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
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

 

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
Adf

 

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
Adf

 

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
Adf

Truly Surreal

Said Lagarde, now are options are few
To complete what you’ve asked us to do
Though growth is “resilient”
It’s clearly not brilliant
And we’ve no more tools in the queue

Meanwhile tales from China reveal
The pain they’re beginning to feel
As tariffs they cut
And more ports are shut
Life there now is truly surreal

Poor Christine Lagarde. Amidst great pomp and circumstance she is named President of the ECB, clearly a step up from Managing Director of the IMF, but finds when she finally sits down that there is precious little to do in the job. Signor Draghi created and used all the tools the institution had in his effort to carry out its mission of achieving an inflation rate of “close to, but below 2.0%”. And he failed dismally in reaching that goal. In fairness, he did save the euro from collapse in 2012 with his famous “whatever it takes” remark, and arguably that saved the ECB from complete irrelevance. (After all, if the euro broke up, what would have been the purpose of maintaining a Eurozone central bank?) But in the end, the Eurozone continues to muddle through with desultory growth and almost no inflation impulse whatsoever. And Madame Lagarde is reduced to giving speeches exhorting governments to spend more money, while an army of economics PhD’s tries to come up with some other way to make the ECB relevant.

This morning this problem was on full display as she explained, yet again, to the European Parliament that the ECB has limited scope to act given the current policy stance. Yet it seems that despite the easiest monetary policy in its history, the positive impact is still missing. This was made clear when Germany reported that Factory Orders for December fell 2.1%, taking the annual decline to -8.7%, its lowest level since the financial crisis in 2009. Fortunately for European equity investors, things like economic growth no longer matter to equity markets, but for the poor folks of Germany, the future continues to look pretty grim. The euro, which had initially edged up by 0.15% ahead of the data release on this broader optimism, has since turned tail and given up those modest gains to sit right on the 1.10 level, unchanged on the day.

The thing is, in the short run, the economic fundamentals seem to point to the dollar continuing its recent strength, although longer term, as long as the Fed continues with QE, I expect the dollar to decline. But the market technicians are looking hard at this 1.0950-1.1000 level as critical support for the single currency, with a break of 1.0950 likely to open the door to a move to, and through, October’s lows of 1.0865.

But while things in Europe may not be looking that great, fortunately the rest of the world has decided that the coronavirus is no longer a relevant issue for investors and equity markets, and thus risk appetite, worldwide continue to make new highs. Yes, the number of confirmed deaths has risen to 562 and the number of infections has grown past 28,000, but the narrative is now incorporating a possible breakthrough in a treatment and vaccine to stop this infection in its tracks. And that would be extraordinary given the usual amount of time it takes to find, and test a cure for some disease.

Meanwhile, as more and more countries restrict travel to and from China, President Xi Jinping gets angrier and angrier that they are fomenting panic. Arguably, they are trying to prevent said panic, but I’m sure that is cold comfort for the Chinese. Of more importance economically is the fact that CNOOC, one of China’s major oil companies, declared force majeure to break a contract to take in a LNG cargo. It seems that the virus has led to a situation where there aren’t enough people available to work the LNG terminals, so there is nothing they can do with the gas. Again, my view is the market is taking this outbreak less seriously than it should, but of course, my view incorporates the idea that central banks cannot prop things up forever.

But for the time being, my view remains in the minority. Equity markets around the world continue to rally sharply, especially after China announced they would be cutting tariffs in half on $75 billion worth of imports as they attempt to live up to the phase one deal. Asian markets led the way overnight (Nikkei +2.4%, Hang Seng +2.6%, Shanghai +1.7%) and European markets didn’t want to miss out with both the CAC and DAX higher by 0.7% this morning while the UK’s FTSE 100 is up 0.4%. And US futures are pointing in the same direction, each up between 0.3% and 0.4%. In fairness, we did see much better than expected data yesterday here in NY, with ADP Employment blowing out at 291K while ISM Non-Manufacturing printed a better than expected 55.5.

All this has led to a growing risk appetite in the FX markets as well as equities. Last night’s best performer was KRW, rallying 1.0% as traders and investors have taken to heart the worst of the coronavirus fears are behind us and Chinese growth should rebound and help South Korea accordingly. Away from the won, however, there has been less movement in the EMG space, with an interesting mix of gainers and losers. It appears THB is suffering from yesterday’s rate cut today, having fallen 0.4%, but despite oil’s continued rebound, the RUB is weaker today by 0.3%. On the plus side, it seems commodity exporters BRL and IDR are the other big winners, rallying 0.5% and 0.4% respectively.

In the G10, the pound is the only currency that has moved more than 0.1% today, falling 0.25%, as talk about the difficulties of the UK-EU trade negotiations continue to garner attention. Otherwise, nada.

This morning’s data brings Initial Claims (exp 215K), Nonfarm Productivity (1.6%) and Unit Labor Costs (1.3%) none of which are likely to excite, especially with tomorrow’s payroll data on the horizon. Instead, FX remains beholden to the broad risk sentiment, which implies higher yield currencies should continue to do well, while those with low rates are likely to suffer.

Good luck
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Don’t Be Fooled

Said Christine Lagarde, don’t be fooled
That we’re on hold can be overruled
If data gets worse
Or else the reverse
Then our policies can be retooled

Madame Lagarde was in fine fettle yesterday between her press conference in Frankfurt following the ECB’s universally expected decision to leave policy unchanged, and her appearance on a panel at the WEF in Davos. The essence of her message is that the ECB’s policy review is critical to help lead the bank forward for the next decades, but that there is no goal in sight as they start the review, other than to try to determine how best to fulfill their mandate. She was quite clear, as well, that the market should not get complacent regarding policy activity this year. Currently, the market is pricing for no policy movement in 2020. However, Lagarde emphasized that at each meeting the committee would evaluate the current situation, based on the most recent data, and respond accordingly.

With that as a backdrop, it is interesting to look at this morning’s flash PMI data, which showed that while manufacturing across the Eurozone may be starting to improve slightly, overall growth remains desultory at best. Interestingly it was France that was the bigger laggard this month, with its Services and Composite data both falling well below expectations, and printing well below December’s numbers. Germany was more in line with expectations, but the situation overall is not one of unadulterated economic health. The euro, not surprisingly has suffered further after the weak data, falling another 0.2% this morning which takes the year-to-date performance to a 1.6% decline. While that is certainly not the worst performer in the G10 (Australia holds the lead for now) it is indicative that despite everything happening in the US politically, the economy continues to lead the G10 pack.

Perhaps a bit more surprising this morning is the British pound’s weakness. It has fallen 0.3% despite clearly more robust PMI data than had been expected. Manufacturing PMI rose to 49.8, well above expectations and the highest level since last April. Meanwhile, the Composite PMI jumped to 52.4, its highest point since September 2018, and indicative of a pretty substantial post-election rebound in the economy. Even better was that some of the sub-indices pointed to even faster growth ahead, and the econometricians have declared that this points to UK GDP growth of 0.2% in Q1, again, better than previously expected. Remember, the BOE meets next Thursday, and a week ago, the market had been pricing in a 70% probability of a 25bp rate cut. This morning that probability is down to 47% and the debate amongst analysts has warmed up on both sides. My view is the recent data removes the urgency on the BOE’s part, and given how little ammunition they have left, with the base rate sitting at 0.75%, they will refrain from moving. That means there is room for the pound to recoup some of its recent losses, perhaps trading back toward the 1.3250 level where we started the year.

Away from those stories, the coronavirus remains a major story with the Chinese government now restricting travel in cities with a total population of more than 40 million. While the WHO has not seen fit to declare a global health emergency, the latest count shows more than 800 cases reported with 27 deaths. The other noteworthy thing is the growing level of anger being displayed on social media in China, with the government getting blamed for everything that is happening. (I guess this is the downside of taking credit for everything good that happens). At any rate, if the spread is contained at its current levels, it is unlikely to have a major impact on the Chinese economy overall. However, if the virus spreads more aggressively, and there are more shutdowns of cities and travel restrictions, it is very likely to start impacting the data. With Chinese markets closed until next Friday, our only indicator in real-time will be CNH, which this morning is unchanged. Watch it closely as weakness there next week could well be an indicator that the situation on the ground in China is getting worse.

But overall, today’s market activity is focused on adding risk. Japanese equities, the only ones open in Asia overnight, stabilized after yesterday’s sharp declines. And European equities are roaring this morning, with pretty much every market on the Continent higher by more than 1.0%. US futures are pointing higher as well, albeit just 0.25%. In the bond market, Treasuries and bunds are essentially unchanged, although perhaps leaning ever so slightly toward higher rates. And gold is under pressure today, along with both the yen and Swiss franc. As I said, risk is back in favor.

There is neither data nor Fedspeak today, so the FX market will need to take its cues from other sources. If equities continue to rally, look for increased risk appetite leading to higher EMG currencies and arguably a generally softer dollar. What about the impeachment? Well, to date it has had exactly no impact on markets and I see no reason for that to change.

Good luck and good weekend
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