Hikes Are Impending

In London on Threadneedle Street
The Old Lady’s not been discrete
Some hikes are impending
With rates soon ascending
Before they shrink their balance sheet

The BOE has made it quite clear that they are itching to raise interest rates pretty soon in order to address rising inflation.  Today’s employment data, which saw the Unemployment Rate fall to 4.5% while employment grew by 235K on a 3M/3M basis, has helped to cement the idea that the economy is continuing to rebound sharply and price pressures are likely to continue to grow.  With CPI at 3.2%, already well above the 2.0% target, and tipped to rise much further by the end of the year given the rapid rise in energy and commodity prices, the BOE has come to believe they need to do something to prevent inflation from getting out of control.  Unlike the Fed, the BOE has also indicated they are quite comfortable raising interest rates before shrinking their balance sheet back to pre-pandemic levels.

The risk they face, which has become the talk of the market today, is that by raising rates so soon, especially before the Fed acts, they will simultaneously destroy the nascent growth impulse while failing to address the cause of the inflation.  And in truth, that could well happen.  Alas, that is a result of trying to address a stagflationary environment with the limited tools available to a central bank.  For the time being, the biggest decision a central bank has is to determine which affliction is a bigger problem, rising prices or slowing economic activity.  Since this seems to be the situation in almost every developed nation, we are going to witness a lot of variations on this theme going forward.

The interesting thing about the pound is that its behavior amid pending rate hikes, as well as the market narrative about the pound, seems to be quite negative.  For some reason, there has been a connection made between an early rate hike in the UK and a falling pound.  This is opposite what we have seen in most other countries, where those rate hikes have been supportive of the currency as would normally be expected.  But there is now talk that the UK is going to make a policy error by tightening ahead of the Fed.  This argument seems specious, however, as economic growth has rarely been a short-term driver of exchange rates, while interest rate changes are critical.  The idea that suddenly traders and investors are critiquing the long-term ramifications of the BOE is preposterous.  Instead, I would offer that any pound weakness, although an early decline after the data release has already been reversed, is far more likely due to the dollar’s continuing broad strength.  So, as I type, the pound is essentially unchanged on the day.

Of course, this begs the question, is the Fed going to start to tighten policy with their potential tapering decision next month.  My answer is leaning towards no.  The reasoning here is that we will have already seen the first estimate of Q3 GDP by the time the Fed meets, and the early indications are that GDP growth has really declined sharply with the Atlanta Fed’s GDPNow forecast declining to 1.306% after the payroll data on Friday.  Tightening policy into a clearly slowing economy seems highly improbable for this Fed regardless of the inflation situation.  It seems far more likely that a weak GDP print will result in the Fed walking back their tapering language by describing the slowing growth as an impediment from achieving that vaunted “substantial further progress” on their employment goals and thus tapering is not yet appropriate.  Remember, after nearly a decade of worrying about deflation, not inflation, concern over rising prices is not their normal response.  Despite talk of the tools they have available to fight inflation, there is no indication the Fed has the gumption to use them if the result would be a recession, or more frighteningly for them, a stock market decline.

Thus, the question that remains is, how will the market respond to a Fed that decides not to taper with inflation still rising?  Much of the current discussion regarding the Treasury market is around the idea that tapering is the driver of the steeper yield curve, although there is a strong case to be made it is simply consistently higher inflation readings doing the work.  For our purposes in the FX markets, it’s not clear the underlying driver matters that much.  The key is where do rates and yields go from here.  If they continue to rise, I expect the dollar has further room to rise as well.

Ok, with markets back to full strength today, a look around sees a pretty negative risk sentiment.  Equities in Asia (Nikkei -0.95%, Hang Seng -1.4%, Shanghai -1.25%) were all under pressure with the latter two dealing with yet another property company that is defaulting on a USD bond.  The China story appears to be getting a bit less comfortable as we watch what seems to be a slow motion implosion of the real estate bubble there.  As to Europe, its all red there as well (DAX -0.4%, CAC -0.5%, FTSE 100 -0.4%) as London is suffering despite the strong data and Germany seems to be feeling the weight of stagflation after PPI (+13.2% Y/Y in Sept) rose to its highest level since 1974 while the ZEW Surveys all fell even further than expected.  At this hour, US futures are either side of unchanged.

On this risk off day, bond markets are seeing a bit of a bid, but in truth, it is not that impressive, especially given how far they have fallen recently.  So, Treasury yields (-1.6bps) have edged just below 1.60% for now while European sovereigns (Bunds -0.6bps, OATs -0.8bps, Gilts -1.4bps) have also seen very modest demand.

Oil prices (+0.4%) continue to lead the way higher for most commodities, although today’s movement has been less consistent.  The trend, however, remains firmly upward in this space.  So, while NatGas (-1.6%) is lower on the session, we are seeing gains in gold (+0.5%) and aluminum (+0.7%) although copper (-0.25%) is consolidating today.  Many less visible commodity prices are rising though, things like lumber (+5.5%) and cotton (+2.3%) which are all part of the same trend.

Finally, the FX markets have seen a very slight amount of dollar weakness net, although there are quite a number of currencies that have fallen vs. the greenback as well.  In the G10, NOK (+0.7%) is the leader on oil price rises while AUD (+0.4%) and NZD (+0.4%) are following on the broader commodity price trend.  Interestingly, JPY (0.0%) is not seeing any bid despite a declining risk appetite.  This seems to be a situation where the spread between Treasuries and JGB’s has widened sufficiently to interest Japanese investors who are selling yen/buying dollars to buy bonds.  As long as Treasury yields continue to rise, look for USDJPY to follow.  After all, it has risen 1.7% in the past week alone.

In the emerging markets, THB (+1.3%) has been the big winner after the government eased restrictions for travelers entering the country thus opening the way for more tourism, a key part of the economy there.  ZAR (+0.85%) and MXN (+0.5%) are the next best performers on the strength of the commodity story.  On the downside, many APAC currencies (TWD (-0.35%, KRW -0.3%, INR -0.2%) saw declines on a combination of continued concerns over the potential implications of the Chinese real estate issue as well as rising commodity prices as all these nations are commodity importers.

Data-wise, NFIB Small Business Optimism was just released at a slightly weaker than expected 99.1, hardly a harbinger of strong future growth, while the JOLTS Jobs report (exp 10.954M) is due at 10:00 this morning.  There are three Fed speakers on the slate with vice-Chair Clarida at the World Bank/IMF meetings and Bostic and Barkin also due.  It will be interesting to see the evolution of the narrative as it becomes clearer that GDP growth is slowing rapidly.  But given that has not yet happened, I expect more taper talk for now.

There is no reason to think that the dollar’s recent strength has reached its peak.  If anything, my take is we are consolidating before the next leg higher so hedge accordingly.

Good luck and stay safe
Adf

The UK’s Current Plight

In England, the doves are in flight
Explaining that NIRP is alright
But hawks keep maintaining
That zero’s restraining
Despite the UK’s current plight

What we’ve learned thus far in 2021 is that Monday is risk-off day, at least, so far.  Yesterday, for the second consecutive week, risk was under pressure as equity markets everywhere fell, while the dollar rallied sharply.  But just like last week, where risk was avidly sought once Monday passed, this morning has seen a rebound in many equity markets, as well as renewed pressure on the dollar.

But aside from a very early assessment of a potential pattern forming, this morning brings a dearth of market-moving news.  Perhaps the most interesting is the battle playing out inside the BOE, where Silvana Tenreyo, one of the more dovish MPC members, has been making the case that in the current situation, the UK should cut the base rate into negative territory.  Her analysis, as well as that of other central banks like the ECB, SNB and Danish central bank, have shown that there are many benefits to the policy and that it has been quite effective.  Of course, those are three of four central banks (the BOJ is the other) that currently maintain negative rates, so it would be pretty remarkable if those studies said NIRP was a failure.  The claim is that NIRP increases the amount of lending that banks extend, thus encouraging spending and investment as well as weakening the currency to help the export industries in the various countries.  And the studies go on to explain that all these factors help drive inflation higher, a key goal of each of those central banks.

Now, there is no question that those are the theoretical underpinnings of NIRP, alas, it is hard to find the data to support this.  Rather, these studies tend to give counterfactual analyses, that indicate if the central banks had not gone negative, things would have been worse.  For instance, let’s look at CPI in the Eurozone (-0.3%), Switzerland (-0.8%) and Denmark (+0.5%).  Not for nothing, but those hardly seem like data that indicate inflation has been supported.  In fact, in each of these countries, inflation was going nowhere fast before the pandemic, although I will grant that Covid has depressed the numbers further to date.  And how about the currency?  Well, one of the biggest stories of the past six months has been how the dollar has declined nearly 10% against these currencies.  Once again, the concept of a weaker currency seems misplaced.

The point here is that the discussion is heating up in the UK, with the independent MPC members pushing for a move below zero, while the BOE insiders are far more reluctant, explaining that the banking system would see serious harm.  (I think if one looks at the banking system in Europe, it is a fair statement that the banks there are not performing all that well, despite (because of?) 6 years of NIRP.  The BOE counterpoint was made this morning by Governor Bailey who explained there were still many issues to be addressed and implied NIRP was not likely to be implemented in the near future.  With all this as background, it should be no surprise that the pound has been the best performer in the G10 today, rising 0.6%, after Bailey’s comments squashed ideas NIRP was on its way soon.

But the dollar, overall, is softer today, not nearly reversing yesterday’s gains (except vs. the pound), but generally under pressure.  However, there is precious little that seems to be driving markets this morning, other than longer term stories regarding fiscal stimulus and Covid-19.

So, a quick tour of markets shows that Asian equity markets shook off the weakness in the US yesterday and rallied nicely.  The Nikkei (+0.1%) was the laggard, as the Hang Seng (+1.3%) and Shanghai (+2.1%) showed real strength.  Europe, on the other hand, is showing a much more mixed picture, wit the DAX (+0.1%) actually the best performer of the big 3, while the CAC (0.0%) and FTSE 100 (-0.6%) are searching for buying interests.  The FTSE is likely being negatively impacted by the pound’s strength, as there is a narrative that the large exporters in the index are helped by a weak pound and so there is a negative correlation between the pound and the FTSE.  The problem with that is when running the correlation analysis, over the past two years, the correlation is just 0.08% and the sign is positive, meaning they move together, not oppositely.  But it is a nice story!  And one more thing, US futures are green, up about 0.25% or so.

Bond markets are selling off this morning as yields continue to rise on expectations that the future is bright.  10-year Treasury yields are up to 1.16%, which is a new high for the move, having rallied a further 1.2bps this morning.  But we are seeing the same type of price action throughout Europe, with yields higher by between 1.7 bps (Bunds) and 4.0bps (Italian BTP’s), with Gilts (+2.3bps) and OATs (+2.0bps) firmly in between.  What I find interesting about this movement is the constant refrain that H1 2021 is going to be much worse than expected, with the Eurozone heading into a double dip recession and the US seeing much slower than previously expected growth as many analysts have downgraded their estimates to 1.0% from 4.0% before.  At the same time, the message from the Fed continues to be that tighter policy is outcome based, and there is no indication they are anywhere near thinking about raising rates.  With that as background, the best explanation I can give for higher yields is concerns over inflation.  Remember, CPI is released tomorrow morning, and since the summer, almost every release was higher than forecast.  As I have written before, the Fed is going to be tested as to their tolerance for above target inflation far sooner than they believe.

The inflation story is supported, as well, but this morning’s commodity price moves, with oil higher by 1.3% and gold higher by 0.8%.  In fact, I believe that inflation is going to become an increasingly bigger story as the year progresses, perhaps reaching front page news before the end of 2021.

Finally, as mentioned above, the dollar is under broad-based, but generally modest pressure this morning.  After the pound, AUD (+0.35%) and CAD (+0.25%) are the leading gainers, responding to the firmer commodity prices, although NOK (0.0%) is not seeing any benefit from oil’s rise.  In the EMG space, it is also the commodity linked currencies that are leading the way, with ZAR (+0.9%), RUB (+0.8%) and MXN (+0.5%) topping the list.  Also, of note is the CNY (+0.3%) which is back to levels last seen in June 2018, as the strengthening trend their continues.

On the data front, the NFIB Small Business Optimism index showed less optimism, falling to 95.9, well below expectations, again pointing to a slowing growth story in H1.  The only other data point from the US is JOLT’s Job Openings (exp 6.4M), which rarely has any impact.  I would like to highlight, in the inflation theme, that Brazilian inflation was released this morning at a higher than expected 4.52% in December, which is taking it back above target and to levels last seen in early 2019.  If this continues, BRL may become a high yielder again.

Finally, we hear from 6 different Fed speakers today, but again, unless they all start to indicate tighter policy, not just better economic outcomes, in H2, while the dollar may benefit slightly, it will not turn the current trend.  And that’s really the story, the medium-term trend in the dollar remains lower, but for now, absent a catalyst for the next leg (something like discussion of YCC or increased QE), I expect a bit of choppiness.

Good luck and stay safe
Adf

Slipping Away

Last week it appeared conversations
On Brexit, had built expectations
To broker a deal
That both sides would feel
Was fruitful for all Europe’s nations

Alas, based on headlines today
That good will is slipping away
Concern has now grown
That both sides condone
No deal, to the market’s dismay

Apparently, Brexit talks have reached their denouement, with the weekend efforts of PM Johnson and European Commission President Von der Leyen unable to bridge the final gaps.  The key issues regarding fishing in UK waters and state support for UK companies remain outstanding and neither side has yet been willing to budge.  There is clearly a great deal of brinksmanship ongoing here, but with the timeline so compressed, the chance for a No-deal outcome is still remarkably high.  In fact, as of a bit past 6am in NY, the headlines claim that negotiations might end by this evening in Europe, after one final call between the two leaders.

So, is this the end?  Is Brexit upon us, three weeks early?  And if so, what can we expect going forward?

The first thing to remember about international negotiations is they are never over, even when they have ended, especially in a situation of this nature.  The economic impact in both the UK and throughout Europe will be significant in a no-deal outcome, and this is something that neither side really wants to occur, despite any rhetoric to the contrary.  The most recent analyst estimates indicate that the UK’s economy will suffer a long-term reduction of 3.0% in GDP compared to the situation if a deal is completed.  Meanwhile, the EU’s impact will be a much smaller 0.5% of GDP, but that impact will be unevenly distributed, with Ireland expected to suffer a 6% decline in economic activity, while various other nations see much smaller effects.  Germany, too, will feel the pain, as German auto exports to the UK are one of the most lucrative parts of German industry, and with tariffs imposed, they will certainly decline.

And, ultimately, that is why the best bet remains that a deal will be done.  Especially given the economic disruption of the pandemic, the ability for either the UK or EU to blithely sit by and allow a critical trade relationship to crumble is virtually nil.  So, even if the talks ostensibly end later today, they will not have ended.  Both sides will still be seeking a deal, as both sides desperately need one.

However, investors are clearly worried, as evidenced by this morning’s price action across markets.  Perhaps the most obvious outcome is that of the pound, which has fallen 1.3% on the news.  Last week I was making the case that the market had not fully priced in a positive deal, and any agreement was likely to see the pound rally.  At the same time, a true collapse in talks with a no-deal outcome is likely to see a further decline, with 5%-7% seen as a reasonable result.  This morning’s movement is just a down payment on that, if no deal actually is the outcome.

But this news seems to have forced investors across markets to reconsider their current positioning and potential market responses to negative news.  Perhaps you are not old enough to remember what negative news actually is, so I will give a brief refresher here.  Negative news is a situation where not only is the economic impact indisputably harmful to a (country, company, currency), but that a central bank response of further policy ease will be unable to change the outcome.  Thus, Friday’s weaker than expected NFP number was not really negative because it encouraged the view that the Fed will ease further next week, thus offsetting any bad economics.  But Brexit changes the structure, not just the data, and no matter what the BOE does, customs checks are still going to slow down trade and commerce.

It is with this in mind that we look at markets this morning and see that risk is broadly being reduced.  Asian equity markets started the move as the Nikkei (-0.75%), Hang Seng (-1.25%) and Shanghai (-0.8%) all showed solid declines.  And this was despite Chinese data showing that exports from the mainland had increased a much greater than expected 21% and fostered a record large trade surplus.  In Europe, the situation is similar with one real exception.  The DAX (-0.3%) and CAC (-0.8%) are leading the Continent lower as investors react to the potential crimp in economic activity.  However, the FTSE 100 (+0.5%) is higher as most members of the index will benefit greatly from a weaker pound, and so are responding to the pound’s market leading decline.

Speaking of the pound, it has fallen 1.3% from Friday’s closing levels and is the leading decliner across all major currencies.  But weakness is evident in the commodity bloc as AUD (-0.5%), NZD (-0.4%) and CAD (-0.2%) are all suffering alongside oil (WTI -0.9%) and gold (-0.4%).  EUR (-0.1%) has been a relative outperformer as the market continues to estimate a much smaller impact of a no-deal scenario.  Meanwhile, in the EMG bloc, losses are virtually universal, but the magnitude is not that substantial.  For example, MXN (-0.7%) is the worst performer today, obviously suffering from oil’s decline, but we have also seen weakness throughout the CE4 (HUF -0.4%, CZK -0.3%, PLN -0.2%) along with ZAR and RUB, both having fallen 0.3%.  In fact, the one bloc that has outperformed today is APAC, where only two currencies (MYR -0.2% and SGD -0.15%) are in the red.  Given the genesis of the problems is in Europe, this should not be that surprising.

Bond markets are taking the risk-off theme seriously with Treasury yields lower by 2.2 basis points and European govvies seeing substantial demand.  Gilts lead the way, with a 5.6bps decline, but Bunds (-3.0bps) and OAT’s (-2.6bps) are also rallying nicely.  Remember, too, that the ECB meets Thursday with expectations built in for a €500 billion increase in PEPP as well as a maturity extension of between six and twelve months in addition to an increase in the TLTRO program, with a maturity extension there as well.  One other thing to watch from the ECB is whether or not they mention the euro and its recent rally.  Madame Lagarde and her colleagues cannot countenance a significant rally from current levels, and I expect they will make that clear.

As to data this week, aside from the ECB, CPI is the biggest thing in the US:

Tuesday NFIB Small Business 102.5
Nonfarm Productivity 4.9%
Unit Labor Costs -8.9%
Wednesday JOLTs Job Openings 6.325M
Thursday Initial Claims 725K
Continuing Claims 5.27M
CPI 0.1% (1.1% Y/Y)
-ex food & energy 0.1% (1.6% Y/Y)
Friday PPI 0.1% (0.7% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Michigan Sentiment 76.0

Source: Bloomberg

With the last FOMC meeting of the year next Wednesday, the Fed is in their quiet period so there will be no commentary on that front.  With this in mind, the dollar, which continues to trend lower, will likely need some new catalyst to take the next step.  At this point, the biggest surprise is likely to be a positive conclusion to the Brexit talks, but given what we have seen over the past eight months, it is pretty clear that investors remain hugely bullish on the idea of the post-pandemic economy and will not be denied in their belief that stocks can only go up.  My gut tells me that US equities, where futures are currently lower by 0.3% or so, will finish the day higher, and the dollar will cede much of its overnight gains, even without a deal.

Good luck and stay safe
Adf

Many Pains

In England and Scotland and Wales
The vaccine will soon be for sale
But Brexit remains
A source of more pains
If talks this week run off the rails

What a difference a day makes, twenty-four little hours.  Yesterday morning at this time, the bulls ruled the world.  Equity markets were rallying strongly everywhere, bond markets were under pressure, and the dollar was breaking below two-year support levels.  Although most commodity prices were having difficulty extending their recent gains, gold did manage to rebound sharply all day, and, in fact, is higher by another 0.7% this morning, its death being widely exaggerated.

However, aside from gold, this morning looks quite different on the risk front.  Perhaps, ahead of a significant amount of data coming the rest of the week (ADP this morning, NFP on Friday), as well as next week’s ECB meeting, this is, as a well-known Atlanta based beverage company first told us in 1929, the pause that refreshes.

Arguably, the biggest news this morning is that the UK has cleared the first vaccine for use against Covid-19 with the initial doses to be injected as early as next week.  I don’t think anyone can argue with the idea this is an unalloyed positive for just about everything.  If it proves as effective as the initial testing indicated, and if a sufficient percentage of the population gets inoculated, and if that leads to a rebound in confidence and the end of all the government imposed economic restrictions and lockdowns, it could open the door for 2021 to be a gangbuster-type year of growth and activity.  But boy, that sure is a lot of ifs!

And a funny thing about the market response to this news is that…nothing has happened.  The FTSE 100 is higher by a scant 0.2%, and has not shown the strength necessary to support other European markets as both the DAX (-0.3%) and CAC (-0.2%) are in the red.  Is it possible that the markets have already priced in all the ifs mentioned above?  And, if that is the case, what does it say about the future direction of risk appetite?

This being 2020, the year with imperfect hindsight, it should also be no surprise that the good news regarding the vaccine was offset with potential bad news about Brexit.  Michel Barnier, the EU’s top negotiator, indicated that while the mood was still positive in the round-the-clock negotiations, it is very possible that no deal is reached in time to be ratified by all parties.  And that time is drawing near.  After all, the previous deadlines were all artificial, to try to goose negotiations, but December 31st is written into a treaty signed by both sides.  The contentious issues remain access to UK waters by EU fishing vessels and the idea of what will constitute a level playing field between UK and EU companies given their newly different legal and regulatory masters.  In the event, GBP (-0.8%) is today’s worst G10 currency performer as it quickly fell when Barnier’s comments hit the tape.  Something else to keep in mind regarding the pound is that it feels an awful lot like a successful completion of a Brexit deal is entirely priced in.  So, if that deal is reached, the pound’s upside is likely to be quite limited.  Conversely, if no deal is agreed, look for a substantial shock to the pound, certainly as much as 5%-7% in short order.

And with that cheery thought in mind, let us peruse the overall market condition this morning, where eyeglasses are losing their tint.  Equity markets in Asia overnight were as close to unchanged as a non-holiday session would allow, with the largest movement from a main index, the Hang Seng, just +0.1%.  Both the Nikkei and Shanghai moved less, as investors seemed to be coping with a bit of indigestion after the recent sharp rally.  As mentioned above, European bourses have been no better, with only Spain’s IBEX (+0.4%) showing any hint of life, but the rest of the continental exchanges all in the red.  Even US futures markets are under modest pressure, with all three lower by about 0.2%.

The Treasury market saw an impressive decline yesterday, with yields rising 7 basis points in the 10-year, as the risk rally exploded all day long.  European bond markets also declined, but not quite like that.  Given the ECB’s reported -0.3% CPI reading, the case that bond yields on the continent should be rising is very difficult to make.  This morning, though, movement is measured in fractions of basis points, with only Italian BTP’s having recorded anything larger than a 1 basis point move today, in this case a decline in yields.  Otherwise, we are + / – 0.5 basis points or less in Treasuries, Bunds, OAT’s and Gilts.  In other words, nothing to see here.

Oil is feeling a bit toppish here, having rallied 36% during the month of November, but how ceding about 4% during the past few sessions.  OPEC+ talks remain mired in disagreement with the previous production cuts potentially to be abandoned.  However, taking a longer-term view, analysts are pointing to the changes in the US fracking community (i.e. bankruptcies there) and forecasting a significant decline in US oil production in 2021, which, if that occurs, is likely to provide significant price support.

And finally, the dollar, which fell sharply against virtually every currency yesterday, led by BRL (+2.7%) in the emerging markets and EUR (+1.2%) in the G10, has found its footing today.  Looking at the G10 first, NOK (-0.65%) is the laggard alongside the aforementioned pound and SEK (-0.5%).  The euro (-0.25%) has maintained the bulk of its gains after having finally pushed through key resistance at 1.2011-20, the levels seen in early September. Remember, short USD is the number one conviction trade for Wall Street for 2021, and EUR positions remain near all-time highs.

An aside in the euro is that markets continue to look to next week’s ECB meeting with expectations rife the PEPP will be expanded and extended.  Madame Lagarde promised us things would change, and every speaker since, including the Latvian central bank President, who this morning explained that €500 billion more in the PEPP with a timing extension to mid-2022 would be acceptable, as would an extension in the maturity of TLTRO loans to 5 years.  The point is that despite the confidence so many have that the dollar is destined to collapse next year, there is no way other central banks will allow that unimpeded.

Back to markets, on the EMG slate, the situation is similar with more losers than gainers led by ZAR (-1.1%) and PLN (-0.6%).  Of course, both these currencies saw stronger gains yesterday, so this seems to be a little catch-up price action.  Actually, CLP (+0.65%) has opened stronger this morning, simply adding to yesterday’s gains without an obvious catalyst, while KRW(+0.5%) continues to benefitt from better than expected trade and GDP data.

On the data front, this morning brings ADP Employment (exp 430K) as well as the Beige Book this afternoon.  As well, we will hear again from Chairman Powell, who in the Senate yesterday told us all that there needed to be more fiscal stimulus and that the Fed would do all they can to support the economy.  Given this has been the message for the past six months, nobody can be surprised.  However, one idea that seems to be developing is that the Fed could well announce purchases of longer dated bonds at their December meeting in two weeks’ time, which would certainly have an impact on the bond market, and would be seen as easier money, thus likely impact the dollar as well.  When he speaks to the House today, don’t look for anything new.

All told, today is a breather.  Clearly momentum is for a weaker dollar right now, but I continue to believe these are excellent levels for receivables hedgers to act.

Good luck and stay safe
Adf

The Story of Boris

Today it’s the story of Boris
A man who commands a thesaurus
When speaking of foes
To prove that he knows
More things than the Press’s Greek chorus

Tell me if you’ve heard this one before…a politician makes a bold promise to achieve something by a specific date.  As the date approaches, and it is clear that promise will not be fulfilled, he changes his tune blaming others for the problems.

I’m certain you recognize this situation, and of course, today it is the story of Boris.  Back on September 7, Johnson was adamant that if a deal was not completed by October 15, the day an EU summit was scheduled to begin, that there would be no deal at all.  It appears that he believed he had the upper hand in the negotiations and wanted to get things done.  As well, the EU had indicated that if a deal was not agreed by the middle of October, it would be nearly impossible for all of the 27 member nations to approve the deal in their respective parliaments.

Alas for Boris, things have not worked out as well as he might have hoped.  Instead, two major issues remain; EU access to fishing in UK waters and the limits on UK state aid for companies, and neither one seems on the verge of a breakthrough.  Yet the calendar pages keep turning and here we are, one day before the ‘deadline’ and nothing has been agreed.  In fact, as the EU prepares for its summit starting tomorrow, this is the statement that has been released, “progress on the key issues of interest to the union is still not sufficient for an agreement to be reached.”

Though Boris’s deadline grows near
It seems that he might not adhere
As now the UK
Will not walk away
From Brexit discussions this year

With this as a backdrop, one would not be surprised to see the pound start to lose some of its recent luster.  Clearly, that was a major part of yesterday’s price action, where the pound declined 1.0% and the rest of the G10 saw an average decline of only 0.4%.  In other words, while the dollar was strong against virtually all comers yesterday, the pound was at the bottom of the barrel.  Apparently, some investors are beginning to get cold feet with respect to their view that despite all the bluster, a Brexit deal will be reached.  It is also not surprising that comments from Number 10 Downing Street this morning indicate the UK will not walk away from Brexit talks immediately.  So, the EU effectively called Johnson’s bluff, and Boris backed down.  It is also important to note that while the EU would like to get a deal agreed as soon as possible, they see no hard deadline with respect to when things need to be completed before the end of the year.

The overnight session saw a follow on from yesterday, with the pound falling another 0.55% before the comments about continuing the discussions hit the tape.  The ensuing rebound now has the pound higher by 0.25% on the session, and actually the best performer in the G10 today.  The bigger point is that the Brexit saga is not nearly done, and there is still plenty of opportunity for more volatility in the pound.  I read one bank claimed the probability of a no-deal Brexit has fallen to 20%.  Whether that is accurate or not, a no-deal Brexit is likely to see the pound fall sharply, with a move to 1.20 entirely realistic.  Hedgers take note.

As to the rest of the market/world, yesterday’s risk reducing session seems to have ended, although risk is not being readily embraced either.  Overnight saw equity markets either little changed (Nikkei and Hang Seng +0.1%) or lower (Shanghai -0.55%).  Chinese Money Supply and lending data showed that the PBOC continues to push funds into the economy to support things, and the renminbi’s price action shows that there continue to be inflows to the country.  CNY (+0.2%) has consistently been a strong performer, even after the PBOC relaxed short selling restrictions at the beginning of the week.

European markets have also proven to be mixed, with the CAC, DAX and FTSE 100 all lower by -0.2%, but Spain and Italy both higher by 0.3%.  Earlier in the session, all markets were higher, so perhaps some concerns are growing, although there have been no comments on the tape of note.  US futures have also given up earlier gains and currently sit essentially unchanged.

Bond markets had a strong performance yesterday, with 10-year Treasury yields declining 5 basis points and a further 1.5 basis points this morning.  We have seen the same type of price action across European government bond markets, with virtually all of them rallying and yields declining by 2-3 bps.

Finally, as we turn to the dollar, yesterday’s broad strength is largely continuing in the EMG bloc, save CNY’s performance, but against its G10 counterparts, it is, arguably, consolidating.  Aside from the pound, the rest of the G10 is +/- 0.15%, with only slightly weaker than expected Eurozone IP data as a guide.  As to the EMG bloc, there is weakness in RUB (-0.6%), HUF (-0.5%) as well as the two highest beta currencies, MXN and SAR (-0.3%).  Russia has the dubious distinction of the highest number of new cases of Covid today, more than 14K, (wait a minute, don’t they have a vaccine?) and Hungary, with nearly 1000 is also feeling the crunch based on population size.  It appears that investors are concerned over economic prospects as both nations see the impending second wave and are considering lockdowns to help stem the outbreak.  As to MXN and SAR, they are simply the most popular vehicles for investors to play emerging markets generally, and as risk seems to be falling out of favor, their decline is no surprise.

On the data front, PPI (exp 0.2%, core 0.2%) is today’s event, but given yesterday’s CPI release was spot on, this will largely be ignored.  The inflation/deflation discussion continues but will need to wait another month for the next installment as yesterday taught us little.

One of the positives of the virtual society is that things like the World Bank / IMF meetings, which had been such big to-dos in Washington in past years, are now held virtually.  As such, they don’t generate nearly the buzz as in the past.  However, it should be no surprise that there is a single thesis that is making the rounds in this virtual event; governments need to spend more money on fiscal stimulus and not worry about increased debt.  Now, while this has been the central bank mantra for the past six months, ever since central banks realized they had run out of ammunition, it is still remarkable coming from two organizations that had made their names hectoring countries about having too much debt.  Yet that is THE approved message of the day, governments should borrow more ‘free’ money and spend it.  And it should be no surprise that is the message from the chorus of Fed speakers as well.  Alas, in the US, at least, the politics of the situation is far more important to the players than the potential benefits of passing a bill.  Don’t look for anything until after the election in my view.

As to the session, I see no reason for the dollar to do much at all.  The dollar bears have been chastened and lightened their positions, while the dollar bulls no longer like the entry point.  It feels like a choppy day with no direction is on the cards.

Good luck and stay safe
Adf

Macron’s Pet Peeve

Each day from the UK we learn
The data implies a downturn
Infections keep rising
Yet what’s so surprising
Is Sterling, no trader will spurn

Investors, it seems, all believe
That fishing rights, Macron’s pet peeve
Will soon be agreed
And both sides proceed
Towards Brexit come this New Year’s Eve

Since the last day of September, the pound has been a top performer in the G10 space, rallying 2.0% despite the fact that, literally, every piece of economic data has fallen short of expectations.  Whether it was GDP, PMI, IP or Employment, the entire slate has been disappointing.  At the same time, stories about Brexit negotiations continue to focus on the vast gap between both sides on fishing rights for the French fleet as well as state aid limits for UK companies.  And yet the pound continues to grind higher, trading back to its highest levels in a month.  Granted this morning it has ceded a marginal -0.2%, but that is nothing compared to this steady climb higher.

It seems apparent that traders are not focusing on the macro data right now, but instead are looking toward a successful conclusion of the Brexit negotiations.  Granted, Europe’s history in negotiations is to have both (or all) sides agree at the eleventh hour or later, but agree, nonetheless.  So, perhaps the investor community is correct, there will be no hard Brexit and thus the UK economy will not suffer even more egregiously than it has due to Covid.  But even if a deal is agreed, does it make sense that the pound remains at these levels?

At this stage, the economic prospects for the UK seem pretty awful.  This morning’s employment report showed the 3M/3M Employment change (a key measure in the UK) falling 153K.  While that is not the worst reading ever, which actually came during the financial crisis in June 2009, it is one of the five worst in history and was substantially worse than market expectations.  Of greater concern was that the pace of job cuts rose to the most on record, with 114K redundancies reported in the June-August period.  Adding it all up leaves a pretty poor outlook for the UK economy, especially as further lockdowns are contemplated and enacted to slow the resurgence in Covid infections seen throughout various parts of the country.  And yet the pound continues to perform well.

Perhaps the rally is based on monetary policy expectations.  Alas, the last we heard from the Old Lady was that they were discussing how banks would handle negative interest rates, something which last year Governor Carney explained didn’t make any sense, but now, under new leadership, seems to have gained more adherents.  If history is any guide, the fact that the BOE is talking to banks about NIRP is a VERY strong signal that NIRP is coming to the UK in the next few months.  Again, it strikes me that this is not a positive for the currency.

In sum, all the information I see points to the pound having more downside than upside, and yet upside is what we have seen for the past several weeks.  As a hedger, I would be cautious regarding expectations that the pound has much further to rally.

Turning to the rest of the market, trading has been somewhat mixed, with no clear direction on risk assets seen.  Equity markets in Asia saw gains in the Hang Seng (+2.2%) although the Nikkei (+0.2%) and Shanghai (0.0%) were far less enthusiastic.  Interestingly, the HKMA was forced to intervene in the FX market last night, selling HKD6.27 billion to defend the strong side of the peg.  Clearly, funds are flowing in that direction, arguably directly into the stock market there, which after plummeting 27.5% from January to March on the back of Covid concerns, has only recouped about 42% of those losses, and so potentially offers opportunity.  Perhaps more interestingly, last night China reported some very solid trade data, with imports rising far more than expected (+13.2% Y/Y) and the Trade Balance falling to ‘just’ $37.0B.  Export growth was a bit softer than expected, but it seems clear the Chinese economy is moving forward.

European bourses, however, are all in the red with the DAX (-0.4%) and CAC (-0.3%) representative of the general tone of the market.  Aside from the weak UK employment data, we also saw a much weaker than expected German ZEW reading (56.1 vs. 72.0 expected), indicating that concerns are growing regarding the near-term future of the German economy.

In keeping with the mixed tone to today’s markets, Treasuries have rallied with yields falling 2 basis points after yesterday’s holiday.  Perhaps that is merely catching up to yesterday’s European government bond markets, as this morning, there is no rhyme or reason to movement in this segment.  In fact, the only movement of note here is Greece, which has seen 10-year yields decline by 3bps and which are now sitting almost exactly atop 10-year Treasuries.

As to the dollar, mixed is a good description here as well.  In the G10 space, given the German data, it is no surprise that the euro has edged lower by 0.2% nor that the pound has crept lower as well.  AUD (-0.24%) is actually the worst performer, which looks a response to softness in the commodity space.  SEK (+0.3%) is the best performer after CPI data turned positive across the board, albeit not rising as much as had been forecast.  You may recall the Swedes are the only country that had moved to NIRP and then raised rates back to 0.0%, declaring negative rates to be a bad thing.  The previous few CPI readings, which were negative, had several analysts calling for Swedish rates to head back below zero, but this seems to support the Riksbank’s view that no further rate cuts are needed.

Emerging market currencies are under a bit more pressure, with the CE4 leading the way lower (CZK -0.8%, PLN -0.7%, HUF -0.65%) but the rest of the bloc has seen far less movement, generally +/- 0.2%.  Regarding Eastern Europe, it seems there are growing concerns over a second wave of Covid wreaking further havoc on those nations inspiring more rate cuts by the respective central banks.  Yesterday’s Czech CPI data, showing inflation falling into negative territory was merely a reminder of the potential for lower rates.

Speaking of CPI, that is this morning’s lead data point, with expectations for a 0.2% M/M gain both headline and ex food and energy, which leads to 1.4% headline and 1.7% core on a Y/Y basis.  Remember, these numbers have been running higher than expectations all summer, and while the Fed maintains that inflation is MIA, we all know better.  I see no reason for this streak of higher than expected prints to be broken.  In addition, we hear from two Fed speakers, Barkin and Daly, but we already know what they are likely going to say; we are supporting the economy, but Congress needs to enact a fiscal support package, or the world will end (and it won’t be their fault.)

US equity futures are a perfect metaphor for the day, with DOW futures down 0.4% and NASDAQ futures higher by 0.9%.  In other words, it is a mixed picture with no clear direction.  My fear is the dollar starts to gain more traction, but my sense is that is not in the cards for today.

Good luck and stay safe
Adf

Nary a Tear

The Ides of October are near
The date by which Boris was clear
If no deal’s agreed
Then he will proceed
To (Br)exit with nary a tear

We are but one week away from the date widely touted by UK PM Johnson as the deadline to reach a deal with the EU on the terms of the post-Brexit relationship between the two.  It seems the date was set with several issues in mind.  First, there is an EU summit to be held that day and the next, and the idea was that any agreed upon deal could be reviewed at the summit and then there would be sufficient time for each of the remaining 27 EU members to enact legislation that would enshrine the deal in their own canon of laws.

On the other hand, if no deal is reached by then, the Johnson government would have the ensuing two- and one-half months to finalize their Brexit plans including such things as tariff schedules and customs procedures.  At the same time, while Boris has been adamant that October 15 is the deadline, the EU has been clear that they see no such artificial deadline and are perfectly willing to continue the negotiations right up until December 31.  The idea here is that if an agreement comes that late, a temporary measure can be put in place while each member enacts the appropriate legislation.

Back on September 29, in All Doom and Gloom, I posited that the market was pricing in a two-thirds probability of a hard Brexit.  The analysis was based on the level of the pound relative to its longer-term valuations and historical price action.  But clearly there is far more to the discussion in these uncertain times than simply historical price action.  And in the ensuing days I have reconsidered my views of both the probability of a hard Brexit and my estimation of the market’s anticipation.

For what it’s worth, I have come to the belief that a hard Brexit remains an unlikely event, less than a 20% probability.  Intransigence in international negotiations is the norm, not an exception, so all of Boris’s huffing and puffing is likely just that, hot air.  And in the end, it is not in either side’s interest to have the UK leave with no deal in place.  Too, the ongoing pandemic has distracted most people from the potential impacts of a hard Brexit, and my understanding is that the subject is hardly even newsworthy on the Continent.  The point is, on the EU side, other than the French fishermen, Brexit is not something of concern to the population.  After all, they are far more concerned with whether or not they will remain employed, be able to feed their families and pay rent, and who will win the UEFA Cup.  For most of Europe, the UK is an abstract thought, although not for all of it.  (An interesting statistic is that German exports to the UK have already fallen 40% since immediately after the Brexit vote four years ago.)  As such, if the EU were to soften their stance on some of the last issues, virtually nobody would notice, certainly not their constituents so, there is likely little price for EU politicians to pay electorally, with that outcome.

The UK, on the other hand, remains highly focused on Brexit, and Boris would certainly suffer in the event that any eventual deal is not widely perceived as beneficial to the UK.  The UK, of course has other problems, notably that the virus is spreading more widely again, and the government response has been to reimpose restrictions and lockdowns in the hardest hit areas.  Of course, this is exactly the thing to halt a recovery in its tracks, which if added to the potential harm from a no-deal Brexit, may be too much for Boris to withstand.  But it is the other problems which are a key driver of the pound’s exchange rate, and the main reason I don’t expect any significant rally from current levels.  Instead, I believe the odds are for a retreat to the 1.20-1.25 level, regardless of the Brexit outcome.  A signed deal would merely delay the achievement of that target for a few months, at best.  The combination of growing fiscal deficits, additional BOE policy ease and a sluggish economic recovery all point to the pound weakening over time.  While a hard Brexit will accelerate that outcome, even a deal will not prevent it from occurring.  Hedgers beware.

On to markets.  Yesterday’s US equity rally begat the same in Asia (Nikkei +1.0%, Australia +1.1%) and Europe, after a slow start, has turned higher as well (DAX +0.7%, CAC +0.55%).  China’s weeklong holiday is ending today, and their markets will reopen tonight.  US futures are also pointing higher, roughly 0.5% across the board.  It seems that the market remains entirely beholden to the US stimulus talks, and yesterday, after the President said negotiations would cease until after the election, that tune changed as there was talk of stand-alone bills on airline support or a second round of $1200 checks for previous recipients.  I have to admit that the market response to the stimulus talks reminds me of the response to the trade talks with China at the beginning of last year, with each positive headline worth another 0.5% in gains despite no net movement.

Bond markets are in vogue this morning as yields are lower in Treasuries and throughout Europe.  Of course, 10-year Treasury yields have been trending higher for the past week and a half and are now more than 25 basis points higher than their nadir seen on August 4th.  Yesterday’s 10-year auction went off without a hitch, with the yield right on expectations and solid investor demand.  Meanwhile, yesterday’s FOMC Minutes explained that several members would consider even more bond buying going forward, which cannot be a surprise given what we have heard from the most dovish members since then.  Just this week, Minneapolis Fed President Kashkari
said just that.  But with that in mind, remember that despite the prospect of more bond buying, Treasury yields are at the high end of their recent range and look like they have further to climb.  Again, this appears to be a market commentary on inflation expectations, and one that I presume the Fed is encouraging!

As to the dollar, it is very slightly softer at this point of the session, although not universally so.  Looking at the G10 space, the biggest mover is AUD, with a gain of just 0.25%.  Meanwhile, both EUR and CHF have edged lower by 0.1%.  The point is there is very little activity or movement as there have been few stories or data of note overnight. EMG currencies have shown a bit more strength led by RUB (+0.7%) and MXN (+0.6%), both benefitting from oil’s modest gains this morning. The rest of the bloc has seen much less positivity, with only KRW (+0.4%) on the back of a widening trade surplus and HUF (+0.3%) after CPI data today showed a modest decline, thus allowing the central bank to maintain its current policy settings.

On the US calendar we get Initial Claims (exp 820K) and Continuing Claims (11.4M), still the timeliest economic information we receive.  The issue here is that after the initial post-Covid spike, the decline in these numbers has really slowed down.  In other words, there are still many layoffs happening, hardly the sign of a robust economy.  In addition, we hear from three more Fed speakers, but their message is already clear.  ZIRP for years to come, and they will buy bonds the whole time.

Investors remain comfortable adding risk these days, as the central banking community worldwide continues to be seen as willing to provide virtually unlimited support.  If risk continues to be “on”, I see little reason for the dollar to rally in the short term.  But neither do I see much reason for it to decline at this stage.

Good luck and stay safe
Adf

Spring Remains Distant

From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
Adf

Yesterday’s News

The first bit of data we’ve seen
Has shown what economists mean
When most business stops
And GDP drops
Reacting to Covid – 19

This data describes people’s fear
Another wave just might appear
But right now those views
Are yesterday’s news
And ‘buy the dip’ traders are here

The UK is an interesting study regarding GDP growth because they actually publish monthly numbers, rather than only quarterly data like the rest of the developed world. So, this morning, the UK reported that GDP activity in April declined 20.4% from March, which had declined 5.8% from February when the first impact of Covid-19 was felt. This has resulted in the UK economy shrinking back to levels last seen in 2002. Eighteen years of growth removed in two months! Of course, when things recover, and they will recover as the lockdowns are eased around the world, we will also get to see the fastest growth numbers in history. However, we must remember that a 20% decline will require a 25% rebound to get back to where we started. Keep that in mind when we start to see large positive numbers in the summer (hopefully) or the autumn if people decide that the risks of Covid outweigh the benefits of returning to previous activities.

Needless to say, this has been an unprecedented decline, on a monthly basis, in the economy for both its depth and speed. But the more remarkable thing, is that despite this extraordinary economic disruption, a look at financial markets shows a somewhat different story. For example, on February 28, the FTSE 100 closed at 6580.61 and the pound finished the session at 1.2823. On April 30, after the worst two-month economic decline in the UK’s history, its main stock market had declined 10.3% while the pound had fallen just 1.8%. Granted, both did trade at substantially lower levels in the interim, bottoming in the third week of March before rebounding. But it seems to me that those are pretty good performances given the size of the economic dislocation. And since then, both the FTSE 100 and the pound have rallied a bit further.

The question is, how can this have occurred? Part of the answer is the fact that on a contemporaneous basis, investors could not imagine the depths of the economic decline that was taking place. While there were daily stories of lockdowns and death counts, it is still hard for anyone to have truly understood the unprecedented magnitude of what occurred. And, of course, part of the answer was this did not happen in a vacuum as policymakers responded admirably quickly with the BOE cutting rates by a total of 0.65% in the period while expanding their balance sheet by £150 billion (and still growing). And the UK government quickly put together stimulus packages worth 5% of then measured GDP. Obviously, those measures were crucial in preventing a complete financial market collapse.

Another thing to remember is that the FTSE 100 was trading at a P/E ratio of approximately 15 ahead of the crisis, which in the long-term scheme of things was actually below its average. So, stock prices in the UK were nowhere near as frothy as in the US and arguably had less reason to fall.

As to the pound, well, currencies are a relative game, and the same things that were happening in the UK were happening elsewhere as well to various degrees. March saw the dollar’s haven status at its peak, at which point the pound traded below 1.15. But as policymakers worldwide responded quite quickly, and almost in unison, the worst fears passed and the ‘need’ to own dollars ebbed. Hence, we have seen a strong rebound since, and in truth a very modest net decline.

The questions going forward will be all about how the recovery actually unfolds, both in timing and magnitude. The one thing that seems clear is that the uniformity of decline and policy response that we saw will not be repeated on the rebound. Different countries will reduce safety measures at different paces, and populations will respond differently to those measures. In other words, as confusing as data may have been before Covid, it will be more so going forward.

Now, quickly, to markets. Yesterday’s equity market price action in the US was certainly dramatic, with the Dow falling nearly 7% and even the NASDAQ falling 5.25%. The best explanation I can offer is that reflection on Chairman Powell’s press conference by investors left them feeling less confident than before. As I wrote in the wake of the ECB meeting last week, the only way for a central banker to do their job (in the market’s eyes) these days is to exceed expectations. While analysts did not expect any policy changes, there was a great deal of talk on trading desks floors chatrooms about the next step widely seen as YCC. The fact that Jay did not deliver was seen as quite disappointing. In fact, it would not be surprising to me that if stock markets continued to decline sharply, the Fed would respond.

But that is not happening as buying the dip is back in fashion with European markets higher by roughly 1.5% and US futures also pointing higher. Meanwhile, with risk back in favor, Treasury yields have backed up 3bps and the dollar is under pressure.

On the FX front, the G10 is a classic depiction of risk-on with the yen (-0.5%) and Swiss franc (-0.3%) both declining while the rest of the bloc is higher led by CAD and AUD, both up 0.5%. In truth, this has the feeling of a bounce from yesterday’s dollar strength, rather than the beginning of a new trend, but that will depend on the broader risk sentiment. If equity market ebullience this morning fades as the session progresses, look for the dollar to take back its overnight losses.

Meanwhile, EMG markets are having a more mixed session with APAC currencies all having fallen last night in the wake of the US equity rout. APAC equities were modestly lower to unchanged but had started the session under far more pressure. At the same time, the CE4, with the benefit of the European equity rebound and higher US futures are mostly firmer led by PLN (+0.6%). But the biggest winner today in this space is MXN, which has rebounded 0.7% from yesterday’s levels, although that represented a nearly 4% decline! In other words, the defining characteristic of the peso these days is not its rate but its volatility. For example, 10-day historic volatility in the peso is currently 28.37%, up from 13.4% last Friday and 21.96% in the middle of May when we were looking at daily 3% moves. Do not be surprised if we see another bout of significant peso volatility, especially given the ongoing concerns over AMLO’s handling of Covid.

On the data front, only Michigan Sentiment (exp 75.0) is on the docket today, which may have an impact if it is surprisingly better than expected, but I don’t anticipate much movement. Rather, FX remains beholden to the overall risk sentiment as determined by the US equity markets. If the rebound continues, the dollar will remain under pressure. If the rebound fails, look for the dollar to resume yesterday’s trend.

Good luck, good weekend and stay safe
Adf

 

Don’t Be Fooled

Said Christine Lagarde, don’t be fooled
That we’re on hold can be overruled
If data gets worse
Or else the reverse
Then our policies can be retooled

Madame Lagarde was in fine fettle yesterday between her press conference in Frankfurt following the ECB’s universally expected decision to leave policy unchanged, and her appearance on a panel at the WEF in Davos. The essence of her message is that the ECB’s policy review is critical to help lead the bank forward for the next decades, but that there is no goal in sight as they start the review, other than to try to determine how best to fulfill their mandate. She was quite clear, as well, that the market should not get complacent regarding policy activity this year. Currently, the market is pricing for no policy movement in 2020. However, Lagarde emphasized that at each meeting the committee would evaluate the current situation, based on the most recent data, and respond accordingly.

With that as a backdrop, it is interesting to look at this morning’s flash PMI data, which showed that while manufacturing across the Eurozone may be starting to improve slightly, overall growth remains desultory at best. Interestingly it was France that was the bigger laggard this month, with its Services and Composite data both falling well below expectations, and printing well below December’s numbers. Germany was more in line with expectations, but the situation overall is not one of unadulterated economic health. The euro, not surprisingly has suffered further after the weak data, falling another 0.2% this morning which takes the year-to-date performance to a 1.6% decline. While that is certainly not the worst performer in the G10 (Australia holds the lead for now) it is indicative that despite everything happening in the US politically, the economy continues to lead the G10 pack.

Perhaps a bit more surprising this morning is the British pound’s weakness. It has fallen 0.3% despite clearly more robust PMI data than had been expected. Manufacturing PMI rose to 49.8, well above expectations and the highest level since last April. Meanwhile, the Composite PMI jumped to 52.4, its highest point since September 2018, and indicative of a pretty substantial post-election rebound in the economy. Even better was that some of the sub-indices pointed to even faster growth ahead, and the econometricians have declared that this points to UK GDP growth of 0.2% in Q1, again, better than previously expected. Remember, the BOE meets next Thursday, and a week ago, the market had been pricing in a 70% probability of a 25bp rate cut. This morning that probability is down to 47% and the debate amongst analysts has warmed up on both sides. My view is the recent data removes the urgency on the BOE’s part, and given how little ammunition they have left, with the base rate sitting at 0.75%, they will refrain from moving. That means there is room for the pound to recoup some of its recent losses, perhaps trading back toward the 1.3250 level where we started the year.

Away from those stories, the coronavirus remains a major story with the Chinese government now restricting travel in cities with a total population of more than 40 million. While the WHO has not seen fit to declare a global health emergency, the latest count shows more than 800 cases reported with 27 deaths. The other noteworthy thing is the growing level of anger being displayed on social media in China, with the government getting blamed for everything that is happening. (I guess this is the downside of taking credit for everything good that happens). At any rate, if the spread is contained at its current levels, it is unlikely to have a major impact on the Chinese economy overall. However, if the virus spreads more aggressively, and there are more shutdowns of cities and travel restrictions, it is very likely to start impacting the data. With Chinese markets closed until next Friday, our only indicator in real-time will be CNH, which this morning is unchanged. Watch it closely as weakness there next week could well be an indicator that the situation on the ground in China is getting worse.

But overall, today’s market activity is focused on adding risk. Japanese equities, the only ones open in Asia overnight, stabilized after yesterday’s sharp declines. And European equities are roaring this morning, with pretty much every market on the Continent higher by more than 1.0%. US futures are pointing higher as well, albeit just 0.25%. In the bond market, Treasuries and bunds are essentially unchanged, although perhaps leaning ever so slightly toward higher rates. And gold is under pressure today, along with both the yen and Swiss franc. As I said, risk is back in favor.

There is neither data nor Fedspeak today, so the FX market will need to take its cues from other sources. If equities continue to rally, look for increased risk appetite leading to higher EMG currencies and arguably a generally softer dollar. What about the impeachment? Well, to date it has had exactly no impact on markets and I see no reason for that to change.

Good luck and good weekend
Adf