Hawks Acquiesce

In Germany and the US
The crisis made hawks acquiesce
To spending more dough
Despite and although
Things ultimately will be a mess

There is only one story of note this morning, at least from the market’s collective perspective, and that is the news that the Senate has agreed the details of a stimulus package in the US. The price tag is currently pegged at $2.0 trillion, although it would not surprise me if when this bill gets to the House, they add a bit more lard. Fiscal hawks have been set aside and ignored as the immediate concerns over the virtual halt in the US (and global) economy has taken precedence over everything else. The package offers support for small and medium sized businesses, direct cash payments to individuals and increased allocations to states in order to help them cope with Covid-19. But overall, what it does is demonstrate that the US is not going to sit by and watch as the economy slides into a deep recession.

And that seems to be the signal that markets were awaiting. We have already seen Germany discard decades of fiscal prudence in their effort to address the collapse in business activity there. In fact, their social demands are even greater than in the US, with no groups of more than 2 people allowed to congregate together. While it cannot be a surprise that the IFO indicator was revised lower this morning, with the Expectations Index falling to within a whisker of its financial crisis lows of 79.2. The real question is if the measures invoked to stop the spread of the virus continue for another month, just how low can this reading go? The one thing that is clear is that we are going to continue to see some unprecedented damage to economic statistics as the next several months evolve.

But none of that matters today, at least in the world of finance. The promise of more money being spent has led to some spectacular rallies in equity markets in the past twenty-four hours. By now you are all aware of yesterday’s late day melt-up in the US, where the Dow closed higher by 11.4%, outpacing even the NASDAQ (+8.1%). And overnight, the Nikkei rocketed 8% higher as a follow-through on the US news and despite the news that the 2020 Tokyo Olympics are now going to be the 2021 Tokyo Olympics. The rest of Asia rose as well (Hang Seng +3.8%, Shanghai +2.7%, Australia +5.5%) and Europe started out on fire. But a funny thing happened in the past hour, it seems that more sober heads took over.

European equity indices, which had exploded higher at the opening (DAX +4.4%, CAC +4.9%) have given back most of those early gains and are now mixed with the DAX lower by 0.4% although the CAC clinging to +0.9% gain. US futures, which were similarly much higher earlier, between 2% and 3%, have now erased all those gains and are now marginally lower on the session. In fact, I suspect that this is going to continue to be the situation in equity markets as each piece of new news will need to be absorbed into the pricing matrix. And for now, there is just as much bad news as good, thus driving significant volatility in this asset class going forward.

Bond markets are seeing similar style moves, alternating between risk-on and risk-off, although with much of the leverage having already been wiped out of these markets, and central banks around the world directly supporting them through massive QE purchases, the magnitude of the moves are much smaller. Early this morning, we saw Treasuries under pressure, with yields higher by as much as 4bps, but now they have actually rallied, and the 10-year yield is lower by 1bp. There is similar price action in European government bond markets although the recent rally has not quite reversed all the early losses. Of course, the ECB’s €750 billion program is dwarfed by the Fed’s QE Infinity, so perhaps that should not be a great surprise.

And finally, turning to the FX markets, the dollar remains under pressure, as we have seen all week, as fears over the availability of dollars has diminished somewhat in the wake of the Fed’s actions. This has led to NOK once again being the leader in the clubhouse, rallying a further 2.1% this morning which takes its movement this week to 7.5%! It seems that the first batch of weekly FX flow statistics from the Norgesbank confirm that they did, indeed, intervene earlier this week, which given the price action, can be the only explanation. (I am, however, proud of them for not publicly blaring it, rather simply doing the job and allowing markets to respond.) And given the oil price collapse and the damage that will do to the Norwegian economy, it makes sense that they would want to manage the situation. But most currencies are firmer so far this week, with AUD (+3.8%) and SEK (+2.75%) recouping at least a part of what had been devastating recent losses. As to today’s session, aside from NOK, the pound is the next best performer, rallying 0.9% on the strength of a new liquidity program by the BOE as well as what appears to be hope that recent government pronouncements regarding social distancing and shelter in place rules, seems to demonstrate Boris is finally going to come into line with the rest of the world’s governments on the proper containment strategy.

EMG currencies are also performing well this morning as the broad-based dollar decline lifts most of them. KRW is the best performer today, +1.6%, which is in line with last night’s euphoria over the US stimulus bill. MXN had been sharply higher early but has since given up some of its gains and is now higher by only 1% as I type. The market is not pleased with AMLO’s attitude toward the virus, nor it seems are the Mexican people based on the erosion in his approval ratings. Meanwhile, the other major LATAM economy, Brazil, is poised to see its currency weaken even further as President Bolsonaro also ignores the current protocols of self-quarantine or shelter-in-place and encourages his nation to ignore the virus and go about their lives. I have a feeling that President Bolsonaro is going to be a one-term president. BRL hasn’t opened yet but has fallen more than 2% this week already. I expect more will come.

On the data front, yesterday’s PMI data while awful, was actually not nearly as bad as the data seen in Europe or Asia. This morning brings Durable Goods (exp -1.0%, -0.4% ex transport) although these are February numbers, so will not really tell us much about the current state of the economy. Rather, all eyes are turning to tomorrow’s Initial Claims data, to see just how high that number will climb. There are numerous stories of state employment websites crashing from the overflow in volumes.

In the end, while the stimulus bill is good news, the proof remains in the pudding, as it were, and we need to see if all of that spending will help stabilize, then lift the US economy back to its prior trajectory. If this virtual lockdown lasts past Easter, the economic damage will become much more difficult to reverse and will make the hoped for V-shaped recovery that much harder to achieve. For now, though, we can only watch and wait. The one thing that remains clear is that in the end, the US dollar remains the haven of all havens, no matter the fiscal situation in the US. It will always be preferred to the alternative.

Good luck and stay safe
Adf

 

Truly a Beast

The PMI data released
Showed just how fast growth has decreased
Tis services that
Have fallen so flat
This virus is truly a beast

But yesterday two bits of news
May help prevent any more blues
The Fed started things
By spreading their wings
And buying all debt that accrues

As well, in a break from the past
The Germans decided at last
To open the taps
As well as, perhaps
Support debt Italians amassed

And finally, where it began
The virus, that is, in Wuhan
Two months from their dawn
Restrictions are gone
Defining the lockdown’s lifespan

Markets have a much better tone this morning as traders and investors react to two very important responses to the ongoing Covid-19 crisis. The first thing that is getting a positive, albeit delayed, response is the Fed’s enactment of a series of new programs including support for CP, mortgage-backed securities, primary dealers and money market funds as well as embarking on QE Infinity, buying $75 billion of Treasuries and $50 billion of mortgage-backed securities every day this week, and then on into the future. Previous concerns about the size of the Fed’s balance sheet relative to the US economy have been completely dismissed, and you can bet that we will soon see a Fed balance sheet with $10 trillion in assets, nearly 50% as large as the economy. But the announcement, while at first not getting quite the positive impact desired, seems to be filtering through into analysis and is definitely seen in a more positive light this morning than yesterday at this time.

The second piece of news was that not only is Germany going to embark on a €750 billion spending program to help the economy, but, more importantly, they are willing to support Italy via European wide programs like the European Stability Mechanism, and even jointly issued coronaviru bonds, to prevent a further catastrophe there. In truth, that seems to be a bigger deal than the Fed, as the long-term implications are much greater and point to a real chance that the European experiment of integration could eventually work. If they move down the path to jointly issue and support debt available to all members, that is a massive change, and likely a long term positive for the single currency. We have to see if they will actually go forward, but it is the most promising structural comment in Europe in years, perhaps even since the euro was formed.

However, we cannot forget that the current reality remains harsh, and were reminded of such by this morning’s Flash PMI data, which, unsurprisingly, fell to record lows throughout Europe and the UK. Services were hit much harder than Manufacturing with readings of 29.0 in France, 34.5 in Germany, 31.4 in the Eurozone and 35.7 in the UK. Japan also released their data, which was equally dismal at 32.7 for Services PMI there. And they added to the story by releasing Department Store Sales, which fell a healthy 12.2%. Of course, everyone knows that the data is going to be awful for the time being, and since we saw China’s PMI data last month, this was expected. Granted, analysts had penciled in slightly higher numbers, but let’s face it, everybody was simply guessing. Let’s put it this way, we are going to see horrific data for at least the next month, so it will have to be extraordinarily bad to really garner a negative market reaction. This is already built into the price structure. While the US has historically looked far more closely at ISM data, to be released next week, than PMI data, we do see the US numbers later this morning, with forecasts at 42.0 for Services and 43.5 for Manufacturing.

So the data is not the driver today, which has seen a more classic risk-on framework, rather I think it is not only the absorption of the Fed and German actions, but also, perhaps, the news from Wuhan that the restrictions on travel, imposed on January 23, are being lifted, nearly two months to the day after imposition. Arguably, that defines the maximum lockdown period, although yesterday President Trump hinted that the US period will be much shorter, with 14 or 15 days mooted. If that is the case, and I would place the start date as this week, we are looking at heading back to our offices come April 6. If the Fed is successful in preventing financial institution collapse, and Congress finally passes a stimulus bill to address the massive income dislocation that is ongoing, (which they will almost certainly do in the next two days), there is every chance that while Q2 GDP will be hit hard, the panic inducing numbers of -30% GDP growth (Morgan Stanley’s forecast) or -50% GDP growth (St Louis Fed President Bullard’s forecast), will be referred to as the height of the panic. We shall see.

But taking a look at markets this morning, we see the dollar under pressure across the board, with the Norwegian krone today’s champion, rallying 5.4% as a follow on to yesterday’s reversal and ultimate 1.2% gain. But the pound has bounced 2.0% this morning along with SEK and AUD is higher by 1.7%. It is entirely possible that what we are seeing is a relief in the funding markets as the Fed’s actions have made USD available more widely around the world and reduced some of that pressure.

EMG markets are seeing similar strength in their currencies, led by MXN (+2.6%) and HUF (+2.3%), but every currency in both blocs is higher vs. the greenback today. Equity markets are all green as well, with major rallies in Asia (Nikkei +7.1%, Hang Seng +4.5%, Shanghai +2.7%) and Europe (DAX +6.25%, CAC +5.25%, FTSE 100 +4.0%) with US equity futures limit up in all three indices. Bonds, meanwhile, have sold off slightly, with yields higher in both the US and Germany by 2bps. I think given the overall backdrop, bonds are unlikely to sell off sharply anytime soon, especially given the central bank promises to buy unlimited quantities of them.

And I would be remiss if I didn’t mention gold, which is up 2.5% today and 6.2% since Friday’s close as investors realize that all the money printing and fiscal stimulus is likely to lead to a much different view on inflation, namely that it is going to rise in the future.

Volatility remains the watchword as 5% daily moves in the equity market, even when they are up moves, remain extremely taxing on all trading activities. Market liquidity remains suspect in most markets, with bid-ask spreads still far wider than we’ve come to expect. Forward FX spreads of 5-10 pips for dates under 1 year are not uncommon in the majors, let alone in things like MXN or BRL. Keep that in mind as you prepare for your balance sheet rolling programs later this week.

Good luck and stay safe
Adf

Forecasts to Hell

The company named like a fruit
Said Covid was going to shoot
Its forecasts to hell
So risk assets fell
And havens all rallied to boot

Essentially, since the beginning of the Lunar New Year, there have been two competing narratives. First was the idea that the spread of the Covid virus would have a significantly detrimental impact on the global economy, reducing both production, due to the interruption of supply chains, and consumption, as the world’s second largest economy went into lockdown. This would result in a risk-off theme with haven assets in significant demand. The second was that, just like the SARS virus from 2003, this would be a temporary phenomenon and the fact that central banks around the world have been ramping up policy support by cutting rates and buying assets means that risk assets would continue their relentless march higher. And quite frankly, while there were a handful of days where the first thesis held sway, generally speaking, equity markets at least, are all-in on the second thesis.

At least that was true until today, when THE bellwether stock in the global equity markets explained that Q1 sales would miss forecasts due not only to production delays caused by supply chain interruptions, but to reduced sales as well. This news certainly put a crimp in the bull theory that the virus impact will be temporary and we have seen equity markets around the world suffer, while Treasuries rally, as fears are reignited over the ultimate impact of the CoVid virus.

While this author is no virologist, and does not pretend to have any special insight into how things with Covid evolve from here, long experience informs me that government efforts have been far more focused on controlling the message than controlling the virus. Confidence plays such an important part in today’s economy, and if the first narrative above is the one that takes hold, then there is very little that governments will be able to do to prevent a more substantial downturn and likely recession. Remember, at least in the G10, most central banks are basically out of ammunition with respect to their abilities to pump up the economy, so if the populace hunkers down because of fear, things could get ugly pretty quickly. And with that cheerful thought, let’s take a tour of the markets this morning.

It turns out the tax
On goods and services was
A growth disaster

During the US holiday weekend, we received a stunningly bad Q4 GDP report from Japan, with a -1.6% Q/Q result which turned into a -6.3% annualized number. Not only was that significantly worse than expected, but it was the worst outturn since the last time the Japanese government raised the GST in 2014. So, in their effort to be fiscally prudent, they blew an even bigger hole in their budget! But the yen didn’t really mind, as it remains a key safe haven, and while it weakened ever so slightly yesterday, this morning’s fear based markets has allowed it to recoup those losses and then some. So as I type, the yen is stronger by 0.15% today. Certainly, selling yen is a fraught operation in a market with as big a potential fear catalyst as currently exists.

Meanwhile, that other erstwhile growth engine, Germany, once again demonstrated that the idea of a rebound this year is on extremely shaky ground. Early this morning the ZEW surveys were released with the Expectations reading falling sharply to 8.7, while Current Situations fell to -15.7. While the numbers themselves have no independent meaning, both results were far worse than expected and crushed the modest rebound that had been seen in December. The euro has been under pressure since the release of the data, falling to a new low for the move and continuing its streak of down days, now up to 10 of the past twelve sessions, with the other two sessions closing essentially flat. The euro story has shown no signs of turning around on its own, and for the euro to stop declining we will need to see the dollar story change. Right now, that seems unlikely.

And generally speaking, the dollar is simply outperforming all other currencies. Versus the EMG bloc, the dollar is higher across the board, with not a single one of these currencies able to rally against the greenback. Today’s biggest decliners are the RUB (-0.6%) as oil prices fall, KRW (-0.5%) as concerns grow over Covid, and ZAR (-0.45%) as both commodity prices decline and global growth fears increase. In the G10 space, it should be no surprise that both AUD (-0.5%) and NZD (-0.7%) are the worst performers (China related) as well as NOK (-0.7%) as oil suffers over concerns of slowing global growth. It seems like we’ve heard this story before.

The one currency doing well today, other than the yen, is the British pound (+0.2%) as UK Employment data, released early this morning, was generally better than expected, with the 3M/3M Employment Change slipping a much less than expected 28K to 180K, a still quite robust number. Interestingly, yesterday saw the pound under pressure as PM Johnson’s Europe Advisor, David Frost, laid out the UK’s goals as ditching all EU social constructs and simply focusing on trade. That is at odds with the hinted at EU view, which is they want the UK to follow all their edicts even though they are no longer in the club. Look for more fireworks as we go forward on this subject.

Looking ahead to this week, the US data is generally second-tier, although we will see FOMC Minutes tomorrow.

Today Empire Manufacturing 5.0
Wednesday Housing Starts 1420K
  Building Permits 1450K
  PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.1% (1.3% Y/Y)
  FOMC Minutes  
Thursday Initial Claims 210K
  Philly Fed 11.0
Friday Leading Indicators 0.4%
  Existing Home Sales 5.45M

Source: Bloomberg

So lots of housing data, which given the interest rate structure should be pretty decent. Of course, the problem is the reason the interest rate structure is so attractive to home buyers is the plethora of problems elsewhere in the economy. In addition, we have seven Fed speakers during the rest of the week with a nice mix of hawks and doves. Although it seems unlikely that anybody will change their views, be alert to Dallas Fed President Kaplan’s comments tomorrow and Friday as he is the only FOMC member who has admitted that continuing to pump up the balance sheet could cause excesses in risk taking.

At this point, there is nothing on the horizon that indicates the dollar’s run is over. Regarding the euro, technically there is nothing between current levels and the early 2017 lows of 1.0341 although I would expect some congestion at 1.0500.

Good luck
Adf

Simply Too Fraught?

The question whose answer is sought
‘Bout what should be sold or be bought
Is will GDP
Rebound like a V
Or are things just simply too fraught?

Risk is neither on nor off this morning as investors and traders continue to sift through both the recent changes in coronavirus news from China and the economic releases and choose a direction. Thus far this morning, that direction is sideways.

In one way, it is a bit surprising there is not a more negative viewpoint as on top of the surge in reported cases of Covid-19 (the coronavirus’s official name), we have heard of more companies closing operations outside of China for lack of parts. The latest is Fiat Chrysler, which closed a manufacturing facility in Serbia due to its inability to source parts that are built in China. While the Chinese government is seemingly trying to get everyone to believe that things are going to be back to normal soon, manufacturers on the ground there who have reopened, are running at fractions of capacity due to an inability of workers to get to the plant floor. Huge swaths of the country remain in effective lockdown, and facemasks, which are seen as crucial to getting back to work, are scarce. Apparently, the capacity to make face masks in China is just 22 million/day. While that may sound like a lot, given everyone needs a new one every day, and that there are around 100 million people under quarantine (let alone 1.3 billion in the country), there just aren’t enough to go around. I remain skeptical that this epidemic will come under any sense of control for a number of weeks yet, and that ultimately, the hit to global economic growth will be far more severe than the market is currently pricing.

Another sign of trouble came from Germany this morning, where Q4 GDP was released at 0.0% taking the annual growth rate to 0.6% in 2019. Eurozone GDP turned out to be just 0.9% in 2019, and that was before the virus was even discovered. In other words, it appears that both those numbers are going to be far worse in Q1 as the Eurozone remains highly reliant on exports to grow, and as the Fiat news demonstrates, exports are going to be reduced.

Keeping this in mind, it is easy to understand why the euro remains under so much pressure. While its decline this morning is just 0.1%, to 1.0830, the euro is trading at its lowest level vs. the dollar since April 2017. The single currency has fallen in 9 of the past 10 sessions and is down 2.4% this month. And let’s face it, on the surface; it is awfully difficult to make a case for the euro to rebound on its own. Any strength will require help from the dollar, meaning either weaker US economic data, or more aggressive Fed policy ease. At this point, neither of those looks likely, but the impact of Covid-19 remains highly uncertain and can easily derail the US economy as well.

But for now, the narrative remains that Chinese GDP growth in Q1 will be hit, but that by Q2 things will be rebounding and this will all fade from memory akin to the SARS virus in 2003. Just remember, China has effectively been closed since January 23, three full weeks, or 6% of a full year. While manufactured goods demand will certainly rebound, there are many services that simply will never be performed and cannot be recouped. The PBOC is already tweaking leverage policies on property lending in an effort to help further support growth going forward, and there is discussion of allowing banks to live with a greater proportion of non-performing loans that are due to the coronavirus. One can only imagine all the garbage loans that will receive that treatment!

Switching to a view of the markets, equity markets are +/- 0.2% generally speaking with US futures in a similar position. Treasury yields have fallen back a few bps, giving up yesterday’s modest gains, and the FX market, on the whole, is fairly benign. Away from the euro’s small decline this morning, we are seeing slight weakness in the pound, Aussie and Kiwi, with the rest of the G10 doing very little. The one gainer today is CAD, +0.15%, which seems to be benefitting from WTI’s ongoing bounce from Monday’s low levels, with the futures contract there higher by 1.4%.

In the EMG space, ZAR is today’s big winner, up 0.65%, in response to President Cyril Ramaphosa’s State of the Nation speech, where he outlined steps to help reinvigorate growth and fix some of the bigger problems, like the state-owned power producer Eskom’s debt issues. Of course, speeches are just that and the proof will be in what policies actually get implemented. The other key gainers here are BRL (+0.6%), which saw the central bank (finally) intervene yesterday to try to stop the real’s dramatic recent plunge (it had fallen more than 4% in the past 10 days and nearly 10% in 2020 so far). After announcing $1 billion in swaps, the market turned tail and we are seeing that continue this morning. HUF also continues to benefit, rallying a further 0.55% this morning, as the market continues to price in growing odds of a rate hike to help rein in much higher than expected inflation.

On the data front, this morning brings Retail Sales (exp 0.3%, 0.3% ex autos) as well as IP (-0.2%), Capacity Utilization (76.8%) and Michigan Sentiment (99.5). Yesterday’s CPI data was a touch firmer than forecast, simply highlighting that the Fed’s measure of inflation does not do a very good job. Also yesterday, we heard from NY Fed President Williams who told us the economy is in a “very good place”, while this morning we hear from uber-hawk Loretta Mester. This week the doves have all cooed about letting inflation run hot and cutting if necessary. Let’s hear what the hawks think.

So as we head into the weekend, I expect traders to reduce positions that have worked as the potential for a weekend surprise remains quite large, and nobody wants to get caught. That implies to me that the dollar can soften ever so slightly as the day progresses.

Good luck
Adf

Feelings of Disquietude

In Germany, growth was subdued
In England, inflation’s now food
For thought rates will fall
As hawks are in thrall
To feelings of disquietude

This morning is a perfect lesson in just how little short-term movement is dependent on long-term factors like economic data. German GDP data was released this morning showing that for 2019 the largest economy in the Eurozone grew just 0.6%, which while expected was still the slowest rate in six years. And what’s more, forecasts for 2020 peg German GDP to grow at 0.7%, hardly enticing. Yet as I type, the euro is the best performer in the G10 space, having risen 0.2%. How can it be that weak data preceded this little pop in the currency? Well, here is where the short-term concept comes in; it appears there was a commercial order going through the market that triggered a series of stop-loss orders at 1.1140, and lo and behold, the euro jumped another 0.15%. My point is that any given day’s movement is only marginally related to the big picture and highly reliant on the short term flows and activities of traders and investors. So forecasts, like mine, that call for the euro to rally during this year are looking at much longer term issues, which will infiltrate trading views over time, not a prescription to act on intraday activity!

Meanwhile, the pound has come under modestly renewed pressure after CPI in the UK surprisingly fell to 1.3% with the core reading just 1.4%. This data, along with further comments by the most dovish BOE member, Michael Saunders, has pushed the probability of a UK rate cut at the end of the month, as measured by futures prices, up to 65%. Remember, yesterday this number was 47% and Friday just 25%. At this point, market participants are homing in on the flash PMI data to be released January 24 as the next crucial piece of data. The rationale for this is that the weakness that we have seen recently from UK numbers has all been backward-looking and this PMI reading will be the first truly forward looking number in the wake of the election in December. FYI, current expectations are for a reading of 47.6 in Manufacturing and 49.4 in Services, but those are quite preliminary. I expect that they will adjust as we get closer. In the meantime, look for the pound to remain under pressure as we get further confirmation of a dovish bias entering the BOE discussion. As to Brexit, it will happen two weeks from Friday and the world will not end!

Finally, the last G10 currency of interest today is the Swiss franc, which is vying with the euro for top performer, also higher by 0.2% this morning, as concern has grown over its ability to continue its intervention strategy in the wake of the US adding Switzerland back to the list of potential currency manipulators. Now, the SNB has been intervening for the past decade as they fight back against the franc’s historic role as a safe haven. The problem with that role is the nation’s manufacturing sector has been extraordinarily pressured by the strength of the franc, thus reducing both GDP and inflation. It seems a bit disingenuous to ask Switzerland to adjust their macroeconomic policies, as the US is alleged to have done, in order to moderate CHF strength given they already have the lowest negative interest rates in the world and run a large C/A surplus. But maybe that’s the idea, the current administration wants the Swiss to be more American and spend money they don’t have. Alas for President Trump, that seems highly unlikely. A bigger problem for the Swiss will be the fact that the dollar is likely to slide all year as QE continues, which will just exacerbate the Swiss problem.

Turning to the emerging market bloc, today’s biggest mover is BRL, where the real is opening lower by 0.5% after weaker than expected Retail Sales data (0.6%, exp 1.2%) point to ongoing weakness in the economy and increase the odds that the central bank will cut rates further, to a new record low of just 4.25%. While this still qualifies as a high-yielder in today’s rate environment, ongoing weakness in the Brazilian economy offer limited prospects for a reversal in the near-term. Do not be surprised to see BRL trade up to its recent highs of 4.25 before the bigger macro trend of USD weakness sets in.

And that’s been today’s currency story. I have neglected the signing of the phase one trade deal because that story has been so over reported there is exactly zero I can add to the discussion. In addition, the outcome has to be entirely priced into the market at this point. Equity markets have had difficulty trading higher during the past two sessions, but they certainly haven’t declined in any serious manner. As earnings season gets underway, investors seem to have turned their attention to more micro issues rather than the economy. Treasury yields have been edging lower, interestingly, despite the general good feelings about the economy and risk, but trying to determine if the stock or bond market is “correct” has become a tired meme.

On the data front, this morning brings PPI (exp 1.3%, 1.3% core) but given that we saw CPI yesterday, this data is likely to be completely ignored. We do get Empire Manufacturing (3.6) and then at 2:00 the Fed releases its Beige Book. We also hear from three Fed speakers, Harker, Daly and Kaplan, but at this point, the Fed has remained quite consistent that they have little interest in doing anything unless there is a significant change in the economic narrative. And that seems unlikely at this time.

And so, this morning the dollar is under modest pressure, largely unwinding yesterday’s modest strength. It seems unlikely that we will learn anything new today to change the current market status of limited activity overall.

Good luck
Adf

No Panacea

Fiscal stimulus
Is no panacea, but
Welcome nonetheless

At least by markets
And politicians as well
If it buys them votes!

Perhaps the MMTer’s are right, fiscal rectitude is passé and governments that are not borrowing and spending massive amounts of money are needlessly harming their own countries. After all, what other lesson can we take from the fact that Japan, the nation with the largest debt/GDP ratio (currently 236%) has just announced they are going to borrow an additional ¥26 trillion ($239 billion) to spend in support of the economy, and the market response was a stock market rally and a miniscule rise in JGB yields of just 1bp. Meanwhile, the yen is essentially unchanged.

Granted, despite the fact that this equates to nearly 5% of the current GDP, given JGB interest rates are essentially 0.0% (actually slightly negative) it won’t cost very much on an ongoing basis. However, at some point the question needs to be answered as to how they will ever repay all that debt. It seems the most likely outcome will be some type of explicit debt monetization, where the BOJ simply tears up maturing bonds and leaves the cash in the economy, thus reducing the debt and maintaining monetary stimulus. However, macroeconomic theory explains following that path will result in significant inflation. And of course, that’s the crux of the MMT philosophy, print money aggressively until inflation picks up.

The thing is, every time this process has been followed in the past, it basically destroyed the guilty country. Consider Weimar Germany, Zimbabwe and even Venezuela today as three of the most famous examples. And while inflation in Japan is virtually non-existent right now, that does not mean it cannot rise quite rapidly in the future. The point is that, currently, the yen is seen as a safe haven currency due to its strong current account surplus and the fact that its net debt position is not terribly large. But the further down this path Japan travels, the more likely those features are to change and that will be a distinct negative for the currency. Of course, this process will take years to play out, and perhaps something else will come along to change the trajectory of these long term processes, but the idea that the yen will remain a haven forever needs to be constantly re-evaluated. Just not today!

In the meantime, markets remain in a buoyant mood as additional comments from the Chinese that both sides remain in “close contact”, implying a deal is near, has the bulls ascendant. So Tuesday’s fears are long forgotten and equity markets are rallying while government bond yields edge higher. As to the dollar, it is generally on its back foot this morning as well, keeping with the theme that risk is ‘on’.

Looking at specific stories, there are several of note today. Overnight, Australia released weaker than expected GDP figures which has reignited the conversation about the RBA cutting rates in Q1 and helped to weaken Aussie by 0.3% despite the USD’s overall weakness. Elsewhere in the G10, British pound traders continue to close out short positions as the polls, with just one week left before the election, continue to point to a Tory victory and with it, finality on the Brexit issue. My view continues to be that the market is buying pounds in anticipation of this outcome, and that once the election results are final, there will be a correction. It is still hard for me to see the pound much above 1.34. However, there are a number of analysts who are calling for 1.45 in the event of a strong Tory majority, so be aware of the differing viewpoints.

On the Continent, German Factory Order data disappointed, yet again, falling 0.4% rather than rising by a similar amount as expected. This takes the Y/Y decline to 5.5% and hardly bodes well for a rebound in Germany. However, the euro has edged higher this morning, up 0.15% and hovering just below 1.11, as we have seen a number of stories rehashing the comments of numerous ECB members regarding the idea that negative interest rates have reached their inflection point where further cuts would do more harm than good. With the ECB meeting next Thursday, expectations for further rate cuts have basically evaporated for the next year, despite the official guidance that more is coming. In other words, the market no longer believes the ECB can will ease policy further, and the euro is likely edging higher as that idea makes its way through the market. Nonetheless, I see no reason for the euro to trade much higher at all, especially as the US economy continues to outperform the Eurozone.

In the emerging markets, the RBI surprised the entire market and left interest rates on hold, rather than cutting by 25bps as universally expected. The rupee rallied 0.35% on the news as the accompanying comments implied that the recent rise in inflation was of more concern to the bank than the fact that GDP growth was slowing more rapidly than previously expected. In a similar vein, PHP is stronger by 0.5% this morning after CPI printed a bit higher than expected (1.3%) and the market assumed there is now less reason for the central bank to continue its rate cutting cycle thus maintaining a more attractive carry destination. On the other side of the ledger, ZAR is under pressure this morning, falling 0.5% after data releases showed the current account deficit growing more rapidly than expected while Electricity production (a proxy for IP) fell sharply. It seems that in some countries, fiscal rectitude still matters!

On the data front this morning, we see Initial Claims (exp 215K), Trade Balance (-$48.5B), Factory Orders (0.3%) and Durable Goods (0.6%, 0.6% ex transport). Yesterday we saw weaker than expected US data (ADP Employment rose just 67K and ISM Non-Manufacturing fell to 53.9) which has to be somewhat disconcerting for Chairman Powell and friends. If today’s slate of data is weak, and tomorrow’s NFP report underwhelms, I think that can be a situation where the dollar comes under more concerted pressure as expectations of further Fed rate cuts will build. But for now, I am still in the camp that the Fed is on hold, the data will be mixed and the dollar will hold its own, although is unlikely to rally much from here for the time being.

Good luck
Adf

A Future Quite Bright

The data from China last night
Implied that growth might be all right
The PMI rose
And everyone knows
That points to a future quite bright!

Is it just me? Or does there seem to be something of a dichotomy when discussing the situation in China? This morning has a decidedly risk-on tone as equity markets in Asia (Nikkei +1.0%, Hang Seng +0.4%, Shanghai +0.15%) rallied after stronger than expected Chinese PMI data was released Friday night. For the record, the official Manufacturing PMI rose to 50.2, its first print above 50.0 since April, while the non-Manufacturing version rose to 54.4, its highest print since March. Then, this morning the Caixin PMI data, which focuses on smaller companies, also printed a bit firmer than expected at 51.8. These data releases were sufficient to encourage traders and investors to scoop up stocks while they dumped bonds. After all, everything is just ducky now, right?

And yet…there are still two major issues outstanding that have no obvious short-term solution, both of which can easily deteriorate into a much worse situation overall. The first, of course, is the trade fiasco situation, where despite comments from both sides that progress has been made, there is no evidence that progress has been made. At least, there is no timeline for the completion of phase one and lately there has been no discussion of determining a location to sign said deal. Certainly it appears that the current risk profile in markets is highly dependent on a successful conclusion of these talks, at least as evidenced by the fact that every pronouncement of an impending deal results in a stock market rally.

The second issue is the ongoing uprising in Hong Kong. China has begun to use stronger language to condemn the process, and is extremely unhappy with the US for passing the Hong Kong Human Rights and Democracy Act last week. However, based on China’s response, we know two things: first that completing a trade deal is more important than words about Hong Kong. This was made clear when the “harsh” penalties imposed in the wake of the Act’s passage consisted of sanctions on US-based human rights groups that don’t operate in China and the prevention of US warships from docking in Hong Kong. While the latter may seem harsh, that has already been the case for the past several months. In other words, fears that the Chinese would link this law to the trade talks proved unfounded, which highlights the fact that the Chinese really need these talks to get completed.

The second thing we learned is that China remains highly unlikely to do anything more than complain about what is happening in Hong Kong as they recognize a more aggressive stance would result in much bigger international relationship problems. Of course, the ongoing riots in Hong Kong have really begun to damage the economy there. For example, Retail Sales last night printed at -24.3%! Not only was this worse than expected, but it was the lowest in history, essentially twice as large a decline as during the financial crisis. GDP there is forecast to fall by nearly 3.0% this year, and unless this is solved soon, it seems like 2020 isn’t going to get any better. But clearly, none of the troubles matter because, after all, PMI rose to 50.2!
Turning to Europe, PMI data also printed a hair better than expected, but the manufacturing sector remains in dire straits. Germany saw a rise to 44.1 while France printed at 51.7 and the Eurozone Composite at 46.9. All three were slightly higher than the flash data from last week, but all three still point to a manufacturing recession across the continent. And the biggest problem is that the jobs sub-indices were worse than expected. At the same time, Germany finds itself with a little political concern as the ruling coalition’s junior partner, the Social Democrats, just booted out their leadership and replaced it with a much more left wing team who are seeking changes in the coalition agreement. While there has been no call for a snap election, that probability just increased, and based on the most recent polls, there is no obvious government coalition with both the far left and far right continuing to gain votes at the expense of the current government. While this is not an immediate problem, it cannot bode well if Europe’s largest economy is moving toward internal political upheaval, which means it will pay far less attention to Eurozone wide issues. This news cannot be beneficial for the euro, although this morning’s 0.1% decline is hardly newsworthy.

Finally, with less than two weeks remaining before the British (and Scottish, Welch and Northern Irish) go to the polls, the Conservatives still hold between a 9 and 11 point lead, depending on which poll is considered, but that lead has been shrinking slightly. Pundits are quick to recall how Theresa May called an election in the wake of the initial Brexit vote when the polls showed the Tories with a large lead, but that she squandered that lead and wound up quite weakened as a result. At this point, it doesn’t appear that Boris has done the same thing, but stranger things have happened. At any rate, the FX market appears reasonably confident that the Tories will win, maintaining the pound above 1.29, although unwilling to give it more love until the votes are in. I expect that barring any very clear gaffes, the pound will range trade ahead of the election and in the event of a Tory victory, see a modest rally. If we have a PM Corbyn, though, be prepared for a pretty sharp decline.

Looking ahead to this week, we have a significant amount of US data, culminating in the payroll report on Friday:

Today ISM Manufacturing 49.2
  ISM Prices Paid 47.0
  Construction Spending 0.4%
Wednesday ADP Employment 140K
  ISM Non-Manufacturing 54.5
Thursday Initial Claims 215K
  Trade Balance -$48.6B
  Factory Orders 0.3%
  Durable Goods 0.6%
  -ex Transport 0.6%
Friday Nonfarm Payrolls 190K
  Private Payrolls 180K
  Manufacturing Payrolls 40K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4
  Michigan Sentiment 97.0

Source: Bloomberg

As we have seen elsewhere around the world, the manufacturing sector in the US remains under pressure, but the services sector remains pretty robust. But overall, if the data prints as expected, it is certainly evidence that the US economy remains in significantly better shape than that of most of the rest of the world. And it has been this big picture story that has underpinned the dollar’s strength overall. Meanwhile, with the Fed meeting next week, they are in their quiet period, so there will be no commentary regarding policy until the next statement and press conference. In fact, next week is set to be quite interesting with the FOMC, the UK election and then US tariffs slated to increase two weeks from yesterday.

And yet, despite what appear to be numerous challenges, risk remains the primary choice of investors. As such, equities are higher and bonds are selling off although the dollar remains stuck in the middle for now. We will need to get more news before determining which way things are likely to break for the buck in the near term.

Good luck
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