Tapering Talk

Despite all the tapering talk
The market did not walk the walk
Now sovereigns worldwide
Have seen their yields slide
While stocks are where people all flock

Remember when the consensus view was that the Fed would begin tapering before the end of 2021 as clues from the FOMC Minutes indicated the discussion about tapering was ongoing?  That was so two days ago.  With the perspective of twenty-four hours to read the entire FOMC Minutes, it appears that many traders have decided they may have been premature to jump to that conclusion.  Instead, a reading of the entire document highlights that while the subject was raised, it was clearly a minority of members interested in the discussion.  Rather, the bulk of the FOMC continue to highlight that not only does “substantial further progress” need to be made toward their goals of maximum employment and steady 2% average inflation, but that they are a long way from achieving those goals.  In other words, tapering is still a long way in the future.

This is not to say the Fed shouldn’t be considering when to end QE, just to point out that the weight of evidence points to the idea that they are not in a hurry to do so.  Remember, they are explicitly reactive on policy, refusing to consider removing accommodation before hard data shows that they have reached their goals.  Do not be misled into believing the Fed is on the cusp of removing accommodation.  They are not!

A quick look at yesterday’s data highlights why they are still a long way off.  While Initial Claims fell to a new post-pandemic low of 455K, a more troubling aspect was the 100K rise in the Continuing Claims data, implying that the rolls of unemployment are not shrinking despite all this economic growth.  As well, the Philly Fed, while still printing at a robust 31.5, fell well short of expectations while price pressures in the sub-indices rose to their highest level ever.  But the Fed has made it clear that; a) they are unconcerned with the transitory nature of price increases; and b) even if those price increases prove to be more long-lasting, they have the tools to deal with the problem.  Meanwhile, underperforming surveys will not dissuade them from the idea that there is much monetary work yet to be completed.

Put it all together and it appears that the market writ large has decided that the risk of Fed tapering is significantly lower than had been anticipated just Wednesday afternoon.  While taper talk made for good headlines, it doesn’t appear to be imminent on the policy radar.

Elsewhere in the world, though, there is also tapering talk as we continue to see economic data demonstrate that the recovery is continuing.  The interesting thing is the contrast between the data from Asia and that from Europe.  It is Flash PMI day, so we started in Japan last night, where Manufacturing PMI remained well above the key 50 level, printing at 52.5.  While a slight decline from the previous month, it is still well into growth territory.  However, renewed lockdowns in Japan (as well as other nations throughout Asia) continues to impede a rebound in services, with the PMI print falling nearly 4 points to 45.7.  There is no indication that the BOJ is going to modify monetary policy and this data certainly does not warrant any change.

European data this morning, however, was far more impressive with strength in both the manufacturing and services data as Europe’s vaccination rate rises (its 20% now) and lockdowns slowly come to an end.  As the market is already pricing in a strong recovery in the US, the surprising strength in Europe has resulted in a more positive outlook and manifested itself in further euro strength.  Although there is no thought that the ECB will tighten policy, the relative change in economic activity is good enough to keep the euro’s upward momentum intact.  While the euro has not moved at all today, it has recouped all its losses from the FOMC Minutes on Wednesday and remains in a modest uptrend.

Lastly, not only was UK PMI data strong, with both manufacturing and services printing well above 60, but UK Retail Sales jumped 9.0% in April, reminding us of just how quickly the UK is exiting the lockdown process and reopening.  The pound continues to be the best performing currency in the G10 this month, with today’s 0.3% gain taking the monthly gain to 3.0%.

Summing up, there appears to be a change of heart regarding the timing of the Fed tapering their QE purchases with the result being lower yields, higher stocks and a weaker dollar.

Speaking of stocks, yesterday’s strong US performance was followed by the Nikkei (+0.8%), but the rest of Asia did not feel the love (Hang Seng 0.0%, Shanghai -0.6%).  Europe, though, is performing better with the CAC (+0.55%) leading the way higher after the relatively best PMI data, with the DAX (+0.2%) hanging in there.  Disappointingly, the FTSE 100 (-0.1%) seems to have already priced in better growth and earnings and thus is little changed on the day.  US futures are all modestly higher at this point, by roughly 0.25%.

As discussed, bond yields, which had rallied sharply in the wake of the Minutes have fallen back to their pre-Minutes levels, although in the last few moments, the 10-year Treasury has edged lower with the yield backing up 0.9bps.  But in Europe, we are seeing a broadly positive performance with Bunds (-0.5bps) and OATs (-0.7bps) edging higher while the peripherals all show much more strength resulting in tighter spreads.  The growth story in the UK has separated Gilts from the pack and yields there are higher by 1.4bps as I type.

Commodity prices are having a mixed day with oil (+1.4%) the best performer by far, and precious metals (Au +0.15%, Ag +0.35%) also firmer.  However, agricuturals are falling (Soybeans -1.1%, Wheat -0.7%, Corn -1.2%) and industrial metals are mostly under pressure as well (Cu -0.25%, Fe -2.6%, Ni -1.0%) although Aluminum (+0.5%) is bucking the trend.

Finally, the dollar is definitely under pressure this morning, which given the decline in yields, should not be terribly surprising. Versus the G10, only the euro is essentially unchanged while the rest of the bloc is modestly firmer led by the pound (+0.3%) as discussed above.  In the EMG bloc, KRW (+0.5%) was the best performer overnight, responding to a huge export reading (53.3% Y/Y growth in the first 20 days of May).  But most APAC currencies rallied, recouping yesterday’s losses and we are seeing modest strength in ZAR (+0.3%) as well as the CE4.  In fact, at this hour, the only loser of note is MXN (-0.2%) which seems to be caught in a struggle regarding belief in Banxico’s willingness to raise rates further to fight rising inflation.

On the data front, PMI (exp 60.2 Manufacturing and 64.4 Services) is due at 9:45 and Existing Home Sales (6.07M) comes at 10:00.  Four Fed speakers round out the day, but we already have a very good idea of what each will say, with Kaplan retaining his hawkish views while the rest will sound far more dovish.

Nothing has changed my view that as go 10-year yields, so goes the dollar.  If yields continue to back off Wednesday’s highs, look for pressure on the dollar to remain.  If, however, yields reverse higher, the dollar will find its footing immediately.

Good luck, good weekend and stay safe
Adf

Retrogression

To taper or not is the question
Resulting in much indigestion
For traders with views
The Minutes were cues
The Fed’s ready for retrogression

A number of participants suggested that if the economy continued to make rapid progress toward the committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases.”  This is the money quote from yesterday’s FOMC Minutes, the one which has been identified as the starting point for the next step in Federal Reserve activity.  Its perceived hawkish tilt led to a decline in both stocks and bonds and saw the dollar rebound nicely from early session weakness.

No one can ever accuse the Fed of speaking clearly about anything, and this quote is full of weasel words designed to hint at but not actually say anything.  So, is this really as hawkish as the commentariat would have us believe?  Let us remember that the April meeting occurred before the surprisingly weak May Nonfarm Payroll report.  Since that report, we have heard many Fed speakers explain that there was still a long way to go before they saw the “substantial progress” necessary to begin to change policy.  Since the meeting, the Citi Economic Surprise Index (an index that seeks to track the difference between economic forecasts and actual data releases) has fallen quite sharply which implies that the economy is not growing as rapidly as forecast at that time.  Of course, since the meeting we have also seen the highest CPI prints on a monthly basis in 15 years (headline) and 40 years (core).

The growing consensus amongst economists is that at the Jackson Hole symposium in August, Chairman Powell will officially reveal the timeline for tapering and by the end of 2021, the Fed will have begun reducing the amount of asset purchases they make on a monthly basis.  That feels like a pretty big leap from “it might be appropriate at some point…to begin discussing…”

Remember, too, the discussion that is important is not what one believes the Fed should do, but rather what one believes the Fed is going to do.  The case for tighter policy is clear-cut in my mind, but that doesn’t mean I expect them to act in that fashion.  In fact, based on everything we have heard from various Fed speakers, it seems apparent that there is only a very small chance that the Fed will even consider tapering in 2021. The current roster of FOMC voters includes the Chair, Vice-Chair and Governors, none of whom could be considered hawkish in any manner, as well as the Presidents of Atlanta, Chicago, Richmond and San Francisco.  Of that group, Chicago’s Evans and SF’s Daly are uber-dovish.  Richmond’s Barkin is a middle-of-the-roader and perhaps only Atlanta’s Bostic could be considered to lean hawkish at all.  This is not a committee that is prepared to agree to tighter policy unless inflation is running at 5% and has been doing so for at least 6 months.  Do not get overexcited about the Fed tapering.

Markets, on the other hand, did just that yesterday, although the follow through has been unimpressive.  Yesterday’s session saw US equity markets open lower on general risk aversion and they had actually been climbing back until the Minutes were released.  Upon release, the S&P fell a quick 0.5%, but had recouped all that and more in 25 minutes and then chopped back and forth for the rest of the session.  In other words, it was hardly a rout based on the Minutes.  The overnight session was, in truth, mixed, with the Nikkei (+0.2%) climbing slightly while the Hang Seng (-0.5%) and Shanghai (-0.1%) slipped a bit.  Europe, which fell pretty sharply yesterday, has rebounded this morning (DAX +0.4%, CC +0.5%, FTSE 100 0.0%) although US futures are all in the red this morning by about -0.4%, so whatever positives traders in Europe are seeing have not yet been identified in the US.

As to the bond market, it should be no surprise that it sold off sharply yesterday, with 10-year yields rising 5 basis points at their worst point but closing higher by 3bps, at 1.67%.  But this morning there is no follow through at all as the 10yr has actually rallied with yields slipping 0.5bps.  This is hardly the sign of a market preparing for a Fed change of heart.  European sovereign markets are under modest pressure this morning, with yields a bit higher throughout the continent (bunds +1.8bps, OATs +1.0bps, gilts +1.5bps).  Neither did the Minutes cause much concern in Asia with both Australia and Japan seeing extremely muted moves of less than 1 basis point.

Commodity prices, on the other hand, have definitely seen some movement led by oil (WTI -1.5%) and Iron Ore (-2.8%).  However, the oil story is more about supply and the news that Iranian crude may soon be returning to the market as a deal to lift sanctions is imminent, while iron ore, and steel, were impacted by strong comments from China designed to halt the runaway price train in both, as they seek to reduce production in an effort to mitigate greenhouse gas emissions.  The non-ferrous metals are very modestly lower (Cu -0.1%, Al -0.2%, Zn -0.4%) while precious metals are little changed on the day.  Agricultural products, though, maintain their bids with small gains across the board.

Perhaps the most interesting market yesterday was cryptocurrencies where there was a very significant decline across the board, on the order of 20%-30%, which has reduced the value of the space by about 50% since its peak in early April.  This largely occurred long before the FOMC Minutes and was arguably a response to China’s announcement that payment for goods or services with any digital currency other than yuan was illegal rather than a response to any potential policy changes. This morning is seeing Bitcoin rebound very slightly, but most of the rest of the space still under pressure.

Finally, the dollar is under modest pressure today, after rallying nicely in the wake of the FOMC Minutes.  Versus the G10, only NOK (-0.1%) is in the red, suffering from the oil price decline, while the rest of the bloc is rebounding led by CHF (+0.4%) and AUD (+0.3%).  Swiss movement appears to be technically oriented while AUD’s rally is counterintuitive given the modestly worse than expected Unemployment report last night.  However, as a key risk currency, if risk appetite is forming, Aussie tends to rally.

Emerging market currencies that are currently trading have all rebounded led by PLN (+0.5%), TRY (+0.5%) and HUF (+0.45%).  All of these are benefitting from the broad based, but mild, dollar weakness.  The story was a bit different overnight as Asian currencies fell across the board with IDR (-0.6%) the leading decliner, as the highest beta currency with the biggest C/A deficit, but the rest of the space saw weakness on the order of -0.1% to -0.2%.

Data today starts with Initial Claims (exp 450K), Continuing Claims (3.63M) and the Philly Fed (41.0).  Then at 10:00 we see Leading Indicators (1.3%).  On the Fed front, only Dallas’s Kaplan speaks, but we already know that he has to have been one of the voices that wanted to discuss tapering, as he has said that repeatedly for the past month.

Frankly, this market has several cross currents, but my gut tells me that the ostensible hawkishness from yesterday’s Minutes will soon be forgotten and the doves will continue to rule the airwaves and sentiment.  Look for the dollar to drift lower on the day.

Good luck and stay safe
Adf

Inflation Be Damned

The Minutes revealed that the Fed
Cares not about outlooks, instead
Inflation be damned
They now are programmed
To wait until growth is widespread

There is a conundrum in markets today, one that when considered thoughtfully can only force you to scratch your head and say, huh?  Economic growth in 2021 is going to be gangbusters, that much is virtually assured at this time.  We heard it from the IMF, we heard it from the Fed and basically from every central bank and government around.  And that’s great!  Equity markets have certainly gotten the message, as we achieve new all-time highs across numerous indices on a regular basis.  Bond markets are also buying the message, or perhaps selling the message is more apropos, as sovereign bond markets have sold off pretty sharply this year with the concomitant rise in yields being quite impressive.  And yet, those same central banks who are forecasting significant economic growth this year remain adamant that monetary policy support is critical, and they will not be withdrawing it for years to come.  A cynic might think that those central banks don’t actually believe their own forecasts.

Yesterday’s FOMC Minutes revealed this exact situation.  “Participants noted that it would likely be some time until substantial further progress toward the committee’s maximum-employment and price-stability goals would be realized.”  In other words, they are nowhere near even thinking about thinking about tapering asset purchases, let alone raising interest rates.  On the subject of inflation, they once again made it clear that there was virtual unanimous belief that short-term rises in PCE would be transitory and that the dynamics of the past decade that have driven inflation lower would soon reassert themselves.  After the Minutes were released, uber-dove Lael Brainerd made all that clear with the following comment, “Our monetary policy forward guidance is premised on outcomes, not the outlook.”

It is also critical to understand that this is not simply a US phenomenon, but is happening worldwide in developed nations.  For example, in Sweden, Riksbank Governor Stefan Ingves explained, “It’s like sitting on top of a volcano.  I’ve been sitting on that volcano for many, many years.  It hasn’t blown up, but it’s not heading in the right direction,” when discussing the buildup in household debt via mortgages in Sweden due to rising house prices.  Recently released data shows that household debt there has risen to 190% of disposable incomes, as housing prices in March rose 17% over the past year, to the highest levels ever.  And yet, Ingves is clear that the Riksbank will not be raising rates for at least three years.

Thus, the conundrum.  Explosive growth in economic activity with central banks adamant that interest rates will remain near, or below, zero and QE will continue.  Certainly every central banker recognizes that monetary policy adjustments work with a lag, generally seen to be between 6 months and 1 year, so if the Fed were to raise rates, it would be September at the earliest when it might show up as having an impact on the economy.  But every central bank has essentially promised they will be falling behind the curve to fight the current battle.

So, let’s follow this line of thought to some potential conclusions.  Economic activity continues to expand rapidly as governments everywhere pump in additional fiscal stimulus on top of the ongoing monetary largesse.  Central banks allow economies to ‘run hot’ in order to drive unemployment rates lower at the expense of rising inflation.  (Perhaps this is the reason that so many central bank studies have declared the Phillips Curve relationship to be dead, it is no longer convenient!)  Equity markets continue to rise, but so do sovereign yields in the back end of the curve, such that refinancing debt starts to cost more money.  Pop quiz: if you are a central banker, do you; A) start to raise rates in order to rein in rising inflation? Or B) cap yields through either expanded QE or YCC to insure that debt service costs remain affordable for your government, but allow inflation to run hotter?  This was not a difficult question, and what we continue to hear from virtually every central bank is the answer is B.  And that’s the point, if we simply listen to what they are saying, it is very clear that whether or not inflation prints higher, policy interest rates are stuck at zero (or below).  Oh yeah, as inflation rises, and it will, real rates will be heading lower as well, you can count on it.

So, with that in mind, let’s take a quick tour of the markets.  Equities in Asia showed the Hang Seng (+1.15%) rising smartly, but both the Nikkei (-0.1%) and Shanghai (+0.1%) relatively unchanged on the day.  In Europe, the picture is mixed with the DAX (-0.2%) lagging but both the CAC (+0.35%) and FTSE 100 (+0.35%) moving a bit higher.  As to the US futures market, there is a split here as well, with the NASDAQ (+0.9%) quite robust, while the SPX (+0.3%) and DOW (0.0%) lag the price action.

As to the bond market, Treasury yields continue to back off from their highs at quarter-end, and are currently lower by 3 basis points, although still within 12bps of their recent highs.  European markets are a little less exuberant this morning with yields on Bunds (-0.7bps), OATs (-0.6bps) and Gilts (-0.5bps) all lower by less than a full basis point.  A quick discussion of Japan is relevant here as well, given the budget released that indicates the debt/GDP ratio there will be rising to 257% at the end of this year!  Despite the fact that the BOJ has pegged yields out to 10 years at 0.0%, debt service in Japan still consumes 22% of the budget.  Imagine what would happen if yields there rose, even 100 basis points.  And this perfectly illustrates the trap that governments and central banks have created for themselves, and why there is a case to be made that policy rates will never be raised again.

Commodity markets are mixed as oil (-0.85%) is softer but we are seeing strength in the metals (Au +0.6%, Ag +0.9%, Cu +0.7%) and the Agricultural sector.  And lastly, the dollar is generally weaker on the day, with only NOK (-0.15%) lagging in the G10 space under pressure from oil’s decline.  But JPY (+0.5%) is the leading gainer after some positive data overnight, with a widening current account and rising consumer confidence underpinning the currency. Otherwise, we are seeing AUD (+0.3%) and NZD (+0.3%) firmer as well on the back of the non-energy commodity strength.

In emerging markets, PLN (+0.6%) is the leading gainer, which seems a bit anomalous given there was no new news today.  Yesterday the central bank left rates on hold at 0.10% despite a much higher than expected CPI print last week.  As described above, inflation s clearly not going to be a major policy driver in most economies for now.  But away from the zloty, movements show a few more gainers than laggards, but all the rest of the movement being relatively small, +/- 0.3%, with no compelling narratives attached.

On the data front, this morning brings us Initial (exp 680K) and Continuing (3638K) Claims at 8:30, and then a few more Fed speakers including Chairman Powell at noon.  But what can the Fed tell us that we don’t already know?

As to the dollar, I continue to look to the 10-year yield as the key driver so if it continues to slide, I expect the dollar to do so as well.  And it is hard to make a case for some new piece of news that will drive Treasury selling here, so further USD weakness makes sense.

Good luck and stay safe
Adf

Suspicions

Fed staffers relayed their suspicions
That ease in financial conditions
Could lead to distress
Which could make a mess
For Powell and all politicians

But Jay heard the story and said
The risks when we’re looking ahead
Are growth is too slow
Inflation too low
So, money still pours from the Fed

Yesterday’s Fed Minutes left us with a bit of a conundrum as there appears to be a difference of opinion regarding the current state of the economy and financial markets between the Fed staffers and their bosses.  The bosses, of course, are the 19 members of the FOMC, 7 governors including the Chair and vice-Chair and the 12 regional Fed presidents.  The staffers are the several thousand PhD economists who work for that group and develop and run econometric models designed, ostensibly, to help better understand the economy and predict its future path.  On the one hand, based on the Fed’s prowess, or lack thereof, in forecasting the economy’s future path, it is understandable how the bosses might ignore their staffers.  When looking at past Fed forecasts, they are notoriously poor at determining how the economy is progressing, seemingly because the models upon which they rely do not represent the US economy very well.  On the other hand, the willful blindness exhibited by the bosses with respect to the current financial conditions is disqualifying, in itself, of trusting their views.  As I said, quite the conundrum.

This was made a little clearer yesterday when the FOMC Minutes showed that the staff had indicated the following:

The staff provided an update on its assessments of the stability of the financial system and, on balance, characterized the financial vulnerabilities of the U.S. financial system as notable. The staff assessed asset valuation pressures as elevated. In particular, corporate bond spreads had declined to pre-pandemic levels, which were at the lower ends of their historical distributions. In addition, measures of the equity risk premium declined further, returning to pre-pandemic levels. Prices for industrial and multifamily properties continued to grow through 2020 at about the same pace as in the past several years, while prices of office buildings and retail establishments started to fall. The staff assessed vulnerabilities associated with household and business borrowing as notable, reflecting increased leverage and decreased incomes and revenues in 2020. Small businesses were hit particularly hard. [author’s emphasis].

And yet, after hearing the staff reports, neither the FOMC statement nor Chairman Powell at the ensuing press conference referred to elevated asset values or financial system vulnerabilities.  Rather, those, and most other concerns, were described as moderate, while explaining that downside outcomes to inflation still dominated their thinking.  In the intervening 3 weeks, we have seen Treasury yields rise 30 basis points in the 10-year and inflation breakevens rise 22 basis points.  In other words, it is beginning to appear as though the Fed and the market are watching two different movies.  The risk to this scenario is that the Fed can fall dangerously behind the curve with respect to keeping the economy on their preferred path, and may be forced to dramatically shift policy (read raise rates) if (when) it becomes clear rising inflation is not a temporary phenomenon.  Now, while it is likely to take the Fed quite a while to recognize this discrepancy, I assure you, when it occurs and the Fed feels forced to act, the market response will be dramatic.  But for now, that is just not on the cards.  If anything, as we continue to hear from various Fed speakers, there is no indication they are going to consider tighter policy for several years to come.

In the meantime, there is no reason to suspect that market participants will change their short-term behavior, so ongoing manias will continue.  Just be careful with your personal accounts.  Remember, when things turn, return OF capital is far more important than return ON capital!

Now to today’s session.  Once again, the traditional risk memes are a bit confused this morning.  Equity markets have not had a good session with Asia mostly lower (Nikkei -0.2%, Hang Seng -1.6%, although Shanghai reopened with a gain, +0.5%).  European markets are also under pressure (DAX -0.1%, CAC -0.4%, FTSE 100 -0.9%) despite the fact that today marks the beginning of the disbursement of EU-wide support funded by EU-wide bond issuance.  You may remember last July when, to great fanfare, the EU agreed a €750 billion joint debt issuance, to be backed by all members.  Well, we are now seven months later, and they are finally starting to disburse the funds.  And do not seek respite in US futures markets as they are all lower by between 0.25% (DOW) and 0.8% (NASDAQ).

What is interesting is that despite the equity market weakness, bond markets are falling as well.  It appears that growing concerns over rising inflation are outweighing the risk aversion theme.  Thus, 10-year Treasury yields are higher by 1.9bps this morning and we are seeing even larger rises in some European markets (Gilts +4.1bps, OATs +2.6bps, Bunds +1.8bps).  So, I ask you, which market is telling us the true risk story today?

Perhaps if we look to commodities we will get a hint.  Alas, the information here is muddled at best.  Oil prices continue to rise, up another 0.3% this morning, as up to 4 million barrels of daily production in Texas and the Midwest have been shut in because of the winter storms.  That is 36% of US production, and clearly making an impact. Meanwhile, base metals have been mixed with Aluminum higher and Copper lower.  Precious metals?  Mixed as well with gold (+0.4%) rebounding from a couple of really bad sessions while silver (-0.75%) continues to slide.

Thus far, making a claim as to the risk sense of markets is essentially impossible.  So, now we turn to the dollar.  If tradition is a guide, the dollar’s broad weakness, lower vs. all G10 counterparts and many EMG ones as well, would indicate a risk on session.  But if investors are moving into risky assets, why are stocks under uniform pressure? Perhaps they are all moving their money into Bitcoin (+0.2% today, +11.2% in the past week).

But back to the fiat world where we see GBP (+0.6%) as the leading G10 gainer which appears to be a result of traders expecting the UK to recover much faster than Europe given the relative success of their Covid vaccination program.  But even the worst performers, CAD and JPY are higher by 0.15% this morning.  NOK (+0.4%) seems to be benefitting from the ongoing oil rally, and the rest of the bloc may be beginning to see the resumption of the dollar short trade.

EMG currencies are a bit more mixed, with most APAC currencies softening overnight, but LATAM and CE4 currencies benefitting from the dollar’s overall softness.  CLP (+0.5%) leads the way on the strength of rising copper prices, with ZAR (+0.45%) following closely behind.

Yesterday’s US data was surprisingly good, with Retail Sales exploding higher by 5.3% on a monthly basis (I guess the most recent stimulus checks were spent!) and PPI jumping by a full percent, to a still low 1.7%, which may well foreshadow the future of CPI.  We also saw strong IP and Capacity Utilization data.  This morning brings Initial Claims (exp 770K), Continuing Claims (4.425M), Housing Starts (1660K), Building Permits (1680K) and Philly Fed (20.0) all at 8:30. We also have two more Fed speakers, the hyper dovish Lael Brainerd and a more middle of the road dove Rafael Bostic.

Wrapping it all up shows a weak dollar, weak bond prices and weak stock prices.  It feels like at least one of these needs to adjust its trajectory for the day to make any sense, but as of now, I am not willing to bet which.  As far as the FX market goes, we appear to be rangebound for now, although any eventual break still feels like it will be for a lower dollar.

Good luck and stay safe
Adf

Blue Wave at Last

Psephologists have now decided
The run-off election provided
A blue wave at last
So laws can be passed
Republicans view as misguided

The market responded by sellin’
The 10-year, with traders foretellin’
Inflation to come
As Powell stays mum
While financing Treasury’s Yellen

While the election results from Georgia are not yet final, the indications at this time are that the Democratic party won one of the seats with the second one still too close to call.  However, the market has already made its decision, that both seats flipped to the Democrats and that the Senate will now be split 50:50, which means that the Vice President will be able to cast the deciding vote.  The clear implication is that, while hardly a mandate, the Democrats will control both the executive and legislative branches and be able to implement a great deal of their agenda.  In other words, the blue wave high tide has finally crested.

The initial reaction to this news has been seen in the sell-off of the 10-year Treasury, where the yield has risen to 1.02% as I type, its first foray above 1.00% since March 19th, during the first days of the Covid-19 market panic.  The reflation trade is back in vogue, with expectations now that the new administration will be aggressively adding fiscal stimulus, thus increasing Treasury issuance significantly and ultimately steepening the yield curve as demand for long-dated Treasuries will not be able to keep pace with the new supply.  However, given the already record levels of debt outstanding, the government simply cannot afford for interest rates to rise too far, as if they do, interest payments will soak up an ever-increasing proportion of available revenues.  It is for this reason that I continue to believe the Fed will increase their current activity, and whether tacitly, by expanding QE and extending the maturity of purchases, or explicitly, by setting a yield target, implement Yield Curve Control (YCC).

At the same time, the Fed has made it abundantly clear that higher inflation is of no concern to the committee.  The latest proof comes from Chicago Fed President Charles Evans, who explained to us yesterday, “Frankly, if we got 3% inflation, that would not be so bad.  It is very difficult to imagine out of control inflation, even with the large debt that fiscal authorities have been running up.”   Perhaps, as a Regional Fed President, he simply lacks imagination.  After all, just yesterday, almost at the same time he was recounting his views, the ISM Prices Paid index printed at 77.6, well above expectations and at a level seen only twice, briefly, in the past decade.  There is a strong correlation between this index and PPI, so the idea that inflation pressures are building is hardly unimaginable.

Which brings us back to the prospects for the dollar, as well as other markets.  While yields have climbed today, the prospect of inflation rising more rapidly and real rates falling further into negative territory still informs my view that the dollar has further to decline.  This will become more obvious when the Fed steps in to prevent the rise in nominal yields, which I am confident will occur sooner rather than later.  Again, while I don’t anticipate a dollar collapse, as other central banks will fight to prevent such an outcome, further dollar weakness is in the cards.

Speaking of other central banks fighting the dollar’s weakness, last night the PBOC started to do just that by establishing the CNY fix at a weaker renminbi rate than anticipated.  Since August 1st, CNY has appreciated by nearly 8% vs. the dollar, which for an economy that remains heavily reliant on exporting for GDP growth, is a growing problem.  As the PBOC makes no bones about directing the value of the currency, you can expect that they will be actively managing the renminbi’s value going forward in an effort to prevent too much further strength.  But, as long as both nominal and real yields remain positive in China, that will attract significant capital flows and continue to pressure the renminbi higher.

So, what has all this news done to other markets?  Well, most of Europe is ecstatic at the election outcome, at least that seems to be the case based on the rallies seen in equity markets there.  The FTSE 100 (+2.3%) is leading the way, but we are seeing strong gains in the DAX (+0.9%) and CAC (+0.8%) as well, despite the fact that the PMI Services data disappointed across the board.  The story in Asia was more mixed with the Nikkei (-0.4%) and Australia (-1.1%) underwhelmed by the outcome, although the Hang Seng (+0.2%) and Shanghai (+0.6%) both wound up in the green.  As to US futures, as I type, they are a mixed bag, with DOW futures higher by 0.2%, SPU’s lower by 0.4% while NASDAQ futures are down 2.0%.  The latter’s decline are a response to the election results as concerns grow that Big Tech will now be in the crosshairs of Congress for more regulation if not outright dismemberment.

While we have already discussed the Treasury market, European government bonds are mostly softer today as well, with yields rising as much as 4bps in the UK, although German bunds are unchanged on the session.

Another inflationary impulse comes from oil, where yesterday the Saudis surprised the market by unilaterally cutting production by 1 million barrels/day helping to take WTI above $50/bbl for the first time since late February.  If this rally continues, look for gasoline prices to creep higher, one of the key sentiment indicators regarding the perception of inflation.

And finally, the dollar remains broadly under pressure this morning, with NOK (+0.75%) the leading gainer in the G10 on the back of the oil rally, although both AUD (+0.6%) and NZD (+0.65%) are also having a good day as both commodity prices gain and they serve as a proxy for Asian growth.  Meanwhile, the euro (+0.35%) is trading at new highs for the move and back to levels not seen since April 2018.

Emerging market currencies are universally higher this morning, led by PLN (+0.85%), MXN (+0.8%) and HUF (+0.8%).  Those stories are easy to see, with oil helping the peso, while the CE4 currencies are tracking the euro’s strength.  Asian currencies, while all firmer, did not show nearly the enthusiasm, with gains between 0.1% and 0.2%, but of course, the election results were not fully known during their session.

On the data front, this morning brings ADP Employment (exp 75K) as well as Factory Orders (0.7%) and the PMI Services index (55.2).  Then, this afternoon, we see the FOMC Minutes of the December meeting, one where they disappointed many folks by not easing further. The first thing to note is that after yesterday’s ISM data, the ADP forecast increased from 50K.  Clearly, the manufacturing sector remains in better shape than expected.  At the same time, the Minutes ought to be interesting as perhaps we will learn more about attitudes regarding any prospects for what could change policy.  Of course, given the world was a different place then, and as Evans explained, inflation is of no concern, the real question from the Minutes will be what will the Fed do next to ease further.

As to the dollar, it is hard to see a short-term path in any direction other than lower, but I continue to expect the decline to be slow and orderly.

Good luck and stay safe
Adf

Dreams All Come True

The Minutes explained that the Fed
Was actively looking ahead
Twixt yield curve control
And guidance, their goal
Might not be achieved, so they said

This morning, though, payrolls are due
And traders, expressing a view
Continue to buy
Risk assets on high
Here’s hoping their dreams all come true!

In the end, it can be no surprise that the Fed spent the bulk of their time in June discussing what to do next. After all, they had to be exhausted from implementing the nine programs already in place and it is certainly reasonable for them to see just how effective these programs have been before taking the next step. Arguably, the best news from the Minutes was that there was virtually no discussion about negative interest rates. NIRP continues to be a remarkable drag on the economies of those countries currently caught in its grasp. We can only hope it never appears on our shores.

Instead, the two policies that got all the attention were forward guidance and yield curve control (YCC). Of course, the former is already part of the active toolkit, but the discussion focused on whether to add an outcome-based aspect to their statements, rather than the more vague, ‘as long as is necessary to achieve our goals of stable prices and full employment.’ The discussion centered on adding a contingency, such as; until inflation reaches a certain level, or Unemployment falls to a certain level; or a time-based contingency such as; rates will remain low until 2023. Some would argue they already have that time-based contingency in place, (through 2022), but perhaps they were leading up to the idea it will be longer than that.

The YCC discussion focused on research done by their staff on the three most well-known instances in recent history; the Fed itself from 1942-1951, where they capped all rates, the BOJ, which has maintained 10-year JGB yields at 0.0% +/- 0.20%, and the RBA, which starting this past March has maintained 3-year Australian yields at 0.25%. As I mentioned last week in “A New Paradigm” however, the Fed is essentially already controlling the yield curve, at least the front end, where movement out to the 5-year maturities has been de minimis for months. Arguably, if they are going to do something here, it will need to be in the 10-year or longer space, and the tone of the Minutes demonstrated some discomfort with that idea.

In the end, my read of the Minutes is that when the FOMC meets next, on July 29, we are going to get a more formalized forward guidance with a contingency added. My guess is it will be an Unemployment rate contingency, not a time contingency, but I expect that we will learn more from the next set of Fed speakers.

Turning to today, as the market awaits the latest payroll report, risk assets continue to be on fire. The destruction in so many areas of the economy, both in the US and around the world, is essentially being completely ignored by investors as they continue to add risk to their portfolios amid abundant central bank provided liquidity. Here are the latest median forecasts as compiled by Bloomberg for today’s data:

Nonfarm Payrolls 3.06M
Private Payrolls 3.0M
Manufacturing Payrolls 438K
Unemployment Rate 12.5%
Average Hourly Earnings -0.7% (5.3% Y/Y)
Average Weekly Hours 34.5
Participation Rate 61.2%
Initial Claims 1.25M
Continuing Claims 19.0M
Trade Balance -$53.2B
Factory Orders 8.7%
Durable Goods 15.8%
-ex Transport 6.5%

Because of the Federal (although not bank) holiday tomorrow, the report is being released this morning. It will be interesting to see if the market responds to the more timely Initial Claims data rather than the NFP report if they offer different messages. Remember, too, that last month’s Unemployment rate has been under much scrutiny because of the misclassification of a large subset of workers which ultimately painted a better picture than it might otherwise have done. Will the BLS be able to correct for this, and more importantly, if they do, how will the market interpret any changes. This is one reason why the Initial and Continuing Claims data may be more important anyway.

But leading up to the release, it is full speed ahead to buy equities as yesterday’s mixed US session was followed by strength throughout Asia (Nikkei +0.1%, Hang Seng +2.85%, Shanghai +2.1%) and in Europe (DAX +1.6%, CAC +1.3%, FTSE 100 +0.6%). US futures are also higher, between 0.4%-0.8%, to complete the virtuous circle. Interestingly, once again bond yields are not trading true to form on this risk-on day, as yields in the US are flat while throughout Europe, bond yields are declining.

But bonds are the outlier here as the commodity space is seeing strength in oil and metals markets and the dollar is under almost universal pressure. For example, in the G10, NZD is the leading gainer, up 0.6%, as its status as a high beta currency has fostered buying interest from the speculative crowd betting on the recovery. But we are also seeing NOK and SEK (both +0.5%) performing well while the euro (+0.3%) and the pound (+0.3%) are just behind them. The UK story seems to be about the great reopening that is due to occur starting Saturday, when pubs and restaurants as well as hotels are to be allowed to reopen their doors to customers. The fear, of course, is that this will foster a second wave of infections. But there is no doubt there is a significant amount of pent up demand for a drink at the local pub.

In the EMG bloc, the ruble is today’s winner, rising 1.2% on the back of oil’s continued rebound. It is interesting, though, as there is a story that Saudi Arabia is having a fight with some other OPEC members, and is close to relaunching a full-scale price war again. It has been the Saudis who have done the lion’s share of production cutting, so if they turn on the taps, oil has a long way to fall. Elsewhere in the space, INR (+0.8%) and ZAR (+0.75%) are having solid days on the back of that commodity strength and recovery hopes. While the bulk of the space is higher, IDR has had a rough session, in fact a rough week, as it has fallen another 0.65% overnight which takes its loss in the past week near 2.0%. Infection rates continue to climb in the country and investors are becoming uncomfortable as equity sales are growing as well.

So, this morning will be a tale of the tape. All eyes will be on the data at 8:30 with the odds stacked for a strong risk session regardless of the outcome. If the data shows the recovery is clearly strengthening, then buying stocks makes sense. On the other hand, if the data is disappointing, and points to a reversal of the early recovery, the working assumption is the Fed will come to the rescue quite quickly, so buying stocks makes sense. In this worldview, the dollar is not seen as critical, so further dollar weakness could well be in our future.

Good luck and stay safe
Adf

Feeling the Heat

As tensions continue to flare
Twixt China and Uncle Sam’s heir
The positive feelings
In equity dealings
Could easily turn to a bear

Meanwhile down on Threadneedle Street
The Old Lady’s fairly downbeat
Thus negative rates
Are now on their plates
With bank stocks there feeling the heat

A yoyo may be the best metaphor for market price action thus far in May as we have seen a nearly equal number of up and down days with the pattern nearly perfect of gains followed by losses and vice versa. Today is no different as equity markets are on their back foot, after yesterday’s gains, in response to increasing tensions between Presidents Trump and Xi. Realistically, this is all political, and largely for each President’s domestic audience, but it has taken the form of a blame game, with each nation blaming the other for the instance and severity of the Covid-19 outbreak. What is a bit different this time is that President Trump, who had been quick to condemn China in the past, had also been scrupulous in maintaining that he and President Xi had an excellent working relationship. However, last night’s Twitter tirade included direct attacks on Mr Xi, a new tactic and one over which markets have now shown concern.

Thus, equity markets around the world are lower this morning with modest losses seen in Asia (Nikkei -0.2%, Hang Seng and Shanghai -0.5%) and slightly larger losses throughout the Continent (DAX -1.6%, CAC -1.1%, FTSE 100 -1.0%). US futures are pointing in the same direction with all three indices currently down about 0.7%. Has anything really changed? Arguably not. After all, both broad economic data and corporate earnings numbers remain awful, yet equity market prices, despite today’s dour mood, remain within sight of all-time highs. And of course, the bond market continues to point to a very different future as 10-year Treasury yields (-1bp today) continue to trade near historically low levels. To reiterate, the conundrum between a bond market that is implying extremely slow economic activity for the next decade, with no concomitant inflation seems an odd companion to an equity market where the median P/E ratio has once again moved above 20, well above its long-term average. This dichotomy continues to be a key topic of conversation in the market, and one which history has shown cannot last forever. The trillion-dollar question is, which market adjusts most?

With the increasing dissent between the US and China as a background, we also learned of the specter of the next country to move toward a negative interest rate stance, the UK. When Mark Carney was governor there, he categorically ruled out negative interest rates as an effective tool to help support the economy. He got to closely observe the experiment throughout Europe and concluded the detriments to the banking community outweighed any potential economic positives. (This is something that is gaining more credence within the Eurozone as well although the ECB continues to insist NIRP has been good for the Eurozone.) However, Carney is no longer governor, Andrew Bailey now holds the chair. And he has just informed Parliament, “I have changed my position a bit,” on the subject, and is now willing to consider negative rates after all. This is in concert with other members of the MPC, which implies that NIRP is likely soon to be reality in the UK. It should be no surprise that UK banking stocks are suffering after these comments as banks are the second victims of the process. (Individual savers are the first victims as their savings no longer offer any income, and in extreme cases decline.)

The other natural victim of NIRP is the currency. As discussed earlier this week, there is a pretty solid correlation between negative real rates and a currency’s relative value. Now granted, if real rates are negative everywhere, then we are simply back to the relative amount of negativity that exists, but regardless, this potential policy shift is clearly new, and one would expect the pound to suffer accordingly. Surprisingly, it is little changed this morning, down less than 0.1% amid a modest trading range overnight. However, it certainly raises the question of the future path of the pound.

When the Eurozone first mooted negative interest rates, in 2014, the dollar was already in the midst of a strong rally based on the view that the Fed was getting set to start to raise interest rates at that time. Thus, separating the impact of NIRP from that of expected higher US rates on the EUR/USD exchange rate is no easy task. However, there is no question that the euro’s value has suffered from NIRP as there is limited incentive for fixed income investment by foreigners. It should therefore be expected that the pound will be weaker going forward as foreign investment interest will diminish in the UK. Whether negative rates will help encourage foreign direct investment is another story entirely, and one which we will not understand fully for many years to come. With all this in mind, though, the damage to the pound is not likely to be too great. After all, given the fact that negative real rates are widespread, and already the situation in the UK, a base-rate cut from 0.1% to -0.1% doesn’t seem like that big a deal overall. We shall see how the market behaves.

As to the session today, FX markets have been as quiet as we have seen in several months. In the G10 space, Aussie and Kiwi are the underperformers, but both are lower by a mere 0.35%, quite a small move relative to recent activity, and simply a modest unwind of yesterday’s much more powerful rally in both. But away from those two, the rest of the bloc is less than 0.2% different from the close with both gainers (EUR, DKK) and losers (GBP, JPY) equidistant from those levels.

On the EMG side, there is a bit more constructive performance with oil’s continued rally (+2%) helping RUB (+0.4%) while the CE4 are also modestly firmer simply following the euro higher. APAC currencies seem a bit worse for wear after the Twitter spat between Trump and China, but the losses are miniscule.

Data this morning showed the preliminary PMI data from Europe is still dire, but not quite as bad as last month’s showing. In the US today we see Initial Claims (exp 2.4M), Continuing Claims (24.25M) and Existing Home Sales (4.22M). But as I have been writing all month, at this point data is assumed to be dreadful and only policy decisions seem to have an impact on the market. Yesterday we saw the Minutes of the Fed’s April 29 meeting, where there was a great deal of discussion about the economy’s problems and how they can continue to support it. Ideas floated were firmer forward guidance, attaching rate moves to numeric economic targets, and yield curve control, where the Fed determines to keep the interest rate on a particular tenor of Treasury bonds at a specific level. Both Japan and Australia are currently executing this, and the Fed has done so in its history, keeping long-term yields at 2.50% during WWII. My money is on the 10-year being pegged at 0.25% for as long as necessary. But that is a discussion for another day. For today, the dollar seems more likely to rebound a bit rather than decline, but that, too, is one man’s view.

Good luck and stay safe
Adf

A Bright Line

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

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

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

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

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

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

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

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

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

Good luck
Adf

No Rapprochement

The topic du jour is Iran
Where threats, to and fro, carry on
Risk appetite’s fallen
And bears are now all in
That this time there’s no rapprochement

The rhetoric between the US and Iran over the weekend has escalated with both sides threatening retaliation for anything the other side does. Stories of cyber-attacks on the US as well as an attack on a base in Kenya where three Americans were killed seem to be the first steps, but with the US deploying reinforcements to the Middle East, and President Trump promising disproportionate responses to any further actions, the situation has become fraught with danger.

Not surprisingly, financial markets are stressing with risk appetites throughout the world dissipating and haven assets in demand. So, for a second day we have seen equity markets fall around the world (Nikkei -1.9%, Hang Seng -0.8%, DAX -1.6%, CAC -1.1%, FTSE -1.0%) and US futures are following along with all three indices currently lower by approximately 0.8%. Treasuries and German bunds have rallied, albeit Friday’s price action was far greater than this morning’s movement which has seen yields on each fall just one more basis point. Gold has soared to its highest level since April 2013 and is now pressing up toward $1600/oz. Oil continues to rise on supply fears, up another 1.0% this morning and nearly 6.0% since Friday morning. But recall that prior to the US action against Soleimani, oil was up more than 20% since October.

And finally, the dollar this morning is…lower. At least mostly that’s the case. In some ways this is quite surprising as the dollar tends to be a haven in its own right, but markets have been known to be fickle prior to today. In the G10 space, the pound is leading the way higher overnight, up 0.5%, which may well be a response to modestly better than expected UK data (New Car Registrations +3.4%, Services PMI 50.0) rather than to the geopolitical risks. Of course, PMI at 50.0 is hardly cause for celebration, but I guess that’s better than further sub-50 readings. The euro has also benefitted this morning, +0.35%, after PMI data across the region was also modestly better than the flash numbers from the week before last. However, based on the latest data, according to most econometric models, GDP for Q1 in the Eurozone is still running at just 0.1%, or less than 0.5% annualized. Again, it’s hard to get too excited about the situation yet.

And then there is the yen, which is essentially unchanged on the day, perhaps the biggest surprise of all. This is because even when the dollar has not run true to course on a risk basis, the yen has been extremely consistent. Granted, since New Year’s Eve, the yen has been the top G10 performer but its 0.5% rally in that time is hardly inspirational. My take is that even heightened rhetoric from either side is likely to see the yen gain further, but remember there are market technicals involved in the trade, with 108.00 having demonstrated strong support since early October. It appears we will need a bit more of a ‘kinetic’ action in Iraq/Iran before the yen takes its next steps higher.

In the EMG bloc, the situation is a bit different, with EEMEA currencies all trading in a tightly linked manner to the euro, and so higher by about 0.35%, but modest weakness seen across most of the APAC region. As to LATAM, CLP is opening much lower (-1.75%) as the central bank backed away from its USD sale program. The bank announced this morning that it would not be selling the $150mm in the spot market it has been executing every day since last autumn. If nothing else, this should be a good indication for hedgers of just how little liquidity exists within that market.

Turning to Friday’s FOMC Minutes, it can be no surprise that the Fed nearly twisted their own arm, patting themselves on the back, for setting policy at just the right place. And then there was the American Economic Association conference this past weekend where the Fed loomed large in the paper production. Former Fed chairs Bernanke and Yellen once again explained that things beyond their control (demographics and technology) were the reason that they could not achieve their policy targets, but both assured us that more of the same policies that have been ineffective for the economy (but great for the stock market) would get the job done! Meanwhile, current Fed members all expressed satisfaction with the current settings, although it is clear there is far more concern over economic weakness than rising price pressures. What is clear is that higher prices are coming to a store (every store) near you.

As to this week, the data parade starts tomorrow and runs through Friday’s payroll report as follows:

Tuesday Trade Balance -$43.9B
  ISM Non-Manufacturing 54.5
  Factory Orders -0.7%
Wednesday ADP Employment 160K
  Consumer Credit $15.8B
Thursday Initial Claims 220K
Friday Nonfarm Payrolls 162K
  Private Payrolls 152K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.4

Source: Bloomberg

In addition, we hear from five more Fed speakers, with many more doves than hawks slated to discuss their views. In truth, I think it would be more effective if they would simply shut up rather than constantly reiterate their opinion that they have done a great job and will continue to do so unless things change. However, with the reduced risk appetite due to the Iran situation, I guess they feel the need to try to support stock prices at all costs.

In the medium term, I think the dollar will continue to come under pressure. In the short term, I think it is much harder to have a view given the highly volatile nature of the current situation in the Middle East. This is why you hedge; to prevent significant problems, but take care in executing those hedges, markets are skittish on the opening, and market depth may be a bit less robust than normal.

Good luck
Adf

Unease In Iraq

While yesterday, risk basked in glory
This morning risk-off is the story
Unease in Iraq
Had markets give back
The gains seen in each category

Well, this is probably not the way most of us anticipated the year to begin, with a retaliatory strike against Iran inside Iraq, but that’s what makes markets interesting. So yesterday’s bright beginning, where the PBOC reduced its reserve requirement ratio (RRR) by 0.50% to add further liquidity to the Chinese economy which led to broad based positive risk sentiment has been completely reversed this morning. Briefly recapping yesterday’s activity, equity markets around the world soared on the news of further central bank easy money, but interestingly, Treasury bonds rallied (yields declined) and gold rallied as did the dollar. This is a pretty unusual combination of market movements, as generally, at least one of that group would sell off in a given session. Perhaps it speaks to the amount of spare cash on the sidelines looking for investment opportunities to start the year.

However, that was soooo yesterday. At about 7:45 last night the news hit the tape that a senior Iranian general from the QUDS force had been killed by a US drone attack near Baghdad airport. When this was confirmed all of the positive sentiment that had been permeating markets disappeared in an instant. Equity prices went from a strong opening in Asia to closing with declines. The dollar and the yen both rallied sharply as did gold and oil. And not to be left out, Treasury yields have plummeted along with Bund and Gilt yields. In other words, today is a classic risk-off session.

So a quick look at markets as NY starts to walk in shows European equity markets under pressure (DAX -1.65%, CAC -0.5%, FTSE -0.5%) and US futures similarly falling (DJIA -1.2%, Nasdaq 1.5%, SPY -1.3%). In the bond market, Treasury yields are down 7.5bps to 1.80% while German Bunds are down 7bps to -0.30%. Gold prices have rallied a further 1.4% and are back to the highs touched in September at $1550/oz, a level which had not been seen since early 2013 prior to that. Oil prices have rocketed higher, up 3.9%, as fears of supply interruptions make the rounds. Of course, given that the US shale producers have essentially become the swing producers in the market, my sense is that we are not likely to see a permanently higher price level here. Remember, when Iran attacked Saudi oil facilities last September, the oil price spike was extremely short-lived, lasting just a couple of days before settling right back down.

And finally, the dollar has rallied sharply this morning against virtually all its counterparts except, naturally, the yen. During the last week of 2019, the dollar sold off broadly, losing about 2.0% against a wide range of currencies as investors and traders seemed to be preparing for a scenario of continued low US interest rates supporting stocks while undermining the dollar’s value. Of course, my view of ‘not QE’ having a significant impact on the dollar has not changed, and although the US economy continues to outperform its G10 peers and US interest rates remain higher than pretty much every other country in that bloc, the history of QE is that it will undermine the dollar this year.

But for right now, long-term structural issues are taking a back seat to the immediacy of growing concern over escalating tensions in Iraq and the Middle East. If a larger conflict erupts, then we are far more likely to see protracted USD and JPY strength alongside weaker equity markets, higher prices for gold and oil and lower Treasury yields. And the thing to remember right now is that traders were establishing short USD positions for the last several weeks, so this sudden reversal could well have further to run on position squaring alone. Markets remain less liquid than normal as most trading desks will not be fully staffed until Monday. So keep that in mind if some hedging needs to be executed today.

With that as an introduction, what else can we anticipate today? Well, we do get a bit of US data, ISM Manufacturing (exp 49.0) and ISM Prices Paid (47.8) as well as Construction Spending (0.4%) and then at 2:00 the FOMC Minutes from the December meeting will be released. Those have garnered a great deal of interest as even though Chairman Powell has essentially told us all that rates are on hold for a long time, all eyes will be searching for further discussion of the repo issue and how the Fed plans to handle it going forward. While they were able to prevent any untoward movement for the year-end turn, they are still buying $60 billion / month of T-bills and the balance sheet has grown more than $400 billion since October. Not coincidentally, equity prices have rallied sharply since October as well. The point is that the Fed remains on a path where they have promised to re-inflate the balance sheet until at least late Spring, and given the direct relationship between the Fed’s balance sheet and equity prices, as well as the demonstrated fear the Fed has shown with respect to doing anything that could be blamed for causing the stock market to decline, it seems awfully likely that ‘not QE’ is going to continue for a very long time. And that is going to weigh on the dollar going forward…just not today.

One more thing to look for this afternoon is a series of comments from a bevy of Fed doves (Brainard, Daly, Evans and Kaplan) who are attending a conference in San Diego. Do not be surprised to hear comments that continue to raise the bar for any possible rate hikes, but allow the idea of rate cuts to filter into the discussion. However, this too, is unlikely to undermine the dollar during a risk-off session. The theme here is that payables hedgers need to consider taking advantage of this short-term dollar strength.

Good luck
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