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

Leavers Cheer

The Governor, in his last meeting
Said data, of late, stopped retreating
There’s no reason why
We need to apply
A rate cut as my term’s completing

Yet all the news hasn’t been great
As Eurozone stats demonstrate
Plus Brexit is here
And though Leavers cheer
The impact, growth, will constipate

Yesterday saw a surprising outcome from the BOE, as the 7-2 vote to leave rates on hold was seen as quite a bit more hawkish than expected. The pound benefitted immensely, jumping a penny (0.65%) in the moments right (before) and after the announcement and has maintained those gains ever since. In fact, this morning’s UK data, showing growth in Consumer Credit and Mortgage Approvals, has helped it further its gains, and the pound is now higher by 0.2% this morning. (As to the ‘before’ remark; apparently, the pound jumped 15 seconds prior to the release of the data implying that there may have been a leak of the news ahead of time. Investigations are ongoing.) In the end, despite the early January comments by Carney and two of his comrades regarding the need for more stimulus, it appears the recent data was sufficient to convince them that further stimulus was just not necessary.

Of course, that pales in comparison, at least historically, with today’s activity, when at 11:00pm GMT, the UK will leave the EU. With Brexit finally completed all the attention will turn to the UK’s efforts to redefine its trading relationship with the rest of the world. In the meantime, the question at hand is whether UK growth will benefit in the short-term, or if we have already seen the release of any pent-up demand that was awaiting this event.

What we do know is that Q4 was not kind to the Continent. Both France (-0.1%) and Italy (-0.3%) saw their economies shrink unexpectedly, and though Spain (+0.5%) continues to perform reasonably well, the outcome across the entire Eurozone was the desultory result of 0.1% GDP growth in Q4, and just 1.0% for all of 2019. Compare that with the US outcome of 2.1% and it is easy to see why the euro has had so much difficulty gaining any ground. It is also easy to see why any thoughts of tighter ECB policy in the wake of their ongoing review make no sense at all. Whatever damage negative rates are doing to the Eurozone economies, especially to banks, insurance companies and pensions, the current macroeconomic playbook offers no other alternatives. Interestingly, despite the soft data, the euro has held its own, and is actually rallying slightly as I type, up 0.1% on the day.

It may not seem to make sense that we see weak Eurozone data and the euro rallies, but I think the explanation lies on the US side of the equation. The ongoing aftermath of the FOMC meeting is that analysts are becoming increasingly dovish regarding their views of future Fed activity. It seems that, upon reflection, Chairman Powell has effectively promised to ease policy further and maintain a more dovish overall policy as the Fed goes into overdrive in their attempts to achieve the elusive 2.0% inflation target. I have literally seen at least six different analyses explaining that the very modest change in the statement, combined with Powell’s press conference make it a lock that ‘lower for longer’ is going to become ‘lower forever’. Certainly the Treasury market is on board as 10-year yields have fallen to 1.55%, a more than 40bp decline this month. And this is happening while equity markets have stabilized after a few days of serious concern regarding the ongoing coronavirus issue.

Currently, the futures market is pricing for a rate cut to happen by September, but with the Fed’s policy review due to be completed in June, I would look for a cut to accompany the report as they try to goose things further.

Tacking back to the coronavirus, the data continues to get worse with nearly 10,000 confirmed cases and more than 200 deaths. The WHO finally figured out it is a global health emergency, and announced as much yesterday afternoon. But I fear that the numbers will get much worse over the next several weeks. Ultimately, the huge unknown is just how big an economic impact this will have on China, and the rest of the world. With the Chinese government continuing to delay the resumption of business, all those global supply chains are going to come under increasing pressure. Products built in China may not be showing up on your local store’s shelves for a while. The market response has been to drive the prices of most commodities lower, as China is the world’s largest commodity consumer. But Chinese stock markets have been closed since January 23, and are due to open Monday. Given the price action we have seen throughout the rest of Asia when markets reopened, I expect that we could see a significant downdraft there, at least in the morning before the government decides too big a decline is bad optics. And on the growth front, initial estimates are for Q1 GDP in China to fall to between 3.0% and 4.0%, although the longer this situation exists, the lower those estimates will fall.

Turning to this morning’s activity, we see important US data as follows:

Personal Income 0.3%
Personal Spending 0.3%
Core PCE Deflator 1.6%
Chicago PMI 48.9
Michigan Sentiment 99.1

Source: Bloomberg

Arguably, the PCE number is the most important as that is what is plugged into Fed models. Yesterday’s GDP data also produces a PCE-type deflator and it actually fell to 1.3%. If we see anything like that you can be certain that bonds will rally further, stocks will rally, and rate cut probabilities will rise. And the dollar? In that scenario, look for the dollar to fall across the board. But absent that type of data, the dollar is likely to continue to take its cues from the equity markets, which at the moment are looking at a lower opening following in Europe’s footsteps. Ultimately, if risk continues to be jettisoned, the dollar should find its footing.

Good luck and good weekend
Adf

Mere Nonchalance

On Friday we learned the US
Grew faster, but not to excess
The market response
Was mere nonchalance
In stocks, but the buck did depress

This morning in Europe, however,
The outcome did not seem as clever
Growth there keeps on slowing
Thus Mario’s going
To need a new funding endeavor

If you needed a better understanding of why the dollar, despite having declined ever so modestly this morning, remains the strongest currency around, the contrasting data outcomes from Friday in the US and this morning in the Eurozone are a perfect depiction. Friday saw US GDP in Q1 rise 3.2% SAAR, significantly higher than expected, as both trade and inventory builds more than offset softer consumption. Whatever you make of the underlying pieces of the number, it remains a shining beacon relative to the rest of the G10. Proof positive of that difference was this morning’s Eurozone sentiment data, where Business Confidence fell to 0.42, its weakest showing in nearly three years while Economic Sentiment fell to 104, its sixteenth consecutive decline and weakest since September 2016.

It is extremely difficult to look at the Eurozone data and conclude that the ECB is not going to open the taps again soon. In fact, while the official line remains that no decisions have been made regarding the terms of the new TLTRO’s that are to be offered starting in June, it is increasingly clear that those terms are going to be very close to the original terms, where banks got paid to borrow money from the ECB and on-lend it to clients. The latest comment came from Finnish central bank chief Ollie Rehn where he admitted that hopes for a rebound in H2 of this year are fading fast.

With that as the backdrop, this week is setting up for the chance for some fireworks as we receive a great deal of new information on both the economic and policy fronts. In fact, let’s take a look at all the information upcoming this week right now:

Today Personal Income 0.4%
  Personal Spending 0.7%
  PCE 0.2% (1.6% Y/Y)
  Core PCE 0.1% (1.7% Y/Y)
Tuesday Employment Cost Index 0.7%
  Case-Shiller Home Prices 3.2%
  Chicago PMI 59.0
Wednesday ADP Employment 181K
  ISM Manufacturing 55.0
  ISM Prices Paid 55.4
  Construction Spending 0.2%
  FOMC Rate Decision 2.5% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  Unit Labor Costs 1.4%
  Nonfarm Productivity 1.2%
  Factory Orders 1.5%
Friday Nonfarm Payrolls 181K
  Private Payrolls 173K
  Manufacturing Payrolls 10K
  Unemployment Rate 3.8%
  Participation Rate 62.9%
  Average Hourly Earnings 0.3% (3.4% Y/Y)
  Average Weekly Hours 34.5
  ISM Non-Manufacturing 57.0

So, by Friday we will have heard from both the Fed and the BOE, gotten new readings on manufacturing and prices, and updated the employment situation. In addition, on Friday, we have four Fed speakers (Evans, Clarida, Williams and Bullard) as the quiet period will have ended.

Looking at this morning’s data, the PCE numbers continue to print below the Fed’s 2.0% target and despite recently rising oil prices, there is no evidence that is going to change. With the employment situation continuing its robust performance, the Fed is entirely focused on this data. As I wrote on Friday, it has become increasingly clear that the Fed’s reaction function has evolved into ‘don’t even consider raising rates until inflation is evident in the data for a number of months.’ There will be no more pre-emptive rate hikes by Jay Powell. Inflation will need to be ripping higher before they consider it. And in fact, as things progress, it is entirely possible that the Fed does cut rates despite ongoing solid GDP growth, if they feel inflation is turning lower in a more protracted manner. As of Friday, the futures market had forecast a 41% probability of a Fed rate cut by the end of 2019. In truth, I am coming around to the belief that we could see more than one cut before the year ends, especially if we see any notable slowing in the US economy. (At this point, the Fed’s only opportunity to surprise the market dovishly is if they do cut rates on Wednesday, (although in the wake of the GDP data, that seems a little aggressive.)

The real question is if the Fed turns more dovish, will that be a dollar negative. One thing for certain is that it won’t be an equity negative, and it is unlikely to have a negative impact on Treasuries either, but by rights, the dollar should probably suffer. After all, a more dovish Fed will offset the dovishness emanating from other nations.

The problem with this thesis is that it remains extremely expensive for speculators to short the dollar given the still significantly higher short-term rates in the US vs. anywhere else in the G10. And so, we are going to need to see real flows exiting the US to push the dollar lower. Either that, or a change in the narrative that the Fed, rather than being on hold, is getting set to take rates back toward zero. For now, neither of those seem very likely, and so significant dollar weakness seems off the table for the moment. As such, while it was no surprise that the dollar fell a bit on Friday as profit taking was evident after a strong run higher, the trend remains in the dollar’s favor, so hedgers need to take that into account. And for all you hedgers, given the significant reduction in volatility that we have witnessed during the past several months, options are an increasingly attractive alternative for hedging. Food for thought.

Good luck
Adf