Negative Views Have Been Banned!

It’s not clear why anyone thought
That Covid, much havoc had wrought
At least based on stocks
Who’s heterodox
Response ignores data quite fraught

Thus, once more with bulls in command
The stock market’s flames have been fanned
So, risk is appealing,
The dollar is reeling
And negative views have been banned!

Acquiring risk continues to be at the top of investor to-do lists as, once again, despite ongoing calamities worldwide, stock markets continue on their mission to recoup all the losses seen in March. It remains difficult for me to understand the idea that company valuations today should be the same as they were in February, before the global economy came to a screeching halt. Aside from the hundreds of millions of people worldwide who have been thrown out of work, millions of companies will disappear forever, whether it is JC Penney (long overdue) or your favorite local bistro (a calamity if there ever was one.) The commonality between the two is that both employed people who were also consumers, and sans an income, they will be consuming much less.

Given that consumption represented more than 60% of the global economy (>68% in the US), all those companies that cater to consumers are going to find it extremely difficult to generate profits if there are no consumers. It is why the hospitality/leisure sectors of the economy have been devastated world-wide, and all the industries that service those companies, like aircraft manufacturing or construction, have also been hit so hard. If you remove the rose-tinted lenses, it appears that the ongoing risk acquisition remains painfully ignorant of the reality on the ground, and that a revaluation seems more likely than not.

One other thing to consider is this, tax rates. US equity markets have been a huge beneficiary of the tax cuts from 2018 with corporate earnings broadly exploding higher. However, even if one looks past the abyss of the next several quarters of economic destruction, it seems quite likely that we are going to see some big picture changes around the world with regard to distribution of income, i.e. higher corporate (and personal) tax rates and lower EPS. Again, my point is that even if, by 2021, economic activity returns to the level seen in 2019, the share of that value that will be attributed to the corporate sector is destined to be much lower, and with after-tax earnings declines ordained it will be extremely difficult to justify high valuations. So, yes, risk is in the ascendancy today, but it continues to feel as though its time is coming to an end.

And with that sobering thought, let us look at just how risk is performing today. Equity markets around the world followed yesterday’s modest US rally higher with both the Nikkei and Hang Seng rallying a bit more than 1.1%, although Shanghai managed only a 0.2% gain. Meanwhile, Europe is feeling quite perky this morning as funds from around the world are flowing into the single currency as well as equity markets throughout the region. The DAX is leading the way higher, up 4.0%, as plans for a mooted €100 billion government support program are all over the tape. And this is in addition to the EU plan for a €750 billion support package. Thus, talk of a cash for clunkers program is supporting the auto manufacturers, while increases in childcare subsidies and employment support are destined to help the rest of the economy.

But the rest of Europe is also rocking, with the CAC +2.2% and both Italy and Spain seeing 2.5% gains in their major indices. Surprisingly, the FTSE 100 is the laggard, up only 1.1%, as concerns over a hard Brexit start to reappear. The current thinking seems to be that even if a hard Brexit causes a poor economic outcome, Boris will be able to blame everything on Covid-19 thus hiding the costs, at least to the bulk of the population. After all, it will not be easy to disentangle the problems caused by Covid from those caused by a hard Brexit for the average bloke.

As I type, US futures are also reversing earlier losses and are now higher by roughly 0.5% across the board. Bond markets, once again, remain extremely uninteresting, at least in the 10-year sector, as yields continue to trade in narrow ranges. In fact, since mid-April, the 10-year Treasury has had a range of just 15bps top to bottom, again, despite extraordinary economic disruption. This same pattern holds true for all the haven bonds as central banks around the world control the activity there and prevent any substantial volatility. In fact, it is becoming increasingly clear that the signaling effect of government bond yields is diminishing rapidly. After all, what information is available regarding investor preferences if yields are pegged by the central bank?

Finally, turning to the dollar we see another day of virtually universal weakness. AUD is the top G10 performer today after the RBA appeared a tad more hawkish last night, leaving policy unchanged but also describing a wait and see approach before making any further decisions. So, while some are calling for further ease Down Under, that does not appear to be on the cards for now. NOK is next on the list, rallying 0.65% as oil prices continue their strong performance of the past 6 weeks. Then comes the pound, up 0.6% this morning after a more than 1% rally yesterday. This is far more perplexing given the growing concerns over a hard Brexit, which will almost certainly result in the pound declining sharply. Remember, as it currently stands, if there is no agreement between the UK and EU by the end of June to extend the current trade negotiations, then a deal must be done by December 31, 2020 or it’s a hard Brexit. Discussions with traders leads me to believe that we have seen a massive short squeeze in the pound vs. both the euro and the dollar. If this is the case, then we are likely looking at some pretty good levels for hedgers to take advantage.

In the EMG space, the board is almost entirely green as well, with IDR (+1.35%) atop the list with MYR (+1.0%) and MXN (+0.9%) following close behind. The rupiah has gained as Indonesia is preparing plans to reopen the economy as soon as they can, deciding that the economic devastation is worse than the disease. Meanwhile, both MYR and MXN are beneficiaries of the oil rally with the ruble (+0.65%) not far behind. In fact, the entire space save the TWD (-0.15%) is firmer this morning. As an aside, TWD seems to be feeling a little pressure from the ongoing US-China trade spat, but despite its modest decline, it has been extremely stable overall.

There is no US data on the schedule for today, so FX markets will continue to take their cues from equities. At this point, that still points in the direction of a weaker dollar as risk continues to be acquired. Despite the currency rallies we have seen in the past weeks, most currencies are still lower vs. the greenback YTD. If you are convinced that the worst is behind us, then the dollar has further to fall. But any reversion to a risk-off sentiment is likely to see the dollar reassert itself, and potentially quite quickly.

Good luck and stay safe
Adf

To Aid and Abet

The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
Adf

 

Yields Are Appalling

Though prices for oil keep falling
And Treasury yields are appalling
The stock market’s view
Is skies will be blue
If Covid’s spread’s finally stalling

The ongoing dichotomy between equity market performance, traditionally a harbinger of future economic activity, and commodity market performance, also a harbinger of future economic activity, remains glaring. The commodity markets are clearly signaling significant demand destruction amid the economic devastation that has followed the spread of Covid-19. At the same time, equity markets around the world continue to recover from the lows seen in March, telling a completely different tale; that the future is bright.

When two key leading indicators offer such different portents, we need to look elsewhere to build our case of likely future outcomes. Clearly, government bond markets are the next best indicator, but their signal has been clouded by the more than $15 trillion that central banks around the world have spent buying those bonds since the financial crisis in 2008-09. Absent those purchases, would 10-year Treasury yields really be 0.65% like they are this morning? Would 10-year German bund yields really be at -0.44%, their 356th consecutive day yielding less than zero? Consider how much new debt has been issued and how that debt would have been absorbed absent central bank intervention. My point is that perhaps, using bond yields now as a proxy for future economic activity may no longer be quite as useful.

Which leaves us with the FX markets as our last signal for future activity. What does the dollar’s value tell us about expectations for the future? The problem with the dollar as an indicator is, its track record is extremely unclear. Throughout history, the US economy has been strong with both a strong dollar and a weak dollar. If anything, the dollar is a far better coincident indicator than anything else. After all, what is the risk-off/risk-on characteristic other than a signal of investors’ current views of the market. Thus, when fear is rampant, which was evident last month, the dollar performed extremely well. A quick look at currency returns during the month of March showed the dollar rising against 9 of its G10 Brethren, from 0.2% vs. the Swiss franc, to 10.7% vs. the oil-linked Norwegian krone. Only the yen, which managed a 0.75% rise, was able to outperform the dollar.

Not surprisingly, the EMG space saw some much more significant declines led by the Mexican peso (-18.1%) and Russian ruble (-15.3%). The broad theme in this bloc was that the best performers, those that fell the least, were APAC currencies with closer links to China, while LATAM and EEMEA were generally devastated. But, again, this was a real-time response to coincident activities, not a harbinger of the future.

The lesson to learn from this brief look at recent history is that there is no consensus view as to how things are going to evolve from here. Both sides make their respective cases strongly, and both sides can point to a substantial amount of data that supports their argument. However, the only universal truth is that economic disruptions that have been caused by the response to Covid-19 are unprecedented in both size and speed, and econometric models built for a different environment are unlikely to be very effective. Modeling of complex systems, whether the economy, the climate or the spread of a pathogen is an extremely fraught undertaking. More often than not, models will produce useless results. Their benefits generally come from the need to define conditions and factors, thus helping to better think and understand a particular situation, not from spurious calculations that produce a result. And this is why hedging is an important part of risk management, because regardless of what certain harbingers indicate, the reality is nobody knows what the future will bring.

But back to today’s activity. As we have seen for the past several sessions, the prospect of the reopening of economies is being seen by the equity markets as a clear positive. Despite abysmal earnings results across most industries, once again equity markets are firmer this morning, with most of Europe higher by 1.5%-2.0% and US futures pointing to gains of more than 1.0% on the open. Countries throughout Europe are starting to announce their plans to reopen with May 11 seeming to be the date where things will really start. And of course, the same process is ongoing in the US, with Georgia dipping its toe into the water yesterday, and other states lining up to do the same. Of course, the end of the lockdown does not mean that that things will return to the pre-virus situation. Incalculable damage has been done to every nation’s economy as regardless of government attempts, thousands upon thousands of small businesses will never return. Arguably, the one thing we know about the future is that it is going to be different than what was envisioned on January 1st.

Bond markets are behaving consistently with a modest risk-on view as Treasury and bund yields edge higher, while yields for the PIGS continue to slide. And finally, the dollar remains under pressure this morning, sliding against most of its counterparts as short-term fears abate. The best performers today in the G10 bloc are SEK and NOK, with the former rallying on what was perceived as a more hawkish than expected message from the Riksbank, when they didn’t cut rates back below zero at today’s meeting, and merely promised to continue to buy more bonds. NOK is a bit more difficult to explain given that oil prices (WTI -7.7%) continue to suffer from either significant excess supply or a complete lack of demand, depending on your point of view. However, given that NOK has been the worst performing G10 currency this year, it is probably due for some recovery given the positive sentiment seen today.

EMG currencies are also generally firmer, with MXN (+1.5%) atop the charts, as it, too, is ignoring the declining price of oil and instead finding demand after a precipitous fall this year. but we are also seeing strength in ZAR (+1.2%) and most EEMEA currencies, as some of last month’s excesses seem to be unwinding as we approach the end of April.

On the data front this morning are two minor releases, Case Shiller Home Prices (exp 3.19%) and Consumer Confidence (87.0). Rather, with the FOMC’s two-day meeting beginning this morning at 9:00, discussions will continue to focus on expectations for the Fed tomorrow, as well as the first look at Q1 GDP. But for today, I expect that we will continue to see this mildly positive risk attitude and the dollar to remain under modest pressure. My view remains that there are still significant issues ahead and the market is not pricing in the length of how bad things are going to be, but clearly for now, I am in the minority.

Good luck and stay safe
Adf

Still Disrespected

According to data last night
The future in Germany’s bright
While right now, it stinks
Most everyone thinks
By Q3, they’ll all be alright

And yet, markets haven’t reflected
The positive vibe ZEW detected
Stock markets are dire
The dollar is higher
While oil is still disrespected

The one constant in the current market and economic environment is that nothing is consistent. For example, in Germany, the lockdown measures were extended for two weeks the day before Frau Merkel said that they would start to ease some restrictions, allowing small shops to open along with some schools. Then, this morning, the ZEW surveys were released with the Current Situation index printing at a historically low -91.5, well below the already dire forecasts of a -77.5 print. And yet, the Expectations index rose to +28.2, far higher than the median forecast of -42.0. Essentially, the commentary was that while Q1 and Q2 would be awful, things would be right as rain in Q3. But here’s a contradiction to that view, Oktoberfest, due to begin in late September, has just been canceled despite the fact that it is five months away and that it is in the middle of Q3, when things are ostensibly going to be much better there. My point is that, right now, interpreting signals of future activity is essentially impossible. Alas, that is what I try to do each morning.

So, what have we learned in the past twenty-four hours? Arguably, the biggest story was oil where the May WTI futures contract closed at -$37.63/bbl. In other words, the contract buyer is paid to take delivery of oil. And that’s the rub, storage capacity is almost entirely utilized while demand destruction continues daily. The IEA reported that current global production is running around 100 million barrels/day, with current demand running around 70 million barrels per day. In other words, plenty of oil is looking for a temporary home, and more of it is coming out of the ground each day. Arguably, this is a great opportunity for the US government to take delivery for the Strategic Petroleum Reserve, especially since they would be getting paid for the oil. But that would require a nimbleness of action that is unlikely to be seen at any government level. This morning, June WTI futures are under further pressure, down by another 20% at $16.50/bbl as I type, simply indicating that there is limited hope for a rebound in the near term. But the curve remains in sharp contango, with prices at $30/bl in December and higher further out. This price action is simply the oil market’s manifestation of the current economic view; negative growth in Q1 and Q2 with a rebound coming in Q3. However, despite the logic, seeing any commodity, let alone the world’s most important commodity, trading below zero is a strange sight indeed.

With the oil market grabbing the world’s focus, it can be no surprise that the dollar has responded by rallying strongly, especially against those currencies that are seen as tightly linked to the price of oil. So, in the G10 space, NOK (-1.7%) and CAD (-0.7%) are suffering, with the Nokkie the worst performer in the group. But AUD (-0.95%), NZD (-1.25%) and GBP (-0.95%) are all under significant pressure as well. It seems that Kiwi has responded negatively to RBNZ Governor Orr’s musings regarding additional stimulus in May, while Aussie has suffered on the back of the weak pricing in energy markets as well as lousy employment data. Meanwhile, today’s pressure on the pound seems to stem from a renewal of the Brexit discussion, and how a hard exit will be deleterious. In addition, there are still those who claim the UK’s response to the pandemic has been inadequate and the impact there will be much worse than elsewhere. Interestingly, UK employment data released this morning did not paint as glum a picture as might have been expected. While we can ignore the Unemployment Rate, which is February’s number, the March Claims data was surprisingly moderate. I expect, however, that next month’s data will be far worse. And I continue to think the pound has far more downside than upside here.

Turning to the EMG bloc, we cannot be surprised to see RUB as the worst performer in the group, down 1.3%, nor, given the growing risk-off sentiment, that the entire space is lower vs. the dollar. As today is a day that ends in ‘y’, MXN is lower, falling 0.7% thus far, as the market is increasingly put off by both the ongoing oil price declines as well as the ongoing incompetence demonstrated by the AMLO administration. (As an aside here, it seems that many Mexican financial institutions see much further peso weakness in the future as they are actively selling pesos in the market.) The other underperformers are HUF (-0.85%), ZAR (-0.8%) and KRW (-0.75%). Working in reverse order, the won is suffering as questions arise about the health of North Korean leader Kim Jong-un, who according to some reports, is critically ill and close to death. The concern is there is no obvious successor in place, and no way to know what the future will hold. Meanwhile, the rand is under pressure from the weakness throughout the commodity space as well as the realization that the carry that can be earned by holding the currency has diminished to its lowest level since 2008. For a currency that has been dependent on foreign holdings, this is a real problem.

I guess, given that the euro is only lower by 0.2%, it is actually a top performer of the day, so perhaps the German data has been a support to the single currency. The thing is, given the export orientation of the German (and Eurozone) economy, unless things pick up elsewhere, growth expectations will need to be modified lower for Q3. Don’t be surprised if we see this in the survey data going forward.

Elsewhere, equity markets everywhere are in the red, with European indices down between 1.7% and 2.5%. Asian stock markets were also lower, by similar amounts, and after yesterday’s US declines, the futures this morning show losses of between 0.7% for the NASDAQ and 1.5% for the Dow. Bond yields continue to fall, with 10-year Treasuries lower by 3bps this morning, and overall, risk is being sold.

The only data this morning is Existing Home Sales from March, with the median expectation for a 9% decline to 5.25M. As to Fed speakers, the quiet period ahead of next Wednesday’s FOMC meeting has begun so there is nothing to hear there. Of course, given what they have already done, as well as the fact that every act is unanimously accepted, I don’t see any value add from their comments in the near-term.

Last week saw a net gain in the equity markets as the narrative embraced the idea that the infection curve was flattening and that we were past the worst of the impact. This week, despite the ZEW data, I would contend investors are beginning to understand that things will take a very long time to get back to normal, and that the chance for new lows is quite high. In this environment, the dollar is likely to remain well bid.

Good luck and stay safe
Adf

 

The Absolute Fact

It’s been one score years and one more
Since prices for oil hit this floor
Despite last week’s pact
The absolute fact
Is there’s no place for, it, to store

Q1 1999 was the last time the price of the front-month oil contract on the Comex was trading as low as it has this morning. As I type, it is currently at $13.55/bbl, down more than $4.70 on the session, which on a percentage basis is more than 25%! And you thought currency volatility was high. At any rate, it seems the major issue is that oil producers have no place left to store the stuff, and since demand has collapsed, the natural response is for the price to collapse as well. Now, in fairness, while this will garner the headlines, the market reality may be slightly different, because the May futures contract, which expires tomorrow, is no longer the active contract, that has moved to June. Now, the June contract is down nearly 10%, but is still trading above $22/bbl, so this morning’s excitement may have less long-term market impact than it seems at first. Nonetheless, it does point to just how disruptive the coronavirus has been to markets all around the world.

Of course, one should not be surprised by the currencies that have felt the repercussions of this oil price decline the most severely; MXN (-1.9%), RUB (-0.45%), NOK (-0.65%) and CAD (-0.7%). The peso has been one of the market’s favorite whipping boys all year, as it has declined nearly 22% thus far. ZAR (-25.7%) and BRL (-23.0%) are the only two currencies to underperform the peso. Thus, this morning’s nearly 2% decline cannot be a surprise. In fact, since March 2, truthfully before Covid was widely understood to be the threat it has become to Western economies, the average daily range in USDMXN has been 3.78% which works out to an annualized volatility of nearly 60%. The remarkable thing is how cheap MXN options are relative to actual movement. For example, this morning, 1-month implied volatility is trading on the order of 25%, clearly far less than the type of movement we have seen in the past seven weeks. And given oil’s extreme volatility, and the peso’s link to the price of oil, I expect that we are going to continue to see the peso trade like this for the foreseeable future. The implication here is that hedgers might want to consider owning some of this optionality to help manage the uncertainties of their exposures during this time.

Away from the oil story, though, we have an entirely different narrative forming regarding the virus and its impact on the broader economy. Despite a number of countries having extended their lockdown procedures into the second week of May, we are also getting the first signs that the peak of infections may have passed, and we are hearing from more and more quarters that reopening the economy is more critical given that fact. This has been a big part of the rationale behind the equity market rally we saw last week, which despite the evidence of just how awful Q1 earnings are going to be, was really remarkably robust.

There continue to be two strong storylines with bulls claiming that this is a temporary hit and given the amount of stimulus, both fiscal and monetary, that has been brought to bear on the problem, the ‘V’ shaped recovery is still a high probability outcome. The bears, on the other hand, continue to highlight that expectations for the economy going forward to look anything like it did three months ago are misguided, and that it will take far longer to achieve any real recovery. Structural changes will have been made resulting in a much higher unemployment rate, considerably less consumption and, thus, much weaker GDP growth. Earnings will suffer and stock prices alongside them. Last week’s price action, with both up and down days, was an excellent depiction of this battle. And this battle will continue until one side’s argument is borne out. In other words, equity market volatility is likely to be with us for many months to come as well.

So, turning to this morning’s session, we have actually seen equity markets somewhat softer, with most of Europe lower by a bit below 1.0% which followed Asia’s similarly modest weakness. US futures, though, are starting to come under more pressure, having only been down 0.5% early in the session, but now looking at 1.5% declines. Interestingly, Treasury yields have barely moved, with the 10-year lower by less than 1 basis point, although in Europe, the weakest economies (PIGS) have all seen their government bond yields rise by more than 8bps, a sign of risk being jettisoned. And finally, gold is little changed on the morning, although given the dollar’s broad rally since the beginning of March, it has held its value extremely well.

As to the rest of the FX market, the dollar is largely, albeit not universally stronger this morning, and has been gaining ground as risk has been selling off. NOK and CAD lead the way lower, but the pound is also feeling stress as Brexit (remember that?) comes back into view with discussions starting up again. There is a big question as to whether PM Johnson will concede to an extension of the current situation given the unprecedented disruption caused by Covid-19. Fears that he won’t, and that the UK will crash out with no deal are likely to start to come back if we don’t hear positive news on this front soon. In the EMG bloc, away from the peso, there were more losers than winners, but the magnitudes of movement this morning have been far less than what we have seen recently. Ultimately, if risk continues to be shed, I expect the dollar to remain well bid against all comers.

On the data front, we start to see a bigger range of March data, which will clearly have been impacted by the virus and response.

Tuesday Existing Home Sales 5.3M
Thursday Initial Claims 4.5M
  Continuing Claims 17.27M
  Markit Mfg PMI 38.0
  Markit Services PMI 31.3
  New Home Sales 644K
Friday Durable Goods -12.0%
  -ex Transport -6.0%
  Michigan Sentiment 68.0

Source: Bloomberg

As we have seen for the past several weeks, the Claims data is likely to be the most important, although the PMI data will be interesting as well. Of course, the question, at this point, is whether the market will have discounted what it perceives to be all the bad news and ignore this data. While we may see that again for another week or two, my sense is that at some point, investors will realize that the future is not quite so bright, and that risk is not where they want to be. That seems to be today’s short-term narrative, but it has not changed the bigger view yet.

Good luck and stay safe
Adf

Prices So Low

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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All Stay at Home

While yesterday was, for most, scary
It seems the moves were temporary
This morning we’ve seen
Our screens filled with green
On hopes of response monetary

Meanwhile, as the virus expands
And spreads across multiple lands
The word out of Rome
Is, ‘all stay at home’
And please don’t go round shaking hands!

What a difference a day makes! After what was a total obliteration of risk on Monday, this morning we have seen equity markets around the world rebound sharply as well as haven assets lose some of their luster. While net, risk assets are still lower than before the oil war broke out, there is a palpable sense of relief in trading rooms around the world.

But is anything really different? Arguably, the big difference this morning is that we have begun to hear from governments around the world about how they are planning to respond to the Covid-19 pandemic epidemic, and more importantly, that they actually do have a response. The most dramatic response is arguably from Italy, where the government has locked down the entire nation. Schools and businesses are closed and travel within as well as in and out of the country is banned save for a dire emergency. Given how badly hit Italy has been hit by Covid, nearly 500 deaths from more than 9,000 cases, and the fact that the case load is increasing, this should be no surprise. At the same time, given the demographics in Italy, only Germany and Japan have older populations, and given the fact that the virus is particularly fatal for elderly people, things are likely to continue to get worse before they get better. I have seen two different descriptions of how dire the situation is there, with both calling the health infrastructure completely overwhelmed. Look for Germany to impose more restrictions later this week as well, given the growing spread of the virus there.

But from a market perspective, what is truly turning things around is the discussion of combined monetary and fiscal response that is making the rounds. Last night President Trump explained the administration was considering payroll tax cuts as well as direct subsidies to hourly workers via increased support for paid sick leave. In addition, the market is certain the Fed will cut at least 50bps next week, and still essentially pricing in 75bps. So, the twin barrels of monetary and fiscal policy should go a long way to helping regain confidence. Of course, neither of these things will solve the problems in the oil patch as shale drillers find themselves under extraordinary financial pressure with oil prices still around $34/bbl. While that is a 10% rebound from yesterday, most of the shale drillers need oil to be near $45-$50/bbl to make a living. But there is very little the government can do about that right now.

And we are hearing about pending support from other governments as well, with the UK, France and Japan all preparing or announcing new measures. However, as long as the virus remains as contagious as it is, all these measures are merely stop-gaps. Lockdowns have serious longer-term consequences and there will be significant lost output that is permanently gone. Recession this year seems a highly likely event in many, if not most, G10 countries, so be prepared.

And with that as a start, let’s take a look around the markets. As I mentioned, equities rebounded in Asia (Nikkei +0.85%, Hang Seng +1.4%, Shanghai +1.8%) and are much higher in Europe (DAX +3.6%, CAC +4.4%, FTSE 100 +4.2%). Of course, that was after significantly larger declines yesterday. US futures are sharply higher as I type, with all three indices more than 4% higher at this time. Meanwhile, bond markets are seeing the opposite price action with 10-year Treasury yields rebounding to 0.71% after touching a low of 0.31% yesterday. Bunds have also rebounded 12bps to -0.74%, and more importantly, both Italian and Greek bonds have rallied (yields falling) sharply. Make no mistake, the bonds of those two nations are not considered havens in any language.

In the FX market, yesterday saw, by far, the most volatile trading we have experienced since the financial crisis in 2008-09. And this morning, along with other markets, much of that is reversing. So we are looking at the yen falling 2.4% this morning, by far the worst performer in the G10, but also seeing weakness in the euro (-0.85%), pound Sterling (-0.7%) and Swiss franc (-0.85%). On the plus side, NOK is higher by 1.05% and CAD has regained a much less impressive 0.35%.

Emerging markets have also seen significant reversals with MXN, yesterday’s worst performer, rebounding 1.8%, ZAR +1.65% and KRW +0.95%. On the downside, RUB is today’s loser extraordinaire, falling 3.5% after Saudi Aramco said they would increase production to a more than expected 12.3 million bbls/day. But the CE4 currencies, which rallied with the euro yesterday, are all softer this morning by roughly 0.8%.

The one thing that seems clear is that volatility remains the base case for now, and although market implied volatilities have fallen today, they remain far higher than we had seen just a week ago. I think there will also be far more market liquidity to be involved in this market as well.

On the data front, the NFIB Small Business Optimism report has already been released at 104.5, rising from last month and far better than expected. Now this survey covers February which means that there had to be at least some virus impact. With that in mind, the result is even more impressive. The thing is that right now, data is just not a market driver, so the FX markets have largely ignored this along with every other release.

Looking ahead to today’s session, the reversal of yesterday’s moves is clearly in place and unless we suddenly get new information that the virus is more widespread, or that there is pushback on support packages and they won’t be forthcoming, I expect this morning’s moves to continue a bit further.

Longer term, we remain dependent on the spread of Covid-19 and government responses as the key driver. After all, the oil news seems pretty fully priced in for now.

Good luck
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All Screens Are Red

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck
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Despite Cash

In China the stock market sank
Despite cash from its central bank
But elsewhere it seems
The narrative deems
Investors, the Kool-Aid, have drank

So, it can be no surprise that after a one and a half week hiatus, the Chinese equity markets sold off dramatically (Shanghai -7.8%) when they reopened last night. After all, equity markets elsewhere in the world had all been under pressure for the entire time as the novel coronavirus spread seemed to accelerate. Of course, since Chinese markets closed for the Lunar New Year holiday, major global markets in the west had fallen only between 3.5% and 4.0%. But given China is the country whose economy will be most impacted, the ratio doesn’t seem wrong.

What we learned over the weekend, though, is that the acceleration has not yet begun to slow down. The latest data shows over 17,000 infected and over 300 deaths are now attributable to this illness. Most epidemiological models indicate that we have not reached the peak, and that it would not be surprising to see upwards of a quarter of a million cases within the next month or two. Remember too, this assumes that the information coming from China is accurate, which given the global reaction to the situation, may be a big ask. After all, I’m pretty sure President Xi Jinping does not want to be remembered as the leader of China when it unleashed a global pandemic. You can be sure that there will be a lot of finger-pointing in China for the rest of 2020, as some heads will need to roll in order to placate the masses, or at least to placate Xi.

But in what has been a classic case of ‘sell the rumor, buy the news’, equity markets in the rest of the world seem to have gotten over their collective fears as we see modest strength throughout Europe (DAX +0.2%, CAC +0.2% FTSE +0.4%) and US futures are all pointing higher as well. So at this point in time, it appears that the market’s modest correction last week is seen as sufficient to adjust for what will certainly be weaker growth globally, at least in Q1 2020. Something tells me that there is further repricing to be seen, but for now, the default belief is that the Fed and other central banks will do “whatever it takes” as Signor Draghi once said, to prevent an equity market collapse. And that means that selling risk would be a mistake.

With that as prelude, let’s turn our attention to what is happening away from the virus. The biggest FX mover overnight has been the pound, which has fallen 1.1% after tough talk from both PM Boris Johnson and EU Brexit negotiator Michel Barnier. The market’s concern seems to be that there will be no agreement reached and thus come December, we will have a Brexit redux. I am strongly in the camp that this is just posturing and that come June, when the decision for an extension must be made, it will be done under the guise of technical aspects, and that a deal will be reached. Neither side can afford to not reach a deal. In fact, one of the key discussion points in Europe this morning is the fact that the EU now has a €6 billion hole in its budget and there is nobody able to fill the gap.

On the data front, Eurozone Manufacturing PMI data was modestly better than forecast, with the bloc-wide number at 47.9, still contractionary, but Italy, France and Germany all edging higher by a tenth or two. However, despite the modestly better data and the modest uptick in equity markets, the single currency is under some pressure this morning, down 0.25%, as the market adjusts its outlook for Fed activity. It remains pretty clear that the ECB is already doing everything it can, so the question becomes will the Fed ease more aggressively as we go forward, especially if we start to see weaker data on the back of the coronavirus situation. Friday’s market activity saw futures traders reprice their expectations for Fed rate cuts, with the first cut now priced for July and a second for December. And that rate change was what undermined the dollar during Friday’s session, as it suddenly appeared that the US would be stepping on the monetary accelerator. In fairness, if the quarantine in China continues through the end of Q1, a quick Fed rate cut seems pretty likely. We shall see how things evolve. However, this morning sees a bit less fear all over, and so less need for Fed action.

The other main mover in the G10 was NOK (-0.7%), which given how much oil prices have suffered, seems quite reasonable. There is a story that Chinese oil demand has fallen 20% since the outbreak, as the combination of factory closures and quarantines reducing vehicle traffic has taken its toll. In fact, OPEC is openly discussing a significant production cut to try to rebalance markets, although other than the Saudis, it seems unlikely other producers will join in. But away from those currencies, the G10 space is in observation mode.

In the emerging markets, it should be no surprise that CNY is much weaker, falling 1.1% on-shore (catching up to the offshore CNH) and trading below (dollar above) 7.00. Again, that seems pretty appropriate given the situation, and its future will depend on just how big a hit the economy there takes. Surprisingly, the big winner today is ZAR, which has rebounded 1.0% after Friday’s sharp decline which took the currency through the 15.0 level for the first time since October. In truth, this feels more like a simple reaction to Friday’s movement than to something new. If anything, this morning’s PMI data from South Africa was much worse than expected at 45.2, which would have seemingly undermined the currency, not bolstered it.

On the data front, this week will be quite active as we see the latest payroll data on Friday, and a significant amount of new data between now and then.

Today ISM Manufacturing 48.5
  ISM Prices Paid 51.5
  Construction Spending 0.5%
Tuesday Factory Orders 1.2%
Wednesday ADP Employment 158K
  Trade Balance -$48.2B
  ISM Non-Manufacturing 55.1
Thursday Initial Claims 215K
  Unit Labor Costs 1.2%
  Nonfarm Productivity 1.6%
Friday Nonfarm Payrolls 160K
  Private Payrolls 150K
  Manufacturing Payrolls -4K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.3
  Participation Rate 63.2%
  Consumer Credit $15.0B

Source: Bloomberg

Obviously, all eyes will be on the payrolls on Friday, although the ISM data will garner a great deal of attention as well. Last Friday’s core PCE data was right on the screws, so the Friday rate movement was all about coronavirus. With the FOMC meeting behind us, we get back to a number of Fed speakers, although this week only brings four. Something tells me there will be a lot of discussion regarding how they will respond to scenarios regarding China and the virus.

In the end, short term price action is going to be all about the virus and its perceived impact on the global economy. Any indication that the outbreak is slowing down will result in an immediate risk grab-a-thon. If it gets worse, look for havens to get bid up quickly.

Good luck
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Unease In Iraq

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

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

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

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

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

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

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

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

Good luck
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