Prices So Low

Since distancing, social, has spread
Demand for petroleum’s bled
Its price has declined
As less is refined
Is OPEC now near its deathbed?

Well, last night the Chinese explained
They’d not let reserves there be drained
With prices so low
Their stockpile they’ll grow
Thus, Pesos and Rubles have gained

One cannot be surprised by the fact that the sharp decline in the price of oil has prompted some nations to take the opportunity to top up their strategic reserves of the stuff. Last night, the story came out that China was going to do just that. In addition to the mooted plans to purchase upwards of 100 million barrels, there is also discussion that they are going to increase the size of their storage facilities. This serves a twofold purpose; first to allow them more storage, but second it is a clear short-term economic stimulus for the country as well, something they are desperately seeking given the quickly slowing growth trajectories of their major export markets.

The market response to the story has been exactly as would be expected, with oil prices surging (both WTI and Brent are higher by a bit more than 10% as I type) and petrocurrencies NOK, RUB and MXN, all rallying nicely as well. At least, that’s how they started the session. Approaching 7:00am in NY, NOK is by far the leading gainer in the G10 space, jumping 1.6% without the benefit of central bank intervention, as any rebound in oil, no matter how short-lived, is a positive for the country and by extension its currency.

The emerging market petros, though, are having a bit of a tougher time of it. Earlier, both the ruble and Mexican peso were firmer by well more than 1% compared with yesterday’s closing levels, but in the past hour, we have seen both give up the bulk of those gains. It just goes to show how difficult it is going to be for some currencies to rebound in the short run. This is because, a 10% rally in oil still leaves it at $22/bbl or so, far below the cost of production and not nearly enough to stem either nation’s fiscal woes. By the way, this is still far below the cost of shale oil production as well. In fact, the only country that really has a production cost below the current market price is Saudi Arabia. But in FX terms that doesn’t really matter as the riyal is fixed to the dollar.

Away from that story, though, financial and economic stories are thin on the ground, with most simply a rehash or update of ongoing themes. For instance, we already know that virtually every developed country is adding fiscal support to their economies, but there have been no new reports of additional stimulus. We already know that virtually every developed country’s central bank has added monetary support to their economies, but, if anything, the overnight stories were complaints that it wasn’t coming fast enough. To wit, the RBNZ is being chastised for not expanding its QE purchases quickly enough as market participants anticipate a significant increase in debt issuance by the government. That said, however, kiwi is a top performer today, rising 0.65% on the back of the Chinese oil story and the knock-on effects of renewed Chinese growth.

Otherwise, the news is almost entirely about the virus and its impacts on healthcare systems around the world, as well as the evolving story about the Chinese having underreported their caseload and by extension, distorting the medical community’s understanding of key features of the pathogen, namely its level of contagion and lethality. But that is all in the political realm, not the market realm.

Yesterday’s equity market decline has stopped for now with European indices modestly higher at this point, generally less than 1%, although US futures are looking a bit perkier, with all of them up by more than that 1% marker. Bond markets are under a bit of pressure, as investors are tentatively reaching out to acquire some risk, with yields in most government bond markets edging higher by a few bps this morning. Treasuries, which had seen a 4bp rise earlier in the session, though, have now rallied back to unchanged on the day.

And if one wants to look at the dollar more broadly, away from the NOK and NZD, the pound is firmer (+0.5% and it has really been holding up remarkably well lately), and CAD and AUD are both firmer by about 0.3% on the back of the oil/China positive story. On the downside, the euro cannot find a bid, falling 0.4% this morning, as the focus turns back to the rampant spread of Covid-19 in both Italy and Spain, as well as how much the German economy will suffer throughout the crisis.

In the EMG space, TRY (+0.5%) has been the top performer after confirmed FX intervention in the markets, but otherwise, despite what seems to be a modestly better tone to markets this morning, no other currency in the space is more than 0.1% firmer. On the downside, ZAR is the loser du jour, falling more than 1% and reaching a new historic low as interest rates in the country decline thus reducing its attractiveness as an investment destination.

This morning’s data brings Initial Claims (exp 3.7M) which has everybody atwitter given just how uncertain this outcome is. The range of estimates is from 800K to 6.5M which is another way of saying nobody has a clue. The one thing of which we can be certain is that it will be a large number. Interestingly, yesterday’s ADP number showed many fewer job losses than expected, which implies that tomorrow’s payroll data will also not give an accurate picture of the current situation. The survey week came before the real shutdowns began, so we will need to wait until the April data, not released until May 8, to get a better picture. And what’s interesting about that is, if the current timeline of a resumption of more normal activity by the end of April comes to pass, that data, while showing the depths of the problem, will no longer be that informative either. The lesson from this is that it may still be quite some time before data serves as a market driver like in the past, especially the NFP report.

Summing up, despite a modestly better attitude toward risk this morning, the dollar continues to be the place to be. Ultimately, until global dollar liquidity demand ebbs, I expect that we are going to see the greenback maintain its strength.

Good luck and stay safe
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All Screens Are Red

Last week it was how Covid spread
That filled most investors with dread
This weekend we learned
The Russians had spurned
The Saudis, now all screens are red

Wow!! It has been more than a decade since we have seen market activity like this across the entire spectrum of asset classes, dating back to the Lehman Brothers bankruptcy in September 2008 and the ensuing six months of activity. And just like then, the only thing that is going to change the current investor dynamic is a series of policy responses that are broadly seen as being effective. Unfortunately for most policymakers in the G10, they don’t have nearly enough tools available to be instantly effective. In other words, my sense is that while we will certainly get a series of announcements in the next several days, even coordinated announcements, investors and traders are going to need to actually see that deeds follow the words, and that the deeds have a chance to be effective. After all, as we have already discussed, cutting the Fed funds rate will not slow the spread of the coronavirus, nor will it patch things up between OPEC and Russia. Oftentimes, passage of time is a critical feature of any solution, but that just means that we will live with the current volatility that much longer.

A brief recap shows that markets, which were already fragile due to the unknown ultimate impact of the spread of the coronavirus, received one negative catalyst too many this weekend when the, always suspect, alliance of OPEC and Russia broke down regarding production cuts to shore up the price of oil. The Russians walked out of the negotiations and the Saudis responded by cutting their prices dramatically and opening the taps fully on production thus driving WTI lower by more than 34% at one point earlier this morning, although as I type at 6:35am it is “only” down by 29% to $32.50/bbl.

The financial market response was exactly as one would expect with fear rising exponentially and risk assets sold at any price. Meanwhile, haven assets are bid through the roof. So, stock markets around the world are all lower by at least 3.0% with the worst performers (Australia -7.3%, Thailand -7.9%, Italy -9.4%) down far more. US futures hit their 5.0% circuit breakers immediately upon opening and have been quiet all evening pinned at limit down. Cash market circuit breakers in the US are 7.0% for 15 minutes, 13.0% for 15 minutes and then if we should decline by 20%, trading is halted for the rest of the day. It certainly appears that we will trigger at least the first one around the opening, but after that I hesitate to speculate.

The other thing that is almost certainly going to happen is we are going to get a policy statement, at least from the Fed, if not a joint statement from G7 central bankers, or the Fed and the Treasury or all of the above, as they make every effort to try to assuage investor confidence. But in this environment, it is hard to come up with a statement that will do that. As I said, passage of time will be required to calm things down.

Regarding the bond market, by now you are all aware of the historic nature of the movement with the entire US yield curve now below 1.0%. The futures market is pricing in a 75bp cut next week by the Fed and another 25bps by June. Thursday, we hear from the ECB with the market anticipating a 10bp cut and analysts looking for additional stimulus measures, perhaps widening further the assets they are willing to purchase. And next week, the BOJ meets as well as the Fed, with the market looking for a 10bp cut there as well.

All this leads us to the FX markets, where the dollar is having a mixed day. Mixed but violent! It should be no surprise that the yen is dramatically higher this morning, currently by 3.0% although at its peak it was nearly 4.0% stronger. As we flirt with the idea of par on the yen, we need to go back to 2013 to see a time when the currency was stronger, which was driven by the 2011 Tohoku earthquake and tsunami. The Swiss franc and euro are also firmer this morning, both by about 1.25% as the former sees haven flows while the latter, in my estimation, is seeing the last of the benefits of the Fed’s ability to ease policy more aggressively than the ECB.

On the flip side, NOK has been devastated, down 2.8%, with CAD falling 1.5%, both on the back of oil’s sharp decline. Aussie, Kiwi and the pound are all trading within 0.4% of Friday’s close, although Aussie did see a 5.0% decline early in the session as lack of liquidity combined with algorithmic stop-loss orders to lead to a significant bout of unruliness.

In the EMG space, the champion is MXN, which has fallen 8.5%! This is a new historic low in the currency which is getting decimated by the coming economic slowdown and now the collapse in oil prices. Let’s just say that all those investors who took comfort in the higher interest rate as a cushion are feeling a lot less sanguine this morning. But we have also seen a sharp decline in ZAR (-2.4%) and a number of Asian currencies fell around 1.0% (MYR, IDR and KRW). And we are awaiting the opening in Sao Paolo as my sense is BRL, which has been falling sharply for the past week, down nearly 5.0%, seems likely to weaken much further.

My advice for those with cash flow programs is to pick a level and leave an order as bid-ask spreads will be much wider today and liquidity will be greatly impaired.

Looking ahead to the week, the ECB meeting on Thursday is clearly the highlight. At home, we only get a bit of data, and given what’s going on it doesn’t seem likely to be very impactful. But here it is:

Tuesday NFIB Small Biz Optimism 102.9
Wednesday CPI 0.0% (2.2% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Thursday Initial Claims 219K
  PPI -0.1% (1.8% Y/Y)
  -ex food & energy 0.1% (1.7% Y/Y)
Friday Michigan Sentiment 95.0

Source: Bloomberg

The thing about this week’s data is that it mostly predates both the onset of the spread of Covid as well as this weekend’s OPEC fiasco. In other words, it is unlikely to be very informative of the current world. We already know that going into these problems, the US economy was in pretty decent shape. The $6.4 trillion question is: How will it look in eight months’ time when the nation heads to the polls?

Remember, orders are likely to be the best execution methodology on a day like today.

Good luck
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A New Paradigm

In Germany for the first time
In months, there’s a new paradigm
The pundits are cheering
A rebound that’s nearing
As data, released, was sublime

Perhaps sublime overstates the case a bit, but there is no doubt that this morning’s German ZEW data was substantially better than forecast, with the Expectations index rising to 10.7, its highest level since March 2018. This follows what seems to be some stabilization in the German manufacturing economy, which while still under significant pressure, may well have stopped declining. It is these little things that add up to create a narrative change from; Germany is in recession (which arguably was correct, albeit not technically so) to Germany has stabilized and is recovering on the back of solid domestic demand growth. On the one hand, this is good news for the global growth story, as Germany remains the fourth largest economy in the world, and if it is shrinking that bodes ill for the rest of the world. However, for all those who are desperate for German fiscal stimulus, this is actually a terrible number. If the German economy is recovering naturally, it beggars belief that they will spend any more money than currently planned.

It is important to remember that the Eurozone fiscal stimulus argument is predicated on two things: the fact that monetary policy is now impotent to help stimulate growth throughout the Eurozone; and the belief that if the German government spends more money domestically, it will magically flow through to those nations that really need help, like Italy, Portugal and Greece. Alas for poor Madame Lagarde, this morning’s data has likely lowered the probability of German fiscal stimulus even more than it was before. The euro, however, seems to like the data, edging higher by 0.15% this morning and working its way back to the levels seen just before the US payroll report turned the short-term crowd dollar bullish. There was other Eurozone data released, but none of it (French and Italian IP) was really that interesting, printing within a tick of forecasts. On the euro front, at this point all eyes are on the ECB to see what Lagarde tells us on Thursday. Remember, the last thing she wants is to come across as hawkish, in any manner, because the ECB really doesn’t need the added pressure of a strong euro weighing on already subpar inflation data.

With two days remaining before the UK election, the polls are still pointing to a strong Tory victory and a PM Boris Johnson commanding a majority of Parliament. At this point, the latest polls show the Tories with 44%, Labour with 32% and the LibDems with just 12%. The pound is higher by 0.2% on the back of this activity, despite a mildly disappointing GDP reading of 0.0% (exp 0.1%). A quick look back at recent GBP movement shows that since the election was called on October 30, the pound has rallied 1.8%. While that is a solid move, it isn’t even the largest mover during that period (NZD is higher by 2.45% since then). In fact, the pound really gained ground several weeks earlier after Boris and Irish PM Leo Varadkar had a lunch where they seemed to work out the final issues for Brexit. Prior to that, the pound had been hovering in the 1.22-1.24 area, but gained sharply in the run up to the previous Brexit deadline.

I guess the question is; just how much higher the pound can go if the polls are correct and Boris wins with a Tory majority. There are two opposing views, with some analysts calling for another solid leg higher, up toward 1.40, as the rest of the market shorts get squeezed out and euphoria for UK GDP growth starts to rebound. The other side of that argument is that the shorts have already been squeezed, hence the move from 1.22 to 1.32 in the past two months, and that though finalization of Brexit will be a positive, there are still numerous issues to address domestically that will prevent a sharp rebound in the UK economy. As I’m sure you are all aware, I fall into the second camp, but there is certainly at least a 25% probability that a larger move is in the cards. The one thing that seems clear, though, is that market implied volatility will fall sharply past the election if the Tories win as uncertainty over Brexit will recede quickly.

Turning south of the border, it seems that the USMCA is finally making its way through Congress and will be enacted shortly. The peso has been the quiet beneficiary of this news over the past week as it has rallied 2% in the past week in a very steady fashion, although so far, this morning, it is little changed. One other thing of note regarding the Mexican peso has been the move in the forward curve over the past three weeks. For example, since November 19, 1-month MXN forwards have fallen from 1030 to this morning’s 683. In the 1-year, the decline has been from 10875 to this morning’s 10075. The largest culprit here appears to be the very large long futures position, (>150K contracts) that need to be rolled over by the end of the week, but there is also a significant maturity of Mexican government bonds that will require MXN purchases. At any rate, added to the USMCA news, we have a confluence of events driving both spot and forward peso rates higher. It is not clear how much longer this will continue, so for balance sheet hedgers with short dated exposures, this is probably a great opportunity to reduce hedging costs.

Beyond these stories, there is far less of interest in the market. This morning’s US data consists of Nonfarm productivity (exp -0.1%) and Unit Labor Costs (3.4%) neither of which is likely to move the needle. This is especially so ahead of tomorrow’s FOMC meeting and Thursday’s ECB meeting and UK election. Equity markets are pointing lower this morning, but that feels more like profit taking than a change of heart, as bonds are little changed alongside oil and gold. In other words, look for more choppy markets with no direction ahead of tomorrow’s CPI data and FOMC meeting.

Good luck
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Flummoxed

Kuroda flummoxed
As inflation fails to rise
How low can rates go?

You know things are tough in Japan, at least for the BOJ, when a sales tax hike, that in the last go-round increased inflation by nearly two percentage points, had exactly zero impact on the latest CPI readings. Last night’s Tokyo CPI data was released at 0.4%, unchanged from the September data and well below the 0.7% expected. And that’s an annual number folks, not the monthly kind. It seems that the government’s efforts to help young families by reducing tuition for pre-school and kindergarten to zero was enough to offset the impact of the rise in the Goods and Services Tax, essentially the Japanese VAT. However, the upshot is that CPI inflation, at least in Tokyo which is seen as a harbinger for the nation as a whole, remains nonexistent. Now for the average Japanese family, one would think that is a good thing. After all, who wants the prices of the stuff they need to buy rising all the time. But for the BOJ, who doggedly continues to believe that unless inflation rises to 2.0% the economy will implode, it is merely the latest sign that central banks are out of ammunition.

The yen’s response to this ongoing futility was to rise ever so marginally, not quite 0.1%, but that has not changed its more recent trend. In the past two months, the yen has weakened a solid 4.4%. But the picture changes if you step a bit further back for more perspective. Over the past six months, since late April, the yen has actually strengthened nearly 3.0%. So, which is it; is the yen getting stronger or weaker? In fact, I would argue that it is doing neither, but rather the yen is in a major long-term consolidation pattern (a triangle formation for the technicians out there) and that barring a major exogenous shock like a GFC2, the yen is likely to continue trading in an even narrower range going forward, perhaps for as long as the next year. The thing is, these triangle patterns tend to resolve themselves with a very significant break-out move when they end. At this stage, there is no way to discern which direction that will follow, and , as I said, it is probably a year away, but it is quite realistic to expect that the doldrums we have experienced in the yen for the past many years is likely to end. Perhaps the US presidential election will be the catalyst to cause a change, at least the timing will be right.

For hedgers, the best advice I can offer is to extend the tenor of your hedges as much as you can. This is especially true for receivables hedgers, where the carry is in your favor. But the reality is that even a payables hedger needs to consider the benefits of hedging in an extremely low volatility environment as opposed to waiting until a breakout, which may result in the yen jumping higher by as much as 5%-10%, completely outweighing the current cost of carry.

Three Latin American nations
Have populist administrations
Brazil, on the right
Of late’s shining bright
But fear’s grown ‘round Argie’s relations

For the past two weeks, the story in Brazil has been one of unadulterated joy, at least for investors. The real has rallied more than 5.0% in that time as President Jair Bolsonaro, the right-wing firebrand, has been able to push pension reform through congress there. That has been warmly received by markets as it implies that Brazil’s long-term finances are likely to remain under control. The pension system had been massively underfunded and was far too generous relative to the government’s ability to pay. Correcting these problems is seen as crucial to allowing Brazil to move forward with other investments to help the nation’s economy and productivity. Again, a glance at the charts shows that USDBRL has formed a triple top formation and is already accelerating lower. Quite frankly, it would not surprise to see BRL strengthen to 3.70 before this movement is over.

Turning to Mexico, it too has performed extremely well over the past two months, rallying more than 5% during that time. It is interesting that the markets have been extremely patient with AMLO as, since his initial action to cancel the Mexico City Airport construction, which was seen in an extremely negative light, his policies have been far less disruptive than most investors feared. Clearly, Mexico has been a beneficiary of the ongoing US-China trade war as companies seek low cost manufacturing sites near the US and given the (still pending) USMCA trade agreement, there is more confidence that companies will be able to set up shop there with fewer repercussions.

However, as with the yen, I might argue that what we have seen over the past five years is an increasingly narrowing consolidation in the peso’s exchange rate, albeit with a tad more volatility attached. And the thing about this pattern is its culmination is likely to occur much sooner than that in the yen. A quick look at MXN’s PPP shows that the peso remains significantly undervalued vs. the dollar, and in truth vs. most currencies. All this points to the idea that barring any surprisingly anti-business actions from AMLO, the peso may be setting up for a much larger rally, especially with the carry benefits that continue to exist.

Argentina, on the other hand, with newly elected left-wing President Fernandez, has its work cut out for itself. If you recall, the preliminary vote back in August, saw the peso decline more than 35%, and while it was choppy for a bit, the price action of late has been for steady depreciation. It is too early to know what Fernandez will do, but given the dire straits in the Argentine economy, with inflation running north of 50% while growth is shrinking rapidly and the debt situation is untenable, it seems the path of least resistance is for ARS to continue to weaken.

A quick look at the majors sees the dollar generally firmer this morning as there is a mild risk-off sentiment in markets. However, the news moments ago that the Labour party agreed to an early election has helped bolster the pound specifically, and risk in general. I expect that the pound will now be reacting to the polls as it becomes clearer if Boris can win with a majority, or if he will go down to defeat and perhaps an even more beneficial outcome for the pound will arise, the withdrawal of Article 50. My money remains on a Johnson victory and a Brexit with the recently negotiated deal.

This morning we get two minor pieces of data, Case Shiller Home Prices (exp 2.10%) and Consumer Confidence (128.0). Yesterday we did see a weak Dallas Fed manufacturing index print, but equity markets made new highs. I can see little reason, beyond the ongoing Brexit story, for traders to alter their positions ahead of tomorrow’s FOMC meeting, and so anticipate another quiet day in the market.

Good luck
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Doves There Held Sway

It seems that a day cannot pass
When one country ‘steps on the gas’
Twas China today
Where doves there held sway
With funding for projects en masse

If I didn’t know better, I would suspect the world’s central banks of a secret accord, where each week one of them is designated as the ‘dove du jour’ and makes some statement or announcement that will serve to goose stock prices higher. Whether it is Fed speakers turning from patience to insurance, the ECB promising more of ‘whatever it takes’ or actual rate cuts a la the RBA, the central banks have apparently realized that the only place they continue to hold sway is in global stock markets. And so, they are going to keep on pushing them for as long as they can.

This week’s champion is the PBOC, which last night eased restrictions further on infrastructure investment by local governments, allowing more issuance of ‘special bonds’ and encouraging banks to lend more for these projects. At the same time, the CNY fix was its strongest in a month, back below the 6.90 level, as the PBOC makes clear that for the time being, it is not going to allow the yuan to display any unruly behavior. True to form, Chinese equity markets roared higher led by construction and cement companies, and once again we see global equity markets in the green.

While in the short run, investors remain happy, the problem is that in the medium and longer term, it is unclear that the central banking community has sufficient ammunition left to really help economic activity. After all, how much lower is the ECB going to cut rates from their current -0.4% level? And will that really help the economy? How many more JGB’s can the BOJ buy given they already own about 50% of the market? In truth, the Fed and the PBOC are the only two banks with any real leeway to ease policy enough to have a real economic impact, rather than just a financial markets impact. And for a world that has grown completely reliant on central bank activity to maintain economic growth, that is a real problem.

Adding to these woes is the ongoing trade war situation which seems to change daily. The latest news on this front is that if President Xi won’t sit down with President Trump at the G20 meeting in Japan later this month, then the US will impose tariffs on all Chinese imports. However, it seems the market is becoming inured to statements like these as there has been precious little discussion on the subject, and the PBOC’s actions were clearly far more impactful.

The question is, how long can markets continue to ignore what is a clearly deteriorating global economic picture before responding? And the answer is, apparently, quite a long time. Or perhaps that question is aimed only at equity markets because bond markets clearly see a less rosy future. At some point, we are going to see a central bank announcement result in no positive impact, or perhaps even a negative one, and when that occurs, be prepared for a rockier ride.

Turning to the FX markets this morning, the dollar has had a mixed session, although is arguably a touch softer overall. So far this month, the euro, which is basically unchanged this morning, has rallied 1.4%, while the pound, which is a modest 0.15% higher this morning after better than expected wage data, is higher by just 0.5%. My point is that despite some recent angst in the analyst community that the dollar was due to come under significant pressure, the overall movements have been quite small.

In the EMG bloc, there has also been relatively little movement this month (and this morning) as epitomized by the Mexican peso, which fell nearly 3% last week after the threat of tariffs being imposed unless immigration changes were made by Mexico, and which has recouped essentially all of those losses now that the tariffs have been averted. China is another example of a bit of angst but no substantial movement. This morning, after the PBOC drove the dollar fix lower, the renminbi is within pips of where it began the month. Again, FX markets continue to fluctuate in relatively narrow ranges as other markets have seen far more activity.

Repeating what I have highlighted many times, FX is a relative market, and the value of one currency is always in comparison to another. So, if monetary policies are changing in the same direction around the world, then the relative impact on any currency is likely to be muted. It is why, despite the fact that the US has more room to ease policy than most other nations, I expect the dollar to quickly find its footing in the event the Fed gets more aggressive. Because we know that if the Fed is getting aggressive, so will every other central bank.

Data this morning has seen the NFIB Small Business Optimism Index rise to 105.0, indicating that things in the US are, perhaps, not yet so dire. This is certainly not the feeling one gets from the analyst community or the bond market, but it is important to note. We do see PPI as well this morning (exp 2.0%, 2.3% core) but this is always secondary to tomorrow’s CPI report. The Fed remains in its quiet period so there will be no speakers, and the stock market is already mildly euphoric over the perceived policy ease from China last night. Quite frankly, it is hard to get excited about much movement at all in the dollar today, barring any new commentary from the White House.

Good luck
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Oy Vey!

The jobs report was quite the dud
And traders began smelling blood
If Powell and friends
Would not make amends
Then stocks would be dragged through the mud

Then later, down Mexico’s way
The tariff dispute went away
At least for the moment
Though Trump could still foment
More problems by tweeting, oy vey!

This morning, despite the confusion
The outcome’s a foregone conclusion
Stock markets will rise
While bonds scrutinize
The data, and fight the illusion

I’m not even sure where to start this morning. Friday’s market activity was largely as I had forecast given the weak payrolls report, just a 75K rise in NFP along with weaker earnings numbers, leading to a massive increase in speculation that the Fed is going to cut, and cut soon. In fact, the probability for a June cut of 25bps is now about 50/50, with a full cut priced in for the July meeting and a total of 70bps of cuts priced in for the rest of 2019. Equity markets worldwide have rallied on the weak data as a new narrative has developed as follows: weaker US growth will force the Fed to ease policy sooner than previously forecast and every other central bank will be forced to follow suit and ease policy as well. And since the reaction function for equity markets has nothing to do with economic activity, being entirely dependent on central bank largesse, it should be no surprise that stock markets are higher everywhere. Adding to the euphoria was the announcement by the Trump administration that those potential Mexican tariffs have been suspended indefinitely after progress was made with respect to the ongoing immigration issues at the US southern border.

This combination of news and data was all that was needed to reverse the Treasury market rally from earlier in the week, with 10-year yields higher by 5bps this morning, and the dollar, which had fallen broadly on Friday, down about 0.6% across the board after the payroll report, has rebounded against most of its counterpart currencies. The one outlier here is the Mexican peso, which after the tariff threat had fallen by nearly 3%, has rebounded and is 2.0% higher vs. the dollar this morning.

To say that we live in a looking glass world where up is down and down is up may not quite capture the extent of the overall market confusion. One thing is certain though, and that is we are likely to continue to see market volatility increase going forward.

Let’s unpack the Fed portion of the story, as I believe it will be most helpful in trying to anticipate how things will play out going forward. President Trump’s threats against Mexico really shook up the market but had an even bigger impact on the Fed. Consider, we have not heard the word ‘patient’ from a Fed speaker since Cleveland Fed President Loretta Mester used the word on May 3rd. When the FOMC minutes were released on May 22, the term was rampant, but the world had changed by then. In the interim, we had seen the US-China trade talks fall apart and an increase in tariffs by both sides, as well as threats of additional actions, notably the banning of Huawei products in the US and the restriction of rare earth metals sales by China. At this point, the trade situation is referred to as a war by both sides and most pundits. We have also seen weaker US economic activity, with Retail Sales and Housing data suffering, along with manufacturing and production. While no one is claiming we are in recession yet, the probabilities of one arriving are seen as much higher.

The result of all this weak data and trade angst was a pretty sharp sell-off in the equity markets, which as we all know, seems to be the only thing that causes the Fed to react. And it did so again, with the Fed speakers over the past two weeks highlighting the weakening data and lack of inflation and some even acknowledging that a rate cut would be appropriate (Bullard and Evans.) This drove full on speculation that the Fed was about to ease policy and futures markets have now gone all-in on the idea. It would actually be disconcerting if the Fed acted after a single poor data point, so June still seems only a remote possibility, but when they meet next week, look for a much more dovish statement and for Chairman Powell to be equally dovish in the press conference afterward.

And remember, if the Fed is turning the page on ‘normalization’ there is essentially no chance that any other major central bank will be able to normalize policy either. In fact, what we have heard from both the ECB’s Draghi and BOJ’s Kuroda-san lately are defenses of the many tools they still have left to utilize in their efforts to raise inflation and inflationary expectations. But really, all they have are the same tools they’ve used already. So, look for interest rates to fall further, even where they are already negative, as well as more targeted loans and more QE. And the new versions of QE will include purchases that go far beyond government bonds. We will see much more central bank buying of equities and corporate bonds, and probably mortgages and municipals before it is all over.

Ultimately, the world has become addicted to central bank policy largesse, and I fear the only way this cycle will be broken is by a crisis, where really big changes are made (think debt jubilee), as more of the same is not going to get the job done. And that will be an environment where havens will remain in demand, so dollars, yen, Treasuries and Bunds, and probably gold will all do quite well. Maybe not immediately, but that is where we are headed.

Enough doom and gloom. Let’s pivot to the data story this week, which is actually pretty important:

Today JOLTs Jobs Report 7.479M
Tuesday NFIB Small Biz 102.3
  PPI 0.1% (2.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday CPI 0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 216K
Friday Retail Sales 0.7%
  -ex autos 0.3%
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 98.1

Clearly CPI will be closely watched, with any weakness just fanning the flames for rate cuts sooner. Also, after the weak NFP report Friday, I expect closer scrutiny for the Initial Claims data. This has been quite steady at low levels for some time, but many pundits will be watching for an uptick here as confirmation that the jobs market is starting to soften. Finally, Retail Sales will also be seen as important, especially given the poor outcome last month, which surprised one and all.

Mercifully, the Fed is in its quiet period ahead of their meeting next week, so we won’t be hearing from them. Right now, however, the momentum for a rate cut continues to build and stories in the media are more about potential weakness in the economy than in the strength that we had seen several months ago. If the focus remains on US economic activity softening, the dollar should come under pressure, but once we see that spread to other areas, notably the UK and Europe, where they had soft data this morning, I expect those pressures to equalize. For today, though, I feel like the dollar is still vulnerable.

Good luck
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Stopped at the Border

On Friday the President tweeted
Unless immigration, unneeded,
Is stopped at the border
I will give the order
To raise tariffs til it’s defeated

Friday’s big market news was President Trump’s threat of new tariffs, this time on Mexico, if they don’t address the illegal immigration issue domestically. This is a novel approach to a non-economic problem, but given the President’s embrace of the tariff process, perhaps it is not that surprising. The impact across markets, however, was substantial, with equities suffering while haven assets, notably Treasuries and Bunds, both rallied sharply. In fact, those moves have continued through the overnight session and we now see the 10-year US Treasury yielding just 2.10%, its lowest since September 2017, while 10-year Bunds are yielding a record low -0.21%! In other words, fear is rife that the future is going to be less amenable to investors than the recent past.

Meanwhile, equity markets have also suffered with Friday’s global sell-off continuing this morning in Europe after a mostly negative day in Asia. As to the dollar, it has been a bit more mixed, falling sharply against the yen (JPY +1.1% Friday, flat today), rising sharply against emerging market currencies (MXN -2.5% Friday, -0.3% today), but actually sliding slightly vs. its other G10 counterparts.

It is instructive to consider why the dollar is not maintaining its full status as a haven. Ultimately, the reason is that expectations for aggressive rate cuts by the Fed are becoming the default market expectation. This compares to a much less aggressive adjustment by other central banks, and so the relative forecasts point to a narrowing interest rate differential. Consider that the futures market has now priced in three rate cuts by Q1 2020 in Fed funds. Six months ago, they were pricing in three rate hikes! That is a huge sentiment change, and yet the dollar is actually stronger today than it was at the beginning of the year by about 2%. The point is that while recent economic estimates in the US continue to be downgraded, estimates for the rest of the world are being downgraded equally. In fact, there is substantially greater concern that China’s GDP growth could slow far more than that of the US adding to knock-on effects elsewhere in the world.

One of the things I have consistently maintained is that a slowdown in the US will not happen in isolation, and if the US is slowing, so will be the rest of the world. This means there is virtually no probability that the Fed will cut rates without essentially every other country easing policy as well, and that all important (at least for FX traders) interest rate differential is not likely to shrink nearly as much as reflected by simply looking at the Fed’s activities. A perfect example is Australia, where tomorrow’s RBA meeting is expected to see a 25bp rate cut, with the market pricing between two and three more during the next several quarters. Aussie has been suffering lately and is likely to continue to do so going forward, especially as pressure remains on China’s economy.

The Fed’s done a year-long review
Of policies they might turn to
They’re hoping to find
A new frame of mind
In order to reach a breakthrough

The other story about which you will hear a great deal this week is the gathering at the Chicago Fed of the FOMC and academics as they try to find a better way to effect policy. The positive aspect of this process is that they recognize they are not really doing a very good job. The negative aspect is that they continue to believe inflation remains too low and are extremely frustrated by their impotence to change the situation. We have already heard a number of the ideas; ranging from choosing a higher inflation target to allowing inflation to run hot (if it ever gets there based on their measurements). Alas, there seems little chance that the fundamental issue, the fact that their models are no longer reasonable representations of the real world, will be addressed. To a (wo)man, they all continue to strongly believe in a Keynesian world where more stimulus equals more economic activity. I would contend that, not dissimilar to the differences between Newtonian physics and particle physics, interest rates at the zero bound (and below) no longer have the same impact as they do at higher levels. And it is this failure by all central bankers to recognize the non-linearity of results which will prevent a viable solution from being found until a crisis materializes. And even then I’m not optimistic.

Turning to this weeks’ data dump, there is a ton of stuff coming, culminating in Friday’s NFP report:

Today ISM Manufacturing 53.0
  ISM Prices Paid 52.0
  Construction Spending 0.4%
Tuesday Factory Orders -0.9%
Wednesday ADP Employment 185K
  ISM Non-Manufacturing 55.5
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Trade Balance -$50.7B
  Nonfarm Productivity 3.5%
  Unit Labor Costs -0.8%
Friday Nonfarm Payrolls 183K
  Private Payrolls 175K
  Manufacturing Payrolls 4k
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.5

There are also eleven Fed speakers including Chairman Powell on Tuesday morning as well as the aforementioned Fed conclave regarding new policy tools. In other words, there is plenty available to move markets this week. And that doesn’t even take into consideration the ongoing trade situation, where fears are extremely high, but both China and Mexico have said they want to sit down and discuss things again.

At this point, given how much new information will be added to the mix, it is impossible to say how markets will perform. However, with that in mind, we will need to see some extraordinarily weak US data to change the idea that the US is still the ‘cleanest dirty shirt in the laundry’, to use a terrible metaphor. As well, do not be surprised to see Mexico, at least, agree to implement new policies to address the immigration issue and reduce pressure on the peso. In the end, I continue to look for the dollar to maintain its overall strength, but a modest drift lower against G10 counterparts is well within reason.

Good luck
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