Tag Archives: #GDP

Desperate Straits

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In Europe, the growth impulse faded
As governments there were persuaded
To lock people down
In city and town
While new strains of Covid invaded

Contrast that with here in the States
Where GDP growth resonates
Tis no real surprise
That stocks made new highs
And bond bulls are in desperate straits

There is no better depiction of the comparative situation in the US and Europe than the GDP data released yesterday and today.  In the US, Q1 saw GDP rise 6.4% annualized (about 1.6% Q/Q) after a gain of 4.3% in Q4 2020.  This morning, the Eurozone reported that GDP shrank -0.6% in Q1 after declining -0.7% in Q4 2020.  In other words, while the US put together a string of substantial economic growth over the past 3 quarters (Q3 was the remarkable 33.4% on this measure), Europe slipped into a double dip recession, with two consecutive quarters of negative growth following a single quarter of rebound.  If you consider how markets behaved in Q1, it begins to make a great deal more sense that the dollar rallied sharply along with Treasury yields, as the economic picture in the US was clearly much brighter than that in Europe.

But that is all backward-looking stuff.  Our concerns are what lies ahead.  In the US, there is no indication that things are slowing down yet, especially with the prospects of more fiscal stimulus on the way to help goose things along.  As well, Chairman Powell has been adamant that the Fed will not be reducing monetary accommodation until the economy actually achieves the Fed’s target of maximum employment.  Essentially, this has been defined as the reemployment of the 10 million people whose jobs were eliminated during the depths of the Covid induced government lockdowns.  (Its stable price target, defined as 2.0% average inflation over time, has been kicked to the curb for the time being, and is unimportant in FOMC discussions…for now.)

At the same time, the fiscal stimulus taps in Europe are only beginning to drip open.  While it may be a bit foggy as it was almost a full year ago, in July 2020 the EU agreed to jointly finance fiscal stimulus for its neediest members by borrowing on a collective level rather than at the individual country level.  This was a huge step forward from a policy perspective even if the actual amount agreed, €750 billion, was really not that much relative to the size of the economy.  Remember, the US has already passed 3 separate bills with price tags of $2.2 trillion, $900 billion and just recently, $1.9 trillion.  But even then, despite its relatively small size, those funds are just now starting to be deployed, more than 9 months after the original approval.  This is the very definition of a day late and a dollar euro short.

Now, forecasts for Q2 and beyond in Europe are much better as the third wave lockdowns are slated to end in early to mid-May thus freeing up more economic activity.  But the US remains miles ahead on these measures, with even NYC declaring it will be 100% open as of July 1st.  Again, on a purely economic basis, it remains difficult to look at the ongoing evolution of the Eurozone and US economies and decide that Europe is the place to be.  But we also know that the monetary story is critical to financial markets, so cannot ignore that.  On that score, the US continues to pump more money into the system than the ECB, offering more support for the economy, but potentially undermining the dollar.  Arguably, that has been one of the key drivers of the weak dollar narrative; at some point, the supply of dollars will overwhelm, and the value of those dollars will decrease.  This will be evident in rising inflation as well as in a weakening exchange rate versus its peers.

The thing is, this story has been being told for many years and has yet to be proven true, at least in any significant form.  In the current environment, unless the Fed actually does ease policy further, via expanded QE or explicit YCC, the rationale for significant dollar weakness remains sparse.  Treasury yields continue to define the market’s moves, thus, that is where we must keep our attention focused.

Turning that attention to market activity overnight, whether it is because it is a Friday and traders wanted to square up before going home, or because of the weak data, risk is definitely on the back foot today.  Equity markets in Asia were all red led by the Hang Seng (-2.0%) but with both the Nikkei and Shanghai falling 0.8% on the session.  Certainly, Chinese PMI data were weaker than expected (Mfg 51.1, Services 54.9) both representing declines from last month and raising questions about the strength of the recovery there.  At the same time, Japanese CPI remains far below target (Tokyo CPI -0.6%) indicating that whatever policies they continue to implement are having no effect on their goals.

European bourses are mixed after the weaker Eurozone data, with the DAX (+0.2%) the star, while the CAC (-0.2%) and FTSE 100 (0.0%) show little positive impetus.  Looking at smaller country indices shows lots of red as well.  Finally, US futures are slipping at this hour, down between -0.4% and -0.7% despite some strong earnings reports after the close.

Perhaps the US markets are taking their cue from the Treasury market, where yields continue to edge higher (+1.2bps) with the idea that we have seen the top in rates fading quickly.  European sovereign bonds, however, have seen demand this morning with yields slipping a bit as follows: Bunds (-1.8bps), OATs (-1.2bps) and Gilts (-1.3bps). Perhaps the weak economic data is playing out as expected here.

Commodities are under pressure this morning led by WTI (-1.9%) but seeing weakness in the Agricultural space (Wheat -0.7%, Soy -0.9%) as well.  The one thing that continues to see no end in demand, though, is the base metals with Cu (+0.3%), Al (+0.9%) and Sn (2.2%) continuing their recent rallies.  Stuff is in demand!

In the FX markets, the day is shaping up to be a classic risk-off session, with the dollar firmer against all G10 counterparts except the yen (+0.1%) with SEK (-0.55%) and NOK (-0.5%) the leading decliners.  We can attribute Nokkie’s decline to oil prices while Stockie seems to be demonstrating its relatively high beta to the euro (-0.3%). EMG currencies have far more losers than gainers led by ZAR (-0.7%), TRY (-0.65%) and RUB (-0.6%).  The ruble is readily explained by oil’s decline while TRY is a bit more interesting as the latest central bank governor just promised to keep monetary policy tight in order to combat inflation. Apparently, the market doesn’t believe him, or assumes that if he tries, he will simply be replaced by President Erdogan again.  The rand’s weakness appears to be technical in nature as there is a belief that May is a particularly bad month to own rand, it having declined in 8 of the past 10 years during the month of May, and this is especially true given the rand has had a particularly strong performance in April.

On the data front, today brings a bunch more information including Personal Income (exp 20.2%), Personal Spending (+4.1%), Core PCE Deflator (1.8%), Chicago PMI (65.3) and Michigan Sentiment (87.5).  Given the Fed’s focus on PCE as their inflation measure, it will be important as a marker, but there is no reason to expect any reaction regardless of the number.  That said, every inflation reading we have seen in the past month has been higher than forecast so I would not be surprised to see that here as well.

In the end, though, it is still the Treasury market that continues to drive all others.  If yields resume their rise, look for a stronger dollar and pressure on equities and commodities.  If they were to head back down, so would the dollar while equities would find support.

Good luck, good weekend and stay safe
Adf

Will a New Normal Emerge?

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Recovery this year is set
To be best in decades, and yet
The central bank’s thumb
Will drive the outcome
By buying quadrillions in debt

The question is, after this surge
Will there be a natural urge
For things to go back
To pre-Covid’s track
Or will a new normal emerge?

The Wall Street aphorism, buy the rumor, sell the news, remains as valid today as it ever was.  The idea behind this concept, something to which I regularly point, is that by the time a particular piece of information has been released, the market has already absorbed the information in the price and is looking forward to the next price driver.  The result is that markets rally into good news and fall upon the release, and vice versa.  The most recent evidence that this remains a key to price action was Friday’s payroll report, where the outcome, in an illiquid market, was a much better than expected 916K NFP number with upward revisions of the previous two months.  And yet Treasury yields, which might have been expected to rise further on the news, have done nothing but decline since then.  Including today’s 1 basis point decline, the 10-year yield is lower by 6bps from the release and is now 10bps lower than the peak hit on March 30.  Is this the end of the yield rally?  Almost certainly not, but no market moves in a straight line.

I highlight this idea to discuss the latest forecast by the IMF and how this news may impact markets going forward.  Yesterday the IMF raised its global growth forecasts again, this time up to 6.0% in 2021 and 4.4% in 2022, representing increases of 0.5% and 0.2% respectively from their January analysis. The leadership in this growth is the US, now forecast to grow 6.4% by the IMF, and China, now forecast to grow 8.4% this year.  These are the fastest GDP growth numbers for the US since 1984, and we certainly all hope they are accurate.  After all, life is certainly better for everyone when the economy is growing rapidly.

But we have now seen a wave of higher forecasts for US GDP from official sources, like the Fed and IMF, and from private forecasters like Wall Street firms, with a strong consensus that the US is looking at GDP expansion this year well in excess of 6.0% and possibly as high as 7.0% or more.  And so I ask, isn’t that already in the price of most assets?

The broad bullish argument for risk is that global GDP growth is going to be much stronger in 2021 as the world’s economy rebounds from the Covid inspired recession of 2020.  And we have seen remarkable rallies in risk assets during this time, with the S&P 500 rising just a bit more than 80% in the twelve months following its nadir on March 24 last year.  All that occurred during a period where the virus was rampant but hopes for a vaccine would lead to an end to the government ordered shutdowns and a return to pre-covid type of economic activity.  While I grant that we have not seen all the shutdowns ended, the vaccine rollout has been impressive and is speeding up every day.  In fact, despite a pretty horrendous start to the process for Europe, the European Commission now believes that the continent will achieve herd immunity by the end of June!

So, if we know that all this is going to happen, haven’t risky assets already priced in this good news?  The other question that hangs over the current situation is the fact that this growth is entirely a product of the multiple trillions of dollars of government stimulus led by the US $5 trillion of fiscal injections, but also inclusive of QE, PEPP and QQE from the Fed, ECB and BOJ respectively, which totaled trillions more dollars of support.  Again, it begs the question, how much better can things be expected to get?

For instance, it is not unreasonable to expect that there will be permanent changes in the economy, specifically in the types of jobs that are available, especially for lower skilled workers.  If anything, the pandemic and resulting government lockdowns will have accelerated this process.  Remember, Chairman Powell has been clear that the Fed’s task will not be complete until the 10 million jobs that were lost as a result of government edicts are replaced. But what if that takes 5 years due to the structural changes in the economy?  Can the Fed maintain ZIRP while GDP growth is surging and inflation is rising alongside?  Historically, the answer would be no, but in the post-Covid world, that is no longer clear.  In fact, the one thing that has been truly consistent is that every government and supranational organization has warned every central bank to make sure they do not remove policy ease too soon.  The entire global political leadership is ‘all-in’ on the idea that printing money and spending it has no negative consequences.  In other words, it is no longer appropriate to worry we might wind up in an MMT world, we are already there!

This leads to the final question, will risk acquisition be unstoppable as a result of this new global thesis?  The famous American economist, Herbert Stein (Ben Stein’s father) made the statement, “if something cannot go on forever, it will stop.”  My observation is that printing money and the illusory growth that it brings cannot go on forever.  When this music stops, it will be a devastating fall.  But, as policymakers will do everything they can to prevent the stopping, this can go on for a while longer.  Simply be careful to not fall into the trap of believing stock prices are at “a permanently high plateau,” a comment another famous economist, Irving Fisher, made just weeks before the Wall Street Crash of 1929.

Ok, a super brief recap of markets shows that both Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.1%) and Europe (DAX -0.1%, CAC 0.0%, FTSE 100 +0.6%) were mixed with modest movement.  US futures are essentially unchanged at 8:00 as I finish typing.  Sovereign yields in Europe have edged lower by roughly 1 basis point, matching the Treasury market, but really not showing much in the way of activity.  Commodity prices are mixed with oil (+0.9%) rallying while metals (Au -0.6%, Cu -1.0%) are softer.

Finally, the dollar is showing little direction today with G10 currencies showing gains (NOK +0.3%) on oil’s rally and losses (AUD -0.5%) on metals price weakness.  But there is no dollar trend here.  In emerging markets, INR (-1.5%) was the biggest loser after the RBI left policy rates on hold, but not merely increased QE, but put a number on it where they will be buying INR1 trillion over the next quarter, driving Indian bond yields lower along with the rupee.  But away from that story, here, too, there is nothing of note with a mixed picture in the space.

On the data front, we see the Trade Balance (exp -$70.5B) this morning and then the FOMC Minutes are released at 2:00.  Today also brings a great deal of Fedspeak, but I remain highly confident that nothing from that story is going to change.

The dollar is wandering aimlessly today but remains closely tied to Treasury yields.  If yields resume their rally, look for the dollar to rebound.  However, if this correction in yields continues, the dollar has further to fall.

Good luck and stay safe
Adf

Pent-Up Demand

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The one thing consistently heard
Is growth in H2 will be spurred
By pent-up demand
Throughout all the land
As people buy things they’ve deferred

But what if the virus has wrought
Some changes in what people sought
Perhaps now it’s saving
That people are craving
Not spending, as routinely thought

There appears to be one universal view regarding economic activity going forward; there is an enormous amount of pent-up demand for things that people have been craving since the onset of the widespread government lockdowns as a result of the spread of Covid-19.  This includes eating out, going to the gym, going to the movies and traveling on vacation.  And it seems pretty clear that there is some truth to this idea.  But given the trauma that governments around the world inflicted on their populations via the inconsistent messaging and lockdown mania, isn’t it possible that many people have reevaluated what they deem as most important?  I know that this author has certainly reconsidered what is really necessary to live a happy and fulfilling life, and I imagine I am not the only one.

But the point is, virtually every economist’s assumption in their econometric models is that there will be a substantial pick-up in activity, especially in those service sectors that have been decimated by the ongoing restrictions, in the second half of the year.  There is no doubt that savings rates are higher now than they were before the pandemic, with the latest BEA data showing a 13.7% rate at the end of 2020 vs. a 7.3% rate at the end of 2019.  But the 2019 data was below the long-term (75 year) average savings rate of 9.0%, and two-thirds the rate seen from the end of WWII to1989.  The point is recent profligacy by the American people is something of a historical anomaly.  While Americans never saved like some other cultures, where savings rates would hover in the 20% range, historically, people really did try to save some money.

The other thing to remember is the past twelve months have been remarkably traumatic to the entire nation, if not the entire world, with a generation of children having their educations disrupted and changed significantly.  As was evident in the wake of the Great Depression, an entire generation altered their behavior, as the Roaring 20’s morphed into the Depression.  The one thing that hasn’t changed is human nature, with peoples’ response to trauma informing their future activities.  This is all a long-winded way of saying that, perhaps, there isn’t nearly as much pent-up demand for things as is currently assumed.  Perhaps, the increase in savings rate is a way for people, in general, to feel a bit more secure about their situation.  While FOMO will never completely disappear, it certainly could wane.

With this in mind, it is possible to turn a more critical eye at forecasts for GDP growth around the world going forward.  For instance, the UK reported that Q4 GDP rose 1.0%, well above forecasts of a 0.5% increase, and insuring that despite likely negative growth in Q1, there will be no double-dip recession.  But BOE Chief Economist, Andy Haldane was positively effusive in his forecasts, saying, “A year from now, annual growth could be in the double digits.”  Wow is all I can say.  That is an optimistic point of view, but it is not an isolated one.  Here in the US, forecasts now indicate that GDP will grow 4.9% in 2021, well above trend and enough to offset 2020’s 3.5% decline.  And maybe they are right.  Certainly, equity markets are all-in on the idea.  However, I would be cautious in blindly accepting these numbers as gospel given no econometric model takes into account the changes wrought in perceptions by Covid-19.  I fear growth could be much less impressive as 2021 evolves which means markets will need to adjust their thinking.  Stay nimble!

On to today’s session, which has seen another lackluster performance across markets.  With most of Asia closed for the New Year holiday, only the Nikkei (-0.15%) was trading and it displayed a general lack of interest.  European bourses are mixed with the DAX (-0.5%) a key underperformer while the CAC and FTSE 100 are both flat on the day.  Given the better than expected data from the UK, it would seem that performance is a bit disappointing, but there are ongoing Brexit travails which seem to be putting a damper on things.  US futures, meanwhile, had spent the bulk of the overnight session in the green, but are now all lower by about 0.2%.  It appears we may be seeing some risk being unloaded into the holiday weekend.

Bond markets are ever so slightly firmer this morning, with the biggest mover Italian BTP’s (-1.5bps) after the FiveStar party voted to support Super Mario for PM.  Otherwise, Treasury yields are essentially unchanged as are bunds and Gilts.

Oil (WTI -1.0%) is under pressure again today, for the second consecutive session, but the uptrend remains firmly in place.  This has all the hallmarks of a modest correction.  Gold, however, is under pressure as well, and has been lagging most other commodities.  Base metals are mixed as are agriculturals, which, again, tells you that there is no strong theme in the markets.

As to the dollar, it is broadly higher this morning, albeit not dramatically so.  In the G10, the commodity currencies are under the most pressure (NZD (-0.5%, AUD -0.3%, CAD -0.3%) but we are also seeing weakness in the two havens with both JPY and CHF softer by 0.3%.  In the emerging markets, RUB (-1.0%) is the weakest of the bunch after the central bank explained they won’t be cutting rates further amid concerns over new sanctions to be imposed by the EU as well as the ongoing spread of Covid.  But aside from the ruble, while most currencies in the bloc are softer, the movement has been relatively small, on the order of -0.1% to -0.3%, indicating this is really a dollar story.

On the data front, the only thing we see today is the preliminary Michigan Sentiment Survey (exp 80.9), which would need to be wildly different to change any views.  As well, we continue to lack Fed speakers, and the data has clearly not shown “substantial further progress” on the Fed’s efforts to support the economy, so policy changes are not in the air.

The dollar’s consolidation after a nearly year-long decline continues, although, as I mentioned yesterday, there seems little impetus for the dollar to extend its corrective rally.  Rather, it feels like we are going to see a little more market chop with no direction into the holiday weekend,

Good luck, good weekend and stay safe
Adf

Growth’s Pace Declining

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

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

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

Now, back to our regularly scheduled programming.

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Quickly Diminished

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As Covid continues to spread
The hopes for a rebound ahead
Have quickly diminished
And though, not quite finished
The data needs to, higher, head

Today, for example, we learned
That Germany’s growth trend has turned
Instead of a V
The bears, filled with glee
Are certain the bulls will be burned

The seeds of doubt that were sown last week may have started to sprout green shoots.  Not only is it increasingly unlikely that any stimulus deal will be reached before the election in eight days, but we are starting to see the data reflect the much feared second wave in the number of Covid-19 cases.  The latest example of this is Germany’s IFO data this morning, which disappointed on the two most important readings, Business Climate and Expectations.  Both of these not only missed estimates, but they fell compared to September’s downwardly revised figures.  This is in concert with last week’s Flash PMI Services data, which disappointed throughout Europe, and can be directly attributed to the resurging virus.  Germany, Spain, Italy and France are all imposing further restrictions on movement and activity as the number of new cases throughout Europe continues to rise, climbing above 200K yesterday.  With this data as this morning’s backdrop, it cannot be surprising that risk is under pressure.

For investors, the landscape seems to have shifted, from a strong belief in a V-shaped recovery amid additional fiscal stimulus throughout the G10 along with a change at the White House, that for many would bring a sigh of relief, to a far less certain outcome.  The increase in government restrictions on activity is leading directly to more uncertainty over the economic future.  Meanwhile, a tightening in the polls has started to force those same investors to reevaluate their primary thesis; a blue wave leading to significant fiscal stimulus, a weaker dollar and a much steeper yield curve.  That has seemingly been the driver of 10-year and 30-year yields in the US, which last week traded to their highest levels since the position related spike in June.  In fact, positioning in the long bond future (-235K contracts) is at record short levels.

With this as backdrop, it is entirely realistic to expect some position unwinding, especially if the underlying theses are being called into question.  This morning, that seems like what we are watching.  Risk is decidedly off this morning, with equity markets around the world broadly lower, haven government bond yields falling and the dollar on the move higher.  Oil prices are under pressure, and the risk bulls’ rose-tinted glasses seem to be fogging up, at the very least.

Starting with equity markets, Asia had a mixed session, taking its lead from Friday’s US price action, as the Hang Seng (+0.5%) managed to rally a bit while both the Nikkei (-0.1%) and Shanghai (-0.8%) finished in the red.  Europe, meanwhile, is floating in a red tide with Germany’s DAX (-2.3%) the laggard, but the CAC (-0.6%) and FTSE 100 (-0.4%) starting to build momentum lower.  The DAX is suffering, not only from the IFO data, but also from the fact that SAP, one of the major components in the index, is lower by nearly 19% after dramatically cutting its revenue forecasts due to the virus’ impact on the economy.  It seems the question should be, how many other companies are going to have the same outcome?  And finally, US futures are all pointing lower by 0.8% or so, certainly not an encouraging sign.

Bond markets have shown quite a bit of volatility this morning, with 10-year Treasury prices climbing and yields down 3 basis points from Friday.  However, the European session is quite different.  The first thing to note is Italian BTP’s have rallied sharply, with yields there falling 5.5 basis points after S&P not only failed to downgrade the country’s credit rating, but actually took it off negative watch on the basis of the idea that ECB support plus a resumption in growth would allow the country to reduce its budget deficit and hence, the trend growth in its debt/GDP ratio.  German bunds, on the other hand, have sold off a bit and are higher by 1bp, but that appears to be the result of the unwinding of Bund-BTP spread wideners, as the market was definitely convinced a downgrade was coming.  The S&P news also has helped the rest of the PIGS, which have all seen yields decline about 2 basis points this morning.  Caution, though, is required, as an ongoing risk-off performance by equity markets will almost certainly result in Bunds finding significant bids.

As to the dollar, it is broadly stronger this morning, although not universally so.  In the G10, the euro (-0.3%) is under pressure as Germany suffers, and we are also seeing weakness in CAD (-0.4%) with oil prices making a strong move lower, and WTI now sitting well below $40/bbl.  On the plus side, the pound (+0.15%) seems to be benefitting from a bit of Brexit hope as talks between the two sides have resumed, while SEK (+0.15%) is the beneficiary of the fact that Sweden will not be locking down the country as the growth in Covid cases there remains miniscule, especially compared to the rest of Europe.

EMG currencies, though, are having a tougher time this morning with TRY (-1.25%) leading the way, but MXN (-0.8%) and ZAR (-0.6%) also significantly underperforming.  The latter two here are directly related to weakness in commodity prices across the board, while Turkey remains in its own private nightmare of an impotent central bank trying to overcome the threat of further economic sanctions driven by President Erdogan’s aggressive actions in the Eastern Mediterranean.  Meanwhile, the CE4 are all softer (CZK -0.6%, PLN -0.4%) as they feel the pain of further government restrictions on social activities amid a growing caseload of new covid infections.  In fact, there was really only one gainer of note in this bloc, KRW (+0.45%) which responded to growing expectations that South Korea’s economy would rebound more quickly than the G7 amid growing exports and the so-far absent second wave.

As it is the last week of the month, we have a bunch of data to which to look forward, including the first reading of Q3 GDP, and we also hear from the ECB on Thursday.

Today New Home Sales 1025K
Tuesday Durable Goods 0.5%
-ex Transport 0.4%
Case Shiller Home Prices 4.20%
Consumer Confidence 101.9
Thursday ECB Deposit Rate -0.50%
Initial Claims 780K
Continuing Claims 7.8M
Q3 GDP 31.8%
Friday Personal Income 0.3%
Personal Spending 1.0%
Core PCE Deflator 0.2% (1.7% Y/Y)
Chicago PMI 58.0
Michigan Sentiment 81.2

Source: Bloomberg

Now, the GDP number, which will almost certainly be the largest ever, is forecast to mirror the percentage gain of Q2’s percentage loss, but remember, the way the math works is that a 30% decline requires a 42% gain to make up the difference, so the economy is still well below the activity levels seen pre-covid.  As to the ECB, there are no expectations for policy changes, but most analysts are looking for strong indications of what will come in December.  To me, the risk is they act sooner rather than later, so perhaps a little more opportunity for the euro to decline on that.

As for today, unless we see positive stimulus bill headlines from the US, my sense is that the dollar will drift a bit lower from here as further position adjustments are the order of the day.

Good luck and stay safe
Adf

Quite Sordid

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For Italy, France and for Spain
The data released showed their pain
Each nation recorded
A number quite sordid
And each, Covid, still can’t contain

As awful as the US GDP data was yesterday, with an annualized decline of 32.9%, this morning saw even worse data from Europe.  In fact, each of the four largest Eurozone nations recorded larger declines in growth than did the US in Q2.  After all, Germany’s 10.1% decline was a Q/Q number.  If we annualize that, it comes to around 41%.  Today we saw Italy (-12.4% Q/Q, -50% annualized), France (-13.8% Q/Q or -55% annualized) and Spain, the worst of the lot (-18.5% Q/Q or -75% annualized).  It is, of course, no surprise that the Eurozone, as a whole, saw a Q/Q decline of 12.1% which annualizes to something like 49%.  At those levels, precision is not critical, the big figure tells you everything you need to know.  And what we know is that the depths of recession in Europe were greater than anywhere else in Q2.

The thing is, none of this really matters any more.  The only thing the Q2 GDP data did was establish the base from which future growth will occur.  We saw this in the US yesterday, where equity markets rallied, and we are seeing and hearing it today throughout Europe as the narrative is quite clear; Q2 was the nadir and things should get better going forward.  In fact, that is the entire thesis behind the V-shaped recovery.  Certainly, one would be hard pressed to imagine a situation where Q3 GDP could shrink relative to Q2, but unfortunately the rebound story is running into some trouble these days.

The trouble is making itself known in various ways.  For example, the fact that the Initial Claims data in the US has stopped declining is a strong indication that growth is plateauing.  This is confirmed by the resurgence of Covid cases being recorded throughout the South and West and the reimposition of lockdown measures and closures of bars and restaurants in California, Texas and Arizona.  And, alas, we are seeing the same situation throughout Europe (and in truth, the rest of the world) as nations that had been lionized for their ability to act quickly and prevent the spread of the virus through draconian measures, find that Covid is quite resilient and infections are surging in Spain, Italy, Germany, the UK, Japan, Singapore, South Korea and even in China.  You remember China, the origin of the virus, and the nation that explained they had eradicated it completely just last month.  Maybe eradicated was too strong a word.

So, the real question is, what happens to markets if the future trajectory of growth is much shallower than a V?  It is not difficult to argue that equity markets, especially in the US, are priced for the retracement of all the lost growth.  That seems to be at odds with the situation on the ground where thousands of small businesses have closed their doors forever.  And not just small businesses.  The list of bankruptcy filings by large, well-known companies is staggeringly long.

Can continued monetary and fiscal support from government institutions really replace true economic activity?  Of course, the answer to that question is no.  Money from nothing and excessive debt issuance will never substitute for the creation of real goods and services that are demanded by the population.  So, while equity markets trade under the assumption that government support is a stop-gap filler until activity returns to normal, the recent, high-frequency data is implying that the gap could be much longer than initially anticipated.

And as has been highlighted in many venues, the bond market is telling a different story.  Treasury yields out to 10 years are now trading at record lows.  The amount of negative yielding debt worldwide is climbing again, now back to $16 trillion, and heading for the record levels seen at the end of last August.  This price behavior is the very antithesis of expected strong growth in the future.  Rather it signals concerns that growth will be absent for years to come, and with it inflationary pressures.  At some point, these two asset classes will both agree on a story, and one of them will require a major repricing.  My money is on the stock market to change its tune.

But that is a longer term discussion.  For now, let us review the overnight session.  It is hard to characterize it as either risk-on or risk-off, as we continue to see mixed signals from different markets.  In Asia, the Nikkei was the worst performer, falling 2.8% as concerns grow that a second wave of Covid infections is going to stop the signs of recovery.  Confirming those fears, a meeting of government and central bank officials took place where they discussed what to do in just such a situation, which of course means there will be more stimulus, both monetary and fiscal, on its way soon.  The yen behaved as its haven status would dictate, rallying further and touching a new low for the move at 104.19 before backtracking and sitting unchanged on the day as I type.  The thing about the yen is that 105 had proven to be a strong support level and is now likely going to behave as resistance.  While I don’t see a collapse, USDJPY has further to fall.

The rest of Asia saw weakness (Hang Seng -0.5%, Sydney -2.0%) and strength (Shanghai +0.7%) with the latter responding to modestly better than expected PMI data, while the former two are feeling the impact of the rise in infections.  Europe, on the other hand, is green across the board, with Italy’s FTSE MIB (+1.25%) leading the way, although the DAX (+0.7%) is performing well.  Here, just like in the US, investors seem to believe in the V-shaped recovery and now that the worst has been seen, those investors are prepared to jump in with both feet.

As discussed above, bond markets continue to rally, and yields continue to fall.  That is true throughout Europe as well as in the US.  In fact, it is true in Asia as well, with China the lone exception, seeing its 10-year yield rise 4bps overnight.

And finally, the dollar can only be described as mixed.  In the G10, NZD (-0.5%) and AUD (-0.2%) are the worst performers as both suffer from concerns over growing numbers of new Covid cases, while SEK and GBP (+0.25% each) lead the way higher.  It is ironic as there is concern over the growing number of cases in those nations as well, and, in fact, the UK is locking down over 4 million people in the north because of a rise in infections.  But the pound has been on fire lately, and that momentum shows no signs of abating for now.  One would almost think that a Brexit deal has been agreed, but the latest news has been decidedly negative there.  This is simply a reminder that FX is a perverse market.

Emerging markets have also seen mixed activity, although it is even more confusing.  Even though commodities are having a pretty good day, with both oil and gold prices higher, the commodity currencies are the worst performers today, with ZAR (-1.35%), RUB (-1.0%) and MXN (-0.9%) all deeply in the red.  On the positive side, THB (+0.85%) and CNY (+0.5%) are showing solid strength.  The renminbi, we already know, is benefitting from the better than expected PMI data while the baht benefitted from ongoing equity inflows.

This morning we see another large grouping of data as follows: Personal Income (exp -0.6%), Personal Spending (5.2%), core PCE Deflator (1.0%), Chicago PMI (44.5) and Michigan Sentiment (72.9).  As inflation is no longer even a concern at the Fed, or any G10 central bank, the market is likely to look at two things, Spending data which could help cement the idea that things are rebounding nicely, or not, and Chicago PMI, as an indication of whether industrial activity is picking up again.

Overall, regardless of the data, the trend remains for the dollar to decline, at least against its G10 brethren and I see nothing that is going to change that trend for now.  At some point, it will make sense for receivables hedgers to take advantage, but it is probably still too early for that.

Good luck, good weekend and stay safe

Adf

 

Struck by the Flu

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If you think that Jay even thought
‘bout thinking ‘bout thinking he ought
To raise interest rates
He’ll not tempt the fates
Despite all the havoc ZIRP’s wrought

Meanwhile, ‘cross the pond what we learned
Is Germany ought be concerned
Their growth in Q2
Was struck by the flu
As exports, their customers, spurned

(Note to self; dust off “QE is Our Fate” on September 16, as that now seems a much more likely time to anticipate how the Fed is going to adjust their forward guidance.) Yesterday we simply learned that rates are going to remain low for the still indeterminate, very long time. Clearly, the bond market has gotten the message as yields along the Treasury curve press to lows in every tenor out through 7-year notes while the 10-year sits just 1.5 bps above the lows seen in March at the height of the initial panic. This should be no surprise as the FOMC statement and ensuing press conference by Chairman Powell made plain that the Fed is committed to use all their available tools to support the economy. Negative rates are not on the table, yield curve control is already there, effectively, so the reality is they only have more QE and forward guidance left in their toolkit. Powell promised that QE would be maintained at least at the current level, and the question of forward guidance is tied up with the internal discussions on the Fed’s overall policy framework. Those discussions have been delayed by the pandemic but are expected to be completed by the September meeting. Perhaps, at that time, they will let us know what they plan to do about their inflation mandate. The smart money is betting on a commitment to allow inflation to overshoot their target for an extended period in order to make up for the ground lost over the past decade, when inflation was consistently below target. I guess you need to be a macroeconomist to understand why rising prices helps Main Street, because, certainly from the cheap seats, I don’t see the benefit!

The market response was in line with what would be expected, as yields fell a bit further, the dollar fell a bit further and stocks rallied a bit further. But that is soooo yesterday. Let’s step forward into today’s activities.

Things started on a positive note with Japanese Retail Sales jumping far more than expected (+13.1%) in June which took the Y/Y number to just -1.2%. That means that Japanese Retail Sales are almost back to where things were prior to the outbreak. Unfortunately, this was not enough to help the Nikkei (-0.3%) and had very little impact on the yen, which continues to trade either side of 105.00. Perhaps it was the uptick in virus cases in Japan which has resulted in further restrictions being imposed on bars and restaurants that is sapping confidence there.

Speaking of the virus, Australia, too, is dealing with a surge in cases, as Victoria and Melbourne have seen significant jumps. As it is winter in the Southern Hemisphere, there is growing concern that when the weather cools off here, we are going to see a much bigger surge in cases as well, and based on the current government response to outbreaks, that bodes ill for economic activity in the US come the fall.

But then, Germany reported their Q2 GDP data and it was much worse than expected at -10.1%. Analysts had all forecast a less severe decline because Germany seemed to have had a shorter shutdown and many fewer unemployed due to their labor policies where the government pays companies to not lay-off workers. So, if the shining star of Europe turned out worse than expected, what hope does that leave us for the other major economies there, France, Italy and Spain, all of which are forecast to see declines in Q2 GDP in excess of 15%. That data is released tomorrow, but the FX market wasted no time in selling the euro off from its recent peak. This morning, the single currency is lower by 0.35%, although its short-term future will also be highly dependent on the US GDP data due at 8:30.

Turning to this morning’s US data, today is the day we get the most important numbers, as the combination of GDP (exp -34.5%), to see just how bad things were in Q2, and Initial (1.445M) and Continuing (16.2M) Claims, to see how bad things are currently, are to be released at 8:30. After the combination of weak German data and resurgence in virus cases in areas thought to have addressed the issue, it should be no surprise that today is a conclusively risk-off session.

We have seen that in equity markets, where both the Hang Seng (-0.7%) and Shanghai (-0.25%) joined the Nikkei lower in Asia while European bourses are all in the red led by the DAX (-2.3%) and Italy’s FTSE MIB (-2.2%). And don’t worry, US futures are all declining, with all three major indices currently pointing to 1% declines at the open.

We have already discussed the bond market, where yields are lower in the US and across all of Europe as well with risk being pared around the world. A quick word on gold, which is lower by 0.8%, and which may seem surprising to some. But while gold is definitely a long-term risk aversion asset, its day to day fluctuations are far more closely related to the movement in the dollar and today, the dollar reigns supreme.

In the G10 bloc, NOK is the laggard, falling 1.0% as oil prices come under pressure given the weak economic data, but we have seen substantial weakness throughout the entire commodity bloc with AUD (-0.6%) and CAD (-0.57%) also suffering. In fact, the only currency able to hold its own this morning is the pound, which is essentially unchanged on the day. In the EMG bloc, there are several major declines with ZAR (-1.6%), RUB (-1.4%) and MXN (-1.0%) leading the way down. The contributing factor to all three of these currencies is the weakness in the commodity space and corresponding broad-based dollar strength. But the CE4 are all lower by between 0.3% and 0.6%, and most Asian currencies also saw modest weakness overnight. In other words, today is a dollar day.

And that is really the story. At this point, we need to wait for the data releases at 8:30 to get our next cues on movement. My view is that the Initial Claims data remains the single most important data point right now. Today’s expectation is for a higher print than last week, which the market may well read as the beginning of a reversal of the three-month trend of declines. A higher than expected number here is likely to result in a much more negative equity day, and correspondingly help the dollar recoup even more of its recent losses.

Good luck and stay safe
Adf

Quite Dramatic

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The Chinese report ‘bout Q2
Showed growth has rebounded, it’s true
But things there remain
Subject to more pain
Til elsewhere bids Covid adieu

The market’s response was emphatic
With Shanghai’s decline quite dramatic
Thus, risk appetite
Today is quite slight
Which means bears are now just ecstatic

It is no surprise that the Chinese reported a rebound to positive GDP growth in Q2 as, after all, the nation was the epicenter of Covid-19 and they, both shut down and reopened their economy first. The numbers, however, were mixed at best, with the GDP number rebounding a more than expected 3.2% Y/Y, but their Retail Sales data failing to keep up, printing at -1.8% Y/Y, rather than the expected 0.5% gain. The lesson to be learned here is that while Chinese industry seems to be heading back to a pre-Covid pace, domestic consumption is not keeping up. This is a problem for China for two reasons; first, they have made an enormous effort to adjust the mix of their economy from entirely export oriented to a much greater proportion of consumption led growth. Thus, weak Retail Sales implies that those efforts are now likely to restrict the nation’s growth going forward. Secondly, the fact that the rest of the world is months behind China in this cycle, with many emerging markets still in the closing process, not nearly ready to reopen, implies that while industry in China may have retooled, their export markets are a long way from robust.

The other interesting thing that came out of China last night, that had a more direct impact on markets there, was yet another round of stories published about the evils of speculation and how Chinese financial institutions would be selling more stocks. You may recall last week, when the Chinese government had an article published singing the praises of a strong stock market, encouraging retail investors to drive a more than 6.0% gain in the Shanghai Composite. Just a few days later, they reversed course, decrying the evils of speculation with a corresponding sharp decline. Well, it seems that speculators are still evil, as last night’s message was unequivocally negative pushing Shanghai lower by 4.5% and finally removing all those initial speculative gains. It seems the PBOC and the government are both concerned about inflating bubbles as they well remember the pain of 2015, when they tried to deflate their last one.

But this activity set the tone for all Asian markets, with red numbers everywhere, albeit not quite to the extent seen on the mainland. For instance, the Nikkei slipped 0.75% and the Hang Seng, fell 2.0%.

Europe has its own set of issues this morning, although clearly the weakness in Asia has not helped their situation. Equity markets throughout the Continent are lower with the DAX (-0.5%) and CAC (-0.7%) representative of the losses everywhere. While traders there await the ECB meeting outcome, the focus seems to be on the UK announcement that they will be increasing their debt issuance by £110 billion in Q3 to help fund all the fiscal stimulus. This will take the debt/GDP ratio above 100%, ending any chance of retaining fiscal prudence.

It’s remarkable how things can change in a short period of time. During the Eurozone debt crisis, less than 10 years ago, when Greece was on the cusp of leaving the euro, they were constantly lambasted for having a debt/GDP ratio of 150% or more while Italy, who was puttering along at 125% was also regularly excoriated by the EU and the IMF. But these days, those entities are singing a different tune, where suddenly, government borrowing is seen as quite appropriate, regardless of the underlying fiscal concerns, with the supranational bodies calling for additional fiscal stimulus and the borrowing that goes along with it. At any rate, there is certainly no sign that the current mantra of issuing debt and spending massive amounts of money to support the economy is about to change. Fiscal prudence is now completely passé.

With that as a backdrop, it should be no surprise that risk is being pared back across all markets. Having already discussed equities, we can look at bond markets and see yields virtually everywhere lower today as investors seek out haven assets. Interestingly, despite the new issuance announced in the UK, Gilts lead the way with a 2.5bp decline, while Treasuries and Bunds have both seen yields decline a more modest 1bp. Oil prices have fallen again, which is weighing on both NOK (-0.65%) and RUB (-0.4%) the two currencies most closely linked to its price. But of course, lower oil prices are indicative of weaker overall sentiment.

As such, it is also no surprise that every one of the currencies in the G10 and major emerging markets is weaker vs. the dollar this morning. While the trendy view remains that the dollar is going to continue to decline, and that has been expressed with near record short dollar positions in futures markets, the greenback is not playing along today.

At this point, I think it is important to remind everyone that a key part of the weak dollar thesis is the ongoing expansion of the Fed’s balance sheet adding more liquidity to the system and thus easing dollar policy further. But for the past 5 weeks, the Fed’s balance sheet has actually shrunk by $250 billion, a not inconsiderable 3.5%, as repo transactions have matured and not been replaced. It appears that for now, the market is flush with cash. So, given the combination of major short dollar positions extant and short term fundamental monetary details pointing to dollar strength, do not be surprised if we see a short squeeze in the buck over the next week or two.

This morning brings the bulk of the week’s data, certainly its most important readings, and it all comes at 8:30. Retail Sales (exp 5.0%, 5.0% ex autos), Philly Fed (20.0), Initial Claims (1.25M) and Continuing Claims (17.5M) will hopefully give us a clearer picture of how the US economy is progressing. One of the problems with this data is that it is mostly backward looking (Philly Fed excepted) and so probably does not capture the apparent second wave of infections seen in Florida, Texas and California, three of the most populous states. So, even if we do see somewhat better than expected data, it could easily slip back next week/month. In fact, this is why the Claims data is so important, it is the timeliest of all the major economic releases, and given the ongoing uncertainty surrounding the current economic situation, it is likely the most helpful. So, while the trend in Initial Claims has been lower, it remains at extremely problematic levels and is indicative of many more businesses retrenching and letting staff go. It has certainly been my go-to data point for the pulse of the economy.

Recent data points have been better than forecast, but nobody doubts that things are still in dire shape. Unfortunately, it appears we are still a long way from recouping all the lost economic activity we have suffered over the past months. But FX remains a relative game, and arguably, so is everyone else.

Good luck and stay safe
Adf

Yesterday’s News

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The first bit of data we’ve seen
Has shown what economists mean
When most business stops
And GDP drops
Reacting to Covid – 19

This data describes people’s fear
Another wave just might appear
But right now those views
Are yesterday’s news
And ‘buy the dip’ traders are here

The UK is an interesting study regarding GDP growth because they actually publish monthly numbers, rather than only quarterly data like the rest of the developed world. So, this morning, the UK reported that GDP activity in April declined 20.4% from March, which had declined 5.8% from February when the first impact of Covid-19 was felt. This has resulted in the UK economy shrinking back to levels last seen in 2002. Eighteen years of growth removed in two months! Of course, when things recover, and they will recover as the lockdowns are eased around the world, we will also get to see the fastest growth numbers in history. However, we must remember that a 20% decline will require a 25% rebound to get back to where we started. Keep that in mind when we start to see large positive numbers in the summer (hopefully) or the autumn if people decide that the risks of Covid outweigh the benefits of returning to previous activities.

Needless to say, this has been an unprecedented decline, on a monthly basis, in the economy for both its depth and speed. But the more remarkable thing, is that despite this extraordinary economic disruption, a look at financial markets shows a somewhat different story. For example, on February 28, the FTSE 100 closed at 6580.61 and the pound finished the session at 1.2823. On April 30, after the worst two-month economic decline in the UK’s history, its main stock market had declined 10.3% while the pound had fallen just 1.8%. Granted, both did trade at substantially lower levels in the interim, bottoming in the third week of March before rebounding. But it seems to me that those are pretty good performances given the size of the economic dislocation. And since then, both the FTSE 100 and the pound have rallied a bit further.

The question is, how can this have occurred? Part of the answer is the fact that on a contemporaneous basis, investors could not imagine the depths of the economic decline that was taking place. While there were daily stories of lockdowns and death counts, it is still hard for anyone to have truly understood the unprecedented magnitude of what occurred. And, of course, part of the answer was this did not happen in a vacuum as policymakers responded admirably quickly with the BOE cutting rates by a total of 0.65% in the period while expanding their balance sheet by £150 billion (and still growing). And the UK government quickly put together stimulus packages worth 5% of then measured GDP. Obviously, those measures were crucial in preventing a complete financial market collapse.

Another thing to remember is that the FTSE 100 was trading at a P/E ratio of approximately 15 ahead of the crisis, which in the long-term scheme of things was actually below its average. So, stock prices in the UK were nowhere near as frothy as in the US and arguably had less reason to fall.

As to the pound, well, currencies are a relative game, and the same things that were happening in the UK were happening elsewhere as well to various degrees. March saw the dollar’s haven status at its peak, at which point the pound traded below 1.15. But as policymakers worldwide responded quite quickly, and almost in unison, the worst fears passed and the ‘need’ to own dollars ebbed. Hence, we have seen a strong rebound since, and in truth a very modest net decline.

The questions going forward will be all about how the recovery actually unfolds, both in timing and magnitude. The one thing that seems clear is that the uniformity of decline and policy response that we saw will not be repeated on the rebound. Different countries will reduce safety measures at different paces, and populations will respond differently to those measures. In other words, as confusing as data may have been before Covid, it will be more so going forward.

Now, quickly, to markets. Yesterday’s equity market price action in the US was certainly dramatic, with the Dow falling nearly 7% and even the NASDAQ falling 5.25%. The best explanation I can offer is that reflection on Chairman Powell’s press conference by investors left them feeling less confident than before. As I wrote in the wake of the ECB meeting last week, the only way for a central banker to do their job (in the market’s eyes) these days is to exceed expectations. While analysts did not expect any policy changes, there was a great deal of talk on trading desks floors chatrooms about the next step widely seen as YCC. The fact that Jay did not deliver was seen as quite disappointing. In fact, it would not be surprising to me that if stock markets continued to decline sharply, the Fed would respond.

But that is not happening as buying the dip is back in fashion with European markets higher by roughly 1.5% and US futures also pointing higher. Meanwhile, with risk back in favor, Treasury yields have backed up 3bps and the dollar is under pressure.

On the FX front, the G10 is a classic depiction of risk-on with the yen (-0.5%) and Swiss franc (-0.3%) both declining while the rest of the bloc is higher led by CAD and AUD, both up 0.5%. In truth, this has the feeling of a bounce from yesterday’s dollar strength, rather than the beginning of a new trend, but that will depend on the broader risk sentiment. If equity market ebullience this morning fades as the session progresses, look for the dollar to take back its overnight losses.

Meanwhile, EMG markets are having a more mixed session with APAC currencies all having fallen last night in the wake of the US equity rout. APAC equities were modestly lower to unchanged but had started the session under far more pressure. At the same time, the CE4, with the benefit of the European equity rebound and higher US futures are mostly firmer led by PLN (+0.6%). But the biggest winner today in this space is MXN, which has rebounded 0.7% from yesterday’s levels, although that represented a nearly 4% decline! In other words, the defining characteristic of the peso these days is not its rate but its volatility. For example, 10-day historic volatility in the peso is currently 28.37%, up from 13.4% last Friday and 21.96% in the middle of May when we were looking at daily 3% moves. Do not be surprised if we see another bout of significant peso volatility, especially given the ongoing concerns over AMLO’s handling of Covid.

On the data front, only Michigan Sentiment (exp 75.0) is on the docket today, which may have an impact if it is surprisingly better than expected, but I don’t anticipate much movement. Rather, FX remains beholden to the overall risk sentiment as determined by the US equity markets. If the rebound continues, the dollar will remain under pressure. If the rebound fails, look for the dollar to resume yesterday’s trend.

Good luck, good weekend and stay safe
Adf

 

Unless Lowered Instead

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All eyes have now turned to the Fed
As pundits expect Jay will spread
The message that rates,
Until future dates,
Are fixed, unless lowered instead

Most market activity is muted this morning as traders and investors await the latest words of wisdom from Chairman Jay and his compadres. The key questions in the air are:

1. What will the Fed’s new forecasts describe?
2. What will the dot plot (remember that?) look like?
3. Will there be any change in current forward guidance?
4. Will there be any mention of yield curve control (YCC)?

Let’s quickly try to unpack these and see what they mean.

1. The Fed ordinarily updates its economic forecasts quarterly, but wisely, in my view, skipped March’s update given the incredible uncertainty that existed due to the beginnings of the Covid-19 impact. Three months later, the breadth of economic destruction has become clearer, but it will be interesting to learn their current views on the topic. For comparison, last week the ECB forecast a central scenario of Eurozone GDP as follows: 2020 -8.7%, 2021 +5.2%, 2022 +3.3%. The OECD forecast global GDP at -6.0% this year and US GDP at -7.3% this year assuming no second wave of infections. Those numbers fall to -7.6% and -8.5% respectively if there is a second wave of Covid infections. No matter how you slice it, 2020 is set to report negative GDP growth, but the question is, will the Fed demonstrate relative optimism or not?

2. The dot plot, as you may recall, was the biggest issue for a long time, as it was the Fed’s non-verbal way of offering forward guidance. The idea was that each FOMC member would offer his/her own views of the future level of rates and the median forecast was seen as a proxy of the Fed’s views. While it is abundantly clear that the view for 2020 will remain 0.00%, the real question is what the timeline anticipated by the FOMC will be as to when rates can start to rise again. It strikes me that while there will be some divergence, as always, we are likely to see only very gradual increases expressed, with a real possibility that 2021’s median will also be 0.00% and rates only beginning to rise in 2022. This begs the question…

3. How will they proffer their forward guidance? Current language is as follows: “The Committee expects to maintain this target (0.00%-0.25%) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Current thoughts are they could become more specific with respect to the timeline, (e.g. saying rates would remain at current levels until the end of 2022) or with respect to data (e.g. until Unemployment is at 5.0% and Inflation is back to 2.0%). Of course, the lesson from Chairman Bernanke is that if they go the latter route, they can easily change the level as they see fit. But for now, the longer the timeline, the more confidence that would seem to be imparted. At least, that’s the theory.

4. Finally, there has been a great deal of discussion regarding YCC and whether the Fed will announce a program akin to the BOJ (10-year) or RBA (3-year) where they target a rate on a specific maturity of the Treasury curve. Most analysts, as well as Cleveland Fed President Mester, believe it is too early to make a pronouncement on this subject, but there are those who believe that despite the equity market’s recent frothiness, they may want to step harder on the gas pedal to make sure they keep up what little momentum seems to have started. To me, this is the biggest story of the afternoon, and the one with the opportunity for the most market impact. It is not fully priced in, by any means, and so would likely see a huge rally in both bonds and stocks as the dollar fell sharply if they were to announce a program like this. I like gold on this move as well.

So, plenty to look forward to this afternoon, which explains why market activity has been so limited overall so far today. Equity markets in Asia were barely changed, although in the past few hours we have seen European bourses start to decline from early modest gains. At this point the DAX (-0.8% and CAC (-0.6%) are fully representative of the entire Eurozone space. At the same time, US futures have turned mixed from earlier modest gains with Dow e-minis down 0.3% although NASAAQ futures are actually higher by a similar amount.

Bond markets are generally anticipating something from the Fed as the 10-year has rallied and yields declined a further 3bps which now takes the decline since Friday’s close to 10bps. Bunds and Gilts are both firmer as well, with modestly lower yields while the PIGS are mixed as Greek yields have tumbled 9bps while Spain (+3bps) and Portugal (+4.5bps) see rising yields instead.

And finally, the dollar is definitely on its back foot this morning. In fact, it is lower vs. the entire G10 bloc with Aussie and Kiwi leading the way with 0.5% gains. Right now, the Aussie story looks more technical than fundamental, as it approaches, but cannot really hold 0.70, its highest point in almost a year. But overall, what is interesting about this movement is that despite yesterday’s desultory equity performance and this morning’s modest one as well, the dollar is behaving in a risk-on manner. Something else is afoot, but I have not yet been able to suss it out. I will though!

In the EMG space, the dollar is lower against virtually all its counterparts with IDR as the major exception. The rupiah fell 0.65% last night, actually recouping larger earlier losses at the end of the session, after the central bank explained they would be capping any strength in an effort to help Indonesian exporters. On the plus side is a range of currencies from all three blocs, which is evidence of pure dollar weakness rather than specific positive currency stories.

On the data front, overnight we learned that Chinese PPI was weaker than expected, reflecting weakness in its export markets and not boding well for that elusive V-shaped recovery. We also saw horrific April French IP data (-34.2% Y/Y), but that was pretty much as expected. This morning we get the latest CPI data from the US (exp 0.3%, 1.3% ex food & energy), but inflation remains a secondary concern to the Fed for now. Rather, there is far more focus on the employment data at the Mariner Eccles Building, so really, for now it is all about waiting for the Fed. If pressed, I think they will be more likely to offer some new, more dovish, guidance as it appears they will not want to lose any positive momentum. That means the dollar should remain under pressure for a little while longer.

Good luck and stay safe
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