Sh*t Out of Luck

Consensus remains that the buck
This year is just sh*t out of luck
Though lately it’s jumped
It soon will be dumped
Or so say the bears run amok

This will be a holiday-shortened note to match our holiday shortened session today.  The broad theme in markets this morning is one of risk avoidance, with most European equity markets lower (CAC -0.4%, FTSE 100 -0.3%, DAX 0.0%), following the Nikkei (-1.0%) although we did see strength in China with both the Hang Seng (+1.0%) and Shanghai (+0.8%) putting in solid sessions.  The Chinese market activity comes on the heels of their latest data which showed that GDP in 2020 grew 2.3%, slightly better than forecast and certainly the only major economy that will show positive growth for the year.  Interestingly, the other data released was not quite as robust with Retail Sales rising a less than forecast 4.6%, down from November and investment activity rising more slowly than anticipated, both Fixed Asset (2.9%) and Property (7.0%).  However, no matter how you slice it, the Chinese economy seems to have weathered the pandemic better than most.

One of the interesting things we have seen of late is the seeming breakdown in the correlation between stocks and bonds.  Whereas the risk meme had generally been stocks falling led to haven asset buying, so Treasuries and the big 3 European government bonds would rally, that is not today’s story.  While the Treasury market is closed today, looking across Europe, despite the weakness in stocks, we are seeing weakness in bonds, with Bund (+1.2bps), OAT (+1.8bps) and Gilt (+0.8bps) prices all sliding a bit on the day.  The news from the PIGS is worse, with yields rising between 1.9 and 2.8 basis points, although given those assets are more risk than haven, this is no real surprise.

There have been three main stories out of Europe this morning, the election of a new CDU party leader in Germany, Armin Laschet, who will replace the retiring Angela Merkel.  However, there is concern that he is a weak candidate for Chancellor and may face a challenge amid slumping popularity ratings.  A weak German Chancellor is not a Eurozone positive, keep that in mind.  The second story is the French dismissal of the unsolicited bid for Carrefour, the largest grocery chain in the country.  Once again, they have proven they have little interest in a free market and will name any company critical to the national interest to prevent the loss of control.  And finally, in Italy, it appears PM Giuseppe Conte is losing his grip on power after a key ally, Matteo Renzi, took his party out of the ruling coalition.  The broader concern there is that if an election is called, Matteo Salvini, the head of the League, a right-wing party with nationalist tendencies could win the election outright, and wreak significant havoc on the Continent with respect to issues like monetary and fiscal policy, immigration and even addressing Covid.

However, at this point, the bulk of that news is fairly noncommittal and almost certainly not having a real impact on the FX markets…yet.  Rather, the story that caught my eye was that Janet Yellen, whose vetting by the Senate for her role as Treasury Secretary takes place tomorrow, will reputedly say she believes the dollar’s value should be determined by the market and that the Treasury will neither speak to it, nor attempt to weaken it directly in any manner.  Of course, the disingenuous part of that statement is that her other policies, which when combined with the Fed’s activity, will almost certainly drive real yields to greater and greater depths of negativity, will undermine the dollar without her having to ever mention the currency once.

Ironically, for now, the dollar continues its rebound from its nadir on January 6th, just three days into the year.  In fact, in the G10, it is stronger against the entire bloc except JPY (+0.1%), with the commodity bloc leading the way lower (NO -0.45%, AUD -0.45%, CAD -0.4%).  You won’t be surprised to know commodities are pulling back a bit as well today (WTI -0.3%).  In the EMG space, the screen is largely red as well, led by RUB (-0.85%) and ZAR (-0.65%) with only BRL (+0.15%) showing any support on the day.  That support seems to be emanating from a survey of Brazilian economists who are calling for a return to growth in 2021 alongside rising interest rates, with the Selic rate (their overnight rate) forecast to rise 125 basis points this year and a further 150 basis points next year to get back to 4.75%.  If that is the case, BRL will certainly find significant support as expectations remain that dollar rates are not going to rise at all.

On the data front, it is a pretty light week, and remember, there are no Fed speakers either.

Thursday ECB meeting -0.5%
Initial Claims 923K
Continuing Claims 5250K
Philly Fed 11.3
Housing Starts 1560K
Building Permits 1603K
Friday Existing Home Sales 6.55M

Source: Bloomberg

While the Fed doesn’t meet until next week, we do hear from the Bank of Canada (exp no change), BOJ (no change) and the ECB (no change) this week, although as you can tell from the forecasts, there is no anticipated movement on policy at this time.  So, adding it all up, it feels to me like the dollar’s short-term momentum remains modestly firmer, although this has not changed my longer-term view that the Fed will be forced to cap nominal yields and as real yields decline, so will the dollar.  But that is more of a summer phenomenon I believe, late Spring at the earliest.

Good luck and stay safe
Adf

There is Trouble

It seems that the virus mutated
In Spain, which has now complicated
The efforts by France
To alter their stance
On lockdowns, with new ones created

In Germany, too, there is trouble
With cases, this week, set to double
So, Madame Lagarde
Will simply discard
Her fears, and inflate the bond bubble

The second wave of infections, or perhaps the third, is clearly washing over Europe with Covid-19 cases surging across the continent.  The situation has deteriorated so rapidly that, in short order, both Germany and France have ordered lockdowns, closing restaurants, bars, gyms and theaters for the next month.  Public gatherings are being restricted to ten people drawn from only two families as hospital beds throughout both nations fill up quickly.  Research to be released this morning has identified a new strain of the virus that apparently originated in Spanish farm workers during the summer and has been the main version in the latest outbreak.  It seems that it was spread by people returning to their homelands from Spanish holidays.

Meanwhile, Spain and Italy are also contemplating nationwide lockdowns as infections surge there, and even countries that saw a limited outbreak last spring, like the Czech Republic, are under severe pressure now.  Add it all up and you have a recipe for a fourth quarter of negative growth on the continent.  Seemingly, the only part of the Eurozone economy that is performing well are German capital goods exporters as their main market, China, has been rebounding.

With this as background, now consider that you are Christine Lagarde and chairing the ECB policy meeting today.  While the ECB has made significant efforts to support every Eurozone nation during the current crisis, clearly the situation remains fraught.  Is there anything that she can do to shore up confidence?

The punditry is pretty united in their views at this time, not expecting any policy changes at today’s meeting in the belief that the council will want to wait for updated economic forecasts in December before adding to the PEPP. Estimates for an increase in that QE program have coalesced around €500 billion.  If anything, the only expectations for today are for Lagarde to essentially promise that the ECB will announce the expansion of their policy accommodation in December.  While this may well be the outcome, if there is one thing we should have learned from Signor Draghi’s time in Lagarde’s chair, it is that acting sooner than expected and larger than expected are the only ways for the ECB to alter the narrative.  And right now, the narrative is leaning toward the ECB is powerless to prevent the next downturn.

With this in mind, and recognizing that Lagarde, while perhaps not the most sophisticated economic mind on the council, is clearly the best politician, and with the new gloom and doom reports coming in daily, if not hourly, I think there is a decent probability that the ECB acts today.  After all, if they are certain they are going to increase the PEPP program in December, what is the advantage to waiting.  And while I don’t think that a rate cut is in the cards yet, there is a non-zero probability of that too.  News earlier this week, that didn’t get much press in the US, highlighted that small German banks, of which there are nearly 1800, have started to charge depositors to maintain deposits from the first euro.  So, savings accounts are going to be taxed subject to negative interest.  If banks are starting to pass on the costs of ECB monetary policy, then the ECB is likely to be far more comfortable in cutting rates further as they recognize that the banking system there is likely to have halted the decline in lending spreads.  Hence, my out of consensus view is we see some definitive action from the ECB this morning.

Leading up to that meeting, with the announcement to be made at 8:45 this morning (Daylight Savings time has already occurred there), markets are rebounding modestly from yesterday’s risk reducing session.  I’m sure you are all aware of he size of the decline in stock market indices yesterday, with US markets falling ~3.5%, their worst single day performance since June.  What was quite interesting about the session, though, was while equity risk was abandoned, haven assets, which had a bid early in the session, lost their luster as well.  In fact, Treasury bonds wound up the day unchanged, and yields there are actually almost a basis point higher this morning.

A quick tour of equity markets shows that Asian markets were somewhat lower (Nikkei -0.4%, Hang Seng -0.5%, Shanghai +0.1%), although they all closed well off the worst levels of the session.  European bourses are ever so slightly higher, on average, with the DAX (+0.4%), CAC (+0.1%) and FTSE 100 (+0.3%) all in the green.  The big outlier here is Spain’s MIB (-0.95%), which is feeling the pain of the latest story about the genesis of the new strain of the virus, as well as responding to the announcement by PM Sanchez that the national state of emergency has been extended for six months, meaning lockdowns are almost certainly coming there soon.  US futures, meanwhile, are currently up about 0.5%-0.7%, although that is well off the earlier session highs.  The question remains is this a modest trading bounce, or was yesterday an aberration?

Unlike the Treasury market, with a modest uptick in yields, Bunds and OATs are both rallying with 1 basis point declines.  It seems I am not the only one who thinks the ECB may act today, as any early action should see an uptick in demand for European paper.  Oil, on the other hand, is having another tough day, down 3.5%, and at $36/bbl, WTI is back to its lowest level since mid-June.  Fears over slipping demand alongside growing supply are infiltrating the market.

As to the dollar, early price activity was mixed, but it is seeing some demand in the past hour and is now largely higher on the day.  NOK (-0.95%) is the laggard again, following oil lower, but we are seeing weakness, albeit modest weakness, from SEK (-0.4%) and EUR (-0.2%).  Certainly, if I am correct in my view on the ECB, we should see the euro decline further.  On the plus side, only JPY (+0.25%) is gaining on the greenback as the BOJ’s lack of policy action combined with a background of fear over the new lockdowns and their impact on economic activity, has some Japanese investors taking their money home.  This is a trend that has legs.

EMG currencies have also turned from a mixed bag to a nearly universal decline, although the losses are not enormous.  For a change of pace, MXN (-0.7%) is the laggard today, suffering from the ongoing oil price declines, and pushing TRY (-0.6%) back to only the second worst performing currency.  But EEMEA currencies are all lower in the 0.3%-0.5% range.  In fact, the only gainer today is CNY (+0.25%) which continues to benefit from investment inflows as the Chinese economy continues to be the world’s top performer.

On the data front, today we see the most important points of the week.  Initial Claims (exp 770K) and Continuing Claims (7.775M) have been falling but remain substantially higher than even during the worst recessions in the past 75 years.  Of possibly more interest will be this morning’s first reading of Q3 GDP (exp 32.0%), which while it will be a record, will not make up for the loss in Q2.  And right after those are released, we hear from the ECB, so the 30 minutes between 8:30 and 9:00 have the chance for some fireworks.

In the end, it appears to me that risk will continue to be shed leading up to the election, and with that activity, we will see the dollar (and yen) grind higher.

Good luck and stay safe
Adf

Quickly Diminished

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
Adf

Struck by the Flu

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

A Wake of Debris

Investors are pining to see
A rebound that’s shaped like a “V”
But data of late
Could well extirpate
Those views midst a wake of debris

For everyone who remains convinced that a V-shaped recovery is the most likely outcome, recent data must be somewhat disconcerting. There is no question that June data will look better than May’s, which was substantially better than April’s, but if one takes a few steps back to gain perspective, the current situation remains dire. One of the features of most economic statistical series is that they tend to measure both monthly and annual changes. The idea is that the monthly data offer’s a picture of the latest activity while the annual data gives a view of the longer-term trend. The problem for the bulls to overcome right now is that while June’s monthly data is showing record-breaking monthly gains, the annual numbers remain horrific. This morning’s German IP data is a perfect example of the situation. While this was actually data from May, it is the latest reading. During the month, Industrial Production rose 7.8%, the largest monthly gain on record, and arguably good news. Alas, expectations were for an even greater 11.1% rebound, and more importantly, the annual data showed a still terrible 19.3% decline from 2019’s levels. So, while there is no question that May’s numbers were an improvement over April’s, it is hardly sounding an all-clear signal.

This has been the pattern we have seen consistently for the past two months and is likely to continue to be the case for quite a while. Ergo, it is fair to state that the economy is rebounding from its worst levels, but to imply that things are even approaching the pre-Covid economy is completely erroneous. This is especially so in the survey data, which, if you recall, simply asks if this month was better than last. We saw some incredible PMI data at the nadir, with readings in the low teens and even single digits in a few countries, indicating that more than 80% of respondents saw things decline from the previous month. As such, it is no surprise that things got better from there, but does a rebound to a reading above 50 on a monthly series, with no annual analog, actually mean the same thing today as it did in January? I contend it is not a reasonable comparison and to imply that the economy is doing anything but slowly climbing back from a historic decline is just plain wrong.

The European Commission clearly understands this issue as they reduced their outlook for the EU’s economic growth in 2020 by a full percentage point to -8.7%, with most member nations seeing a substantial downgrade. A key reason for this downgrade has been the recent uptick in infections and the sporadic second closures of areas within the economies. The second wave of infections is dreaded for exactly this reason, it is preventing economies around the world from gaining growth momentum, something that comes as confidence builds that things will get better. Every interruption just extends the timeline for a full recovery, a prospect that none of us welcome. Alas, it appears that the most likely outcome right now is a very slow, drawn out recovery with a continued high rate of unemployment and ongoing fiscal and monetary support abetting every economy on the planet while simultaneously preventing markets from clearing and thus insuring slower growth ahead when it finally returns.

With that as preamble, a look at today’s markets shows essentially a full reversal from yesterday’s price action. Yesterday was always a bit odd as there was no clear rationale for the risk rally, yet there it was, around the world. However, this morning, the data continues to demonstrate just how far things are from the pre-Covid world, and it seems the risk bulls are having a tougher time. Starting in Asia, we saw weakness in Japan (-0.45%) and Hong Kong (-1.4% and long overdue given what is happening there) although Shanghai (+0.4%) has managed to keep the positive momentum going for yet another day. While there were no articles exhorting share ownership in the papers there last night, it remains a key feature of the Chinese government’s strategy, encourage individuals to buy stocks to support both markets and confidence. We shall see how long it can continue. European bourses have reversed much of yesterday’s gains as well, down a bit more than 1.0% on average and US futures are trading at similar levels, -1.0%. Bond markets continue to prove to be irrelevant at this stage, no longer seen as haven assets given the fact that there is no yield available but unwilling to be sold by traders as central banks have promised to buy them all if they deem it necessary. So, for the time being, it is extremely difficult to gain any credible price signals from these markets.

Commodity markets are under a bit of pressure, with oil prices lower by 1.5% and gold falling 0.5%, while the dollar is today’s big winner. Yesterday it fell against all its G10 counterparts and most EMG ones as well. This morning, it is just the opposite, with only the pound, essentially unchanged on the day, not declining while AUD and NOK lead the way lower with 0.55% and 0.45% declines respectively. The data situation continues to show that the early signs of a rebound are leveling off, so investing based on a brighter outlook is not in the cards.

In the EMG space, MXN is today’s big loser, down 1.25%, but here, too, it is nearly universal as only IDR (+0.35%) has managed to eke out a gain, ostensibly on the back of views that the central bank’s debt monetization plan will draw inward investment. We shall see.

On the data front, yesterday’s ISM Non-Manufacturing number was a much better than expected 57.1, but as I discuss above, I don’t believe that is indicative of growth so much as a rebound from the worst conditions in the series history. This morning we only see the JOLTS Job Openings data, (exp 4.5M), but this is a delayed number as it represents May openings. Remember, too, this is down from more than 7.5M in early 2019 and 7.0M earlier this year.

Yesterday we heard from Atlanta Fed President Bostic who sounded a warning that the second wave, if it expands, would have a significantly detrimental impact on the US economy, and thus he was quite concerned with the future trajectory of growth. Remember, it is the Atlanta Fed that calculates the widely watched GDPNow number, which is currently reading an extremely precise -35.18% decline for Q2. It is no surprise he is worried.

Overall, risk is on the back foot today and appears set to continue this move. Barring some overly upbeat commentary from the White House, something that is always possible on a down day, I expect the dollar to drift slightly higher from here.

Good luck and stay safe
Adf

 

Value, Nought

In college Econ 101
Professors described the long run
As when we all died
Like Keynes had replied
Debating a colleague for fun

However, the rest that they taught
Has turned out to have, value, nought
Their models have failed
While many have railed
That people won’t do what they ought

Observing market activity these days and trying to reconcile price action with the theories so many of us learned in college has become remarkably difficult. While supply and demand still seem to have meaning, pretty much every construct more complex than that turns out to have been a description of a special case and not a general model of behavior. At least, that’s one conclusion to be drawn from the fact that essentially every forecast made these days turns out wrong while major pronouncements, regarding the long-term effect of a given policy, by esteemed economists seem designed to advance a political view rather than enhance our knowledge and allow us to act in the most effective way going forward. Certainly, as merely an armchair economist, my track record is not any better. Of course, the difference is that I mostly try to highlight what is driving markets in the very short term rather than paint a picture of the future and influence policy.

I bring this up as I read yet another article this morning, this by Stephen Roach, a former Chairman of Morgan Stanley Asia and current professor at Yale, about the imminent collapse of the dollar and the end of its status as the world’s reserve currency. He is not the first to call for this, nor the first to call on the roster of models that describe economic activity and determine that because one variable has moved beyond previous boundaries, doom was to follow. In this case growth of the US current account deficit will lead to the end of the dollar’s previous role as reserve currency. Nor will he be the last to do so, but the consistent feature is that every apocalyptic forecast has been wrong over time.

This has been true in Japan, where massive debt issuance by the government and massive debt purchases by the BOJ were destined to drive inflation much higher and weaken the yen substantially. Of course, we all know that the exact opposite has occurred. This has been true around the world where negative interest rates were designed to encourage borrowing and spending, thus driving economic growth higher, when it only got half the equation right, the borrowing increase, but it turns out spending on shares was deemed a better use of funds than spending on investment, despite all the theories that said otherwise.

Ultimately, the point is that despite the economics community having built a long list of very impressive looking and sounding models that are supposed to describe the workings of the economy, those models were built based on observed data rather than on empirical truths. Now that the data has changed, those models are just no longer up for the task. In other words, when it comes to forecasting models, caveat emptor.

Turning to the markets this morning, equity markets seem to have stopped to catch their collective breath after having recouped all of their March losses. In fact, the NASDAQ actually set a new all-time high yesterday, amid an economy that is about to print a GDP number somewhere between -20% and -50% annualized in Q2.

I get the idea of looking past the short-run problems, but it still appears to me that equity traders are ignoring long-run problems that are growing on the horizon. These issues, like the wave of bankruptcies that will significantly reduce the number of available jobs, as well as the potential for behavioral changes that will dramatically reduce the value of entire industries like sports and entertainment, don’t appear to be part of the current investment thesis, or at least have been devalued greatly. And while in the long-run, new companies and activities will replace all these losses, it seems highly unlikely they will replace them by 2021. Yet, yesterday saw US equity indices rally for the 7th day in the past eight. While this morning, futures are pointing a bit lower (SPU’s and Dow both lower by 1.2%, NASDAQ down by 0.7%), that is but a minor hiccup in the recent activity.

European markets are softer this morning as well, with virtually every major index lower by nearly 2% though Asian markets had a bit better showing with the Hang Seng (+1.1%) and Shanghai (+0.6%) both managing gains although the Nikkei (-0.4%) edged lower.

Bond markets are clearly taking a closer look at the current risk euphoria and starting to register concern as Treasury yields have tumbled 5bps this morning after a 4bp decline yesterday. We are seeing similar price action in European markets, albeit to a much lesser extent with bunds seeing yields fall only 2bps since yesterday. But, in true risk-off fashion, bonds from the PIGS have all seen yields rise as they are clearly risk assets, not havens.

And finally, the dollar is broadly stronger this morning with only the other havens; CHF (+0.3%) and JPY (+0.4%) gaining vs. the buck. On the downside, AUD is the laggard, falling 1.4% as a combination of profit taking after a humongous rally, more than 27% from the lows in March, and a warning by China’s education ministry regarding the potential risks for Chinese students returning to university in Australia have weighed on the currency. Not surprisingly, NZD is lower as well, by 1.1%, and on this risk-off day, with oil prices falling 2.5%, NOK has fallen 1.0%. But these currencies’ weakness has an awful lot to do with the dollar’s broad strength.

In the emerging markets, the Mexican peso, which had been the market’s darling for the past month, rallying from 25.00 to below 21.50 (13.5%) has reversed course this morning and is down by 1.4%. But, here too, weakness is broad based with RUB (-0.95%), PLN (-0.7%) and ZAR (-0.6%) all leading the bloc lower. The one exception in this space was KRW (+0.6%) after the announcement of some significant shipbuilding orders for Daewoo and Samsung Heavy Industries improved opinions of the nation’s near-term trade situation.

Turning to the data, although it’s not clear to me it matters much yet, we did see some horrific trade data from Germany, where their surplus fell to €3.5 billion, its smallest surplus in twenty years, and a much worse reading than anticipated as exports collapsed. Meanwhile, Eurozone Q1 GDP data was revised ever so slightly higher, to -3.6% Q/Q, but really, everyone wants to see what is happening in Q2. At home, the NFIB Small Biz Index was just released at a modestly better than expected 94.4 but has been ignored. Later this morning we see the JOLT’s Jobs data (exp 5.75M), but that is for April so seems too backward-looking to matter.

Risk is on its heels today and while hopes are growing that the Fed may do something new tomorrow, for now, given how far risk assets have rallied over the past two weeks, a little more consolidation seems a pretty good bet.

Good luck and stay safe
Adf

Negative Views Have Been Banned!

It’s not clear why anyone thought
That Covid, much havoc had wrought
At least based on stocks
Who’s heterodox
Response ignores data quite fraught

Thus, once more with bulls in command
The stock market’s flames have been fanned
So, risk is appealing,
The dollar is reeling
And negative views have been banned!

Acquiring risk continues to be at the top of investor to-do lists as, once again, despite ongoing calamities worldwide, stock markets continue on their mission to recoup all the losses seen in March. It remains difficult for me to understand the idea that company valuations today should be the same as they were in February, before the global economy came to a screeching halt. Aside from the hundreds of millions of people worldwide who have been thrown out of work, millions of companies will disappear forever, whether it is JC Penney (long overdue) or your favorite local bistro (a calamity if there ever was one.) The commonality between the two is that both employed people who were also consumers, and sans an income, they will be consuming much less.

Given that consumption represented more than 60% of the global economy (>68% in the US), all those companies that cater to consumers are going to find it extremely difficult to generate profits if there are no consumers. It is why the hospitality/leisure sectors of the economy have been devastated world-wide, and all the industries that service those companies, like aircraft manufacturing or construction, have also been hit so hard. If you remove the rose-tinted lenses, it appears that the ongoing risk acquisition remains painfully ignorant of the reality on the ground, and that a revaluation seems more likely than not.

One other thing to consider is this, tax rates. US equity markets have been a huge beneficiary of the tax cuts from 2018 with corporate earnings broadly exploding higher. However, even if one looks past the abyss of the next several quarters of economic destruction, it seems quite likely that we are going to see some big picture changes around the world with regard to distribution of income, i.e. higher corporate (and personal) tax rates and lower EPS. Again, my point is that even if, by 2021, economic activity returns to the level seen in 2019, the share of that value that will be attributed to the corporate sector is destined to be much lower, and with after-tax earnings declines ordained it will be extremely difficult to justify high valuations. So, yes, risk is in the ascendancy today, but it continues to feel as though its time is coming to an end.

And with that sobering thought, let us look at just how risk is performing today. Equity markets around the world followed yesterday’s modest US rally higher with both the Nikkei and Hang Seng rallying a bit more than 1.1%, although Shanghai managed only a 0.2% gain. Meanwhile, Europe is feeling quite perky this morning as funds from around the world are flowing into the single currency as well as equity markets throughout the region. The DAX is leading the way higher, up 4.0%, as plans for a mooted €100 billion government support program are all over the tape. And this is in addition to the EU plan for a €750 billion support package. Thus, talk of a cash for clunkers program is supporting the auto manufacturers, while increases in childcare subsidies and employment support are destined to help the rest of the economy.

But the rest of Europe is also rocking, with the CAC +2.2% and both Italy and Spain seeing 2.5% gains in their major indices. Surprisingly, the FTSE 100 is the laggard, up only 1.1%, as concerns over a hard Brexit start to reappear. The current thinking seems to be that even if a hard Brexit causes a poor economic outcome, Boris will be able to blame everything on Covid-19 thus hiding the costs, at least to the bulk of the population. After all, it will not be easy to disentangle the problems caused by Covid from those caused by a hard Brexit for the average bloke.

As I type, US futures are also reversing earlier losses and are now higher by roughly 0.5% across the board. Bond markets, once again, remain extremely uninteresting, at least in the 10-year sector, as yields continue to trade in narrow ranges. In fact, since mid-April, the 10-year Treasury has had a range of just 15bps top to bottom, again, despite extraordinary economic disruption. This same pattern holds true for all the haven bonds as central banks around the world control the activity there and prevent any substantial volatility. In fact, it is becoming increasingly clear that the signaling effect of government bond yields is diminishing rapidly. After all, what information is available regarding investor preferences if yields are pegged by the central bank?

Finally, turning to the dollar we see another day of virtually universal weakness. AUD is the top G10 performer today after the RBA appeared a tad more hawkish last night, leaving policy unchanged but also describing a wait and see approach before making any further decisions. So, while some are calling for further ease Down Under, that does not appear to be on the cards for now. NOK is next on the list, rallying 0.65% as oil prices continue their strong performance of the past 6 weeks. Then comes the pound, up 0.6% this morning after a more than 1% rally yesterday. This is far more perplexing given the growing concerns over a hard Brexit, which will almost certainly result in the pound declining sharply. Remember, as it currently stands, if there is no agreement between the UK and EU by the end of June to extend the current trade negotiations, then a deal must be done by December 31, 2020 or it’s a hard Brexit. Discussions with traders leads me to believe that we have seen a massive short squeeze in the pound vs. both the euro and the dollar. If this is the case, then we are likely looking at some pretty good levels for hedgers to take advantage.

In the EMG space, the board is almost entirely green as well, with IDR (+1.35%) atop the list with MYR (+1.0%) and MXN (+0.9%) following close behind. The rupiah has gained as Indonesia is preparing plans to reopen the economy as soon as they can, deciding that the economic devastation is worse than the disease. Meanwhile, both MYR and MXN are beneficiaries of the oil rally with the ruble (+0.65%) not far behind. In fact, the entire space save the TWD (-0.15%) is firmer this morning. As an aside, TWD seems to be feeling a little pressure from the ongoing US-China trade spat, but despite its modest decline, it has been extremely stable overall.

There is no US data on the schedule for today, so FX markets will continue to take their cues from equities. At this point, that still points in the direction of a weaker dollar as risk continues to be acquired. Despite the currency rallies we have seen in the past weeks, most currencies are still lower vs. the greenback YTD. If you are convinced that the worst is behind us, then the dollar has further to fall. But any reversion to a risk-off sentiment is likely to see the dollar reassert itself, and potentially quite quickly.

Good luck and stay safe
Adf

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
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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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