All the PIGS in Her Fief

Said Madame Lagarde, ‘Well I guess
Things really are in quite a mess’
And so up we’ll step
To introduce PEPP
As we try to deal with the stress

The market’s response was relief
That Europe’s new central bank chief
Has realized at last
The time is long past
To help all the PIGS in her fief

Another day, another bunch of new programs! First, though, a quick observation about the overall situation right now. There is no panic in the streets (after all the streets are mostly empty due to shelter-in-home and self-quarantining) but there is panic in… Washington DC, London, Bonn, Frankfurt, Paris, Madrid, etc. And that panic emanates from the fact that all those elected politicians are facing the biggest crisis of all…they might not get reelected because of Covid-19. I believe it is the belated realization that their jobs are on the line that has seen a significant acceleration in the number of new programs being proposed and introduced around the world.

Central banks, which had borne the brunt of the heavy lifting, are starting to get help from fiscal policy actions, but those central banks are still on the front lines. To wit, in an unprecedented intermeeting action, last night the ECB unveiled a new QE program called the Pandemic Emergency Purchase Program (PEPP) which will authorize the purchase of €750 billion of public and private assets for the rest of the year, or longer if deemed necessary. This time they are including Greek government bonds, which the ongoing QE program would not touch due to the credit rating, they are ignoring the capital key, which means they can purchase far more Italian debt than Italy’s share of the Eurozone economy would dictate, and they are expanding the corporate purchases to non-financial CP. And the market liked what they heard with European government bonds rallying sharply pushing 10-year benchmark yields down by 47bps in Portugal, 71bps in Italy, 167bps in Greece and 45bps in Spain. Equity markets in Europe have stopped collapsing, but we still see pressure in Germany and the UK, while the PIGS are all higher. One other thing about Germany was the release of the IFO Expectations Index which fell to 82.0, its lowest point since the financial crisis in 2008. Certainly short-term prospects seem dire there.

And what about the euro you may ask? Well, it continues to slide, down 1.0% this morning, but is actually about middle of the pack in the G10. If you want to see real carnage, look no further than Norway, where the krone has fallen another 2.75% as I type, but that is only after it had been lower by nearly 7.5% at 6:00 this morning, which forced a response from the Norgesbank that they would be intervening if things got worse. Looking over price action during the past month, when oil prices collapsed from $53.78 to as low as $20.06 (currently $22.88), which has been a 57% decline, the worst performing currencies have been; MXN (-23.8%), RUB (-21.2%), NOK (-19.7%) and COP (-17.3%). Two caveats on this list are Norway was down much further earlier this morning, and Colombia hasn’t opened yet today, so has room for a further decline. The only positive I can take from this is that the correlation between the currencies of oil producers and the price of oil remains intact. At least we know what to expect!

But there was plenty of other activity as well. For instance, the RBA cut rates again, by 25bps, taking their base rate to a historic low of 0.25%. In addition they have implemented their first QE plan where they are targeting the yield on 3-year AGB’s at 0.25%. The problem is that the 10-year bond got hammered on the news with yields there jumping 23bps overnight, taking the move since Monday to 57bps. Look for the RBA to do more, and probably soon. And the Aussie dog dollar? Down a further 1% this morning, which takes the decline in the past month to 14.3% and it is now trading at levels not seen since 2003.

And let’s not forget South Korea, which is stepping into the market to buy KRW 1.5 trillion (~$1.1 billion) of government bonds, as it prepares both bond and stock stabilization funds to help support markets there. In other words, the government is going to be buying equities to stop the slide. The KRW response? -3.2%!

Japan would not be left out of this parade, buying a new record ¥201.6 billion of ETF’s last night while injecting ¥5.3 trillion yen in new liquidity to the money markets. Unfortunately, the Nikkei continued its decline, although fell only 1.0%, arguably an improvement over recent performance. The yen has no haven characteristics this morning, falling 1.50%, which is actually now the worst performing currency as NOK continues to rebound as I type on the back of Norgesbank activity.

Finally, I would be remiss if I didn’t mention that the Fed has unveiled yet another program, this time to backstop money market funds, a key part of the US financial plumbing system, and one that when it broke in 2008 after Lehman’s bankruptcy, resulted in financial markets seizing up entirely. The fund is there to make liquidity available to funds to meet increased redemptions without having to sell their holdings. Instead, they will pledge them as collateral and receive cash from the Fed.

This note is too short to go through every action taken, but we continue to see other central bank rate cuts and we continue to see fiscal packages starting to get enacted. In fact, President Trump signed into law the latest yesterday, to support paid sick leave and increased unemployment benefits, and now Congress turns to the MOAS (mother of all stimuli) packages which may include helicopter money as well as bailouts of airlines and hospitality businesses that have been decimated by the virus response. Mooted price tag…$1.3 trillion, but my bet is it winds up larger than that.

Meanwhile, the dollar remains the single place to be. It has rallied against everything yet again as holding cash is seen as the only response to the current situation. And the cash everyone wants to hold is green. Foreign borrowers are scrambling and struggling as their local currencies collapse and swap spreads blow out. And domestic borrowers are wondering how they are going to repay or roll over their debt given the absolute collapse in economic activity.

For now, this is likely to continue to be the situation, as there is no obvious end in site. However, the growing sense of urgency in those national capitals leads me to believe that we are going to start to see much bigger fiscal packages and a newfound belief that printing money and giving it out is a better solution than allowing economic activity to seize up completely. As I said last week, the MMT proponents have won the day. It has just not yet been made explicit.

Good luck and stay safe
Adf

 

Gone Astray

There once was a banker named Jay
Who, for a few weeks, had his way
Stock markets rose nicely
But that led precisely
To things that have now gone astray

Protagonists now can’t discern
What’s safe or what assets to spurn
Their hunt for more yield
Has finally revealed
That risk is attached to return

Apparently, when the Fed cuts rates, it is not a guarantee that stock prices will rally. That seems to be yesterday morning’s lesson in the wake of the Fed’s “surprise” 50bp rate cut. After a brief rally, which lasted about 15 minutes, the bottom fell out again as investors and traders decided that things were actually much worse than they feared. In addition, Chairman Jay did himself no favors by opening the kimono a bit and admitting that there was nothing the Fed could do to directly address the current issues.

This is a real problem for the global central bank community because the Fed was the player with the most ammunition left, and they just used one-third of their bullets with a disastrous outcome. Ask yourself what more the ECB can do, with rates already negative and QE ongoing. They have no more bullets left, just the whispering of sweet nothings from Madame Lagarde to Eurozone FinMins to spend more money. If the data turns further south in Europe, which seems almost guaranteed, I would look for a suspension of the Eurozone rules on financing and deficits. After all, Covid-19 was not part of the bargain, and this is clearly an emergency…just ask Jay. Japan? They are already printing yen as fast as they can to buy more assets, and will not stop, but are unable to achieve their goals.

Arguably, the only central bank left that matters, and that has room to move is the PBOC, which has already been active adding liquidity and trying to steer it to SME’s. But if the pressure continues on both the Chinese economy and its markets, they will do more regardless of the long-term debt problems they may exacerbate. We have clearly reached a point where every central bank is all-in to try to stop the current stock market declines. And you thought all they cared about was money supply!

So, what about a fiscal response by the major economies? After all, to a man, every central bank has explained that monetary policy is not the appropriate tool to address the current economic and market concerns. As Chairman Jay explained in his press conference, “A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that, but we do believe that our action will provide a meaningful boost to the economy.” A cynic might conclude that central banks were trying to force the fiscal authorities’ collective hands, but in reality, I think the issue is simply that, at least in the G7, fiscal issues are political questions that by their very nature take longer to answer. Getting agreement on spending money, especially in the current fractious political environment, is extremely difficult short of a major crisis like the financial market meltdown in 2008. And for now, despite all the press, and some really bad data releases, Covid-19 has not achieved that level of concern.

Is that likely to change soon? My impression based on what we have seen and heard so far is that unless there is another significant uptick in the number of infections, and especially in the mortality rate, we are likely to see relatively small sums of money allocated to this issue. Of course, if economic activity is impeded by travel restrictions and supply chains cannot get back in business by the end of March, we are likely to have a change of heart by these governments, but for now, its central banks or bust.

So, this morning, after yesterday’s rout in US markets, things seem to have stabilized somewhat with most Asian equity markets flat to slightly higher, European markets ahead by about 1% and US futures currently sitting ~2% stronger. Part of the US showing is undoubtedly due to yesterday’s Super Tuesday primaries which showed former VP Joe Biden build on his recently recovered momentum to actually take a slight delegate lead. There is certainly some truth to the idea that part of the US markets’ recent malaise was due to a concern that Senator Sanders was poised to become the Democratic nominee, and that his policy platforms have been extremely antagonistic to private capital.

But despite the equity market activity, which on the whole looks good, there is no shortage of demand for Treasuries, which implies that there is still a great deal of haven demand. Yesterday, the 10-year yield breached 1.00% for the first time in its 150-year history, trading as low as 0.90% before rebounding ahead of the close. But here we are this morning with the yield down a further 5bps, back to 0.95%, and quite frankly there is nothing to indicate this move is over. In fact, futures markets are pricing in another Fed rate cut at their meeting 2 weeks from today, and another three cuts in total by the end of 2020! While German bunds have not seen the same demand, the rest of the European government bond market has rallied with yields everywhere falling between 1bp and 8bps. And don’t forget JGB’s, which have also seen yields decline 2bps, heading further into negative territory despite the BOJ’s efforts to steepen their yield curve. Certainly, a look at the bond market does not inspire confidence that the all clear has been sounded.

And finally, in the FX markets, the dollar remains under general pressure as the market continues to price in further Fed activity which is much greater than anywhere else. Yesterday’s cut took US rates to their narrowest spread vs. Eurozone rates since 2016, when the Fed was in the process of raising rates. It is no coincidence that the euro has recovered to levels seen back then as well. The thing about the dollar’s current weakness, though, is that it seems to be running its course. After all, if the interest rate market is pricing for US rates to fall back to the zero-bound, and there is no indication that the US will ever go negative, how much more room does the euro have to rally? While yesterday’s peak at just above 1.12 may not be the absolute top, I think we are much nearer than further from that point.

A quick look at the EMG bloc shows that today’s winners have largely centered in Asia as those currencies respond belatedly to yesterday’s Fed actions, although we have also seen commodity focused currencies like ZAR (+0.8%), MXN (+0.7%) and RUB (+0.5%) perform well on the rebound in oil and metals prices. I expect that CLP, BRL and COP will also open well on the same thesis.

While yesterday was barren in the US on the data front, this morning we see ADP Employment (exp 170K) and ISM Non-Manufacturing (54.9) as well as the Fed’s Beige Book at 2:00pm. Monday’s ISM Manufacturing data was a touch weak, but it is getting very difficult to read with the Covid-19 situation around. Was this weakness evident prior to the outbreak? I think that’s what most investors want to understand. Also, I would be remiss if I didn’t mention that Chinese auto sales plunged 80% in February and the Caixin PMI data was also disastrous, printing at 27.5.

For now, uncertainty continues to reign and with that comes increased volatility. We have seen that with a substantial rebound in the equity market VIX, and we have seen that with solid rebounds in FX option volatility, which had been trading at historically low levels but are now, in G7 currencies, back to levels not seen since December 2018, when equity markets were correcting and fear was rampant. My take there is that implied vols have further to rally as there is little chance we have seen the end of the current crisis-like situation. Hedgers beware!

Good luck
Adf

 

A Too Bitter Pill

Three stories today are of note
First, Italy’s rocking the boat
Next Brexit is still
A too bitter pill
While OPEC, a cut soon may vote

The outcome in all of these cases
Has been that the market embraces
The dollar once more
(It’s starting to soar)
And quite clearly off to the races

On this Veteran’s Day holiday in the US, where bond markets will be closed although equity markets will not, the dollar has shown consistent strength across the board. Interestingly, there have been several noteworthy stories this morning, but each one of them has served to reinforce the idea that the dollar’s oft-forecast demise remains somewhere well into the future.

Starting with Italy, the current government has shown every indication that they are not going to change their budget structure or forecasts despite the EU’s rejection of these assumptions when the budget was first submitted several weeks ago. This sets up the following situation: the EU can hold firm to its fiscal discipline strategy and begin the procedure to sanction Italy and impose a fine for breaking the rules, or the EU can soften its stance and find some compromise that tries to allow both sides to save face, or at least the EU to do so.

The problem with the first strategy is the EU Commission’s fear that it will increase the attraction of antiestablishment parties in the Parliamentary elections due in May. After all, the Italian coalition was elected by blaming all of Italy’s woes on the EU and its policies. The last thing the Commission wants is a more unruly Parliament, especially as the current leadership may find themselves on the sidelines. The problem with the second strategy is that if they don’t uphold their fiscal probity it will be clear, once and for all, that EU fiscal rules are there in name only and have no teeth. This means that going forward, while certain countries will follow them because they think it is proper to do so, many will decide they represent conditions too difficult with which to adhere. Over time, the second option would almost certainly result in the eventual dissolution of the euro, as the problems from having such dramatically different fiscal policies would eventually become too difficult for the ECB to manage.

With this in mind, it is no surprise that the euro is softer again today, down 0.6% and now trading at its lowest level since June 2017. In less than a week it has fallen by more than 2.0% and it looks as though this trend will continue for a while yet. We need to see the Fed soften its stance or something else to change in order to stop this move.

Turning to the UK, the clock to make a deal seems to be ticking ever faster and there is no indication that PM May is going to get one. Over the weekend, there was no progress made regarding the Irish border issue, but we did hear from several important constituents that the PM’s current deal will fail in Parliament. If Labour won’t support it and the DUP won’t support it and the hard-line Brexiteers won’t support it, there is no deal to be had. With this in mind it is no surprise that the pound has suffered greatly this morning, down 1.4% and back well below 1.30. You may recall that around Halloween, the market started to anticipate a Brexit deal and the pound rallied 3.7% in the course of a week. Well, it has since ceded 2.7% of that gain and based on the distinct lack of progress on the talks, it certainly appears that the pound has further to fall. Do not be surprised if the pound trades below its recent lows of 1.2700 and goes on to test the post-Brexit vote lows of 1.1900.

The third story of note is regarding OPEC and oil prices, which have fallen nearly 20% during the past six weeks as US production and inventories continue to climb while the price impact of sanctions on Iran turned out to be much less then expected. This has encouraged speculation that OPEC may cut its production quotas, although the news from various members is mixed. Adding to oil’s woes (and in truth all commodity prices) has been the fact that global growth has been slowing as well, thus reducing underlying demand. In fact, the biggest concern for the market has been the slow down in China, which continues apace and where stories of further policy ease by the PBOC, including interest rate cuts, are starting to be heard. Two things to note are first, the typical inverse correlation between the dollar and commodity prices such that when the dollar rises, commodity prices tend to fall, and second, in line with the dollar’s broad strength, the Chinese yuan has fallen further today, down 0.3%, and pushing back to the levels that inspired calls for a move beyond 7.00 despite concerns over increased capital outflows.

And frankly, those are the stories of note. The dollar is higher vs. pretty much every other currency today, G10 and EMG alike, with no distinction and few other stories that are newsworthy. Looking at the data this week, there are two key releases, CPI and Retail Sales along with a bit of other stuff.

Tuesday NFIB Biz Confidence 108.0
  Monthly Budget -$98.0B
Wednesday CPI 0.3% (2.5% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 215K
  Philly Fed 20.2
  Empire State 20.0
  Retail Sales 0.5%
  -ex Autos 0.5%
Friday IP 0.2%
  Capacity Utilization 78.2%

Overall, the data continues to support the Fed’s thesis that tighter monetary policy remains the proper course of action. In addition to the data we will hear from three Fed speakers including Chairman Powell on Wednesday. It seems hard to believe that he will have cause to change his tune, so I expect that as long as the rest of the world exhibits more short-term problems like we are seeing today, the dollar will remain quite strong.

Good luck
Adf

Powell’s Fixation

Though spending by business has slowed
(And debt from the government growed)
There’s no indication
That Powell’s fixation
On raising rates soon will erode

The Fed left rates on hold yesterday, as universally expected. The policy statement was largely unchanged although it did tweak the wording regarding business investment, which previously had been quite strong but is now slowing somewhat. That said, there is absolutely no indication that the Fed is going to slow its trajectory of rate increases anytime soon. With the meeting now out of the way, I expect that the Fedspeak we hear going forward will reinforce that view, with only Kashkari and Bullard seeking to slow the pace, and neither of them is yet a voting member. The market response was actually mildly surprising in that equities sold off somewhat after the news (and have fallen sharply in Asia and Europe) despite the fact that this was the expected outcome. Meanwhile the dollar has continued to rebound from its recent lows touched on Wednesday, with the euro having declined 0.2% further this morning and 1.4% from its peak.

As an aside, I am constantly amazed at the idea that the Fed, especially as overseen by Jay Powell, is more than mildly interested in the happenings in the stock market. The Fed mandate is clear, maximum employment and stable prices, notably lacking any discussion of rising equity markets. Alas, ever since the Maestro himself, Alan Greenspan, was Fed Chair, it seems that the default reaction has been to instantly add liquidity to the market if there was any stock market decline. The result is we have seen three massive bubbles blown in markets, two of which have burst (tech stocks and real estate) with the third ongoing as we speak. If you understand nothing else about the current Fed chairman, it is abundantly clear that he is unconcerned with the day-to-day wobbles in financial markets. I am confident that if there is a significant change in the economic situation, and markets respond by declining sharply, the current Fed will address the economic situation, not the markets, and that, in my view, is the way policy should be handled.

But back to today’s discussion. I fully admit that I did not understand the market response to the election results, specifically why the dollar would have declined on the news. After all, a split Congress is not going to suddenly change policies that are already in place, especially since the Republican majority in the Senate expanded. And as the Fed made clear yesterday, they don’t care about the politics and are going to continue to raise rates for quite a while yet. Certainly, we haven’t seen data elsewhere in the world which is indicative of a significant uptick in growth that would draw investment away from the US, and so the dollar story will continue to be the tension between the short-term cyclical factors (faster US growth and tighter monetary policy) vs. the long-term structural factors (rising budget deficits and questionable fiscal sustainability). Cyclical data points to a stronger dollar; structural data to a weaker one, and for now, the cyclical story is still the market driver. I think it is worth keeping that in mind as one observes the market.

Regarding other FX related stories, the Brexit situation is coming to a head in the UK as PM May is trying to get her cabinet to sign off on what appears to be quite a bad deal, where the Irish border situation results in the UK being forced to abide by EU rules without being part of the EU and thus having no input to their formation. This is exactly what the Brexiteers wanted to avoid, and would seemingly be the type of thing that could result in a leadership challenge to May, and perhaps even new elections, scant months before Brexit. While I have assumed a fudge deal would be agreed, I am losing confidence in that outcome, and see an increasing chance that the pound falls sharply. Its recent rally has been based entirely on the idea that a deal would get done. For the pound, it is still a binary outcome.

The Italian budget story continues to play out with not only Brussels upset but actually the backers of the League as well. While I am no expert on Italian politics, it looks increasingly likely that there could be yet another election soon, with the League coming out on top, five star relegated to the backbenches, and more turmoil within the Eurozone. However, in that event, I think it highly improbable that the League is interested in leaving the euro, so it might well end up being a euro positive net.

So the week is ending on a positive note for the dollar, and I expect to see that continue throughout the session. This morning’s PPI data was much firmer than expected with the headline print at 2.9% and the core at 2.6%, indicating that there is no real moderation in the US inflation story. This data is likely tariff related, but that is no comfort given that there is no indication that the tariff situation is going to change soon. And if it does, it will only get worse. So look for the dollar to continue its rebound as the weekend approaches.

Good luck and good weekend
Adf

 

Good Times Will Endure

Elections are out of the way
The outcome caused little dismay
Investors seem sure
Good times will endure
With stocks set to rally today

The dollar, however, is weak
Some pundits claim we’ve seen the peak
Still folks at the Fed
See rate hikes ahead
Which could, on those views, havoc wreak

The midterm elections are now past, with expectations largely fulfilled. The Democrats will run the House, while the Senate’s Republican majority has actually grown by four seats to a 53-47 count. At least that’s what appears to be the case at this time, although there are some runoff elections that need yet to be completed in the next weeks. The traditional view of a political split is that gridlock will ensue and very little in the way of new policy will come out of the next Congress. However, in this case, things may not actually work out that way. Consider the fact that President Trump’s populist leanings may well dovetail with Democratic priorities, especially on spending. It wouldn’t be that surprising if the next budget is even more stimulative than the last, especially as by next summer it is highly likely that the US growth impulse will be slowing down somewhat as the effects of the last stimulus fade away. And through it all, there is no indication that the Fed is going to stop raising interest rates, so I might argue that things haven’t changed all that much.

The risks to this view are if the new Democratic majority in the House chooses to use their power to rehash the battles from 2016 or, more disconcertingly for markets, decide that they want to proceed with an Impeachment process against the President. Two things about this issue are that, first, with the Republicans in control of the Senate, there is essentially zero probability that the President would be removed from office, so it would all be for show. But second, as I mentioned yesterday, the last time we saw this movie, in the autumn of 1998, the dollar fell sharply during the proceedings. This is just something to keep in mind as headlines start to flow going forward.

Enough about the elections. The market response overnight showed equity markets feeling a little better, with Europe higher and US futures pointing in the same direction, although APAC markets were largely flat. Meanwhile, the dollar has come under pressure across the board. The latter seems a little counterintuitive, although I guess it is simply a result of the embrasure of risk by investors. There is no need to flock to dollars, or yen for that matter, if expectations turn positive. And that’s what we seem to have seen.

Focusing on the FX market, the dollar is down pretty sharply across the board. Both the euro and the pound are higher by more than 0.5% despite what I would argue was some mildly negative news. In the Eurozone, while German IP was a touch firmer than expected at +0.2%, Retail Sales data throughout the Eurozone was actually quite weak, with both Italian and Austrian data showing contraction while the French managed to just hold on to an unchanged result, and all three coming well short of expectations.

Meanwhile, the pound continues to trade on hopes that a Brexit breakthrough is coming, despite the fact that yesterday’s widely publicized cabinet meeting produced exactly nothing. PM May has two potential problems here; first is the question of actually coming up with a deal that her cabinet can agree to support that also has EU support, a task that has thus far been out of reach. Second, remember that May has a coalition partner, not a majority in Parliament, and the Labor Party is now coming on record that they will vote against any deal. If that is the case, it is entirely possible that it all falls apart and the UK leaves the EU with no deal in place. While the pound has rallied nicely over the past week, up more than 3.5%, I continue to see the downside risks being significantly greater than the upside. Certainly the rally on a deal announcement would be much smaller in magnitude than the decline in the event of a hard Brexit. Hedgers must keep this in mind as they manage their risks.

As to the rest of the G10, the dollar has fallen even further than the euro and pound, with 0.7% pretty common across virtually the entire bloc. The only two exceptions are JPY, with a more modest 0.3% rally and CAD with a similar gain. My sense is the former is all about risk reduction mitigating some of the dollar weakness, while the latter is related to the fact that oil prices continue to fall, having come down nearly 20% from their highs reached in early October.

In the EMG bloc, there is broad dollar weakness as well with IDR leading the way (+1.5%) and ZAR jumping a solid 1.25%. We discussed the IDR story yesterday as investment flows continue to find their way back to the country given its continued strong growth and low inflation. ZAR, on the other hand, has benefitted from the combination of broad dollar weakness and gold’s recent strength, with the “barbarous relic” having rallied more than 4% in the past month. But it is not just those two currencies showing strength this morning; it is a universal dollar down day, with most freely traded currencies rising more than 0.5%.

And that’s really the day overall. There is no US data to be released today, and the Fed is just starting its two-day meeting, although there is no expectation that there will be any policy change regardless of the fact that it has been pushed back a day in deference to Election day yesterday. There is certainly no reason to believe that the dollar will reverse course in the near term, unless we see a significant uptick in US data that might cause the Fed to step up their pace of activity. However, that is not going to happen today, no matter what, and so I would look for the dollar to continue the overnight move and sell off modestly from this morning’s levels. Although I do not believe that the big picture has changed, any dollar strength is likely to be fleeting in the near future.

Good luck
Adf

 

Trembling With Fear

The one thing increasingly clear
Is markets are trembling with fear
As stock markets tumble
Most central banks fumble
Their message, then get a Bronx cheer

Being a central banker has become much more difficult recently, especially in the wake of yesterday’s global equity market rout. It seems that policies that they have collectively promulgated, QE and ZIRP/NIRP are now quite long in the tooth, and no longer having the positive impact desired. Let’s recap quickly.

The Great recession in 2008 called for an extraordinary monetary response by central banks around the world, and rightly so. The deepest recession since the Great Depression saw liquidity across many markets completely dry up. Even FX, arguably the most liquid market of them all, had structural problems. So the combination of QE and USD swap lines offered by the Fed to the rest of the world’s central banks was an appropriate response to help untangle the mess. Alas, fiscal policy never chipped in to the recovery and central banks took it upon themselves to do all the lifting, thus relieving governments of the need to make hard decisions. In hindsight, this was a key mistake!

Fast forward ten years to today and the situation, remarkably, is that most of that extraordinary monetary stimulus is still sloshing around the world as other than the Fed and the Bank of Canada (who raised rates yesterday and indicated they would be quickening the pace of doing so in the future), no other major central bank has done anything of note. The ECB, the BOJ and the PBOC are all still adding liquidity to their systems, while the BOE has raised rates just 25bps, net, from the lows established after the crisis. And the same is true of peripheral nations like Switzerland, Sweden and Australia, where interest rates remain at their post crisis nadirs (-0.75%, -0.50% and 1.50% respectively).

The problem for these central banks is that growth is starting to slow on a global basis. Whether it is the increased trade friction between the US and China, concerns over Brexit or simply that the US recovery (which still arguably drives most of the global economy) is now the longest on record and due to end, the situation is increasingly fraught. And that’s the rub. If interest rates are already negative, what can central banks do to stimulate the economy in the event of a recession? The answer, of course, is not much. More QE and even deeper negative interest rates are unlikely to have the same positive impact the first efforts had, in fact they could have the opposite effect by generating greater concern amongst investors and causing a more severe sell-off in markets. But politically, no central bank will be able to sit by and do nothing if a recession does appear. As I said, central banking has become much more difficult lately.

That is all a preamble to discuss what is going on in markets right now. FX is a backburner issue with equities front and center around the world. While European markets have stabilized at this time, one session of stability is not sufficient to declare an end to the rout. In the end, markets remain beholden to broad sentiment, the narrative if you will, and for the past ten years that narrative was that continued low inflation combined with steady growth would allow the central banks to maintain ultra easy monetary policy with no negative side effects. But in the past year, the cracks in that narrative have grown to the point where it is no longer seen as viable. First, inflation has begun to creep higher in certain areas around the world, notably the US and China. At the same time, growth data appears to have peaked last quarter. Tomorrow we will see the first estimate of Q3 GDP growth in the US (exp 3.3%), which is already considerably lower than Q2. In addition, we have seen Chinese growth slow more than expected and German growth fall to 0.0% in Q3. The combination of rising inflation and slower growth has put central banks in a bind forcing them to choose which issue to address first. The problem is by addressing one they are likely to exacerbate the other. So as the Fed fights threats of higher inflation, it impedes growth. Meanwhile, China has opted to support growth, thus feeding faster inflation. In the end, as the next recession looms closer, central banks will find themselves with fewer policy arrows in their quiver.

But this is an FX note, so let’s take a quick look at the market this morning. The dollar is a touch softer, with both the euro and the pound higher by 0.15% while we are seeing similar moves in most emerging market currencies. Activity in the market seems muted relative to the excitement in equities, but my sense is this will not last. Rather, if the equity sell-off continues, the dollar should find itself in a much stronger position. As to the stories that have been driving things in FX, the Italian budget, Brexit, central bank policies, there have been no real changes in the past twenty-four hours. The possible exception is that the interest rate futures market in the US has removed one price hike from the Fed’s expected path as concern grows that a continues slide in the stock market will lead to weaker growth and less need to keep driving rates higher. It seems that the Fed realizes that it began its tightening process far too late (thank you Chair Yellen!) and is now desperately trying to catch up so they can respond to the next downturn. But hey, the ECB is MUCH further behind.

Looking forward to today’s session, we start with the ECB meeting, where they announced no change in policy rates, but we still await Signor Draghi’s press conference at 8:30. It will be interesting if he continues to characterize the Eurozone economy risks as balanced, or if the downside risks are now elevated. If the latter, look for the euro to decline sharply! We also get US data including Durable Goods (exp -1.0%, ex transport +0.5%) and the Goods Trade Balance (-$74.9B). Yesterday’s New Home Sales data was awful, just 553K, well below expectations, and another sign that parts of the economy here are rolling over. I still don’t believe that the data turn has been enough to change the Fed’s mind about a December rate hike, but if numbers start to fall, watch out. Tomorrow’s GDP print will be quite important to the market. But today, I think the ECB dominates the story.

Good luck
Adf

 

Not Quite Yet Elated

The sell-off in stocks has abated
Though bulls are not quite yet elated
Most bonds, which had jumped
This morning were dumped
While dollar bears still are frustrated

Two days of substantial equity weakness has halted this morning, with Asian markets rebounding nicely and Europe also on the rise. As usual, it is not clear exactly what caused this reaction, but there are several reasonable candidates. The first was a softer than expected US inflation print yesterday morning. If, in fact, inflation in the US continues to remain just north of 2.0%, then the Fed may feel much less urgency to raise rates aggressively, and markets around the world will appreciate that change of stance. Remember, one of the reasons that we have seen such disruption elsewhere in the world, most notably throughout emerging market economies and markets, is that during the eight year long period of US ZIRP, companies and governments around the world gorged themselves on cheap USD debt. Eight rate hikes later, that debt is no longer so cheap, especially when it comes time for those borrowers to refinance. So any hint that the Fed will have a lower terminal rate is going to be perceived as a market positive.

The other news was a surprise increase in the Chinese trade surplus, which rose to $31.7B, far above the expected $19.4B. Exports, to everyone’s surprise, rose 14.5% despite the tariff situation. While some of this may be due to timing issues of when these shipments were recognized, the news was positive nonetheless. I expect that as we go forward, Chinese export data is likely to suffer, but for now, the news is better than expected. Beyond those two stories, it is difficult to make a case for any real change anywhere.

One of the interesting things about the past two sessions is that while risk was clearly being jettisoned, the dollar was not a beneficiary like it had been in the past during these events. Traditionally, dollar strength accompanies weak equity and commodity markets, but not this time. Of course, one of the big issues in the market right now is the structural deficit in the US. Expansionary fiscal policy here has resulted in the highest non-wartime budget deficits on record, now approaching $1 trillion for this year and certain to be more than that next year, which means that the Treasury is going to need to issue a lot more debt to pay for things. At the same time, the Fed continues to reduce its bid for Treasury bonds as it shrinks its balance sheet steadily. This combination of events is almost certainly going to lead to higher US interest rates out the curve, as more price sensitive investors become the marginal buyer.

For the past six months, higher US rates have been an unalloyed USD positive, driving the dollar back to its levels of late last year and scotching all the talk of a significant dollar decline. But if you recall, I wrote about the opposing structural and cyclical issues facing the dollar several months ago, where the cyclical highlighted the faster growth in the US economy and higher interest rates as a dollar support, while the structural issues of growing twin deficits (budget and current account) pointed to a weaker currency going forward. It is entirely possible that the market’s recent behavior, where despite a risk-off situation the dollar is falling, is an indication that the structural issues are starting to lead the conversation. If that is the case, the dollar is likely to have seen its peak. While it is too early to know for sure, this is something that we will monitor closely going forward.

With regard to specifics in today’s session, most currencies have halted their rally but not really declined much. Other than the Chinese trade data, there has not been much of interest released today, and in the US all we get is Michigan Sentiment (exp 100.4). What we do know is that it is a Friday at the end of a stressful week for markets, which typically results in less active markets. Equity futures in the US are pointing higher, and as long as the US markets follow suit with Asia and Europe and rebound, I expect the dollar will do very little on the day. However, if we see this early strength turn around and US equity markets wind up closing lower on the day, look for much more global anxiety over the weekend and the risk-off sentiment to resume in earnest next week. That includes, at this time, further dollar weakness. So unusually, a modest equity market rally should result in modest USD strength, while a sell-off will likely see the dollar suffer as well.

Good luck and good weekend
Adf

Southeast of France

The nation that’s southeast of France
Seems willing to leap at the chance
Of increasing spending
While also descending
Into a black hole of finance

Today’s markets have been dominated by a renewed fear that Italy may become Quitaly, quitting the euro in an effort to regain control of their finances. This view came about when Claudio Borghi, the chairman of the lower house budget committee (analogous to the House finance committee in the US), said that the euro was “not sufficient” to solve Italy’s fiscal issues. That was seen as an allusion to the idea that if Italy ditched the euro and returned to the lire, they would have more flexibility to implement the fiscal policies they wanted. In this case, flexibility can be understood to mean that Italy would be able to print and spend more money domestically, while allowing the lire to depreciate. The problem with the euro, as Italy sees it, is since they don’t control its creation, they cannot devalue it by themselves. There can be no surprise that the euro declined, falling 0.6% after a 0.3% decline yesterday. Of course, Italian stock and bond markets have also suffered, and there has been a more general feeling of risk aversion across all markets.

In the meantime, the latest Brexit news covers a new plan to allegedly solve the Irish border issue. It seems that PM May is going to offer up the idea that the UK remains in the customs union while allowing new checks on goods moving between Northern Ireland and the UK mainland. The problem with this idea, at least on the surface, is that it will require the EU to compromise, and that is not something that we have seen much willingness to embrace on their part. Remember, French President Macron has explicitly said that he wants the UK to suffer greatly in order to serve as a warning to any other members from leaving the bloc. (Funnily enough, I don’t think that either Matteo Renzi or Luigi Di Maio, the leaders of the League and Five-Star Movement respectively in Italy, really care about that.)

For now, the market will continue to whipsaw around these events as hopes ebb and flow for a successful Brexit resolution. While it certainly doesn’t seem like anything is going to be agreed at this stage, my suspicion remains that some fudge will be found. The one caveat here is if PM May is ousted at the Conservative Party conference that begins later this week. PM Boris Johnson, for instance, will tell the Europeans to ‘bugger off’ and then no deal will be found. In that case, the pound will fall much further, but that seems a low probability event for right now. With all of that in mind, the pound has fallen 0.6% this morning and is back below 1.30 for the first time in three weeks.

In fact, the dollar is higher virtually across the board this morning, with AUD also lower by 0.6% after the RBA left rates unchanged at 1.50% while describing potential weakening scenarios, including a slowdown in China. Even CAD is lower, albeit only by 0.15%, despite the resolution of the NAFTA replacement talks yesterday.

Emerging markets have fared no better with, for example, IDR having fallen nearly 1.0% through 15,000 for the first time in twenty years, despite the central bank’s efforts to protect the rupiyah through rate hikes and intervention. We have also seen weakness in INR (-0.6%), ZAR (-1.3%), MXN (-0.6%), TRY (-1.9%) and RUB (-0.7%). Stock markets throughout the emerging markets have also been under pressure and government bond yields there are rising. In other words, this is a classic risk-off day.

Yesterday’s ISM data was mildly disappointing (59.8 vs. 60.1 expected) but continues to point to strong US economic growth. Since there are no hard data points released today (although we do see auto sales data) my sense is the market will turn its focus on Chairman Powell at 12:45, when he speaks at the National Association of Business Economics Meeting in Boston. His speech is titled, The Outlook for Employment and Inflation, obviously the exact issues the market cares about. However, keeping in mind the fact that Powell has been consistently bullish on the economy, it seems highly unlikely that he will say anything that could derail the current trend of tighter US monetary policy. Combining this with the renewed concerns over Europe and the UK, and it seems the dollar’s rally may be about to reignite.

Good luck
Adf

 

A Terrible Day

The UK’s Prime Minister May
Last night had a terrible day
Her plans for a deal
Were seen as unreal
As hawks in the EU held sway

But elsewhere the market’s embraced
The concept that fear was misplaced
Instead, stocks they’re buying
And so, fortifying
The idea, for risk, they have taste

Arguably, the key headline this morning was the extremely poor reception British PM May received from her 27 dinner companions at the EU dinner last night. She continues to proffer the so-called Chequers deal (named for the PM’s summer residence where the deal was agreed amongst Tory members several weeks ago), which essentially says the UK will toe the EU line when it comes to manufactured and agricultural goods, but wants a free hand in services and immigration. French President Macron was quick to dismiss the notion as he remains adamant that leaving the EU should be seen as a disaster, lest any other nations (Italy are you watching?) consider the idea. At any rate, while the pound had been rallying for the past week, reaching its highest level since early July, that all came a cropper last night. The growing hope that a Brexit deal would be found has been shattered, at least for now, and it should be no surprise that the pound has suffered for it. This morning, it is leading the way lower, having fallen 0.6% from yesterday’s closing levels.

However, while the dollar is modestly firmer this morning across the board, my strong dollar thesis is being severely tested of late. We have seen the dollar fall broadly all week despite the resumption of the march higher in US yields. Or is it because of that movement that the dollar is falling? Let’s consider the alternatives.

Several months ago I wrote about the conflicting cyclical and structural aspects of the market that were impacting the dollar’s value. The cyclical factors were US growth outpacing the rest of the world and the Fed tightening monetary policy faster than any other central bank. This combination led to higher US rates and a better investment environment in the US than elsewhere, and consequently, an increase in dollar buying for global investors to take advantage of the opportunities. Thus higher short-term interest rates led to a higher US dollar, along with a flatter yield curve.

On the other hand, the structural questions that hang over the US economy consist of the impact of late cycle fiscal stimulus in the form of both tax cuts and increased spending. The fact that this was occurring at the same time the Fed was reducing the size of its balance sheet meant that at some point, it seemed likely that increased Treasury supply would find decreased demand. The growing budget and current account deficits would in turn pressure the dollar lower while the excess Treasury supply would push long-term yields higher ending up with a weaker dollar and a steeper yield curve.

Starting in April, it became clear that the cyclical story was the primary market driver, with strong US growth pushing up short-term rates as well as US corporate earnings. Investors flocked to the US to take advantage with the dollar rallying sharply while US equity markets significantly outperformed their foreign counterparts. This was especially notable in the EMG space, where a decade of QE had forced funds to the highest yielding assets they could find, which happened to be those EMG markets. But now that there was an alternative, those funds were quick to return to the US, driving EMG equity markets lower and hammering those currencies as well. There was also a great deal of concern that if the divergence in markets continued, it could result in much more significant losses elsewhere that would eventually come back to haunt US markets.

But a funny thing happened last week, US CPI printed lower than expected. Now you might not think that a 0.1% miss on a number would be that important, but essentially what that signaled to markets was that the Fed would be more likely to ease back on the pace of tightening, thereby slowing the rise in the short-term interest rate structure. It also indicated that US growth may not be as robust as had been previously thought, and therefore, opportunities here, while still excellent, needed to be weighed against what was going on elsewhere in the world. At the same time, elsewhere in the world we have seen continued central bank rhetoric about removing policy accommodation, with ECB President Draghi’s press conference seen as mildly hawkish, while the BOJ seems to be in stealth taper mode. We have also seen the trade situation get pushed to the back of the collective market’s mind as the US imposed a lower tariff rate than expected on Chinese goods, and has not yet moved forward on any other tariffs.

But wait, there’s more!, after four months of selling off, EMG assets have suddenly started to look like they represent a ‘value’ play, with the first buyers tentatively dipping their toes back into those markets. And finally, remember that the speculative long dollar position has been building for months and reaching near record levels. Adding it all up leads to the following conclusion: there is room for the dollar to continue this decline in the medium term. Continued fund movement into EMG markets combined with the reduction of the long dollar positions will be more than sufficient to continue to drive the dollar lower.

That combination is what has taken place this week, and despite the break today, it seems quite viable that we will continue to see this pattern for a bit longer. In the end, I don’t think that the market will completely ignore the cyclical dollar prospects, but for now, the broad structural story is holding sway. Add to this the idea that market technicians are going to get excited about selling dollars because it has reached levels below the 50-day and 100-day moving averages, and thus is ‘breaking out lower’, and we could be in for a couple of months of dollar weakness. If this is true, while individual currencies could still underperform, like the pound if the Brexit situation collapses, it is entirely possible that Chairman Powell could find himself in the best position he could imagine, continuing to remove policy ease while the dollar falls, thus ameliorating the President’s concerns. But it’s not clear to me that is such a good thing overall. We shall see.

Good luck and good weekend
Adf

Money More Dear

Next week, though it’s certainly clear
The Fed will price money more dear
The dollar’s incurred
Some selling and spurred
More weakness than seen since last year

The dollar remains under pressure this morning with a number of stories having a separate, but a cumulative impact on the buck. For example, overnight we learned that New Zealand’s GDP grew 1.0% in Q2, higher than the expected 0.7% outcome, and sufficient to get investors and traders to consider that the RBNZ, which just last month promised to maintain record low interest rates until at least 2020, may wind up raising rates sooner than that. A surprise of this nature usually leads to currency strength and so it is this morning with NZD higher by 0.8%.

Or consider the UK, where Retail Sales data surprised one and all by rising 0.3% in August (3.3% Y/Y), a much better performance than expected. This was enough to overcome the ongoing Brexit malaise and drive the pound higher by 0.7% and back to its highest level in two months. In truth, this is somewhat surprising given the quite disappointing outcome from the EU meeting Wednesday night in Brussels. Rather than more positive remarks about the viability of a deal being completed, we heard more of the hard-core negativity from the French and Irish, basically saying if the UK doesn’t cave, then there will be no deal. This is certainly not a welcome outcome, especially since there are only 190 days until Brexit will occur, deal or no. Meanwhile, PM May continues to fight a rearguard action against the avid pro-Brexiters in her party in order to retain her position.

Logically, I look at the situation and believe there is no real chance of a satisfactory deal being agreed on time. Frankly, the Irish border issue is intractable in my view. But given that this is entirely about politics, and the Europeans and British are both famous for kicking the can down the road, I suspect that something along the lines of a pure fudge, with neither side agreeing anything, will be achieved in order to prevent a complete disaster. However, there is a very real probability that the UK will simply leave the EU with no deal of any sort, and if that is the case, the initial market reaction will be for a sharp sell-off in the pound.

Interestingly, despite the fact that the little Eurozone data released was on the soft side, the euro has managed to continue its recent rally and is higher by 0.4% as I type. This seems more of a piece with the general dollar weakness that we have witnessed the past two sessions than anything else.

Another potential conundrum is US interest rates, where 10-year Treasury yields jumped to 3.08% yesterday, their highest level since early May, and now gathering momentum for the breakout that many pundits have been expecting for a while. Remember, short Treasury futures are one of the largest positions in the market. This thought process has been led by two concurrent features; the Fed continues to raise short term rates while the Treasury, due to increased fiscal policy stimulus and a growing budget deficit, will be forced to increase the amount of debt issued. When this is wrapped up with the fact that the Fed is reducing the size of its balance sheet, thus removing the one true price-insensitive bid from the market, it seemed a recipe for much higher 10-year yields. The fact that we remain at 3.08% nine months into the year is quite surprising, at least to me. But it is entirely possible that we see a much more aggressive sell-off in Treasuries going forward, especially if the Fed tweaks their message next week to one that is more hawkish.

In this context, let me give a concrete example of just how important the central bank message really is. This morning, Norgesbank raised interest rates in Norway by 25bps, as was universally expected. This was the first time in 7 years they raised rates, and are doing so because the economy there is expanding rapidly while inflation moves closer to their target. But in their policy discussion, they reduced the forecast pace of future interest rate hikes, surprising everyone, and the result was a sharp decline in NOK. Versus the euro it fell more than 1%, which translated into a 0.7% decline vs. the dollar. The point is the market is highly focused on the policy statements as well as the actual moves.

This is equally true, if not more so, with regard to the Fed. Current expectations are that the Fed will raise rates 25bps next week and another 25bps in December. Where things get cloudier is what next year will look like, and how fast they will continue to tighten policy. It is for this reason that next week’s meeting is so widely anticipated, because the Fed will release its updated dot plot, the effective forecasts of each Fed member as to where Fed funds will be at various points in the future. If the dot plot implies higher rates than the last iteration in June, you can expect the dollar to benefit from the outcome. Any implication of a slower pace of rate hikes will certainly undermine the dollar.

In the end, the mixture of new information has been sufficient to push the dollar lower by 0.3% when looking at the broad dollar index. Interestingly, despite its recent weakness, it remains within the trading range that has defined its movement since it stopped appreciating in April. Frankly, I expect this range trading to continue unless the Fed significantly changes its tune.

This morning brings a bit more data with Initial Claims (exp 210K) and Philly Fed (17.0) due at 8:30 while Existing Home Sales (5.35M) are released at 10:00. Yesterday’s housing data was mixed with New Home Sales rising more than expected, but Building Permits plunging. And remember that both of those data points tend to have a great deal of volatility. With that in mind, looking at the longer term trend shows that while Housing Starts seem to be rebounding from a bad spot, the trend in Permits is clearly downward, which doesn’t speak well for the housing market in the medium term.

In the end, as I wrote yesterday, continued modest dollar weakness seems the most likely outcome for now, but I suspect that we are coming to the end of this soft patch, and that the dollar will find its legs soon. I remain confused as to why there is so much bullishness attached to the Eurozone economy given the data continues to underperform. And there is no indication that the ECB is going to suddenly turn truly hawkish. Current levels strike me as attractive for dollar buyers.

Good luck
Adf