Growth’s Pace Declining

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

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

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

Now, back to our regularly scheduled programming.

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

Quickly Diminished

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

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

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

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

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

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
Adf

Playing Hardball

Last night China shocked one and all
With two policy shifts not too small
They’ve now become loath
To target their growth
And in Hong Kong they’re playing hardball

It seems President Xi Jinping was pining for the spotlight, at least based on last night’s news from the Middle Kingdom. On the economic front, China abandoned their GDP target for 2020, the first time this has been the case since they began targeting growth in 1994. It ought not be that surprising since trying to accurately assess the country’s growth prospects during the Covid-19 crisis is nigh on impossible. Uncertainty over the damage already done, as well as the future infection situation (remember, they have seen a renewed rise in cases lately) has rendered economists completely unable to model the situation. And recall, the Chinese track record has been remarkable when it comes to hitting their forecast, at least the published numbers have a nearly perfect record of meeting or beating their targets. The reality on the ground has been called into question many times in the past on this particular subject.

The global economic community, of course, will continue to forecast Chinese GDP and current estimates for 2020 GDP growth now hover in the 2.0% range, a far cry from the 6.1% last year and the more than 10% figures seen early in the century. Instead, the Chinese government has turned its focus to unemployment with the latest estimates showing more than 130 million people out of a job. In their own inimitable way, they manage not to count the rural unemployed, meaning the official count is just 26.1M, but that doesn’t mean those folks have jobs. At this time, President Xi is finding himself under much greater pressure than he imagined. 130 million unemployed is exactly the type of thing that leads to revolutions and Xi is well aware of the risks.

In fact, it is this issue that arguably led to the other piece of news from China last night, the newly mooted mainland legislation that will require Hong Kong to enact laws curbing acts of treason, secession, sedition and subversion. In other words, a new law that will bring Hong Kong under more direct sway from Beijing and remove many of the freedoms that have set the island territory apart from the rest of the country. While Covid-19 has prevented the mass protests seen last year from continuing in Hong Kong, the sentiments behind those protests did not disappear. But Xi needs to distract his population from the onslaught of bad news regarding both the virus and the economy, and nothing succeeds in doing that better than igniting a nationalistic view on some subject.

While in the short term, this may work well for President Xi, if he destroys Hong Kong’s raison d’etre as a financial hub, the downside is likely to be much greater over time. Hong Kong remains the financial gateway to China’s economy largely because the legal system their remains far more British than Chinese. It is not clear how much investment will be looking for a home in a Hong Kong that no longer protects private property and can seize both people and assets on a whim.

It should be no surprise that financial markets in Asia, particularly in Hong Kong, suffered last night upon learning of China’s new direction. The Hang Seng fell 5.6%, its largest decline since July 2015. Even Shanghai fell, down 1.9%, which given China’s announcement of further stimulus measures despite the lack of a GDP target, were seen as positive. Meanwhile, in Tokyo, the Nikkei slipped a more modest 0.9% despite pledges by Kuroda-san that the BOJ would implement even more easing measures, this time taking a page from the Fed’s book and supporting small businesses by guaranteeing bank loans made in a new ¥75 trillion (~$700 billion) program. It is possible that markets are slowly becoming inured to even further policy stimulus measures, something that would be extremely difficult for the central banking community to handle going forward.

The story in Europe is a little less dire, although most equity markets there are lower (DAX -0.4%, CAC -0.2%, FTSE 100 -1.0%). Overall, risk is clearly not in favor in most places around the world today which brings us to the FX markets and the dollar. Here, things are behaving exactly as one would expect when investors are fleeing from risky assets. The dollar is stronger vs. every currency except one, the yen.

Looking at the G10 bloc, NOK is the leading decliner, falling 1.1% as the price of oil has reversed some of its recent gains and is down 6% this morning. But other than the yen’s 0.1% gain, the rest of the bloc is feeling it as well, with the pound and euro both lower by 0.4% while the commodity focused currencies, CAD and AUD, are softer by 0.5%. The data releases overnight spotlight the UK, where Retail Sales declined a remarkable 18.1% in April. While this was a bit worse than expectations, I would attribute the pound’s weakness more to the general story than this particular data point.

In the EMG bloc, every market that was open saw their currency decline and there should be no surprise that the leading decliner was RUB, down 1.1% on the oil story. But we have also seen weakness across the board with the CE4 under pressure (CZK -1.0%, HUF -0.75%, PLN -0.5%, RON -0.5%) as well as weakness in ZAR (-0.7%) and MXN (-0.6%). All of these currencies had been performing reasonably well over the past several sessions when the news was more benign, but it should be no surprise that they are lower today. Perhaps the biggest surprise was that HKD was lower by just basis points, despite the fact that it has significant space to decline, even within its tight trading band.

As we head into the holiday weekend here in the US, there is no data scheduled to be released this morning. Yesterday saw Initial Claims decline to 2.44M, which takes the total since late March to over 38 million! Surveys show that 80% of those currently unemployed expect it to be temporary, but that still leaves more than 7.7M permanent job losses. Historically, it takes several years’ worth of economic growth to create that many jobs, so the blow to the economy is likely to be quite long-lasting. We also saw Existing Home Sales plummet to 4.33M from March’s 5.27M, another historic decline taking us back to levels last seen in 2012 and the recovery from the GFC.

Yesterday we also heard from Fed speakers Clarida and Williams, with both saying that things are clearly awful now, but that the Fed stood ready to do whatever is necessary to support the economy. This has been the consistent message and there is no reason to expect it to change anytime soon.

Adding it all up shows that investors seem to be looking at the holiday weekend as an excuse to reduce risk and try to reevaluate the situation as the unofficial beginning to summer approaches. Trading activity is likely to slow down around lunch time so if you need to do something, early in the morning is where you will find the most liquidity.

Good luck, have a good holiday weekend and stay safe
Adf

 

Terribly Slow

From Germany data did show
That Q1 was terribly slow
As well, for Q2
Recession’s in view
Their hope remains Q3 will grow

Meanwhile last night China revealed
‘twill be a long time ere its healed
Despite what they’ve said
‘bout moving ahead
Consumers, their checkbooks, won’t wield

While the market has not yet truly begun to respond to data releases, they are nonetheless important to help us understand the longer-term trajectory of each nation’s economy as well as the overall global situation. So, despite very modest movement in markets overnight, we did learn a great deal about how Q1 truly fared in Europe. Remember, Covid-19’s impact really only began in the second half of March, just a small slice of the Q1 calendar. And yet, Q1 GDP was released early this morning from Germany, with growth falling at a 2.2% quarterly rate, which annualized comes in somewhere near -9.0%. In addition, Q4 data was revised lower to -0.1%, so Germany’s technical recession has already begun. Remember, prior to the outbreak, Germany’s economy was already in the doldrums, having printed negative quarterly GDP data in three of the previous six quarters. Of course, those numbers were much less dramatic, but the point is the engine of Europe was sputtering before the recent calamity. Forecasts for Q2 are even worse, with a quarterly decline on the order of 6.5% penciled in there despite the fact that Germany seems to be leading the way in reopening their economy.

For the Eurozone as a whole, GDP in Q1 fell 3.8% in Q1 as Germany’s performance was actually far better than most. Remember, Italy, Spain and France all posted numbers on the order of -5.0%. The employment situation was equally grim, as despite massive efforts by governments to pay companies to keep employees on the payroll, employment fell 0.2%, the first decline in that reading since the Eurozone crisis in 2012-13. One other highlight (lowlight?) was Italian Industrial Activity, which saw both orders and sales fall more than 25% in March. Q2 is destined to be far worse than Q1, and the current hope is that there is no second wave of infections and that Q3 sees a substantial rebound. At least, that’s the current narrative.

The problem with the rebound narrative was made clear, though, by the Chinese last night when they released their monthly statistics. Retail Sales there have fallen 16.2% YTD, a worse outcome than forecast and strong evidence that despite the “reopening” of the Chinese economy, things are nowhere near back to normal. Fixed Asset Investment printed at -10.3% with Property Investment continuing to decline as well, -3.3%. Only IP showed any improvement, rising 3.9% in April, but the problem there is that inventories are starting to build rapidly as consumers are just not spending. Again, the point is that shutting things down took mere days or weeks to accomplish. Starting things back up will clearly take months and likely years to get back close to where things were before the outbreak.

However, as I mentioned at the top, market reactions to data points have been virtually nonexistent for the past two months. At this point, investors are well aware of the troubles, and so data confirming that knowledge is just not that interesting. Rather, the information that matters now is the policy response that is in store.

The one thing we have learned over the past decade is that the stigma of excessive debt has been removed. Japan is the poster child for this as JGB’s outstanding represent more than 240% of Japan’s GDP, and yet the yield on 10-year JGB’s this morning is -0.01%. Obviously, this is solely because the BOJ continues to buy up all the issuance these days, but in the end, the lesson for every other nation is that you can issue as much debt and spend as much money as you like with few, if any consequences. Central bank reaction functions have been to support the economy via market actions like QE whenever there is a hint of a downturn in either the economy or the stock market. Both the Fed and ECB have learned this lesson well, and look set to continue with extraordinary support for the foreseeable future.

But the consequence of this in the one market that is not directly supported (at least in the case of the G10), the FX market, is what we need to consider. And as I observe central bank activity and try to discern its economic impacts, I have become persuaded that the medium-term outlook for the dollar is actually much lower.

Consider that the Fed is clearly going to continue its QE programs across as many assets as they deem necessary. Not merely Treasuries and Agencies, but Corporates, Munis and Junk bonds as well. And as is almost always the case, these ‘emergency’ measures will evolve into ordinary policy, meaning they will be doing this forever. The implication of this policy is that yields on overall USD debt are going to decline from a combination of continued reductions in Treasury yields and compression of credit spreads. After all, don’t fight the Fed remain a key investment philosophy. Thus, nominal yields are almost certain to continue declining.

But what about real yields? Well, that is where we get to the crux of the story and why my dollar view has evolved. CPI was just released on Tuesday and fell to 0.3% Y/Y. Thus, strictly speaking, 10-year Treasuries show a +0.31% real yield this morning (nominal of 0.61% – CPI of 0.3%). The thing is, while current inflation readings are quite low, and may well fall for another few months, the supply shock we have felt in the economy is very likely to raise prices considerably over time. Inflation is not really on the market’s radar right now, nor on that of the Fed. If anything, the concern is over deflation. But that is exactly why inflation remains a far more dangerous concern, because higher prices will not only crimp consumer spending, it will create a policy conundrum for the Fed of epic proportions. After all, Paul Volcker taught us all that raising interest rates was how to fight inflation, but that is directly at odds with QE. The point is, if (when) inflation does begin to rise, the Fed is certain to ignore the evidence for as long as possible. And that means we are going to see increasingly negative real rates in the US. History has shown that when US real rates turn negative; the dollar suffers accordingly. Hence the evolution in my medium- and long-term views of the dollar.

A quick look at this morning’s markets shows that yesterday’s late day equity rally in the US has largely been followed through Asia and Europe. Bonds are also in demand as yields throughout the government sector are mostly lower. And the dollar this morning is actually little changed overall, with a smattering of winners and losers across both G10 and EMG blocs, and no truly noteworthy stories.

We do see a decent amount of US data this morning led by Retail Sales (exp -12.0%, -8.5% ex autos). We also see Empire Manufacturing (-60.0), IP (-12.0%), Capacity Utilization (63.8%), JOLTs Job Openings (5.8M) and finally Michigan Sentiment (68.0). Only the Empire number is truly current, but to imply that a rise from -78.2 to -60.0 is progress really overstates the case. As I’ve pointed out, the data has not been a driver. Markets are exhausted after a long period of significant volatility. My expectation is for the dollar to do very little today, and actually until we see a new narrative evolve. So modest movement should be the watchword.

Good luck, good weekend and stay safe
Adf

Riven By Obstinacy

Said Jay, in this challenging time
Our toolkit is truly sublime
It is our desire
More bonds to acquire
And alter the Fed’s paradigm

In contrast, the poor ECB
Is riven by obstinacy
Of Germans and Dutch
Who both won’t do much
To help save Spain or Italy

Is anybody else confused by the current market activity? Every day reveals yet another data point in the economic devastation wrought by government efforts to control the spread of Covid-19, and every day sees equity prices rally further as though the future is bright. In fairness, the future is bright, just not the immediate future. Equity markets have traditionally been described as looking forward between six months and one year. Based on anything I can see; it is going to take far more than one year to get global economies back to any semblance of what they were like prior to the spread of the virus. And yet, the S&P is only down 9% this year and less than 13% from its all-time highs set in mid-February. As has been said elsewhere, the economy is more than 13% screwed up!

Chairman Powell seems to have a pretty good understanding that this is going to be a long, slow road to recovery, especially given that we have not yet taken our first steps in that direction. This was evidenced by the following comment in the FOMC Statement, “The ongoing public health crisis will weigh heavily on economic activity, employment and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.” (My emphasis.) And yet, we continue to see equity investors scrambling to buy stocks amid a great wave of FOMO. History has shown that bear markets do not end in one month’s time and I see no reason to believe that this time will be different. I don’t envy Powell or the Fed the tasks they have ahead of them.

So, let’s look at some of the early data as to just how devastating the response to Covid-19 has been around the world. By now, you are all aware that US GDP fell at a 4.8% annualized rate in Q1, its sharpest decline since Q4 2008, the beginning of the GFC. But in truth, compared to the European data released this morning, that was a fantastic performance. French Q1 GDP fell 5.8%, which if annualized like the US reports the data, was -21.0%. Spanish Q1 GDP was -5.2% (-19.0% annualized), while Italy seemed to have the best performance of the lot, falling only 4.8% (-17% annualized) in Q1. German data is not released until the middle of May, but the Eurozone, as a whole, printed at -3.8% Q1 GDP. Meanwhile, German Unemployment spiked by 373K, far more than forecast and the highest print in the history of the series back to 1990. While these were the highlights (lowlights?), the story is uniformly awful throughout the continent.

With this in mind, the ECB meets today and is trying to determine what to do. Last month they created the PEPP, a €750 billion QE program, to support the Eurozone economy by keeping member interest rates in check. But that is not nearly large enough. After all, the Fed and BOJ are at unlimited QE while the BOE has explicitly agreed to monetize £200 billion of debt. In contrast, the ECB’s actions have been wholly unsatisfactory. Perhaps the best news for Madame Lagarde is the German employment report, as Herr Weidmann and Frau Merkel may finally recognize that the situation is really much worse than they expected and that more needs to be done to support the economy. Remember, too, that Germany has been the euro’s biggest beneficiary by virtue of the currency clearly being weaker than the Deutschemark would have been on its own and giving their export industries an important boost. (I am not the first to notice that the euro’s demise could well come from Germany, Austria and the Netherlands deciding to exit in order to shed all responsibility for the fiscal problems of the PIGS. But that is a discussion for another day.)

The consensus is that the ECB will not make any changes today, despite a desperate need to do more. One of the things holding them back is an expected ruling by the German Constitutional Court regarding the legality of the ECB’s QE programs. This has been a bone of contention since Signor Draghi rammed them through in 2012, and it is not something the Germans have ever forgiven. With debt mutualization off the table as the Teutonic trio won’t even consider it, QE is all they have left. Arguably, the ECB should increase the PEPP by €1 trillion or more in order to have a truly positive impact. But thus far, Madame Lagarde has not proven up to the task of forcing convincing her colleagues of the necessity of bold action. We shall see what today brings.

Leading up to the ECB announcement and the ensuing press briefing, Asian equity markets followed yesterday’s US rally higher, although early gains from Europe have faded since the release of the sobering GDP data. US futures have also given back early gains and remain marginally higher at best. Bond markets are generally edging higher, with yields across the board (save Italy) sliding a few bps, and oil prices continue their recent rebound, although despite some impressive percentage moves lately, WTI is trading only at $17.60/bbl, still miles from where it was at the beginning of March.

The dollar, in the meantime, remains under pressure overall with most G10 counterparts somewhat firmer this morning. The leaders are NOK (+0.45%) on the strength of oil’s rally, and SEK (+0.4%) which seems to simply be continuing its recent rebound from the dog days of March. Both Aussie and Kiwi are modestly softer this morning, but both of those have put in stellar performances the past few days, so this, too, looks like position adjustments.

In the EMG bloc, IDR was the overnight star, rallying 2.8% alongside a powerful equity rally there, as investors who had been quick to dump their holdings are back to hunting for yield and appreciation opportunities. As markets worldwide continue to demonstrate a willingness to look past the virus’s impact, there are many emerging markets that could well see strength in both their currencies and stock markets. The next best performers were MYR (+1.0%) and INR (+0.75%), both of which also responded to a more robust risk appetite. As LATAM has not yet opened, a quick look at yesterday’s price action shows BRL having continued its impressive rebound, higher by 3.0%, but strength too in CLP (+2.9%), COP (+1.2%) and MXN (2.5%).

We get more US data this morning, led by Initial Claims (exp 3.5M), Continuing Claims (19.476M), Personal Income (-1.5%), Personal Spending (-5.0%) and Core PCE (1.6%) all at 8:30. Then, at 9:45 Chicago PMI (37.7) is due to print. As can be seen, there is no sign that things are doing anything but descending yet. I think Chairman Powell is correct, and there is still a long way to go before things get better. While holding risk seems comfortable today, look for this to turn around in the next few weeks.

Good luck and stay safe
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