Christine Lagarde’s Goal

This morning, Christine Lagarde’s goal
Is focused on how to cajole
The market to see
That her ECB
Has total command and control

Ahead of the ECB statement and the subsequent press conference this morning, markets are mostly biding their time.  Monday’s risk-off session is but a hazy memory and everyone is completely back on board for the reflation trade despite rising numbers of Covid cases as well as newly imposed lockdowns by governments throughout the world.  While that may seem incongruous, apparently, the belief is that any such lockdowns will be for a much shorter period this time than we saw last year, and so the impact on economic activity will be much smaller.

With a benign backdrop, it is worthwhile, I believe, to consider what we are likely to see and hear from the ECB and how it may impact markets.  We already know that they have changed their inflation target from, “close to, but below 2.0%” to ‘2.0%’.  In addition, we have been told that there is a willingness to accept a period of time where inflation runs above their target as the ECB seeks to fine-tune both the message and the outcome.  Of course, when you think about what CPI measures, it is designed to measure the average rate of price increases for the population as a whole, the idea of fine-tuning something of this nature is ridiculous.  Add to that the extreme difficulty in measuring the data (after all, what exactly makes up the consumer basket? and how does it change over time?  and isn’t it different for literally every person?) and the fact that central banks are concerned if inflation prints at 1.7% or 2.0% is ludicrous.  As my friend @inflation_guy (you should follow him on Twitter) always explains, you cannot reject the null hypothesis that 1.7% and 2.0% are essentially the same thing in this context.  In other words, there is no difference between 2.0% inflation, where central bankers apparently feel comfortable, and 1.7% inflation, where central bankers bemoan the impending deflationary crisis.

As well, the ECB is going to explain their new asset purchase process.  Currently, there are two programs, the Public Sector Purchase Program (PSPP) which is the original QE program and had rules about adhering to the capital key and not purchasing more than 33% of the outstanding debt of any nation in order to prevent monetizing that debt.  Covid brought a second program, the Pandemic Emergency Purchase Program (PEPP), which had no such restrictions regarding what was eligible and how much of any particular nation’s bonds could be acquired but was limited in size and time.  Granted they both expanded the size of the program twice and extended its maturity, but at least they tried to make believe it was temporary.  The recent framework review is likely to allow PEPP to expire in March 2022, as currently planned, but at the same time expand the PSPP and its pace of purchases so that there will be no difference at all to the market.  In other words, though they will attempt to describe their policies as ‘new’, nothing is likely to change at all.

Finally, they apparently will be altering their forward guidance to promise interest rates will remain unchanged at current levels until inflation is forecast to reach or slightly surpass 2% and remain there for some time within the central bank’s projection period of two to three years.  Given the decades long lack of inflationary impulse in the Eurozone due to anemic underlying economic growth and ongoing high unemployment, this essentially means that the ECB will never raise rates again.  The ongoing financial repression being practiced by central banks shows no sign of abating and the ECB’s big framework adjustment will do nothing to change that outcome.

Will any of this matter?  That is debatable.  First, the market is already fully aware of all these mooted changes, so any price impact has arguably already been seen.  And second, have they really changed anything?  I would argue the answer to that is no.  While the descriptions of policies may have changed, the actions forthcoming will remain identical.  Interest rates will not move, and they will continue to purchase the same number of bonds that they are buying now.  As such, despite a lot of tongue wagging, I expect that the impact on the euro will be exactly zero.  Instead, the single currency will remain focused on the Fed’s (remember the FOMC meets next week), interest rate policy and the overall risk appetite in the market.

Turning to markets ahead of the ECB announcement we see that risk remains in vogue with strong gains in Asia (Hang Seng +1.85, Shanghai +0.35%, Nikkei closed) and Europe (DAX +0.9%, CAC +0.8%) although the FTSE 100 is barely changed on the day.  US futures are all green and higher by about 0.2% at this hour.

Bond markets have calmed down after a few very choppy days with Treasury yields backing up 1bp and now back to 1.30%, nearly 18 basis points above the low print seen Monday.  European sovereigns are mixed with Gilts seeing yields edge up by 0.8bps, while OATs have seen yields slide 0.8bps and Bunds are unchanged on the day.  Of course, with the ECB imminent, traders are waiting to see if there is any surprise forthcoming so are being cautious.

Oil prices continue their sharp rebound from Monday’s virtual collapse, rising another 0.6% and now firmly back above $70/bbl.  It turns out that Monday was a great opportunity to buy oil on the cheap!  Precious metals continue to disappoint with gold (-0.4%) slipping back below $1800/oz, although really just chopping around in a range.  Copper is firmer by 0.8% this morning but the rest of the non-ferrous group is slightly softer.

As to the dollar, it is under pressure virtually across the board this morning as there is certainly no fear visible in markets.  In the G10, NOK (+0.9%) is the leader on the back of oil’s rebound with the rest of the bloc seeing broad-based, but shallow, gains.  In the emerging markets, HUF (+0.55%) is the leader after recent comments from a central banker that they will be raising rates until their inflation goal is met.  (So old school!)  Meanwhile, overnight saw strength in APAC currencies (PHP +0.45%, IDR +0.4%, KRW +0.35%) as positive risk sentiment saw foreign inflows into the entire region’s stock markets.

We do get some data this morning starting with Initial (exp 350K) and Continuing (3.1M) Claims at 8:30 as well as Leading Indicators (0.8%) and Existing Home Sales (5.90M).  Fed speakers remain incommunicado due to the quiet period so as long as the ECB meets expectations the dollar should continue to follow its risk theme, which today is risk-on => dollar lower.

Good luck and stay safe
Adf

Central Banks Scoff

In Italy more cash is needed
Or so Super Mario pleaded
The virus is raging
And Mario’s waging
A war so its spread is impeded

Meanwhile Chairman Jay and his mates
Remain steadfast that in the States
Though forecasts are nice
They will not suffice
It’s hard growth they need to raise rates

And lastly, from China we learned
Inflation just might have returned
Though central banks scoff
Bond markets sold off
As clearly some folks are concerned

In the financial world these days, there is only one true constant, the Fed remains as dovish as possible.  Yesterday, Chairman Powell, speaking at an IMF sponsored event, explained that the Fed would continue to aggressively support the economy until it is once again “great”.  (And here I thought that description of America was verboten.)  He harped on the 9 million to 10 million jobs that are still missing from before the Covid-induced crisis and said any inflationary pressures this year would be temporary.  His colleague, SF Fed President Daly doubled down on those comments, once again explaining that the Fed will not react to mere forecasts of growth, they will wait until they see hard data describing that growth is real, before considering tightening policy.

Regarding inflation, Powell, when asked specifically on the subject, explained, “We would be monitoring inflation expectations very carefully.  If we see them moving persistently and materially above levels we’re comfortable with, then we’d react to that.”  Remember, the Fed constantly reminds us they have the tools to deal with rising inflation.  But talk is cheap.  It remains an open question as to whether they have the fortitude to address rising inflation in an economy that has not come close to reaching full employment, let alone maximum employment.  Recall Q4 2018, when a modest increase in interest rates and gradual reduction in the size of the balance sheet led to a sharp stock market sell-off and a reversal of Fed policies via the “Powell Pivot.”  And the economy then was clearly in better shape than now.

There is another inflation issue I find puzzling as well, and that is the Fed’s inexorable faith that the Core PCE number is the right way to measure inflation.  This is especially true since a number of Fed members, including Powell, have been vocal in their view that the U-3 Unemployment Rate, the one published the first Friday of each month, is a very imperfect indicator of the overall jobless situation despite its long history as a key indicator.  So, happily, they are willing to question the totality of the information available from a single data point.  And yet, while they pay some lip service to inflation expectations, they are absolutely beholden to a single inflation data point, and one that has very little in common with most people’s reality.  One would think that given their broad-mindedness regarding unemployment, that same attitude might extend to inflation.  Alas, my understanding is that their econometric models don’t work well with any other data point, and so rather than building models based on reality, they create their reality from the data that works.

While on the subject of inflation, Chinese data overnight showed that, while CPI rose only 0.4% Y/Y, PPI rose a much greater than expected 4.4%.  This matters because China remains the world’s major manufacturing center and if prices at the factory are rising there, the implication is that those higher prices are coming to a product near you soon. Another sign of pending inflation comes from an IHS Markit report explaining that the PMI price data is running at its highest level since 2008 and is showing no signs of slowing down.  Add to this the increases in shipping costs, and rising prices for every day items seem in store.  Thank goodness the Fed has tools!

A quick look at Europe shows a tale of two countries, with Italy heading into its fourth wave of lockdowns and PM Draghi putting together a €40 billion support package following on from a €30 billion package a few months ago.  The vaccine rollout remains slow and insufficient and the government has closed bars and restaurants (and that’s really a crime, given just how good the food is there!)  Germany, on the other hand, is leading the hawkish contingent of the ECB along with the Dutch, in pushing for tapering the PEPP activity as those economies have been far more resilient to the virus and are starting to see some price pressures.  Granted, this morning’s German IP data (-6.4% Y/Y) was much worse than expected, but forecasts remain quite positive there.  Unlike the Fed, the ECB seems to be turning a bit more hawkish, indicating the Frugal Four are gaining in power.  ECB PEPP purchases declined to just €10.2 billion last week, far below their average in Q1 and even more surprising given Madame Lagarde’s comments in the wake of the ECB meeting that they would be far more active in Q2.

Adding all the new information together brings us to a market situation this morning where Treasury bonds have sold off, yields are higher by 5 basis points in the US and about 4 basis points in the major European markets except Italy, where they are 8 basis points higher.  Equity markets are mixed in Europe (DAX +0.1%, CAC +0.25%, FTSE -0.1%) after broad weakness in Asia (Hang Seng -1.1%, Shanghai -0.9%) and US futures are little changed to slightly higher at this time.

Rather, it is the dollar that is today’s big winner, rallying against all its G10 counterparts with NOK (-0.6%) the laggard on still soft oil prices, but weakness seen in JPY (-0.3%) and AUD (-0.25%) with smaller declines elsewhere.  The yen’s weakness appears corrective in nature, as it had strengthened 1.7% in the past week. While Aussie is simply chopping about in its recent 0.7550/0.7675 trading range and slipping today.

In the EMG bloc, CZK (-0.65%) is the worst performer, followed by RUB (-0.5%) and KRW (-0.3%), although the bulk of the bloc is somewhat softer this morning.  Here, too, we appear to be seeing some trading reactions to the past week’s dollar weakness, although the bigger trend remains for dollar strength.

On the data front, PPI (exp 0.5%, 3.8% Y/Y) is the only release with the core expectations (0.2%, 2.7% Y/Y) also well above the Fed target.  Of course, the relationship between PPI and Core PCE is limited at best, however, it is certainly indicative of the fact that there are rising price pressures throughout many sectors of the economy.  It is not unreasonable to expect them to show up in PCE soon, as they will certainly begin to show up in CPI next week.

Only one Fed speaker is on the docket today, Dallas Fed President Kaplan, but it would be beyond shocking if he said anything that was different than what we have both read and heard this week; nothing will change until the hard data achieves their targets.

Despite new information this morning, or perhaps because of it, the market theme remains the same, Treasury yields are the key driver of markets, with the dollar following in step while equities will have an inverse relationship.  And, while Treasury yields are off their recent highs, they appear to have finished this short-term correction.  I have a feeling the dollar will be firmer today and continue with that into next week, at least.

Good luck, good weekend and stay safe
Adf

Our Fear and Our Dread

Said Madame Lagarde, don’t misread
The fact that our PEPP has lost speed
The quarter to come
A good rule of thumb
Is twice as much is guaranteed
 
This morning, though, markets have said
That’s just not enough to imbed
The idea your actions
Of frequent transactions
Will offset our fears and our dread
 
As we walk in this morning, there is a distinct change in tone in the markets from yesterday.  It seems that the initial impressions of yesterday’s two big events, the ECB meeting and the 30-year auction, were fleeting, and fear, once again, has taken over.
 
A quick recap shows that ECB President Lagarde, in responding to the growing questions about the reduced pace of ECB PEPP purchases, promised to significantly increase them during the next quarter.  While she refused to quantify ‘significantly’, the analyst community is moving toward the idea that means at least doubling the weekly purchase amounts to ~€25 billion.  At the same time, we heard from several ECB members this morning that this action did not presage increasing the size of the PEPP, which still has approximately €1 trillion in firepower remaining.  Lagarde emphasized the flexible nature of the program and explained that varying the speed of purchases is exactly why that flexibility was created.  However, despite today’s comments, Lagarde also assured us that, if necessary, the ECB could recalibrate the program, which is lawyer/central bank speak for increase the size.
 
The market liked what it heard, and the result was a bond rally on both sides of the Atlantic.  Several hours later, the results of the Treasury’s 30-year auction were released and, while not fantastic, were also not as disastrous as the 7-year auction from two weeks ago.  In the end, bond yields basically ended the day flat, equities rallied, and the dollar was under pressure all day.  Risk had regained its allure and the bulls were back in command.
 
Aahh, the good old days.  This morning, it is almost as though Madame Lagarde never said a word, or perhaps said too many.  Bond markets are selling off sharply, with 10-year Treasury yields higher by 7 basis points and above 1.60%, while European sovereigns are weaker across the board, led by UK gilts (+5.4bps), but with most continental bonds showing yield gains of 2.0-3.0 basis points.  So, what happened to all the goodwill from yesterday?
 
Perhaps that goodwill has fled from fears of rising inflation after President Biden (sort of) laid out his plan for vaccinating the entire nation by May and reopening the economy by summer.  Many analysts have pointed to the massive increase in savings and combined that with the newest stimulus checks to come (as soon as this weekend according to Treasury Secretary Yellen) and forecast a huge spending surge, significant economic growth and rising inflation. After all, the Atlanta Fed’s GDPNow forecast is at 8.35%, which while slightly lower than a few weeks ago, is still an extremely rapid pace for the US economy.  This pundit, however, questions whether or not that spending surge will materialize.  Historically, after a deeply shocking financial event like we have just experienced, behaviors tend to change, with the most common being a tendency to maintain a higher savings ratio.  As such, expectations for a massive consumer boom may be a bit optimistic.
 
Or, perhaps the goodwill has disappeared after further crackdowns by Chinese authorities on its most successful companies, with TenCent now under the gun, receiving fines and being reined in following their efforts to crush Ant Financial.  The Hang Seng certainly felt it, falling 2.2% overnight, although Shanghai (+0.5%) and the Nikkei (+1.7%) were still euphoric from yesterday’s US equity rally.  Rapidly rising Brazilian inflation (5.2% vs. 3.0% target) could be the cause, as concerns now increase that the central bank, when it meets next week, will be raising rates 0.50% to battle that, despite the economic weakness and ongoing Covid related stresses.
 
There is, however, one other potential cause of the bond market’s poor performance, which I believe is leading to the general risk-off attitude; but it is a sort of inside baseball issue.  The Supplementary Leverage Ratio (SLR) is part of bank regulation that was designed to insure banks would remain stable during hard times and not need to be bailed out, a la 2008.  However, during the initial stresses of the Covid crisis, the Fed suspended the need for banks to count Treasury securities and bank reserves as part of that ratio, thus allowing banks to hold more of those assets on their books while remaining within the regulations.  But this exemption is due to expire on March 31, which means banks either need a LOT more equity capital, or they need to shrink their balance sheet by selling off those excess Treasuries.  And, of course, selling Treasuries is much easier and exactly what we have seen in the past two weeks.  If the Fed does not give further guidance on this issue, and lets it expire, bonds probably have further to fall.  Ironically, that doesn’t seem to fit with what the Fed really wants to happen, as the higher yields would result in tighter financial conditions, especially if equity markets sold off in sync.  So, my guess is the Fed blinks and rolls the exemption over for at least 6 months, but until we know, look for bouts of selling in bonds and all the ensuing market reactions that come with that.
 
Just like today’s, where European markets are lower (DAX -0.6%, CAC -0.1%, FTSE 100 -0.1%) although in the latter two cases not by much and US futures are also lower, especially the tech laden NASDAQ (-1.4%) although also SPX (-0.4%). 
 
Commodity prices are also under a bit of pressure with oil (-0.25%) slipping a bit as well as precious (gold -1.0%) and base (copper -1.25%) metals.  In fact, today is also seeing weakness throughout the agricultural sector, with declines of the 0.75%-1.75% range across the board.
 
And what of the dollar, you ask?  Stronger across the board, with yesterday’s leading gainers showing the way lower today.  NZD (-0.75%), SEK (-0.7%) and CHF (-0.7%) are in the worst shape, but in truth, the entire G10 is under pretty significant pressure with only CAD (-0.15%) showing any signs of holding up as Canadian government bond yields rise right along with US yields. 
 
Emerging market currencies are also under significant pressure this morning, led by TRY (-1.5%) but seeing MXN (-1.3%) and ZAR (-1.0%) also suffering greatly.  In fact, all of LATAM and the CE4 are under significant pressure today but then all of them had seen substantial strength yesterday.  In fact, the two-day movement in many of these currencies is virtually nil.  Their futures will depend on a combination of the ongoing evolution of US interest rates and their unique  domestic situation.  If rising inflation is ignored in order to support these economies, look for much further weakness in that nation’s currency.  In other words, there is every chance that the dollar gains strength broadly against this bloc in the next several months.
 
On the data front, today brings PPI (exp 2.7%, 2.6% core) and Michigan Sentiment (78.5).  Certainly, that PPI data looks like inflation is in the pipeline, but the relationship between PPI and CPI is not nearly as strong as you might think, with just a 0.079% correlation over the past 5 years, although it does have a stronger relationship to core PCE (0.228%).  But if history is any guide, the market will not be flustered by any print at all. 
 
So, today is shaping up as risk-off with both bonds and stocks selling and no commentary from the Fed coming.  Just like yesterday’s risk appetite fed stronger currencies, it appears the opposite is true today.  I don’t expect to see substantial further gains, but a modest continuation of the dollar rally does feel like it is in the cards.
 
Good luck, good weekend and stay safe
Adf
 

If Things Cohere

Said Madame Lagarde, it’s not clear
If the PEPP need extend past next year
It could be the case
We’ll slow down the pace
Of purchases if things cohere

Yesterday’s ECB meeting presented mixed messages to the market as it has become evident there is a growing split between the hawks and doves.  While policy was left unchanged, as universally expected, the question of the disposition of the PEPP was front and center.  Once again, Madame Lagarde indicated that they would continue supporting the economy, but that the need to utilize the entire amount of authorized spending power could be absent.  Despite the fact that she admitted Q1 GDP growth would likely be negative, thus causing a second recession, she would not commit to full utilization, let alone any additional monetary stimulus.  Rather, she discussed “financing conditions” which need to remain “favorable” for the ECB to be happy.  Alas, there is no definition of what those conditions are, nor how to track them.   She mentioned a number of indicators they monitor including; bank lending, credit conditions, corporate yields, and sovereign bond yields, but not which may have more or less importance nor how they combine them.  There doesn’t appear to be an index of any sort although as part of their ongoing strategic review, they are investigating whether or not to create one.  In the end, though, it appears they are very keen to insure they don’t get pinned down to a mechanical reaction function based on either economic or financial indicators.  Instead, they will continue to wing it.

As to the growing split, it is becoming evident that the hawkish contingent, almost certainly led by Germany but likely including the Frugal Four, has been pushing back on any additional stimulus as they already see sufficient money in the system.  Remember, German DNA has been informed by the hyperinflation of the Weimar Republic in the 1930’s and Bundesbankers, like Jens Weidmann, everywhere and always see the specter of too much money leading to a recurrence of that outcome.  While that hardly seems like a possible outcome in the current situation, especially with most European countries extending lockdowns through February now, thus further stressing the economy, they know that debt monetization is the first step toward hyperinflation. And while the ECB will never explicitly monetize the debt, they can pretty easily do it implicitly.  All that has to happen is for them to permanently reinvest the proceeds of maturing sovereign debt into the same securities, and that money will be permanently in the system.

Consider, because of the ECB’s construction, with 19 central bank members, the way policy is promulgated is that each national central bank is instructed to purchase sovereign bonds issued by their own country in a given amount. So, the Banca d’Italia buys BTP’s and the Bundesbank buys bunds.  If instructions from the ECB council are to replace maturing debt with newly issued debt constantly, then the country never has to repay the bond, and therefore, the money injection is permanent, i.e. debt monetization.  It seems likely, this is the hawks’ major concern.  It is almost certainly why they insist on repeating the idea that full utilization of the PEPP is not a given, and why Lagarde cannot follow her instincts to throw more money at the second recession.  But of course, this is anathema to the hawks, who want to see the collective ECB balance sheet slowly wound down.  In the end, this tension will inform the ECB’s actions going forward, which implies, to me, that the ECB will be less dovish than some other central banks, namely the Fed, and which implies the euro could well head somewhat higher over time.

And perhaps, despite a clear risk-off theme for today’s trading activity, that is why the euro is retaining a better bid than its G10 brethren.  As equity markets around the world pare back some of their recent gains (Nikkei -0.4%, Hang Seng -1.6%, Shanghai -0.4%, DAX -0.85%, CAC -1.2%, FTSE 100 -0.7%), the clear message is risk is to be reduced heading into the weekend.  And yes, US futures are all pointing lower as well, between -0.5% and -0.8%.  Meanwhile, bond markets are playing their part, true to form, on this risk-off day, with Treasury yields lower by 1.9bps, Bunds by 2.0bps and Gilts by 2.5bps.  However, Italian BTPs have seen yields climb 3.6bps as the market responds to this newly created concern that the ECB will not be supporting Italy as they had in the past.  Add to that the ongoing political concerns in Italy, where PM Conte has just indicated he may be forced to call a new election, and the fact that today’s PMI data showed the recent lockdowns have really been crushing the economy there, and BTP’s are behaving like the risk asset they truly are, rather than the haven asset they aspire to be.

Commodity prices are under pressure across the board this morning, led by oil (-2.5%) but seeing the same in gold (-1.1%) and the entire agricultural bloc, with prices down between 0.8% (cotton) and 2.4% (soft red wheat).

This brings us back to the dollar, which is broadly higher this morning in both G10 and EMG space.  The euro (+0.1%) is the star performer today, as per the above discussion, but beyond that and the CHF (+0.05%), the rest of the bloc is weaker.  NOK (-0.8%) leads the way down with the rest of the commodity bloc (AUD -0.7%, NZD -0.5%, CAD -0.5%) not quite as badly impacted.  At the same time, EMG currencies are also under broad pressure led by RUB (-1.4%) on weaker oil, MXN (-1.0%) and BRL (-1.0%) both on weaker commodities and general risk aversion, and ZAR (-0.9%) as its main export, gold, falls. As to the positive side of the ledger, only minor East European currencies, BGN and RON (both +0.05%), have managed to eke out any gains, apparently tracking the euro ever so slightly higher.

The data picture has not helped inspire any risk taking this morning as preliminary PMI data for January showed weakness throughout.  As we have seen, manufacturing continues to hold up fairly well, but services have seen no respite.  Of all those countries reporting today, the UK was in the worst shape (PMI Services 38.8, down from 49.4) but the Eurozone as a whole (Services 45.0) was no great shakes.  It is abundantly clear that Europe is in the midst of a double-dip recession.  On the US calendar, the preliminary PMI data is released (exp Manufacturing 56.5, Services 53.4) and then Existing Home Sales (6.56M) at 10:00.  One thing we learned yesterday is that the housing market in the US remains quote robust.

But, with the Fed still in its quiet period until the meeting next Wednesday, and Yellen’s testimony done and dusted, FX is going to be reliant on other markets for direction.  If risk continues to be shed, the dollar should be able to hold its own, and even edge a bit higher.  But if equity markets manage to reverse course, then the dollar could well head back lower.

Good luck, good weekend and stay safe
Adf

A New Paradigm

As mid-year approaches, it’s time
To ponder the central bank clime
Will negative rates
Appear in the States
And welcome a new paradigm?

With the end of the first half of 2020 approaching, perhaps it’s time to recap what an extraordinary six months it has been as well as consider what the immediate future may hold.

If you can recall what January was like, the big story was the Phase One trade deal, which was announced as almost completed at least half a dozen times, essentially every time the stock market started to decline, before it was finally signed. In hindsight, the fact that it was signed right at the beginning of the Lunar New Year celebrations in China, which coincided with the recognition that the novel coronavirus was actually becoming a problem, is somewhat ironic. After all, it was deemed THE most important thing in January and by mid-February nobody even cared about it anymore. Of course, by that time, Covid-19 had been named and was officially declared a pandemic.

As Covid spread around the world, the monetary responses were impressive for both their speed of implementation and their size. The Fed was the unquestioned leader, cutting rates 150bps in two emergency meetings during the first half of March while prepping the market for QE4. They then delivered in spades, hoovering up Treasuries, mortgage-backed bonds, investment grade corporate bonds and junk bonds (via ETF’s) and then more investment grade bonds, this time purchasing actual securities, not ETF’s. Their balance sheet has grown more than $3 trillion (from $4.1 trillion to $7.1 trillion) in just four months and they have promised to maintain policy at least this easy until the economy can sustainably get back to their inflation and employment goals.

On the fiscal front, government response was quite a bit slower, and aside from the US CARES act, signed into law in late March, most other nations have been less able to conjure up enough spending to make much of a difference. There was important news from the EU, where they announced, but have not yet enacted, a policy that was akin to mutualization of debt across the entire bloc. If they can come to agreement on this, and there are four nations who remain adamantly opposed (Sweden, Austria, Denmark and the Netherlands), this would truly change the nature of the EU and by extension the Eurozone. Allowing transfers from the richer northern states to the struggling Mediterranean countries would result in a boon for the PIGS as they could finally break the doom-loop of their own nation’s banks owning the bulk of their own sovereign debt. But despite the support of both France and Germany, this is not a done deal. Now, history shows that Europe will finally get something along these lines enacted, but it is likely to be a significantly watered-down version and likely to take long enough that it will not be impactful in the current circumstance.

Of course, the ECB, after a few early stumbles, has embraced the idea of spending money from nothing and is in the process of implementing a €1.35 trillion QE program called PEPP in addition to their ongoing QE program.

Elsewhere around the world we have seen a second implementation of yield curve control (YCC), this time by Australia which is managing its 3-year yields to 0.25%, the same level as its overnight money. There is much talk that the Fed is considering YCC as well, although they will only admit to having had a discussion on the topic. Of course, a quick look at the US yield curve shows that they have already essentially done so, at least up to the 10-year maturity, as the volatility of yields has plummeted. For example, since May 1, the range of 3-year yields has been just 10bps (0.18%-0.28%) while aside from a one-week spike in early June, 10-year yields have had an 11bp range. The point is, it doesn’t seem that hard to make the case the Fed is already implementing YCC.

Which then begs the question, what would they do next? Negative rates have been strongly opposed by Chairman Powell so far, but remember, President Trump is a big fan. And we cannot forget that over the course of the past two years, it was the President’s view on rates that prevailed. At this time, there is no reason to believe that negative rates are in the offing, but in the event that the initial rebound in economic data starts to stumble as infection counts rise, this cannot be ruled out. This is especially so if we see the equity market turn back lower, something which the Fed seemingly cannot countenance. Needless to say, we have not finished this story by a long shot, and I would contend there is a very good chance we see additional Fed programs, including purchasing equity ETF’s.

Of course, the reason I focused on a retrospective is because market activity today has been extremely dull. Friday’s equity rout in the US saw follow through in Asia (Nikkei -2.3%, Hang Seng -1.0%) although Europe has moved from flat to slightly higher (DAX +0.5%, CAC +0.25%, FTSE 100 +0.5%). US futures are mixed, with the surprising outcome of Dow and S&P futures higher by a few tenths of a percent while NASDAQ futures are lower by 0.3%. The bond market story is that of watching paint dry, a favorite Fed metaphor, with modest support for bonds, but yields in all the haven bonds within 1bp of Friday’s levels.

And finally, the dollar is arguably a bit softer this morning, with the euro the leading gainer in the G10, +0.5%, and only the pound (-0.2%) falling on the day. It seems that there are a number of algorithmic models out selling dollars broadly today, and the euro is the big winner. In the EMG bloc, the pattern is the same, with most currencies gaining led by PLN(+0.65%) after the weekend elections promised continuity in the government there, and ZAR (+0.55%) which is simply benefitting from broad dollar weakness. The exception to the rule is RUB, which has fallen 0.25% on the back of weakening oil prices.

On the data front, despite nothing of note today, we have a full calendar, especially on Thursday with the early release of payroll data given Friday’s quasi holiday

Tuesday Case Shiller Home Prices 3.70%
  Chicago PMI 44.0
  Consumer Confidence 90.5
Wednesday ADP Employment 2.95M
  ISM Manufacturing 49.5
  ISM Prices Paid 45.0
  FOMC Minutes  
Thursday Initial Claims 1.336M
  Continuing Claims 18.904M
  Nonfarm Payrolls 3.0M
  Private Payrolls 2.519M
  Manufacturing Payrolls 425K
  Unemployment Rate 12.4%
  Average Hourly Earnings -0.8% (5.3% Y/Y)
  Average Weekly Hours 34.5
  Participation Rate 61.2%
  Trade Balance -$53.0B
  Factory Orders 7.9%
  Durable Goods 15.8%
  -ex transport 4.0%

Source: Bloomberg

So, as you can see, a full slate for the week. Obviously, all eyes will be on the employment data on Wednesday and Thursday. At this point, it seems we are going to continue to see data pointing to a sharp recovery, the so-called V, but the question remains, how much longer this can go on. However, this is clearly today’s underlying meme, and the ensuing risk appetite is likely to continue to undermine the dollar, at least for the day. We will have to see how the data this week stacks up against the ongoing growth in Covid infections and the re-shutting down of portions of the US economy. The latter was the equity market’s nemesis last week. Will this week be any different?

Good luck and stay safe
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Depression’s Price In

As cities continue to burn
The stock market bears never learn
Depression’s priced in
And to bears’ chagrin
Investors have shown no concern

Once again risk is on fire this morning as every piece of bad news is seen as ancient history, riots across the US are seen as irrelevant and the future is deemed fantastic based on ongoing (permanent?) government economic support and the continued belief that Covid-19 has had its day in the sun and will soon retreat to the back pages. And while the optimistic views on government largesse and the virus’s retreat may be well founded, the evidence still appears to point to an extremely long and slow recovery to the global economy. Just yesterday, the Congressional Budget Office, released a report indicating it will take nearly ten years before GDP in the US will return to its previous trend growth levels. That hardly sounds like they type of economy that warrants ever increasing multiples in the stock market. But hey, I’m just an FX guy.

A look around the world allows us to highlight what seem to be the driving forces in different regions. There are two key assumptions underpinning European asset performance these days; the fact that the EU has finally agreed to joint financing of a budget and mutualized debt issuance and the virtual certainty that the ECB is going to increase the PEPP in their step tomorrow. The flaws in these theories are manifest, although, in fairness, despite themselves the Europeans have generally found a way to get to the goal. However, the EU financing program requires unanimous approval of all 27 members, something that will require a great deal of negotiation given the expressed adamancy of the frugal four (Austria, the Netherlands, Sweden and Denmark) who are not yet convinced that they should be paying for the spendthrift habits of their southern neighbors. And the problem with this is the amount of time it will take to finally agree. Given the urgent need for funding now, a delay may be nearly as bad as no support at all.

At the same time, the ECB, despite having spent only €250 billion of the original €750 billion PEPP monies are now assumed to be ready to announce a significant increase to the size of the program. Not surprisingly, members of the governing council who hail from the frugal four have expressed reluctance on this matter as well. However, after Madame Lagarde’s gaffe in March, when she declared it wasn’t the ECB’s job to protect peripheral nation bond markets (that’s their only job!) I expect that she will steamroll any objections and look for a €500 billion increase.

Clearly, traders and investors are on the same page here as the euro continues to rally, trading higher by 0.3% this morning (+4.2% since mid-May) and back above 1.12 for the first time since March. European equity markets are rocking as well, with the DAX once again leading the way, up 2.4%, despite a breakdown in talks between Chancellor Merkel’s CDU and its coalition partner SPD over the nature of the mooted €100 billion German support program. But the rest of Europe is flying as well, with the CAC up 2.0% and both Italy’s and Spain’s main indices higher by about 2.0%. European government bonds are sliding as haven assets are simply no longer required, at least so it seems.

Meanwhile, in Asia, we have seen substantial gains across most markets with China actually the laggard, essentially flat on the day. But, for example, Indonesia’s rupiah has rallied another 2.2% this morning after a record amount of bidding for a government bond auction showed that investors are clearly comfortable heading back to the EMG bloc again. The stock market there jumped 2.0% as well, and a quick look shows the rupiah has regained almost the entirety of the 22% it lost during the crisis and is now down just 1.6% on the year. What a reversal. But it is not just Indonesia that is seeing gains. KRW (+0.7%, -5.0% YTD), PHP (+0.5%, +1.1% YTD) and MYR (+0.35%, -4.0% YTD) are all gaining today as are their stock markets. And while both KRW and MYR remain lower on the year, each has recouped more than half of the losses seen at the height of the crisis.

So, the story seems great here as well, but can these nations continue to support their economies to help offset the destruction of the shutdowns? That seems to vary depending on the nation. South Korea is well prepared as they announced yet another extra budget to add stimulus, and given the country’s underlying finances, they can afford to do so. But the Philippines is a different story, with far less resources to support themselves, although they have availed themselves of IMF support. And Indonesia? Well, clearly, they have no problem selling bonds to investors, so for the short term, things are great. The risk to all this is that the timeline to recovery is extended far longer than currently perceived, and all of that support needs to be repaid before economic activity is back.

The point of all this is that while there is clearly a bullish story to be made for these markets, there are also numerous risks that the bullish case will not come to fruition, even with the best of intentions.

And what about the US? Looking at the stock market one would think that the economy is going gangbusters and things are great. But reading the news, with every headline focused on the ongoing riots across the nation and the destruction of property and businesses, it is hard to see how the latter will help the economy return to a strong pace of growth in the short run. If anything, it promises to delay the reopening of many small businesses and restaurants, which will only exacerbate the current economic malaise.

The other thing that seems out of step with the politics is the underlying belief that there will be another stimulus bill passed by Congress soon. While the House passed a bill several weeks ago, there has been no action in the Senate, nor does there seem to be appetite in the White House for such a bill at this time with both seeming to believe that enough has been done and ending the lockdowns and reopening businesses will be sufficient. But if there are riots in the streets, will ordinary folks really be willing to resume normal activities like shopping and eating out? That seems a hard case to make. While the cause of the riots was a tragedy, the riots themselves have created their own type of tragedy as well, the delay and destruction of an economic rebound. And that will not help anybody.

So, on a day where the dollar is under pressure across the board, along with all haven assets, we have a bit of data to absorb starting with the ADP Employment number (exp -9.0M) and then ISM Non-Manufacturing (44.4) and Factory Orders (-13.4%). The Services and Composite PMI data from Europe that was released earlier showed still awful levels but marginally better results than the preliminary reports. However, it is hard to look at Eurozone PMI at 31.9 and feel like the economy there is set to rebound sharply. Those levels still imply a deep, deep recession.

However, today is clearly all about adding risk to the portfolio, and that means that equities seem likely to continue their rally while the dollar is set to continue to decline. For receivables hedgers, I think we are getting to pretty interesting levels. If nothing else, leave some orders a bit above the market to take advantage.

Good luck
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Infinite Buying

Is infinite buying
Kuroda-san’s new mantra
If so, will it help?

An interesting lesson was learned, for those paying attention, yesterday after a headline hit the tape about the BOJ. The headline, BOJ Considering Unlimited JGB Purchases, had an immediate impact on the yen’s value, driving it lower by 0.7% in minutes. After all, logic dictates that a central bank that will buy all the government debt available will drive rates, no matter where they are, even lower, and that the currency would suffer on the back of the news. But, as is often the case, upon further reflection, the market realized that there was much less here than met the eye, and the yen recouped all those losses by early afternoon. In fact, over the past two sessions, the yen is essentially unchanged overall.

But why, you may ask, would that headline have been misleading. The key is to recognize that the BOJ’s current policy describes their QQE (Qualitative and Quantitative Easing) as targeting ¥80 trillion per year, equivalent in today’s market to approximately $740 billion. But they haven’t come close to achieving that target since 2017, actually only purchasing about ¥15 trillion last year. That’s a pretty big miss, but a year after they created that target, they began Yield-Curve Control (YCC), which states that 10-year JGB’s will be kept at around a 0.0% yield, +/-0.2%. Now, given that the BOJ already owns nearly 50% of all JGB’s outstanding, there is very little actual trading ongoing in the JGB market, so it doesn’t really move very much. The point is, the BOJ doesn’t need to buy many JGB’s to keep yields around 0.0%. However, they have been concerned over the optics of reducing that ¥80 trillion target, as reducing it might seem a signal that the BOJ was tightening policy. But now, in the wake of the Fed’s announcement that they will be executing unlimited QE, the BOJ has the perfect answer. They can get rid of a target that no longer means anything, while seeming to expand their program. At the same time, when pressed, they will point to their successful YCC and claim they are purchasing everything necessary to keep rates low. And in fairness, they will be right.

Next week it’s the central bank three
Who meet and they’ll try to agree
On proper next steps
(Increasing the PEPP?)
And printing cash like it was free

This was merely a prelude to what the next several days are going to hold, anticipation of the next central bank actions as the three major central banks, BOJ, Fed and ECB, all meet next week. At this point, we have already seen all the excitement regarding the BOJ, and as to the Fed, while they may well announce more details on their efforts to get funds flowing to SME’s, they are already at unlimited QE (and they are active, buying $75 billion/day) and so it seems unlikely that there will be anything else new to be learned.

The ECB, however, is the place where all the action is going to be. Remember, Madame Lagarde was a little slow off the mark, when back in March she stated that the ECB’s job was not to worry about spreads in the government bond market. Granted, within two weeks, after the market crushed Italian BTP’s and called into question Italy’s ability to fund its Covid-19 response, she realized that was, in fact, her only role. And so subsequently we got a €750 billion PEPP program that included Greek debt for the first time. But clearly, based on the recent PMI data, as well as things like this morning’s Ifo Expectations Survey (69.4 vs. exp 75.0), more is needed. So, speculation is now rampant that PEPP will be increased by €250 billion, and that the Capital Key will be explicitly scrapped. The latter is important because that is the driver of which nation’s debt they purchase and is based on the relative size of each economy. But the main problem is Italy, and so you can be sure that the ECB is going to wind up with a lot more Italian debt than would be allowed under the old rules.

Turning back to this week, though, we still have a whole day to traverse before the weekend arrives. Overall, markets are beginning to quiet down, with actual volatility a bit softer than we had seen recently. For example, though equity markets in Europe are lower, the declines are between 0.7% (FTSE 100) and 1.1% (Spain’s IBEX), with the CAC and DAX in between. If you recall, we were seeing daily movement on the order of 2%-5% not that long ago. The same was true overnight, with the Nikkei (-0.9%), Hang Seng (-0.6%) and Shanghai (-1.1%) all softer but by less dramatic amounts. As to US futures, while they were negative earlier, they are actually currently higher by about 0.5%, although we have a long way to go before the opening.

Bond markets are uninspiring, with Treasuries basically unchanged. European markets are a bit firmer (yields lower) across the board as investors try to anticipate the mooted increase in PEPP. And JGB’s are yielding -0.026%, right where the BOJ wants them.

The dollar this morning is now ever so slightly softer, with CAD actually the leading gainer up 0.2%, while the rest of the G10 is +/-0.1%. The Ifo data was the only release of note, although we have seen oil prices rebound slightly, currently higher by about 1.0% helping both CAD and NOK. In the EMG bloc, the story is a bit more mixed, although gainers have had a better day than losers. By that I mean, CZK (+1.35%), HUF (+1.1%) and RUB (+1.0%) have seen stronger gains than the worst performers (INR and KRW both -0.5%). As always, there are idiosyncratic drivers, with CZK seeming to benefit from word that lockdowns are about to ease, while HUF is gaining on the imminent beginning of QE purchases by the central bank. As to RUB, the combination of oil’s continuing rally off its worst levels earlier this week, and the Bank of Russia’s 50bp rate cut, to 5.50%, has investors looking for better times ahead. Ironically, that stronger oil seems to be weighing on the rupee, while the won fell as foreign equity selling dominated the market narrative.

Yesterday’s Claims data was pretty much as expected, granted that was 4.4M, still horrific, but the market absorbed the news easily. This morning brings Durable Goods (exp -12.0%, -6.5% ex transport) and then at 10:00 Michigan Sentiment (68.0). Not surprisingly, expectations are for some of the worst readings in history, but the way the market has been behaving, I think the risk is actually for a less negative data print and a sharp risk rally. Eventually, unless there really is a V-shaped recovery, I do see risk being shed, but it doesn’t seem like today is the day to get started.

Good luck, good weekend and stay safe
Adf

 

A Huge Threat

In Europe officials now fret
‘bout dealing with Italy’s debt
If it gets downgraded
It could be blockaded
From PEPP, which would be a huge threat

At home, both the Senate and House
Agreed that it’s time to espouse
More spending is needed
And so, they proceeded
To spend half a trill, thereabouts

While oil prices are still getting press (and still under pressure), the return to positive prices has quickly turned that story into one about supply and demand, and the knock-on economic impacts of lower oil prices, rather than the extraordinary commentary on the meaning of negative prices for a commodity. In other words, it’s just not so exciting any more. Instead, today has seen markets turn their collective attention back toward government and central bank activities with investors trying to determine the next place to take advantage of all the ongoing financial largesse.

Starting in Europe, this evening the ECB will be having a video conference to discuss its next steps. Topic number one is what to do about Italian, and to a lesser extent, the rest of Southern Europe’s debt. Remember, the ECB is precluded from financing government spending by its charter, and the Teutonic trio watch that issue like hawks. So, news from Rome this morning that highlighted PM Conte’s promise to double the stimulus spending to €55 billion in order to better support the economy is at odds with that promise.

The problem is, that much spending will take the budget deficit above 10% of GDP and drive the debt/GDP ratio above 155%. While the latter will still simply be the third highest ratio in the world (Japan and Greece have nothing to fear yet), both the budget and debt numbers are far higher than currently allowed under the Stability and Growth Pact as defined by the EU. (For good order’s sake, the EU demands its members to maintain budget deficits below 3% of GDP and a debt/GDP ratio of 60% or lower).

A potentially larger problem is that Italy’s sovereign debt is currently rated at BBB with a negative outlook, just two notches above junk. Italian interest rates have been rising as BTP’s are no longer seen as a haven, but rather a pure risk trade. Combining all this together puts the ECB in a very tough position. If Italian debt is downgraded to junk, the ECB charter would preclude it from purchasing Italian debt. But if that were the case, you could pretty much bank on a collapse in the Italian bond market, followed by a collapse in the Italian economy, and a very real risk that Italy exits the euro, likely collapsing that as well. Clearly, the ECB wants to prevent that sequence of events. Thus, to successfully sail between the Scylla of financing government spending and the Charybdis of a euro collapse, the ECB is very likely to revise their collateral rules such that sub-investment grade debt is acceptable to purchase. And they will be buying the long-dated bonds which they will hold to maturity, thus effectively funding Italy but being able to technically tell the Germans they are not. It is an unenviable position for Madame Lagarde, but the alternatives are worse. Once again, if you wonder about the euro’s long-term viability, these are the questions that need to be answered.

However, despite the latest drama on the rates side, the market seems to be focusing on the positive stories today, namely the decisions by a number of European governments to gradually reduce the ongoing covid-inspired restrictions on their citizens. Throughout Europe, small shops are gradually being allowed to reopen and there have been discussions of schools reopening as well. The infection data appears to have stabilized overall, with many countries reporting a downtick in the number of new infections. Governments worldwide have the unenviable task of balancing the risk of further damage to their economies vs. the risk of another increase in the spread of the disease. At this time, it seems clear that there is a broad-based move toward getting on with life. And that’s a good thing!

In the meantime, this morning, the House is set to approve the Senate bill to extend further stimulus in the US, this time with a $480 billion price tag. The bulk of this will go to extending the Paycheck Protection Program, but there are various other goodies to support farms and hospitals. As well, the discussion about reopening the US economy continues apace, with the latest updates seeming to show that about half the states, mostly in the Midwest and mountain states, are going to be returning to a more normal footing, as they have been the least impacted. Even parts of western New York are now being considered for a removal of restrictions, given the demographic there is far closer to Wyoming than Manhattan.

Put it all together, and the bulls get to define the narrative today, with a better future ahead and more government spending to support things. It should be no surprise that equity markets are modestly higher this morning, with European bourses up by 1% or so, and US futures higher by a similar amount. Treasuries have seen some supply, with the yield on the 10-year rising 2bps, and the dollar is softer vs. almost all other currencies.

In the G10 bloc, only NOK is weaker today, and by just 0.1% as oil prices continue to slide, but even CAD, also closely linked to oil, is higher today, up 0.5%. Aussie is the biggest winner today, higher by 1.0% after a short-covering spree emerged in the wake of better than expected Retail Sales data. But the dollar’s weakness is broad-based today.

EMG currencies are also faring well today with ZAR (+1.15%) leading the way on the back of a $26 billion stimulus package, and RUB (+0.75%) following up as traders begin to believe the currency markets have oversold the ruble. MXN (+0.55%) is gaining on the same thesis, and, in fact, most of the space is higher due to this more positive feeling in the markets. The one outlier here is KRW (-0.2%) which is coming under pressure as a second wave of Covid infections makes its way through the country.

On the data front this morning, there is nothing of note to be released in the US. Yesterday saw Existing Home Sales fall slightly less than expected, to 5.27M, but just slightly. All eyes are on tomorrow’s claims data, as well as the PMI’s. The only data from Europe showed that UK inflation remains quiescent (and is likely to fall further) while Italian industry continues to shrink with Industrial Orders -2.6% in February, ahead of the worst of the outbreak.

Risk has a better tone this morning, but I fear it has the ability to be a fleeting break. Markets have shown they still like new stimulus, but at some point, questioning the ability to pay for it all is going to overwhelm the short-term benefits of receiving it. Today doesn’t seem like that day, but I assure you it is getting closer.

Good luck and stay safe
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