Tag Archives: #FX

Real Savoir Faire

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There once was an aging Fed Chair

With poise and some real savoir faire

He claimed the foundation

Of rising inflation

Were objects that, right now, were rare

But soon when supply chains are mended

And joblessness falls as intended

Inflation will sink

To levels we think

Are fine, and the world will be splendid

Remember when the FOMC Statement and following press conference were seen as hawkish?  That was sooo last week!  There was talk of rate hikes in only TWO YEARS!  There was talk about talk about tapering the purchase of assets as monetary policy started to ‘normalize’.  (Not for nothing but given we have had the same monetary policy for effectively the past 13 years, ZIRP and QE might be considered normal now, not positive real rates and a stable balance sheet.)  Well, apparently the market reaction was not seen as appropriate by Chairman Jay and his cadre of central bankers, so we have heard a definitive retreat on those concepts in the ensuing six days.  

Just since Monday, we have heard from six different FOMC members and every one of them has essentially said, “just kidding!”  Yesterday, Chairman Powell testified to a House Subcommittee on Covid and was forced to explain, yet again, that policy changes were still a long way down the road and that inflation remains transitory.  It was not, however, just Powell delivering that message.  It was also Cleveland’s Loretta Mester, SF’s Mary Daly and NY’s John Williams amongst others.  Current policy settings are appropriate, inflation is transitory and there is still a long way to go before that elusive substantial further progress toward the Fed’s dual mandates will have been achieved.

History has shown that the Fed’s effective reaction function, at least since Alan Greenspan was Chair, is defined by an equity market decline of a certain amount.  This is especially true if the decline happens quickly whereupon they will jump in and ease policy.  It appears that the amount of market angst necessary to get the Fed to change their tune regarding infinite liquidity and monetary support continues to shrink.  It used to take a decline on the order of 15%-20% to get the Fed nervous.  This time, the S&P 500 fell less than 2% before virtually the entire committee was on the tape walking back their tough talk.  And yet, they would have you believe that when inflation is roaring higher for the rest of the year, they have the intestinal fortitude to fight it effectively by raising interest rates or reducing QE.  As actions speak louder than words, my money is on the Fed being completely unable to address rising inflation.  Be prepared.

This topic continues to be the primary narrative in markets around the world, with many other countries now grappling with the transitory inflation story as well.  Nothing else really matters, and rightly so.  If inflation is building a head of steam and will be rising around the world, central banks are going to be forced to respond.  Some will respond more forcefully and more quickly than others, and it is those currencies which are likely to outperform going forward.  Investors today are generally unfamiliar with investing in an inflationary environment.  The 1970’s were the last time we really saw inflation of substance and even I was still in college (and I am almost certainly much older than you) when that was the situation, with many, if not most, of the current investment community not yet even born.

A quick look at the chart of the Dollar Index (DXY) from that time shows that from the autumn of 1971, right after President Nixon closed the gold window and ended Breton Woods, through the end of 1979, right after Paul Volcker was named Fed Chair and had just started his inflation fight, the dollar declined about 28% (roughly 4% per annum).  Of course, once Volcker got going and US interest rates were raised dramatically to kill off inflation, the dollar rose more than 75% in the following four years.

The point is that while we may disparage the Fed’s actions as being wrong-headed, their policies matter immensely.  Jay Powell may wind up with his reputation in tatters akin to Arthur Burns and G. William Miller, the Fed Chairs who oversaw the sharp rises in inflation in the 1970’s preceding Mr Volcker.  It seems unlikely this outcome is his goal, however, his insistence on toeing the political line rather than hewing to sound money policies bodes ill for the future.

Anyway, while US equity markets have essentially retraced all their post FOMC losses, the rest of the world has seen a more mixed outcome.  In Asia last night, the Nikkei (0.0%) was essentially flat although there were gains in the Hang Seng (+1.8%) and Shanghai (+0.25%).  Europe, on the other hand, is under some pressure this morning with both the DAX (-0.5%) and CAC (-0.4%) feeling some pain based on softer than expected, though still strong, Flash PMI data.  The UK, however, is seeing a much better performance (FTSE 100 +0.35%) as not only was the PMI data stronger than expected, but there apparently is a breakthrough on the lingering Brexit issues of treating goods in Northern Ireland.  Meanwhile, US futures are essentially unchanged this morning, perhaps waiting for some more encouragement from today’s roster of Fed speakers.

Bond markets, after a very choppy few days, have calmed down greatly with Treasuries (+1.2bps) softening a bit while European sovereigns (Bunds -1.4bps, OATs -1.4bps) are seeing some demand.  UK Gilts are little changed as the market there awaits tomorrow’s BOE meeting, where some believe there is a chance for a more hawkish tilt.

Commodity prices are definitely firmer this morning led by oil (+0.7%) but also seeing strength in precious metals (Au +0.25%, Ag +0.7%), base metals (Cu +0.7%, Fe +1.4%, Sn +0.2%) and agricultural products (Soybeans +0.5%, Wheat +1.2%, Corn +0.4%).  Clearly the commodity markets see inflation in the future.

Finally, the dollar is mixed this morning but, in truth, the relatively small movements indicate a lack of interest.  Commodity currencies like NOK (+0.1%), AUD (+0.2%) and NZD (+0.2%) are the leading G10 gainers while JPY (-0.35%) continues to come under pressure, arguably suffering from the fact that Japan imports virtually all its commodities.

In the EMG space, the picture is also mixed with HUF (+0.7%) the leading gainer after the central bank raised its benchmark rate to 0.9% yesterday a 0.3% increase that was expected.  But the idea that they are joining the several other EMG central banks in tightening mode (Brazil, Russia, Ukraine) has investors buying up the forint.  Away from that, ZAR (+0.4%) is clearly benefitting from higher commodity prices as are RUB (+0.2%) and MXN (+0.1%) although the latter two are quite modest.  On the downside, KRW (-0.5%) saw the sharpest declines as a combination of equity outflows as well as a sharp rise in Covid infections was seen quite negatively.  But in truth, most APAC currencies were under some pressure overnight, albeit not to the extent seen in Seoul.

Today’s data brings the Flash PMI (exp 61.5 Mfg, 70.0 Services) as well as New Home Sales (865K).  But more importantly, we have three more Fed speakers set to reiterate the message that policy is not going to change for a while yet, so no need for investors to panic in any market.  The dollar responded logically to the idea that the Fed was going to tighten policy, but now that they have gone out of their way to walk that idea back, I expect the dollar is more likely to drift lower for now.  Perhaps when it becomes clearer that the Fed is actually going to move, we could see some strength again.  But that is likely still a few weeks or months away.  Trade the range for now.

Good luck and stay safe

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Getting Upset

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The Chinese are getting upset

Commodity prices, as yet

Continue to rise

As shrinking supplies

Now pose, to their model, a threat

So, naturally, what did they do?

They ordered state firms to eschew

Stockpiling provisions

As now all decisions

Will come from Beijing ‘pon review

With the FOMC meeting on virtually everyone’s mind this morning, market activity overall has been muted.  However, the one place in the world that doesn’t revolve around the Fed is China, and news from there last night is quite interesting.  You may recall my quick story about the Department of Price two weeks’ ago and how that ‘august’ institution warned commodity hoarders and speculators to stop what they were doing.  Well, apparently, not enough people listened to those warnings as last night two more Orwellian entities in China joined the conversation regarding commodity prices.  The State-owned Assets Supervision and Administration Commission (SASAC) ordered companies under its purview, the SOE’s, to “control risks and limit their exposure to overseas commodities markets”.  This was clearly the stick to accompany the carrot dangled by the National Food and Strategic Reserves Administration, which has indicated it will soon release state stockpiles of copper, aluminum and zinc amongst other metals.

It is obvious that China has figured out that rising commodity prices may soon start to pass through from the factory to the consumer and drive CPI higher on the mainland.  President Xi is clearly concerned that rising prices could lead to some political unrest given that the bargain he has made with his citizens is to enhance their lives economically so he can control all the levers of power.  Thus, if inflation starts to rise more seriously, the population may call his leadership into question.

The problem for China, however, is that while in the past, they had been the marginal buyer of virtually all commodities as they grew their economic capacity dramatically, that situation no longer holds.  Yes, they still have an impact, but in this post-Covid environment where the rest of the world is rebounding very quickly, demand for commodities outside of China is growing rapidly.  But perhaps more importantly, because the previous decade saw commodity prices lag financial prices, investment in the sector was greatly reduced.  This has led to reduced supplies of many critical things and now that demand is resurgent, not surprisingly the prices of copper, steel and other commodities have been rising rapidly even if China isn’t buying as much as they used to.

Adding to this dynamic is the great conundrum of ESG.  On the one hand, ESG’s goals are to reduce environmental impact of economic activity which has largely played out as trying to substitute electricity for fossil fuels as a power source.  On the other hand, in order to electrify economies, the amount of metals like steel and copper required to achieve the stated goals is dramatically higher than the current model.  So, reducing investment in commodity producers results in much higher prices for the very commodities needed to achieve ESG goals in the long run.  While this is not the only argument to rebut the Fed’s transitory inflation story, it is an important part of the inflationists’ views.  China’s actions will only have a very temporary impact on the prices of the commodities in question, but the long-term demand is here to stay.  Until investment in extraction of commodities increases sufficiently to bring more capacity online, odds are that commodity prices will continue to rise, whether Xi Jinping likes it or not.  And if input prices continue to rise, at some point soon, so will prices of end products.  We have been witnessing the beginnings of that trend, but I fear it has much further to go.

Interestingly, despite all the sturm und drang in Beijing about metals prices, after a sharp decline yesterday, this morning they are edging higher (Cu +0.2%, Al +0.1%, Fe +0.5%, Steel +2.8%) although not nearly reversing yesterday’s moves.  If you ever wanted proof that China no longer calls the shots in commodities, here is exhibit A.

Today Chairman Jay will expound

On growth and its stunning rebound

But do not expect

That he will project

Some changes will shortly gain ground

The other story today, really the biggest for our session, is the FOMC meeting.  Broadly speaking, expectations are that the Fed will not make any policy changes of note, although there will clearly be some tweaking to the statement.  They cannot ignore the 5.0% CPI reading, I think, and they will certainly focus on the idea that the employment situation isn’t improving as rapidly as they would like.  And ultimately, for now, it is the latter issue that will continue to inform policy choices.  So tapering is not going to be on the menu, and when Powell is asked in the press conference, as he surely will be, I expect a response along the lines of, substantial further progress needs to be made before they will change things.

If I were to assess the risks, it feels like there is more risk of a hawkish outcome than a dovish one as the inflation story will not go away.  But that implies to me that the market is according a hawkish twist some real probability, so the big surprise to markets would be if they were excessively dovish.  However, I think Powell will do everything he can to be as nondescript as possible, stay on message and there will be very little movement.

A brief recap of markets overnight shows that Asian equities suffered, led by Shanghai (-1.1%).  Not only are they dealing with rising commodity prices, but the data released (Retail Sales, IP and Fixed Asset Investment) all disappointed vs. expectations.  China’s negativity bled into the Nikkei (-0.5%) and Hang Seng (-0.7%) as well.  Europe, on the other hand, has gone nowhere ahead of the Fed, with virtually every equity index within 0.1% of yesterday’s closes.  It should be no surprise that US futures markets are also essentially unchanged ahead of the Fed.

As to the bond market, we are beginning to see a touch of strength with yields declining ever so slightly.  Treasuries are lower by 0.5bps, while Bunds (-1.1bps), OATs (-0.9bps) and Gilts (-0.7bps) are also performing reasonably well ahead of this afternoon’s announcements.  It remains remarkable to me that with inflation rising universally, bond yields continue to ignore the situation.  One has to give credit to the central banks for selling their transitory story.

In the FX markets, the picture is mixed with gainers and losers evenly split in the G10.  AUD and NZD (+0.3% each) lead the way higher, although there does not appear to be a clear catalyst implying this is a positioning issue.  GBP (+0.25%) has gained on the back of slightly higher than expected CPI readings (2.1% vs. 1.9% expected), as traders look for more concrete tightening of policy there.  On the downside, both NOK and SEK have fallen by 0.35%, despite oil’s modest gains and a lack of other news.  Again, this feels more technical than fundamental.

EMG currencies are also little changed overall, with a touch of weakness seen in the APAC bloc overnight, but only on the order of -0.1%, while RUB (+0.3%) and MXN (+0.25%) are the leaders, clearly helped by oil’s ongoing gains, but also seeming to benefit from some political stories.

Data this morning bring Housing Starts (exp 1630K) and Building Permits (1730K), but they will not be noticed with the Fed story coming later this afternoon.  Yesterday’s data was mixed at best with Retail Sales disappointing for May but seeing large positive revisions in April to offset, while PPI once again printed at much higher than expected levels (6.6%).  But let’s face it, today is Fed day and we are unlikely to see much movement until at least 2:00 when the statement is released if not until 2:30 when Chairman Powell starts to speak.  At this time, any hawkishness is very likely to support the dollar with the opposite true as well, a dovish tilt will lead to a dollar decline.

Good luck and stay safe

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Out of Gas

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Though prices are forecast to rise
The Treasury market implies
That Jay has it right
And this is the height
Inflation will reach at its highs

Instead, once the base effects pass
Inflation will run out of gas
So there is no need
For Powell to heed
The calls to halt QE en masse

This morning we finally get to learn about two of the three potential market catalysts I outlined on Monday, as the ECB announces their policy decision at 7:45 EDT with Madame Lagarde speaking at a press conference 45 minutes later.  And, as it happens, at 8:30 EDT we will also see the May CPI data (exp 0.5% M/M, 4.7% Y/Y headline; 0.5% M/M, 3.5% Y/Y ex food & energy).  Obviously, these CPI prints are far higher than the Fed target of an average of 2.0% over time, but as we have been repeatedly assured, these price rises are transitory and due entirely to base effects therefore there is no need for investors, or anybody for that matter, to fret.

And yet…one cannot help but notice the rising prices that we encounter on a daily basis and wonder what the Fed, and just as importantly, the bond market, is thinking.  Perhaps the most remarkable aspect of the current inflation discussion is that despite an enormous amount of discussion on the topic, and anecdotes galore about rising prices, the one market that would seem to be most likely to respond to these pressures, the Treasury market, has traded in exactly the opposite direction expected.  Yesterday, after a very strong 10-year auction, where the coverage ratio was 2.58 and the yield fell below 1.50%, it has become clear that bond investors have completely bought into the Fed’s transitory story.  All of the angst over the massive increases in fiscal spending and huge growth in the money supply have not made a dent in the view that inflation is dead.

Recall that as Q1 ended, 10-year yields were up to 1.75% and forecasters were falling all over themselves to revise their year-end expectations higher with many deciding on the 2.25%-2.50% area as a likely level for 10-year yields come December.  The economy was reopening rapidly and expectations for faster growth were widespread.  The funny thing is that those growth expectations remain intact, yet suddenly bond investors no longer seem to believe that growth will increase price pressures.  Last week’s mildly disappointing NFP report is a key reason as it was the second consecutive report that indicated there is still a huge amount of labor slack in the economy and as long as that remains the case, wage rises ought to remain capped.  The counter to that argument is the heavy hand of government, which is both increasing the minimum wage and paying excessive unemployment benefits thus forcing private companies to raise wages to lure workers back to the job.  In effect, the government, with these two policies, has artificially tightened the labor market and historically, tight labor markets have led to higher overall inflation.

The last bastion of the inflationists’ views is that the recent rally in Treasuries has been driven by short-covering and that has basically been completed thus opening the way for sellers to reemerge.  And while I’m sure that has been part of the process, my take, also anecdotal, is that fixed income investors truly believe the Fed at this time, despite the Fed’s extraordinarily poor track record when it comes to forecasting literally anything.  

As an example, two weeks ago, I was playing golf with a new member of my golf club who happened to be a portfolio manager for a major insurance company.  We spent 18 holes discussing the inflation/deflation issue and he was 100% convinced that inflation is not a problem.  More importantly, he indicated his portfolio is positioned for that to be the case and implied that was the house view so his was not the only portfolio so positioned.  This helps explain why Treasury yields are at 1.49%, 25 basis points lower than on April 1.  However, it also means that while today’s data, whatever it is, will not be conclusive to the argument, as the summer progresses and we get into autumn, any sense that the inflation rate is not heading back toward 2.0% will likely have major market consequences.  Stay tuned.

As to the ECB, it seems highly unlikely that they will announce any policy changes this morning with the key issue being their discussion of the pace of QE purchases.  You may recall that at the April meeting, the key words were, “the Governing Council expects purchases under PEPP over the current quarter to continue to be conducted at a significantly higher pace than during the first months of the year.”  In other words, they stepped up the pace of QE to roughly €20 billion per week, from what had been less than €14 billion prior to that meeting.  While the data from Europe has improved since then, and reopening from pandemic induced restrictions is expanding, it would be shocking if they were to change their view this quickly.  Rather, expectations are for no policy change and no change in the rate of QE purchases for at least another quarter.  The inflationary impulse in the Eurozone remains far lower than in the US and even though they finally got headline CPI to touch 2.0% last month, there is no worry it will run away higher.  Remember, too, there is no way the ECB can countenance a stronger euro as it would both impair its export competitiveness as well as import deflation.  As long as the Fed continues to buy bonds at the current rate you can expect the ECB to do the same.

In the end, we can only wait and see what occurs.  Until then, a brief recap of markets shows that things have continued to trade in tight ranges as investors worldwide await this morning’s news.  Equity markets in Asia were very modestly higher (Nikkei +0.3%, Shanghai +0.5%, Hang Seng 0.0%) and in Europe the movement has been even less pronounced (DAX +0.1%, CAC -0.1%, FTSE 100 +0.3%).  US futures are mixed as well with the three major indices within 0.2% of closing levels.

Bond markets, after a strong rally yesterday, have seen a bit of profit taking with Treasury yields edging higher by 0.8bps while Europe (Bunds +1.0bps, OATs +1.6bps, Gilts +0.7bps) have moved up a touch more.  But this is trader position adjustments ahead of the news, not investors making wholesale portfolio changes.

Commodity markets are mixed with crude oil (+0.1%) barely higher while precious metals (Au -0.5%, Ag -0.4%) are under a bit of pressure.  Base metals, however, are seeing more selling pressure (Cu -1.5%, Al -0.2%, Sn -0.7%) while foodstuffs are mixed as wheat is lower though corn and soybeans have edged higher.

Finally, in the FX market, the G10 is generally mixed with very modest movement except for one currency, NOK (-0.5%) which has fallen sharply after CPI data came out much lower than expected thus relieving pressure on the Norgesbank to tighten policy anytime soon.  In the EMG bloc, ZAR (+0.6%) is the leading gainer after its C/A surplus was released at a much stronger than expected 5.0% indicating finances in the country are improving.  But away from that, things have been much less exciting as markets await today’s data and ECB statements.

In addition to the CPI data this morning, as it is Thursday, we will see Initial Claims (exp 370K) and Continuing Claims (3.65M).  Interestingly, those may be more important data points as the Fed is clearly far more focused on employment than on inflation.  But they will not be sensational, so will not get the press.  FWIW my money is on a higher than expected CPI print, 5.0% or more with nearly 4.0% ex food & energy.  However, even if I am correct, it is not clear how big a market impact it will have beyond a very short-term response.  In the end, if Treasury yields continue to fall, I believe the dollar will follow.

Good luck and stay safe
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Kept at Bay

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The key for investors today
Is payrolls and how they portray
The jobs situation
Thus, whether inflation
Will rocket, or be kept at bay

It’s Payrolls day, generally a session where there is a great deal of anticipation leading up to the release, often followed by a burst of activity and then a very slow afternoon.  However, given today also happens to be Good Friday, with all European markets closed in observation, as well as US equity markets, it is likely the burst activity, assuming one comes, will be compressed into an even shorter timeline than usual.  Of course, what makes this potentially unnerving is that market liquidity will be significantly impaired relative to most sessions, and any surprising outcome could result in a much larger move than would normally be the case.

It is not a bank holiday, which means the bond market will be trading, and that is, in truth, the market that continues to drive the action.  As evidenced by yesterday’s price action, the bond rally, with 10-year Treasury yields sliding 7 basis points, led to a declining dollar and new record highs in the stock market.  We also saw gold and other commodities rally as the combination of strong data (ISM at 64.7) and lower yields was a double-barreled benefit.

With that in mind, here are the latest expectations:

Nonfarm Payrolls 660K
Private Payrolls 643K
Manufacturing Payrolls 35K
Unemployment Rate 6.0%
Average Hourly Earnings 0.1% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

All that seems fine, but it is worth a look at the individual forecasts that make up that NFP number.  There is a wide dispersion of views ranging from a gain of just 350K to eight forecasts greater than 900K and three of those at a cool million each.

Let’s consider, for a moment, if the optimists are correct.  Harking back to Chairman Powell’s constant refrain regarding the recovery of the 10 million lost jobs, the expected timeline for that to happen remains sometime in late 2023.  But if this morning’s release is 1000K or more, that would seem to potentially shorten the timeline for those jobs to return.  And following that logic, it seems likely that the Fed may find themselves in a situation where ZIRP is no longer appropriate somewhat earlier in 2023 than currently expected as inflation rises, and unemployment falls back to their new goal of 3.5%-4.0%.  The implication here is that the bond market will anticipate this activity and we could see the 10-year yield break through to new highs quite quickly.  Based on broad market behavior as seen yesterday, a sharp decline in the bond market would likely result in the dollar rebounding sharply and equity futures, which are trading, retreating.  And all this on a day when there is much less liquidity than normal.

Of course, a weak number is likely to have just the opposite effect, with the bond bulls making the case that we have seen the high in yields, and dollar bears back in the saddle making the case the dollar’s run higher has ended.

And that’s really what we have in store for the day.  The two markets that were open overnight saw equities rally on the heels of the US equity rally, with the Nikkei (+1.6%) and Shanghai (+0.5%) both performing well.  Every European market is closed for the holiday and will be on Monday as well.  Meanwhile, US futures are all pointing modestly higher, roughly 0.25%, ahead of the payroll report.

As NY is walking in, we are seeing the first movement in Treasury yields and they have edged higher by 1.1bps at this point.  But as I highlight above, this is all about the data today.

In the commodity markets, only precious metals are trading but both gold and silver are essentially unchanged at this hour ahead of the data.  This follows yesterday’s strong performance with both rallying more than 1% in the session.

And finally, in the FX market, except for TRY (+0.7%) and KRW (+0.4%) there is no movement more than 0.2%, which is indicative of the fact that some positions are being adjusted but there is no news driving things.  In the case of TRY, the new central bank governor, in a speech today, made clear that he was not going to cut rates and that he was likely to raise them again in an effort to combat the rising inflation in the country.  This was well received by the market and has helped TRY recover much of its initial losses upon the sacking of the previous central bank chief.  As to KRW, they released CPI data last night, 1.5%, which was the highest print since January 2020, indicating that growth was persistent, and the BOK would be more vigilant going forward.  This also encouraged equity inflows resulting in the won’s modest appreciation.

So, now we wait for the payroll data.  Based on the releases that we have seen during the past couple of weeks, where the economy is clearly pushing ahead, I suspect this number will be somewhere above 800K, although 1000K is clearly not out of the question.  As such, my view is we will see the bonds sell off and the dollar retest its recent highs, if not break through them.

Good luck, good weekend and stay safe
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A Tiny Tsunami

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Covid’s wrought havoc
Like a tiny tsunami
Can Japan rebound?

In what is starting off as a fairly quiet summer morning, there are a few noteworthy items to discuss. It cannot be surprising that Japan’s economy suffered greatly in Q2, given the damage to economic activity seen worldwide due to Covid-19. Thus, although the -7.8% Q2 result was slightly worse than forecast, it merely served to confirm the depths of the decline. But perhaps the more telling statistic is that, given Japan was in recession before Covid hit, the economy there has regressed to its size in 2011, right after the Tohoku earthquake and tsunami brought the nation to its knees.

Back then, the dollar had been trending lower vs. the yen for the best part of the previous four years, so the fact that it dropped sharply on the news of the earthquake was hardly surprising. In fact, it was eight more months before the dollar reached its nadir vs. the yen (75.35), which simply tells us that the trend was the driver and the singular event did not disrupt that trend. And to be clear, that trend was quite steep, averaging nearly 11% per year from its beginning in 2007. In comparison, the current trend in USDJPY, while lower, is much less dramatic. Since its recent peak in June 2015, the entire decline has been just 15.5% (~3.2% per annum). Granted, there have been a few spikes lower, most recently in March during the first days of the Covid panic, but neither the economic situation nor the price action really resembles those days immediately after Tohoku.

The point is, while the dollar is certainly on its back foot, and the yen retains haven status, the idea of a dollar collapse seems far-fetched. I’m confident that Japan’s Q3 data will show significant improvement compared to the Covid inspired depths just reported, but given the massive debt overhang, as well as the aging demographics and trend growth activity in the country, it is likely to be quite a few years before Japan’s economy is once again as large as it was just last year. Ironically, that probably means the yen will continue to trend slowly higher over time. But even getting to 100 will be a long road.

The other interesting story last night was from China, where the PBOC added substantially more liquidity to the markets than had been anticipated, RMB 700 billion in total via one-year injections. This more than made up for the RMB550 billion that is maturing over the next week and served as the catalyst for the Shanghai Exchange’s (+2.35%) outperformance overnight. This merely reinforces the idea that excess central bank liquidity injections serve a singular purpose, goosing stock market returns supporting economic activity.

There is something of an irony involved in watching the central banks of communist nations like China and Russia behave as their actions are essentially identical to the actions of central banks in democratic nations. Is there really any difference between the PBOC injecting $100 billion or the Fed buying $100 billion of Treasuries? In the end, given the combination of uncertainty and global ill will, virtually all that money finds its way into equity markets, with the only question being which nation’s markets will be favored on any given day. It is completely disingenuous for the Fed, or any central bank, to explain that their activities are not expanding the current bubble in markets; they clearly are doing just that.

But the one thing of which we can be certain is that they are not going to stop of their own accord. Either they will be forced to do so after changes in political leadership (unlikely) or the investment community will become more fearful of their actions than any possible inaction on their parts. It is only at that point when this bubble will burst (and it will) at which time central banks will find themselves powerless and out of ammunition to address the ensuing financial distress. As to when that will occur, nobody knows, but you can be certain it will occur.

And with that pleasant thought now past, a recap of the overnight activity shows that aside from Shanghai, the equity picture was mixed in Asia (Nikkei -0.8%, Hang Seng +0.6%) while European bourses are similarly mixed (DAX +0.2%, CAC 0.0%, Spain’s IBEX -0.75%). US futures are modestly higher at this point, but all well less than 1%. Bond markets are starting to find a bid, with 10-year Treasuries now down 1.5 basis points, although still suffering indigestion from last week’s record Treasury auctions. And in fact, Wednesday there is another huge Treasury auction, $25 billion of 20-year bonds, so it would not be surprising to see yields move higher from here. European bond markets are all modestly firmer, with yields mostly edging lower by less than 1bp. Commodity markets show oil prices virtually unchanged on the day while gold (and silver) are rebounding from last week’s profit-taking bout, with the shiny stuff up 0.5% (AG +2.1%).

Finally, the dollar is arguably slightly softer overall, but there have really been no large movements overnight. In G10 world, the biggest loser has been NZD (-0.3%) as the market voted no to the announcement that New Zealand would be postponing its election by 4 weeks due to the recently re-imposed lockdown in Auckland. On the plus side, JPY leads the way (+0.25%, with CAD and AUD (both +0.2%) close by on metals price strength. Otherwise, this space is virtually unchanged.

Emerging markets have had a bit more spice to them with RUB (-1.25%) the outlier in what appears to be some position unwinding of what had been growing RUB long positions in the speculative community. But away from that, HUF (-0.6%) is the only other mover of note, as investors grow nervous over the expansion of the current account deficit there.

This week’s data releases seem likely to be less impactful as they focus mostly on housing:

Today Empire Manufacturing 15.0
Tuesday Housing Starts 1240K
  Building Permits 1320K
Wednesday FOMC Minutes  
Thursday Initial Claims 915K
  Continuing Claims 15.0M
  Philly Fed 21.0
Friday Manufacturing PMI 51.8
  Services PMI 51.0
  Existing Home Sales5.40M  

Source: Bloomberg

Of course, the FOMC Minutes will be greatly anticipated as analysts all seek to glean the Fed’s intentions regarding the policy overhaul that has been in progress for the past year. Away from the Minutes, though, there are only two Fed speakers, Bostic and Daly. And let’s face it, pretty much every FOMC member is now on board with the idea that raising the cost of living inflation is imperative, and that if inflation runs hot for a while, there is no problem. Clearly, they don’t do their own food-shopping!

It is hard to get too excited about markets one way or the other today, but my broad view is that though the medium-term trend for the dollar may be lower, we continue to be in a consolidation phase for now.

Good luck and stay safe
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Deep-Sixed

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This morning the UK released
Fresh data that showed growth decreased
By quite an extent
(Some twenty percent)
Last quarter. Boy, Covid’s a beast!

But really the market’s transfixed
By gold, where opinions are mixed
It fell yesterday
An awfully long way
With shorts praying it’s been deep-sixed

Two stories are vying for financial market headline supremacy this morning; the remarkable collapse in gold (and silver) prices, and the remarkable collapse in the UK economy in Q2. And arguably, they are sending out opposite messages.

Starting with the gold price, yesterday saw the yellow metal fall nearly 6%, which translated into $114/oz decline. On a percentage basis, silver actually fell far further, -14.7%, although for now let’s simply focus on gold. The question is, what prompted such a dramatic decline? Arguably, gold’s rally has been based on two key supports, the increasingly larger negative real yield in US interest rate markets and an underlying concern over the impact of massive monetary stimulus by the Fed and other central banks undermining all fiat currencies. These issues drove a speculative frenzy where gold ETF’s were trading above NAV and demand for physical metal was increasing faster than production.

Looking at the real yield story, last Thursday saw the nadir, at least so far, in that metric, with real10-year Treasury yields falling to -1.08%. However, as risk appetite recovered a bit, nominal yields rebounded by 10bps, and real yields did the same, now showing at ‘just’ -0.99%. At this point, it is important to remember that markets move at the margin, so even though real yields remain highly negative, the modest rebound changed the tone of the trade and encouraged a bout of profit-taking in gold. Simultaneously, we saw a much more positive risk environment, especially after Germany’s ZEW survey showed much better than forecast Expectations, pumping up European equity markets and US ones as well. This simply added to the rationale to take profits on what had been a very sharp, short-term increase in the precious metals markets. As these things are wont to do, the selling begat more selling and bingo, a major correction resulted.

Is this the end of the gold story? I sincerely doubt it, as the underlying drivers are likely to continue their original trend. If anything, what we continue to see from central banks around the world is additional stimulus driving ever lower nominal and real yields. We saw this last night in New Zealand, where the RBNZ increased their QE program and openly discussed NIRP, pushing kiwi (-0.5%) lower. But in this context, the important issue is that, yet another G10 central bank is leaning closer to negative nominal yields, which will simply drive real yields even lower. Simultaneously, additional QE is exactly the issue driving concern over the ultimate value of fiat currencies, so both key factors in gold’s rise are clearly still relevant and growing today. Not surprisingly, gold’s price has rebounded about 1.0% this morning, although it did fall an additional 2.5% early in the Asian session.

As to the other story, wow is all you can say. Q2 GDP fell 20.4% in the UK, more than double the US decline and the worst G10 result by far. Social distancing is a particularly damaging policy for the UK economy because of the huge proportion of services activity that relies on personal contact. But the UK government’s relatively slow response to the outbreak clearly did not help the economy there, and the situation on the ground indicates that there are still several pockets of rampant infection. One thing working in the UK’s favor, and thus the pound’s as well, is that despite the depths of the Q2 data, recent activity reports on things like IP and capital formation have actually been better than expected. The point is, this data, while shocking, is old news, as is evidenced by the fact that the pound is unchanged on the day while the FTSE 100 is higher by more than 1% as I type.

So, what are the mixed messages? Well, the collapse in gold prices on the back of rising yields would ordinarily be an indication of a stronger than expected economic result, as increased activity led to more credit demand and higher yields. But the UK GDP result is just the opposite, a dramatic decline that has put even more pressure on both PM Johnson’s government as well as the BOE to increase fiscal and monetary stimulus, thus driving yields lower and debasing the currency even further. So which story will ultimately dominate? That, of course, is the $64 trillion question, but for now, my money is on weaker growth, lower yields and a gold rebound.

Not dissimilar to the mixed messages of those two stories, today’s session has seen a series of mixed outcomes. For instance, equity markets are showing no consistency with both gainers (Nikkei +0.4%, Hang Seng +1.4%) and losers (Shanghai -0.6%) in Asia with similar mixed action in Europe (CAC +0.4%, DAX 0.0%, Stockholm -0.5%). Not to worry, US futures are pointing higher across the board by roughly 0.75%.

Bond markets, however, are pretty consistent, with 10-year yields higher in virtually every market (New Zealand excepted), as Treasuries rise 2.5bps, UK gilts a similar amount and German bunds a bit more than 3bps. In fact, Treasury yields, now at 0.67%, are 17bps higher in the past 6 sessions, the largest move we have seen since May. But again, I see no evidence that the big picture stories have changed nor any reason for US yields, at least in the front end, to rebound any further. One can never get overly excited by a single day’s movement, especially in as volatile an environment as we currently sit.

Finally, the dollar, too, is having a mixed session, with kiwi the leading decliner, but weakness also seen in JPY (-0.45%) and AUD (-0.25%). Meanwhile, the ongoing rally in oil prices continues to support NOK (+0.55%), with SEK (+0.45%) rising on the back of firmer than expected CPI data this morning. (As an aside, the idea that we are in a massively deflationary environment is becoming harder and harder to accept given that virtually every nation’s inflation data has been printing at much higher than expected levels.)

EMG currencies, keeping with the theme of the day, are also mixed, with TRY (-1.3%) the worst in the world as investors and locals continue to flee the currency and the country amid disastrous monetary policy activity. IDR (-0.55%) is offered as Covid cases continue to rise and despite the central bank’s efforts to contain its weakness, and surprisingly, RUB (-0.25%) is softer despite oil’s rally. On the plus side, the gains are quite modest, but CZK (+0.3%) and ZAR (+0.3%) lead the way with the former simply adding to yesterday’s gains while the rand seemed to benefit from a positive economic survey result.

This morning brings US CPI (exp 0.7%, 1.1% ex food & energy) on an annual basis, but as Chairman Powell and his minions have made clear, inflation is not even a top ten concern these days. However, if we see a higher than expected print, it is entirely realistic to see Treasury yields back up further.

Overall, the dollar remains under modest pressure, but one has to wonder if yesterday’s gold price action is a precursor to a correction here as well. Remember, positioning is extremely short the dollar, so any indication that the Fed will be forced to address inflation could well be a signal for position reductions, and hence a dollar rebound.

Good luck and stay safe
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They’ll See the Light

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In China, a new rule applies
Which helped stocks close on session highs
The news was released
Insurers increased
The size of their equity buys

Meanwhile, Brussels has been the sight
Of quite a large policy fight
Four nations refuse
Their cash to misuse
But in the end, they’ll see the light

Once upon a time, government announcements were focused on things like international relations, broad economic policies and the occasional self-kudos to try to burnish their reputation with the electorate, or at least with the population.  But that ideal has essentially disappeared from today’s world.  Instead, as a result of the ongoing financialization of economies worldwide, there are only two types of government announcements these days; those designed to explain why the current government is the best possible choice, and those designed to prop up the nation’s stock market.  Policy comments are too hard for most people to understand, or at least to understand their potential ramifications, so they are no longer seen as useful.  But, do you know what is seen as useful?  Explaining that institutions should buy more stocks because a higher stock market is good for everyone!

Once again, China leads the way in this vein, with Friday night’s announcement that henceforth, Insurers should can allocate as much as 45% of their assets to equities, up from the previous cap of 30%.  Some quick math shows that this new regulation has just released an additional $325 billion of new buying power into the Chinese stock market, or roughly 4% of the total market capitalization in the country.  It cannot be a surprise that the Shanghai Exchange rallied 3.1% last night, which was, of course, exactly the idea behind the announcement.  In fact, lately, the Chinese have been really working to manipulate the stock market there, apparently seeking a steady move higher, probably something like 1% a day, but have been having trouble reining in the exuberance of the large speculative community there.  So, all of their little nudges higher result in 3%-5% gains, which they feel could be getting out of hand, and so they need to squash them occasionally.  But for now, they are back on the rally bandwagon, so look for some steady support this week.

Interestingly, however, this was clearly not seen as a global risk-on signal as equity activity elsewhere has been far more muted.  The rest of Asia was basically flat (Nikkei +0.1%, Hang Seng -0.1%) and Europe has seen a mixed session as well, with small gains by the DAX (+0.3%) and losses by the CAC (-0.3%).  In other words, investors realize this is simply Chinese activity.  PS, US futures are basically unchanged on the day as well.

At the same time, there is a critical story building out of Europe, the outcome of the EU Summit. This began with high hopes on Friday as most people expected the Frugal Four to quickly cave into the pressure to give more money away to the PIGS.  However, after three full days of talks, there is still no agreement.  Remember, their concern is that the EU plan to give away €500 billion in grants to countries most in need (read Italy, Spain and Greece), is simply delaying the inevitable as they will almost certainly waste these funds, just like they have each wasted funds for decades.  And the frugal four nations were not interested in throwing their money away.  But in the end, it was always clear that with support from Germany and France, a deal would get done in some form.  The latest is that “only” €390 billion will be given as grants, so a 22% reduction, but still a lot of free cash.

While no one has yet signed on the dotted line, you can be sure that by the end of the day, they will have announced a successful conclusion to the process.  The funny thing is that regardless of the outcome of the Summit, it seems to me that the entire package, listed at €750 billion, is actually pretty small.  After all, the CARES act here had a price tag of $3.2 trillion, four times as large, and the EU economy is going to suffer just as much as the US.  But that is not the way the market is looking at things.  Rather, they have collectively decided that this package is a huge euro positive and have been pushing the single currency higher steadily for pretty much the entire month of July (+2.5%), with it now sitting just pips below the spike high seen in March, and back to levels last seen, really, in January 2019.  How much further can it rise?  Personally, I am skeptical that it has that much more room to run, but I know the technicians are really getting excited about a big breakout here.

As to the rest of the FX market, activity has been fairly muted with the dollar slightly softer against most G10 and EMG counterparts.  On the G10 side, NOK and SEK lead the way higher, both up by 0.45%, as in a broad move, these higher beta currencies tend to have the best performance.  JPY is a touch softer on the day, and a number of currencies, CAD, NZD, CHF, are all within just basis points of Friday’s close.

We are seeing similar price action in the emerging markets, with one notable loser, IDR (-0.5%) as traders there continue to price in further policy ease by the central bank after last week’s 25bp rate cut. On the plus side, the CE4 are leading the way higher, with gains between 0.3% and 0.6%, simply tracking the euro with a bit more beta.  But really, there is not too much of note to discuss here.

On the data front, it is an extremely quiet week upcoming as follows:

Wednesday Existing Home Sales 4.80M
Thursday Initial Claims 1.293M
  Continuing Claims 16.9M
  Leading Indicators 2.1%
Friday PMI Manufacturing 52.0
  PMI Services 51.0
  New Home Sales 700K

Source: Bloomberg

In addition, there are no Fed speakers on the docket as it seems everybody has gone on holiday.  So, once again, Initial Claims seems to be the key data point this week, helping us to determine if things are actually getting better, or we have seen a temporary peak in activity.  With the ongoing spread of what appears to be a second wave of Covid, there is every chance that we start to see the rebound in data seen for the past two months start to fade.  If that is the case, it strikes me that we will see a bit more risk-off activity and the dollar benefit.  But that is a future situation.  Today, the dollar remains under modest pressure as traders respond to the perceived benefits of striking a deal at the EU.

Good luck and stay safe

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Twiddling Their Thumbs

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Investors are twiddling their thumbs
Awaiting the next news that comes
The Old Lady’s meeting’s
Impact will be fleeting
And Jay’s finished flapping his gums

Which leads to the question at hand
Is risk on or has it been banned?
The one thing we know
Is growth’s awfully slow
Beware, markets could well crash land

Markets are taking a respite this morning with modest movement across all three major asset classes. While the Bank of England is on tap with their latest policy announcement, the market feels certain they will leave rates on hold, at 0.10%, and that they will increase their QE purchases by £100 billion, taking the total to £745 billion, in an effort to keep supplying liquidity to the economy. It is somewhat interesting that the story from earlier in the week regarding positive movement on Brexit had such a modest and short-term impact on the pound, which has actually begun to decline a bit more aggressively as I type. After peaking a week ago, the pound has ceded 2.5% from that top (-0.6% today). There is nothing in the recent UK data that would lead one to believe that the economy there is going to be improving faster than either the EU or the US, and with monetary policy at a similar level of ease on a relative basis, any rationale to buy pounds is fragile, at best. I continue to be concerned that the pound leads the way lower vs. the dollar, at least until the current sentiment changes. And while the BOE could possibly change that sentiment, I would estimate that given yesterday’s inflation reading (0.5%) and their inflation target (2.0%), they see a weaker pound as a distinct benefit. Meanwhile, remember the current central bank mantra, ease more than expected. If there is any surprise today, look for £150 billion of QE, which would merely add further urgency to selling pounds.

But aside from the BOE meeting, there is very little of interest to the markets. The ECB announced that their TLTRO III.4 program had a take-up of €1.31 trillion, within the expected range, as 742 banks in the Eurozone got paid 1.0% to borrow money from the ECB in order to on lend it to their clients. But while an interesting anecdote, it is not of sufficient interest to the market to respond. In fact, the euro sits virtually unchanged on the day this morning, waiting for its next important piece of news.

In the G10 space, the only other mover of note is NOK, which has rallied 0.5% on the back of two stories. First, oil prices have moved a bit higher, up slightly less than 1% this morning, which is clearly helping the krone. But perhaps more importantly, the Norgesbank met, left rates on hold at 0.00%, but explained that there was no reason for rates to decline further, once again taking NIRP off the table.

However, away from those two poles, there is very little of interest in the G10 currency space. As to the EMG space, it too is pretty dull today, with RUB the leading gainer, +0.55%, on the oil move and ZAR the leading decliner, -0.4%, amid rising concern over the spread of Covid there as the infection curve remains on a parabolic trajectory. Similar to the G10 space, there is not much of broad interest overall.

Equity markets have also “enjoyed” a mixed session, with Asian markets showing gainers, Shanghai +0.1%, and losers, Nikkei -0.25%, but nothing of significant size. In Europe, the news is broadly negative, but other than Spain’s IBEX (-1.0%) the losses are quite modest. And finally, US futures are mixed but all within 0.1% of yesterday’s closing prices.

Lastly, bond markets are generally firmer, with yields falling slightly as 10-year Treasuries have decline 3 basis points on the session, broadly in line with what we are seeing in European government bond markets. Arguably, we should see the PIGS bonds perform well as that TLTRO money finds its way into the highest yielding assets available.

Perhaps we can take this pause in the markets as a time to reflect on all we have learned lately and try to determine potential outcomes going forward. From a fundamental perspective, the evidence points to April as the nadir of economic activity, which given the widespread shutdowns across the US and Europe, should be no surprise. Q2 GDP data is going to be horrific everywhere, with the Atlanta Fed’s GDPNow number currently targeting -45.5%. But given the fact that economies on both sides of the Atlantic are reopening, Q3 will certainly show a significant rebound, perhaps even the same percentage gain. Alas, a 45% decline followed by a 45% rebound still leaves the economy more than 20% lower than it was prior to the decline. And that, my friends, is a humongous growth gap! So, while we will almost certainly see a sharp rebound, even the Fed doesn’t anticipate a recovery of economic activity to 2019 levels until 2022. Net, the economic picture remains one of concern.

On the fiscal policy front, the US story remains one where future stimulus is uncertain and likely will not be nearly as large as the $2.2 trillion CARES act, although the Senate is currently thinking of $1 trillion. In Europe, the mooted €750 billion EU program that would be funded by joint taxation and EU bond issuance, is still not completed and is still drawing much concern from the frugal four (Austria, Sweden, the Netherlands and Denmark). And besides, that amount is a shadow of what is likely necessary. Yes, we have seen Germany enact their own stimulus, as has France, Spain and Italy, but net, it still pales in comparison to what the US has done. Other major nations continue to add to the pie, with both China and Japan adding fiscal stimulus, but in the end, what needs to occur is for businesses around the world to get back to some semblance of previous activity levels.

And yet, investors have snapped up risk assets aggressively over the past several months. The value in an equity is not in the ability to sell it higher than you bought it, but in the future stream of earnings and cashflows the company produces. The multiple that investors are willing to pay for that future stream is a key determinant of long-term equity market returns. It is this reason that there are many who are concerned about the strength of the stock market rebound despite the destruction of economic activity. This conundrum remains, in my view, the biggest risk in markets right now and while timing is always uncertain, provides the potential for a significant repricing of risk. In that event, I would expect that traditional haven assets would significantly outperform, including the dollar, so hedgers need to stay nimble.

A quick look at this morning’s data shows Initial Claims (exp 1.29M), Continuing Claims (19.85M), Philly Fed (-21.4) and Leading Indicators (+2.4%). The claims data remains the key short-term variable that markets are watching, although it appears that economists have gotten their models attuned to the current reality as the last several prints have been extremely close to expectations.

Overall, until something surprising arises, it feels like the bulls remain in control, so risk is likely to perform well. Beware the disconnect, though, between the dollar and the stock market, as that may well be a harbinger of that repricing on the horizon.

Good luck and stay safe
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This Terrible Blight

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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
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Cash Is Undoubtedly King!

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Historically bonds were the thing
To own in a market downswing
But lately it seems
Those days were just dreams
Now cash is undoubtedly king!

While this note is focused on the FX markets, where once again the dollar is top dog, I think a quick discussion of government bonds is in order to help try to make some sense of the overall market situation.

Clearly, the lead story in financial markets has been equities, which have proven that volatility is not dead. In fact, these constant +/- 5% days are exhausting for both investors and traders. And of course, most of us have at least some portion of our investment in the equity markets and are afraid to look at our accounts these days. But the behavior that has really been at odds with what had become the overriding narrative is the incredibly abrupt sell-off in Treasuries and other government bond markets during the past week. The idea that government bonds are a safe haven has been underpinning financial markets since long before the financial crisis in 2008. Yesterday I highlighted two of the issues that I think are driving recent price action; the prospect of staggeringly high new issuance to pay for all the proposed and enacted fiscal stimulus that is coming; and the fact that when yields reach a low enough point, the idea that holding bonds will guarantee the return of principal starts to diminish.

But I don’t think those explanations are sufficient to explain the speed and size of the movement that we have experienced since last Monday. Instead, movement like that can only be caused by massive position liquidation. Consider, 10-year Treasury yields rallied 36bps on Monday while 30-year yields closed 40bps higher after touching levels a further 15bps higher than that earlier in the session. So the real question is; who is liquidating their position(s)?

To answer that question we have to consider who holds large positions in Treasuries. The largest holder is likely the Fed, but obviously, they are not sellers. China and Japan come next on the list of holders, and while Japan would never be selling, there continue to be rumors that China has wanted to do that. I have never been a believer that China would sell their holdings for two reasons; first that they couldn’t get rid of them all at once, so a large sale would devalue their remaining holdings; and second because they would still have USD in their account and need to find something to do with them. Now that rates are back to 0.0%, what would they do with the money? After all, that’s a really big mattress they would need. And given the fact that the price of gold has fallen sharply through all this, it would imply there is no big bid for gold either. This leads me to believe that the Chinese have not touched their Treasury portfolio.

After those central banks, the biggest holders are leveraged fund managers with Risk Parity strategies having been an extremely popular investment product for the past decade. The idea was that by holding a certain percentage of different asset classes (e.g. 60% stocks/40% bonds), one could target a specific risk/return ratio. But nothing is simple these days, and as bond yields continued to grind lower over time, hedge fund managers started levering up to buy more and more Treasuries to hold against a given portfolio of stocks. However, what appears to have happened in the past week is that many of those highly levered Treasury positions needed to be reduced given the dramatic decline in the equity portion of the portfolio. Thus, the only explanation that I can see to explain this type of unprecedented Treasury bond movement is a massive liquidation trade by the hedge fund community. My sense is that we will hear of a number of funds closing shop over the next month or so. As an aside, this reinforces the idea that we are still paying the price for the Fed’s actions in 2008-09 and the fact that they never returned market conditions to pre-crisis settings. In the end, once these positions are liquidated, we are likely to see bonds show a little more stability and perhaps, they will regain their haven status. But for now, they are as tough a place to be as stocks.

Now to today’s session. The equity euphoria felt after the US announcement of substantial stimulus coming, measured right now at $1.2 trillion, and very likely taking the shape of true helicopter money with checks cut to all Americans earning less than a given amount, has ended as quickly as it formed. Asian equities got killed (Nikkei -1.7%, Hang Seng -4.2%, Australia -6.4%) and European indices are also tumbling (DAX -5.5%, CAC -5.5%, FTSE100 -5.0%). US equity futures are limit down (-5.0%) at this point, so a lower opening seems likely.

In the FX world, as I mentioned, the dollar is top dog. Today’s worst performer is MXN, which has fallen a further 4% to yet another new low (dollar high) with USDMXN now trading near 24.00. Vacations there will be cheap when we can travel again! But RUB is lower by 3.6% as oil continues to slide, and ZAR is down 2.0% on the weakness in gold and all metals. APAC currencies were all weaker by between 0.2% and 0.6% except for PHP, which actually rallied 0.7% today after the government reopened the Philippine stock market. Yesterday, they had closed trading completely and the decision was not well received at all, so now they are all working remotely and that seemed to cheer the FX market as some funds flowed back into the country.

In the G10, the pound is the leading decliner, down 1.5% as I type and looking for all the world like it is going to test its historic 1985 lows of 1.06! Today was the day that Brexit negotiations were to begin with the EU, with plans for a large group of negotiators on both sides. Obviously, in the current situation, that is no longer viable and it seems inevitable that Boris is going to need to postpone the eventual exit. Of course, he will pay no political price for that given the circumstance. But the rest of the G10 is also sliding, and the slide has accelerated since NY walked in at 7:00. For instance, the euro had actually been a bit higher earlier this morning, but is now down 0.25%. But it is Aussie and Kiwi (-1.4% each) as well as SEK (-1.3%) and CAD (-0.8%) that are pacing the blocs decline. The only exception is the one we would expect, JPY which has edged 0.2% higher this morning. While dollar needs remain substantial worldwide, yen investors continue to liquidate internationally and bring home their money.

On the data front, we do see Housing Starts (exp 1500K) and Building Permits (1500K), but again, nobody really cares. The focus will remain on Fed and Administration policies and market responses to those announcements will continue to be the primary drivers going forward.

Good luck and stay safe
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