Tag Archives: #IFO

Fading

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In Germany, growth has been fading
Down Under, inflation’s upgrading
Chair Jay gave his views
But it was old news
And Trump, for more cuts, is crusading

 

Some days, there is less to discuss than others, and this morning that seems to be the case.  Even my X feed had very little of interest.  Arguably, the top story is German Ifo readings came out much lower than expected and have now reversed most of the gains that occurred from front-running US tariff policy changes.  Germany’s bigger problem, though, is that the trend here is abysmal, as ever since Russia’s invasion of Ukraine and the dramatic rise in energy prices there, the German economy has been under significant pressure.  A look at the 5-year history of the Ifo series does an excellent job of explaining why growth has completely stalled there.

Source: tradingeconomics.com

In fact, if we look at the last three+ years of GDP activity in Germany, as per the below chart, we see that seven of the thirteen quarters were negative while two were exactly flat and the sum total of growth was -0.9%.  It’s amazing what happens to a nation that decides to impose extreme conditions on the production of energy domestically.  Or perhaps it’s not so amazing.  After all, economic activity is merely energy transformed.  If the cost of energy is high, economic activity is going to be slow.

Source: tradingeconomics.com

I highlight this because it runs counter to the narrative that Europe is a better place to invest than the US, which has been the thesis of the ‘end of American exceptionalism’ trade.  Germany is the largest European nation by far and had been a manufacturing powerhouse.  But those days appear to have passed.  If Germany is going to continue to lag, and I see no reason for that to change based on the current political dynamic there, please explain the idea behind long-term strength in the euro.  As I wrote yesterday, if the Fed cuts aggressively, the dollar will decline in the short run, but one cannot look at the trajectories of the relative economies and claim Europe is the place to be in the long run.

This morning, the euro (-0.5%) has responded logically to the data but the dollar is broadly stronger as well after Chair Powell’s speech yesterday where he continued the modestly hawkish tone from the FOMC press conference.  He continues to agonize over the fact that inflation won’t fall while unemployment is edging higher, although he finally admitted that tariffs would likely have a temporary, one-off impact on prices.  While there is no doubt the dollar has fallen since the beginning of the year, a 10% or 15% move is hardly unprecedented, but rather occurs pretty frequently.  A look at the below chart from the beginning of the euro’s existence in 1999 shows at least six or seven other instances when the euro rallied that much in a short period of time.

Source: tradingview.com

In fact, to demonstrate the politicization of the current world, one need only go back to the period in 2008 when the euro peaked at 1.60 or so to see that it was not seen as a global calamity, simply a period where US monetary policy had loosened dramatically relative to the rest of the world.

The other marginally interesting story this morning is Australia’s inflation rate, which came in at 3.0%, higher than expected and demonstrating what appears to be a break in the declining trend previously seen.

Source: tradingeconomics.com

This matters as AUD (+0.1%) is outperforming all its G10 peers this morning on the back of the idea that the RBA will be stuck on hold, rather than cutting rates again soon.  Too, this weighed on Australian equities (-0.9%) which underperformed other Asian markets overnight.

But that’s really all the interesting stuff, and it wasn’t that interesting, I fear.  So, let’s look at the rest of the market behavior overnight.  While I thought it was illegal, yesterday resulted in US equity markets declining on the session, albeit less than 1%.  And this morning, you’ll be happy to know, the futures are all modestly green.  As to Asian markets, Japan (+0.3%), China (+1.0%) and HK (+1.4%) all had strong sessions although it appears most of the other regional bourses declined.  The Chinese story making the rounds is the lessening in trade tensions between the US and China was seen as a key positive while HK survived Typhoon Ragasa without any major impacts.  But Korea, India, Taiwan and Singapore were all softer on the session.

In Europe, markets have generally done little with marginal declines the norm although, surprisingly, Germany’s DAX is unchanged on the day despite the weak Ifo data.  However, it is hard to get excited about anything happening there right now.

Bond yields fell yesterday with Treasuries declining -4bps although this morning they have edged back higher by 1bp.  Perhaps Powell’s tone yesterday was enough to keep the bond vigilantes on the sidelines, or perhaps there is simply not enough new information to change any views right now.  The Fed funds futures market continues to price a 94% probability of a cut at the end of next month and apparently bond investors are cool with that.  European yields are also little changed this morning as were JGB yields last night.

In the commodity space, oil (+1.1%) is heading back toward the top of the range I highlighted yesterday, but still more than $1 away and there have been no stories to drive things.  This is all just range trading in my view.  As to the metals markets, this morning gold and silver are essentially unchanged, consolidating their recent gains while copper (-.0.75%) is slipping slightly and has retraced some of its gains from earlier in the month.  Remember, copper is much more an economic play than a fear play or inflation play.

Finally, the dollar is firmer across the board this morning with gains against almost all G10 counterparts on the order of 0.5% and against EMG counterparts it is more like 0.8%.  Even CNY (-0.25%) is weakening as it appears Chinese state banks are selling renminbi in the spot market and hedging in the swap market to help mitigate its recent gains.  It is beginning to feel like the dollar’s decline this year, which has been widespread, is coming to an end.  

On the data front, today brings only New Home Sales (exp 650K) and EIA oil inventories.  Yesterday’s Flash PMI data was right in line with expectations, and my take is until NFP a week from Friday, there is going to be little of interest on the data front for markets overall.  Even PCE this week will have to be significantly different from expectations to have any impact.

It appears that absent Stephen Miran convincing the rest of the FOMC to cut rates aggressively, a very low probability event, the dollar is finding a bottom, and the next major move will be higher on the basis of stronger growth in the US vs. the rest of the world.  Of course, if the Fed does start to get more aggressive, then the dollar will suffer, I just don’t see that happening anytime soon.

Good luck

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The Time Has Come

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(with apologies to Lewis Carroll)

The time has come, the Chairman said,
To speak of many things.
Of joblessness and how inflation,
            Social unrest, brings
And whether we have done our job
            Although we live like kings
 
But wait a bit, the pundits cried
            Before you do explain
For we thought that inflation was
            The overwhelming bane
It was, the Chairman did remark
            But now its jobs that reign

 

On Friday morning, Fed Chair Jay Powell laid out his vision for the immediate future, and much as many had hoped, he was quite clear in his belief that the inflation mission is accomplished.

A person in a suit and tie Description automatically generated

Now, many of us remember how that worked out for the last official who exclaimed that concept a bit too early, but hey, maybe this time IS different!  At any rate, during his Jackson Hole speech, the below comments were what got speculative juices quickening, although a quick look at history indicates all may not be well, at least in the risk asset world.  But first to the soothing words of the Chairman [emphasis added]:

“The time has come for policy to adjust. The direction of travel is clear, and the timing and pace of rate cuts will depend on incoming data, the evolving outlook, and the balance of risks.”  

“We will do everything we can to support a strong labor market as we make further progress toward price stability. With an appropriate dialing back of policy restraint, there is good reason to think that the economy will get back to 2 percent inflation while maintaining a strong labor market. The current level of our policy rate gives us ample room to respond to any risks we may face, including the risk of unwelcome further weakening in labor market conditions.”

So, why, you may ask, would anything negative occur if the Fed is finally going to cut rates?  After all, lower rates add monetary stimulus and allow companies to borrow more cheaply while allowing individuals to reduce their borrowing costs and afford more stuff, like cheaper mortgages making houses more affordable.  But under the rubric, a picture is worth a thousand words, the following chart purloined from X in @allincapital’s feed, does an excellent job of highlighting how equity markets have performed after the Fed pivots to cutting rates.

A screenshot of a graph Description automatically generated

You may have notices that each pivot led to a substantial decline in the S&P 500.  Of course, if you think it through, the basic reason the Fed is pivoting is because the economy is typically heading into, or already in, a recession.  And there has never been a recession when corporate earnings rose across the board. 

This is the crux of the recession argument.  If those who are convinced we are already in a recession are correct, then the prospects for risk assets are dour at best.  On the other hand, for those who remain pollyannaish and believe that the data continues to point to economic strength, the first question is, why should the Fed cut?  And the second question is, why is the data showing rising unemployment, which has an almost perfect correlation of occurring during recessions, not indicating a recession this time?

One last thing, inflation.  You remember that bugaboo, the thing that has had the Fed’s undivided attention for the past two plus years.  Well, given that the money supply has resumed its growth, and money velocity continues to rise, while Chairman Powell has convinced himself that he won the battle, so did Chairman Arthur Burns…three times!  Friday, the equity bulls were in the ascendancy and the market moved to price a 36% chance of a 50bp cut in September with 100bps priced in for the rest of the year while the major indices all rose > 1%.  Personally, I’m a bit wary.

But enough of Friday.  It will take a great deal of new and contradictory information to change the narrative now with the next real chance the NFP report to be released on September 6th.  In the meantime, let’s see what happened overnight.  There was very little in the way of data or activity with only German Ifo readings showing a continuation in their trend lower, printing at 86.6.  It has become increasingly difficult to look at Germany, and its place within Europe as the largest economy by far, and not be concerned over the entire continent’s economic situation.  Energy policies around the Eurozone have hamstrung the economy significantly, and there is no indication that this is either recognized, or if it is, of concern to the governments across the continent.  I understand the short-term view that the Fed is going to start cutting rates and that the dollar has the opportunity to decline because of that, but the longer-term prospects for the euro seem far more dire, at least to my eyes.

Ok, let’s see how markets are handling the unmitigated joy of the Fed finally doing what everyone was so fervently wishing them to do.  In Asia, the Nikkei (-0.7%) didn’t get the bullish memo, likely suffering on the yen’s strength (+1.3% Friday, +0.2% this morning) which started on Friday, right as the Powell speech began.  However, the Hang Seng (+1.0%), India (+0.75%) and Australia (+0.8%) all followed the US movement.  Alas, mainland Chinese shares (-0.1%) continue to lag as the PBOC left rates on hold last night, although some were hopeful of another cut.  In Europe, Germany (-0.3%) is the laggard this morning, not surprisingly given the Ifo data, but overall, markets are moving very little with only the FTSE 100 (+0.5%) showing any life as the only market there following the US.  As to US futures, at this hour (7:10) they are essentially unchanged.

In the bond market, Treasury yields are unchanged this morning, but did fall 5bps on Friday.  In Europe, sovereign yields have all rebounded 2bps, basically unwinding the Friday declines seen in the wake of the Powell comments.  In truth, this is surprising given the lackluster data that was released from Germany, but markets can be that way.  As to JGB yields, they slipped 1bp lower overnight, still not showing any evidence that there is concern the BOJ is going to tighten policy substantially going forward.

In the commodity markets, oil (+2.6%) is rocketing higher after Israel initiated a pre-emptive attack on Hezbollah in Lebanon and Hezbollah responded.  While the WSJ headline is that both sides are now trying to de-escalate things, the oil market, which has seemingly been underpricing risks of a greater supply disruption, has woken up to those risks this morning.  Arguably part of that wakening was the fact that Libya just declared force majeure and has stopped pumping oil because of internal conflict over the central bank and its use of monetary reserves.  Hence, a supply disruption!  Remember, though, the Saudis have a decent amount of spare capacity to fill in if prices start to rise “too” quickly.  

In the metals markets, green is today’s theme with gold (+0.6%) continuing to show its luster as a haven asset.  Meanwhile, silver (+0.9%) has been gaining rapidly amidst stories that China is hording it along with stories that there is not enough silver around to meet the plans for all the solar panels that are still expected to be built.  This movement is dragging copper and aluminum higher as well.

Finally, the dollar is slightly higher this morning overall, although there are some reasonably large movers in smaller currencies.  Surprisingly, NOK (-0.9%) is under pressure despite the big move in oil price higher.  As well, NZD (-0.5%) has slipped, but that was after a very sharp rally on Friday of nearly 2% which seemed to be based on the Fed rate cut story, although NZD responded far more aggressively than any other currency.  We are also seeing weakness in MXN (-0.4%) and SEK (-0.5%) while the euro (-0.2%) and pound (-0.2%) hold up slightly better.  ZAR (-0.1%) may be the best performer today as the metals’ strength seems to be offsetting the dollar’s own strength.

On the data front, there is a decent amount of new information culminating in the PCE data on Friday.

TodayDurable Goods5.0%
 -ex transport-0.1%
TuesdayCase Shiller Home Prices6.0%
 Consumer Confidence100.6
ThursdayInitial Claims234K
 Continuing Claims1870K
 Q2 GDP (2nd look)2.8%
 Goods Trade Balance-$97.5B
FridayPCE0.2% (2.5% Y/Y)
 Ex food & energy0.2% (2.7% Y/Y)
 Personal Income0.2%
 Personal Spendinmg0.5%
 Chicago PMI45.5
 Michigan Sentiment68.0

Source: tradingeconomics.com

In addition to the data, we hear from Fed Governor Waller and Atlanta Fed president Bostic but given that Powell just basically gave the market the roadmap for the Fed’s thinking, it would be surprising if either one changed anything at all.  And given the next really important data point is NFP at the end of next week, Fed speak is likely not that important right now.

At this point, Powell has explained what the Fed is going to do, so the data will help traders and investors adjust the amount of risk they want to take, at least until the point where a recession is more obvious.  Maybe Powell will have successfully prevented a recession, but I still believe the odds are against him.  With that in mind, though, I expect the dollar will remain under pressure for as long as the market believes that Powell is going to cut more aggressively than everybody else.

Good luck

Adf

Bright or Bleak

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As we look ahead to this week
Til Thursday, when Jay’s set to speak
There’s little of note
That’s like to promote
A change in one’s views, bright or bleak

Then Friday, we’ll get PCE
When traders are waiting to see
If there’s any chance
The Fed’s hawkish stance
May change and they’ll restart QE

Some days there is less happening than others, and today is one of those days.  There has been very limited data released with the German Ifo the most notable statistic and it showed virtually no change from last month, still quite negative on the German economy.  Given that Germany is in a recession, I guess that shouldn’t be a big surprise, but the depth of the gloom has only been surpassed by the Covid situation and the GFC.  Even the Eurozone bond crisis in 2012 never saw this indicator so weak.  However, beyond that, there is really very little to discuss.

Thus, let us focus on how things may look going forward.  There continues to be an underlying negative perception across most macroeconomic indicators with the US economy the last bastion of any sort of strength.  China remains in the doldrums with the property sector still under huge pressure and the government there not yet willing to truly bail it out.  Germany is leading Europe lower with other nations beginning to see accelerating weakness as evidenced by last week’s flash PMI data, and emerging markets are beholden to global growth as they do not yet have the ability to drive things on their own.  If the situation in the US is one of a slide into recession, then I expect that the EMG nations will find themselves under further pressure.

And what, you may ask, is driving this process?  Clearly it is the G10 central bank mantra of higher for longer as inflation continues to run rampant around the world.  This results in a situation where investors and hedgers need to determine how much longer the Fed and its brethren central banks will be able to hold the line.  The problem here is this is a political question, not an economic one and political answers are extremely difficult to forecast.

Given that there is a presidential election in the US in 2024 and that the UK will be going to the polls as well with PM Sunak’s stint in office on the line, I expect that there will be significant pressure from both those governments to have the central banks back off the policy tightening and support economic activity.  However, it is unclear when that pressure will really increase and how long either Powell or Bailey will be able to hold the current line.  One of the biggest problems for the Biden administration is that a Republican House of Representative seems unlikely to pass significant stimulus to help the president when recession arrives.  This can be seen in the current fight over the completion of the funding bills for next fiscal year and the potential for a government shutdown at the end of the month.  As such, for Biden, he will be entirely reliant on monetary stimulus which, right now, doesn’t seem forthcoming.

The UK situation will be different, as the Tories control Parliament, however, they are extremely unpopular right now, and it is not clear what they can do to change that situation.  Certainly, if the BOE were to ease policy, it might be a positive but remember, inflation in the UK is the highest in the developed world and so driving inflation higher will not be seen as a positive at all.  My understanding is inflation remains the major pub talking point throughout the UK.  And not in a good way!

In the end we are going to need to see some policy changes to change market behaviors and right now, that seems a fairly distant prospect.  For all of us holding risk assets, that may lead to an uncomfortable time as we have seen over the past week or two and as we see continuing this morning.  Unfortunately, the prospects for a reversal seem as gloomy as this morning’s NY weather.

Anyway, let’s turn to the markets and take stock.  The Nikkei (+0.85%) was the outlier overnight as it managed to rally while the rest of Asia, notably Chinese and Hong Kong shares, all fell pretty sharply.  As to Europe, it is all red there with most bourses pushing lower by about -1.0%.  It seems there is no reprieve yet.  US futures at this hour (8:00) are also under pressure after a lousy week last week, with all three major indices lower by about -0.3%.

However, don’t look for any support in the bond market with yields higher virtually across the board.  Treasury yields are now north of 4.50% and show no sign of slowing down while the 2yr note is not rising in sync.  The curve inversion is down to -60bps now, as the bear steepening continues.  But yields are higher across Europe as well as concerns over inflation continue to grow.  The only exception here is Japan, where JGB yields have edged down 1bp.

In the commodity space, it should be no surprise that the base metals are softer this morning given the economic gloom. As to oil, it was higher for most of the overnight session although it has slipped back to unchanged as New York gets going.  One interesting story is that Eastern Russian crude is now trading above Brent prices near $100/bbl, far, far above the G7 price cap of $60/bbl that was imposed last year.  I guess the G7 didn’t have the market power implicit with that ridiculous idea.

Finally, the dollar is firmer this morning against most of its counterpart currencies.  In the G10 the one outlier is SEK (+0.9%) which has rallied on the idea that the Riksbank has further to tighten than previously expected.  But otherwise, USDJPY is pushing toward 149 and clearly getting close to an uncomfortable level for the BOJ/MOF.  In the EMG space, the story is similar, with the dollar broadly higher across the board.  This has all the appearances of a straight dollar story on the back of rising yields.

On the data front, as mentioned earlier, there is not much on the docket:

TodayChicago Fed Nat’l Activity0.15
TuesdayCase Shiller Home Prices-1.0%
 New Home Sales700K
 Consumer Confidence105.6
WednesdayDurable Goods-0.4%
 -ex Transport0.2%
ThursdayInitial Claims217K
 Continuing Claims1675K
 Q2 GDP Final2.2%
FridayPersonal Spending0.5%
 Personal Income0.4%
 Core PCE0.2% (3.9% y/Y)
 Chicago PMI47.4
 Michigan Sentiment67.7

Source: Tradingeconomics.com

As well as the data, we hear from five Fed speakers beyond Chairman Powell, but clearly all eyes will be on him Thursday afternoon.  It is very difficult to look at the sweep of data and feel confident that the economy is going to avoid a recession.  However, as long as we continue to see strength in the payroll data, I think the Fed has the cover to maintain higher for longer.  Next week’s NFP is going to be crucial with the early estimates at 145K, still positive but sliding down from the past several years.  In the meantime, especially as yields continue to climb in the US, the dollar should remain underpinned against all its counterparts.

Good luck

Adf

Confusion Reigns

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Investors and traders are caught
Twixt data which shows that they ought
Be uber concerned
Although they have learned
That fighting momentum is fraught

And so, it’s confusion that reigns
Reminding us of Maynard Keynes
Though logic dictates
We’re in dire straits
That doesn’t prevent further gains

One of the remarkable things about the current situation across markets and macroeconomics is that every piece of new information seems to add to the confusion rather than any sense of clarity.  As such, both the bulls and the bears, or perhaps the hawks and the doves, have constant reinforcements for their views.  As John Maynard Keynes famously told us all in 1920, “the market can stay irrational longer than you can stay solvent,” and right now, there are many who are flummoxed by the seeming irrationality of the markets.

 

Data continues to print demonstrating economic weakness, with this morning’s German IFO results simply the latest.  Expectations fell sharply to 83.6, a level whose depths had only been plumbed in the past during the GFC, at the beginning of Covid and when Russia invaded Ukraine.  Too, the Business Climate fell to 88.5, mirroring the Expectations index in futility.  In other words, this is an indication that businesses in Germany are not merely in a recession currently but see no escape soon.  And why would they?  After all, Madame Lagarde promised another rate hike next month and there is talk of further hikes later.  So, it appears there will be no short-term relief for the citizens there.   And yet, despite a very modest amount of equity market selling at the end of last week, most equity markets remain solidly higher halfway through 2023.

 

This morning’s data begs the question, can the global economy, or really any industrialized nation’s economy, avoid a recession if the manufacturing sector is declining.  We are all aware that most of the G10 economies are services oriented, while we see much larger proportions of GDP driven by manufacturing in larger emerging markets.  The following table, with data from the World Bank shows what these proportions as percentages of GDP were in 2021 (latest data available):

 

Australia

6

Brazil

10

Canada

10

China

27

Germany

19

India

14

Ireland

35

Japan

20

Korea

25

Mexico

18

South Africa

12

Spain

12

Sweden

13

UK

9

US

11

 

It should be no surprise that China, given their mercantilist policies, are at 27%, nor that South Korea (25%) and Mexico (18%) have relatively large manufacturing sectors.  But both Germany (19%) and Japan (20%) are also quite manufacturing focused.  As such, it should not be that surprising they both had run large trade and current account surpluses given that’s what mercantilist policies generate.  The point is, if manufacturing is heading into a slump, or perhaps already in one, can the broader economy maintain overall growth? 

 

Arguably, there is a significant portion of the services economy that is highly dependent on manufacturing as well.  Consider things like financial services for those companies, transportation of manufactured goods as well as raw materials to factories and food and janitorial services at factories.  Those are not part of the equation, but if factories close down in ‘service oriented’ economies, all those services will shrink as well.  The point is even in the US, where manufacturing technically represents only 11% of GDP, a slump in that sector will have wide ranging impacts.   And what we have seen just this month is a litany of lousy data on the manufacturing side.  ISM Manufacturing (46.9), Kansas City Fed (-12), Philly Fed (-13.7), Dallas Fed (-29.1) and Chicago PMI (40.4) all point to severe weakness in the US manufacturing sector.  Can the US economy really grow strongly with a key sector under such pressure?  Can any economy?  Germany is already in a recession, and we know that their manufacturing sector is sliding.  China, too, has shown weaker data consistently and the government there is trying to figure out how to support the economy to prevent a severe slowdown.  These are the arguments for why an official recession is coming to the US and all of Europe and probably the world. 

 

And yet, equity market bullishness remains intact.  At least based on the major indices.  Despite the fastest set of interest rate hikes in history by the Fed, ECB and BOE amongst others, equity indices are higher throughout the G10 this year, led by the NASDAQ’s remarkable 29% rally.  In addition, as we approach month/quarter end this week investment managers who have not been willing to close their eyes and buy are finding themselves forced into that situation.  Meanwhile, inflation data, while slowing from its peak seen 6mo-9mo ago remains well above central bank targets indicating that there is further monetary policy tightening to come.

 

So, who do you believe?  The data that shows key sectors of the global economy are slowing?  Or the data that shows ongoing strong employment means overall economic activity is continuing to rise?  It is easy to understand why so many analysts are forecasting a recession.  It is also easy to understand why investors don’t respond that way as they watch market performance.  And this, of course, is why Keynes’ words were so prescient, right now, markets do not seem rational, but they are what they are.

 

Arguably the one thing that is not frequently discussed but has been shown to be true over time is that G10 governments do not like to see recessions at all and will do anything they can and spend any amount, to prevent one from occurring.  As long as central banks continue to monetize the debt required to do so, this structure can continue.  But at some point, the debt will overwhelm the system and a correction will occur.  It is anybody’s guess as to when that might happen, but it certainly feels like that day is slowly coming into view.  At some point, investors will ignore what the central banks say and there will be a very significant correction.  But there’s nothing to say it can’t wait five more years.  As I said, confusion reigns.

 

Turning to the market activity overnight, After Friday’s down session in the US, Asia continued that trend with Chinese equity markets the weakest of the bunch, but screens red across the region.  Europe, which had been uniformly negative earlier in the session has now seen a very modest bounce back to basically unchanged although US futures remain slightly in the red.

 

That risk-off feeling is being seen in bond markets with yields lower across the board this morning as both Treasuries and European sovereigns find themselves with yields sitting between 3bps and 4bps softer than Friday’s closing levels.  The 2yr-10yr yield curve inversion remains -102bps, certainly not a positive economic sign, and we are seeing European curves invert as well.  Even JGB yields are a touch lower this morning.

 

Oil prices are a touch higher this morning although WTI remains below $70/bbl and metals prices are also a bit firmer, bouncing off recent lows.  However, that seems more to do with dollar weakness than commodity strength.

 

Which is a bit odd as during a classic risk-off session, the dollar tends to do quite well, yet today it is softer vs. all its G10 counterparts led by NOK (+0.9%) and many EMG currencies.  Forgetting TRY (-2.7%), the other losers are CNY (-0.7%) which is catching up after a few days of Mainland holidays, and TWD (-0.3%).  However, there is a long list of gainers led by ZAR (+0.9%) and HUF (+0.6%).  Arguably, falling Treasury yields are hurting the dollar somewhat, but quite frankly, I’m not convinced that is the driver here.

 

On the data front, as it is the last week of the month, we will get updated GDP and PCE figures as well as an array of things:

 

Today

Dallas Fed

-20.0

Tuesday

Durable Goods

-0.9%

 

-ex transportation

0.0%

 

Case Shiller Home Prices

-2.60%

 

New Home Sales

675K

 

Consumer Confidence

103.8

Thursday

Initial Claims

264K

 

Continuing Claims

1772K

 

Q1 GDP

1.4%

Friday

Personal Income

0.3%

 

Personal Spending

0.2%

 

Core PCE Deflator

0.3% (4.7% Y/Y)

 

Chicago PMI

44.0

 

Michigan Sentiment

63.9

Source: Bloomberg

 

On the speaker front, the ECB has their summer confab in Sintra, Portugal this week with Powell, Lagarde, Ueda and Bailey all speaking on Wednesday and Thursday.  It will certainly be interesting to hear them all together as they try to convince themselves they are in control.

 

I remain skeptical as to the potential for further gains in risk assets, but I have been skeptical for months and been wrong.  As to the dollar, if yields are going to decline, I could see the dollar slide further, but if risk does get jettisoned, I expect the dollar to find a bid.

 

Good luck

Adf

Unchecked

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In Europe, the maximum nation
Is facing the scourge of inflation
And so, they are calling,
To help it start falling,
For less money accommodation

But others in Europe reject
The idea inflation’s unchecked
T’would be premature
To tighten, they’re sure
As QE they want to protect

It appears there is a growing rift in the ECB as we are beginning to hear more opposing views regarding the nature of inflation and correspondingly as to the prescription to address the issue.  On the one hand, the hawks have been sharpening their talons with Germany’s Schnabel, Slovenia’s Vasle and Spain’s de Guindos having all warned of inflation’s surprising persistence and explaining that the risk is to the upside for higher inflation still.  Meanwhile, this morning we had an erstwhile Hawk, Austria’s Holzmann, and an uber-dove, Italy’s Panetta pushing back on that view and insisting that the inflation that has been afflicting Europe is being driven by “purely temporary factors” and that premature withdrawal of stimulus would be a mistake.

The surprising feature of this discussion is that the Spanish voice is hawkish while the Austrian is dovish.  Perhaps what that tells us is that, just like in the US, inflation has become a bigger political problem in Spain and the Socialist PM, Pedro Sanchez, is feeling the heat from the population there.  This would not be surprising given inflation is running at 5.4%, the highest level since the introduction of the euro in 1999.  Arguably, the fact that Robert Holzmann seems to be siding with the transitory camp is also quite the surprise, but as they say, politics makes strange bedfellows.  In the end, as long as Madame Lagarde remains at the helm, the doves remain in control.  As such, these comments sound very much like posturing for particular audiences.

Turning to other news, Germany is at the center of the most interesting stories today as local politics (the formation of a new government…finally) as well as data (IFO Expectations fell to 94.2) seem to be driving the euro bus, and with the euro, the rest of the markets.  A brief look at the proposed government shows a coalition of the Social Democrats (SPD), the Greens and the Free Democratic Party (FDP) which is a pro-growth, free markets group.  This unprecedented grouping of 3 parties remains tenuous, at best, if only because the underlying belief sets are very different.  It remains unclear how a party whose focus is on less government (FDP) is going to work effectively with a party whose focus is on bigger government (SPD).  Olaf Scholz will be the new PM, a man with long experience in politics and a widely respected name.  As I said before, politics makes strange bedfellows!

On the economic side, this morning’s IFO data was quite disappointing, with Expectations falling back to levels seen in the beginning of the year and reaching a point that foretells of a recession coming.  Adding this to the imminent lockdown scenario (Germany’s Covid caseload jumped by 54K yesterday, with a significant surge ongoing), leaves quite the negative impression for the German economy.  In fact, given this news, it becomes harder for the hawks to make their case as the central bank model continues to believe that slowing growth will slow inflation.  (And while that would be true for demand-pull inflation, the whole cost-push framework is different.)  At any rate, the result is a day where risk is being shed and havens sought.  This is especially so in Germany, where the DAX (-0.6%) is the weakest performer in Europe, while Bunds (-1.7bps) have rallied despite a terrible auction outcome as investors adjust asset mixes.  And the euro?  Down a further 0.3%, trading just above 1.1200, although it appears that there is further to run.

What about the rest of markets?  Well, the Nikkei (-1.6%) fell sharply as investors in Japan expressed concern that the Fed would begin to tighten, and it would have negative impacts throughout the world.  At least that is what they claim.  China, on the other hand saw much less movement with the Hang Seng (+0.1%) and Shanghai (+0.1%) seeing a mix of gainers and losers internally thus offsetting for the index as a whole.  The rest of Europe is generally softer (CAC -0.2%, Spain’s IBEX -0.3%), although the FTSE 100 is basically unchanged on the day.  And after a mixed day yesterday, US futures are pointing modestly lower, -0.2% or so across the board.

As to the rest of the bond market, Treasuries (-2.4bps) are finally rallying after seeing a dramatic 12 basis point rise in the past three sessions.  We have also seen OATs (-0.7bps) rally slightly and Dutch bonds (-1.6bps) all the havens.  It should not, however, be surprising that Italian BTPs (+1.2bps) and Greek bonds (+3.9bps) are being sold as they remain risk assets in full.

On the commodity front, oil, which has been suffering from the SPR release story, seems to have absorbed that risk and after rebounding yesterday is flat this morning.  While still below $80/bbl, my sense is this has further to run higher.  NatGas (-0.25%) is a touch lower in the US as is gold (-0.1%).  However, the industrial metals are performing far better (Cu +0.7%, Al +0.7%, Sn +0.4%).

Lastly, the dollar is generally having a good day again, as risk appetite wanes.  NZD (-0.6%) is the weakest G10 currency after the market was disappointed in their actions last night, only raising the base rate by 0.25% while the whisper number was 0.5%. SEK (-0.4%) is the next laggard, with the krona continuing to suffer on the view that the Riksbank will remain reluctant to tighten policy at all in the face of actions by the Fed and potentially the BOE.  The rest of the bloc is generally softer with only the haven, JPY (+0.1%), showing any strength.

In the EMG space, we need to look away from TRY (+5.6%) which is retracing some of yesterday’s remarkable decline, as it is destined for extreme volatility in the near future.  But elsewhere, there is actually a mixed result with BRL (+0.6%) and PHP (+0.5%) leading the gainers while THB (-0.7%) and RUB (-0.3%) lag the space.  The real is benefitting from the central bank announcement it will be auctioning off 14K contracts in the FX markets, part of their intervention process, while the Philippine peso has benefitted from further investment inflows to the local stock market.  On the flipside, the baht seems to be suffering from concerns that the lockdowns in Europe will reduce tourism there during the high season, while the ruble continues to suffer from concerns over potential military activity and the further negative impacts of sanctions that could follow.

Given tomorrow’s Thanksgiving holiday, all the rest of the week’s data will be released today:

Initial Claims 260K
Continuing Claims 2033K
GDP Q2 2.2.%
Durable Goods 0.2%
-ex Transport 0.5%
Personal Income 0.2%
Personal Spending 1.0%
Core PCE 0.4% (4.1% Y/Y)
Michigan Sentiment 67.0
New Home Sales 800K
FOMC Minutes

Source: Bloomberg

As the GDP data is a revision, it will not garner much attention.  Rather, all eyes will be focused on Core PCE, as if recent form holds, it will print higher than expectations, further forcing the Fed debate.  And of course, the Minutes will be parsed intently as traders try to divine just how quickly things may change next month, especially since Chairman Powell and Governor Brainerd have both been clear that inflation is their primary concern now.

At this point, there is nothing to stand in the way of the dollar and I expect that it will continue to grind higher for a while.  The hallmark of the move so far this month, where the single currency has fallen 3.0%, is that it has been remarkably steady with a majority of sessions showing modest declines.  That pattern seems likely to continue for now unless there is a change from either the Fed or the ECB, neither of which seems likely.  Hedge accordingly.

Have a wonderful Thanksgiving holiday and poetry will return on Monday November 29th.

Good luck, good weekend and stay safe
Adf

Flames of Concern

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The story is still Evergrande
Whose actions last night have now fanned
The flames of concern
‘Til bondholders learn
If coupons will be paid as planned

Though pundits have spilled lots of ink
Explaining there’s really no link
Twixt Evergrande’s woes
And fears of new lows
The truth is they’re linked I would think

It must be very frustrating to be a government financial official these days as despite all their efforts to lead investors to a desired outcome, regardless of minor details like reality, investors and traders continue to respond to things like cash flows and liquidity, or lack thereof.  Hence, this morning we find ourselves in a situation where China Evergrande officially failed to pay an $83.2 million coupon yesterday and now has a 30-day grace period before they can be forced into default on the bond.  The concern arises because China Evergrande has more than $300 billion in bonds outstanding and another $300 billion in other liabilities and it is pretty clear they are not going to be able to even service that debt, let alone repay it.

At the same time, the number of articles written about how this is an isolated situation and how the PBOC will step in to prevent a disorderly outcome and protect the individuals who are on the hook continue to grow by leaps and bounds.  The true victims here are the many thousands of Chinese people who contracted with Evergrande to build their home, some of whom prepaid for the entire project while others merely put down significant (>50%) deposits, and who now stand to lose all their money.  Arguably, the question is whether or not the Chinese government is going to bail them out, even if they allow Evergrande to go to the wall.  Sanguinity in this situation seems optimistic.  Remember, the PBOC has been working very hard to delever the Chinese property market, and there is no quicker way to accomplish that than by allowing the market to reprice the outstanding debt of an insolvent entity.  As well, part of President Xi’s calculus will be what type of pain will be felt elsewhere in the world.  After all, if adversaries, like the US, suffer because of this, I doubt Xi would lose any sleep.

But in the end, markets this morning are demonstrating that they are beginning to get concerned over this situation.  While it may not be a Lehman moment, given that when Lehman was allowed to fail it was truly a surprise to the markets, the breadth of this problem is quite significant and the spillover into the entire Chinese property market, which represents ~25% of the Chinese economy, is enormous.  If you recall my discussion regarding “fingers of instability” from last week (Wednesday 9/15), this is exactly the type of thing I was describing.  There is no way, ex ante, to know what might trigger a more significant market adjustment (read decline), but the interconnectedness of Chinese property developers, Chinese banks, Chinese shadow financiers and the rest of the world’s financial system is far too complex to parse.  However, it is reasonable to estimate that there will be multiple knock-on effects from this default, and that the PBOC, no matter how well intentioned, may not be able to maintain control of an orderly market.  Risk should be off, and it is this morning.

It ought not be surprising that Chinese shares were lower last night with the Hang Seng (-1.3%) leading the way but Shanghai (-0.8%) not that far behind.  Interestingly, the only real winner overnight was the Nikkei (+2.1%) which seemed to be making up for their holiday yesterday.  European shares are having a rough go of it as well, with the DAX (-0.8%), CAC (-1.0%) and FTSE 100 (-0.3%) all under the gun.  There seem to be several concerns in these markets with the primary issue the fact that these economies, especially Germany’s, are hugely dependent on Chinese economic growth for their own success, so signs that China will be slowing down due to the Evergrande mess are weighing on these markets.  In addition, the German IFO surveys were all released this morning at weaker than expected levels and continue to slide from their peaks in June.  Slowing growth is quickly becoming a market meme.  After yesterday’s rally in the US, futures this morning are all leaning lower as well, on the order of -0.3% or so.

The bond market this morning, though, is a bit of a head-scratcher.  While Treasuries are doing what they are supposed to, rallying with yields down 2.6bps, the European sovereign market is all selling off despite the fall in equity prices.  So, yields are higher in Germany (Bunds +1.4bps) and France (OATs +2.2bps), with Italy (BTPs +5.0bps) really seeing some aggressive selling.  Gilts are essentially unchanged on the day.  But this is a bit unusual, that a clear risk off session would see alleged haven assets sell off as well.

Commodity markets are having a mixed day with oil unchanged at this hour while gold (+0.75%) is rebounding somewhat from yesterday’s sharp decline.  Copper (+0.1%) has edged higher, but aluminum (-1.4%) is soft this morning.  Agricultural prices are all lower by between 0.25% and 0.5%.  In other words, it is hard to detect much signal here.

As to the dollar, it is broadly stronger with only CHF +0.1%) able to rally this morning.  While the euro is little changed, we are seeing weakness in the Antipodean currencies (AUD, NZD -0.4%) and commodity currencies (CAC -0.2%, NOK -0.15%).  Granted, the moves have not been large, but they have been consistent.

In the EMG bloc, the dollar has put on a more impressive show with ZAR (-1.3%) and TRY (-0.9%) leading the way, although we have seen other currencies (PHP -0.6%, MXN -0.4%) also slide during the session.  The rand story seems to be a hangover from yesterday’s SARB meeting, where they left rates on hold despite rising inflation there.  TRY, too, is still responding to the surprise interest rate cut by the central bank yesterday.  In Manila, concern seems to be growing that the Philippines external balances are worsening too rapidly and will present trouble going forward.  (I’m not sure you remember what it means to run a current account deficit and have markets discipline your actions as it no longer occurs in the US, but it is still the reality for every emerging market economy.)

On the data front, we see only New Home Sales (exp 715K), a number unlikely to have an impact on markets.  However, we hear from six different Fed speakers today, including Chairman Powell, so I expect that there will be a real effort at fine-tuning their message.  Three of the speakers are amongst the most hawkish (Mester, George and Bostic), but of this group, only Bostic is a voter.  You can expect more definitive tapering talk from these three, but in the end, Powell’s words still carry the most weight.

The dollar remains in a trading range and we are going to need some exogenous catalyst to change that.  An Evergrande collapse could have that type of impact, but I believe it will take a lot more contagion for that to be the case.  So, using the euro as a proxy, 1.17-1.19 is still the right idea in my view.

Good luck, good weekend and stay safe
Adf

No Need to be Austere

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From every Fed speaker we hear
That prices might rise some this year
But they all confirm
It will be short-term
So, there’s no need to be austere

I feel like today’s note can be very short as there really has been nothing new of note to discuss.  Risk is on the rise as market participants continue to absorb the Federal Reserve message that monetary stimulus is going to continue, at least at the current pace, for at least the next two years.  That’s a lot of new money, nearly $3 trillion more to add to the Fed balance sheet, and if things hold true to form, at least 60% of it will wind up in the equity market.

This was confirmed by four Fed speakers yesterday, including Powell and Vice Chair Clarida, who made it quite clear that this was no time to start tapering, and that rising bond yields were a vote of confidence in the economy, not a precursor to rising inflation.  What about inflation you may ask?  While they fully expect some higher readings in the short run due to base effects, they will be transitory and present no problem.  And if inflation should ever climb to a more persistent level that makes them uncomfortable, they have the tools to address that too!  I know I feel a lot better now.

Europe?  The big news was the German IFO Expectations index printing at a much better than expected 100.4, despite the fact that Covid continues to run rampant through the country.  While they have managed to avoid the massive Easter lockdown that had been proposed earlier this week, the ongoing failure to vaccinate the population remains a damper on activity, or at least the perception of activity.  Otherwise, we learned that Italy is struggling to pay its bills, as they need to find €15 billion quickly in order to continue the present level of fiscal support, but have a much tougher time borrowing, and have not yet received the money from the Eurozone fiscal support package.  In the end, however long the Fed is going to be expanding its balance sheet, you can be sure the ECB will be doing it longer.

The UK?  Retail Sales were released showing the expected gains relative to last month (+2.
1% M/M. -3.7% Y/Y) and excitement is building that given the rapid pace of vaccinations there, the economy may be able to reopen more fully fairly soon.  Certainly, the pound has been a beneficiary of this versus the euro, with the EURGBP cross having declined more than 5% this year, meaning the pound has appreciated vs. the euro by that much.  Perhaps Brexit is not as big a deal as some thought.

Japan?  The latest $1 trillion budget is being passed, which simply adds to the three supplementary budgets from last year totaling nearly $750 billion, with most observers expecting more supplementary budgets this year.  But hey, the Japanese have perfected the art of borrowing unfathomable sums, having the central bank monetize them and maintaining near zero interest rates.  Perhaps it should be no surprise that USDJPY has been rising, because on a relative basis, the Japanese situation does seem worse than that here in the US.

Other than these stories, things are just not that exciting.  The Suez Canal remains closed and we are starting to see ships reroute around the Cape of Good Hope in Africa, which adds more than a week to transit times and considerable expense.  But I’m sure these price rises are transitory too, just ask the Fed.

So, let’s take a quick tour of markets.  Equities are all green right now and were so overnight.  The three main Asian indices, Nikkei, Hang Seng and Shanghai, all rose 1.6% last night after US markets turned around in the afternoon.  European bourses are looking good, with the DAX (+0.6%), CAC (+0.4%) and FTSE 100 (+0.7%) all solidly higher on the day.  As to US futures, both Dow and S&P futures are a touch higher, 0.2% or so, but NASDAQ futures are under a bit of pressure at this hour, -0.3%.

In the bond market, 10-year Treasury yields are higher by 4.1bps in the wake of yesterday’s really mediocre 7-year auction.  While it wasn’t as bad as the last one of this maturity, it continues to call into question just how able the Treasury will be to sell sufficient bonds to fund all their wish list.  Even at $80 billion per month of purchases, the Fed is falling behind the curve here and may well need to pick up the pace if yields start to climb more.  I know that is not their current story, but oversupply is certainly at least part of the reason that Treasuries have been so weak.  And today, despite ECB support, European sovereign bonds are all lower with yields higher by 4.5bps or more virtually across the board.  Either the ECB has taken today off, or there are bigger worries afoot.  One little known fact is that alongside the ECB, European commercial banks had been huge buyers of their own country’s debt for all of last year.  However, that pace has slowed, so perhaps today’s movement is showing a lack of natural buyers here as well.

Commodity prices are pretty much firmer across the board with the exception of precious metals, which continue to suffer on the back of higher US yields.  But oil (+2.3%) is back at $60/bbl and base metals and agricultural prices are all firmer this morning.

Finally, the dollar is broadly weaker at this hour, with the commodity bloc of the G10 leading that group (NZD +0.5%), NOK (+0.4%), (AUD +0.4%), although the pound (+0.3%) is also doing well after the Retail Sales numbers.  Meanwhile, the havens are under pressure (JPY -0.5%), CHF (-0.15%), as there is no need for a haven when the central bank has your back!

EMG currencies are a bit less interesting, although the APAC bloc was almost uniformly higher by small amounts.  That was simply on the back of the risk-on attitude that was manifest overnight.  The one exception here is TRY (-1.1%) which continues to suffer over the change of central bank leadership and concerns that inflation will run rampant in Turkey.  Two other noteworthy things here were in LATAM, where Banxico left rates on hold at 4.0%  yesterday afternoon and reaffirmed they were entirely focused on data, and that S&P downgrade Chile’s credit rating to A from A+ on the back of the changes in government structure and concerns about the medium term fiscal position.

On the data front we see Personal Income (exp -7.2%), Personal Spending (-0.8%), Core PCE (1.5%) and then at 10:00 Michigan Sentiment (83.6).  To me, the only number that matters is the PCE print, but this is a February number, so not expected to be impacted by the significant base effects from last year’s events.  Of course, given the constant chorus of any rising inflation will be transitory, we will need to see a lot of high prints before the market gets nervous…or will we?  After all, the bond market seems to be getting nervous already.

At any rate, while the dollar is under pressure this morning, my take is that if US yields continue to climb, we are likely to see it retrace its steps.  At this point, I would argue the dollar’s trend is higher and will be until we see much higher inflation readings later this spring and summer.

Good luck, good weekend and stay safe
Adf

Covid Comes Calling

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The German economy’s stalling
In Q1, as Covid comes calling
But still there’s belief
That fiscal relief
Will stop it from further snowballing

Consensus is hard to find this morning as we are seeing both gains and losses in the various asset classes with no consistent theme.  Perhaps the only significant piece of news was the German IFO data, which disappointed across the board, not merely missing estimates but actually declining compared with December’s data.  This is clearly a response to the renewed lockdowns in Germany and the fact that they have been extended through the middle of February.  The item of most concern, is that the manufacturing sector, which up until now had been the brightest spot, by far, is also seeing softness.  Now part of this problem has to do with the fact that shipping has been badly disrupted with insufficient containers available to ship products.  This has resulted in higher shipping costs and reduced volumes, hence reduced sales.  But part of this issue is also the fact that since virtually all of Europe is in lockdown, economic activity on the continent is simply slowing down.  It is the latter point that informs my view of the ECB’s future activities, namely non-stop monetary ease for as far as the eye can see.

When combining that view, the ECB will continue to aggressively ease policy, with the fact that the Fed is also going to continue to ease policy, it becomes much more difficult to estimate which currency is going to underperform.  Heading into 2021, the strongest conviction trade across markets was that the dollar was going to decline sharply, continuing the descent from its March 2020 highs.  And that’s exactly what we saw…for the first week of the year.  However, since then, the dollar has reversed those losses and currently sits higher on the year vs. most currencies.  My point is, and has consistently been, that in the FX market, the dollar is a relative game, and the policies of both nations are critical in establishing its value.  Thus, if every nation is aggressively easing policy, both monetary and fiscal, then the magnitude of those policy efforts are critical.  Perhaps, the fact that Congress has yet to pass an additional stimulus bill, especially given the strong belief that the Blue Wave would quickly achieve that, has been sufficient to change some views of the dollar’s future strength (weakness?).  Regardless, the one thing that is clear is that the year has just begun and there is plenty of time for more policy action as well as more surprises.  In the end, I do believe that as inflation starts to climb in the US, and real interest rates fall to further negative levels, the dollar will ultimately fall.  But that is a Q2-Q3 outcome, not really a January story.

And remarkably, that is basically the biggest piece of news from overnight.  At this point, traders and investors are turning their attention to the FOMC meeting on Wednesday, although there are no expectations for policy shifts yet.  However, the statement, and Chairman Powell’s press conference, will be parsed six ways to Sunday in order to try to glean the future.  Based on what we heard from a majority of Fed speakers before the quiet period began, there is no current concern over the backup in Treasury yields, and there is limited sentiment for the Fed to even consider tapering their policy of asset purchases, with just four of the seventeen members giving it any credence.  One other thing to remember is that the annual rotation of voting regional presidents has turned more dovish, with Cleveland’s Loretta Mester, one of the two most hawkish members, being replaced by Chicago’s Charles Evans, a consistent dove.  The other changes are basically like for like, with Daly for Kashkari (two extreme doves) and Barkin and Bostic replacing Harker and Kaplan.  These four are the minority who discussed the idea that tapering purchases could be appropriate by the end of the year, so, again, no change in voting views.

With this in mind, we can see the lack of consistent message from overnight activity.  Asian equity markets were all firmer, led by the Hang Seng (+2.4%), with the Nikkei (+0.7%) and Shanghai (+0.5%) trailing but in the green.  However, Europe has fared less well after the soft IFO data with all three major markets (DAX, CAC and FTSE 100) lower by -0.6%.  As to US futures, they are the perfect embodiment of a mixed session with NASDAQ futures higher by 0.8% while DOW futures are lower by 0.2%,

Bond markets, though, have shown some consistency, with yields falling in Treasuries (-1.0bp) and Europe (Bunds -1.7bps, OATs -1.5bps, Gilts -2.2bps).  The biggest winner, though, are Italian BTPs, which have rallied more than half a point and seen yields decline 5.3 basis points.  It seems that concerns over the government falling have abated.  Either that or the 0.70% yield available is seen as just too good to pass up.

On the commodity front, oil prices have edged up by the slightest amount, just 0.1%, as the consolidation of the past three months’ gains continues.  Gold has risen 0.4%, but there is a great deal of discussion that, technically, it has begun a downtrend and has further to fall.  Again, consistent with my view that real interest rates are likely to decline sharply in Q2, when inflation really starts to pick up, we could easily see gold slide until then, before a more emphatic recovery.

And lastly, the dollar, where both G10 and EMG blocs show a virtual even split of gainers and losers.  Starting with the G10, NZD (+0.3%) is today’s “big” winner, with SEK (+0.25%) next in line.  Market talk is about the reduction of restrictions in Australia’s New South Wales state as a reason for optimism in AUD (+0.15%) and NZD.  As for SEK, this is simply a trading move, with no obvious catalysts present.  On the flip side, the euro (-0.1%) is the worst performer, arguably suffering from that German IFO data, with other currencies showing little movement in either direction.

The EMG bloc is led by TRY (+0.4%), as it seems discussions between Turkey and Greece to resolve their competing claims over maritime boundaries is seen as a positive.  After the lira, though, no currency has gained more than 0.2%, which implies there is nothing of note to describe.  On the downside, ZAR (-0.4%) is the worst performer, which appears to be a positioning move as long rand positions are cut amid concerns over the spread of Covid and the lack of effective government response thus far.

On the data front, the week is backloaded with Wednesday’s FOMC clearly the highlight.

Tuesday Case Shiller Home Prices 8.65%
Consumer Confidence 89.0
Wednesday Durable Goods 1.0%
-ex transport 0.5%
FOMC Meeting 0.00%-0.25% (unchanged)
Thursday Initial Claims 880K
Continuing Claims 5.0M
GDP Q4 4.2%
Leading Indicators 0.3%
New Home Sales 860K
Friday Personal Income 0.1%
Personal Spending -0.4%
Core PCE 1.3%
Chicago PMI 58.0
Michigan Sentiment 79.2

Source: Bloomberg

So, plenty of stuff at the end of the week, and then Friday, two Fed speakers hit the tape.  One thing we know is that the housing market continues to burn hot, meaning data there is assumed to be strong, so all eyes will be on the PCE data on Friday.  After all, that is the Fed’s measuring stick.  The other thing that we have consistently seen during the past six months is that inflationary pressures have been stronger than anticipated by most analysts.  And it is here, where the Fed remains firmly of the belief that they are in control, where the biggest problems are likely to surface going forward.  But that is a story for another day.  Today, the dollar is wandering.  However, if the equity market in the US can pick up its pace, don’t be surprised to see the dollar come under a little pressure.

Good luck and stay safe
Adf

Quickly Diminished

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck and stay safe
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‘Twas Nothing At All

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Does anyone here still recall
When Covid had cast a great pall
On markets and life
While causing much strife?
Me neither, ‘twas nothing at all!

One can only marvel at the way the financial markets have been able to rally on the same story time and again during the past two years. First it was the trade talks. After an initial bout of concern that growing trade tensions between the US and China would derail the global economy led to a decline in global equity market indices, about every other day we heard from President Trump that talks were going very well, that a Phase One deal was imminent and that everything would be great. And despite virtually no movement on the subject for months, those comments were sufficient to drive stock prices higher every time they were made. Of course, we all know that a phase one deal was, in fact, reached and signed, but it occurred a scant week before the outbreak of the novel coronavirus.

What has been truly remarkable is that the market’s reaction to the virus has followed almost the exact same pattern. Once it became clear that Covid-19 was going to be a big deal, causing significant disruption throughout the world, stock prices tumbled in a series of extraordinary sessions in March and early April. But since then, we have seen a powerful rally back to within a few percent of the all-time highs set in February. And these days, every rally is based on the exact same story; to wit, some company [insert name here] is on the cusp of creating a successful Covid vaccine and things will be back to normal soon.

So, as almost all of us continue to work from home, shelter in place and maintain our social distance, investors (gamblers?) have discerned that everything is just fine, and that economic recovery is on the way. And maybe they are right. Maybe history is going to look back on this time and show it was an extremely large disruption, but an extremely short-term one that had almost no long-term impact. But, boy, that seems like a hard picture to paint if you simply look at the data and understand how economies work.

Every day we see data that describes how extraordinary the impact of government lockdown policies has been, with rampant unemployment, virtual halts in manufacturing, complete halts in group entertainment and bankruptcies of erstwhile venerable companies. And every day the global equity markets rally on the prospect of a new vaccine being discovered. I get that markets are forward looking, but they certainly seem blind to the extent of damage already inflicted and what that means for the future. Even if activities went back to exactly the way they were before the outbreak, the fact remains that many businesses are no longer in existence. They could not withstand the complete absence of revenues for an extended period of time, and so have been permanently shuttered. And while new businesses will rise to take their place, that is not an overnight process. It seems thin gruel to rally on the fact that Germany’s IFO Expectations Index rallied from its historically worst print (69.4) to its second worst print (80.1), but slightly higher than expected. Or that the GfK Consumer Confidence managed the same feat (-23.4 to -18.9). Both of these data points are correlated with extremely deep recessions.

And yet, that is the situation in which we find ourselves. The dichotomy between extremely weak economic activity and a strong belief that not only is the worst behind us, but that the damage inflicted has been modest, at best. Today is a perfect example of that situation with risk firmly in the ascendancy after the long holiday weekend.

Equity markets are on fire, rallying sharply in Asia (Nikkei +2.5%, Hang Seng +1.9%, Shanghai +1.0%) despite the fact that there is evidence that a second wave of infections is growing in China and may once again force the government there to shut down large swathes of the economy. Europe, too, is rocking with the FTSE 100 (+1.2%) leading the way although gains seen across the board (DAX +0.6%, CAC +1.1%). And US futures would not dare to be left out of this rally, with all three indices up around 2.0%. Meanwhile, Treasury yields are higher by 3.5 basis points with German bund yields higher by 6bps. Of course, Italy, Portugal and Greece have all seen their yields slide as those bond markets behave far more like risk assets than havens.

I would be remiss to ignore the commodity markets which have seen oil rally a further 2.25% this morning, back to $34/bbl and the highest point since the gap down at the beginning of this process back in early March. Gold, on the other hand, is a bit softer, down 0.3%, but remains firmly above $1700/oz as many investors continue to look at central bank activity and register concern over the future value of any fiat currency.

And then there is the dollar, which has fallen almost across the board overnight, and is substantially lower than where we left it Friday afternoon. In the G10 space, AUD (+1.3%) and NZD (+1.5%) are the leaders on the back of broadly positive risk sentiment helped by a better than expected Trade Surplus in New Zealand along with a larger than expected rebound in the ANZ Consumer Confidence Index, to its second lowest reading in history. But the pound is higher by 1.1% on prospects of an end to the nationwide lockdown in the UK. And in fact, other than the yen, which is unchanged, the rest of the bloc is firmer by 0.5% or more, largely on the positive risk sentiment.

In the emerging markets, the runaway winner is the Mexican peso, up 2.7% since Friday’s close as a combination of higher oil prices, a more hawkish Banxico than expected and growing belief that the US, its major export partner, is reopening has led to a huge short-squeeze in the FX markets. In the past week, the peso has recouped nearly 7% of its losses this year and is now down a mere 14.5% year-to-date. Helping the story is the just released GDP number for Q1, which showed a decline of only -1.2%, better than the initially reported -1.6%. But we are also seeing strength throughout the EMG bloc, with PLN (+1.8%), BRL (+1.6%) and ZAR (+1.2%) all putting in strong performances. Risk sentiment is clearly strong today.

Into this voracious risk appetite, we will see a great deal of data this holiday-shortened week as follows:

Today Case Shiller Home Prices 3.40%
  New Home Sales 480K
  Consumer Confidence 87.0
Wednesday Fed’s Beige Book  
Thursday Initial Claims 2.1M
  Continuing Claims 25.75M
  Q1 GDP -4.8%
  Q1 Personal Consumption -7.5%
  Durable Goods -19.8%
  -ex transport -15.0%
Friday Personal Income -6.5%
  Personal Spending -12.8%
  Core PCE Deflator -0.3% (1.1% Y/Y)
  Chicago PMI 40.0
  Michigan Sentiment 74.0

Source: Bloomberg

In addition to the plethora of data, we hear from six different Fed speakers, including Chairman Powell on Friday morning. On this front, however, the entire FOMC has been consistent, explaining that they will continue to do what they deem necessary, that they have plenty of ammunition left, and that the immediate future of the economy will be awful, but things will improve over time.

In the end, risk is being snapped up like it is going out of style this morning, as both investors and traders continue to look across the abyss. I hope they are right…I fear they are not. But as long as they continue to behave in this manner, the dollar will remain under pressure. It rallied a lot this year, so there is ample room for it to decline further.

Good luck and stay safe
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