Patience is Needed

Mnuchin said patience is needed
While Powell said growth must be seeded
As both testified
And each justified
Their views, which both said must be heeded

Two months into the response to Covid-19, differences in policy views between the Fed and the Administration are starting to appear. In Senate testimony yesterday, Treasury Secretary Mnuchin indicated the belief that sufficient fiscal support has been authorized and its implementation is all that is needed, alongside the relaxation of lockdown rules around the country, for the economy to rebound sharply. The Administration’s base case remains a V-shaped recovery, with Q3 and Q4 showing substantial growth after what everyone agrees will be a devastatingly awful Q2 result.

Meanwhile, the Fed, via Chairman Powell, took the view that we remain in a critical period and that further stimulus may well be necessary to prevent permanent long-term damage to the economy. He continued to focus on the idea that until people feel safe with personal interactions, any rebound in the economy will be substandard. Of course, to date, of the $454 billion that Congress authorized for the Treasury to use as seed money underlying Fed lending schemes, less than $75 billion has been utilized. It seems that if Chairman Powell was truly that concerned, he would be ramping up the use of those funds more quickly. While part of the problem is the normal bureaucratic delays that come with implementing any new program, it is also true that the Fed is not well suited to support small businesses and individuals. Programs of that nature tend to require more fiscal than monetary support, at least as currently defined and implemented in today’s world. Remember, the Fed is not able to take losses according to its charter, which is why all the corporate bond buying and main street lending programs are already on shaky legal grounds.

The interesting thing about the dueling testimonies was just how little of an impact they had on market behavior yesterday. In fact, the late day equity market sell-off was almost certainly driven by the concern that yesterday’s media darling, the biotech firm Moderna, Inc., may not actually have a viable vaccine ready this year. Remember, it was the prospect that a vaccine was imminent and so lockdowns could be lifted that was critical in investor minds yesterday. If the vaccine story is no longer on track, it is much harder to justify paying over the top for equities. At any rate, that late day move set the tone for a much more subdued session in both Asia and Europe overnight.

Looking at markets, last night saw a mixed equity picture in Asia (Nikkei +0.8%, Shanghai -0.5%) and a very modest positive light in Europe (DAX +0.6%, CAC 0.0%, FTSE 100 +0.2%). More positively, US futures are pointing higher as I type, with all three indices looking at a 1% gain on the open if things hold. Bond markets are similarly uninspired this morning, with Treasury yields higher by less than 1bp while German bund yields are down by the same. In fact, looking across the European market, half are slightly higher, and half are slightly lower. Again, nothing of interest here.

Commodity markets show that oil continues to rebound sharply, up another 1% this morning and now above $32/bbl for WTI. Remember, it was less than a month ago that the May futures contract settled at -$37/bbl as storage was nowhere to be found. Certainly, any look at commodity markets would indicate that economic growth was making a return. But it sure doesn’t feel like that yet.

Finally, FX markets continue to see the dollar cede some recent gains as fears over USD funding by global counterparts continue to ebb on the back of Fed lending programs. In fact, this is exactly where the Fed can do the most good, helping to ensure that central banks around the world have the ability to access USD liquidity for their local markets.

A tour of the G10 shows that today’s biggest winner is NZD (+0.65%) followed by AUD and CHF, both higher by about 0.4%. The Kiwi dollar was supported by central bank comments about NIRP remaining a distant prospect, at best, with many hurdles to be jumped before it would make sense. Aussie seems to have benefitted from Japanese investment flows into their government bond markets, which are now relatively attractive vs. US Treasuries. Finally, after a short-lived decline yesterday afternoon, apparently driven by some options activity, the Swiss franc is simply returning to its previous levels. The other seven currencies are within a few bps of yesterday’s closing levels with only the background story of the Franco-German détente on EU economic support even getting press in the group.

In the EMG space, ZAR is today’s runaway leader, currently higher by 1.75% as a combination of continued strength in the price of gold and a major technical break have helped the rand. It must be remembered that the rand, even after today’s sharp rally, has been the third worst performing currency over the past three months having fallen more than 16%. This morning, the technicians are all agog as the spot rate traded back through its 50-day moving average, a strong technical signal to buy the currency. While economic prospects continue to be dim overall there and there is no evidence that the rate of infection is slowing, technical algorithms will continue to support the currency for the time being.

Otherwise, it is RUB (+1.1%) and MXN (+0.9%) that are trailing only the rand higher this morning, with both clearly benefitting from the ongoing rebound in oil and, more importantly, in the broad sentiment in the future for oil. Last month it appeared that oil was never going to matter again. That is not so much the case anymore. On the downside today, KRW (-0.4%) is the leading, and only, decliner in the space as the BOK creates a 10 trillion won (~$8 billion) SPV to inaugurate a QE program.

On the data front, yesterday’s housing data was pretty much as expected, with both Starts and Permits falling sharply. Today the only news of note comes at 2:00 when the FOMC Minutes are released. But given how much we have heard from Powell and the rest of the committee, will this really have that big an impact? I would be surprised.

The dollar continues under pressure for the time being and will stay that way as long as USD funding pressures overseas remain in check. While there are no obvious drivers in the near term, I continue to look at the pending change of heart in Europe regarding fiscal support and see an opportunity for a more structural case for dollar weakness over time.

Good luck and stay safe
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Manna From Heaven

On Friday, the world nearly ended
On Monday, investors felt splendid
Today the G7
Brings manna from heaven
But will rate cuts work as intended?

Of course, everyone is aware of yesterday’s remarkable equity market rally as investors quickly grasped the idea that the world’s central banks are not going to go down without a fight. While there were separate statements yesterday, this morning the G7 FinMins and Central bankers are having a conference call, led by Treasury Secretary Mnuchin, to discuss next steps in support of the global markets economy.

It is pretty clear that they are going to announce coordinated actions, with the real question simply what each bank is going to offer up. The argument in the US is will the cut be 25bps or 50bps? In the UK it is clearly 25bps. The ECB and BOJ have their own problems, although I wouldn’t be shocked to see 10bps from them as well as a pledge to increase asset purchases. And, of course, Canada remains largely irrelevant, but will almost certainly cut 25bps alongside the Fed.

But equity markets rebounded massively yesterday, so is there another move in store on this new news? That seems less probable. And remember, Covid-19 has not been cured and continues to spread pretty rapidly. The issue remains the government response, as we continue to see large events canceled (the Geneva Auto Show was the latest) which result in lost, not deferred, economic activity. The one thing that is very clear is that Q1 economic data is going to be putrid everywhere in the world, regardless of what the G7 decides. But perhaps they can save Q2 and the rest of the year.

The interesting thing is that bond markets don’t seem to be singing from the same hymnal as the stock markets. We continue to see a massive rally in bonds, with 2-year yields down to 0.87% while the 10-year is at 1.15%. That is hardly a description of a rip-roaring economy. Rather, that sounds like fears over an imminent recession. The only thing that is certain is that there are as many different views as there are traders and investors, and that has been instrumental in the significant increase in volatility we have observed.

As to the dollar, it has been under significant pressure since yesterday morning, with the euro climbing to its highest level since mid-January. I maintain the dollar’s weakness can be ascribed to the fact that the Fed is the only major central bank with room to really cut rates, and the market is in the process of pricing in 4 cuts for 2020, with more beyond. So further USD weakness ought not be too surprising, but I expect it is nearer its bottom than not, as in the end, the US remains the best place to invest in the current global economy. My point is that receivables hedgers need to be active and take advantage of the dollar’s recent decline. I don’t foresee it lasting for a long period of time.

The first actions were seen in Asia, as both Australia and Malaysia cut their base rates by 25bps while explaining that their close relationships with China require action. And that is certainly true as the extent of how far the Chinese economy will shrink in Q1 is still a huge unknown. Interestingly, AUD managed to rally 0.35% after the rate cut as investors seemed to approve of the action. The thing is, now rates Down Under are at 0.50%, so there is precious little room left to maneuver there. MYR, on the other hand, slipped slightly, -0.1%, although stocks there managed to rally 0.8% on the news.

Meanwhile, the market continues to punish certain nations that have their own domestic problems which are merely being exacerbated by Covid-19. A good example is South Africa, where the rand tumbled 1.45% this morning after Q4 GDP was released at a much worse than expected -0.5% Y/Y, which takes the nation to the edge of recession. And remember, this was before there was any concern over the virus, so things are likely to get worse before they get better. This doesn’t bode well for the rand in the near and medium term.

But overall, today has been, and will continue to be driven by expectations for, and then the response to the G7 meeting. While it is certain that whatever statement is made will be designed to offer support, given yesterday’s huge rebound in markets, there is ample chance for the G7 to disappoint. Arguably, the risks for the G7 are asymmetric as even an enormous support package of rate cuts and added fiscal spending seem mostly priced into the market. On the other hand, any disappointment could easily see the next leg down in both equity markets and bond yields as investors realize that sometimes, the only way to deal with a virus is to let it run its course.

Good luck
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