No Use Delaying

In Europe, the powers that be
Are feeling quite smug, don’t you see
Not only have they
Held Covid at bay
But also, they borrow for free

Thus, Italy now wants to spend
More money, recession, to end
If Germany’s paying
There’s no use delaying
With Merkel now Conte’s best friend

The euro is continuing its climb this morning, as it mounts a second attack on 1.1600, the highest level it has traded since October 2018. While the overall news cycle has been relatively muted, one thing did jump out today. It should be no surprise, but Italy is the first nation to take advantage of the new EU spending plans as they passed a supplemental €25 billion budget to help support their economy.

Now, it must be remembered that prior to the pandemic, Italy was in pretty bad shape already, at least when looking at both fiscal and economic indicators. For instance, Italy was in recession as of Q4 2019, before Covid, and it was maintaining a debt/GDP ratio of more than 130%. Unemployment was in double digits and there was ongoing political turmoil as the government was fighting for its life vs. the growing popularity of the conservative movement, The League, led by Matteo Salvini. Amongst his supporters were a large number of Euroskeptics, many of whom wanted to follow in the UK’s footsteps and leave the EU. (Quitaly, not Italexit!) However, it seems that the economic devastation of Covid-19 may have altered the equation, and while Salvini’s League still has the most support, at 26%, it has fallen significantly since the outbreak when it was polling more than 10 points higher. Of course, when the government in power can spend money without limits, which is the current situation, that tends to help that government stay in power. And that is the current situation. The EU has suspended its budget restrictions (deficits <3.0%) during the pandemic, and Italy clearly believes, and are probably correct, that the EU is ultimately going to federalize all EU member national debt.

It seems the growing consensus is that federalization of EU fiscal policies will be a true benefit. Of course, it remains to be seen if the 8 EU nations that are not part of the Eurozone will be forced to join, or if the EU will find a way to keep things intact. My money is on the EU forcing the issue and setting a deadline for conversion to the euro as a requisite for remaining in the club. Of course, this is all looking far in the future as not only are these monumental national decisions, but Europe takes a very long time to move forward on pretty much everything.

This story, though, is important as background information to developing sentiment regarding the euro, which is clearly improving. In fairness, there are shorter term positives for the single currency’s value, notably that real interest rates in the rest of the world are falling rapidly, with many others, including the US, now plumbing the depths of negative real rates. Thus, the rates disadvantage the euro suffered is dissipating. At the same time, as we have seen over the past several months, there is clearly very little fear in the market these days, with equity prices relentlessly marching higher on an almost daily basis. Thus, the dollar’s value as a safe haven has greatly diminished as well. And finally, the appearance of what seems to be a second wave of Covid infections in the US, which, to date, has not been duplicated as widely in Europe, has added to confidence in the Eurozone and the euro by extension.

With all this in mind, it should be no surprise that the euro continues to rally, and quite frankly, has room for further gains, at least as long as the economic indicators continue to rebound. And that is the big unknown. If the economic rebound starts to falter, which may well be the case based on some high-frequency data, it is entirely likely that there will be some changes to some of the narrative, most notably the idea that risk will continue to be eagerly absorbed, and the euro may well find itself without all its recent supports.

But for now, the euro remains in the driver’s seat, or perhaps more accurately, the dollar remains in the trunk. Once again, risk is on the move with equity markets having gained modestly in Asia (Hang Seng +0.8%, Sydney +0.3%, Nikkei was closed), while European bourses have also seen modest gains, on the order of 0.5% across the board. US futures are also pointing higher, as there is no reason to be worried for now. Bond markets have behaved as you would expect, with Treasuries and bunds little changed (although Treasuries remain at levels pointing to significant future economic weakness) while bonds from the PIGS are seeing more demand and yields there are falling a few basis points each. Oil is higher on optimism over economic growth, and gold continues to rally, preparing to set new all-time highs as it trades just below $1900/oz. The gold (and silver) story really revolves around the fact that negative real interest rates are becoming more widespread, thus the opportunity cost of holding that barbarous relic have fallen dramatically. Certainly, amongst the market punditry, gold is a very hot topic these days.

As to the rest of the currency space, there are two noteworthy decliners in the G10, NOK (-0.5%) and GBP (-0.25%). The former, despite rising oil prices, fell following the release of much worse than expected employment data. After all, rising unemployment is hardly the sign of an economic rebound. The pound, on the other hand, has suffered just recently after comments by both sides regarding Brexit negotiations, where the essence was that they are no nearer a positive conclusion than they were several months ago. Brexit has been a background issue for quite a few months, as most market players clearly assume a deal will be done, and that is a fair assumption. But that only means that there is the potential for a significant repricing lower in the pound if the situation falls apart there. Otherwise, the G10 is broadly, but modestly firmer.

In the emerging markets, the picture is a bit more mixed with the CE4 tracking the euro higher, but most other currencies ceding earlier session gains. IDR is the one exception, having rallied 0.5% for a second day as equity inflows helped to support the rupiah. On the downside, KRW (-0.2%) suffered after GDP data was released at a worse than expected -3.4%, confirming Korea is in a recession. Meanwhile, the weakest performer has been ZAR (-0.6%) as traders anticipate a rate cut by the SARB later today.

Data in the US this morning includes the ever-important Initial Claims (exp 1.3M) and Continuing Claims (17.1M), as well as Leading Indicators (2.1%). But all eyes will be on the Claims data as the consensus view is weakness there implies the rebound is over and the economic situation may slide back again. Counterintuitively, that could well help the dollar as it spreads fear that the V-shaped recovery is out of the question. However, assuming the estimates are close, I would look for the current trends to continue, so modestly higher equities and a modestly weaker dollar.

Good luck and stay safe
Adf

Tremors of Dread

This weekend we learned nothing new
‘Bout what central bankers will do
As they look ahead
With tremors of dread
That QE’s a major miscue

There is a bit of a conundrum developing as headlines shout about a surge in new cases of the coronavirus at the same time that countries around the world continue to reopen from their previous lockdowns. It has become increasingly apparent that governments everywhere have determined that the economic damage of the shutdown in response to Covid now outweighs the human cost of further fatalities from the disease. Of course, three months on from when the epidemic really began to rage in the West, there is also a much better understanding of who is most vulnerable and how to maintain higher levels of safe behavior, notably social distancing and wearing masks. And so, while there are still extremely vocal views on both sides of the argument about the wisdom of reopening, it is very clear economies are going to reopen.

Meanwhile, central banks continue to bask in the glow of broadly positive press that their actions have been instrumental in propping up the stock market preventing an even greater contraction of economic activity than what has actually played out. The constant refrain from every central bank speaker has been that cutting rates and expanding their balance sheets has been very effective. Oh, they are also prepared to do even more of both if they deem such action necessary because it turns out it wasn’t effective.

However, despite these encomiums about central bank perspicacity, investors find themselves at a crossroads these days. Risk assets continue to perform extremely well overall, with stocks having recouped most of their losses from March, but haven assets continue to demonstrate significant concern over the future as long-term government bond yields continue to point to near-recessionary economic activity over the medium and long term. At the end of the day, however, I think the only universal truth is that the global economy, and certainly financial markets, have become addicted to QE, and the central banks are not about to stop providing that liquidity no matter what else happens.

On this subject, this morning we had two very different visions espoused, with BOE Governor Bailey explaining that when things get better, QT will be the first response, not a raising of rates. Of course, we all remember the “paint drying” effect of QT in the US in 2018, and how it turns out removing that liquidity is really hard without causing a financial earthquake. At the same time, the ECB’s Madame Lagarde and her minions have been enthusiastically describing just how proportionate their QE purchases have been in response to the German Constitutional Court ruling from last month. Frankly, it would be easy for the ECB to point out the proportionality of buying more Italian debt given there is much more Italian debt than any other type in the EU. But I don’t think that was the German court’s viewpoint. At any rate, there is no reason to expect anything but ongoing QE for the foreseeable future. In fact, the only thing that can stop it is a significant uptick in measured inflation, but that has not yet occurred, nor does it seem likely in the next couple of quarters. So, the presses will continue to roll.

With this as background, a turn to the markets shows a fairly benign session overall. Equity market in Asia were very modestly lower (Nikkei -0.2%, Hang Seng -0.5%, Shanghai flat) while European markets are also a touch softer (DAX -0.1%, CAC -0.2%, FTSE 100 flat) although US futures are pointing higher, with all three indices up about 0.75% as I type. Meanwhile, bond markets are also showing muted price action, although the tendency is toward slightly lower yields as Treasuries have decline 1bp and Bunds 2bps. While the direction here is consistent with a risk off session, the very slight magnitude of the moves makes it less convincing.

As to the dollar, it is definitely on its back foot this morning, falling against most G10 and many EMG currencies. Kiwi is atop the leaderboard this morning, rallying 0.6% with Aussie just behind at 0.5%, as both currencies recoup a bit of the past two week’s losses. In fact, that seems to be the story behind most of the G10 today, we are seeing a rebound from the dollar’s last two weeks of strength. The only exception is the yen, which is essentially unchanged, after its own solid recent performance, and NOK, which has edged lower by 0.15% on the back of a little oil price weakness.

In the EMG bloc, the picture is a bit more mixed with APAC currencies having suffered last night, led by KRW (-0.5%) as tensions with the North increase, and IDR (-0.35%) as the market demonstrated some concern over the future trajectory of growth and interest rates there. On the positive side, it is the CE4 that is showing the best gains today with PLN (+0.8%) far and away the best performer after posting a much better than expected Retail Sales number of +14.5%, which prompted the government to highlight the opportunity for a v-shaped recovery.

Looking ahead to data this week, nothing jumps out as likely to have a big impact.

Today Existing Home Sales 4.09M
Tuesday PMI Manufacturing 50.8
  PMI Services 48.0
  New Home Sales 635K
Thursday Initial Claims 1.35M
  Continuing Claims 19.85M
  Durable Goods 10.9%
  -ex transport 2.3%
  GDP Q1 -5.0%
Friday Personal Income -6.0%
  Personal Spending 8.8%
  Core PCE 0.0% (0.9% Y/Y)
  Michigan Sentiment 79.0

Source: Bloomberg

The thing about the PMI data is that interpretation of the data is more difficult these days as a rebound from depression levels may not be indicative of real strength, rather just less weakness. In fact, the bigger concern for policymakers these days is that the Initial Claims data is not declining very rapidly. After that huge spike in March, we have seen a substantial decline, but the pace of that decline has slowed alarmingly. It seems that we may be witnessing a second wave of layoffs as companies re-evaluate just how many employees they need to operate effectively, especially in a much slower growth environment. And remember, if employment doesn’t rebound more sharply, the US economy, which is 70% consumption based, is going to be in for a much longer period of slow or negative growth. I assure you that is not the scenario currently priced into the equity markets, so beware.

As to the dollar today, recent price activity has not been consistent with the historic risk appetite, and it is not clear to me which is leading which, stocks leading the dollar or vice versa. For now, it appears that the day is pointing to maintaining the overnight weakness, but I see no reason for this to extend in any major way.

Good luck and stay safe
Adf

Make Hay

The Fed, today’s, finally set
To start to buy corporate debt
Meanwhile the UK
Did start to make hay
With its largest Gilt issue yet

While markets are fairly docile this morning, there are four interesting stories to note, all of which are likely to have bigger impacts down the road.

The first of these emanates from the Mariner Eccles Building in Washington, where the FOMC will begin to implement its Secondary Market Corporate Credit Facility (SMCCF), purchasing its first investment grade bond ETF’s. Ironically, in their effort to stabilize corporate credit markets that are suffering a hangover of excess issuance prior to the Covid-19 crisis, the Fed is going to ramp up margin debt for the purchases. A little ‘hair of the dog’ it seems is the best idea they have. Consider, the process of these purchases is that the Treasury has deposited $37.5 billion into an SPV account which will serve as collateral for that SPV to purchase up to 10x that amount in securities. Talk about speculative! If the SPV purchases its full allotment, then the Fed will effectively be increasing the total amount of margin debt outstanding by nearly 80%. Granted, there is no concern about the Fed being able to pay for these securities in actuality, it’s just the legal questions that may arise if they fall in price by more than 10% and the Fed has actual losses on its balance sheet. Naturally, the idea is that with the Fed buying, there is almost no possibility that prices could fall. However, do not believe that for a moment, just as we have seen in the Treasury market, despite the Fed buying $ trillions worth, bond prices still decline all the time. And don’t forget what we saw in March, when yields rocketed higher for a period of time. Perhaps the most surprising aspect is that US equity futures have been trading either side of flat despite this new money entering the market.

The second interesting story comes from across the pond, where the UK issued gilts via a syndicate for the first time, offering a new 10-year bond and garnering £65 billion pounds of demand, a record amount of attraction. It seems that one of the things that got buyers excited was a comment by BOE Deputy Governor Broadbent hinting that negative rates are not out of the question as the Old Lady seeks to insure sufficient policy support for the economy.

While on the subject of negative rates, it is worth noting that two Fed regional presidents, Bostic and Evans, were both circumspect as to the need for the Fed to ever go down that road. That is certainly good news, but one cannot forget the language change made in September of last year when the Fed stopped referring to the “zero lower bound” and began calling it the “effective lower bound”. Observers far more prescient than this one have noted that the change clearly opens the door for negative rates in the future. There is certainly no indication that is on the cards right now, but it is not an impossibility. Keep that in mind.

From Austria, Herr PM Kurz
Admitted that fiscal transfers
Are what are required
Lest Rome is inspired
To exit, which no one prefers

Another interesting headline this morning comes from Vienna, where Austrian PM Sebastian Kurz explained that the only way Italy can survive is via debt mutualization by the EU, as there is no way they will ever be able to repay their debt. While it is refreshing to hear some truth, it is also disconcerting that in the very next comment, PM Kurz explained there was no way that Austria was comfortable with that course of action. While Austria stood ready to support Italy, they would not take on their obligations. Of course, this is the fatal flaw in the EU, the fact that the Teutonic trio of Germany, Austria and the Netherlands are the only nations that can truly help fund the crisis but are completely unwilling to do so. I once again point to the German Constitutional Court ruling last week as a sign that the euro is likely to remain under pressure for a time to come. While this morning it is now higher by 0.2%, it remains near the bottom of its recent range with ample opportunity to decline further. Beware the ides of August, by which time the ECB will have responded to the court.

And finally, it must be noted that it is raining in Norway. By this I mean that the Government Pension Fund of Norway, the world’s largest wealth fund, is going to be selling as much as $41 billion in assets in order to fund the Norwegian government and its response to the crisis. This is exactly what a rainy-day fund is meant for, so no qualms there. But it does mean that we are going to see some real selling pressure on financial assets as they liquidate that amount of holdings, many of which are in US stocks. NOK, however, has been the beneficiary, rallying 0.8% this morning on the news. Given the krone has been the worst performing G10 currency this year, it has plenty of room to rally further without having any negative economic impacts.

Those are the most interesting headlines of the day, and the ones most likely to have a market impact. However, today, for the first time in a while, there is not much market impact in any markets. Equity prices in Asia were modestly softer, while those in Europe are mixed but edging higher. Bond prices are within a tick or two of yesterday’s closing levels, and the dollar is having a mixed session, although I would estimate that on net it is slightly weaker.

On the data front, it has been extremely quiet overnight with a few Sentiment indicators in France and Japan, as well as the NFIB here in the US, all printing terrible numbers, but none quite as terrible as the median forecasts. My observation is that analysts are now expanding their view of just how bad things are and beginning to overstate the case. As for this morning, we have CPI on the docket, with expectations of a 0.4% headline print and 1.7% core print. While inflation may well be in our future given the combination of monetary and fiscal policy response, it is not in the near future.

Barring some other news story, markets seem pretty happy to consolidate for a change, and I expect that is what we will see today. However, nothing has changed my view that a substantial repricing of risk is still in our future, and with it, a stronger dollar. While we don’t know what the catalyst will be, I have my eye on the ECB response to the German Constitutional Court ruling.

Good luck and stay safe
Adf

Riven By Obstinacy

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

 

How Far Did It Sink?

This morning the data we’ll see
Is highlighted by GDP
How far did it sink?
And is there a link
Twixt that and the FOMC?

Which later today will convene
And talk about Covid-19
What more can they do
To help us all through
The havoc that we all have seen

Market activity has been somewhat mixed amid light volumes as we await the next two important pieces of information to add to the puzzle. Starting us off this morning will be the first look at Q1 GDP in the US. Remember, the virus really didn’t have an impact on the US economy until the first week of March, although the speed of its impact, both on markets and the broad economy were unprecedented. A few weeks ago, I mentioned that I created a very rough model to forecast Q1 GDP and came up with a number of -13.6% +/- 2%. This was based on the idea that economic activity was cut in half for the last three weeks of the month and had been reduced by 25% during the first week. My model was extremely rough, did not take into account any specific factors and was entirely based on anecdotal evidence. After all, sheltering in home, it is exceedingly difficult to survey actual activity. As it turns out, my ‘forecast’ is much more bearish than the professional chattering classes which, according to the Bloomberg survey, shows the median expectation is for a reading of -4.0%, with forecasts ranging from 0.0% to -10.0%. Ultimately, a range of forecasts this wide tells us that nobody has any real idea what this number is going to look like.

Too, remember that while things have gotten worse throughout April, as much of the nation has been locked down, the latest headlines highlight how many places will be easing restrictions in the coming days and weeks. So, it appears that the worst of the impact will straddle March and April, an inconvenient time for quarterly reporting. In the end, the issue for markets is just how much devastation is already reflected in prices and perhaps more importantly, how quick of a recovery is now embedded in the price. It is this last point which gives me pause as to the current levels in equity markets, as well as the overall risk framework. The evidence points to a strong investor belief that the trillions of dollars of support by central banks and governments around the world is going to ensure that V-shaped rebound. If that does not materialize (and I, for one, am extremely skeptical it will), then a repricing of risk is sure to follow.

The other key feature today is the FOMC meeting, with the normal schedule of a 2:00 statement release and a 2:30 press conference. There are no updated forecasts due to be released, and the general consensus is that the Fed is unlikely to add any new programs to the remarkable array of programs already initiated. Arguably, the biggest question for today’s meeting is will they try to clarify their forward guidance regarding the future path of rates and policy or is it still too early to change the view that policy will remain accommodative until the economy weather’s the storm.

While hard money advocates bash the Fed and many complain that their array of actions has actually crossed into illegality, Chairman Powell and his crew are simply trying to alleviate the greatest disruption any economy has ever seen while staying within a loose interpretation of the previous guidelines. Powell did not create the virus, nor did he spend a decade as Fed chair allowing significant financial excesses to be built up. For all the grief he takes, he is simply trying to clean up a major mess that he inherited. But market pundits make their living on being ‘smarter’ than the officials about whom they write, so don’t expect the commentary to change any time soon.

With that as prelude, a survey of this morning’s activity shows that equity markets in Europe are generally slightly higher, although a few, France and Switzerland, are in the red. Interestingly, Italy’s FTSE MIB is higher by 0.4% despite the surprise move by Fitch to cut Italy’s credit rating to BBB-, the lowest investment grade rating and now the same as Moody’s rating. S&P seems to have succumbed to political pressure last week and left their rating one notch higher at BBB although with a negative outlook. Though Italian stocks are holding in, BTP’s (Italian government bonds) have fallen this morning with yields rising 4bps. In fact, a conundrum this morning is the fact that the bond market is clearly in risk-off mode, with Treasury and bund yields lower (2bp and 3bp respectively) while PIGS yields are all higher. Meanwhile, European equities are performing fairly well, US equity futures are all higher by between 0.5%-1.0%, and the dollar is softer virtually across the board. These latter signal a more risk-on scenario.

Speaking of the dollar, it is lower vs. all its G10 counterparts except the pound this morning although earlier gains of as much as 1.0% by AUD and NZD have been cut by more than half as NY walks in. This currency strength is despite weaker than expected Confidence data from the Eurozone, although with an ECB meeting tomorrow, market participants are beginning to bet on Madame Lagarde adding to the ECB’s PEPP. Meanwhile, CAD and NOK seem to be benefitting from a small rebound in the price of oil, although that seems tenuous at best given the fear of holding the front contract after last week’s dip into negative territory on the previous front contract.

EMG currencies are also uniformly stronger this morning, led by IDR (+1.0%) after a well-received government bond issuance increased confidence the country will be able to get through the worst of the virus’ impact. We are also seeing ZAR (+0.9%) firmer on the modestly increased risk appetite, and MXN (+0.7%) follow yesterday’s rally of nearly 1.7% as the worst fears over a collapse in LATAM activity dissipate. Yesterday also saw Brazil’s real rebound 2.75%, which is largely due to aggressive intervention by the central bank. The background story in the country continues to focus on the political situation with the resignation of Justice Minister Moro and yesterday’s Supreme Court ruling that an investigation into President Bolsonaro could continue regarding his firing of the police chief. However, BRL had fallen nearly 14% in the previous two weeks, so some rebound should not be surprising. In fact, on a technical basis, a move back to 5.40 seems quite viable. However, in the event the global risk appetite begins to wane again, look for BRL to once again underperform.

Overall, this mixed session seems to be more likely to evolve toward a bit of risk aversion than risk embrasure unless the Fed brings us something new and unexpected. Remember, any positive sign from the GDP data just means that Q2 will be that much worse, not that things are better overall.

Good luck and stay safe
Adf

The Real Threat

Around the world, government’s fret
Is it safe to reopen yet?
As growth worldwide slows
Each government knows
Elections are now the real threat

The common theme in markets today, the one that is driving asset prices higher, is that we are beginning to see a number of countries, and in the US, states, schedule the easing of restrictions on activity. Notably, in Italy, the European epicenter of the virus, PM Conte is trying to reschedule the return to some sense of normality with the first relief to occur one week from today in the manufacturing and construction industries, followed by retailers two weeks later. Personal services and restaurants, alas, must wait until June 1 at the earliest. While that hardly seems like an aggressive schedule, the forces arrayed on both sides of the argument grow louder with each passing day, neither of which has been able to convince the other side. (This sounds like the Democrats and Republicans in Congress.) But the reality is, there is no true playbook as to the “right” way to do this as we still know remarkably little about the disease, and its true infectiousness. Of course, collapsing the global economy in fear is likely to result in just as many, if not more, victims.

But it’s not just Italy that is starting. In the US, Georgia is under close scrutiny as it begins easing restrictions as of today. New York’s Governor Cuomo is now talking about a phased in reopening of certain areas, mostly upstate NY, beginning on May 15. And the truth is that many states in the US are preparing to reopen sections of their respective economies. The same is true throughout Europe and Asia, as the rolling lockdowns globally have essentially inflicted as much pain as governments can tolerate.

Of course, the real question is, what exactly does it mean to reopen the economy? I think it is fair to say that the immediate future will not at all resemble the pre-virus situation. Even assuming that most personal financial situations were not completely disrupted (and they truly were), how many people are going to rush out to sit in a movie theater with 200 strangers? How many people are going to jump on an enclosed metal tube with recirculated air for a quick weekend getaway? In fact, how many are going to be willing to go out to their favorite restaurant, assuming it reopens? After all, you cannot eat dinner while wearing an N95 mask!

My point is, the upcoming recovery of this extraordinary economic disruption is likely to be very slow. In fact, history has shown that traumatic events of this nature (think the Depression in the 1930’s) result in significant behavioral changes, especially regarding personal financial habits. The virus has highlighted the fragility of many job situations. It has exposed just how many people worldwide live close to the edge with almost no ability to handle a situation that interrupts their employment cashflow. And these lessons are the type that stick. They will almost certainly result in reduced consumption and increased personal savings. And that is almost the exact opposite of what built the global economy since the end of WWII.

With this in mind, it strikes me that the dichotomy we continue to see in markets, where equity investors are remarkably bullish, while bond and commodity investors seem to be planning for a very long period of slow/negative growth, is going to ultimately be resolved in favor of the bond market. No matter how I consider the next several months, no scenario results in that fabled V-shaped recovery.

But perhaps I am just a doom monger who only sees the negatives. After all, a quick look at markets today shows that the bulls are ascendant. Equity markets around the world are firmer this morning as the combination of prospective reopening of economies and additional central bank stimulus have convinced investors that the worst is behind us. Last night, the BOJ, as widely expected, promised unlimited JGB buying going forward. In addition, they increased their corporate bond buying to ¥20 trillion, essentially following in the Fed’s footsteps from two weeks ago. If their goal was to prop up the stock market, then it worked as the Nikkei closed higher by 2.7% helping the rest of Asia (Hang Seng +1.9%, Australia +1.5%) as well. Europe took the baton, and with more policy ease expected from the ECB on Thursday, has seen markets rise between 1.4% (FTSE 100) and 2.4% (DAX). Meanwhile, the euphoria continues to seep westward as US futures are all higher by roughly 1% this morning.

Bond markets, too, are feeling a bit better with Treasuries and bunds both seeing yields edge higher, 2bp and 1bp respectively, while the risky bonds from the PIGS, all see yields fall sharply. Interestingly, commodity markets don’t seem to get the joke, as oil (-15.8%) is under significant pressure. Finally, the dollar is under pressure across the board, falling against all its G10 counterparts with AUD (+1.4%) leading the way on a combination of today’s positivity and some short-term positive technicals. Even NOK (+0.75%) is firmer today despite oil’s sharp decline, showing just how much the big picture is overwhelming market idiosyncrasies.

In EMG space, pretty much the entire bloc is firmer vs. the dollar with ZAR (+1.15%) and HUF (+0.85%) on top of the list. The rand seems to be the beneficiary of the idea that South Africa is set to receive $5 billion from the IMF and World Bank to help them cope with Covid-19 related disruptions. Meanwhile, the forint is seeing demand driven by expectations of the country easing its lockdown restrictions this week. One quick word about BRL, which has not opened as yet. Last week saw some spectacular movement with the real having fallen nearly 10% at its worst point early Friday afternoon as President Bolsonaro’s most important ally, Justice Minister Moro, resigned amid allegations that Bolsonaro was interfering with a corruption investigation into his own son. The central bank stepped in to stem the tide, and successfully pushed the real higher by nearly 3%, but the situation remains tenuous and as Bolsonaro’s popularity wanes, it seems like there is a lot of room for further declines.

On the data front this week, the first look at Q1 GDP will be closely scrutinized, as well as the FOMC meeting on Wednesday and Thursday’s Claims data.

Tuesday Case Shiller Home Prices 3.13%
  Consumer Confidence 87.9
Wednesday Q1 GDP -3.9%
  FOMC Rate Decision 0.00% – 0.25%
Thursday Initial Claims 3.5M
  Continuing Claims 19.0M
  Personal Income -1.6%
  Personal Spending -5.0%
  Core PCE -0.1% (1.6% Y/Y)
  Chicago PMI 38.2
Friday ISM Manufacturing 36.7
  ISM Prices Paid 28.9

Source: Bloomberg

Obviously, the data will be nothing like any of us have ever seen before, but the real question is just how much negativity is priced into the market. In addition, while the Fed is not expected to change any more policies, you cannot rule out something new to goose things further.

In the end, there is no economic evidence yet that the situation is improving anywhere in the world. And while measured cases of Covid-19 infections may be dropping in places, human behaviors are likely permanently altered. This crisis is not close to over, regardless of what the stock markets are trying to indicate. My money is on the bond market view that things are going to be very slow for a long time to come. And that implies the dollar is going to retain its bid as well.

Good luck and stay safe
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Dire Straits

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

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

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

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

Source: Bloomberg

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

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

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

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

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

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

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

Good luck and stay safe
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A Huge Threat

In Europe officials now fret
‘bout dealing with Italy’s debt
If it gets downgraded
It could be blockaded
From PEPP, which would be a huge threat

At home, both the Senate and House
Agreed that it’s time to espouse
More spending is needed
And so, they proceeded
To spend half a trill, thereabouts

While oil prices are still getting press (and still under pressure), the return to positive prices has quickly turned that story into one about supply and demand, and the knock-on economic impacts of lower oil prices, rather than the extraordinary commentary on the meaning of negative prices for a commodity. In other words, it’s just not so exciting any more. Instead, today has seen markets turn their collective attention back toward government and central bank activities with investors trying to determine the next place to take advantage of all the ongoing financial largesse.

Starting in Europe, this evening the ECB will be having a video conference to discuss its next steps. Topic number one is what to do about Italian, and to a lesser extent, the rest of Southern Europe’s debt. Remember, the ECB is precluded from financing government spending by its charter, and the Teutonic trio watch that issue like hawks. So, news from Rome this morning that highlighted PM Conte’s promise to double the stimulus spending to €55 billion in order to better support the economy is at odds with that promise.

The problem is, that much spending will take the budget deficit above 10% of GDP and drive the debt/GDP ratio above 155%. While the latter will still simply be the third highest ratio in the world (Japan and Greece have nothing to fear yet), both the budget and debt numbers are far higher than currently allowed under the Stability and Growth Pact as defined by the EU. (For good order’s sake, the EU demands its members to maintain budget deficits below 3% of GDP and a debt/GDP ratio of 60% or lower).

A potentially larger problem is that Italy’s sovereign debt is currently rated at BBB with a negative outlook, just two notches above junk. Italian interest rates have been rising as BTP’s are no longer seen as a haven, but rather a pure risk trade. Combining all this together puts the ECB in a very tough position. If Italian debt is downgraded to junk, the ECB charter would preclude it from purchasing Italian debt. But if that were the case, you could pretty much bank on a collapse in the Italian bond market, followed by a collapse in the Italian economy, and a very real risk that Italy exits the euro, likely collapsing that as well. Clearly, the ECB wants to prevent that sequence of events. Thus, to successfully sail between the Scylla of financing government spending and the Charybdis of a euro collapse, the ECB is very likely to revise their collateral rules such that sub-investment grade debt is acceptable to purchase. And they will be buying the long-dated bonds which they will hold to maturity, thus effectively funding Italy but being able to technically tell the Germans they are not. It is an unenviable position for Madame Lagarde, but the alternatives are worse. Once again, if you wonder about the euro’s long-term viability, these are the questions that need to be answered.

However, despite the latest drama on the rates side, the market seems to be focusing on the positive stories today, namely the decisions by a number of European governments to gradually reduce the ongoing covid-inspired restrictions on their citizens. Throughout Europe, small shops are gradually being allowed to reopen and there have been discussions of schools reopening as well. The infection data appears to have stabilized overall, with many countries reporting a downtick in the number of new infections. Governments worldwide have the unenviable task of balancing the risk of further damage to their economies vs. the risk of another increase in the spread of the disease. At this time, it seems clear that there is a broad-based move toward getting on with life. And that’s a good thing!

In the meantime, this morning, the House is set to approve the Senate bill to extend further stimulus in the US, this time with a $480 billion price tag. The bulk of this will go to extending the Paycheck Protection Program, but there are various other goodies to support farms and hospitals. As well, the discussion about reopening the US economy continues apace, with the latest updates seeming to show that about half the states, mostly in the Midwest and mountain states, are going to be returning to a more normal footing, as they have been the least impacted. Even parts of western New York are now being considered for a removal of restrictions, given the demographic there is far closer to Wyoming than Manhattan.

Put it all together, and the bulls get to define the narrative today, with a better future ahead and more government spending to support things. It should be no surprise that equity markets are modestly higher this morning, with European bourses up by 1% or so, and US futures higher by a similar amount. Treasuries have seen some supply, with the yield on the 10-year rising 2bps, and the dollar is softer vs. almost all other currencies.

In the G10 bloc, only NOK is weaker today, and by just 0.1% as oil prices continue to slide, but even CAD, also closely linked to oil, is higher today, up 0.5%. Aussie is the biggest winner today, higher by 1.0% after a short-covering spree emerged in the wake of better than expected Retail Sales data. But the dollar’s weakness is broad-based today.

EMG currencies are also faring well today with ZAR (+1.15%) leading the way on the back of a $26 billion stimulus package, and RUB (+0.75%) following up as traders begin to believe the currency markets have oversold the ruble. MXN (+0.55%) is gaining on the same thesis, and, in fact, most of the space is higher due to this more positive feeling in the markets. The one outlier here is KRW (-0.2%) which is coming under pressure as a second wave of Covid infections makes its way through the country.

On the data front this morning, there is nothing of note to be released in the US. Yesterday saw Existing Home Sales fall slightly less than expected, to 5.27M, but just slightly. All eyes are on tomorrow’s claims data, as well as the PMI’s. The only data from Europe showed that UK inflation remains quiescent (and is likely to fall further) while Italian industry continues to shrink with Industrial Orders -2.6% in February, ahead of the worst of the outbreak.

Risk has a better tone this morning, but I fear it has the ability to be a fleeting break. Markets have shown they still like new stimulus, but at some point, questioning the ability to pay for it all is going to overwhelm the short-term benefits of receiving it. Today doesn’t seem like that day, but I assure you it is getting closer.

Good luck and stay safe
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New Aspirations

In Europe, the largest of nations
Has made clear its new aspirations
As Covid now peaks
In less than three weeks
Some schools can return from vacations

Despite less than stellar results from other countries that have started to reopen their economies (Japan, Singapore, South Korea) after the worst of the virus seemed to have passed, Germany has announced that by May 4, they expect to begin reopening secondary schools as well as small retail shops, those less than 800 square meters in size. This is a perfect example of the competing pressures on national leaders between potential health outcomes and worsening economic conditions.

The economic damage to the global economy has clearly been extraordinary, and we are just beginning to see the data that is proving this out. For instance, yesterday’s US Retail Sales data fell 8.7%, a record decline, while the Empire Manufacturing result was a staggering -78.2. To better understand just what this means, the construction of the number is as follows: % of surveyed companies reporting improving conditions (6.8%) less % of surveyed companies reporting worsening conditions (85%). That result was far and away the worst in the history of the series and more than double the previous nadir during the GFC. We also saw IP and Capacity Utilization in the US decline sharply, although they did not achieve record lows…yet.

Interestingly, we have not yet seen most of the March data from other countries as they take a bit longer to compile the information, but if the US is any indication, and arguably it will be, look for record declines in activity around the world. In fact, the IMF is now forecasting an actual shrinkage of global GDP in 2020, not merely a reduction in the pace of growth. In and of itself, that is a remarkable outcome.

And yet, the question with which each national leader must grapple is, what will be the increased loss of life if we get back to business too soon? Once again, I will remind everyone that there is no ‘right’ answer here, and that these life and death tradeoffs are strictly the purview of government leadership. I don’t envy them their predicament. In the meantime, markets continue to try to determine the most likely path of action and the ultimate outcome. Unfortunately for the market set, the unprecedented nature of this government activity renders virtually all forecasting based on historical information and data irrelevant.

This should remind all corporate risk managers that the purpose of a hedging program is to mitigate the changes in results, not to eliminate them. It is also a cogent lesson in the need to have a robust hedging program in place. After all, hedge ineffectiveness is not likely to be a major part of earnings compared to the extraordinary disruption currently underway. Yet a robust hedging program has always been a hallmark of strong financial risk management.

In the meantime, as we survey markets this morning, here is what is happening. After yesterday’s weak US equity performance, Asia was under pressure, albeit not aggressively so with the Nikkei (-1.3%) and Hang Seng (-0.6%) falling while Shanghai (+0.3%) actually managed a small gain. European bourses are mostly positive this morning, but the moves are modest compared to recent activity with the DAX (+1.0%), CAC (+0.6%) and FTSE 100 (+0.4%) all green. And US futures are pointing higher, although all three indices are looking at gains well less than 1.0%.

Bond markets have been similarly uninteresting, with 10-year Treasury yields virtually unchanged this morning, although this was after a near 12bp decline yesterday. German bunds, too are little changed, with yields higher by 1bp, but the standout mover today has been Italy, where 10-year BTP’s have seen yields decline 14bps as hope permeates the market after the lowest number of new Covid infections in more than a month were reported yesterday, a still high 2.667.

Turning to the FX market, despite what appears to be a generally more positive framework in markets, the dollar continues to be the place to be. In the G10 space, only SEK is stronger this morning, having rallied 0.25% on literally no news, but the rest of the bloc is softer by between 0.15% and 0.3%. So, granted, the movement is not large, but the direction remains the same. Ultimately, the global dollar liquidity shortage, while somewhat mitigated by Federal Reserve actions, remains a key feature of every market.

Meanwhile, in the EMG bloc, we have seen two noteworthy gainers, RUB (+1.0%) and ZAR (+0.5%). The former is responding to oil’s modest bounce this morning, with prices there up about 2.0%, while the latter is the beneficiary of international investor inflows in the hunt for yield. After all, South African 10-year bonds yield 10.5% these days, a whole lot more than most other places! But, for the rest of the bloc, it is business as usual, which these days means declines vs. the dollar. Remarkably, despite oil’s rebound, the Mexican peso remains under pressure, down 0.6% this morning. But it is KRW (-0.95%) and MYR (-0.85%) that have been the worst performers today. The won appears to have suffered on the back of yesterday’s weak US equity market/risk-off sentiment, with the market there closing before things started to turn, while Malaysia was responding to yesterday’s weakness in oil prices. Arguably, we can look for both of these currencies to recoup some of last night’s losses tonight.

On the data front, this morning brings the latest Initial Claims number (exp 5.5M) as well as Housing Starts (1300K), Building Permits (1300K) and Philly Fed (-32.0). I don’t think housing data is of much interest these days, but the claims data will be closely scrutinized to see if the dramatic changes are ebbing or are still going full force. I fear the latter. Meanwhile, after yesterday’s Empire number, I expect the Philly number to be equally awful.

As much as we all want this to be over, we are not yet out of the woods, not even close. And over the next month, we are going to see increasingly worse data reports, as well as corporate earnings numbers that are likely to be abysmal as well. The point is, the market is aware of these things, so inflection in the trajectory of data is going to be critical, not so much the raw number. For now, the trend remains weaker data and a stronger dollar. Hopefully, sooner, rather than later, we will see that change.

Good luck and stay safe
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A Bright Line

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

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

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

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

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

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

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

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

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

Good luck
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