Hope Springs Eternal

The White House and Congress have talked
‘Bout stimulus but both sides balked
Still, hope springs eternal
That both sides infernal
Intransigence will get unblocked

Throughout 2019, it seemed every other day was a discussion of the trade deal with China, which morphed into the Phase one trade deal, which was, eventually, signed early this year.  But each day, the headlines were the market drivers, with stories about constructive talks leading to stock rallies and risk accumulation, while the periodic breakdowns in talks would result in pretty sharp selloffs.  I’m certain we all remember those days.  I only bring them up because the stimulus talks are the markets’ latest version of those trade talks.  When headlines seem positive that a deal will get done, stock markets rally in the US, and by extension, elsewhere in the world.  But, when there is concern that the stimulus talks will break down, investors head for the exits.  Or at least algorithms head for the exits, its not clear if investors are following yet.

Yesterday was one of those breakdown days, where despite reports of ongoing discussions between Treasury Secretary Mnuchin and House Speaker Pelosi, the vibes were negative with growing concern that no deal would be reached ahead of the election.  Of course, adding to the problem is the fact that Senate Majority Leader McConnell has already said that the numbers being discussed by the House and Congress are far too large to pass the Senate.  Handicapping the probability of a deal being reached is extremely difficult, but I would weigh in on the side of no action.  This seems far more like political posturing ahead of the election than an attempt to address some of the current economic concerns in the country.

Yet, despite yesterday’s negativity, and the ostensible deadline of today imposed by Speaker Pelosi (we all know how little deadlines mean in politics, just ask Boris), this morning has seen a return of hope that a deal will, in fact get done, and that the impact will be a huge boost to the economy, and by extension to the stock market.  So generally, today is a risk-on session, at least so far, with most Asian markets performing nicely and most of Europe in the green, despite rapidly rising infection counts in Europe’s second wave.  Remember, though, when markets become beholden to a political narrative like this, it is extremely difficult to anticipate short-term movements.

Down Under, the RBA said
We’re thinking, while looking ahead
A negative rate
Is still on the plate
So traders, their Aussie, did shed

While the politics is clearly the top story, given the risk-on nature of markets today, and the corresponding general weakness in the dollar, it was necessary to highlight the outliers, in this case, AUD (-0.4%) and NZD (-0.5%), which are clearly ignoring the bigger narrative.  However, there is a solid explanation here.  Last night, between the RBA’s Minutes and comments from Deputy Governor Kent, the market learned that the RBA is now considering negative interest rates.  Previously, the RBA had been clear that the current overnight rate level of 0.25% was the lower bound, and that negative rates did not make sense in Australia (in fairness, they don’t make sense anywhere.)  But given the sluggish state of the recovery from the initial Covid driven recession, the RBA has decided that negative rates may well be just the ticket to goose growth once covid lockdowns are lifted.  It is no surprise that Aussie fell, and traders extended the idea to New Zealand as well, assuming that if Australia goes negative, New Zealand would have no choice but to do so as well.  Hence the decline in both currencies overnight.

But really, those are the only stories of note this morning, in an otherwise dull session.  As I mentioned, risk is ‘on’ but not aggressively so.  While the Nikkei (-0.4%) did slip, we saw modest gains in Shanghai (+0.5%) and Hong Kong (+0.1%).  Europe, too, is somewhat higher, but not excessively so.  Spain’s IBEX (+0.85%) is the leader on the continent, although we are seeing gains in the CAC (+0.4%) and the FTSE 100 (+0.3%) as well.  The DAX (-0.3%), however, is unloved today as Covid cases rise back to early April levels and lockdowns are being considered throughout the country.  Finally, the rose-tinted glasses have been put back on by US equity futures traders with all three indices higher by a bit more than 0.5% at this hour.

Bond markets, however, are following the risk narrative a bit more closely and have sold off mildly across the board.  Well mildly except for the PIGS, who have seen another day with average rises in yield of around 3 basis points.  But for havens, yields have risen just 1 basis point in the US, Germany and the UK.

Commodity prices are little changed on the session, seemingly caught between hopes for a stimulus deal and fears over increased covid cases.

And lastly, the dollar is arguably a bit softer overall, but not by that much.  Aside from Aussie and Kiwi mentioned above, only the yen (-0.15%) is lower vs. the dollar, which is classic risk-on behavior.  On the plus side, SEK and NOK (both +0.5%) are leading the way higher, although the euro has been grinding higher all session and is now up 0.4% compared to yesterday’s close.  There has been no news of note from either Sweden or Norway to drive the gains, thus the most likely situation is that both currencies are simply benefitting from their relatively high betas and the general trend of the day.  As to the euro, the technicians are in command today, calling for a move higher due to an expected (hoped for?) break of a symmetrical triangle position.  Away from these three, though, gains are extremely modest.

In the emerging markets, CZK (+0.7%) is the outlier on the high side, although there is no obvious driver as there have been neither comments by officials nor new data released.  In fact, given that Covid infections seem to be growing disproportionally rapidly there, one might have thought the Koruna would have fallen instead.  But the rest of the CE4 are also firmer, simply tracking the euro this morning as they are up by between 0.3%-0.4%.  There have been some modest losers in the space as well, with THB (-0.25%) leading the charge in that direction.  The Thai story is a combination over concerns about further stimulus there not materializing and anxiety over the political unrest and student protests gaining strength throughout the nation.

On the data front, this morning brings Housing Starts (exp 1465K) and Building Permits (1520K), as well as four more Fed speakers.  Yesterday, Chairman Powell was not focused on monetary policy per se, but rather on the concept of digital currencies, and specifically, central bank digital currencies.  This is something that is clearly coming our way, but the timing remains unclear.  One thing to keep in mind is that when they arrive, interest rates will be negative, at least in the front end, forever.  But that is a story for another day.

Today, we are beholden to the stimulus talks.  Positive news should see further risk accumulation, while a breakdown will see stocks fall and the dollar rebound.

Good luck and stay safe
Adf

Risk is in Doubt

The chatter before the Fed met
Was Powell and friends were all set
To ease even more
Until they restore
Inflation to lessen the debt

And while Jay attempted just that
His efforts have seemed to fall flat
Now risk is in doubt
As traders clear out
Positions from stocks to Thai baht

Well, the Fed meeting is now history and in what cannot be very surprising, the Chairman found out that once you have established a stance of maximum policy ease, it is very difficult to sound even more dovish.  So, yes, the Fed promised to maintain current policy “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”  And if you really parse those words compared to the previous statement’s “…maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, you could make the case it is more dovish.  But the one thing at which market participants are not very good is splitting hairs.  And I would argue that is what you are doing here.  Between the old statement and Powell’s Jackson Hole speech, everybody already knew the Fed was not going to raise rates for a very long time.  Yesterday was merely confirmation.

In fact, ironically, I think the fact that there were two dissents on the vote, Kaplan and Kashkari, made things worse.  The reason is that both of them sought even easier policy and so as dovish as one might believe the new statement sounds, clearly some members felt it could be even more dovish than that.  At the same time, the dot plot added virtually nothing to the discussion as the vast majority believe that through 2023 the policy rate will remain pegged between 0.00%-0.25% where it is now.  Also, while generating inflation remains the animating force of the committee, according to the Summary of Economic Projections released yesterday, even their own members don’t believe that core PCE will ever rise above 2.0% and not even touch that level until 2023.

Add it all up and it seems pretty clear that the Fed is out of bullets, at least as currently configured with respect to their Congressional mandate and restrictions.  It will require Congress to amend the Federal Reserve Act and allow them to purchase equities in order to truly change the playing field and there is no evidence that anything of that nature is in the cards.  A look at the history of the effectiveness of QE and either zero or negative interest rates shows that neither one does much for the economy, although both do support asset markets.  Given those are the only tools the Fed has, and they are both already in full use (and not just at the Fed, but everywhere in the G10), it is abundantly clear why central bankers worldwide are willing to sacrifice their independence in order to cajole governments to apply further fiscal stimulus.  Central banks seem to have reached the limit of their capabilities to address the real economy.  And if (when) things turn back down, they are going to shoulder as much blame as elected officials can give with respect to who is responsible for the bad news.

With that as background, let’s take a peek at how markets have responded to the news.  Net-net, it hasn’t been pretty.  Equity markets are in the red worldwide with losses overnight (Nikkei -0.7%, Hang Seng -1.6%, Shanghai -0.4%) and in Europe (DAX -0.7%, CAC -0.8%, FTSE 100 -1.0%).  US futures are pointing lower after equity markets in the US ceded all their gains after the FOMC and closed lower yesterday.  At this time, all three futures indices are lower by about 1.0%.

Meanwhile, bond markets, which if you recall have not been tracking the equity market risk sentiment very closely over the past several weeks, are edging higher, at least in those markets truly seen as havens.  So, Treasury yields are lower by 2bps, while German bunds and French OATS are both seeing yields edge lower, but by less than one basis point.  However, the rest of the European government bond market is under modest pressure, with the PIGS seeing their bonds sell off and yields rising between one and two basis points.  Of course, as long as the ECB continues to buy bonds via the PEPP, none of these are likely to fall that far in price, thus yields there are certainly capped for the time being.  I mean even Greek 10-year yields are 1.06%!  This from a country that has defaulted six times in the modern era, the most recent being less than ten years ago.

Finally, if we look to the FX markets, it can be no surprise to see the dollar has begun to reverse some of its recent losses.  Remember, the meme here has been that the Fed would be the easiest of all central banks with respect to monetary policy and so the dollar had much further to fall.  Combine that with the long-term theme of macroeconomic concerns over the US twin deficits (budget and current account) and short dollars was the most popular position in the market for the past three to four months.  Thus, yesterday’s FOMC outcome, where it has become increasingly clear that the Fed has little else to do in the way of policy ease, means that other nations now have an opportunity to ease further at the margin, changing the relationship and ultimately watching their currency weaken versus the dollar.  Remember, too, that essentially no country is comfortable with a strong currency at this point, as stoking inflation and driving export growth are the top two goals around the world.  The dollar’s rebound has only just begun.

Specifically, in the G10, we see NOK (-0.5%) as the laggard this morning, as it responds not just to the dollar’s strength today, but also to the stalling oil prices, whose recent rally has been cut short.  As to the rest of the bloc, losses are generally between 0.15%-0.25% with no specific stories to drive anything.  The exception is JPY (+0.2%) which is performing its role as a haven asset today.  While this is a slow start, do not be surprised to see the dollar start to gain momentum as technical indicators give way.

Emerging market currencies are also under pressure this morning led by MXN (-0.7%) and ZAR (-0.6%).  If you recall, these have been two of the best performing currencies over the past month, with significant long positions in each driving gains of 5.3% and 7.1% respectively.  As such, it can be no surprise that they are the first positions being unwound in this process.  But throughout this bloc, we are seeing weakness across the board with average declines on the order of 0.3%-0.4%.  Again, given the overall risk framework, there is no need for specific stories to drive things.

On the data front, yesterday’s Retail Sales data was a bit softer than expected, although was generally overlooked ahead of the FOMC.  This morning saw Eurozone CPI print at -0.2%, 0.4% core, both still miles below their target, and highlighting that we can expect further action from the ECB.  At home, we are awaiting Initial Claims (exp 850K), Continuing Claims (13.0M), Housing Starts (1483K), Building Permits (1512K) and the Philly Fed index (15.0).

Back on the policy front, the BOE announced no change in policy at all, leaving the base rate at 0.10% and not expanding their asset purchase program.  However, in their effort to ease further they did two things, explicitly said they won’t tighten until there is significant progress on the inflation goal, but more importantly, said that they will “engage with regulators on how to implement negative rates.”  This is a huge change, and, not surprisingly the market sees it as another central bank easing further than the Fed.  The pound has fallen sharply on the news, down 0.6% and likely has further to go.  Last night the BOJ left policy on hold, as they too are out of ammunition.  The fear animating that group is that risk appetite wanes and haven demand drives the yen much higher, something which they can ill afford and yet something which they are essentially powerless to prevent.  But not today.  Today, look for a modest continuation of the dollar’s gains as more positions get unwound.

Good luck and stay safe
Adf