those most in need, namely individual households, those same central banks continue to do the only thing they know how to do, print more money, and by extension fund governments and large companies, who already have access to funding.  As the saying goes, the rich get richer.

The cycle goes as follows: central banks cut interest rates => investors move out the risk curve seeking returns => corporations and governments issue more debt at cheaper levels => an excess (and ultimately unsustainable) amount of debt outstanding.  Currently, that number, globally, is approaching 400% of GDP, and on current trends, has further to go.  The problem is, repayment of this debt can only be achieved in one of two ways, realistically, neither of which will be pleasant.  Either, inflation actually begins to rise sufficiently to diminish the real value of the debt or we get to a debt jubilee, where significant portions are simply written off.

If you were ever wondering why central banks are desperate for higher inflation, this is your answer.  While they are mostly economists, they still recognize that inflation is exactly the kind of debt destructive force necessary to eventually balance the books.  It will take time, even if they can manage the rate of inflation, but their firmly held belief is if they could just get inflation percolating, all that debt would become less of a problem.  At least for the debtors. Creditors may not feel the same excitement.

On the other hand, the debt jubilee idea is being bandied about in many forms these days, with the latest being the cancellation of student debt outstanding.  That’s $1.6 trillion that could be dissolved with the signing of a law.  Now, who would pay for that?  Well, I assure you it is not a free lunch.  In fact, the case could be made that it is this type of action that will lead to the central banks’ desired inflation outcome.  Consider, wiping out that debt would leave $1.6 trillion in the economy with no corresponding liabilities.  That’s a lot of spending power which would suddenly be used to chase after a still restricted supply of goods and services.  And that is just one small segment of the $100’s of trillions of dollars of debt outstanding.  The point is, there are still many hard decisions yet to be made and there are going to be winners and losers based on those decisions.  Covid-19 did not cause these issues to arise, it merely served as a catalyst to make them more widely known, and potentially, will push us toward the endgame.  Be prepared!

But that is all just background information to help us try to understand market activity a bit better.  Instead, let’s take a look at the market today, where yesterday’s risk appetite seems to have developed a bit of indigestion.  Overnight saw a mixed equity picture (Nikkei +0.4%, Hang Seng +0.1%, Shanghai -0.2%) with the magnitude of movements more muted than recent activity.  Europe, on the other hand, has been largely in the red (DAX -0.35%, CAC -0.3%, FTSE -1.15%) as apparently Mr Lane’s comments were not seen as supportive enough, or, more likely, markets are simply overbought after some enormous runs this month, and are seeing a bit of profit taking.  US futures are mixed at this point, with the DOW and S&P both down -0.5%, while the NASDAQ is up about 0.3%.  The biggest stock market story is S&P’s decision to add Tesla to the S&P500 index starting next month, which has helped goose the stock higher by another 10%.

Bond markets this morning are a tale of three regions.  Asian hours saw Australian and New Zealand bonds fall sharply with 10-year yields rising about 7 basis points, as the RBA’s YCC in the 3-year space is starting to really distort markets there.  However, in Europe, we are seeing a very modest bond rally, with yields slightly softer, about 1 basis point throughout the continent, and Treasuries have seen yields slip 1.5 basis points so far in the session. Clearly, a bit of risk-off attitude here.

FX markets, however, are not viewing the world quite the same way as the dollar, at least vs. its G10 counterparts, is somewhat softer, although has seen a more mixed session vs. EMG currencies.  Leading the way in the G10 is GBP (+0.5%) as stories make the rounds that a Brexit deal will be agreed next week.  Now, they are just stories, with no official comments, but that is the current driver.  Next in line is JPY (+0.3%) which perhaps we can attribute to a risk-off attitude, especially as CHF (+0.25%) is moving the same way.  As to the rest of the bloc, gains have been much smaller, and there has been absolutely zero data released this morning.

In the EMG bloc, EEMEA currencies have been the weak spot, with HUF (-0.5%) the worst performer, although weakness in PLN (-0.3%) and RUB (-0.25%) is also clear.  This story has to do with the Hungarian and Polish vetoes of the EU budget and virus recovery fund, as they will not accept the rule of law conditions attached by Brussels.  You may have heard about the concerns Brussels has over these two nations move toward a more nationalist viewpoint on many issues like immigration and judicial framework, something Brussels abhors.  On the positive side, BRL (+0.5%) has opened strongly, and CNY (+0.45%) led the Asian bloc higher overnight.  The China story continues to focus on the apparent strength of their economic rebound as well as the fact that interest rates there are substantially higher than elsewhere in the world and drawing in significant amounts of investor capital.  As to BRL, it seems the central bank has hinted they will be increasing the amount of dollars available to the market, thus adding to pressure on the dollar.

On the data front, yesterday saw a weaker than expected Empire Mfg number, but this morning is really the week’s big number, Retail Sales (exp 0.5%, 0.6% ex autos) as well as IP (1.0%) and Capacity Utilization (72.3%) a little later. On the Fed front, we have Chairman Powell speaking at 1:00, but not a speech, part of a panel, as well as another five Fed members on the tape at 3:00.  However, I anticipate the only thing we will learn is that the entire group will back up Vice-Chair Clarida regarding additional actions.

Despite the lack of risk appetite, the dollar is on its back foot this morning.  Ironically, I expect that we will see a rebound in risk appetite, rather than a rebound in the dollar as the session unfolds.

Good luck and stay safe
Adf

Aged Like Bad Wine

While Veterans here are recalled
And politics has us enthralled
The dollar’s decline
Has aged like bad wine
With strategies soon overhauled

US markets are closed today in observance of the Veteran’s Day holiday, but the rest of the world remains at work.  That said, look for a far less active session than we have seen recently.  In the first place, with the Fed on holiday, the Treasury market is closed and price action there has been one of the biggest stories driving things lately.  Secondly, while US equity futures markets are trading, all three stock exchanges are closed for the day, so the opportunity for individual company excitement is absent.  And finally, with today being an official bank holiday, while FX staff will be available, staffing will be at skeleton levels and come noon in New York, when London goes home, things here will slow to a standstill.

However, with that as a caveat, the world continues to turn.  For instance, while last week saw meetings in three key central banks, with two of them (RBA and BOE) explaining that easier monetary policy was in store, although the Fed made no such claims, last night saw the smallest of G10 nations, New Zealand, make headlines when the RBNZ explained that they were not changing policy right now, but that the economy there has been far more resilient than expected and they would not likely need to ease monetary policy any further.  It should be no surprise that the market responded by selling New Zealand government bonds (10-year yields rose 14.5 basis points), while overnight rates rose 16 basis points and traders removed all expectations for NIRP. QED, the New Zealand dollar is today’s best performer, rising 0.8%.

Sticking with the central bank theme, and reinforcing my view that the dollar’s decline has likely run its course broadly, although certainly individual currencies can strengthen based on country specific news, were comments from the Bank of Spain’s chief economist, Oscar Arce, explaining that the ECB must do still more to combat the threat of deflation in the Eurozone and that the December meeting will bring an entirely new discussion to the table.  The takeaway from the ECB meeting two weeks ago was that they would be expanding their stimulus programs in December.  Literally every comment we have heard from a European banking official in the interim has, not merely reinforced this view, but has implied that actions then will be massive.

I will repeat my strongly held view that the ECB will not, nay cannot, allow the euro to rise very far in their efforts to reboot the Eurozone economy.  Remember, one of the major benefits expected from easing monetary policy is a weakening of the currency.  When an economy is struggling with growth and deflation issues, as the Eurozone is currently struggling, a weak currency is the primary prescription to fix things.  You can be certain that every time the euro starts to rally near 1.20, which seems to be their tolerance zone, we will hear even more from ECB members about the additional easing in store as Madame Lagarde does her level best to prevent a euro rally.  And if the euro declines, so will the CE4 as well as the pound, Swiss franc and the Scandies.  In other words, the dollar is unlikely to decline much further than we have already seen.

In truth, those are the most noteworthy stories of the session so far.  Virtually every other headline revolves around either the ongoing election questions in the US, both the contestation of the presidential outcome and the upcoming run-off elections in Georgia for two Senate seats and control of the Upper House, or the vaccine and how quickly it can be approved and then widely distributed.

So, a quick look around markets this morning shows that risk appetite is moderate, at best.  For instance, equity markets in Asia were mixed with the Nikkei (+1.8%) continuing its recent strong run, up more than 10% this month, but the Hang Seng (-0.3%) and Shanghai (-0.5%) couldn’t find the same support.  Europe, on the other hand, is all in the green, but the movement is pretty modest with the FTSE 100 (+0.7%) the leader and both the DAX and CAC up just 0.4% at this hour.  US futures, which are trading despite the fact that equity markets here will be closed today, are all higher as well, with the NASDAQ (+1.0%) leading the way after having been the laggard for the first part of the week, while the other two are showing solid gains of 0.65%.

Bond markets in Europe are rising slightly, with yields slipping between 1 and 3 basis points on prospects for further ECB policy ease courtesy of Senor Arce as highlighted above, as there was no new economic data nor other statements of note.  As I mentioned, the Treasury market will be closed today for the holiday.

But commodity markets continue to perform well, with oil prices higher yet again, this morning by 3.2% taking the gains this week to 15%!  Metals prices, both base and precious, are also firmer as the vaccine news continues to spread good cheer regarding economic prospects going forward.

And finally, the dollar is best described as mixed to stronger.  For instance, against its G10 brethren, only NZD is firmer, as explained above.  But the rest of the bloc is softer led by NOK (-0.65%) and EUR (-0.4%).  While the euro makes sense given the Arce comments and growing belief that the ECB will really be aggressive next month, with oil’s sharp rebound, one must be surprised at the krone’s performance.  In fact, this merely reinforces my view that as the euro goes (lower) it will drag many currencies along for the ride.

However, in the EMG bloc, movement has been pretty even (excepting TRY) with a few more losers than gainers, but generally speaking, no really large movement.  On the plus side we see THB (+0.5%) and KRW (+0.45%) leading while on the downside it is MXN (-0.6%) and HUF (-0.45%) in the worst shape.  Looking a bit more deeply, the baht has been rallying all quarter and we may be looking at the last hurrah as the government has asked the BOT to manage the currency’s strength in order to help export industries compete more effectively.  Meanwhile, the won was the beneficiary of a significant jump in preliminary export data, with a 20.1% Y/Y gain for the first ten days of November auguring well for the economy.  Meanwhile, on the downside, the peso, which would have been expected to rally on the back of oil prices, is actually serving as a proxy for Peruvian risk as the impeachment of the president there Monday night has thrown the nation into turmoil and investors are seeking a proxy that is more liquid than the sol.  As to HUF, it is simply tracking the euro’s decline, and we can expect to see the same behavior for the entire CE4 bloc.

And that’s really it for today.  There is no news and no scheduled speakers and the session will be short.  But the dollar is edging higher, so keep that in mind.

Good luck and stay safe
Adf

Growth’s Pace Declining

Lagarde said, ‘what we have detected’
“More rapidly than [we] expected”
Is growth’s pace declining
And so, we’re designing
New ways for cash to be injected

The pundits were right about the ECB as they left policy unchanged but essentially promised they would be doing more in December.  In fact, Madame Lagarde emphasized that ALL their tools were available, which has been widely interpreted to mean they are considering a cut to the deposit rate as well as adding to their QE menu of APP, PEPP and TLTRO programs.  Interviewed after the meeting, Austrian central bank president, Robert Holtzmann, generally considered one of the most hawkish ECB members, confirmed that more stimulus was coming, although dismissed the idea of an inter-meeting move.  He also seemed to indicate that a further rate cut was pointless (agreed) but that they were working on even newer tools to utilize.  Meanwhile, Lagarde once again emphasized the need for more fiscal stimulus, which has been the clarion call of every central banker in the Western world.

As an aside, when considering central bank activities during the pandemic, the lesson we should have learned is; not only are they not omnipotent, neither are they independent.  The myth of central bank independence is quickly dissipating, and arguably the consequences of this process are going to be long-lasting and detrimental to us all.  The natural endgame of this sequence will be central bank financing of government spending, a situation which, historically, has resulted in the likes of; Zimbabwe, Venezuela and the Weimar Republic.

Now, back to our regularly scheduled programming.

Meanwhile, this morning brought the first set of European GDP data, following yesterday’s US Q3 print.  By now, you have surely heard that the US number was the highest ever recorded, +33.1% annualized, which works out to about +7.4% rise in the quarter.  While this was slightly better than expected, it still leaves the economy about 8.7% below its pre-Covid levels.  As to Europe, France (+18.2%), Germany (+8.2%), Italy (+16.1%) and the Eurozone as a whole (+12.7%) all beat expectations.  On the surface this all sounds great.  Alas, as we have discussed numerous times in the past, GDP data is very backward looking.  As we finish the first month of Q4, with lockdowns being reimposed across most of Europe, it is abundantly clear that Q4 will not continue this trend.  Rather, the latest forecasts are for another negative quarter of growth, adding to the woes of the global economy.

Keeping yesterday’s activities in mind, it cannot be surprising that the euro was the weakest performer around.  In fact, other than NOK, which suffered from the sharp decline in oil prices, even the Turkish lira outperformed the single currency.  If the ECB is promising to open the taps even wider than they are already, the euro has further to fall.  This has been my rebuttal to the ‘dollar is going to collapse’ crowd all along; whatever you think the Fed will do, there is literally a zero probability that the ECB will not respond in kind.  Europe cannot afford for the euro to strengthen substantially, and the ECB will do everything in its power to prevent that from happening, right up to, and including, straight intervention in the FX markets should the euro trade above some fail-safe level.  As it is, we are nowhere near that situation, but just remember, the euro is capped.

Turning to markets this morning, risk appetite remains muted, at best.  Asian equity markets ignored the US rebound and sold off across the board with the Hang Seng (-1.95%) leading the way lower, but closely followed by both the Nikkei and Shanghai, at -1.5% each.  European markets are trying to make the best of the GDP data, as well as the idea that the ECB is going to offer support, but that has resulted in a lackluster performance, which is, I guess, better than a sharp decline.  The DAX (-0.4%) and FTSE 100 (-0.35%) are both under a bit more pressure than the CAC (+0.1%), but the French index is hardly inspiring.  As to US futures, the screen is dark red, with all three futures gauges down about 1.0% at this hour.  One other thing to watch here is the technical picture.  US equity markets certainly appear to have put in a short-term double top, which for the S&P 500 is at 3600.  Care must be taken as many traders will be looking to square up positions, especially given that today is month end, and a break of 3200, which, granted, is still 3% away, could well open up a much more significant correction.

Once again, bond market behavior has been out of sync with stocks as in Europe this morning we see bonds under some pressure and yields climbing about 1 basis point in most jurisdictions despite the lackluster equity performance.  And despite the virtual promise by the ECB to buy even more bonds. Treasuries, meanwhile, are unchanged this morning, but that is after a sharp price decline (yield rally) yesterday, which took the 10-year back to 0.82%.  With the US election next week, it appears there are many investors who are reducing exposures given the uncertainty of the outcome.  But, other than a strong Blue wave, where market participants will assume a massive stimulus bill and much steeper yield curve, the chance for a more normal risk-off performance in Treasuries, seems high.  After all, while growth in Q3 represented the summer reopening of the economy, we continue to hear of regional shutdowns in the US as well, which will have a detrimental impact on the numbers.

And lastly, the dollar, which today is mixed to slightly softer.  Of course, this is after a week of widespread strength.  In fact, the only G10 currency that outperformed the greenback this week is the yen, which remains a true haven in most participants’ eyes.  Today, however, we are seeing SEK (+0.4%) leading the way higher followed by GBP (+0.3%) and NOK (+0.2%).  Nokkie is consolidating its more than 3% losses this week and being helped by the fact that the oil price, while not really rallying, is not falling either.  The pound, too, looks to be a trading bounce, as it fell sharply yesterday, and traders have taken the Nationwide House price Index data (+5.8% Y/Y) as a positive that the economy there is not collapsing.  Finally, SEK seems to be benefitting from the fact that Sweden is not being impacted as severely by the second wave of the virus, and so, not forced to shut down the economy.

In the emerging markets, the picture is mixed, with about a 50:50 split in performance.  Gainers of note are ZAR (+0.7%), which seems to be a combination of trading rebound and the benefit from gold’s modest rebound, and CNY (+0.4%), which continues to power ahead as confidence grows that the Chinese economy is virtually back to where it was pre-pandemic.  On the downside, TRY (-0.5%) continues to be troubled by President Erdogan’s current belligerency to the EU and the US, as well as his unwillingness to allow the central bank to raise rates.  Meanwhile, RUB (-0.35%) is continuing its weeklong decline as, remember, Russia continues to get discussed as interfering in the US elections and may be subject to further sanctions in their wake.

Once again, we have important data this morning, led by Personal Income (exp +0.4%) and Personal Spending (+1.0%); Core PCE (1.7% Y/Y); Chicago PMI (58.0) and Michigan Sentiment (81.2).  Arguably, the PCE data is what the Fed will be watching.  It has been rising rapidly, although this month saw CPI data stall, and that is the expectation here as well.  Now, the Fed has been pretty clear that inflation will have to really pick up before they even think about thinking about raising rates, but that doesn’t mean they aren’t paying attention, nor that the market won’t respond to an awkwardly higher print.  If inflation is running hotter than expected, it has the potential to mean the Fed will be less inclined to ease further, and that is likely to help the dollar overall.  However, barring a sharp equity market decline today, and given the dollar’s strength all week, I expect we will see continued consolidation with very limited further USD strength.

Good luck, good weekend and stay safe
Adf

QE’s Not Constrained

For everyone who seems to think
The dollar will steadily sink
This weekend disclosed
The world is opposed
To letting the buck’s value shrink

In China they eased the restrictions
On short sales in all jurisdictions
While Europe explained
QE’s not constrained
And further rate cuts are not fictions

It cannot be a surprise that we are beginning to see a more concerted response to dollar weakness from major central banks.  As I have written consistently, at the current time, no nation wants their currency to be strong.  Each is convinced that a weak currency will help obtain the twin goals of improved export performance leading to economic growth and higher inflation.  While financial theory does show that, in a closed system, those are two natural consequences of a weak currency, the evidence over the past twelve years has been less convincing.  Of course, as with every economic theory, a key assumption is ‘ceteris paribus’ or all else being equal.  But all else is never equal.  A strong argument can be made that in addition to the global recession undermining pricing power, the world is in the midst of a debt deflation.  This is the situation where a high and rising level of overall debt outstanding directs cash flow to repayment and reduces the available funding for other economic activity.  That missing demand results in price declines and hence, the debt deflation.  History has shown a strong correlation between high levels of debt and deflation, something many observers fail to recognize.

However, central banks, as with most large institutions, are always fighting the last war.  The central bank playbook, which had been effective from Bretton Woods, in 1944 until, arguably, sometime just before the Great Financial Crisis in 2008-09, explained that the reflexive response to economic weakness was to cut interest rates and ease financing conditions.  This would have the dual effect of encouraging borrowing for more activity while at the same time weakening the currency and making the export community more competitive internationally, thus boosting growth further.  And finally, a weaker currency would result in imported inflation, as importers would be forced to raise prices.

The Great Financial Crisis, though, essentially broke that model, as both the economic and market responses to central bank activities did not fit that theoretical framework.  Instead, adhering to the playbook saw interest rates cut to zero, and then below zero throughout Europe and Japan, additional policy ease via QE and yet still extremely modest economic activity.  And, perhaps, that was the problem.  Every central bank enacted their policies at the same time, thus there was no large relative change in policy.  After all, if every central bank cut interest rates, then the theoretical positive outcomes are negated.  In other words, ceteris isn’t paribus.

Alas, central banks have proven they are incapable of independent thought, and they have been acting in concert ever since.  Thus, rate cuts by one beget rate cuts by another, sometimes explicitly (Denmark and Switzerland cutting rates after the ECB acts) and sometimes implicitly (the ECB, BOE and BOC cutting rates after the Fed acts).  In the end, the results are that the relative policy settings remain very close to unchanged and thus, the only beneficiary is the equity market, where all that excess money eventually flows in the great hunt for positive returns.

Keeping the central bank mindset at the fore, we have an easy time understanding the weekend actions and comments from the PBOC and the ECB.  The PBOC adjusted a reserve policy that had been aimed at preventing rampant selling speculation against the renminbi.  For the past two plus years, all Chinese banks had been required to keep a 20% reserve against any short forward CNY positions they executed on behalf of customers.  This made shorting CNY prohibitively expensive, thus reducing the incentive to do so and helped support the currency.  However, the recent price action in CNY has been strongly positive, with the renminbi having appreciated nearly 7% between late May and Friday.  For a country like China, that sells a great many low margin products to the rest of the world, a strong currency is a clear impediment to their economic plans.  The PBOC action this weekend, removing that reserve requirement completely, is perfectly in keeping with the mindset of a weaker currency will help support exports and by extension economic growth.  Now there is no penalty to short CNY, so you can expect more traders to do so.  Especially since the fixing last night was at a weaker CNY level than expected by the market.  Look for further CNY (-0.8% overnight) weakness going forward.

As to the ECB, their actions were less concrete, but no less real.  ECB Chief Economist Philip Lane, the member with the most respected policy chops, was on the tape explaining that the Eurozone faces a rocky patch after the initial rebound from Covid.  He added, “I do not see that the ECB has a structurally tighter orientation for monetary policy[than the Federal Reserve].  Anyone who pays attention to our policies and forward guidance knows that we will not tighten policy without inflation solidly appearing in the data.”  Lastly, he indicated that both scaling up QE purchases and further rate cuts are on the table.

Again, it should be no surprise that the ECB is unwilling to allow the euro to simply rally unabated in the current environment.  The playbook is clear, a strong currency needs to be addressed, i.e. weakened. This weekend simply demonstrated that all the major central banks view the world in exactly the same manner.

Turning to the markets on this holiday-shortened session, we see that Chinese equities were huge beneficiaries of the PBOC action with Shanghai (+2.65%) and the Hang Seng (+2.0%) both strongly higher although the Nikkei (-0.25%) did not share the market’s enthusiasm.  European markets are firming up as I type, overcoming some early weakness and now green across the board.  So, while the FTSE 100 (+0.1%) is the laggard, both the DAX (+0.45%) and CAC (+0.75%) are starting to make some nice gains.  As to US futures, they, too, are now all in the green with NASDAQ (+ 1.3%) far and away the leader.  Despite the federal holiday in the US, the stock market is, in fact, open today.

Banks, however, are closed and the Treasury market is closed with them.  So, while there is no movement there, we are seeing ongoing buying interest across the European government bond markets as traders prepare for increased ECB QE activity.  After all, if banks don’t own the bonds the ECB wants to buy, they will not be able to mark them up and sell them to the only price insensitive buyer in the European government bond market.  So, yields here are lower by about 1 basis point across the board.

As to the dollar, it is broadly, but mildly stronger this morning.  Only the yen (-0.15%) is weaker in the G10 space as the rest of the block is responding to the belief that all the central banks are going to loosen policy further, a la the ECB.  As to the EMG bloc, CZK is actually the biggest loser, falling 0.9% after CPI there surprised the market by falling slightly, to 3.2%, rather than extending its recent string of gains.  This has the market looking for further central bank ease going forward, something that had been questioned as CPI rose.  Otherwise, as we see the prices of both oil and gold decline, we are seeing MXN (-0.6%), ZAR (-0.5%) and RUB (-0.5%) all fall in line.  On the flip side, only KRW (+0.55%) has shown any strength as foreign investors continue to pile into the stock market there on the back of Chinese hopes.

We do get some important data this week as follows:

Tuesday CPI 0.2% (1.4% Y/Y)
-ex food & energy 0.2% (1.7% Y/Y)
Wednesday PPI 0.2% (0.2% Y/Y)
-ex food & energy 0.2% (0.9% Y/Y)
Thursday Empire Manufacturing 14.0
Initial Claims 825K
Continuing Claims 10.4M
Philly Fed 14.0
Friday Retail Sales 0.8%
-ex autos 0.4%
IP 0.6%
Capacity Utilization 71.9%
Michigan Sentiment 80.5

Source: Bloomberg

Remember, we have seen five consecutive higher than expected CPI prints, so there will be a lot of scrutiny there, but ultimately, the data continues to point to a slowing recovery with job growth still a major problem.  We also hear from nine more Fed speakers, but again, this message is already clear, ZIRP forever and Congress needs to pass stimulus.

In the end, I find no case for the dollar to weaken appreciably from current levels, and expect that if anything, modest strength is the most likely path going forward, at least until the election.

Good luck and stay safe
Adf

I’m Concerned

Said Madame Lagarde, ‘I’m concerned
That strength in the euro’s returned
If that is the case
We’ll simply debase
The currency many have earned

Christine Lagarde, in a wide-ranging interview last week, but just released this morning, indicated several things were at the top of her agenda.  First is the fact that the containment measures now reappearing throughout the continent, notably in France, Spain and Germany, will weaken the recovery that started to gather steam during the summer. This cannot be a surprise as the key reason for the economic devastation, to begin with, was the dramatic lockdowns seen throughout Europe, and truthfully around the world.  But her second key concern, one about which I have written numerous times in the past, is that the euro’s recent strength is damaging the ECB’s efforts to support a recovery.  The new euphemism from ECB members is they are “very attentive” to the exchange rate.  The implication seems to be that if the euro starts to head back to the levels seen in early September, when it touched 1.20, they might act.  Clearly, the preferred action will be more verbal intervention.  But after that, I expect to see an increase in the PEPP program followed by a potential cut in the deposit rate and lastly actual intervention.

To be fair, most economists are already anticipating the PEPP will be expanded in December, when the ECB next publishes its economic forecasts.  Currently, the program has allocated €1.35 trillion to purchase assets on an unencumbered basis.  Recall, one of the issues with the original QE program, the APP, was that it followed the capital key, meaning the ECB would only purchase government bonds in amounts corresponding with a given economy’s size in the region.  So German bunds were the largest holdings, as Germany has the largest economy.  The problem with this was that Italy and Spain were the two large nations that needed the most help, and the ECB could not overweight their purchases there.  Enter PEPP, which has no such restrictions, and the ECB is now funding more purchases of Italian government bonds than any other nation’s.  Of course, there are more Italian government bonds than any other nation in Europe, and in fact Italy is the fourth largest issuer worldwide, following only the US, Japan and China.

As to further interest rate cuts, the futures market is already pricing in a 0.10% cut next year, so in truth, for the ECB to have an impact, they would need to either surprise by cutting sooner, or cut by a larger amount.  While the former is possible, the concern is it would induce fear that the ECB knows something negative about the economy that the rest of the market does not and could well induce a sharp asset sell-off.  As to cutting by a larger amount, European financial institutions are already suffering mightily from NIRP, and some may not be able to withstand further downward pressure there.

What about actual intervention?  Well, that would clearly be the last resort.  The first concern is that intervention tends not to work unless it is a concerted effort by multiple central banks together (think of the Plaza Agreement in 1985), so its efficacy is in doubt, at least in the medium and long term.  But second, depending on who occupies the White House, ECB intervention could be seen as a major problem for the US inspiring some type of retaliation.

In the end, for all those dollar bears, it must be remembered that the Fed does not operate in a vacuum, and in the current global crisis, (almost) every country would like to see their currency weaken on a relative basis in order to both support their export industries as well as goose inflation readings.  As such, nobody should be surprised that other central banks will become explicit with respect to managing currency appreciation, otherwise known as dollar depreciation.

Keeping this in mind, a look at markets this morning shows a somewhat mixed picture.  Yesterday’s strong US equity performance, ostensibly on the back of President Trump’s release from the hospital, was enough to help Asian markets rally with strength in the Nikkei (+0.5%) and Hang Seng (+0.9%).  China remains closed until Friday.  European markets started the day a bit under the weather, as virtually all of them were lower earlier in the session, but in the past hour, have climbed back toward flat, with some (Spain’s IBEX +0.95%) even showing solid gains.  However, the DAX (+0.1%) and CAC (+0.3%) are not quite following along.  Perhaps Madame Lagarde’s comments have encouraged equity investors that the ECB is going to add further support.  As to US futures markets, only NASDAQ futures are showing any movement, and that is actually a -0.4% decline at this time.

The bond market, on the other hand, has been a bit more exciting recently, as yesterday saw 10-year Treasury yields trade to their highest level, 0.782%, since June.  While this morning’s price action has seen a modest decline in yields, activity lately speaks to a trend higher.  Two potential reasons are the ever increasing amount of US debt being issued and the diminishing appetite for bonds by investors other than the Fed; and the potential that the recent trend in inflation, which while still below the Fed’s targeted level, has investors concerned that there are much higher readings to come.  After all, core PCE has risen from 0.9% to 1.6% over the past five months.  With the Fed making it clear they will not even consider responding until that number is well above 2.0%, perhaps investors are beginning to become a bit less comfortable that the Fed has things under control.  Inflation, after all, has a history of being much more difficult to contain than generally expected.

Finally, looking at the dollar, it is the least interesting market this morning, at least in terms of price action.  In the G10, the biggest mover has ben AUD, which has declined 0.4%, as traders focus on the ongoing accommodation of the RBA as stated in their meeting last night.  But away from Aussie, the rest of the G10 is +/- 0.2% or less from yesterday’s closing levels, with nothing of note to discuss.  In the emerging markets. THB (+0.7%) was the big winner overnight as figures showed an uptick in foreign purchases of Thai bonds.  But away from that, again, the movement overnight was both two-way and modest at best.  Clearly, the FX market is biding its time for the next big thing.

On the data front, this morning brings the Trade Balance (exp -$66.2B) and JOLTS Job Openings (6.5M).  Yesterday’s ISM Services number was a bit better than expected at 57.8, indicating that the pace of growth in the US remains fairly solid.  In fact, the Atlanta Fed GDPNow forecast is up to 34.6% for Q3.  But arguably, Chairman Powell is today’s attraction as he speaks at 10:40 this morning.    I imagine he will once again explain how important it is for fiscal stimulus to complement everything they have done, but as data of late has been reasonably solid, I would not expect to hear anything new.  In the end, the dollar remains range-bound for now, but I expect that the bottom has been seen for quite a while into the future.

Good luck and stay safe
Adf

More Sales Than Buys

The virus has found a new host
As Trump has now been diagnosed
Investors reacted
And quickly transacted
More sales than buys as a riposte

While other news of some import
Explained that Lagarde’s come up short
Seems prices are static
Though she’s still dogmatic
Deflation, her ideas, will thwart

Tongues are wagging this morning after President Trump announced that he and First Lady Melania have tested positive for Covid-19.  The immediate futures market response was for a sharp sell-off, with Dow futures falling nearly 500 points (~2%) in a matter of minutes.  While they have since recouped part of those losses, they remain lower by 1.4% on the session.  SPU’s are showing a similar decline while NASDAQ futures are down more than 2.2% at this time.

For anybody who thought that the stock markets would be comfortable in the event that the White House changes hands next month, this seems to contradict that theory.  After all, what would be the concern here, other than the fact that President Trump would be incapacitated and unable to continue as president.  As vice-president Pence is a relative unknown, except to those in Indiana, investors seem to be demonstrating a concern that Mr Trump’s absence would result in less favorable economic and financial conditions.  Of course, at this time it is far too early to determine how this situation will evolve.  While the President is 74 years old, and thus squarely in the high-risk age range for the disease, he also has access to, arguably, the best medical attention in the world and will be monitored quite closely.  In the end, based on the stamina that he has shown throughout his tenure as president, I suspect he will make a full recovery.  But stranger things have happened.  It should be no shock that the other markets that reacted to the news aggressively were options markets, where implied volatility rose sharply as traders and investors realize that there is more potential for unexpected events, even before the election.

Meanwhile, away from the day’s surprising news we turn to what can only be considered the new normal news.  Specifically, the Eurozone released its inflation data for September and, lo and behold, it was even lower than quite low expectations.  Headline CPI printed at -0.3% while Core fell to a new all-time low level of 0.2%.  Now I realize that most of you are unconcerned by this as ECB President Lagarde recently explained that the ECB was likely to follow the Fed and begin allowing inflation to run above target to offset periods when it was ‘too low’.  And according to all those central bank PhD’s and their models, this will encourage businesses to borrow and invest more because they now know that rates will remain low for even longer.  The fly in this ointment is that current expectations are already for rates to remain low for, essentially, ever, and business are still not willing to expand.  While I continue to disagree with the entire inflation targeting framework, it seems it is becoming moot in Europe.  The ECB has essentially demonstrated they have exactly zero influence on CPI.  As to the market response to this news, the euro is marginally softer (-0.25%), but that was the case before the release.  Arguably, given we are looking at a risk off session overall, that has been the driver today.

Finally, let’s turn to what is upcoming this morning, the NFP report along with the rest of the day’s data.  Expectations are as follows:

Nonfarm Payrolls 875K
Private Payrolls 875K
Manufacturing Payrolls 35K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Factory Orders 0.9%
Michigan Sentiment 79.0

Source: Bloomberg

Once again, I will highlight that given the backward-looking nature of this data, the Initial Claims numbers seem a much more valuable indicator.  Speaking of which, yesterday saw modestly better (lower) than expected outcomes for both Initial and Continuing Claims.  Also, unlike the ECB, the Fed has a different inflation issue, although one they are certainly not willing to admit nor address at this time.  For the fifth consecutive month, Core PCE surprised to the upside, printing yesterday at 1.6% and marching ever closer to their (symmetrical) target of 2.0%.  Certainly, my personal observation on things I buy regularly at the supermarket, or when going out to eat, shows me that inflation is very real.  Perhaps one day the Fed will recognize this too.  Alas, I fear the idea of achieving a stagflationary outcome is quite real as growth seems destined to remain desultory while prices march ever onward.

A quick look at other markets shows that risk appetites are definitely waning today, which was the case even before the Trump Covid announcement.  The Asian markets that were open (Nikkei -0.7%, Australia -1.4%) were all negative and the screen is all red for Europe as well.  Right now, the DAX (-1.0%) is leading the way, but both the CAC (-0.9%) and FTSE 100 (-0.9%) are close on its heels.  It should be no surprise that bond markets have caught a bid, with 10-year Treasury yields down 1.5 basis points and similar declines throughout European markets.  In the end, though, these markets remain in very tight ranges as, while central banks seem to have little impact on the real economy or prices, they can manage their own bond markets.

Commodity prices are softer, with oil down more than $1.60/bbl or 4.5%, as both WTI and Brent Crude are back below $40/bbl.  That hardly speaks to a strong recovery.  Gold, on the other hand, has a modest bid, up 0.2%, after a more than 1% rally yesterday which took the barbarous relic back over $1900/oz.

And finally, to the dollar.  This morning the risk scenario is playing out largely as expected with the dollar stronger against almost all its counterparts in both the G10 and EMG spaces.  The only exceptions are JPY (+0.35%) which given its haven status is to be expected and GBP (+0.15%) which is a bit harder to discern.  It seems that Boris is now scheduled to sit down with EU President Ursula von der Leyen tomorrow in order to see if they can agree to some broad principles regarding the Brexit negotiations which will allow a deal to finally be agreed.  The market has taken this as quite a positive sign, and the pound was actually quite a bit higher (+0.5%) earlier in the session, although perhaps upon reflection, traders have begun to accept tomorrow’s date between the two may not solve all the problems.

As to the EMG bloc, it is essentially a clean sweep here with the dollar stronger across the board.  The biggest loser is RUB (-1.4%) which is simply a response to oil’s sharp decline.  But essentially all the markets in Asia that were open (MYR -0.3%, IDR -0.2%) fell while EEMEA is also on its back foot.  We cannot forget MXN (-0.55%), which has become, perhaps, the best risk indicator around.  It is extremely consistent with respect to its risk correlation, and likely has the highest beta to that as well.

And that’s really it for the day.  The Trump story is not going to change in the short-term, although political commentators will try to make much hay with it, and so we will simply wait for the payroll data.  But it will have to be REALLY good in order to change the risk feelings today, and I just don’t see that happening.  Look for the dollar to maintain its strength, especially vs. the pound, which I expect will close the day with losses not gains.

Good luck, good weekend and stay safe
Adf

We Won’t Acquiesce

Said Madame Lagarde to the press
In Frankfurt, we won’t acquiesce
To prices not rising
So, it’s not surprising
That average inflation we’ll stress

Raise your hand if you had, ‘the ECB will copy the Fed’s average inflation framework’ when announcing their own policy initiatives.  That’s right folks, I’m sure you are all shocked to learn that the ECB is now considering (read has already decided) to follow in the Fed’s footsteps and target an average inflation rate over an indeterminate time in their own policy review.  As Lagarde pointed out, “If credible, such a strategy can strengthen the capacity of monetary policy to stabilize the economy when faced with the lower bound.”  Perhaps the key words to this statement are the first two, if credible.  After all, given the ECB’s demonstrated futility at achieving their targeted inflation rate since its creation in 1997, why would it be credible that the ECB is going to generate inflation now that will run above target.  In fact, over the entire history of ECB policymaking, there was a single stretch of 15 months (October 2001 – December 2002) where their favorite measure, Core CPI, rose above 2.0%.  Otherwise, during the other 270 months, they have seen inflation below their target, oftentimes well below.  The average inflation rate since the ECB’s founding has been 1.4%.  But now we are supposed to believe that because they claim they will allow inflation to run hot, suddenly that makes policy easier.  Personally, I don’t find their claim credible.

But from the market perspective, the importance of her comments, as well as agreement by other ECB members on the subject, is that the Fed has ceased to be the central bank with the easiest money around.  With the ECB and the Fed now both following the same path on inflation targeting, there is not much to choose between the two.  This is especially so given that neither one has been able to approach their current target, let alone exceed it in more than a decade.  But for dollar bears, this is bad news because a key part of the bearish thesis was the idea that the Fed was the easiest money around.  Average inflation targeting meant interest rates would remain near zero for at least three more years.  Well I have news for you, ECB rates will remain negative far longer than that.  Just as a man with a hammer sees every problem as a nail, a central bank with a single policy tool (QE) sees every problem solvable by more bond purchases.

Adding to the euro’s medium-term woes is the situation in Italy, where despite more than €209 billion euros of EU aid, the debt/GDP ratio is destined to head ever higher, rising to 158% this year.  That cements its current third place worldwide status (Japan 234%, Greece 182%) and starts to bring Greece’s number two slot into sight.  With a history of slow growth and a rapidly aging population, it becomes ever harder to envision a solution to Italy’s macroeconomic woes that doesn’t include either debt relief or debt monetization.  And I assure you, that is not a currency positive for the euro.  The point here is that the many negatives that underlie the euro’s construction are likely to become a greater topic of market conversation going forward, and it appears the odds of a significant rally from current levels has greatly diminished, regardless of your views of US policies.

Speaking of US policies, I will admit that I could only tolerate a few minutes of last night’s presidential debate, as the name-calling and interruptions became far too annoying.  Equity futures declined, seemingly on the view that Biden cemented his lead, at least so that’s what the punditry is explaining this morning.  Perhaps equity futures declined as investors decided that no outcome is positive for the US.  But while clearly the presidential campaign will have some market impact over the next five weeks, at this point, it seems unlikely the polls will change much, nor the betting markets.  And yet, we cannot forget that in 2016, the polls and betting markets were pointing to the exact same outcome and turned out to be spectacularly wrong.  In the end, regardless of who wins the election, the Fed is going to continue their current policy mix and more fiscal stimulus is destined to arrive.  As such, I am hard-pressed to say it will impact the dollar.

One other thing of note overnight was Chinese PMI data (Mfg 51.5, Services 55.9), which showed that growth on the mainland continued to expand moderately on the strength of increases across both manufacturing and services sectors.  Even the Caixin PMI (53.0), which focuses on small companies, put in a solid performance.  Interestingly, neither the Shanghai Composite (-0.2%) nor the renminbi (unchanged) reflected any positivity in the outcome.  And neither was that news sufficient to generate any risk taking elsewhere in the world, at least on any sustained basis.

Looking at the rest of the equity markets, we see the Nikkei (-1.5%) fell sharply although the Hang Seng (+0.8%) managed to show the only rise amongst major equity indices.  European bourses are all in the red (DAX -0.5%, CAC -0.6%, FTSE 100 -0.3%) and US futures continue to point lower, with all three indices down about -0.6% at this hour.  Bond market movement continues to largely be absent as 10-year Treasury yields are still 0.65%, unchanged, and both Bunds and Gilts are less than 1 basis point different than yesterday’s levels.  Even Italian BTP’s are unchanged despite the increasing concerns over their fiscal situation.  In other words, the central banks have done an excellent job in controlling yield curves and thus preventing the bond market from offering any economic signals.

As to the dollar, it is broadly, albeit mildly, stronger this morning against its G10 counterparts.  NOK and SEK (both -0.5%) are the leading decliners with Norway suffering from oil’s slide back below $40/bbl, while SEK is simply demonstrating its higher beta to broad movements.  But the whole space is feeling it today, with the exception of CAD, which is essentially unchanged.  Clearly, the Lagarde comments have served to soften the euro (-0.3%) at the margin.

As to the emerging market bloc, things are a bit more mixed.  The notable movers include RUB (+0.9%) and TRY (+0.5%) on what appears to be the first attempts by both nations to de-escalate the Armenian-Azerbaijani conflict.  As well, we see MXN (+0.8%) and ZAR (+0.7%) on the positive side, which is more difficult to justify given the lack of risk appetite, but is likely related to the calendar, as investors rebalance positions into month-end, and so are reducing shorts in those currencies.  On the negative side sits the CE4, following the euro’s decline with their usual ability to outpace the single currency.  Interestingly, APAC currencies have done little overnight, with most movement less than 10 basis points.

On the data front this morning we get ADP Employment (exp 649K), Q2 GDP’s final revision (-31.7%) and Chicago PMI (52.0).  Arguably, the market will be more concerned with the ADP data than anything else as investors try to get a picture of the employment situation.  We also have three more Fed speakers, Kashkari, Bowman and Bullard, but based on yesterday’s outcome, where the message is that the Fed is moderately optimistic that growth will continue but that more fiscal support would be useful, it seems unlikely that these comments will interest many people.

Overall, the big story remains the indication that the ECB is going to match the Fed every step of the way going forward, as will, eventually, every other key central bank, and so the dollar’s value will need to be determined by other means.  But for now, it points to a bit more dollar strength as short positions start to get unwound.

Good luck and stay safe
Adf

Signs of Dissension

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
Adf

The New Weasel Word

The bulk of the FOMC
Explained their preferred policy
More government spending,
Perhaps never ending,
Is what almost all want to see

Meanwhile, ‘cross the pond, what we heard
Is ‘bove 2% is preferred
They’ll soon change their stance
To give growth a chance
Inflation’s the new weasel word

Another day, another central bank explanation that higher inflation is just what the doctor ordered to improve the economy.  This time, Banque de France’s Governor, Francois Villeroy de Galhau, explained that the current formulation used by the ECB, “below, but close to, 2%”, is misunderstood.  Rather than 2% being a ceiling, what they have meant all along is that it is a symmetrical target.  Uh huh!  I’ve been around long enough to remember that back in 1988, when the ECB was first being considered, Germany was adamant that they would not accept a central bank that would allow inflation, and so forced the ECB to look just like the Bundesbank.  That meant closely monitoring price pressures and preventing them from ever getting out of hand.  Hence, the ECB remit, was absolutely designed as a ceiling, with the Germans reluctant to even allow 2% inflation.  Of course, for most of the rest of Europe, inflation was the saving grace for their economies.  Higher inflation begat weaker currencies which allowed France, Italy, Spain, et.al. to continue to compete with a German economy that became ever more efficient.

But twenty-some years into the experiment of the single currency, and despite the fact that the German economy remains the largest and most important in the Eurozone, the inflationistas of Southern Europe are gaining the upper hand.  These comments by Villeroy are just the latest sign that the ECB is going to abandon its price stability rules, although you can be sure that they will never say that.  Of course, the problem the ECB has is similar to that of Japan and the US, goosing measured inflation has been beyond their capabilities for the past decade (more than two decades for the BOJ), so simply changing their target hardly seems like it will be sufficient to do the job.  My fear, and that of all of Germany, is that one day they will be successful in achieving this new goal and will not be able to stop inflation at their preferred level, but instead will see it rise much higher.  But that is not today’s problem.  Just be aware that we are likely to begin hearing many other ECB members start discussing how inflation running hot for a while is a good thing.  Arguably, the only exceptions to this will be the Bundesbank and Dutch central bank.

And once again, I will remind you all that there is literally no chance that the ECB will sit back and watch, rather than act, if the Fed actually succeeds in raising inflation and weakening the dollar.

Speaking of the Fed, this week has seen a significant amount of Fedspeak already, with Chairman Powell on the stand in Congress for the past three days.  What he, and virtually every other Fed speaker explained, was that more fiscal stimulus was required if the government wanted to help boost growth.  The Fed has done all they can, and to listen to Powell, they have been extremely effective, but the next step was Congress’s to take.  The exception to this thought process came from St Louis Fed President Bullard, who explained that based on his forecasts, the worst is behind us and no further fiscal stimulus is needed.  What makes this so surprising is that he has been one of the most dovish of all Fed members, while this is a distinctly hawkish sentiment.  But he is the outlier and will not affect the ultimate outcome at this stage.

Powell was on the stand next to Treasury Secretary Mnuchin, who made the comment with the biggest impact on markets.  He mentioned that he and House Speaker Pelosi were back to negotiating on a new stimulus package, which the equity market took as a sign a deal would be reached quickly.  We shall see.  Clearly, there is a great deal of angst in Congress right now, so the ability to agree on anything across the aisle is highly questionable.

With that in mind, a look at markets shows what had been a mixed opening is turning into a more negative session.  Overnight saw Asian equity markets with minimal gains and losses (Nikkei +0.5%, Hang Seng -0.3%, Shanghai -0.2%), but Europe, which had been behaving in a similar manner early in the session has turned sharply lower.  At this time, the DAX (-1.95%) and CAC (-2.0%) are leading the way lower, with the FTSE 100 (-0.8%) having a relatively better day.  At the same time, US futures turned from flat to lower, with all three indices now pointing to -0.6% losses at the open.

It is difficult to point to a specific comment or piece of news driving this new sentiment, but it appears that the bond market is in the same camp as stocks.  Treasury yields, while they remain in a narrow range, have slipped 1bp, to 0.65%, and we are seeing Bunds (-2bps) and Gilts (-3bps) also garner demand as havens are in play.  Apparently, central bank desire for inflation is not seen as a serious situation quite yet.

Commodity prices have turned around as well, with oil falling 2% from morning highs, and gold dropping 1%.  In other words, this is a uniform risk reduction, although I would suspect that gold prices should lag the decline elsewhere.

As to the dollar, it is starting to pick up a more substantial bid with EUR (-0.3%) and GBP (-0.35%) sliding from earlier levels.  NOK (-1.15%) remains the worst performer in the G10, which given the decline in oil prices and evolving risk sentiment should be no surprise.  But at this point in the day, the entire bloc is weaker vs. the buck.  EMG currencies, too, have completely reversed some modest early morning strength, and, once again, ZAR (-1.2%) and MXN (-1.0%) lead the way lower.  One must be impressed with the increased volatility in those currencies, as they start to approach levels seen in the initial stages of the Covid crisis.  For anyone who thought that the dollar had lost its haven status, recent price action should put paid to that notion.

On the data front, today brings Durable Goods (exp 1.4%, 1.0% ex Transport) and we hear from two more Fed speakers, Williams and Esther George.  While Williams is almost certain to repeat Powell’s current mantra of more fiscal support, Ms George is one of the more hawkish Fed members and could well sound more like James Bullard than Jay Powell.  We shall see.

This has been a risk-off week, with equity markets down across the board and the dollar higher vs. every major currency in the world.  It seems highly unlikely that the Durable Goods number will change that broader sentiment, and so the ongoing equity market correction, as well as USD rebound seems likely to continue into the weekend.  Remember, short USD positions are still the rule, so there is plenty of ammunition for a further short covering.

Good luck, good weekend and stay safe
Adf