An Untimely End

Should risk appetite ever fall
The asset price rally could stall
And that could portend
An untimely end
To trust in the Fed overall

Yesterday afternoon the Fed released their annual financial stability report.  In what may well be the most unintended ironic statement of all time, on the topic of asset valuations the report stated, “However, valuations for some assets are elevated relative to historical norms even when using measures that account for Treasury yields.  In this setting, asset prices may be vulnerable to significant declines should risk appetite fall.” [Author’s emphasis.]  Essentially, the Fed seems to be trying to imply that for some reason, having nothing to do with their policy framework, asset prices have risen and now they are in a vulnerable place.  But for the fact that this is very serious, it is extraordinary that they could make such a disingenuous statement.  The reason asset prices are elevated is SOLELY BECAUSE THE FED CONTINUES TO PURCHASE TREASURIES VIA QE AND FORCE INVESTORS OUT THE RISK CURVE TO SEEK RETURN.  This is the design of QE, it is the portfolio rebalance channel that Ben Bernanke described a decade ago, and now they have the unmitigated gall to try to describe the direct outcome of their actions as some exogenous phenomenon.  If you wondered why the Fed, and truly most central banks, are subject to so much criticism, you need look no further than this.

In Europe, a little-known voice
From Latvia outlined a choice
The ECB may
Decide on one day
In June, and then hawks will rejoice

In a bit of a surprise, this morning Latvian central bank president, and ECB Governing Council member, Martins Kazaks, explained that the ECB could decide as early as their June meeting to begin to scale back PEPP purchases.  His view was that given the strengthening rebound in the economy as well as the significant progress being made with respect to vaccinations of the European population, overall financial conditions may remain favorable enough so they can start to taper their purchases.  This would then be the third major central bank that is on the taper trail with Canada already reducing purchases and the BOE slowing the rate of weekly purchases, although maintaining, for now, the full target.

This is a sharp contrast to the Fed, where other than Dallas Fed president Kaplan, who is becoming almost frantic in his insistence that it is time for the Fed to begin discussing the tapering of asset purchases, essentially every other FOMC member is adhering to the line that the US economy needs more monetary support and any inflation will merely be transitory.  As if to reaffirm this view, erstwhile uber-hawk Loretta Mester, once again yesterday explained that any inflation was of no concern due to its likely temporary nature, and that the Fed has a long way to go to achieve its new mission of maximum employment.

A quick look at the Treasury market this morning, and over the past several sessions, shows that the 10-year yield (currently 1.577%, +0.7bps on the day) seems to have found a new equilibrium.  Essentially, it has remained between 1.54% and 1.63% for about the last month despite the fact that virtually every data release over that timespan has been better than expected.  Thus, despite a powerful growth impulse, yields are not following along.  It is almost as if the market is beginning to price in YCC, which is, of course, exactly the opposite of tapering.  Given the concerns reflected in the Financial Stability Report, maybe the only way to prevent that asset price decline would be to cap yields and let inflation fly.  History has shown bond investors tend to be pretty savvy in these situations, so do not ignore this, especially because YCC would most likely result in a sharply weaker dollar and sharply higher commodity and equity prices.

This morning the market will see
The labor report, NFP
Expecting one mill
The Fed’s likely, still,
To say they’ll continue QE

Finally, it is payroll day with the following current expectations according to Bloomberg:

Nonfarm Payrolls 1000K
Private Payrolls 938K
Manufacturing Payrolls 57K
Unemployment Rate 5.8%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%

The range of forecasts for the headline number is extremely wide, from 700K to 2.1 million, just showing how little certainty exists with respect to econometric models more than a year removed from the initial impact of Covid-induced shutdowns.  As well, remember, even if we get 1 million new jobs, based on Chairman Powell’s goal of finding 10 million, as he stated back in January, there are still another 7+ million to find, meaning the Fed seems unlikely to respond to the report in any manner other than maintaining current policy.  In fact, it seems to me the bigger risk today is a disappointing number which would encourage the Fed to double down!  We shall learn more at 8:30.

As to markets ahead of the release, Asian equities were mixed (Nikkei +0.1%, Hang Seng -0.1%, Shanghai -0.65%) although Europe is going gangbusters led by Germany’s DAX (+1.3%), with the CAC (+0.3%) and FTSE 100 (+0.8%) also having good days.  German IP data (+2.5% M/M) was released better than expected and has clearly been a catalyst for good.  At the same time, French IP (+0.8% M/M) was softer than expected, arguably weighing on the CAC.

Away from Treasuries, European sovereign bonds are all selling off as risk appetite grows, or so it seems.  Bunds (+1.0bps) and OATs (+2.8bps) are feeling pressure, although not as much as Italian BTPs (+4.8bps).  Gilts, on the other hand, are little changed on the day.

Commodity prices continue to rally sharply, at least in the metals space, with gold (+0.3%, +1.5% yesterday), silver (+0.1%, +3.5% yesterday), copper (+2.6%), aluminum (+1.0%) and nickel (+0.2%) all pushing higher.  Interestingly, oil prices are essentially unchanged on the day.

Lastly the dollar is mixed on the session, at least vs. the G10.  SEK (+0.35%) is the leading gainer on what appears to be positive risk appetite, while NZD (-0.25%) is the laggard after inflation expectations rose to a 3-year high.  The other eight are all within that range and split pretty evenly as to gainers and losers.

EMG currencies, though, are showing more positivity with only two small losers (ZAR -0.25%, PLN -0.15%) and the rest of the bloc firmer.  APAC currencies are leading (KRW +0.4%, INR +0.35%, TWD +0.3%) with all of them benefitting from much stronger than forecast Chinese data. We saw Caixin PMI Services rise to 56.3 and their trade balance expand to $42.85B amid large growth in both exports and imports.  Models now point to Chinese GDP growing at 9.0% in 2021 after these releases.

At this point, we are all in thrall to the NFP release later this morning.  The dollar response is unclear to me, although I feel like a strong number may be met with a falling dollar unless Treasury yields start to climb.  Given their recent inability to do so, I continue to believe that is the key market signal to watch.

Good luck, good weekend and stay safe
Adf

The Seeds of Inflation

Inflation continues to be
A topic where some disagree
The Fed has the tools
As well as the rules
To make sure it’s transitory

But lately, the data has shown
The seeds of inflation are sown
So later this year
It ought to be clear
If Jay truly has a backbone

Yet again this weekend, we were treated to a government official, this time Janet Yellen, explaining on the Sunday talk show circuit that inflation would be transitory, but if it’s not, they have the tools to address the situation.  It is no coincidence that her take is virtually identical to Fed Chair Powell’s, as the Fed and the Treasury have clearly become joined at the hip.  The myth of Fed independence is as much a victim of Covid-19 as any of the more than 3.2 million unfortunate souls who lost their lives.  But just because they keep repeating they have the tools doesn’t mean they have the resolve to use them in the event that they are needed.  (Consider that the last time these tools were used, in the early 1980’s, Fed Chair Paul Volcker was among the most reviled government figures in history.)

For instance, last Friday’s data showed that PCE rose 2.3% in March with the Core number rising 1.8%.  While both those results were exactly as forecast, the trend for both remains sharply higher.  The question many are asking, and which neither Janet nor Jay are willing to answer, is how will the Fed recognize the difference between sustained inflation and transitory inflation?  After all, it is not as though the data comes with a disclaimer.  Ultimately, a decision is going to have to be made that rising prices are becoming a problem.  Potential indicators of this will be a sharply declining dollar, sharply declining bond prices and sharply declining stock prices, all of which are entirely realistic if/when the market decides that ‘transitory’ is no longer actually transitory.

For now, though, this issue remains theoretical as there is virtually unanimous agreement that the next several months are going to show much higher Y/Y inflation rates given the base effects of comparisons to the depth of the Covid inspired recession.  The June data will be the first test as that monthly CPI print last year was a robust 0.5%.  Should the monthly June print this year remain at that level or higher, it will deepen the discussion, if not at the Fed, then certainly in the investor and trader communities.  But in truth, until the data is released, all this speculation is just that, with opinions and biases on full display, but with no way to determine the outcome beforehand.  In fact, it is this uncertainty that is the primary rationale for corporate hedging.  There is no way, ex ante, to know what prices or exchange rates will be in the future, but by hedging a portion of the risk, a company can mitigate the variability of its results.  FWIW my view continues to be that the inflation genie is out of the bottle and will be far more difficult to tame going forward, despite all those wonderful tools in the Fed’s possession.

This week is starting off slowly as it is the so-called “golden week” in both China and Japan, where there are holidays Monday through Wednesday, with no market activity ongoing.  Interestingly, Hong Kong was open although I’m guessing investors were less than thrilled with the results as the Hang Seng fell a sold 1.3%.  Europe, on the other hand, is feeling frisky this morning, with gains across the board (DAX +0.6%, CAC +0.45%. FTSE 100 +0.1%) after the final PMI data was released and mostly confirmed the preliminary signs of robust growth in the manufacturing sector.  In addition, the vaccine news has been positive with Germany crossing above the 1 million threshold for the first time this weekend while Italy finally got to 500,000 injections on Saturday.  The narrative that is evolving now is that as Europe catches up in vaccination rates, the Eurozone economy will pick up speed much faster than previously expected and that will bode well for both Eurozone stocks and the single currency.  Remember, on a relative basis, the market has already priced in the benefits of reopening for the US and UK, while Europe has been slow to the party.

Adding to the story is the bond market, where European sovereigns are softening a bit in a classic risk-on scenario of higher stocks and lower bonds.  So, yields have edged higher in Germany (Bunds +1.5bps) and France (OATs +1.3bps) although Gilts are unchanged.  Meanwhile, Treasury yields are creeping higher as well, +1.6bps, and remain a critical driver for most markets.  Interestingly, the vaccine news has inspired the latest comments about tapering PEPP purchases by the ECB, although it remains in the analyst community, not yet part of the actual ECB dialog.

Most commodity prices are also in a quiet state with oil unchanged this morning although we continue to see marginal gains in Cu (+0.4%) and Al (+0.2%).  The big story is agricultural prices where Corn, Wheat and soybeans continue to power toward record highs.  Precious metals are having a good day as well, with both gold (+0.55%) and silver (+0.85%) performing nicely.

It should be no surprise with this mix that the dollar is under pressure as the pound (+0.4%) and euro (+0.3%) lead the way higher.  Only JPY (-0.1%) and CHF (-0.1%) are in the red as haven assets are just not needed today.  Emerging market currencies are mostly stronger with the CE4 all up at least as much as the euro and ZAR (+0.55%) showing the benefits of dollar weakness and gold strength.  There was, however, an outlier on the downside, KRW (-1.0%) which fell sharply overnight after its trade surplus shrunk much more than expected with a huge jump in imports fueling the move.

As it is the first week of the month, get ready for lots of data culminating in the NFP report on Friday.

Today ISM Manufacturing 65.0
ISM Prices Paid 86.1
Construction Spending 1.7%
Tuesday Trade Balance -$74.3B
Factory Orders 1.3%
-ex transport 1.8%
Wednesday ADP Employment 875K
ISM Services 64.1
Thursday Initial Claims 540K
Continuing Claims 3.62M
Nonfarm Productivity 4..2%
Unit Labor Costs -1.0%
Friday Nonfarm Payrolls 978K
Private Payrolls 900K
Manufacturing Payrolls 60K
Unemployment Rate 5.7%
Average Hourly Earnings 0.0% (-0.4% Y/Y)
Average Weekly Hours 34.9
Participation Rate 61.6%
Consumer Credit $20.0B

Source: Bloomberg

As well, we hear from five Fed speakers, including Chairman Powell this afternoon.  Of course, since we just heard from him Wednesday and Yellen keeps harping on the message, I don’t imagine there will be much new information.

Clearly, all eyes will be on the payroll data given the Fed has explained they don’t care about inflation and only about employment, at least for now and the near future.  Given expectations are for nearly 1 million new jobs, my initial take is we will need to see a miss by as much as 350K for it to have an impact.  Anything inside that 650K-1350K is going to be seen as within the margin of error, but a particularly large number could well juice the stock market, hit bonds and benefit the dollar.  We shall see.  As for today, given Friday’s Chicago PMI record print at 72.1, whispers are for bigger than forecast.  While the dollar is under modest pressure right now, if we see Treasury yields backing up further, I expect to see the dollar eventually benefit.

Good luck and stay safe
Adf

Will a New Normal Emerge?

Recovery this year is set
To be best in decades, and yet
The central bank’s thumb
Will drive the outcome
By buying quadrillions in debt

The question is, after this surge
Will there be a natural urge
For things to go back
To pre-Covid’s track
Or will a new normal emerge?

The Wall Street aphorism, buy the rumor, sell the news, remains as valid today as it ever was.  The idea behind this concept, something to which I regularly point, is that by the time a particular piece of information has been released, the market has already absorbed the information in the price and is looking forward to the next price driver.  The result is that markets rally into good news and fall upon the release, and vice versa.  The most recent evidence that this remains a key to price action was Friday’s payroll report, where the outcome, in an illiquid market, was a much better than expected 916K NFP number with upward revisions of the previous two months.  And yet Treasury yields, which might have been expected to rise further on the news, have done nothing but decline since then.  Including today’s 1 basis point decline, the 10-year yield is lower by 6bps from the release and is now 10bps lower than the peak hit on March 30.  Is this the end of the yield rally?  Almost certainly not, but no market moves in a straight line.

I highlight this idea to discuss the latest forecast by the IMF and how this news may impact markets going forward.  Yesterday the IMF raised its global growth forecasts again, this time up to 6.0% in 2021 and 4.4% in 2022, representing increases of 0.5% and 0.2% respectively from their January analysis. The leadership in this growth is the US, now forecast to grow 6.4% by the IMF, and China, now forecast to grow 8.4% this year.  These are the fastest GDP growth numbers for the US since 1984, and we certainly all hope they are accurate.  After all, life is certainly better for everyone when the economy is growing rapidly.

But we have now seen a wave of higher forecasts for US GDP from official sources, like the Fed and IMF, and from private forecasters like Wall Street firms, with a strong consensus that the US is looking at GDP expansion this year well in excess of 6.0% and possibly as high as 7.0% or more.  And so I ask, isn’t that already in the price of most assets?

The broad bullish argument for risk is that global GDP growth is going to be much stronger in 2021 as the world’s economy rebounds from the Covid inspired recession of 2020.  And we have seen remarkable rallies in risk assets during this time, with the S&P 500 rising just a bit more than 80% in the twelve months following its nadir on March 24 last year.  All that occurred during a period where the virus was rampant but hopes for a vaccine would lead to an end to the government ordered shutdowns and a return to pre-covid type of economic activity.  While I grant that we have not seen all the shutdowns ended, the vaccine rollout has been impressive and is speeding up every day.  In fact, despite a pretty horrendous start to the process for Europe, the European Commission now believes that the continent will achieve herd immunity by the end of June!

So, if we know that all this is going to happen, haven’t risky assets already priced in this good news?  The other question that hangs over the current situation is the fact that this growth is entirely a product of the multiple trillions of dollars of government stimulus led by the US $5 trillion of fiscal injections, but also inclusive of QE, PEPP and QQE from the Fed, ECB and BOJ respectively, which totaled trillions more dollars of support.  Again, it begs the question, how much better can things be expected to get?

For instance, it is not unreasonable to expect that there will be permanent changes in the economy, specifically in the types of jobs that are available, especially for lower skilled workers.  If anything, the pandemic and resulting government lockdowns will have accelerated this process.  Remember, Chairman Powell has been clear that the Fed’s task will not be complete until the 10 million jobs that were lost as a result of government edicts are replaced. But what if that takes 5 years due to the structural changes in the economy?  Can the Fed maintain ZIRP while GDP growth is surging and inflation is rising alongside?  Historically, the answer would be no, but in the post-Covid world, that is no longer clear.  In fact, the one thing that has been truly consistent is that every government and supranational organization has warned every central bank to make sure they do not remove policy ease too soon.  The entire global political leadership is ‘all-in’ on the idea that printing money and spending it has no negative consequences.  In other words, it is no longer appropriate to worry we might wind up in an MMT world, we are already there!

This leads to the final question, will risk acquisition be unstoppable as a result of this new global thesis?  The famous American economist, Herbert Stein (Ben Stein’s father) made the statement, “if something cannot go on forever, it will stop.”  My observation is that printing money and the illusory growth that it brings cannot go on forever.  When this music stops, it will be a devastating fall.  But, as policymakers will do everything they can to prevent the stopping, this can go on for a while longer.  Simply be careful to not fall into the trap of believing stock prices are at “a permanently high plateau,” a comment another famous economist, Irving Fisher, made just weeks before the Wall Street Crash of 1929.

Ok, a super brief recap of markets shows that both Asia (Nikkei +0.1%, Hang Seng -0.9%, Shanghai -0.1%) and Europe (DAX -0.1%, CAC 0.0%, FTSE 100 +0.6%) were mixed with modest movement.  US futures are essentially unchanged at 8:00 as I finish typing.  Sovereign yields in Europe have edged lower by roughly 1 basis point, matching the Treasury market, but really not showing much in the way of activity.  Commodity prices are mixed with oil (+0.9%) rallying while metals (Au -0.6%, Cu -1.0%) are softer.

Finally, the dollar is showing little direction today with G10 currencies showing gains (NOK +0.3%) on oil’s rally and losses (AUD -0.5%) on metals price weakness.  But there is no dollar trend here.  In emerging markets, INR (-1.5%) was the biggest loser after the RBI left policy rates on hold, but not merely increased QE, but put a number on it where they will be buying INR1 trillion over the next quarter, driving Indian bond yields lower along with the rupee.  But away from that story, here, too, there is nothing of note with a mixed picture in the space.

On the data front, we see the Trade Balance (exp -$70.5B) this morning and then the FOMC Minutes are released at 2:00.  Today also brings a great deal of Fedspeak, but I remain highly confident that nothing from that story is going to change.

The dollar is wandering aimlessly today but remains closely tied to Treasury yields.  If yields resume their rally, look for the dollar to rebound.  However, if this correction in yields continues, the dollar has further to fall.

Good luck and stay safe
Adf

Money’s Still Free

There once was a time, long ago
When traders all just had to know
If payrolls were strong
So they could go long
If not, they would sell with the flow

But these days, with ZIRP and QE
Attention’s not on NFP
Instead it’s the pace
Of central bank grace
And making sure money’s still free

One of the biggest changes in the market environment since the onset of the global pandemic has been the change in what markets find important.  This is not the first time market focus has changed, nor will it be the last, but a change has definitely occurred.  Consider, for a moment, why the market focuses so intently on certain data points.  Essentially, traders and investors are looking for the information that best describes the policy focus of the time, and therefore, changes in that information are sufficient to change opinions, at least in the short term, about markets.  And remember, that policy focus can come from one of two places, either the Fed or the Administration.

A step back in time shows that in the early 1980’s, when Paul Volcker was Fed Chair, the number that mattered the most was the M2 money supply which was reported on Thursday afternoons.  In fact, the market impact grew so large that they had to change the release time from 3:50 pm to 4:10 pm, after the stock market closed, to reduce market volatility. Trading desks would have betting pools on the number and there were a group of economists, Fed watchers, whose entire job was to observe Fed monetary activity in the markets and make estimates of this number.  At the time, the Fed would not explicitly publish their target Fed Funds rate, they would add and remove liquidity from the money markets in order to achieve it.  And, in fact, you never heard comments from FOMC members which is why Fed Chairs are now compelled to testify to Congress twice a year.

But as time passed and the economy recovered from the recession of 1980-81, the Reagan Administration became highly focused on the US Trade Balance, (especially the deficit with Japan) which became THE number right up through the early 90’s.  Once again, betting pools were common on trading desks and futures markets would move sharply in the wake of the 8:30am release.

At some point there, while Alan Greenspan was still Fed Chair, but there was a new administration, the market turned its attention away from trade and started to focus on domestic indicators, with payrolls claiming the mantle of the best indicator of economic activity.  This suited the Fed, given its mandate included employment, and it suited the Clinton Administration, given they were keen to show how well the economy was doing in order to distract the populace from various scandals.

With the change in Fed Chair from Greenspan to Ben Bernanke, the Fed suddenly became a very different source of market information.  No longer did economists need to read tea leaves, but instead the Fed told us explicitly what they were doing and where rates were set.  Thus, during the GFC, Bernanke was on the tape constantly trying to guide markets to his preferred place.  And that place was full employment, so payrolls still mattered a great deal.  Of course, the market still cared about other things, like the level of interest rates, but still, NFP was seen as the single best indicator available.  Remember, during Bernanke’s leadership, the Fed initiated the QE that began the expansion of its balance sheet and changed the way the Fed worked, seemingly forever.  No longer would the Fed adjust the reserve balances in the system, instead, they would simply post an interest rate and if supply or demand didn’t suffice to achieve that rate, they would step into the markets and smooth things out.

Payrolls were still the focus through Chair Yellen’s term, especially since her background is as a labor economist, so the employment half of the mandate was far more important to her than the inflation half, and so, if anything, NFP took on greater importance.

Jay Powell’s turn at the Fed started amid a period where the economy was getting significant fiscal support and interest rates were trying to be normalized.  In fact, the Unemployment Rate had fallen to its lowest level in more than 50 years and seemed quite stable there, so Powell seemed to have an easy job, just don’t screw things up.  Alas, his efforts to continue normalizing interest rates (aka tightening policy) resulted in a sharp equity market correction in December 2018.  The President was none too pleased with that outcome, as the Trump administration was highly focused on the stock market as a barometer of its performance.  Thus, once again, the Fed stepped in to stabilize markets, and turned from tightening policy to easing in the Powell Pivot.  And perhaps that is the real message here, the most important data point to both the Fed and every administration is not payrolls or unemployment or inflation.  It is the S&P500.

But Covid’s shock to the market was unlike anything seen in a century, at least, and arguably, given the interconnectivity of the global economy compared to the last pandemic in 1918-20, ever.  So, the first NFP data points were shocking, but the market quickly grew accustomed to numbers that would have been unthinkable just months prior.  Instead, the numbers that mattered were the infection count, and the mortality rate.  And arguably, those are still the numbers that matter, along with the vaccination rate and the stimulus size.  All of these have been the market’s primary focus since March last year, and until the idea of the government lockdown fades, are likely to continue to be the keys for market behavior.

Which brings us back to this morning, when the payroll report is to be published.  Does it really have that much impact any longer?  Or has its usefulness as an indicator faded?  Well, it seems apparent that market participants are far more intent on hearing from Fed speakers and trying to discern when monetary accommodation is going to be reduced (never) than on the jobs number.  In fact, given virtually every major central bank has explained that rates will remain at current levels for the next 3 to 4 years, at least, the only thing the data can tell us is if that will last longer than currently expected.

Ok, ahead of payrolls we have seen a general embrasure of risk, with equity markets strong, following yesterday’s US rally.  The Nikkei (+1.5%) and Hang Seng (+0.6%) both performed well although shanghai (-0.2%) slipped slightly.  In Europe, the CAC (+1.1%) leads the way followed by the DAX (+0.3%) after weak Factory order numbers (-1.9%) and the FTSE 100 (+0.1%).  US futures are currently trading higher by about 0.5% to round things out.

Bond markets are behaving as you would expect in a risk on session, with 10-year Treasuries printing at a new high yield for the move, 1.16%, up 2.1bps.  In Europe, the bond selling is greater with Bunds (+2.5bps) and Gilts (+5.3bps) getting tossed in favor of stocks.  Commodities are still in vogue, with oil (+1.0%) and gold (+0.4%) firm alongside all the base metals and agriculturals.

Finally, the dollar, is acting a bit more like expected, softening a bit while risk is being acquired.  The dollar’s recent rally alongside the equity rally seemed unusual compared to recent history, but today, things look more normal.  S,o NOK (+0.4%) and CAD (+0.3%) lead the G10 charge while JPY (-0.15%) is today’s laggard.  Clearly these stories are commodities and risk preference.  In the EMG space, APAC currencies were under a bit of pressure overnight, led by KRW (-0.4%) and MYR (-0.25%), but this morning we are seeing strength in TRY (+1.0%), RUB (+0.8%) and MXN (+0.4%) to lead the way.  The CE4 are also performing relatively well alongside modest strength in the euro (+0.2%).

Now the data:

Nonfarm Payrolls 105K
Private Payrolls 163K
Manufacturing Payrolls 30K
Unemployment Rate 6.7%
Average Hourly Earnings 0.3% (5.0% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%
Trade Balance -$65.7B

Source: Bloomberg

Which brings us back to the question, does it really matter?  And the answer is, not to the stock market, and therefore not really to the Fed.  However, a strong number here could well hit the bond market pretty hard as well as support the dollar more fully.  We shall see.  FWIW, I don’t believe the dollar’s correction is over, and another 1%-2% is entirely viable in the short-run.

Good luck, good weekend and stay safe
Adf

Perfect Right Here

Said Harker, by end of this year
A taper could be drawing near
But Mester explained
No cash would be drained
As policy’s perfect right here

Ahead of this morning’s payroll report, I believe it worthwhile to recap what we have been hearing from the FOMC members who have been speaking lately.  After all, the Fed continues to be the major force in the market, so maintaining a clear understanding of their thought process can only be a benefit.

The most surprising thing we heard was from Philadelphia Fed president Harker, who intimated that while he saw no reason to change things right now, he could see the Fed beginning to taper their asset purchases by the end of 2021 or early 2022.  Granted, that still implies an additional $1 trillion plus of purchases, but is actually quite hawkish in the current environment where expectations are for rates to remain near zero for at least the next three years.  Given what will almost certainly be a significant increase in Treasury issuance this year, if the Fed were to step back from the market, we could see significantly higher rates in the back end of the curve.  And, of course, it has become quite clear that will not be allowed as the government simply cannot afford to pay higher rates on its debt.   As well, Dallas Fed President Kaplan also explained his view that if the yield curve steepened because of an improved growth situation in the US, that would be natural, and he would not want to stop it.

But not to worry, the market basically ignored those comments as evidenced by the fact that the equity market, which will clearly not take kindly to higher interest rates in any form, rallied further yesterday to yet more new all-time highs.

At the same time, three other Fed speakers, one of whom has consistently been the most hawkish voice on the committee, explained they saw no reason at all to adjust policy anytime soon.  Regional Fed presidents from Cleveland (Loretta Mester), Chicago (Charles Evans) and St Louis (James Bullard) were all quite clear that it was premature to consider adjusting policy as a response to the Georgia election results and the assumed increases in fiscal stimulus that are mooted to be on the way.

Recapping the comments, it is clear that there is no intention to adjust policy, meaning either the Fed Funds rate or the size of QE purchases, anytime soon, certainly not before Q4.  And if you consider Kaplan’s comments more fully, he did not indicate a preference to reduce support, just that higher long-term rates ought to be expected in a well-performing economy.  Vice-Chairman Clarida speaks this morning, but it remains difficult to believe that he will indicate any changes either.  As I continue to maintain, the government’s ability to withstand higher interest rates on a growing amount of debt is limited, at best, and the only way to prevent that is by the Fed capping yields.  Remember, while the Fed has adjusted its view on inflation, now targeting an average inflation rate, they said nothing about allowing yields to rise alongside that increased inflation.  Again, the dollar’s performance this year will be closely tied to real (nominal – inflation) yields, and as inflation rises in a market with capped yields, the dollar will decline.

Turning to this morning’s payroll release, remember, Wednesday saw the ADP Employment number significantly disappoint, printing at -123K, nearly 200K below expectations.  As of now, the current median forecasts are as follows:

Nonfarm Payrolls 50K
Private Payrolls 13K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

These numbers are hardly representative of a robustly recovering economy, which given the cresting second wave of Covid infections and the lockdowns that have been imposed in response, ought not be that surprising.  The question remains, will administration of the vaccine be sufficient to change the trajectory?  While much has been written about pent up demand for things like travel and movies, and that is likely the case, there has been no indication that governments are going to roll back the current rules on things like social distancing and wearing masks.  One needs to consider whether those rules will continue to discourage those very activities, and thus, crimp the expected recovery.  Tying it together, a slower than expected recovery implies ongoing stimulus

But you don’t need me to explain that permanent stimulus remains the basic premise, just look at market behavior.  After yesterday’s US equity rally, we have seen a continuation around the world with Japan’s Nikkei (+2.35%) leading the way in Asia, but strength in the Hang Seng (+1.2%) and Australia (+0.7%), although Shanghai (-0.2%) didn’t really participate.  Europe, too, is all green, albeit in more measured tones, with the DAX (+0.8%) leading the way but gains in the CAC (+0.5%) and FTSE 100 (+0.2%) as well as throughout the rest of the continent.  And finally, US futures are all pointing higher at this hour, with all three indices up by 0.25%-0.35%.

The Treasury market, which has sold off sharply in the past few sessions, is unchanged this morning, with the yield on the 10-year sitting at 1.08%.  In Europe, haven assets like bunds, OATs and gilts are little changed this morning, but the yields on the PIGS are all lower, between 1.6bps (Spain) and 3.9bps (Italy).  Again, those bonds behave more like equities than debt, at least in the broad narrative.

In the commodity space, oil continues to rally, up another 1.3% this morning, and we continue to see strength in base metals and ags, but gold is under the gun, down 1.1%, and clearly in disfavor in this new narrative of significant new stimulus and growth.  Interestingly, bitcoin, which many believe as a substitute for gold has continued to rally, vaulting through $41k this morning.

And lastly, the dollar, which everyone hates for this year, is ending the week on a mixed note.  In the G10, NOK (+0.3%) is the best performer, as both oil’s rise and much better than expected IP data have investors expecting continued strength there.  But after that, the rest of the bloc is +/- 0.2% or less, implying there is no driving force here, rather that we are seeing position adjustments and, perhaps, real flows as the drivers.

In the emerging markets, ZAR (+1.2%) and BRL (+0.6%) are the leading gainers, while IDR (-0.8%) and CLP (-0.6%) are the laggards.  In fact, other than those, the bloc is also split, like the G10, with winners and losers of very minor magnitude.  Looking first at the rand, today’s gains appear to be position related as ZAR has been under pressure all week, declining more than 5.6% prior to today’s session.  BRL, too, is having a similar, albeit more modest, correction to a week where it has declined more than 5% ahead of today’s opening.  Both those currencies are feeling strain from weakening domestic activity, so today’s gains seem likely to be short-lived.  On the downside, IDR seems to be suffering from rising US yields, as the attractiveness of its own debt starts to wane on a relative basis.  As to Chile, rising inflation seems to be weighing on the currency as there is no expectation for yields to rise in concert, thus real yields there are under pressure.

And that’s really it for the day.  We have seen some significant movement this week, as well as significant new news with the outcome of the Georgia election, so the narrative has had to adjust slightly.  But in the end, it is still reflation leads to higher equities and a lower dollar.  Plus ça change, plus ça meme chose!

Good luck, good weekend and stay safe
Adf

Still a Threat

For Boris, and all Brexiteers
They can’t wait for this, Eve, New Year’s
Alas, as of yet
There is still a threat
That no deal might bring both sides tears

Investors, however, seem sure
The UK, a deal, will secure
That’s why Britain’s pound
Is robustly sound
Let’s hope that view’s not premature

EU official sees UK trade deal “imminent” barring last-minute glitch

This Reuters News headline from this morning, aside from being inane, is a perfect example of the market narrative in action.  The broad view is that a deal will be reached, despite the fact that deadline after deadline has been missed during these negotiations.  The pound has rallied nearly 10% since the only deadline of consequence on June 30.  That was the date on which both sides would have been able to extend the current negotiations.  However, no extension was sought by the UK and none granted, so we are heading into the last four weeks of the year with nothing concrete completed.  And yet, markets on the whole continue to trade under the assumption a deal will be reached and there will be no meaningful disruption to either the UK or EU economy on January 1st.

And that is the point of the headline.  It is essentially telling us a deal is a given, and both sides are now just playing to their domestic constituencies to show how hard they are working to achieve a ‘good’ deal.  In fact, once again today, the French held out the possibility that they would veto a deal as French European Affairs Minister, Clement Beaune, told us, “If there is a deal which is not good, then we would oppose it.  We always said so.”  This comment appears to be just another part of the ongoing theater.  A senior UK official, meanwhile, claimed talks had regressed because of a change in the EU’s position regarding the fishing issue.

But let’s go back to the pound.  A 10% rally in five months is a pretty impressive outcome.  Can this movement be entirely attributed to Brexit beliefs?  At this stage, I think not.  Consider, that during that same period, both SEK and NOK have rallied nearly 11%.  And even the laggard of the G10, JPY, has rallied 3.5% in the second half of the year.  The point is that perhaps the market has not priced in as high a probability of a successful outcome as many, including me, had thought likely.  After all, if the other nine G10 currencies have rallied an average of 8.0% in a given time frame, at the margin, the additional 1.6% that cable has rallied does not seem that impressive after all.

What are the potential ramifications of this line of thinking?  Well, assuming that a deal is actually reached on time, and I believe that is the most likely outcome, it seems possible that the pound has considerably more upside than the rest of the G10.  Looking back to the original referendum in the summer of 2016, the pound touched 1.50 the night of the vote, before it became clear that Brexit was going to be the outcome.  Since then, in Q1 2018, the pound traded above 1.40, but that too, was simply a reflection of the times as the euro was trading above 1.25.  In other words, the Brexit impact on the pound, other than in the immediate aftermath of the vote, seems to have been remarkably modest.  Certainly, month-to-month movement has been in lockstep with all the other G10 currencies, and it is only the level of the pound, which adjusted back in June 2016, which is different.  The implication is that the announcement of a successful deal is likely to see the pound outperform higher.  This is opposite my previous views but appears to account for the historical price action more effectively.  Remember, within two days of the Brexit vote, the pound fell 11%.  While a deal seems unlikely to recoup that entire amount, perhaps half of that is available, which from current levels means that a move above 1.40 is viable without a corresponding rise in the euro.  At that point, the pound will revert to being just another G10 currency, with price movement locked into the dollar narrative, not the Brexit narrative.  Food for thought.

As to today’s session, it is payrolls day with the following expectations according to Bloomberg:

Nonfarm Payrolls 470K
Private Payrolls 540K
Manufacturing Payrolls 45K
Unemployment Rate 6.7%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.7%
Trade Balance -$64.8B
Factory Orders 0.8%

The question, of course, is has this data yet returned to its prior place of importance in investors’ minds.  And arguably, the answer is no.  There continues to be a strong market narrative that the current data is unimportant because everyone knows that the ongoing lockdowns are going to make things look worse.  This is true all over the world (except, perhaps, China).  But given the near universal central bank promises of low rates forever for the foreseeable future, investors continue to add risk to their portfolios with abandon.  In order to change that mindset, I believe we would need to see a number so shocking, something like -1000K, that it could indicate the impact of Covid might not be temporary.  But barring that, my sense is the payroll number has lost its luster.

It will be interesting to see if that luster returns in the post-Covid environment, or perhaps some other statistic will embody the zeitgeist in the future.  Remember, NFP has not always been that important.  When Paul Volcker was Fed Chair, M2 money supply was the only number that mattered.  Once Alan Greenspan took over, it was the trade data that drove markets.  Perhaps inflation will be deemed “THE” number going forward, especially in the event that MMT becomes the norm.

Ahead of the data, a tour of markets shows that risk appetite is positive, if modest.  European equity markets are generally firmer (CAC +0.3%, FTSE 100 +0.8%) although the DAX just gave up its earlier gains and is now lower by 0.2%.  Overnight, things were also fairly dull as the Nikkei (-0.2%) slipped modestly while both the Hang Seng (+0.4%) and Shanghai (+0.1%) edged higher.  In fact, the best performer overnight was South Korea with the KOSPI (+1.3%) rallying on continued strong data and KRW (+1.35%) rallying on the back of inflows to the KOSPI as well as market technicals.  Meanwhile, US futures are higher by roughly 0.3% at this hour.

The bond market has slipped a bit with yields rising by 2bps in Treasuries, but European govvies, which had been softer (higher yields) earlier in the session, have found support with yields now edging lower by about 0.5bps.  It seems a Bloomberg story released a short time ago indicated that the ECB is likely to extend their PEPP by a full year, not the 6 months mooted by most analysts.

As to the dollar, it is actually mixed in the G10, but movement has been modest in both directions.  So, CHF (+0.25%) and GBP (+0.2%) are leading the way, but realistically don’t tell us much given how insignificant the moves have been.  On the downside, NZD (-0.4%) and AUD (-0.2%) are lagging, but neither has released data of note.  Essentially, this all seems like position adjustments.

Emerging markets, however, have seen a bit more demand with the commodity bloc supported after OPEC+ reached a compromise and helped oil prices back above $46/bbl.  This is the highest they have been since before the Covid panic, so it is quite important from a market technical perspective.  In the meantime, RUB (+0.55%) and MXN (+0.5%) are leading the way (after KRW of course) with most others in this space higher by much lesser amounts.

And that’s where we stand heading into payrolls and then the weekend.  Nothing has changed the dollar weakening narrative, and the pound remains the true wildcard.  Despite my change of heart regarding the pound’s upside, that does not change my view that if the negotiations fall apart and no Brexit deal is reached, the pound can decline 5%-7%.  Arguably, we are looking at some symmetry there.  In any event, a case for a larger move in the pound is very viable, one way or the other.

Good luck, good weekend and stay safe
Adf

Haven’t a Doubt

The Fed, yesterday, made the case
That fiscal support they’d embrace
But even without
They haven’t a doubt
The dollar they still can debase
Their toolbox can help growth keep pace

As of yet, there is no winner declared in the Presidential election, although it seems to be trending toward a Biden victory.  The Senate, as well, remains in doubt, although is still assumed, at least by the market, to be held by the Republicans.  But as we discussed yesterday, the narrative has been able to shift from a blue wave is good for stocks to gridlock is good for stocks.  And essentially, that remains the situation because the Fed continues to support the market.

With this in mind, yesterday’s FOMC meeting was the market focus all afternoon.  However, the reality is we didn’t really learn too much that was new.  While universal expectations were for policy to remain unchanged, and they were, Chairman Powell discussed two things in the press conference; the need for fiscal stimulus from the government as quickly as possible; and the composition of their QE program.  Certainly, given all we have heard from Powell, as well as the other FOMC members over the past months, it is not surprising that he continues to plea for a fiscal response from Congress.  As I have written before, they clearly recognize that their toolkit has basically done all it can for the economy, although it can still support stock and bond markets.

It is a bit more interesting that Powell was as forthright regarding the discussion on the nature of the current asset purchase program, meaning both the size of purchases and the tenor of the bonds they are buying.  Currently, they remain focused on short-term Treasuries rather than buying all along the curve.  Their argument is that their purchases are doing a fine job of maintaining low interest rates throughout the Treasury market.  However, it seems that this question was the big one during the meeting, as clearly there are some advocates for extending the tenor of purchases, which would be akin to yield curve control.  The fact that this has been such an important topic internally, and the fact that the erstwhile monetary hawks are on board, or seem to be, implies that we could see a change to longer term purchases in December, especially if no new fiscal stimulus bill is enacted and the data starts to turn back lower.  This may well be the only way that the Fed can ease policy further, given their (well-founded) reluctance to consider negative interest rates.  If this is the case, it would certainly work against the dollar in the near-term, at least until we heard the responses from the other central banks.

But that was yesterday.  The Friday session started off in Asia with limited movement.  While the Nikkei (+0.9%) managed to continue to rally, both the Hang Seng (+0.1%) and Shanghai (-0.25%) had much less interesting performances.  Europe, on the other hand, started off with a serious bout of profit taking, as early on, both the DAX and CAC had fallen about 1.5%.  But in the past two hours, they have clawed back around half of those losses to where the DAX (-0.9%) and CAC (-0.6%) are lower but still within spitting distance of their recent highs.  US futures have shown similar behavior, having been lower by between 1.5% and 2.0% earlier in the session, and now showing losses of just 0.5% across the board.  One cannot be surprised that there was some profit taking as the gains in markets this week have been extraordinary, with the S&P up more than 8% heading into today, the NASDAQ more than 9% and even the DAX and CAC up by similar amounts.

The Treasury rally, too, has stalled this morning with the 10-year yield one basis point higher, although we are seeing continued buying interest throughout European markets, especially in the PIGS, where ongoing ECB support is the most important.  Helping the bond market cause has been the continued disappointment in European data, where for example, German IP was released at a worse than expected -7.3%Y/Y this morning.  Given the increasingly rapid spread of Covid infections throughout Europe, with more than 300K new infections reported yesterday, and the fact that essentially every nation in the EU is going back on lockdown for the month of November, it can be no surprise that bond yields here are falling.  Prospects for growth and inflation remain bleak and all the ECB can do is buy more bonds.

On the commodity front, oil is slipping again today, down around 3% as the twin concerns of weaker growth and potentially more supply from OPEC+ weigh on the market.  Gold however, had a monster day yesterday, rallying 2.5%, and is continuing this morning, up another 0.3%.  This is one market that I believe has much further to run.

Finally, looking at the dollar, it is definitely under pressure overall, although there are some underperformers as well.  For instance, in the G10, SEK (+0.6%), CHF (+0.5%) and NOK (+0.5%) are all nicely higher with NOK being the biggest surprise given the decline in oil prices.  The euro, too, is performing well, higher by 0.45% as I type.  Arguably, this is a response to the idea that Powell’s discussion of buying longer tenors is a precursor to that activity, thus easier money in the US.  However, the Commonwealth currencies are all a bit softer this morning, led by AUD (-0.15%) which also looks a lot like a profit-taking move, given Aussie’s 4.2% gain so far this week.

In the emerging markets, APAC currencies were all the rage overnight, led by IDR (+1.2%) and THB (+0.95%) with both currencies the beneficiaries of an increase in investment inflows to their respective bond markets.  But we are also seeing the CE4 perform well this morning, which given the euro’s strength, should be no surprise at all.  On the flipside, TRY (-1.2%) continues to be the worst performing currency in the world, as its combination of monetary policy and international gamesmanship is encouraging investors to flee as quickly as possible.  The other losers are RUB (-0.5%) and MXN (-0.3%), both of which are clearly feeling the heat from oil’s decline.

This morning, we get the payroll data, which given everything else that is ongoing, just doesn’t seem as important as usual.  However, here is what the market is looking for:

Nonfarm Payrolls 593K
Private Payrolls 685K
Manufacturing Payrolls 55K
Unemployment Rate 7.6%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

You may recall that the ADP number was much weaker than expected, although it was buried under the election news wave.  I fear we are going to see a decline in this data as the Initial Claims data continues its excruciatingly slow decline and we continue to hear about more layoffs.  The question is, will the market care?  And the answer is, I think this is a situation where bad news will be good as it will be assumed the Fed will be that much more aggressive.

As such, it seems like another day with dollar underperformance is in our future.

Good luck, good weekend and stay safe
Adf

More Sales Than Buys

The virus has found a new host
As Trump has now been diagnosed
Investors reacted
And quickly transacted
More sales than buys as a riposte

While other news of some import
Explained that Lagarde’s come up short
Seems prices are static
Though she’s still dogmatic
Deflation, her ideas, will thwart

Tongues are wagging this morning after President Trump announced that he and First Lady Melania have tested positive for Covid-19.  The immediate futures market response was for a sharp sell-off, with Dow futures falling nearly 500 points (~2%) in a matter of minutes.  While they have since recouped part of those losses, they remain lower by 1.4% on the session.  SPU’s are showing a similar decline while NASDAQ futures are down more than 2.2% at this time.

For anybody who thought that the stock markets would be comfortable in the event that the White House changes hands next month, this seems to contradict that theory.  After all, what would be the concern here, other than the fact that President Trump would be incapacitated and unable to continue as president.  As vice-president Pence is a relative unknown, except to those in Indiana, investors seem to be demonstrating a concern that Mr Trump’s absence would result in less favorable economic and financial conditions.  Of course, at this time it is far too early to determine how this situation will evolve.  While the President is 74 years old, and thus squarely in the high-risk age range for the disease, he also has access to, arguably, the best medical attention in the world and will be monitored quite closely.  In the end, based on the stamina that he has shown throughout his tenure as president, I suspect he will make a full recovery.  But stranger things have happened.  It should be no shock that the other markets that reacted to the news aggressively were options markets, where implied volatility rose sharply as traders and investors realize that there is more potential for unexpected events, even before the election.

Meanwhile, away from the day’s surprising news we turn to what can only be considered the new normal news.  Specifically, the Eurozone released its inflation data for September and, lo and behold, it was even lower than quite low expectations.  Headline CPI printed at -0.3% while Core fell to a new all-time low level of 0.2%.  Now I realize that most of you are unconcerned by this as ECB President Lagarde recently explained that the ECB was likely to follow the Fed and begin allowing inflation to run above target to offset periods when it was ‘too low’.  And according to all those central bank PhD’s and their models, this will encourage businesses to borrow and invest more because they now know that rates will remain low for even longer.  The fly in this ointment is that current expectations are already for rates to remain low for, essentially, ever, and business are still not willing to expand.  While I continue to disagree with the entire inflation targeting framework, it seems it is becoming moot in Europe.  The ECB has essentially demonstrated they have exactly zero influence on CPI.  As to the market response to this news, the euro is marginally softer (-0.25%), but that was the case before the release.  Arguably, given we are looking at a risk off session overall, that has been the driver today.

Finally, let’s turn to what is upcoming this morning, the NFP report along with the rest of the day’s data.  Expectations are as follows:

Nonfarm Payrolls 875K
Private Payrolls 875K
Manufacturing Payrolls 35K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Factory Orders 0.9%
Michigan Sentiment 79.0

Source: Bloomberg

Once again, I will highlight that given the backward-looking nature of this data, the Initial Claims numbers seem a much more valuable indicator.  Speaking of which, yesterday saw modestly better (lower) than expected outcomes for both Initial and Continuing Claims.  Also, unlike the ECB, the Fed has a different inflation issue, although one they are certainly not willing to admit nor address at this time.  For the fifth consecutive month, Core PCE surprised to the upside, printing yesterday at 1.6% and marching ever closer to their (symmetrical) target of 2.0%.  Certainly, my personal observation on things I buy regularly at the supermarket, or when going out to eat, shows me that inflation is very real.  Perhaps one day the Fed will recognize this too.  Alas, I fear the idea of achieving a stagflationary outcome is quite real as growth seems destined to remain desultory while prices march ever onward.

A quick look at other markets shows that risk appetites are definitely waning today, which was the case even before the Trump Covid announcement.  The Asian markets that were open (Nikkei -0.7%, Australia -1.4%) were all negative and the screen is all red for Europe as well.  Right now, the DAX (-1.0%) is leading the way, but both the CAC (-0.9%) and FTSE 100 (-0.9%) are close on its heels.  It should be no surprise that bond markets have caught a bid, with 10-year Treasury yields down 1.5 basis points and similar declines throughout European markets.  In the end, though, these markets remain in very tight ranges as, while central banks seem to have little impact on the real economy or prices, they can manage their own bond markets.

Commodity prices are softer, with oil down more than $1.60/bbl or 4.5%, as both WTI and Brent Crude are back below $40/bbl.  That hardly speaks to a strong recovery.  Gold, on the other hand, has a modest bid, up 0.2%, after a more than 1% rally yesterday which took the barbarous relic back over $1900/oz.

And finally, to the dollar.  This morning the risk scenario is playing out largely as expected with the dollar stronger against almost all its counterparts in both the G10 and EMG spaces.  The only exceptions are JPY (+0.35%) which given its haven status is to be expected and GBP (+0.15%) which is a bit harder to discern.  It seems that Boris is now scheduled to sit down with EU President Ursula von der Leyen tomorrow in order to see if they can agree to some broad principles regarding the Brexit negotiations which will allow a deal to finally be agreed.  The market has taken this as quite a positive sign, and the pound was actually quite a bit higher (+0.5%) earlier in the session, although perhaps upon reflection, traders have begun to accept tomorrow’s date between the two may not solve all the problems.

As to the EMG bloc, it is essentially a clean sweep here with the dollar stronger across the board.  The biggest loser is RUB (-1.4%) which is simply a response to oil’s sharp decline.  But essentially all the markets in Asia that were open (MYR -0.3%, IDR -0.2%) fell while EEMEA is also on its back foot.  We cannot forget MXN (-0.55%), which has become, perhaps, the best risk indicator around.  It is extremely consistent with respect to its risk correlation, and likely has the highest beta to that as well.

And that’s really it for the day.  The Trump story is not going to change in the short-term, although political commentators will try to make much hay with it, and so we will simply wait for the payroll data.  But it will have to be REALLY good in order to change the risk feelings today, and I just don’t see that happening.  Look for the dollar to maintain its strength, especially vs. the pound, which I expect will close the day with losses not gains.

Good luck, good weekend and stay safe
Adf

Singing Off-Tune

The Jobless report showed that June
Saw Payroll growth really balloon
But stubbornly, Claims
Are fanning the flames
Of bears, who keep singing off-tune

Markets are quiet this morning as not only is it a summer Friday, but US equity and commodity markets are closed to celebrate the July 4th holiday. In fact, it is curious that it is not a Fed holiday. But with a limited and illiquid session on the horizon, let’s take a quick peak at yesterday’s data and some thoughts about its impact.

The Jobless report was clearly better than expected on virtually every statistic. Payrolls rose more than expected (4.8M vs. exp 3.06M) while the Unemployment Rate fell substantially (11.1% from 13.3%). Happily, the Participation Rate also rose which means that the country is getting back to work. It should be no surprise that this was touted as a great outcome by one and all.

Of course, there was some less positive news, at least for those who were seeking it out. The Initial and Continuing Claims data, both of which are much more current, declined far less than expected. The problem here is that while tremendous progress was made in June from where things were before, it seems that progress may be leveling off at much worse than desired numbers.

It seems there are two things at work here. First, the second wave of Covid is forcing a change in the timeline of the reopening of the economy. Several states, notably Texas and California, are reimposing lockdowns and closing businesses, like bars and restaurants, that had reopened. This is also slowing the reopening of other states’ economies. Second is the pending end of some of the CARES act programs, notably PPP, which has seen the money run out and layoffs occur now, rather than in April. It is entirely realistic that the Initial and Continuing Claims data run at these much higher levels going forward for a while as different businesses wrestle with the right size for their workforce in the new economy.

Odds are we will see a second stimulus bill at some point this summer, but it is not yet a certainty, nor is it clear how large it will be or what it will target. But it would be a mistake to assume that the road ahead will be smooth.

The other potential market impacting news was this morning’s European Services PMI data, which was generally slightly better than expected, but still pointing to slowing growth. For instance, Germany’s Services number was at 47.3, obviously well above the April print of 16.2, but still pointing to a slowing economy. And that was largely the case everywhere.

The point is that nothing we have seen either yesterday or today indicates that the global economy is actually growing relative to 2019. It is simply not shrinking as quickly as before. The implication here is that central banks will continue to add liquidity to their respective economies through additional asset purchases and, for those with positive interest rates still, further rate cuts. Governments will be loath to stop their fiscal stimulus as well, especially those who face elections in the near-term. But in the end, 2020 is going to be a decidedly lost year when it comes to the world’s economy!

On the market side, risk generally remained in demand overnight as Asian equity markets continued to rally (Nikkei +0.7%, Hang Seng +1.0%, Shanghai +2.0%). Will someone please explain to me how Hong Kong’s stock market continues to rally in the face of the draconian new laws imposed by Beijing on the freedom’s formerly available to its citizens? While I certainly don’t have proof, this must be coordinated buying by Chinese government institutions trying to demonstrate that everything there is great.

However, despite the positive cast of APAC markets, Europe has turned red this morning with the DAX (-0.2%), CAC (-0.7%) and FTSE 100 (-0.9%) all under pressure. Each nation has a story today starting with Germany’s Angela Merkel trying to expand fiscal stimulus, not only in Germany, but fighting for the EU program as well. Meanwhile, in France, President Macron has shaken up his entire government and replace most of the top positions including PM and FinMin. Finally, the UK is getting set to reopen tomorrow, and citizens are expected to be ready to head back to a more normal life.

In the bond markets, while US markets are closed, we are seeing a very modest bid for European government bonds, but yields are only about 1 basis point lower on the day. Commodity markets show that oil is once again under pressure, down a bit more than 1% but still hanging onto the $40/bbl level.

Turning to currencies, in the G10, only NOK (+0.4%) is showing any real life today as its Unemployment Rate printed at a lower than expected 4.8% encouraging some to believe it is leading the way back in Europe. Otherwise, this bloc is doing nothing, with some gainers and some losers and no direction.

In emerging markets, the story is of two weak links, IDR (-1.0%) and RUB (-0.9%). The former, which has been falling for more than a week, is suffering from concerns over debt monetization by the central bank there, something that I’m sure will afflict many currencies going forward. As to the ruble, the only explanation can be the oil price decline as their PMI data was better than expected, although still below 50.0. But there are issues there regarding the spread of the infection as well, and concerns over the potential imposition of new sanctions by the US.

And that is really it for the day. With no data or speakers here, look for markets to close by lunchtime, so if you have something to do, get it done sooner rather than later.

Have a wonderful holiday weekend 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
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