Won’t Be Repaid

Said Merkel and French Prez Macron
This calls for a grant, not a loan
When speaking of aid
That won’t be repaid
By nations where Covid’s full-blown

The euro is firmer this morning, up a further 0.35% after yesterday’s 0.9% rally, as the market responds to the news that German Chancellor Angela Merkel and French President Emanuel Macron have agreed on a plan for EU-wide assistance to all members. This is the first time that there has been German support for a plan that includes grants to nations, not loans to be repaid, and that these grants are to be distributed to the membership, not based on the capital key, but rather based on where the money is needed most. The funding will come from debt issued by the European Commission and paid out of that entity’s budget. In sum, while this is not actually Eurozone bond issuance, it is a clear step in that direction.

Of course, nothing in the EU is easy, and this is no different. Immediately upon the announcement, Austrian Chancellor Kurz explained that there is no path forward for grants, and that Austria is happy to lend money to those countries in need. Too, the Dutch, Danes and Finns are none too happy about this outcome, but with Germany on board, it will be very difficult to fight. Even so, French FinMin LeMaire made it clear that it will take time to complete the procedure (and he is 100% behind the idea) with the first funds not likely available before early 2021.

However, the importance of this step cannot be underestimated. The tension within the Eurozone has always revolved around how much Germany and its frugal northern neighbors would be willing to pay to the more profligate south in order to maintain the euro as a functioning currency. When looking at which nations benefit most from the single currency, Germany tops the list as the euro is certainly weaker than the Deutschemark would have been in its stead, and thus Germany’s export industries, and by extension its economic performance, have benefitted significantly. It appears that Chancellor Merkel and her administration have now done the math and decided that spending some money to maintain that export advantage is a smart investment. While in the past I have been suspect of the euro’s longevity, this appears to be the first step toward a joint fiscal policy resulting in a far stronger basis for the euro. While there will no doubt be rough seas for this process ahead, if Germany and France are on board, they will ultimately drag everyone else along. This is arguably the most bullish long-term euro story since its creation two decades ago.

The other bullish news for markets yesterday was the announcement that a tiny biotech company in Massachusetts, Moderna Inc, with just 25 employees (although a $29 billion market cap) has seen extremely positive results from a Covid vaccine trial. Apparently, it not only does the job, but does so with limited side effects to boot. While it has yet to undergo larger phase 2 and phase 3 trials, it is certainly extremely bullish news.

The combination of these stories was extremely beneficial for risk assets yesterday, which explains the 3+% rallies in US equity indices, the sell-off in Treasuries (10-year yields rose 7bps) and the dollar’s overall weakness. That bullishness followed through overnight with Asian equity markets gaining nicely (Nikkei +1.5%, Hang Seng +1.9%, Shanghai +0.8%) and Europe starting in the green as well. However, those early gains in Europe have turned red now, with what appears to be profit taking after yesterday’s substantial gains. Clearly, European equity markets were the main beneficiaries of the Franco-German announcement on debt although Italian debt has not done too badly either, with yields on 10-year BTP’s falling 22bps since Friday’s close.

Put it all together and we have a very positive backdrop for the near-term. While data continues to be dreadful, with today’s poster child being the 856K jump in Jobless Claims in the UK last month, we already know the market is looking through the bad news toward the recovery. Of much more importance to market sentiment is the prospect for the reopening of economies around the world. This is where the vaccine story supports everything, because undoubtedly, if there was a widely available vaccine, the stories of devastation would diminish and confidence would quickly return. And while there will certainly be changes in the way people behave going forward, they are not likely to be as dramatic as once imagined. After all, if people are confident they are immune to Covid-19 after a vaccination, they will likely return to their previous lifestyle as quickly as they can.

So, with that overall bullish framework, we cannot be surprised that the other key haven assets, the dollar and the yen, are under pressure this morning. Yesterday’s dollar weakness has extended this morning virtually across the board. In the G10 space, it is the high beta currencies, NZD (+0.85%) and SEK (+0.6%) leading the way, but even the pound, after that terrible employment data, is higher by 0.5%. Only the yen (-0.2%) has ceded ground to the dollar this morning in what is clearly a straight risk-on session.

The EMG bloc is much the same, with every currency on the board firmer vs. the dollar this morning led by HUF (+1.4%) and CZK (+1.2%) as clear beneficiaries of the mooted EU financing program. Remember, this €500 billion can be spent anywhere desired by the Commission. But we are also seeing commodity currencies benefit as MXN (+1.0%) and ZAR (+0.8%) continue to perform well. In fact, over the past two sessions, one is hard-pressed to find a currency that has not appreciated vs. the dollar.

On the data front, beyond the awful UK data, we did see a much better than expected German ZEW Expectations outcome, printing at 51.0, although the current conditions index remains horrendous at -93.5. But the future is much brighter this morning, adding to the euro’s strength. At home, we see Housing Starts (exp 900K) and Building Permits (1000K), neither of which is likely to have a big impact, although stronger than expected data would surely add to the overall positive risk feeling this morning.

As well, Chairman Powell will be testifying to the Senate Banking Committee, but after Sunday night’s performance it is not clear what they will ask that he has not already answered. The Fed is all-in to do everything possible to support the economy. Arguably, the bigger question is will they be able to stop once things have evidently turned better. History shows that once government programs get going, they are virtually indestructible. In this instance, that implies ongoing Fed largesse far past when it is needed, thus much lower interest rates than are appropriate. Combine negative real rates in the US with a bullish structural story in the EU and we have the recipe for a much weaker dollar over time. This week could well be the beginning of a new trend.

Good luck and stay safe
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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

Overkill

The talk in the market is still
‘Bout German high court overkill
While pundits debate
The bond program’s fate
The euro is heading downhill

Amid ongoing dreadful economic data, the top story continues to be the German Constitutional Court’s ruling on (rebuke of?) the ECB’s Public Sector Purchase Program, better known as QE. The issue that drew the court’s attention was whether the ECB’s actions to help support the Eurozone overall are eroding the sovereignty of its member states. Consider, if any of the bonds that are bought by the central banks default, it is the individual nations that will need to pay the cost out of their respective budgets. That means that the unelected officials at the ECB are making potential claims on sovereign nations’ finances, a place more rightly accorded to national legislatures. This is a serious issue, and a very valid point. (The same point has been made about Fed programs). However, despite the magnitude of the issues raised, the court gave the ECB just three months to respond, and if they are not satisfied with that response, they will bar the Bundesbank from participating in any further QE programs. And that, my friends, would be the end. The end of the euro, the end of the Eurozone, and quite possibly the end of the EU.

Remember, unlike the Fed, which actually executes its monetary policy decisions directly in the market, the ECB relies on each member nation’s central bank to enter the market and purchase the appropriate assets. So, the ECB’s balance sheet is really just a compilation of the balance sheets of all the national central banks. If the Bundesbank is prevented from implementing ECB policy on this score, given Germany’s status as the largest nation, and thus largest buyer in the program, the effectiveness of any further ECB programs would immediately be called into question, as would the legitimacy of the entire institution. This is the very definition of an existential threat to the single currency, and one that the market is now starting to consider more carefully. It is clearly the driving force behind the euro’s further decline this morning, down another 0.5% which makes 1.5% thus far in May. In fact, while we saw broad dollar weakness in April, as equity markets rallied and risk was embraced, the euro has now ceded all of those gains. And I assure you, if there is any doubt that the ECB will be able to answer the questions posed by the court, the euro will decline much further.

The euro is not the only instrument under pressure from this ruling, the entire European government bond market is falling today. Now, granted, the declines are not that sharp, but they are universal, with every member of the Eurozone seeing bond prices fall and yields tick higher. This certainly makes sense overall, as the ECB has been the buyer of (first and) last resort in government bond markets, and the idea that they may be prevented from acting in the future is a serious concern. Simply consider how much more debt all Eurozone nations are going to need to issue in order to pay for their fiscal programs. Across the entire Eurozone, forecasts now point to in excess of €1 trillion of new bonds this year, already larger than the ECB’s PEPP. And if there is a second wave of the virus, forcing a reclosing of economies with a longer period of lockdown, that number is only going to increase further. Without the ECB to absorb the bulk of that debt, yields in Eurozone debt will have much further to climb. The point is that this issue, which was initially seen as minor and technical, may actually be far more important than anything else. And while the odds are still with the ECB to continue with business as usual, the probability of a disruption is clearly non-zero.

Away from the technicalities of the German Constitutional Court, there is far less of interest in the markets overall. Equity markets are mixed, with gainers and losers in both the Asian session as well as Europe. US futures, at this time, are pointing higher, with all three indices looking toward 1% gains at the open. And the dollar is broadly, though not universally, higher.

Aside from the euro’s decline, we have also seen weakness in the pound (-0.4%) after the Construction PMI (the least impactful of the PMI measures) collapsed to a reading of 8.2, from last month’s dreadful 39.2. This merely reinforces what type of hit the UK economy is going to take. On the plus side, the yen is higher by 0.3%, seemingly on the back of position adjustments as given the other risk signals, I would not characterize today as a risk-off session.

In the EMG space, there are far more losers than gainers today, led by the Turkish lira (-1.0%) and the Russian ruble (-0.8%). The lira is under pressure after new economic projections point to a larger economic contraction this year of as much as 3.4%. This currency weakness is despite the central bank’s boosting of FX swaps in an effort to prevent a further decline. Meanwhile, despite oil’s ongoing rebound (WTI +3.6%) the ruble seems to be reacting to recent gains and feeling some technical selling pressure. Elsewhere in the space, we have seen losses on the order of 0.3%-0.5% across most APAC and CE4 currencies. The one exception to the rule is KRW, which rallied 0.6% overnight as expectations grow that South Korea is going to be able to reopen the bulk of its economy soon. One other positive there is that demand for USD loans (via Fed swap lines) has diminished so much the BOK is stopping the auctions for now. That is a clear indication that financial stress in the nation has fallen.

On the data front, this morning brings the ADP Employment number (exp -21.0M), which will be the latest hint regarding Friday’s payroll data. Clearly, a month of huge Initial Claims data will have taken its toll. Yesterday’s Fed speakers didn’t tell us very much new, but merely highlighted the fact that each member has their own view of how things may evolve and none of them are confident in those views. Uncertainty remains the word of the day.

For now, the narratives of the past several weeks don’t seem to have quite the strength that they did, and I would say that the focus is on the process of economies reopening. While that is very good news, the concern lies after they have reopened, and the carnage becomes clearer. Just how many jobs have been permanently erased because of the changes that are coming to our world in the wake of Covid-19? It is that feature, as well as the nature of economic activity afterwards, that will drive the long-term outcome, and as of now, no clear path is in sight. The opportunity for further market dislocations remains quite high, and hedgers need to maintain their programs, especially during these times.

Good luck and stay safe
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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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Dire Straits

In Europe, that grouping of states
Now find themselves in dire straits
The PMI data
Described a schemata
Of weakness and endless low rates

In the past, economists and analysts would build big econometric models with multiple variables and then, as new data was released, those models would spit out new estimates of economic activity. All of these models were based on calculating the historic relationships between specific variables and broader growth outcomes. Generally speaking, they were pretty lousy. Some would seem to work for a time, but the evolution of the economy was far faster than the changes made in the models, so they would fall out of synch. And that was before Covid-19 pushed the pace of economic change to an entirely new level. So now, higher frequency data does a far better job of giving indications as to the economic situation around the world. This is why the Initial Claims data (due this morning and currently expected at 4.5M) has gained in the eyes of both investors and economists compared to the previous champ, Nonfarm Payrolls. The latter is simply old news by the time it is released.

There is, however, another type of data that is seen as quite timely, the survey data. Specifically, PMI data is seen as an excellent harbinger of future activity, with a much stronger track record of successfully describing inflection points in the economy. And that’s what makes this morning’s report so disheartening. Remember, the PMI question simply asks each respondent whether activity is better, the same or worse than the previous month. They then subtract the percentage of worse from the percentage of better and, voila, PMI. With that in mind, this morning’s PMI results were spectacularly awful.

Country Manufacturing Services Composite
France 31.5 10.4 11.2
Germany 34.4 15.9 17.1
UK 32.9 12.3 12.9
Eurozone 33.6 11.7 13.5

Source: Bloomberg

In each case, the data set new historic lows, and given the service-oriented nature of developed economies, it cannot be that surprising that the Services number fell to levels far lower than manufacturing. After all, social distancing is essentially about stopping the provision of individual services. But still, if you do the math, in France 94.8% of Service businesses said that things were worse in April than in March. That’s a staggering number, and across the entire continent, even worse than the dire predictions that had been made ahead of the release.

With this in mind, two things make more sense. First, the euro is under pressure this morning, falling 0.6% as I type and heading back toward the lows seen last month. Despite all the discussion of how the Fed’s much more significant policy ease will ultimately undermine the dollar, the short-term reality continues to be, the euro has much bigger fundamental problems and so is far less attractive. The other thing is the ECB’s announcement last evening that they were following the Fed’s example and would now be accepting junk bonds as collateral, as long as those bonds were investment grade as of April 7. This is an attempt to prevent Italian debt, currently rated BBB with a negative outlook, from being removed from the acceptable collateral list when if Standard & Poor’s downgrades them to junk tomorrow. Italian yields currently trade at a 242bp premium to German yields in the 10-year bucket, and if they rise much further, it will simply call into question the best efforts of PM Conte to try to support the Italian economy. After all, unlike the US, Italy cannot print unlimited euros to fund themselves.

Keeping all that happy news in mind, market performance this morning is actually a lot better than you might expect. Equities in Asian markets were mixed with the Nikkei up nicely, +1.5%, but Shanghai slipping a bit, -0.2%. Another problem in Asia is Singapore, where early accolades about preventing the spread of Covid-19 have fallen by the wayside as the infection rate there spikes and previous efforts to reopen the economy are halted or reversed. Interestingly, the Asian PMI data was relatively much better than Europe, with Japanese Services data at 22.8. Turning to Europe, the picture remains mixed with the DAX (-0.3%) and FTSE 100 (-0.3%) slipping while the CAC (+0.1%) has managed to keep its head above water. The best performer on the Continent is Italy (+1.0%) as the ECB decision is seen as a win for all Italian markets. US futures markets are modestly negative at this time, but just 0.2% or so, thus it is hard to get a sense of the opening.

Bond markets are also having a mixed day, with the weakest links in Europe, the PIGS, all rallying smartly with yields lower by between 5bps (Italy) and 19bps (Greece). Treasury yields, however, have actually edged higher by a basis point, though still yield just 0.63%. And finally, the dollar, too, is having a mixed session. In the G10 bloc, the euro and Swiss franc are at the bottom of the list today, with Switzerland inextricably tied to the Eurozone and its foibles. On the plus side, NOK has jumped 1.0% as oil prices, after their early week collapse, are actually rebounding nicely this morning with WTI higher by 12.4% ($1.70/bbl), although still at just $15.50/bbl. Aussie (+0.6%) and Kiwi (+0.75%) are also in the green, as both have seen sharp recent declines moderate.

EMG currencies also present a mixed picture, with the ruble on top of the charts, +1.4%, on the strength of the oil market rebound. India’s rupee has also performed well overnight, rising 0.8%, as the market anticipates further monetary support from the Reserve bank there. While there are other gainers, none of the movement is significant. On the other side of the ledger, the CE4 are all under pressure, tracking the euro’s decline with the lot of them down between 0.3% and 0.5%. I must mention BRL as well, which while it hasn’t opened yet today, fell 2.6% yesterday as the market responded to BCB President Campos Neto indicating that further rate cuts were coming and that QE in the future is entirely realistic. The BRL carry trade has been devastated with the short-term Selic rate now sitting at 3.75%, and clearly with room to fall.

Aside from this morning’s Initial Claims data, we see Continuing Claims (exp 16.74M), which run at a one week lag, and then we get US PMI data (Mfg 35.0, Services 30.0) at 9:45. Finally at 10:00 comes New Home Sales, which are forecast to have declined by 16% in March to 644K.

The big picture remains that economic activity is still slowing down around the world with the reopening of economies still highly uncertain in terms of timing. Equity markets have been remarkable in their ability to ignore what have been historically awful economic outcomes, but at some point, I fear that the next leg lower will be coming. As to the dollar, it remains the haven of choice, and so is likely to remain well bid overall for the foreseeable future.

Good luck and stay safe
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Still Disrespected

According to data last night
The future in Germany’s bright
While right now, it stinks
Most everyone thinks
By Q3, they’ll all be alright

And yet, markets haven’t reflected
The positive vibe ZEW detected
Stock markets are dire
The dollar is higher
While oil is still disrespected

The one constant in the current market and economic environment is that nothing is consistent. For example, in Germany, the lockdown measures were extended for two weeks the day before Frau Merkel said that they would start to ease some restrictions, allowing small shops to open along with some schools. Then, this morning, the ZEW surveys were released with the Current Situation index printing at a historically low -91.5, well below the already dire forecasts of a -77.5 print. And yet, the Expectations index rose to +28.2, far higher than the median forecast of -42.0. Essentially, the commentary was that while Q1 and Q2 would be awful, things would be right as rain in Q3. But here’s a contradiction to that view, Oktoberfest, due to begin in late September, has just been canceled despite the fact that it is five months away and that it is in the middle of Q3, when things are ostensibly going to be much better there. My point is that, right now, interpreting signals of future activity is essentially impossible. Alas, that is what I try to do each morning.

So, what have we learned in the past twenty-four hours? Arguably, the biggest story was oil where the May WTI futures contract closed at -$37.63/bbl. In other words, the contract buyer is paid to take delivery of oil. And that’s the rub, storage capacity is almost entirely utilized while demand destruction continues daily. The IEA reported that current global production is running around 100 million barrels/day, with current demand running around 70 million barrels per day. In other words, plenty of oil is looking for a temporary home, and more of it is coming out of the ground each day. Arguably, this is a great opportunity for the US government to take delivery for the Strategic Petroleum Reserve, especially since they would be getting paid for the oil. But that would require a nimbleness of action that is unlikely to be seen at any government level. This morning, June WTI futures are under further pressure, down by another 20% at $16.50/bbl as I type, simply indicating that there is limited hope for a rebound in the near term. But the curve remains in sharp contango, with prices at $30/bl in December and higher further out. This price action is simply the oil market’s manifestation of the current economic view; negative growth in Q1 and Q2 with a rebound coming in Q3. However, despite the logic, seeing any commodity, let alone the world’s most important commodity, trading below zero is a strange sight indeed.

With the oil market grabbing the world’s focus, it can be no surprise that the dollar has responded by rallying strongly, especially against those currencies that are seen as tightly linked to the price of oil. So, in the G10 space, NOK (-1.7%) and CAD (-0.7%) are suffering, with the Nokkie the worst performer in the group. But AUD (-0.95%), NZD (-1.25%) and GBP (-0.95%) are all under significant pressure as well. It seems that Kiwi has responded negatively to RBNZ Governor Orr’s musings regarding additional stimulus in May, while Aussie has suffered on the back of the weak pricing in energy markets as well as lousy employment data. Meanwhile, today’s pressure on the pound seems to stem from a renewal of the Brexit discussion, and how a hard exit will be deleterious. In addition, there are still those who claim the UK’s response to the pandemic has been inadequate and the impact there will be much worse than elsewhere. Interestingly, UK employment data released this morning did not paint as glum a picture as might have been expected. While we can ignore the Unemployment Rate, which is February’s number, the March Claims data was surprisingly moderate. I expect, however, that next month’s data will be far worse. And I continue to think the pound has far more downside than upside here.

Turning to the EMG bloc, we cannot be surprised to see RUB as the worst performer in the group, down 1.3%, nor, given the growing risk-off sentiment, that the entire space is lower vs. the dollar. As today is a day that ends in ‘y’, MXN is lower, falling 0.7% thus far, as the market is increasingly put off by both the ongoing oil price declines as well as the ongoing incompetence demonstrated by the AMLO administration. (As an aside here, it seems that many Mexican financial institutions see much further peso weakness in the future as they are actively selling pesos in the market.) The other underperformers are HUF (-0.85%), ZAR (-0.8%) and KRW (-0.75%). Working in reverse order, the won is suffering as questions arise about the health of North Korean leader Kim Jong-un, who according to some reports, is critically ill and close to death. The concern is there is no obvious successor in place, and no way to know what the future will hold. Meanwhile, the rand is under pressure from the weakness throughout the commodity space as well as the realization that the carry that can be earned by holding the currency has diminished to its lowest level since 2008. For a currency that has been dependent on foreign holdings, this is a real problem.

I guess, given that the euro is only lower by 0.2%, it is actually a top performer of the day, so perhaps the German data has been a support to the single currency. The thing is, given the export orientation of the German (and Eurozone) economy, unless things pick up elsewhere, growth expectations will need to be modified lower for Q3. Don’t be surprised if we see this in the survey data going forward.

Elsewhere, equity markets everywhere are in the red, with European indices down between 1.7% and 2.5%. Asian stock markets were also lower, by similar amounts, and after yesterday’s US declines, the futures this morning show losses of between 0.7% for the NASDAQ and 1.5% for the Dow. Bond yields continue to fall, with 10-year Treasuries lower by 3bps this morning, and overall, risk is being sold.

The only data this morning is Existing Home Sales from March, with the median expectation for a 9% decline to 5.25M. As to Fed speakers, the quiet period ahead of next Wednesday’s FOMC meeting has begun so there is nothing to hear there. Of course, given what they have already done, as well as the fact that every act is unanimously accepted, I don’t see any value add from their comments in the near-term.

Last week saw a net gain in the equity markets as the narrative embraced the idea that the infection curve was flattening and that we were past the worst of the impact. This week, despite the ZEW data, I would contend investors are beginning to understand that things will take a very long time to get back to normal, and that the chance for new lows is quite high. In this environment, the dollar is likely to remain well bid.

Good luck and stay safe
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A Bright Line

In Europe there is a bright line
Twixt nations, those strong, those supine
The Germans and Dutch
Refuse to give much
While Italy wilts on the vine

Once again, the EU has failed to accomplish a crucial task and once again, market pundits are calling for the bloc’s demise. The key story this morning highlights the failure of EU FinMins, after a 16-hour meeting yesterday, to reach a support deal for the whole of Europe. The mooted amount was to be €500 billion, but as always in this group, the question of who would ultimately pick up the tab could not be agreed. And that is because, there are only three nations, Germany, Austria and the Netherlands, who are in a net financial position to do so. Meanwhile, the other twenty-four nations all have their collective hands out. (And you wonder why the UK voted to leave!) Ultimately, the talks foundered on the desire by the majority of nations to mutualize the costs of the support (i.e. issue Eurobonds backed by the full faith and credit of the entire EU), while the Germans, Dutch and Austrians would not agree. Realistically, it is understandable why they would not agree, because in the end, the obligation will fall on those three nations to pick up the tab. But the outcome does not bode well for either the present or the future.

In the current moment, the lack of significant fiscal support is going to hamstring every EU nation, other than those three, in their attempts to mitigate the impacts of shutting down economies to halt the spread of Covid-19. But in the future, this issue is the latest manifestation of the fundamental flaw in the EU itself.

That flaw can be described as follows: the EU is a group of fiercely competitive nations masquerading as a coherent whole. When the broad situation is benign, like it is most of the time, and there is positive economic growth and markets are behaving well, the EU makes a great show of how much they do together and all the things on which they agree. However, when the sh*t hits the fan, it is every nation for themselves and woe betide any attempt by one member to collaborate with another on a solution. This makes perfect sense because, despite the fact that they have constructed a number of institutions that sound like they are democratically elected representatives of each nation, the reality is in tough times, each nation’s political class is concerned first and foremost with its own citizenry, and only when that group is safeguarded, will they consider helping others. At this point, in the virus crisis, no nation feels its own citizens are safe, so it would be political suicide to offer help to others. (Asking for help is an entirely different matter, that’s just fine.) In the end, I am confident that this group will make an announcement of some sort that will describe the fantastic cooperation and all they are going to do to support the continent. But I am also confident that it will not include a willingness by the Teutonic three to pay for the PIGS.

The initial market impact of this failure was exactly as expected, the euro (-0.5%) declined along with the other European currencies (SEK -0.75%, NOK -1.25%) and European equity markets gave back some of their recent gains with the DAX and CAC both falling around 1.5%. Meanwhile, European government bonds saw Italian, Spanish and Greek yields all rise, as hoped for support has yet to come. However, the EU is nothing, if not persistent, and the comments that have come out since then continue to suggest that they will arrive at a plan by the end of the week. This has been enough to moderate those early moves and at 7:00, as New York walks in the door, we see markets with relatively modest changes compared to yesterday’s closing levels.

In the G10 currencies, while the dollar remains broadly stronger, its gains are far less than seen earlier. For example, NOK is the current laggard, down 0.35%, while SEK (-0.3%) and EUR (-0.2%) are next in line. The pound has actually edged higher this morning, but its 0.1% gain is hardly groundbreaking. However, it is interesting to note that the non-EU currencies are outperforming those in the EU.

Emerging market currencies have also broadly fallen, with just a few exceptions. The worst performer today is INR (-0.9%), which seems to be responding to the growth in the number of coronavirus cases there, now over 5,000. But we are also seeing weakness, albeit not as much, from EU members CZK (-0.35%), BGN (-0.3%) and the rest of the CE4. The one notable gainer today is ZAR (+0.5%) which seems to be benefitting from a much smaller than expected decline in a key Business Confidence indicator. However, I would not take much solace in that as the data is certain to get worse there (and everywhere) before it gets better.

Overall, though, the market picture is somewhat mixed today. The FX market implies some risk mitigation, which is what we are seeing in the European equity space as well. However, US equity futures are all pointing slightly higher, about 0.5% as I type, and oil prices are actually firmer along with most commodities. In other words, there is no clear direction right now as market participants await the next piece of news.

The only data point we see today in the US is the FOMC Minutes, but I don’t see them as being that interesting given both how much the Fed has already done, thus leaving less things to do, and the fact they have gone out of their way to explain why they are doing each thing. So I fear today will be dependent on the periodic reports of virus progression. At the beginning of the week, it seemed as though the narrative was trying to shift to a peak in infections and better data ahead. Alas, that momentum has not been maintained and we have seen a weries of reports where deaths are increasing, e.g. in Spain and New York to name two, where just Monday it was thought things had peaked. Something tells me that the virus will not cooperate with a smooth curve of progress, and that more volatility in the narrative, and thus markets, lays ahead. We are not yet near the end of this crisis, so hedgers, you need to keep that in mind as you plan.

Good luck
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