Tag Archives: #Operationtwist

Much Bluer Skies

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Ahead of the Fed, PMI’s
From Europe were quite a surprise
It seems that despite
The lockdowns in sight
The future has much bluer skies

Preliminary PMI data from around the world this morning is the market’s key focus, at least until 2:00 this afternoon when we hear from the Fed.  But, in the meantime, the much better than expected readings surprised the market and are driving yet another increase in risk appetite.  (One wonders if that appetite will ever be sated!)

Starting in Asia, Australian data was considerably stronger than last month, with the Composite figure printing at 57.0, its second highest print in the (short) history of the series.  On the other hand, Japanese data was the sole disappointment, with the Composite slipping 0.1 to 48.0, still pointing to a contracting economy.  The European numbers, however, were all much better than expected with Germany printing 2 points higher than expected at 52.5 on the Composite while France (49.6 Composite) actually beat expectations by 6.6 points.  As such, the Eurozone Composite PMI printed at 49.8, significantly better than expectations of a 45.7 print.  The point here is that while the Eurozone economy is hardly booming (other than German manufacturing), there is a clear sense that the worst may be behind it.

Of course, what makes this so surprising is that the German government has shuttered non-essential businesses until January 10th, with hints that could be extended, after the largest single day fatality count was recorded yesterday.  We are also hearing from other European countries, (France and Italy), that further lockdowns and restrictions on gatherings are being considered as the second (third?) wave of Covid-19 sweeps across the continent.  Yet, not only markets, but businesses have clearly grabbed hold of the idea that the vaccine is going to lead to a swift end to the government intervention in virtually every economy and allow economic activity to resume as it was before.

The spanner in the works, as it were, is that governments are loathe to cede power and control once it is obtained.  If this holds true again, then businesses need to be prepared to have far more rules and restrictions imposed on their operations, something which is typically not associated with an economic boom.  However, for now, it appears that the prospect of the tightest restrictions being lifted outweighs the potential longer-term negative impacts of intrusive government.  So, as Timbuk 3 explained back in 1986, “The Future’s So Bright (I Gotta Wear Shades).

With that in mind, a quick turn to the FOMC meeting today shows us that the market consensus is for no policy changes in scope or size, but rather, more clarity on what is required for the Fed to consider tighter policy in the future.  Expectations continue to center on achieving a specific Unemployment Rate or Inflation Rate or, probably, both in combination.  Perhaps Chairman Powell will resurrect the Misery Index (not the current show on TBS, but the original one defined by Ronald Reagan, when he was running for president in 1980, as the sum of inflation and unemployment.)  For instance, a target of 3.5% Unemployment and 2.0% Inflation would seem to be right where policymakers would be thrilled.  Alas, today we are looking at a reading of 7.9%, with a poor mixture to boot (Unemployment 6.7%, CPI 1.2%).  However, as long as Congress fails to pass a new fiscal stimulus bill, do not be too surprised if the Fed does change the program, with my bet being on Operation Twist redux, where they extend the maturities of their current purchases.  We will find out at 2.

Turning to the markets, all that hunger for risk has shown up in all markets today, with equities and commodities broadly firmer while bonds and the dollar are broadly weaker.  Last night, following the strong equity performance in the US yesterday, we saw less impressive, but still positive price action in Asia with the Nikkei (+0.3%) and Hang Seng (+1.0%) both rallying although Shanghai was flat on the day.  Europe, however, has embraced the PMI data, as well as word that a Brexit deal is approaching (told ya so!) and markets there are all much firmer; DAX (+1.6%), CAC (+0.7%), FTSE 100 (+1.0%).  Finally, US futures are actually the laggards this morning, with all three in the green but the magnitude of those gains more muted than one might have expected, in the 0.2%-0.3% range.

Bond markets have come under pressure as there is certainly no case to own a low yielding haven asset when one can be gorging on risk, but the price declines are far larger in Europe (Bunds and OATs +3.7bps, Gilts +2.7bps) than in the US (Treasuries +1.0bp).  Interestingly, even the PIGS bonds are selling off as it appears Portugal is not quite so interesting a place to hold your cash when the yield there is -0.04% on 10-year paper!

Commodities are firmer, with gold having a second strong performance in a row, up 0.4% this morning, and oil prices are also drifting higher, albeit barely so at this hour.  And finally, the dollar is under significant pressure this morning after breaking through several key technical levels, with only CAD (-0.4%) underperforming in the G10.  And in truth, I cannot find a good reason for the decline as there don’t appear to be either technical or fundamental reasons evident.  On the other side, though, NOK (+0.45%) and GBP (+0.4%) are the leading gainers, although the rest of the space is higher by about 0.3%.  Aside from the Brexit hopes, this is all really about the dollar and the ever-growing conviction that it has much further to fall as 2021 approaches and unfolds.

As to the emerging markets, the CE4, taking their cues from the euro, are leading the way with CZK (+0.75%) and PLN (+0.6%) at the head of the pack.  Beyond those, the gains are less impressive, on the order of 0.2%-0.3%, with APAC currencies little changed overnight and LATAM currencies opening with less oomph than we are seeing in Europe.

On the data front, ahead of the FOMC this afternoon, we see Retail Sales (exp -0.3%, +0.1% ex autos) and then the preliminary PMI data as well (55.8 Manufacturing, 55.9 Services).  My sense is stronger than expected data would have only a limited impact on the dollar, but if the data is weak, another wave lower seems quite possible.

And that is really what we have today.  For now, the dollar is under pressure and likely to remain so.  At 2:00, there is potential for an additional leg lower, if the Fed opts to increase QE or extend maturities, but I cannot make a case for the dollar to benefit from their announcement.  In fact, for now, the only thing that can help the dollar is the fact that it has already moved a long way, and it could be due for a simple trading correction.

Good luck and stay safe
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Not Whether but When

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The question’s not whether but when
The Fed adds more money again
With Congress unable
To reach cross the table
It’s up to Jay and his (wo)men

For the first time in months, the top stories today are simply a rehash of the top stories yesterday.  In other words, there is nothing new under the sun, at least with respect to market activities.  There has been nothing new regarding Brexit (talks continue but no word on an outcome); nothing new regarding US fiscal stimulus (talks continue but no word on an outcome);  and nothing new regarding Covid-19 (vaccines have begun to be administered, but lockdowns continue to be the primary tool to fight the spread of the infection).

True, we received some data from China overnight describing an economy that continues to recover, but one whose pace of recovery is barely accelerating and certainly not exceeding expectations.  We saw some data from the UK that described the employment situation as less dire than forecast, but still a mess.  And we saw some inflation data from both Italy and France describing the complete lack of an inflationary impulse on the Continent.  The point is, none of this could be called new information, and so investor response has been extremely muted.

Rather, the story that is developing traction seems to be the question of what the FOMC is going to do when they meet tomorrow.  There seem to be two questions of note; first, will they leave everything just as it is, reiterating their current forward guidance to continue to support the economy until it is deemed capable of recovering on its own, or will they start to attach some metrics to their views; and second, will they leave their current asset purchase program unchanged, or will they alter either the size or tenor?

The bigger picture on this issue needs to consider what we have heard from various Fed speakers prior to the quiet period.  To a (wo)man, they all explained that more fiscal stimulus was critical in helping the economy to recover, and so the fact that none has been forthcoming must be weighing on their views of the future.  This would seem to bias a call for action, not inaction.

Regarding the first question, if we learned anything from the FOMC Minutes three weeks’ ago, it was that there seemed to be movement in the direction of applying metrics to their hitherto vague statements regarding when they will act.  The concern with this approach is that in the wake of the financial crisis, they did just this, explaining that rates would remain near zero until the Unemployment Rate reached their then-current view of full employment, which initially was pegged at 5.0%.  That target was changed several times until it was finally abandoned, as it turned out their models weren’t all that accurate.  Which begs the question, do they want to put themselves in the same position of defining a position and subsequently finding out their initial assumptions were wrong, so they need to change that position?  Remember, credibility is one of a central bank’s most crucial assets and moving targets on policy because of model or forecast errors does not enhance credibility.  In the end, it seems more likely they will not apply hard numbers to their targets, rather much softer views like, full employment rather than a specific unemployment rate; or trend inflation rather than a specific average inflation rate with a timeline attached.

As to the second question, based on positioning indicators, current expectations are pretty evenly distributed as to a change (either more purchases or a Twist) or standing pat.  Again, based on the commentary that fiscal stimulus is crucial and its failure to be agreed, I would lean toward the side of more stimulus to be announced now, perhaps stoking the Christmas rally in equities.  (After all, half the time it seems stoking equity rallies is their entire focus.)

But away from that conversation, there is precious little else to discuss today.  A quick tour of markets shows that after yesterday afternoon’s US equity selloff, Asian equities followed suit with modest declines across the board (Nikkei -0.2%, Hang Seng -0.7%, Shanghai -0.1%).  European bourses, which had been modestly higher earlier, are starting to fade a bit, although the DAX (+0.6%) and CAC (+0.3%) remain in the green.  However, the FTSE 100 (-0.3%) has turned lower as the pound has recently started to edge higher.  US futures are all pointing higher, though, with gains of around 0.6% across the board.

Bond prices are mixed, with Treasuries very slightly softer and yields there higher by less than 1 basis point, but European markets starting to find a bid with yields declining modestly across the board.  The outperformers right now are the PIGS, with yield declines of between 1.5 and 4 basis points, while the rest of Europe’s markets are looking at smaller price gains.

Commodities are reversing yesterday’s price action with oil virtually unchanged while gold has rallied 1.0% this morning.  And finally, the best way to describe the dollar is modestly, but not universally, softer.  In the G10, as I write, GBP (+0.4%) has rallied in the past hour although there has been nothing on the tape that would seem to account for the price action.  But most of the bloc is modestly firmer, between 0.1% and 0.2%, with only two laggards, AUD and NZD (both lower by -0.1%) which have responded to China’s announcement they would be banning shipments of coal from Australia going forward.

EMG currencies are also somewhat firmer in general, led by LATAM (BRL, MXN and CLP all +0.50%) with two others showing similar strength (ZAR and RUB).  As to the rest of the bloc, gains and losses are less than 0.2%, which is another way of saying there is no new information there either.  Broadly speaking, this bloc is going to take its cues from the G10 space, and while the consensus for 2021 remains a much weaker dollar, today that is not taking shape.

On the data front, we see Empire Manufacturing (exp 6.3), IP (0.3%) and Capacity Utilization (73.0%) this morning, although none of these seem likely to change any views.  As such, at this point, it seems the best bet is the FX market will follow the broad risk theme, assuming one develops, or will respond to news, perhaps a fiscal stimulus breakthrough will come today, which is likely to lead to further dollar weakness.  But we will have to wait for that.

Good luck and stay safe
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Further Afflictions

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Each day there is growing conviction
The buck is due further affliction
More views now exist
The Fed will soon ‘Twist’
Thus, slaking the market’s addiction

But even if Powell and friends
Do act as the crowd now contends
Does anyone think
Lagarde will not blink
And cut rates at which her group lends?

You cannot read the financial press lately without stumbling across multiple articles as to why the dollar is due to fall further.  There is no question it has become the number one conviction trade in the hedge fund community as well as the analyst community.  There are myriad reasons given with these the most common:

1.     The introduction of the vaccine will lead to a quicker recovery globally and demand for risk assets not havens like the dollar
2.     The Biden administration will be implementing a new, larger stimulus package adding to the global reflation trade
3.     The Fed is going to embark on a new version of Operation Twist (where they swap short-dated Treasuries for long-dated Treasuries) in order to add more stimulus, thus weakening the dollar
4.     The market technical picture is primed for further dollar weakness in the wake of recent price action breaking previous dollar support levels.

Let’s unpack these ideas in order to try to get a better understanding of the current sentiment.

The vaccine story is front page news worldwide and we have even had the first country, the UK, approve one of them for use right away.  There is no question that an effective vaccine that is widely available, and widely taken, could easily alter the current zeitgeist of fear and loathing.  If confidence were to make a comeback, as lockdowns ended and people were released from home quarantines, it would certainly further support risk appetite.  Or would it?

Consider that risk assets, at least equities, are already trading at record high valuations as investors have priced in this outcome.  You may remember the daily equity rallies in October and November based on hopes a vaccine would be arriving soon.  The point is, it is entirely possible, and some would say likely, that the vaccine implementation has already been priced into risk assets.  One other fly in this particular ointment is that so many businesses have already permanently closed due to the government-imposed restrictions worldwide, that even if economic demand rebounds, supply may not be available, thus driving inflation rather than activity.

How about the idea of a new stimulus package adding to global reflation?  Again, while entirely possible, if, as is still widely expected, the Republicans retain control of the Senate, any stimulus bill is likely to disappoint the bulls.  As well, if this is US stimulus, arguably it will help support the US economy, US growth and extend the US rebound further and faster than its G10 and most EMG peers.  Yes, risk will remain in favor, but will that flow elsewhere in the world?  Maybe, maybe not.  That is an open question.

Certainly, a revival of Operation Twist, where the Fed extends the maturity of its QE purchases in order to add further support to the economy by easing monetary policy further would be a dollar negative.  I thought it might be instructive to see how the dollar behaved back in 2011-12 when Ben Bernanke was Fed Chair and embarked on the first go-round of this policy.  Interestingly enough, from September 2011 through June 2012, the first leg of Operation Twist, the dollar rallied 8.7% vs. the euro.  When the Fed decided to continue the program for another six months, the first dollar move was a continuation higher, with another 2.75% gain, before turning around and weakening about 6%.  All told, through two versions of the activity, the dollar would up slightly firmer (2.5%) than when it started.

And this doesn’t even consider the likelihood that if the Fed eases further, all the other major central banks will be doing so as well.  Remember, FX is a relative game, so relative monetary policy moves are the driver, not absolute ones.  And once again, I assure you, that if the euro starts to rally too far, the ECB will spare no expense to halt that rally and reverse it if possible.  Currently, the trade-weighted euro is back to levels seen in early September but remains 1.75% below the levels seen in 2018.  It is extremely difficult to believe that the ECB will underperform next week at their meeting if the euro is climbing still higher.  Deflation in Europe is rampant (CPI was just released at -0.3% in November), and a strong currency is not something Lagarde and her compatriots can tolerate.

Finally, looking at the technical picture, it may well be the best argument for further dollar weakness.  To the uninitiated (including your humble author) the variety of technical indicators observed by traders can be dizzying.  However, some include satisfying the target of an “inverted hammer” pattern, recognition of the next part of an Elliott Wave ABC correction and DeMark targets now formed for further dollar weakness.  While that mostly sounded like gibberish, believe me when I say there are many traders who base every action on these indicators, and when levels are reached in the market, they swarm in to join the parade.  At the same time, the hedge fund community, while short a massive amount of dollars, is reputed to have ample dry powder to increase those positions.

In sum, ironically, I would contend that the technical picture is the strongest argument for the dollar to continue its recent decline.  Risk assets are already priced for perfection, the vaccine is a known quantity and any Fed move is likely to be matched by other central banks.  This is not to say that the dollar won’t decline further, just that any movement is likely to be grudging and limited.  The dollar is not about to collapse.

A quick recap of today’s markets shows that risk appetite, not unlike yesterday’s lack of enthusiasm, remains satisfied for now.  Asian equities were mixed with the Hang Seng (+0.7%) the leader by far as both the Nikkei (0.0%) and Shanghai (-0.2%) showed no life.  European bourses are mostly lower (DAX -0.4%, CAC -0.25%) although the FTSE 100 is flat on the day.  And US futures are also either side of flat.

Bond markets, are rebounding a bit from their recent decline, with Treasuries seeing yields lower by 1 basis point and European bonds all rallying as well, with yields falling between 2bps and 3bps.  The latter may well be due to the combination of weaker than expected Services PMI releases as well as the news that Germany is extending its partial lockdown to January 10.  (Tell me again why the euro is a good bet here!)

Gold continues to rebound from its correction last week, up another $10 while the dollar, overall, this morning is somewhat softer, keeping with the recent trend.  GBP (+0.6%) is the leading gainer in the G10 on continued hopes a Brexit deal will soon be reached, but the rest of the bloc is +/-0.2%, or essentially unchanged.  EMG gainers include HUF (+0.7%) as the government there expands infrastructure spending, this time on airports, while the rest of the bloc has seen far smaller gains, which seem to be predicated on the idea of US stimulus talks getting back on track.

Initial Claims (exp 775K) data leads the calendar this morning with Continuing Claims (5.8M) and then ISM Services (55.8) at 10:00.  Yesterday’s Beige Book harped on the negative impact that government shutdowns have had on companies with no sign, yet, of vaccine hopes showing up in businesses.  At the same time, Chairman Powell, in his House testimony yesterday, explained that there was no rift between the Fed and the Treasury, and the Fed response when Treasury Secretary Mnuchin said he was recalling unused funds from the CARES act, was merely reinforcement of the idea that the Fed was not going to back away from their stated objectives.

In the end, the dollar remains under pressure and the trend is your friend.  With that in mind, though, it strikes that a decline of more than another 1%-2% will be very difficult to achieve without a more significant correction first.  Again, for receivables hedgers, these are good levels to consider.

Good luck and stay safe
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