Covid’s Attacks

We’re finally going to see
The data which shows the degree
Of all the impacts
By Covid’s attacks
On life as we knew it to be

Risk assets are under pressure this morning as market participants once again reevaluate the cost-benefit analysis of government actions during the ongoing Covid-19 crisis. The question which bedevils both politicians and markets is, what is the proper balance between restricting economic activity via lockdown orders to prevent further spread of the virus vs. maintaining economic activity in order to prevent the global economy from collapsing? The problem is there is no easy answer to this dilemma, and the reality is that every nation has a different tradeoff based on the nature of its economy as well as the social and cultural mores that exist there.

And so, every nation continues to go their own way as they try to figure out the response best suited for their own circumstances. What is beginning to change as time passes is the data reports that will be released in the coming days and weeks will now be reflective of the first periods of shutdowns and will offer the best indications yet of just how severe the economic damage, thus far, has been. Remember, most data are backward looking. In fact, other than the Initial Claims data, which is both timely and has been awful, analysts are simply guessing at the economic impact so far. Thus, much will be learned this week and next as we start to see the first measurements of how significant the impact has been to date. In fact, we start with today’s Retail Sales data (exp -8.0%, -5.0% ex autos), as well as Empire Manufacturing (-35.0), IP (-4.0%), Capacity Utilization (74.0%) and then the Fed’s Beige Book at 2:00. All of this data is for March, which means that the crisis was in full swing for the bulk of the period. Expectations, as can be seen above, are for substantial declines across the board. But are econometric models based on history going to be effective in forecasting unprecedented events? My money is on no. If the first pieces of data we have seen are any indication, then today’s numbers will be much worse than currently anticipated.

However, as any economist worth their salt will explain, markets are discounting instruments, always looking some period into the future, rather than looking backwards. And that is, no doubt, just as true now as before the Covid-19 outbreak. The question of the moment then becomes, just how far ahead is the market discounting? There seems to be a significant difference of opinion between the bond and equity markets, with the latter having a far more optimistic view than the former. In fact, the bond market appears to be pricing in a significantly longer period of economic disruption, as evidenced by the 30-year yield at 1.32%, than is the stock market, which has already retraced 50% of its initial decline.

One other thing to remember is that recent government actions indicate further delays in reopening economies, rather than any speeding up of the process. This is evidenced by this morning’s German announcement that they will be extending lockdown measures to May 3, from the previously expected April 19. And the Germans have had a measure of success in slowing the spread of the virus, with today being the sixth consecutive day of a lower count of new infections. So, for those nations where the infection rate is not slowing, like the US, it becomes that much more difficult to revert to any sense of normalcy.

History has shown that when the stock and bond markets tell different stories, like they are now, it is more frequent the bond market has things right. I see no reason that this situation is any different and expect that we are coming to the end of the equity market bounce. Risk is far more likely to be shed than added in the next few weeks, and that means that haven assets like the dollar and they yen should resume their climb.

With that in mind, let’s look at markets this morning. The dollar is definitely in the ascendant vs. its G10 brethren with NOK (-1.9%) the leading decliner after the OPEC+ talks led to a disappointing outcome and oil prices have fallen to new lows for the move with WTI touching $19.20/bbl earlier this morning. But Aussie (-1.8%) and Kiwi (-1.7%) are feeling the weight of weaker commodity prices and less confidence in China’s rebound as well. Even JPY, the best performer today is lower by 0.15%, just reinforcing that in the strange new world we inhabit, the dollar remains the single most attractive currency in which to hold assets.

In the Emerging markets, the story is similar with most currencies under pressure led by ZAR (-1.8%), MXN and RUB (both -1.7%) on the back of the weak oil/commodity story. However, we did see two gainers overnight, IDR (+0.45%) and THB (+0.3%). The former seems to be benefitting from the fact that the central bank there surprised markets and did not cut rates yesterday, as well as the positive economic impact of showing a small trade surplus, thus reducing external financing pressures. Meanwhile, the baht seems to be the beneficiary of an announcement of a new fiscal stimulus totaling nearly $31 billion, which is seen as quite substantial there. Otherwise, the bulk of this bloc has seen more modest losses, somewhere between 0.2% and 1.0%.

Having already discussed today’s data, I think the real question for FX markets today will be just how equity markets perform as a better indicator of risk sentiment. Europe has been under pressure all morning, with almost all markets there lower by about 2.0%. Meanwhile, US equity futures are pointing in the same direction, with losses currently pegged between 1.1% (NASDAQ) and 1.7%(S&P 500). Of course, the Retail Sales data will be out before the equity market opening, so there is ample opportunity for either a significantly worse opening in the event the data is even worse than expected, as well as an extension of the recent rally should the data somehow surprise on the high side. I fear the worst.

So be prepared for a risk-off session as we finally start to see just how badly the US economy has been damaged by Covid-19. Ironically, this implies that the dollar is set for further gains as the rest of the world is likely to be even worse off.

Good luck


This Terrible Blight

The data from China last night
Showed PMI looking alright
But what does this mean?
Has China now seen
The end of this terrible blight?

Many pundits were both shocked and amazed when China’s PMI data was released last night and printed back above 50 (Manufacturing 52.0 and Composite 53.0), given the ongoing global economic shutdown. But if you simply consider the question asked to create the statistic; are things worse, the same or better than last month, it seems pretty plausible that things were at least the same as the previous month when commerce on the mainland shut down. And arguably, given the word that some proportion of the Chinese economy is starting to get back to work, the idea that a small proportion of respondents indicated improvement is hardly shocking. Instead, what I think we need to do is reconsider exactly what the PMI data describes.

Historically, when the global economy was functioning on, what we used to consider, a normal basis, the difference of a few tenths of a percent were seen as important. They seemed to tell a story of marginal improvement or decline on an early basis. Perhaps this was a false precision, but it was clearly the accepted narrative. The PMI data remains a key input into many econometric models, and those tenths were enough to alter forecasts. But that was then. As we all are abundantly aware, today’s economy and working conditions are dramatically different than they were, even in January. And so, the key question is; does the data we used to focus on still tell us the same story it did? Forward looking survey data is going to be far more volatile than in the past given the extraordinary actions taken by governments around the world. Quarantine, shelter-in-place and working from home will require a different set of measurements than the pre-Covid commuting world with which most of us are familiar.

Certainly, measurements of employment and consumption will remain key, but things like ISM, Fed surveys and productivity measurements are going to be far more suspect in the information they provide. After all, when the lockdowns end, and the surveys shoot higher, while the relative gains will be large, we are still likely to be in a much slower and different economic situation than we were back in January. A major investment bank is now forecasting Q2 GDP to decline by 34% annually, while Q3 is forecast to rebound 19%. The total story is one of overall decline, but the Q3 story will certainly be played up for all it is worth as the fastest growth in US history. My point is, be a little careful with what the current data is describing because it is not likely the same things we are used to from the past. The new narrative has yet to form, as the new economy has yet to emerge. While we can be pretty sure things will be different, we just don’t yet know exactly in which sectors and by how much. In other words, data will continue to be uncertain for a while, and its impact on markets will be confusing.

With that in mind, let’s take a look at where things stand this morning. After a very strong start to the week yesterday, at least on the equity front, things are a bit more mixed today. Asian markets saw both strength (Hang Seng + 1.8%) and weakness (Nikkei -0.9%), although arguably there were a few more winners than losers. Interestingly, despite the blowout Chinese PMI data, Shanghai only rose 0.1%. It seems the equity market there had a reasonable interpretation of the data. In Europe, meanwhile, things are generally positive, but not hugely so, with the DAX and FTSE 100 both higher by 0.8%, although the CAC has edged lower by 0.1%. at this time, US futures are pointing modestly higher and well off the earlier session highs.

Bond markets suffered yesterday on the back of the equity rally, as risk assets had some short-term appeal, but this morning the picture is more mixed. Treasury yields have fallen by 4bps, but Bund yields are little changed on the day. And in the European peripheral markets, Italian BTP’s are seeing yields edge higher by 1bp while Greek yields have softened by 4bps. I think today’s price action has much more to do with the fact it is month and quarter end, and there is a lot of rebalancing of portfolios ongoing, rather than as a signal of future economic/intervention activity.

In the FX market, though, the dollar continues to reign supreme with only NOK able to rally this morning in the G10 space as oil prices have rebounded sharply. A quick peek there shows WTI +7.5% and Brent +3.9%, although the price of oil remains near its lowest levels since 2001’s recession. But away from NOK, the dollar is quite firm with AUD under the most pressure, down 1.4% after some awful Australian confidence data. Clearly, the surprisingly positive Chinese data had little impact. But the euro has fallen 1.0% as concerns grow over Italy’s ability to repay its debt and what that will mean for the rest of the continent with respect to picking up the tab. Even the yen is under pressure today, perhaps on the news that the government is preparing a ¥60 trillion support package, something that will simply expand their already remarkable 235% debt/GDP ratio.

In the emerging markets, it should be no surprise that Russia’s ruble is top dog today, +1.3% on the oil rebound. Meanwhile, ZAR and KRW have also moved higher by 0.5% each with the rand benefitting from a massive influx of yield seekers as they auctioned a series of debt with yields ranging from 7.17% for 3-year to 11.37% for the 10-year variety. Meanwhile, in Seoul, the results of the USD swap auctions showed that liquidity there is improving, meaning there is less pressure on the currency. On the downside, CE4 currencies are under the gun as they track the euro lower, with the entire group down by between 0.8% and 1.3%. Perhaps the biggest disappointment today is MXN, which despite the big rebound in oil is essentially unchanged today after a 2% decline yesterday. The peso just cannot seem to get out of its own way, and as long as AMLO continues to be seen as ineffective, it is likely to stay that way.

There is some data due this morning, with Case Shiller Home Prices (exp 3.23%) and the Conference Board’s Consumer Confidence Index (110.0 down from 130.7), but it is not clear it will have much impact. Yesterday’s Dallas Fed Manufacturing Index was released at -70, the worst print in its 16-year history, but one that cannot be surprising given the nationwide shutdowns and problems in the oil patch. I don’t see today’s data having an impact, and instead, expect that the focus will be on the next bailout package, the implementation of this one, and month-end rebalancing. It is hard to make the case that the dollar will decline in this environment, but that remains a short-term view.

Good luck