A Blank Check

While much of the nation’s a wreck
The good news is there’s still Big Tech
Whose prices ne’er fall
Thus, keeping in thrall
Investors who wrote a blank check

One cannot but be impressed with the performance of the tech sector in US equity markets.  It seems that no matter what else happens anywhere in the world, a small group of companies has unearthed the secret to infinite value, or at least a never-ending rally in their share prices. Yesterday’s price action was instructive in that a group of just seven companies, all tech titans, added nearly $300 billion in value, which was greater than the entire NASDAQ’s 2.5% gain. While we all are happy to see equity markets continue to rally, it certainly is beginning to appear as though some of these valuations are unsustainable, especially if the V-shaped recovery doesn’t materialize. One other thing to consider about the values of these companies is that if there is a change in the White House, it is almost certain to bring with it significantly higher corporate taxes (39.6% anyone?), which will almost certainly result in a repricing of the future stream of earnings available to shareholders. But for now, clearly nothing matters but the fact that these companies are market darlings and are set to continue to rally…until they stop.

In Europe, those twenty plus nations
(Ahead of their summer vacations)
Have finally agreed
To help those in need
With billions in brand new donations

However, arguably the biggest story in the markets today is that the EU finally did agree to a spending plan to help those nations most severely impacted by the Covid recession. It was inevitable that this would be the result as the political imperative was too great for four smaller nations to prevent its completion. To hear the frugal four, though, is quite amusing. They seem to believe that their “principled” stand, where they each get a larger rebate from the general pool of funds (each is a net payer into the EU budget), and their demands that this is a one-time solution to an extraordinary event means that in the future, debt mutualization will not expand. If there is one thing that we know about government programs, it is that they always expand, and they never die. There is no such thing as a one-time program. Debt mutualization is now the standard in the EU, and one should expect nothing less. Redistribution from the North to the South of the continent is now a permanent feature.

The market reaction to this news is mostly what one would have expected. European equity markets have rallied, with those in Italy (+2.2%) and Spain (+1.9%) leading the way higher, although the strength is broad-based. As well, European government bond markets are also performing appropriately, with the havens seeing a modest rise in yields while the risk bonds, like Italian and Greek debt, falling as investors have greater assurances that they will now be repaid. After all, with debt mutualization, Greek and German debt are basically the same!

Finally, looking at the FX markets, we find the euro slightly softer on the session, having briefly traded higher, but now falling victim to what appears to be a buy the rumor, sell the news type event. But the euro has been a stellar performer for the past two months, rising 4.5% in that period as the market narrative has turned back to some previously discredited themes. Notably, we continue to hear a great deal about the dollar’s twin deficit issue and how that will undermine the greenback. In addition, given the ongoing risk rally, the idea of needing a safe haven currency, has simply faded from existence. In fact, this morning there is now talk that the euro, with its new solidarity, is really a haven asset. PPP models continue to point to the euro being undervalued at current levels with forecasts creeping ever higher. In fact, one large bank is out calling for 1.30 in the euro by the end of next year.

Of course, there is a great irony in the discussion of a stronger euro, the fact it is the absolute last thing Madame Lagarde and her ECB compatriots want (or need). After all, one of the key reasons for them to cut interest rates below zero was to undermine the euro in order to both import inflation and help European exporters become more price competitive. You can be sure that if the euro does start to break higher, we will hear a great deal more about the inappropriate price action of a rising euro. For now, all eyes are on 1.1495, which was the spike high seen in March, and which is currently serving as a resistance point for the technicians. A break there is likely to see a test of the 1.17-1.18 level before the end of the summer.

As to the dollar overall, it continues its recent weakening trend, with only a handful of currencies modestly softer and some decent moves the other way. For instance, Aussie is the top pick in the G10 this morning, rising 0.85%, as a combination of risk appetite and a short squeeze is doing the job nicely. But we are also seeing strength in NOK (+0.6%) and CAD (+0.5%), both of which are benefitting from oil’s rally today (WTI +2.8%). In the EMG space, it should be no surprise that RUB and ZAR (both +0.8%) are the leaders as the oil and commodity price rallies are clear supports. In fact, the bulk of this bloc is firmer this morning with only a handful of currencies (RON, CNY, SGD) in the red, and there just by a few basis points. Overall, it is fair to say the dollar is on its back foot again today.

With no data due today, and none of note released overnight, the FX market seems set to take its cues from the equity space and the broad risk themes. And it is pretty clear that the broad risk theme today is…buy more risk!

Herbert Stein, a very well-respected economist in the 1960’s was quoted as saying, “that which cannot continue, will not continue.” His point was that while exuberance may manifest itself periodically, it always ends when reality intrudes. Right now, it feels like risk assets, especially that formidable group of tech names, is completely disconnected with the economic reality and best-case prospects. The implication is this cannot go on. But that doesn’t mean it won’t go further before it ends. The narrative is risk assets are the thing to own, and as long as that is the case, the dollar is likely to remain under pressure.

Good luck and stay safe
Adf

Fear of Deflation

The ECB’s fear of deflation
Inspired more euro creation
They’ll keep buying bonds
Until growth responds
In every EU member nation

Investors responded by buying
As much as they could while still trying
To claim, it’s quite clear
That early next year
Economies all will be flying

Madame Lagarde is clearly getting the hang of what it means to be a central banker these days, at least at a major central bank. The key to success is to listen to how much easing the pundits are expecting and deliver significantly more than that. In the mold of Chairman Powell back in March, Lagarde yesterday exceeded all expectations. The ECB increased its PEPP by €600 billion, extended the minimum deadline to June 2021 and explained they would be reinvesting the proceeds of all maturing purchases until at least the end of 2022. They, of course, kept their other programs on autopilot, so the APP (their first QE program) will still be purchasing €20 billion per month through at least the end of this year. And finally, they left the interest rate structure on hold, so the deposit rate remains at -0.50%, but more importantly, they didn’t adjust the tiering. Tiering is the ECB’s way of limiting the amount of bank reserves that ‘earn’ negative interest rates. So, if the ECB decides that rates need to be cut even lower, they will be able to adjust the tiering levels to help minimize the damage to bank balance sheets. This is key in Europe because banks remain far more important in the transmission of monetary policy than in the US and negative rates have been killing them.

With this increase in accommodation, the Eurozone has finally created a support structure that is in concert with the size of the Eurozone economy. Adding up the pieces shows the ECB buying €1.5 trillion in assets, the EU having already created a €500 billion cheap lending program and now close to agreeing on an additional €750 billion program with joint borrowing and grants as well as loans. Add to that the individual national support (remember Germany just plumped for €130 billion yesterday) and the total is now well over €3 trillion. That is real money and should help at least mitigate the worst impacts of the economic shutdowns across the continent.

And so, can anybody be surprised that markets responded favorably to the news. Equity markets throughout Europe are higher this morning with the DAX (+1.8%), CAC (+2.3%) and the rest of the continental bourses all looking forward to more free money. Of course, the risk-on attitude has investors swapping their haven bonds for stocks and risky bonds, so bund yields have risen 1.5bps (Dutch bonds are up 2.5bps) while Greek yields have fallen 3bps. Italy and Spain are unchanged on the day, as there is no real selling, but just more interest in equities in the two nations. Finally, the euro, although currently slightly softer on the day (-0.15%) traded to a new high for this move at 1.1384. Except for two days in early March, as the virus story was disrupting markets, this is the highest level for the single currency since last July.

Technically, it is pretty easy to make the case that the euro is breaking out of a multi-year downtrend, although that is not confirmed. When viewing fundamentals, the question at hand is whether the Fed or ECB has more accommodative monetary policy. Clearly, despite the recent EU package, the US has been far more accommodative fiscally. And while the longer end of the US yield curve continues to sell off (10-year yields are now up to 0.85%, 20 bps this week, with 30-year yields at 1.66%, also 20bps higher on the week), the 2-year T-note remains anchored at 0.2% with a real yield firmly negative. Recall, there is a strong correlation between real 2-year yields and the value of the dollar, so those negative yields are clearly weighing on the buck. While it will not be a straight line, as long as the market continues to believe that central banks will not allow a market correction, the dollar should continue to slide.

Away from the euro, the dollar is soft almost across the board again today, with only PLN (-0.5%) having fallen any distance in the EMG bloc, and the Swiss franc (-0.3%) the only real loser in the G10. The Swiss story seems to be a technical one as the EURCHF cross has broken higher technically after the ECB announcement yesterday and continued with a little momentum. Poland is a bit more mystifying as there does not appear to be any specific news that would have led to selling, although the trend for the past 3 weeks remains clearly higher.

On the plus side, the big winner today is IDR (+1.55%) after the central bank governor, Perry Warjiyo, commented that the rupiah remains undervalued amid low inflation and a declining current account deficit.

With this as a backdrop, this morning brings the US payroll report with the following forecasts:

Nonfarm Payrolls -7.5M
Private Payrolls -6.75M
Manufacturing Payrolls -400K
Unemployment Rate 19.1%
Average Hourly Earnings 1.0% (8.5% Y/Y)
Average Weekly Hours 34.3
Participation Rate 60.1%

Source: Bloomberg

Remember, Wednesday’s ADP number was much lower than expected at -2.76M, still remarkably awful, but nonetheless surprising. However, data continues to be of secondary importance to the markets. I expect this will be the case until we start to see a recovery in earnest, but for now, we seem to be trying to define the bottom. The dichotomy between the destruction of the economy via lockdowns and the ebullience of the stock markets remains a key concern. The positive spin is that we truly will see a very sharp recovery in Q3 and Q4 with unemployment rolls tumbling back to a more normal recessionary level, and the bulls will have been right. Alas, the other side of that coin is that forecasts of permanent job destruction and decimated corporate earnings will prove too much for the central banks to overcome and we will have a longer-term decline in equity prices as the recession/depression lingers far longer.

For now, the bulls remain in charge. Today’s data is unlikely to change that view, so further dollar weakness seems the best bet. However, be aware of the risk of the other side of the trade, it has not disappeared by any stretch.

Good luck, good weekend and stay safe
Adf

Revert to the Mean

For more than two weeks we have seen
Risk assets all polish their sheen
But now has the bar
Been raised much too far?
And will we revert to the mean?

I read today that recent price action (+42% since March 23) has been the largest 50-day rally in the S&P 500’s long history. Think about that for a moment, the economy has cratered (the Atlanta Fed GDPNow forecast is currently at -52.8% for Q2), unemployment has hit levels not seen since the Great Depression with more than 40 million Americans losing their job in the past three months and the stock market is flying. Well, at least the S&P 500 index is flying as the value of its five largest constituents continues to rise, seemingly inexorably, thus dragging the index along with them. The disconnect between the performance of risk assets and the data representing the economy is truly stunning. And while I understand that equity markets are discounting ‘instruments’ looking ahead to the future, it still beggars belief that most of the companies in the index are going to see earnings recover in anywhere near the time anticipated by the market. Remember, the CBO just published an analysis describing the most likely outcome being a 10-year timeframe before the US economy gets back to the levels seen in 2019.

Part and parcel of this movement in risk assets has been the dollar’s decline, with the Dollar Index (DXY) down more than 5% during the same period. While that is not historic in nature, it is still a very large move for such a short period of time.

And so I must ask, is this movement in risk assets sustainable? Clearly the driving force here has been central bank, (mainly the Fed) largesse as they have pumped trillions of dollars of liquidity into the economy, much of which seems to have found its way into stocks. But remember, the Fed started its unlimited QE by buying $75 billion A DAY of securities. That number is now down to less than $5 billion each day and declining on a weekly basis. In fairness, the Fed got ahead of the curve, recognizing just how devastating the situation was going to be. But the Treasury has caught up and has been issuing debt as quickly as they can. Now the Fed’s liquidity is being funneled directly to the Treasury, rather than finding a home elsewhere, and unless Powell reverses course and starts to increase daily purchases again, there is every chance for equity markets to begin to suffer instead.

One other thing that is missing from this market, and which has been a key driver of the long bull market, is share repurchases by companies. Stock buybacks represented nearly all of the net stock buying seen during the rally. And I assure you, that ship has sailed and is not likely to return to port for many years to come. In fact, it would not be surprising if new laws are enacted that limit or prohibit repurchases going forward. The point I am trying to make is that there are numerous reasons to believe that this remarkable rebound in the stock market, and risk assets in general, is overdone and due for its own correction.

Is today that correction? Well, for a start, it is not an extension of the rally as equity markets in Asia were little changed (Nikkei +0.35%, Hang Seng +0.2%, Shanghai -0.15%) and those in Europe are all in the red (DAX -0.7%, CAC -0.6%, FTSE 100 -0.3%). The DAX performance is quite interesting given the announcement by the German government that they have agreed on a €130 billion stimulus package, 30% larger than anticipated. Meanwhile, US futures are all pointing lower as well, down between 0.2% and 0.5%.

Bond markets continue to lack any informational value as they have become entirely controlled by the central bank community. While yield curve control is only explicit in Japan (for the 10-year) and Australia (for the 2-year) the reality is that every central bank is actively preventing government interest rates from rising out of necessity. After all, given how much borrowing is ongoing, governments cannot afford for interest rates to rise, they would not be able to pay the bills. Perhaps the only exception to this rule is the very long end, 30 years and beyond, where yields continue to rise as curves continue to steepen. (Remember when an inverted yield curve was seen as the death knell of the economy? The reality is the problem comes when it steepens like this! Steepening curves are not so much about future economic growth as much as about higher future inflation.)

And then there is the dollar, which is broadly higher this morning, albeit not in any dramatic fashion. As the market awaits word from Madame Lagarde and her 24 colleagues, we have seen the dollar rise modestly vs. both G10 and EMG counterparts. The biggest retreats have been seen by PLN (-1.25%), where the government just announced an expected 8.5% budget deficit, and MXN (-0.9%), which is suffering as oil sells off a bit. However, both those currencies have seen significant rallies in the past two weeks, so a little reversal is not surprising. As to the rest of the bloc, EEMEA currencies are underperforming APAC currencies, but generally they are all lower.

In the G10, the movement have been much more muted, with GBP, AUD and SEK all lower by 0.4% or so and the rest of the bloc, save the Swiss franc’s 0.1% rally, lower by smaller amounts. Again, it is difficult to point to any one thing as the cause for this movement, arguably it is simply position reductions after a long run.

At this point, all eyes are on the ECB, where expectations have built for an increase in the PEPP of as much as €500 billion. While they have not come close to using the original amount, it seems clear they will need more before the end of the year, and so the market has latched onto the idea it will be announced today. One potential problem with this action is it could reduce pressure on the EU to actually go ahead with their mooted €750 billion fiscal support program that includes joint borrowing, a key feature for the euro’s future. It is clear that as much as the frugal four don’t want to see the ECB distort markets further, they are even more disinclined to give their money to the Italians and Spanish directly. However, in the end, I believe Madame Lagarde will give the market what it wants and raise the PEPP limit.

Today’s data picture brings Initial Claims (exp 1.843M), Continuing Claims (20.0M), the April Trade Balance (-$49.2B), Nonfarm Productivity (-2.7%) and Unit Labor Costs (5.0%). With the monthly NFP report tomorrow, it seems unlikely the market will respond to today’s data in any meaningful way. Earlier we saw Eurozone Retail Sales decline 11.7%, not as bad as feared but still the worst outcome in the history of the series dating back to January 1998. And yet, as we have seen lately, the data is not the driver right now, it is the central banks and sentiment. While we have paused today, sentiment still seems to be for a further rally, but my take is that sentiment is getting old and tired. Beware the reversion to the mean!

Good luck and stay safe
Adf

 

Depression’s Price In

As cities continue to burn
The stock market bears never learn
Depression’s priced in
And to bears’ chagrin
Investors have shown no concern

Once again risk is on fire this morning as every piece of bad news is seen as ancient history, riots across the US are seen as irrelevant and the future is deemed fantastic based on ongoing (permanent?) government economic support and the continued belief that Covid-19 has had its day in the sun and will soon retreat to the back pages. And while the optimistic views on government largesse and the virus’s retreat may be well founded, the evidence still appears to point to an extremely long and slow recovery to the global economy. Just yesterday, the Congressional Budget Office, released a report indicating it will take nearly ten years before GDP in the US will return to its previous trend growth levels. That hardly sounds like they type of economy that warrants ever increasing multiples in the stock market. But hey, I’m just an FX guy.

A look around the world allows us to highlight what seem to be the driving forces in different regions. There are two key assumptions underpinning European asset performance these days; the fact that the EU has finally agreed to joint financing of a budget and mutualized debt issuance and the virtual certainty that the ECB is going to increase the PEPP in their step tomorrow. The flaws in these theories are manifest, although, in fairness, despite themselves the Europeans have generally found a way to get to the goal. However, the EU financing program requires unanimous approval of all 27 members, something that will require a great deal of negotiation given the expressed adamancy of the frugal four (Austria, the Netherlands, Sweden and Denmark) who are not yet convinced that they should be paying for the spendthrift habits of their southern neighbors. And the problem with this is the amount of time it will take to finally agree. Given the urgent need for funding now, a delay may be nearly as bad as no support at all.

At the same time, the ECB, despite having spent only €250 billion of the original €750 billion PEPP monies are now assumed to be ready to announce a significant increase to the size of the program. Not surprisingly, members of the governing council who hail from the frugal four have expressed reluctance on this matter as well. However, after Madame Lagarde’s gaffe in March, when she declared it wasn’t the ECB’s job to protect peripheral nation bond markets (that’s their only job!) I expect that she will steamroll any objections and look for a €500 billion increase.

Clearly, traders and investors are on the same page here as the euro continues to rally, trading higher by 0.3% this morning (+4.2% since mid-May) and back above 1.12 for the first time since March. European equity markets are rocking as well, with the DAX once again leading the way, up 2.4%, despite a breakdown in talks between Chancellor Merkel’s CDU and its coalition partner SPD over the nature of the mooted €100 billion German support program. But the rest of Europe is flying as well, with the CAC up 2.0% and both Italy’s and Spain’s main indices higher by about 2.0%. European government bonds are sliding as haven assets are simply no longer required, at least so it seems.

Meanwhile, in Asia, we have seen substantial gains across most markets with China actually the laggard, essentially flat on the day. But, for example, Indonesia’s rupiah has rallied another 2.2% this morning after a record amount of bidding for a government bond auction showed that investors are clearly comfortable heading back to the EMG bloc again. The stock market there jumped 2.0% as well, and a quick look shows the rupiah has regained almost the entirety of the 22% it lost during the crisis and is now down just 1.6% on the year. What a reversal. But it is not just Indonesia that is seeing gains. KRW (+0.7%, -5.0% YTD), PHP (+0.5%, +1.1% YTD) and MYR (+0.35%, -4.0% YTD) are all gaining today as are their stock markets. And while both KRW and MYR remain lower on the year, each has recouped more than half of the losses seen at the height of the crisis.

So, the story seems great here as well, but can these nations continue to support their economies to help offset the destruction of the shutdowns? That seems to vary depending on the nation. South Korea is well prepared as they announced yet another extra budget to add stimulus, and given the country’s underlying finances, they can afford to do so. But the Philippines is a different story, with far less resources to support themselves, although they have availed themselves of IMF support. And Indonesia? Well, clearly, they have no problem selling bonds to investors, so for the short term, things are great. The risk to all this is that the timeline to recovery is extended far longer than currently perceived, and all of that support needs to be repaid before economic activity is back.

The point of all this is that while there is clearly a bullish story to be made for these markets, there are also numerous risks that the bullish case will not come to fruition, even with the best of intentions.

And what about the US? Looking at the stock market one would think that the economy is going gangbusters and things are great. But reading the news, with every headline focused on the ongoing riots across the nation and the destruction of property and businesses, it is hard to see how the latter will help the economy return to a strong pace of growth in the short run. If anything, it promises to delay the reopening of many small businesses and restaurants, which will only exacerbate the current economic malaise.

The other thing that seems out of step with the politics is the underlying belief that there will be another stimulus bill passed by Congress soon. While the House passed a bill several weeks ago, there has been no action in the Senate, nor does there seem to be appetite in the White House for such a bill at this time with both seeming to believe that enough has been done and ending the lockdowns and reopening businesses will be sufficient. But if there are riots in the streets, will ordinary folks really be willing to resume normal activities like shopping and eating out? That seems a hard case to make. While the cause of the riots was a tragedy, the riots themselves have created their own type of tragedy as well, the delay and destruction of an economic rebound. And that will not help anybody.

So, on a day where the dollar is under pressure across the board, along with all haven assets, we have a bit of data to absorb starting with the ADP Employment number (exp -9.0M) and then ISM Non-Manufacturing (44.4) and Factory Orders (-13.4%). The Services and Composite PMI data from Europe that was released earlier showed still awful levels but marginally better results than the preliminary reports. However, it is hard to look at Eurozone PMI at 31.9 and feel like the economy there is set to rebound sharply. Those levels still imply a deep, deep recession.

However, today is clearly all about adding risk to the portfolio, and that means that equities seem likely to continue their rally while the dollar is set to continue to decline. For receivables hedgers, I think we are getting to pretty interesting levels. If nothing else, leave some orders a bit above the market to take advantage.

Good luck
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More Than a Molehill

The House passed a stimulus bill
With price tag of more than three trill
Japan’s latest play
Three billion a day
Adds up to more than a molehill

But turning to Europe we find
Their efforts are quite ill-designed
Despite desperate needs
The trouble exceeds
The laws that their treaties enshrined

Apparently, it’s Stimulus Day today, a little-known holiday designed by politicians to announce new fiscal stimulus measures to great fanfare. At least, that’s what it seems like anyway. Last night, Japanese PM Abe announced Japan’s second extra stimulus package in just over a month, this one with a price tag of ¥117 trillion, or roughly $1.1 trillion at today’s exchange rate (which, if you do the math works out to just over $3 billion/day over the course of a year). For an economy with a total GDP of ~$4.9 trillion, that is a huge amount of extra money.

The BOJ has explained that they will not allow JGB yields to rise, which means that they are going to mop up all the issuance and the market (or what’s left of it) clearly believes them as 10-year JGB yields actually fell 1bp last night and are currently trading at -0.006%. It is certainly no imposition for the Japanese government to borrow money from the BOJ as it is essentially a free loan. The impact on the Nikkei was mildly positive, with the index rallying 0.7%, while the yen has edged lower by a mere 0.15% and remains firmly ensconced in its 106-108 range.

And one last thing, Japan lifted its state of emergency, as well, meaning lockdowns continue to dissipate around the world. Of course, the thing about stimulus during the Days of Covid is that it is not designed to boost growth so much as designed to replace activity that was prevented by government lockdowns. Unfortunately, none of the measures announced anywhere in the world will be able to fully offset the impact of all those closures, and so despite governments’ best efforts, the global economy is set to shrink in 2020.

But on this Stimulus Day, we cannot ignore what is likely a far more important piece of news emanating from Europe, the creation of a €750 billion (~$825 billion) fiscal stimulus package consisting of €500 billion of grants and the rest of loans. While the size of this package is dwarfed by the Japanese efforts, despite the fact that the EU represents an economy with GDP of more than €14.3 trillion, the importance stems from the fact that part of the funding will come from joint debt issuance. This, of course, has been the holy grail for the entirety of southern Europe as well as the French. Because this means that the Germans (and Dutch and Austrians) are going to pay for the rest of the continent’s problems. And since those three nations are the only ones that can afford to do so, it is certainly a big deal.

The timing of this cannot be ignored either as ECB President Lagarde, just this morning, informed the world that of the ECB’s GDP forecasts last month, the mild downturn scenario is now “out of date”, with a much greater likelihood that GDP will decline between 8% and 12% in 2020. The market response has been clear with the euro rallying 0.8% on the news and now higher by 0.3% on the day, and back above 1.10. Yields on the debt of the PIGS have also fallen nicely since the news hit the tape, with all four nations seeing a 5-6bp decline. And European equity markets, which seem to have anticipated the news, have climbed a bit further, and are now all higher by more than 1.25% with Spain’s IBEX leading the way, up 2.25%.

I guess the question is will the US Senate join in the festivities (you recall the House already passed a $3 trillion package last week) and agree to at least discuss the idea, although they have made clear the House bill is a non-starter. The thing is, as has been evidenced by the recent stock market performance in the US, there are many that believe no further government stimulus is needed in the US. Optimism in the stock market has been driven by optimism that the gradual reopening of the economy in certain states will start to accelerate and that before too long, the lockdown period will end. Along those lines, Los Angeles mayor, Eric Garcetti, last night decided that small retail stores would be allowed to open today. Similarly, New York mayor Bill DiBlasio has now said that the first steps toward reopening could take place in the second week of June. The point is, if economic activity is going to start to rekindle on its own, why is further stimulus needed.

With this as background, we have seen a pretty substantial reversal in the FX market this morning, mostly since the EU stimulus announcement. While the yen has not moved, the G10 has seen currencies reverse course from a 0.3%-0.5% decline to similar sized gains. In other words, the market has seen this as further evidence that risk is to be acquired at all costs. Certainly, if the EU can figure out how to effectively fund its weakest members without causing a political uproar in the Teutonic trio, then one of the key negative fundamentals for the single currency will have been corrected. This works hand in hand with my view of increasingly negative real interest rates in the US as a driver of medium-term dollar weakness. While I don’t expect the euro to run away higher, this is certainly very positive news.

Meanwhile, those EMG currencies whose markets are open have all reversed course as well, with the CE4 higher by an average of 0.45%, having been lower by a similar amount before the announcement. APAC currencies, which had suffered a bit overnight, have not had a chance to react to the news as their local markets had closed before the report. I expect that, ceteris paribus, they will perform better tonight. The one currency, though, that is not performing well today is the Chinese renminbi, and more specifically CNH, the offshore version. It is lower by -.35%, having fallen early in last night’s session as tensions continue to increase between the US and China. As I have maintained for a very long period, the currency is an important outlet for Chinese economic imbalances and further weakness is a far more likely outcome than a reversal anytime soon.

Yesterday’s housing data in the US was surprisingly robust, with New Home Sales falling far less than expected. Today, the only real release will be the Fed’s Beige Book at 2:00, which might be interesting, but can be expected to paint a very dire picture of the regional economies. But none of that matters anymore. The future is clearly much brighter this morning as the combination of Japanese and EU stimulus along with additional easing of US restrictions has investors primed to use all that stimulus money and pump up asset prices even further. What could possibly go wrong?

Good luck and stay safe
Adf

Undeterred

Said Christine, we are “undeterred”
By Germany’s court that inferred
QE is lawbreaking
As there’s no mistaking
Our power, from Brussels’, conferred

Thus, QE is here til we say
The ‘conomy’s finally okay
More bonds we will buy
And don’t even try
To hint there might be a delay!

Last week, when the German Constitutional Court ruled that the ECB’s original QE program, PSPP, broke EU laws about monetary financing of EU governments, there was a flurry of interest, but no clear understanding of the eventual ramifications of the ruling. This morning, those ramifications are beginning to become clear. Not surprisingly the ruling ruffled many feathers within the EU framework, as it contradicted the European Court of Justice, which is the EU’s highest court. This is akin to a State Supreme Court contradicting the US Supreme Court on a particular issue. At least, that’s what the legal difference is. But in one way, this is much more dangerous. There is no serious opportunity for any US state to leave the union, but what we have learned over the course of the past several years is that while the German people, on the whole, want to remain in the Eurozone and EU, they also don’t want to pay for everybody else’s problems. So, the question that is now being raised is, will Frau Merkel and her government be able to contain the damage?

In the end, this will most likely result in no changes of any sort by the ECB. There will be much harrumphing about what is allowed, and a great deal of technical jargon will be discussed about the framework of the EU. But despite Merkel’s weakened political state, she will likely manage to prevent a blow-up.

The thing is, this is the likely outcome, but it is certainly not the guaranteed outcome. The EU’s biggest problem right now is that Italy, and to a slightly lesser degree Spain, the third and fourth largest economies in the EU, have run are running out of fiscal space. As evidenced by the spreads on their debt vs. that of Germany, there remains considerable concern over either country’s ability to continue to provide fiscal support during the Covid-19 crisis. The ECB has been the only purchaser of their bonds, at least other than as short-term trading vehicles, and the entire premise of this ruling is that the ECB cannot simply purchase whatever bonds they want, but instead, must adhere to the capital key.

The threat is that if the ECB does not respond adequately, at least according to the German Court, then the Bundesbank would be prevented from participating in any further QE activities. Since they are the largest participant, it would essentially gut the program and correspondingly, the ECB’s current monetary support for the Eurozone economies. As always, it comes down to money, in this case, who is ultimately going to pay for the current multi-trillion euros of largesse. The Germans see the writing on the wall and want to avoid becoming the Eurozone’s ATM. Will they be willing to destroy a structure that has been so beneficial for them in order to not pick up the tab? That is the existential question, and the one on which hangs the future value of the euro.

Since the ruling was announced, the euro has slumped a bit more than 1.25% including this morning’s 0.2% fall. This is hardly a rout, and one could easily point to the continued awful data like this morning’s Italian March IP release (-28.4%) as a rationale. The thing about the data argument is that it no longer seems clear that the market cares much about data. As evidenced by equity markets’ collective ability to rally despite evidence of substantial economic destruction, it seems that no matter how awful a given number, traders’ attitudes have evolved into no data matters in the near-term, and in the longer-term, all the stimulus will solve the problem. With this as background, it appears that the euro’s existential questions are now a more important driver than the economy.

But it’s not just the euro that has fallen today, in fact the dollar is stronger across the board. In the G10 space, Aussie (-0.7%) and Kiwi (-0.8%) are the leading decliners, after a story hit the tapes that China may impose duties on Australia’s barley exports to the mainland. This appears to be in response to Australia’s insistence on seeking a deeper investigation into the source of the covid virus. But the pound (-0.65%), too, is softer this morning as PM Johnson has begun lifting lockdown orders in an effort to get the country back up and running. However, he is getting pushback from labor unions who are concerned for the safety of their members, something we are likely to see worldwide.

Interestingly, the yen is weaker this morning, down 0.6%, in what started as a risk-on environment in Asia. However, we have since seen equity markets turn around, with most of Europe now lower between 0.3% and 1.3%, while US futures have turned negative as well. The yen, however, has not caught a bid and remains lower at this point. I would look for the yen to gain favor if equity markets start to add to their current losses.

In the EMG space, the bulk of the group is softer today led by CZK (-1.1%) and MXN (-1.0%), although the other losses are far less impressive. On the plus side, many SE Asian currencies showed marginal gains overnight while the overall risk mood was more constructive. If today does turn more risk averse, you can look for those currencies to give back last night’s gains. A quick look at CZK shows comments from the central bank that they are preparing for unconventional stimulus (read QE) if the policy rate reaches 0%, which given they are currently at 0.25% as of last Thursday, seems quite likely. Meanwhile, the peso seems to be preparing for yet another rate cut by Banxico this week, with the only question being the size. 0.50% is being mooted, but there is clearly scope for more.

On the data front, to the extent this still matters, this week brings a modicum of important news:

Tuesday NFIB Small Biz Optimism 85.0
  CPI -0.8% (0.4% Y/Y)
  -ex food & energy -0.2% (1.7% Y/Y)
Wednesday PPI -0.5% (-0.3% Y/Y)
  -ex food & energy 0.0% (0.9% Y/Y)
Thursday Initial Claims 2.5M
  Continuing Claims 24.8M
Friday Retail Sales -11.7%
  -ex autos -6.0%
  IP -12.0%
  Capacity Utilization 64.0%
  Empire Manufacturing -60.0
  Michigan Sentiment 68.0

Source: Bloomberg

But, as I said above, it is not clear how much data matters right now. Certainly, one cannot look at these forecasts and conclude anything other than the US is in a deep recession. The trillion-dollar questions are how deep it will go and how long will this recession last. Barring a second wave of infections following the reopening of segments of the economy, it still seems like it will be a very long time before we are back to any sense of normalcy. The stock market continues to take the over, but the disconnect between stock prices and the economy seems unlikely to continue growing. As to the dollar, it remains the ultimate safe haven, at least for now.

Good luck and stay safe
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Riven By Obstinacy

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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Outrageous

The ECB’s fin’lly decided
That limits were badly misguided
So, starting today
All bonds are in play
To purchase, Lagarde has confided

As well, in the Senate, at last
The stimulus bill has been passed
Amidst all its pages
The Fed got outrageous
New powers, and hawks were aghast

Recent price action in risk assets demonstrated the classic, ‘buy the rumor, sell the news’ concept as equity market activity in the past two sessions had been strongly positive on the back of the anticipated passage of a huge stimulus bill in the US. And last night, the Senate finally got over their procedural bickering and hurdles and did just that. As such, it should be no great surprise that risk assets are under pressure today, with only much less positive news on the horizon. Instead, we can now look forward to death tolls and bickering about government responses to the quickly evolving crisis. If that’s not a reason to sell stocks, I don’t know what is!

But taking a break from descriptions of market activity, I think it is worthwhile to discuss two other features of the total government response to this crisis. And remember, once government powers are enacted, it is extremely difficult to remove them.

The first is from the US stimulus bill, where there is a $500 billion portion of the bill that is earmarked for support of the business community. $75 billion is to go to shore up airlines and the aerospace infrastructure, but the other $425 billion is added to the Treasury’s reserve fund which they can use to backstop, at a 10:1 leverage ratio, Fed lending. In other words, all of the programs about which we have been hearing, including the CP backstop, the primary dealer backstop, and discussion of purchases of municipal and corporate bonds as well as even equities, will now have the funding in place to the tune of $4.25 trillion. This means that we can expect the Fed balance sheet to balloon toward at least $9 trillion before long, perhaps as quickly as the end of the year. Interestingly, just last year we consistently heard from mainstream economists as well as Chairman Powell and Secretary Mnuchin, how Modern Monetary Theory (MMT) was a crock and a mistake to consider. And yet, here we are at a point where it is now the best option available and about to effectively be enshrined in law. It seems this crisis will indeed be quite transformational with the death of the Austrian School of economics complete, and the new math of MMT at the forefront of the dismal science.

Meanwhile, Madame Lagarde could not tolerate for Europe to be left behind in this monetary expansion and so the ECB scrapped their own eligibility rules regarding purchases of assets to help support the Eurozone member economies. This means that the capital key, the guideline the ECB used to make sure they didn’t favor one nation over another, but rather executed their previous QE on a proportional basis relative to the size of each economy, is dead. This morning the ECB announced that they can buy whatever they please and they will do so in size, at least €750 billion, for the rest of this year and beyond if they deem it necessary. This goes hand in hand with the recent German repudiation of their fiscal prudence, as no measure is deemed unreasonable in an effort to fight Covid-19. In addition to this, the OMT program (Outright Monetary Transactions) which was created by Signor Draghi in the wake of the Eurozone bond crisis in 2012 but never utilized, may have a new lease on life. The problem had been that in order for a country (Italy) to avail themselves of the ECB hoovering up their debt, the country needed to sign up for specific programs aimed at addressing underlying structural problems in said country. But it seems that wrinkle is about to be ironed out as well, and that OMT will finally be utilized, most likely for Italian bonds.

While neither the Fed nor ECB will be purchasing bonds in the primary market, you can be sure that is not even remotely a hindrance. In fact, buying through the secondary market ensures that the bank intermediaries make a profit as well, another little considered, but important benefit of these programs.

The upshot is that when this crisis passes, and it will do so at some point, governments and central banks will have even more impact and control on all decisions made, whether business or personal. Remember what we learned from Milton Friedman, “nothing is so permanent as a temporary government program.”

Now back to market behavior today. It is certainly fair to describe the session as a risk-off day, with equity markets have been under pressure since the beginning of trading. Asia was lower (Nikkei -4.5%, Hang Seng -0.75%), Europe has been declining (DAX -2.3%, CAC -1.8%, FTSE 100 -2.1%) and US futures are lower (SPU’s -1.4%, Dow -1.0%). Meanwhile, Treasury yields have fallen 6bps, and European government bonds are all rallying on the back of the ECB announcement. After all, the only price insensitive buyer has just said they are coming back in SIZE. Commodity prices are soft, with WTI falling 2%, and agriculturals softer across the board although the price of gold continues to be a star, as it is little changed this morning but that means it is holding onto its recent 11% gain.

And finally, in the FX markets, while G10 currencies are all looking robust vs. the dollar, led by the yen’s 1.2% gain and Norway’s continued benefit from recent intervention helping it to rally a further 0.75%, EMG currencies are more mixed. ZAR is the worst of the day, down 0.9% as an impending lockdown in the country to fight Covid-19, is combining with its looming credit rating cut to junk by Moody’s to discourage buying of the currency. We’ve also seen weakness in an eclectic mix of EMG currencies with HUF (-0.35%), KRW (-0.25%) and MXN (-0.2%) all softer this morning. In fairness, the peso had a gangbusters rally yesterday, jumping nearly 3.5%, so a little weakness is hardly concerning. On the plus side, APAC currencies are the leaders with MYR, IDR and INR all firmer by 1.2% on the strength of their own stimulus (India’s $22.6 billiion package) or optimism over the impact of the US stimulus.

Perhaps the biggest thing on the docket this morning is Initial Claims (exp 1.64M) which would be a record number. But so you understand how uncertain this forecast is, the range of forecasts is from 360K to 4.40M, so nobody really has any idea how bad it will be. My fear is we will be worse than the median, but perhaps not as high as the 4.4M guess. And really, that’s the only data that matters. The rest of it is backward looking and will not inform any views of the near future.

We have seen two consecutive days of a risk rally, the first two consecutive equity rallies in more than a month, but I expect that there are many more down days in our future. The dollar’s weakness in the past two sessions is temporary in my view, so if you have short term receivables to hedge, now is a good time. One other thing to remember is that bid-ask spreads continue to be much wider than we are used to, so do not be shocked when you begin your month-end balance sheet activity today.

Good luck and stay safe
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All the PIGS in Her Fief

Said Madame Lagarde, ‘Well I guess
Things really are in quite a mess’
And so up we’ll step
To introduce PEPP
As we try to deal with the stress

The market’s response was relief
That Europe’s new central bank chief
Has realized at last
The time is long past
To help all the PIGS in her fief

Another day, another bunch of new programs! First, though, a quick observation about the overall situation right now. There is no panic in the streets (after all the streets are mostly empty due to shelter-in-home and self-quarantining) but there is panic in… Washington DC, London, Bonn, Frankfurt, Paris, Madrid, etc. And that panic emanates from the fact that all those elected politicians are facing the biggest crisis of all…they might not get reelected because of Covid-19. I believe it is the belated realization that their jobs are on the line that has seen a significant acceleration in the number of new programs being proposed and introduced around the world.

Central banks, which had borne the brunt of the heavy lifting, are starting to get help from fiscal policy actions, but those central banks are still on the front lines. To wit, in an unprecedented intermeeting action, last night the ECB unveiled a new QE program called the Pandemic Emergency Purchase Program (PEPP) which will authorize the purchase of €750 billion of public and private assets for the rest of the year, or longer if deemed necessary. This time they are including Greek government bonds, which the ongoing QE program would not touch due to the credit rating, they are ignoring the capital key, which means they can purchase far more Italian debt than Italy’s share of the Eurozone economy would dictate, and they are expanding the corporate purchases to non-financial CP. And the market liked what they heard with European government bonds rallying sharply pushing 10-year benchmark yields down by 47bps in Portugal, 71bps in Italy, 167bps in Greece and 45bps in Spain. Equity markets in Europe have stopped collapsing, but we still see pressure in Germany and the UK, while the PIGS are all higher. One other thing about Germany was the release of the IFO Expectations Index which fell to 82.0, its lowest point since the financial crisis in 2008. Certainly short-term prospects seem dire there.

And what about the euro you may ask? Well, it continues to slide, down 1.0% this morning, but is actually about middle of the pack in the G10. If you want to see real carnage, look no further than Norway, where the krone has fallen another 2.75% as I type, but that is only after it had been lower by nearly 7.5% at 6:00 this morning, which forced a response from the Norgesbank that they would be intervening if things got worse. Looking over price action during the past month, when oil prices collapsed from $53.78 to as low as $20.06 (currently $22.88), which has been a 57% decline, the worst performing currencies have been; MXN (-23.8%), RUB (-21.2%), NOK (-19.7%) and COP (-17.3%). Two caveats on this list are Norway was down much further earlier this morning, and Colombia hasn’t opened yet today, so has room for a further decline. The only positive I can take from this is that the correlation between the currencies of oil producers and the price of oil remains intact. At least we know what to expect!

But there was plenty of other activity as well. For instance, the RBA cut rates again, by 25bps, taking their base rate to a historic low of 0.25%. In addition they have implemented their first QE plan where they are targeting the yield on 3-year AGB’s at 0.25%. The problem is that the 10-year bond got hammered on the news with yields there jumping 23bps overnight, taking the move since Monday to 57bps. Look for the RBA to do more, and probably soon. And the Aussie dog dollar? Down a further 1% this morning, which takes the decline in the past month to 14.3% and it is now trading at levels not seen since 2003.

And let’s not forget South Korea, which is stepping into the market to buy KRW 1.5 trillion (~$1.1 billion) of government bonds, as it prepares both bond and stock stabilization funds to help support markets there. In other words, the government is going to be buying equities to stop the slide. The KRW response? -3.2%!

Japan would not be left out of this parade, buying a new record ¥201.6 billion of ETF’s last night while injecting ¥5.3 trillion yen in new liquidity to the money markets. Unfortunately, the Nikkei continued its decline, although fell only 1.0%, arguably an improvement over recent performance. The yen has no haven characteristics this morning, falling 1.50%, which is actually now the worst performing currency as NOK continues to rebound as I type on the back of Norgesbank activity.

Finally, I would be remiss if I didn’t mention that the Fed has unveiled yet another program, this time to backstop money market funds, a key part of the US financial plumbing system, and one that when it broke in 2008 after Lehman’s bankruptcy, resulted in financial markets seizing up entirely. The fund is there to make liquidity available to funds to meet increased redemptions without having to sell their holdings. Instead, they will pledge them as collateral and receive cash from the Fed.

This note is too short to go through every action taken, but we continue to see other central bank rate cuts and we continue to see fiscal packages starting to get enacted. In fact, President Trump signed into law the latest yesterday, to support paid sick leave and increased unemployment benefits, and now Congress turns to the MOAS (mother of all stimuli) packages which may include helicopter money as well as bailouts of airlines and hospitality businesses that have been decimated by the virus response. Mooted price tag…$1.3 trillion, but my bet is it winds up larger than that.

Meanwhile, the dollar remains the single place to be. It has rallied against everything yet again as holding cash is seen as the only response to the current situation. And the cash everyone wants to hold is green. Foreign borrowers are scrambling and struggling as their local currencies collapse and swap spreads blow out. And domestic borrowers are wondering how they are going to repay or roll over their debt given the absolute collapse in economic activity.

For now, this is likely to continue to be the situation, as there is no obvious end in site. However, the growing sense of urgency in those national capitals leads me to believe that we are going to start to see much bigger fiscal packages and a newfound belief that printing money and giving it out is a better solution than allowing economic activity to seize up completely. As I said last week, the MMT proponents have won the day. It has just not yet been made explicit.

Good luck and stay safe
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Urgent Action

Said Madame Lagarde urgent action
Is needed if we’re to gain traction
In putting a lid
On spreading Covid
Or we’ll have an ‘08 contraction

No sooner were those words reported
Than Governor Carney supported
A 50bp cut
(More than scuttlebutt!)
Thus, hoping recession is thwarted

Another day and another raft of new and important news driving markets. So far this morning, the biggest news has been the BOE’s surprise emergency rate cut of 0.50%, taking the base rate back down to 0.25%, its all-time low first reached during the financial crisis. Governor Carney, in his last official act, as he steps down on Sunday, explained that the idea behind the early cut (after all, the BOE has its regularly scheduled meeting in two weeks) was to show coordination with the government which will be releasing its budget for the new fiscal year later today. In addition, he explained, and was seconded by incoming Governor Andrew Bailey, that the BOE still had plenty of tools available to ease policy further if necessary.

In addition to the rate cut, they also restarted a targeted lending scheme that is designed to support bank lending to SME’s. As I type, we have not yet heard the nature of the budget package, but expectations are for a significant increase in spending focused on the National Health Service and small businesses. The market response has been positive for equities (FTSE 100 +0.8%), although Gilt yields have edged higher by 5bps. In the FX market, the pound’s initial reaction on the rate cut was to fall sharply, more than a penny, but it has since recouped all of that and then some and is currently higher by 0.2%.

Turning to Europe, Madame Lagarde led a conference call of EU leaders this morning and explained that if they don’t respond quickly and aggressively, the situation could devolve into the same type of financial crisis that the 2008 mortgage and credit crisis engendered with an equally deep recession. At the same time, Italian PM Conte is trying to get the rest of the EU to allow him to break the spending limits in order to rescue his country. With the entire nation on lockdown, economic activity is screeching grinding to a halt and the impact on individuals, who will not be able to get paid and therefore pay their bills, as well as small companies will be devastating. But remarkably, the EU has not yet endorsed the package, which is set to be as much as €25 billion. In the end, there is no question the package will be implemented even if the Germans are dragged along kicking and screaming. Italian stocks rallied on the announcement, +0.9%, while Italian BTP’s (their treasury bonds) rallied sharply with yields falling 16bps. The euro has also benefitted this morning, currently higher by 0.4%, although I think a lot of that is simply a rebound from yesterday’s sharp decline. After all, the single currency fell 1.5% yesterday.

Turning to the dollar itself, broadly speaking it is weaker overall, albeit not universally so. Versus its G10 counterparts, the dollar is on the back foot, which seems to reflect the fact that we are hearing of every other G10 country taking concrete action to fight Covid-19, while the US remains a little behind the curve. The $8 billion package passed last week is small beer in this economy, but the administration’s calls for a reduction in payroll taxes and federally supported sick leave pay has fallen on deaf ears in Congress. With Congress due to go on a one-week recess starting Thursday, it is hard to believe they will come up with something before they leave. This policy uncertainty is weighing on US assets with equity futures pointing lower as I type, on the order of 1.7%, and Treasuries rallying again with the 10-year yield falling by 10bps.

At this point, all eyes are on the Fed with market expectations still fully baked in for a 50bp rate cut one week from today. What is interesting is the number of pundits who are pointing to a speech given last summer by NY Fed President Williams, where he highlighted research showing that when policy space is limited (i.e. rates are already low), a central bank should be more aggressive to get an impact from their actions, rather than trying to hold onto what limited ammunition they have left. This has a number of economists around Wall Street calling for a 1.00% rate cut next week by the Fed, which would truly be a shock and awe move, at least initially. The problem for the Fed is that they don’t have the structure to create targeted lending facilities the way other central banks do, and they can only buy securities issued or guaranteed by the US government, so Treasuries and mortgages. While that law can be changed, it will not be done either quickly or without controversy. In other words, the Fed may find it has a more limited toolkit than they need in the short run. At this point, a 0.50% cut to Fed funds next week will not do very much, but more than that is likely to have a big market impact. In fact, I’m leaning toward the idea that they cut 1.00% next week to see if they can get a positive response and force the government to step up.

In the EMG bloc, only ZAR (-0.7%) and MXN (-0.65%) are under any real pressure this morning as both feel the weight of sinking commodity prices. While some others here are soft, the moves are modest (RUB -0.3%). On the positive side, INR is the leader, rising 0.7% in a catch-up move as the country was on holiday yesterday during the rally by other Asian currencies.

But as we look ahead to today, unless we get new news from the US administration, my sense is the dollar will remain under pressure overall. There is data upcoming as CPI will print at 8:30 (exp 2.2%, 2.3% core), but I don’t think anybody is paying attention. The market is still completely driven by comments and official actions, with longer term views sidelined.

Good luck
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