Truly Sublime

The Chairman said, now’s not the time
To offer a new paradigm
More debt we will buy
Til we certify
The data is truly sublime

Then later, with, kudos, widespread
The new president clearly said
He’d give out more dough
To soften the blow
We’ll suffer from lockdowns ahead

It appears that the question of whether or not the Fed will consider tapering bond purchases by the end of this year has been answered…No!  Yesterday, Fed Chair Powell made it crystal clear that it was way too early to consider the idea of reducing QE purchases, and that eventually, if such time arrives, the Fed would be signaling their actions well in advance of any changes.  This is broadly the message that we heard from vice-Chairman Clarida two days ago, as well as from Governor Brainerd and some of the more dovish regional presidents.  Thus, the comments of the four regional presidents from earlier this week, indicating that tapering could happen as soon as the end of 2021, are likely to seem diminished in the eyes of the market, and the idea of a much more rapid sell-off in Treasuries needs to be rethought.

Beyond that specific question, the Chairman waxed about the good job the Fed has been doing, all the tools they have available to address any future issues, and, remarkably, that the record high levels of debt in the non-financial sector are really no big deal at all given the current level of interest rates.  Low rates obviously allow more debt to be serviced easily.  The problem, of course, is that if rates do rise in the future, servicing that debt will not be so easy, and the ramifications for the economy would be quite negative.  This is the primary factor in the thought that the Fed may never raise rates again, because doing so would result in significant economic stress throughout the country, and truly, the world.

The market response to Powell’s comments was modest at best, with the dollar softening a bit, while equity and bond markets didn’t really react at all.  Then last night, President-elect Biden made his first policy speech promising a new approach to things.  But one thing that is clearly not set to change is the political view that spending more money is always the right action.  He thus unveiled a $1.9 trillion spending program designed to address the ongoing economic impacts of Covid and the concurrent lockdowns around the country.  As well, he talked about another $3 trillion program for longer term needs like infrastructure and environmental issues that need to be addressed.

Interestingly, the market appears a bit disappointed in this proposed spending bill, and not because it is going to increase the debt load.  Rather, it appears expectations were high for more immediate spending to help goose the economy and by extension, the profit profile of the market.  However, the combination of Fed confirmation only that they would not be tightening, rather than expanding programs, and the disappointing cash outlay in the Biden proposal has forced a bit of reconsideration about the future trajectory of the economy and equity markets.  After all, if the Fed is not adding to the size of its balance sheet, where is the money going to come from to support buying more stocks?  Of course, it could simply be that the Friday before a holiday weekend has encouraged a bit of profit-taking by traders, who will be back in force on Tuesday, but whatever the cause, this morning is opening with a clear risk-off tone.

Looking at equity markets in Asia, the Nikkei (-0.6%) was the laggard, but Shanghai (0.0%) and the Hang Seng (+0.3%) hardly inspired.  Meanwhile, European screens are filled with red, led by the CAC (-0.95%) but seeing both the DAX and FTSE 100 falling -0.8%.  It is interesting to note that there was a bit of data this morning which arguably could have been construed as positive, yet clearly has not been seen that way.  UK November GDP fell only -2.6% M/M, a better than expected performance, especially given the ravages of Covid on that economy. While IP was a bit softer than forecast Services was clearly better, which for the UK economy will be crucial going forward.  The other data point showed French CPI at 0.0% in December, which remarkably, helps raise the Eurozone number!  But equity investors are having none of it today, and shedding positions into the weekend.  As to US futures markets, they are pointing lower as well, between -0.35% and -0.5% at this hour.

One cannot be surprised that Treasury prices are rallying given the risk stance, with the 10-year up ¼ of a point and yields lower by 2.7bps.  While I continue to believe that there is a near term cap in yields, at least at 1.1%, the idea of the bond offering safety makes a bit more sense than when the yield was 0.7% like most of the summer.  Remember, part of the safety of the bond is that it pays a steady income stream.  As to European markets, the big 3 are essentially unchanged at this hour, although all of them have rallied from early session lows where yields had climbed a bit.  This behavior is a bit unusual as I would have expected increased demand for these havens, but markets can be perverse on a regular basis.

Oil prices are under pressure this morning, with WTI lower by 1.3%, although that remains simply a consolidation of the large move higher we had seen over the past two plus months.  As to gold, it is little changed on the day, firmly in the middle of its recent trading range.

Finally, the dollar is definitely the beneficiary of today’s risk stance, rising against most currencies, with only the havens of JPY (+0.1%) and CHF (+0.05%) managing to eke out any gains.  However, the commodity bloc is weak; NOK (-0.6%), AUD (-0.6%) and CAD (-0.5%), and the euro (-0.3%) and pound (-0.45%) are under pressure as well.  There doesn’t need to be a more specific story than risk-off to explain these movements.

Emergers, too, are broadly under pressure led by the commodity linked currencies there.  ZAR (-0.9%), BRL (-0.8%) and CLP (-0.6%) are leading the charge lower, although pretty much every currency in the space has fallen except IDR (+0.3%).  The story here was that exports climbed a more than expected 14.6% leading to a larger trade surplus.  The indication that the economy could weather then Covid storm better than many peers has increased the attractiveness of the rupiah, especially given the yield there, which is amongst the highest in the world these days at 3.75%.

On the data front, yesterday saw much worse than expected Initial Claims data, a potential harbinger of weaker data to come.  This morning brings PPI (exp 0.8% Y/Y, 1.3% Y/Y -ex food & energy), Retail Sales (0.0%, -0.2% -ex autos), Capacity Utilization (73.6%), IP (0.5%), and Michigan Sentiment (79.5).  So, lots of things, but really Retail Sales is the one that matters most here, I think.  Certainly, yesterday’s Claims data has put the market on notice that things slowed down in Q4 and are likely starting Q1 in the same state.  However, do not be too surprised if a bad number is met with a rally as expectations grow that the Fed could, in fact, step up the pace of purchases.  We shall see.

Beyond that, Minneapolis Fed president Kashkari, the uber-dove, is the last Fed speaker before the quiet period begins ahead of the January 27 meeting.  But we already know he is going to say not enough is being done.

As long as risk remains on the back foot, the dollar can certainly maintain its modest bid here.  However, if things turn around, notably if equities climb into the green, look for the dollar to give up its gains.  At this point, the dollar’s strength does not seem to be built on a strong foundation.

Good luck, good weekend and stay safe
Adf

Pending A-pocalypse

Inflation’s on everyone’s lips
As traders now need come to grips
With data still soft
But forecasts that oft
Point to pending a-pocalypse

Is inflation really coming soon?  Or perhaps the question should be, is measured inflation really coming soon?  I’m confident most of us have seen the rise in prices for things that we purchase on a regular basis, be it food, clothing, cable subscriptions or hard goods.  And of course, asset price inflation has been rampant for years, but apparently that doesn’t count at all.  However, the focus on this statistic has increased dramatically during the past several months which is a huge change from, not only the immediate post-pandemic economy, but in reality, the past thirty years of economic activity.  In fact, ever since Paul Volcker, as Fed Chair, slew the inflationary dragon that lived in the 1970’s, we have seen a secular move lower in measured consumer prices alongside a secular move lower in nominal interest rates.

But the pandemic has forced a lot of very smart people (present company excluded) to reconsider this trend, with many concluding that higher prices, even the measured kind, are in our future.  And this is not a discussion of a short-term blip higher due to pent up demand, but rather the long-term trend higher that will need to be addressed aggressively by the Fed lest it gets out of hand.

The argument for inflation centers on the difference between the post GFC financial response and the post Covid shock financial response.  Back in 2009, the Fed cut rates to zero and inaugurated their first balance sheet expansion of note with QE1.  Several more bouts of QE along with years of near zero rates had virtually no impact on CPI or PCE as the transmission mechanism, commercial banks, were not playing their part as expected.  Remember, QE simply replaces Treasuries with bank reserves on a commercial bank balance sheet.  It is up to the commercial bank to lend out that money in order for QE to support the economy.  But commercial banks were not finding the risk adjusted returns they needed, especially compared to the riskless returns they were receiving from the Fed from its IOER program.  So, the banking sector sold the Fed their bonds and held reserves where they got paid interest, while enabling them to have a riskless asset on their books.  In other words, only a limited amount of QE wound up in the public’s pocket.  The upshot was that spending power did not increase (remember, wages stagnated) and so pricing pressures did not materialize, hence no measured inflation.

But this time around, fiscal policy has been massive, with the CARES act of nearly $2 trillion including direct payments to the public as well as forgivable small business loans via the PPP program.  So, banks didn’t need to lend the money to get things moving, the government solved that part of the equation. Much of that money wound up directly in the economy (although certainly some found its way into RobinHood accounts and Bitcoin), thus amping up demand.  At the same time, the lockdowns around the world resulted in broken supply chains, meaning many goods were in short supply.  This resulted in the classic, more money chasing fewer goods situation, which leads to higher prices.  This helps explain the trajectory of inflation since the initial Covid impact, where prices collapsed at first, but have now been rising back sharply.  While they have not yet reached pre-Covid levels, it certainly appears that will be the case soon.

Which leads us back to the question of, what will prevail?  Will the rebound continue, or will the long-term trend reassert itself?  This matters for two reasons.  First, we will all be impacted by rising inflation in some manner if it really takes off.  But from a markets perspective, if US inflation is rising rapidly, it will put the Fed in a bind with respect to their promise to keep rates at zero until the end of 2023.  If the market starts to believe the Fed is going to raise rates sooner to fight inflation, that will likely have a very deleterious effect on equity and bond prices, but a very positive effect on the dollar.  The combination of risk-off and higher returns will make the dollar quite attractive to many, certainly enough to reverse the recent downtrend.

Lately, we are seeing the beginnings of this discussion, which is why the yield curve has steepened, why stock markets have stalled and why the dollar has stopped sliding.  Fedspeak this week has been cacophonous, but more importantly has shown there is a pretty large group of FOMC members who see the need for tapering policy, starting with reducing QE, but eventually moving toward higher rates.  Yesterday, uber-dove Governor Lael Brainerd pushed back on that story, but really, all eyes will be on Chairman Powell this afternoon when he speaks.  To date, he has not indicated a concern with inflation nor any idea he would like to taper purchases, so any change in that stance is likely to lead to a significant market response.  Pay attention at 12:30!

With that as backdrop, a quick tour of the markets shows that risk appetite is moderately positive this morning.  While the Nikkei (+0.85%) and Hang Seng (+0.9%) both did well, Shanghai suffered (-0.9%) despite data showing record export performance by China last year.  Europe is far less exciting with small gains (DAX +0.2%, CAC +0.1% and FTSE 100 +0.7%) following Germany’s release of 2020 GDP data showing a full-year decline of “just” -5.0%, slightly less bad than expected.  US futures are mixed at this hour, but the moves are all small and offer no real news.

Bond markets show Treasury yields higher by 2bps, while European bonds have all seen yields slip between 1.0 and 1.7bps, at least the havens there.  Italian BTP’s are selling off hard, with yields rising 5.7bps, and the rest of the PIGS have also been under pressure.  Oil prices are little changed this morning, still holding onto their gains since November.  Gold prices are slightly softer and appear to be biding their time until the next big piece of news hits.

Finally, the dollar is somewhat mixed this morning, with the G10 basically split between gainers and losers, although the gains have been a bit larger (AUD +0.4%, SEK +0.3%) than the losses (CHF -0.2%, JPY -0.1%).  But this looks like position adjustments and potential order flow rather than a narrative driven move.  EMG currencies are also split, but there are clearly more gainers than losers here, with the commodity bloc doing best (ZAR +0.85%, RUB +0.65%, BRL +0.6%) and losses more random led by KRW (-0.25%) and CZK (-0.2%).  If pressed, one needs look past oil and gold to see agricultural commodities and base metals still performing well and supporting those currencies.  KRW, on the other hand is a bit more confusing given the growth in China, it’s main exporting destination.  Again, position adjustments are quite viable given the won’s more than 11% gain since May.

This morning’s data slate includes only Initial Claims (exp 789K) and Continuing Claims (5.0M), which if far from expectations could wiggle markets, but seem unlikely to do so as everyone awaits Powell’s speech.  Until then, I expect that the dollar will continue to remain supported, but if Powell reiterates a very dovish stance, we could easily see the dollar head much lower.  Of course, if he gives credence to the taper view, look for some real market fireworks, with both bonds and stocks selling off and the dollar jumping sharply.

Good luck and stay safe
Adf

The Dollar’s Fate (In the Coming Year)

With apologies to Henry Wadsworth Longfellow

Listen, my children, and you shall hear
Of the dollar’s fate in the coming year
In the wake of a time that’s ne’er been seen
Since the Spanish Flu of Nineteen Eighteen
Perhaps Twenty-One will bring joy, not fear

Recapping Twenty shows that despite
A plague of biblical magnitude
The printing press revealed its might
As governments everywhere, debt, accrued
And flooded the markets with cash untold
(The better their citizens be controlled)
But all of that money was used, not for,
Increased production of goods onshore
Instead, for the purchase of stocks galore

Thus, equity markets at home rose higher
With Asia, too, on proverbial fire
Though Europe lagged, as the ECB
Was late to the party with more QE
Risk was embraced with a multiplier
Government bonds, though falling of late
Had seen yields tumble, year-to date
And lastly, the dollar, is now descending
As traders await this trend extending

Looking ahead, what can we expect?
Has Covid passed? Will ‘normal’ return?
Or are there surprises we’ve yet to learn?
Will stocks continue their flights of fancy?
Will bonds, inflation, at last detect?
Will dollars, everyone, start to spurn?
Will gold and bitcoin still seem chancy?

Regarding the virus, it’s not dead yet
Though hope springs eternal, and at last
The vaccines imply the worst has passed
But life, as we knew it, has been reset
Working from home (or living at work)
Is mainstream now, and not just a quirk
Office demand will certainly slide
And travel for business will lessen worldwide
Normal has changed, for boss and for clerk

Let us now speak of growth and inflation
Will growth improve on last year’s “success”?
Or will it instead fall flat and regress
Lockdown renewals bode ill for salvation
Policymakers constantly flail
As policy efforts constantly fail
Stimulus, fiscal, continues to flow
Interest rates are now forevermore low
Central banks tell us that this combination
Is perfect to counter a fearful stagnation
But in their efforts, good times to hail
The rising of prices will bypass their gaze
Leading to many more difficult days
GDP this year will struggle to One
Inflation, however, at Four, will not stun

How, then, will markets respond to this fate?
Equity prices at first will inflate
By spring, though, ‘twill be clear something’s amiss
Traders, their holdings, will start to truncate
While we shall not tumble into the abyss
Do not be shocked if the market does fall
Some twenty percent, at the least, is my call
What about bonds? How will they react?
Powell will ne’er let their prices contract
Yield Curve Control is the future we’ll see
Alongside the horror of pure MMT
Hence, ten-year bonds when December arrives
Will keep up their value, a cat with nine lives
One percent will be the height they attain
Implying the real yield most certainly dives
And so, the dollar will suffer great pain

Starting in Europe where Madame Lagarde
Is trying to keep up with Fed Chairman Jay
Sadly, what’s clear, at the end of the day
The ECB’s structure will make it too hard
While Fed and the Treasury work hand in hand
Pushing more money throughout all the land
Treaties in Europe have outcomes, unplanned
PEPP’s not enough for a rebound unscarred

Even though growth throughout Europe will sag
Even though prices will still be a drag
Nothing Lagarde can create will impact
The outcome, a euro that’s sure to move higher
Thus, if it’s something you need to acquire
At year-end, One-Thirty, you’ll need, that’s a fact

Tumultuous best describes last year’s UK
Twixt Covid and Brexit, the nation felt pain
Unhappily, this year, to Johnson’s dismay
Could worsen for every old bloke on the street
With growth in the toilet while prices show heat
It doesn’t seem much like Pound Sterling could gain

But real rates keep diving throughout the US
Offsetting those troubles, so if you need quid
Come Christmas, One-Fifty, if I had to guess
Is what they will cost as the dollar’s declined
Looking elsewhere, perhaps north of the border
Canada still seems a bit out of order
Oil’s rebounded but still seems confined
Meanwhile, housing there is quite well bid

However, again, it is Fed Chairman Jay
Who’s promised support for considerable time
Thus, when we get to our next Boxing Day
One-Fifteen for Loonies you’ll see on your screen
Eastward now, let’s turn our gaze as we glean
Whether the yen can continue its climb
Long-term, the dollar, its trend has been clear
Even before the debasement of late
Several percent, like a clock every year
Why would this year, something new, demonstrate?

Frankly, it won’t, as the Fed’s in control
Rather, the yen, will continue to roll
So, Winter Solstice this year will reveal
Dollar-Yen, Ninety-Six, where you can deal
Let us turn now to both future and past
Bitcoin and gold, which have both been amassed
Can both their prices continue to rise?
Certainly, as they’ve restricted supplies

For centuries, gold has defined what’s secure
Its glitter unblemished while paper’s debased
So, don’t be surprised if the relic’s embraced
As buyers pay Three Grand their wealth to insure
But youth has ideas which to many seem odd
And bitcoin is one such that’s been called a fraud
So, is it? Or is Bitcoin digital gold?
An updated version important to hold
As fiat debasement continues apace
This digital token gains further allure
And this year it seems Bitcoin’s making its case
As something that everyone needs to procure

It’s starting this year right around thirty grand
And hodlers believe that ‘tween here and the sky
Unless countries call for Bitcoin to be banned
A doubling or tripling’s the gain they’ll apply
One last thing I’ll highlight in digital space

The DCEP is now leading the race
This digital yuan, the first CBDC
Is coming soon courtesy of Mr Xi
It’s impact initially is quite unclear
But I guarantee that inside of a year
Nations worldwide will each roll out their own
And each will define a DC trading zone

While last year was filled with surprises galore
This year we’re likely to see many more
And finally, thank you, my readers and friends
For listening to all the twists and the bends
Now looking ahead to Twenty Twenty-One
Let’s all keep perspective and try to have fun.

Good luck, stay safe and have a wonderful new year
Adf

DCEP = Digital Currency / Electronic Payment
CBDC = Central Bank Digital Coin

Infinite Easing

Until “further progress” is made
On joblessness, Jay won’t be swayed
From infinite easing
Which stocks should find pleasing
Explaining how he will get paid

As well, one more time he inferred
That Congress was being absurd
By not passing bills
With plenty of frills
So fiscal relief can be spurred

We’re going to keep policy highly accommodative until the expansion is well down the tracks.”  This statement from Chairman Powell in yesterday’s post-meeting press conference pretty much says it all with respect to the Fed’s current collective mindset.  While the Fed left the policy rate unchanged, as universally expected, they did hint at the idea that additional QE is still being considered with a subtle change in the language of their statement.  Rather than explaining they will increase their holdings of Treasuries and mortgage-backed securities “at least at the current pace”, they now promise to do so by “at least $80 billion per month” in Treasuries and “at least $40 billion per month” in mortgages.  And they will do this until the economy reaches some still unknown level of unemployment alongside their average 2% inflation target.

What is even more interesting is that the Fed’s official economic forecasts were raised, as GDP growth is now forecast at 4.2% for 2021 and 3.2% for 2022, each of these being raised by 0.2% from their September forecasts.  At the same time, Unemployment is expected to fall to 5.0% in 2021 and 4.2% in 2022, again substantially better than September’s outlook of 5.5% and 4.6% respectively.  As to PCE Inflation, the forecasts were raised slightly, by 0.1% for both years, but remain below their 2% target.

Put it all together and you come away with a picture of the Fed feeling better about the economy overall, albeit with some major risks still in the shadows, but also prepared to, as Mario Draghi declared in 2012, “do whatever it takes” to achieve their still hazy target of full employment and average inflation of 2%.  For the equity bulls out there, this is exactly what they want to hear, more growth without tighter policy.  For dollar bears, this is also what they want to hear, a steady supply increase of dollars that need to wash through the market, driving the value of the dollar lower.  For the reflatonistas out there, those who are looking for a steeper yield curve, they took heart that the Fed did not extend the duration of their purchases, and clearly feel better about the more upbeat growth forecasts, but the ongoing lack of inflation, at least according to the Fed, means that the rationale for higher bond yields is not quite as clear.

After all, high growth with low inflation would not drive yields higher, especially in the current world with all that liquidity currently available.  And one other thing argues against much higher Treasury yields, the fact that the government cannot afford them.  With the debt/GDP ratio rising to 127% this year, and set to go higher based on the ongoing deficit spending, higher yields would soak up an ever increasing share of government revenues, thus crowding out spending on other things like the entitlement programs or defense, as well as all discretionary spending.  With this in mind, you can be sure the Fed is going to prevent yields from going very high at all, for a very long time.

Summing up, the last FOMC meeting of the year reconfirmed what we already knew, the Fed is not going to tighten monetary policy for many years to come.  For their sake, and ours, I sure hope inflation remains as tame as they forecast, because in the event it were to rise more sharply, it could become very uncomfortable at the Mariner Eccles Building.

In the meantime, this morning brings the last BOE rate decision of the year, with market expectations universal that no changes will be forthcoming.  That makes perfect sense given the ongoing uncertainty over Brexit, although this morning we heard from the EU’s top negotiator, Michel Barnier, that good progress has been made, with only the last stumbling blocks regarding fishing to be agreed.  However, in the event no trade deal is reached, the BOE will want to have as much ammunition as possible available to address what will almost certainly be some major market dislocations.  As I type, the pound is trading above 1.36 (+0.8% on the day) for the first time since April 2018 and shows no signs of breaking its recent trend.  I continue to believe that a successful Brexit negotiation is not fully priced in, so there is room for a jump if (when?) a deal is announced.

And that’s really it for the day, which has seen a continuation of the risk-on meme overall.  Looking at equity markets, Asia saw strength across the board (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +1.1%), although Europe has not been quite as universally positive (DAX +0.8%, CAC +0.4%, FTSE 100 0.0%).  US futures markets are pointing higher again, with all three indices looking at 0.5%ish gains at this time.

The bond market is showing more of a mixed session with Treasuries off 2 ticks and the yield rising 0.7bps, while European bond markets have all rallied slightly, with yields declining across the board between 1 and 2 basis points. Again, if inflation is not coming to the US, and the Fed clearly believes that to be the case, the rationale for higher Treasury yields remains absent.

Commodity markets are feeling good this morning with gold continuing its recent run, +0.7%, while oil prices have edged up by 0.3%.  And finally, the dollar is on its heels vs. essentially all its counterparts this morning, in both G10 and EMG blocs.  Starting with the G10, NOK (+1.0%) is the leader, although AUD and NZD (+0.8% each) are benefitting from their commodity focus along with the dollar’s overall weakness.  In fact, the euro (+0.3%) is the laggard here, while even JPY (+0.4%) is rising despite the risk-on theme.  This simply shows you how strong dollar bearishness is, if it overcomes the typical yen weakness attendant to risk appetite.

In the emerging markets, it is also the commodity focused currencies that are leading the way, with ZAR (+0.9%) and CLP (+0.75%) on top of the leaderboard, but strong gains in RUB (+0.7%), BRL (+0.6%) and MXN (+0.5%) as well.  The CE4, have been a bit less buoyant, although all are stronger on the day.  But this is all of a piece, stronger commodity prices leading to a weaker dollar.

On the data front, I think we are in an asymmetric reaction function, where strong data will be ignored while weak data will become the rationale for further risk appetite.  This morning we see Initial Claims (exp 815K), Continuing Claims (5.7M), Housing Starts (1535K), Building Permits (1560K), and Philly Fed (20.0).  Yesterday saw a much weaker than expected Retail Sales outcome (-1.1%, -0.9% ex autos) although the PMI data was a bit better than expected.  But now that the Fed has essentially said they are on a course regardless of the data, with the only possible variation to be additional easing, data is secondary.  The dollar downtrend is firmly entrenched at this time, and while we will see reversals periodically, and the trend is not a collapse, there is no reason to believe it is going to end anytime soon.

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

Post-Covid Themes

With Thanksgiving now in the past
And Christmas approaching quite fast
The only thing clear
Through end of the year
Is dollar shorts have been amassed

For many, conviction is strong
That currencies, they need be long
The idea, it seems
Is post-Covid themes
Mean risk averse views are now wrong

Having been away for a week, the most interesting thing this morning is the rising conviction in the view that the dollar has much further to decline in 2021.  Much is made of the fact that since its Covid induced highs in March, the dollar has fallen by more than 12% vs the Dollar Index (DXY) which is basically the euro.  Of course, that is nothing compared to the recoveries seen by the commodity currencies like NOK (+33.2%), AUD (+27.6%) and NZD (+23.6%) over the same period.  Yet when viewed on a year-to-date basis, the movement is far less impressive, with NOK actually unchanged on the year, and the leader, SEK, higher by 10.8%.  It is also worth remembering that the euro has rallied by a relatively modest 6.9% thus far in 2020, hardly worthy of the term dollar collapse.

In addition, as I have written before, but given the growing dollar bearish sentiment, I feel worth repeating, is that in the broad scheme of things, the dollar is essentially right in the middle of its long-term trading range.  For instance, from the day the euro came into existence, January 1, 1999, the average daily FX rate, according to Bloomberg, has been 1.1999, almost exactly where it currently trades.  It has ranged from a low of 0.8230 in October 2000 to a high of 1.6038 the summer before the GFC hit.  The point is EURUSD at 1.20 is hardly unusual, neither can it be considered weak nor strong.

Unpacking the rationale, as best I understand it, for the dollar’s imminent decline, we see that a great deal of faith is put upon the idea of a continuing risk rally over the next months as the global economy recovers with the advent of the Covid vaccines that seem likely to be approved within weeks.  The sequence of events in mind is that the distribution of the vaccine will have the dual impact of dramatically reducing the Covid caseloads while simultaneously reinvigorating confidence in the population to resume pre-Covid activities like going out to restaurants, bars and the movies, as well as resuming their travel plans.  The ensuing burst of activity will result in a return to pre-Covid levels of economic activity and all will be right with the world.  (PS  pre-Covid economic activity was a desultory 1.5% GDP growth with low inflation that caused the central bank community to maintain ultra-low interest rates for a decade!)

Equity markets, which are seemingly already priced for this utopian existence, will continue to rally based on the never-ending stream of central bank liquidity…or is it based on the massive growth in earnings given the near certainty of higher taxes and higher interest rates in the future.  No, it can’t be the second view, as higher taxes and higher interest rates are traditionally equity negatives.  So perhaps, equity markets will continue to rally as the prospect of future growth will remain just close enough to seem real, but far enough away to discourage policymakers from changing the rules now.  Perhaps this is what is meant by the Goldilocks recovery.

Of course, while commodity markets have bought into the story hook, line and sinker, it must be recalled that they have been the greatest underperforming segment of markets for the past decade.  Since December 1, 2010, the Goldman Sachs Commodity Index (GSCI) has fallen 36.5%, while the S&P500 has rallied 191%.  My point is the fact that commodity markets are performing well with the prospects of incipient economic growth ought not be that surprising.

The fly in the ointment, however, is the bond market, where despite all the ink spilled regarding the reflation trade and the steepening of the US Treasury yield curve, 10-year Treasuries refuse to confirm the glowing views of the future. At least, while they may be agnostic on growth, there is certainly little concern over a rekindling of inflation, despite the earnest promises of every central banker in the world to stoke the fires and bring measured inflation back to their targets.  As I type this morning, 10-year Treasury yields are 0.85%, right in the middle of its range since the US election.  You remember that, the event that was to usher in the great reflation?

In the end, while sentiment has clearly been growing toward a stronger recovery next year, encouraging risk appetites in both G10 and, especially, EMG economies, as yet, the data has not matched expectations, and positioning remains based on hope rather than evidence.

Now a quick tour around today’s markets shows that the equity rally has paused, at the very least, with weakness in Asia (Nikkei -0.8%, Hang Seng -2.1%, Shanghai -0.5%) despite stronger than expected economic data from both Japan (IP +3.8%) and China (Mfg PMI 52.1, non-Mfg PMI 56.4).  European markets are also mostly in the red, although the DAX (+0.2%) is the exception to the rule.  However, the CAC (-0.4%) and FTSE 100 (-0.15%) have joined the rest of the continent lower despite positive comments regarding a Brexit deal being within reach this week.  US futures have a bit of gloom about themselves as well, with both DOW and SPX futures pointing to 0.5% declines at the open, although NASDAQ futures are little changed at this hour.

Surprisingly, despite the soft tone in the equity markets, European government bond yields are all edging higher, with Bunds (+1.6bps) pretty much defining the day’s activity as most other major markets are seeing similar moves, including Treasuries (+1.8 bps).  Commodity prices are under pressure with oil (-1.3%) and gold (-0.9%) both suffering although Bitcoin seems to be regaining its footing, rallying 2.3% this morning.

Finally, the dollar, is under a modicum of pressure this morning with G10 currencies mostly a bit firmer (NOK and SEK +0.4%) GBP (+0.3%), although AUD (-0.1%) seems to be getting nosebleeds as it approaches its highest level in two years.  Potentially, word that China has slapped more tariffs on Australian wines, as the acrimony between those two nations escalates, could be removing the rose-colored tint there.  Meanwhile, in the EMG bloc, there is a mix of activity, with some gainers (HUF +0.8%) and BRL (+0.65%), and some losers (ZAR -0.3%), KRW (-0.25%).  Broadly, the commodity focused currencies here are feeling a little pressure from the underperformance in oil and metals, while the CE4 are tracking the euro nicely.

It is an important data week, and we also hear from numerous central bankers.

Today Chicago PMI 59.0
Tuesday ISM Manufacturing 58.0
Construction Spending 0.8%
Wednesday ADP Employment 420K
Fed Beige Book
Thursday Initial Claims 765K
Continuing Claims 5.81M
ISM Services 57.6
Friday Nonfarm Payrolls 500K
Private Payrolls 608K
Manufacturing Payrolls 46K
Unemployment Rate 6.8%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Trade Balance -$64.8B
Factory Orders 0.8%

Source: Bloomberg

In addition, we have seven Fed speakers this week, including most importantly, Chairman Powell’s testimony to the Senate Banking Committee tomorrow and the House Finance Panel on Wednesday.  We also hear from Madame Lagarde twice this week, and with the euro hovering just below 1.20, be prepared for her to mention that a too-strong euro is counterproductive.  You may recall in early September, the last time the euro was at these levels, that both she and Philip Lane, ECB Chief Economist, were quickly on the tape talking down the single currency.  Although since that time CNY has rallied strongly (+4%) thus removing some of the pressure on the ECB, there is still no way they want to see the euro rally sharply from here.

But do not be surprised to see the market test those euro highs today or tomorrow, if only to see the ECB response and pain threshold.  Clearly, momentum is against the greenback lately, and today is no exception, but I do not buy the dramatic decline story, if only because no other central bank will sit idly by and allow it.

Good luck and stay safe
Adf

Pandemic Support

Til now the direction’s been clear
As Jay and Mnuchin did fear
If they didn’t spend
The US can’t mend
And things would degrade through next year

But now, unless there’s a breakthrough
It seems Treasury won’t renew
Pandemic support
Which likely will thwart
A rebound til late Twenty-Two

Just when you thought things couldn’t get more surprising, we wind up with a public disagreement between the US Treasury Secretary and the Federal Reserve Chair.  To date, Steve Mnuchin and Jay Powell have seemed to work pretty well together, and at the very least, were both on the same page.  Both recognized that the impact of the pandemic would be dramatic and there was no compunction by either to invent new ways to support both markets and the economy.  As well, both were appointed by the same president, and although their personal styles may be different, both seemed to have a single goal in mind, do whatever is necessary to maintain as much economic activity as possible.

Aah, but 2020 is unlike any year we have ever seen, especially when it comes to policy decisions.  The legalities of the alphabet soup of Fed programs (e.g. PMCCF, SMCCF, MMLF, etc.) require that they expire at the end of the year and must be renewed by the Treasury Department.  And in truth, this is a good policy as expiration dates on spending programs require continued debate as to their efficacy before renewal.  The thing is, given the rapid increase in covid infections and rapid increase in state economic restrictions and shutdowns, pretty much every economist and analyst agrees that all of these programs should continue until such time as the spread of the coronavirus has slowed or herd immunity has been achieved.  Certainly, every FOMC member has been vocal in the need for more fiscal stimulus as they know that their current toolkit is inadequate.  (Just yesterday we heard from both Loretta Mester and Robert Kaplan with exactly that message.)  But to a (wo)man, they have all explained that the Fed will continue to do whatever it can to help, and that means continuing with the current programs.

Into this mix comes the news that Secretary Mnuchin sent a letter to the Fed that they must return the funds made available to backstop some of the Fed’s lending programs, as they were no longer needed.  The Fed immediately responded by saying “the full suite” of programs should be maintained into 2021.

Let’s consider, for a moment, some of the programs and what they were designed to do.  For instance, the Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility do seem superfluous at this stage.  After all, more than $1.9 trillion of new corporate debt has been issued so far in 2020 and the Fed has purchased a total of $45.8 billion all year, just 2.4%, mostly through ETF’s.  It seems apparent that companies are not having any difficulty accessing financing, at very low rates, in the markets directly.  In the Municipal space, the Fed has only bought $16.5 billion while more than $250 billion has been successfully issued year to date.  Mnuchin’s point is, return the unused funds and deploy them elsewhere, perhaps as part of the widely demanded fiscal policy support.  The other side of that coin, though, is the idea that the reason the market’s have been able to support all that issuance is because the Fed backstop is in place, and if it is removed, then markets will react negatively.

In fairness, both sides have a point here, and perhaps the most surprising outcome is the public nature of the spat.  Historically, these two agencies work closely together, especially during difficult times.  But as I said before, 2020 is unlike any time we have seen in our lifetimes.  There is one other potential driver of this dissension, and that could be that politically, the Administration is trying to get Congress to act on a new stimulus plan quickly by threatening to remove some of the previous stimulus.  However, whatever the rationale, it clearly has the market on edge, interrupting the good times, although not yet resulting in a significant risk-off outcome.

If this disagreement is not resolved before the next FOMC meeting in three weeks’ time, the market will be looking for the Fed to expand its stimulus measures in some manner, either by increasing QE purchases or by purchasing longer tenor bonds, thus weighing on the back end of the curve as well as the front.  And for our purposes, meaning in the FX context, that would be significant, as either of those actions are likely to see a weaker dollar in response.  Remember, while no other central bank is keen to see the dollar weaken vs. their own currency, as long as CNY continues to outperform all, further dollar weakness vs. the euro, yen, pound, et al, is very much in the cards.

So, with that as our backdrop, markets today don’t really know what to do and are, at this point, mixed to slightly higher.  Asia, overnight, saw further weakness in the Nikkei (-0.4%), but both the Hang Seng and Shanghai exchanges gained a similar amount.  European bourses have slowly edged higher to the point where the CAC, DAX and FTSE 100 are all 0.5% higher on the day, although US futures are either side of unchanged as traders try to figure out the ultimate impact of the spat.  Bonds are mixed with Treasury yields higher by 1 basis point, but European yields generally lower by the same amount this morning.  Of course, a 1 basis point move is hardly indicative of a directional preference.

Both gold and oil are essentially flat on the day, and the dollar can best be described as mixed, although it is starting to soften a bit.  In the G10 space, NZD (+0.45%) leads the way with the rest of the commodity bloc (AUD, NOK, CAD) all higher by smaller amounts.  Meanwhile, the havens are under a bit of pressure, but only a bit, with JPY and CHF both softer by just (-0.1%).  EMG currencies have seen a similar performance as most Asian currencies strengthened overnight, but by small amounts, in the 0.2%-0.3% range.  Meanwhile, the CE4 were following the euro, which had been lower most of the evening but is now back toward flat, as are the CE4.  And LATAM currencies, as they open, are edging slightly higher.  But overall, while there is a softening tone to the dollar, it is modest at best.

On the data front, there is none to be released in the US today, although early this morning we learned that UK Retail Sales were a bit firmer than expected while Italian Industrial activity (Sales and Orders) was much weaker than last month.  On the speaker front, four more Fed speakers are on tap, but they all simply repeat the same mantra, more fiscal spending, although now they will clearly include, don’t end the current programs.

For the day, given it is the Friday leading into Thanksgiving week, I expect modest activity and limited movement.  However, if this spat continues and the Treasury is still planning on ending programs in December, I expect the Fed will step in to do more come December, and that will be a distinct dollar negative.

One last thing, I will be on vacation all of next week, so there will be no poetry until November 30.

Good luck, good weekend, stay safe and have a wonderful holiday
Adf

Each of them Dreads

The word from three central bank heads
Was something that each of them dreads
Is failing to let
Inflation beset
Their nations, thus tightening spreads

Instead, each one promised that they
Won’t tighten till some future day
When ‘flation is soaring
And folks are imploring
They stop prices running away

As we come to the end of the week, on a Friday the 13th no less, investors continue to be encouraged by the central bank community.  Yesterday, at an ECB sponsored forum, the heads of the three major central banks, Fed Chairman Jerome Powell, ECB President Christine Lagarde and BOE Governor Andrew Bailey, all explained that their greatest fear was that the second wave of Covid would force extended shutdowns across their economies and more permanent scarring as unemployment rose and the skills of those who couldn’t find a job diminished.  The upshot was that all three essentially committed to displaying patience with regard to tightening policy at such time in the future as inflation starts to return.  In other words, measured inflation will need to be really jumping before any of these three, and by extension most other central bankers, will consider a change in the current policy stance.

Forgetting for a moment, the fact that this means support for asset prices will remain a permanent feature, let us consider the pros and cons of this policy stance.  On the one hand, especially given the central banking community’s woeful forecasting record, waiting for confirmation of a condition before responding means they are far less likely to inadvertently stifle a recovery.  On the other hand, this means central banks are promising to become completely reactive, waiting for the whites of inflation’s eyes, as it were, and therefore will be sacrificing their ability to manage expectations.  In essence, it almost seems like they are dismantling one of the major tools in their toolkits, forward guidance.  Or perhaps, they are not dismantling it, but rather they are changing its nature.

Currently, forward guidance consists of their comments/promises of policy maintenance for an uncertain, but extended period of time.  For instance, the Fed’s forecasts indicate interest rates will remain at current levels through 2023.  (Remember Powell’s comment, “we’re not even thinking about thinking about raising rates.”)  But what if inflation were to start to rise significantly before then?  Does the current guidance preclude them from raising rates sooner?  That is unclear, and I would hope not, but broken promises by central banks are also not good policy.  However, if the new forward guidance is metric based, for instance, we won’t adjust policy until inflation is firmly above 2.0% for a period of time, then all they can do is sit back and watch the data, waiting for the economy to reach those milestones, before acting.  The problem for them here is that inflation has a way of getting out of hand and could require quite severe policy medicine to tame it.  Remember what it took for Paul Volcker as Fed Chair back in the early 1980’s.

My observation is that, as with the initiation of forward guidance, this is a policy that is much easier to start than to unwind, and either it will become a permanent feature of monetary policy (a distinct possibility) or the unfortunate soul who is Fed Chair when it needs to be altered will be roasted alive.  In the meantime, what we know is that central banks around the world are extremely unlikely to tighten policy for many years to come.  We have heard that from the BOJ, the RBA, and the RBNZ as well as the big three.  All told, one could make the case that interest rates have found their new, permanent level.

And with that in mind, let us tour market activity this Friday morning.  Equities in Asia followed from Wall Street’s disappointing performance yesterday and all sold off.  The Nikkei (-0.5%) fell for only the second time in the past two weeks.  Meanwhile, after President Trump signed an executive order preventing US investors from supporting companies owned or controlled by the PLA (China’s armed forces), equities in HK (Hang Seng -0.1%) and Shanghai (-0.9%) both fell as well.  The story in Europe is less clear, with some modest strength (DAX +0.2%), CAC (+0.3%) but also some weakness (FTSE -0.5%).  I would blame the latter on further disruption in the UK government (resignation of a high ranking minister, Dominic cummings) and a fading hope on a Brexit deal, but then the pound is higher, so that doesn’t seem right either.

Bond markets, which all rallied sharply yesterday, are continuing that price action, albeit at a more modest pace, with all European markets showing yield declines of between one and two basis points, although Treasuries are essentially unchanged right now.  Of course, Treasuries had the biggest rally yesterday.

Oil is softer (WTI – 1.0%) and gold is a touch firmer (+0.2%) although the latter seems clearly to have found significant support a bit lower than here.  As to the dollar, on the whole it is softer, but not terribly so.  For instance, GBP (+0.3%) is the leading gainer, with AUD (+0.2%) next on the list, but those are hardly impressive moves.  While the bulk of this bloc are firmer, SEK (-0.4%) has fallen on what appears to be a combination of position adjustments and bets on the future direction of the NOKSEK cross.  As to the EMG bloc, there are more gainers than losers, but MXN (+0.3%) is the biggest positive mover, which seems to be a hangover from Banxico’s surprise decision yesterday afternoon, to leave the overnight rate at 4.25% while the market was anticipating a 25-basis point reduction.  On the downside, CLP (-0.95%) is the worst performer, as investors appear concerned that there will be further financial policy adjustments that hinder the long-term opportunity in the country.

On the data front, overnight we saw Eurozone Q3 GDP released at 12.6% Q/Q (-4.4% Y/Y), a tick worse than expectations but it is hard to imply that had an impact of any sort on the markets.  In the US, yesterday saw a modestly better outcome in Initial Claims, and CPI was actually 0.1% softer than expected (helping the bond rally). This morning brings PPI (exp 0.4%, 1.2% Y/Y), about which nobody cares given we have seen CPI already, and then Michigan Sentiment (82.0) at 10:00.  We have two Fed speakers on the docket, Williams early, and then James Bullard.  But given the unanimity of the last vote, and the fact that we just heard from Chairman Powell, it would be a huge surprise to hear something new from either of them.

So, as we head into the weekend, with the dollar having been strong all week, a little further softness would not be a big surprise.  However, there is no reason to believe that there will be a significant move in either direction before we log off for the weekend.

Good luck, good weekend and stay safe
Adf

Electees Are Concerned

In England and Scotland and Wales
The third quarter saw rising sales
But this quarter will
Repeat the standstill
Of Q2, with different details

In fact, worldwide what we have learned
(And why electees are concerned)
Is policy choices
That help certain voices
By others, are frequently spurned

Markets, writ large, continue to seek the next strong narrative to help generate enthusiasm for the next big move.  But for now, as we are past the ‘Blue wave is good’, and we are past ‘gridlock is good’, and we are past ‘the vaccine is here’, there seems precious little for investors to anticipate.  At least with any specificity.  And that is the key to a compelling narrative, it needs to have a plausible story, a rationale behind that story for the directional movement, but perhaps most importantly, it has to have a target that can be realized.  Whether that target is an announcement, a deadline or long-awaited policy speech, it needs an endgame.  And right now, there is no obvious endgame to drive the narrative.  With that in mind, it should not be very surprising that markets have lost their way.

So, let’s consider what we do know and try to anticipate potential impacts.  The UK Q3 GDP data this morning was of a piece with the US release two weeks ago, as well as what we saw for all the Eurozone nations that have reported, and what we are likely to see from Japan Sunday night; record breaking growth in the quarter, but growth insufficient to make up for the losses in Q2.  Of greater concern for governments everywhere is that Q4 is going to see a dramatic slowing, and in some nations, a return to negative output, due to the resumption of lockdowns throughout Europe as well as in some major US cities.

Economists and analysts seem to have an interesting take on this, essentially explaining that if Q4 turns out worse than previously forecast, it just means that Q1 of next year will be better.  No biggie!  But, of course, that is absurd, especially given the severity of the Covid recession’s impacts already.  After all, the loss of millions of small businesses around the world, and the concurrent loss of employment by those businesses workers is not something that can be quickly reversed.  While in the long term, entrepreneurs will almost certainly restart new businesses, there is a significant time lag between the two events.  And ironically, governments tend to make starting businesses very hard with regulations and licensing fees imposed on the would-be entrepreneur, thus restricting the very economic growth those same governments are desperate to rekindle.

It is this dynamic that has resulted in the need for massive fiscal support by governments worldwide and given the growth of the second wave of the virus, the demand request by central bankers for governments to do even more. The problem inherent in this dynamic is that government largesse is not actually free, despite ZIRP and NIRP.  The cost of further increases in government debt, which is already at record high ratio vs. GDP (>92% globally), is the reduced prospects for future growth.  The requirement to repay debt removes the capital available to invest in productive assets and businesses thus reducing the future pace of growth for everyone.

Up to this point, central banks have been able to absorb the bulk of that new issuance by printing money to do so, but that dynamic is also destined to fail over time.  Especially since it is a global phenomenon.  When only Japan, with debt/GDP >230%, was in this situation, it could rely on growth elsewhere in the world to absorb its exports and help service that debt.  But the global recession we saw in Q2 (>90% of the world was in recession) and are likely to see again in Q4 means that there will not be anybody else around to absorb those exports.  This is why every country is seeking a weaker currency, to help those exports, and remains a key reason that the dollar’s demise remains unlikely in the near future.  (This is also why there are a number of analysts who are anticipating a debt jubilee, where government debt owned by central banks will simply be torn up, leaving the cash in the system, but no bonds to repay.  While debt/GDP ratios will decline sharply, inflation will become the new bugbear.)

Of course, this is all in the future, and a lot to read out of UK GDP data, but this cycle has been pretty clear, and at this stage, even the hope for a vaccine to become widely available early next year is unlikely to change the immediate future.  Which brings us back to square one, a market searching for a narrative.

That lack of direction is clear across markets this morning, with equities mixed in Asia (Nikkei +0.7%, Hang Seng (-0.2%, Shanghai -0.1%), lower in Europe (DAX -0.8%, CAC -0.9%, FTSE -0.35%) and US futures split (DOW -0.4%, SPX -0.1%, NASDAQ +0.5%).  I’m not getting a sense of a strong narrative here at all.

Bond markets, meanwhile, are reversing some of their losses from earlier this week, with Treasuries (-3.3bps), Bunds (-1bp) and Gilts (-2.4bps) all firmer while the rest of Europe is also seeing demand for havens amid the modest equity weakness.  Oil prices are virtually unchanged this morning, holding onto their recent gains, but with no capacity to continue to rally.  Gold, on the other hand, has edged slightly higher, up 0.3%.

Finally, the dollar is truly mixed this morning with half the G10 currencies firmer, led by EUR (+0.25%) and CHF (+0.25%), and half weaker led by the pound’s 0.5% decline and AUD (-0.3%).  We already know why the pound is weak, their GDP data, while very strong on paper, disappointed relative to expectations.  As to the rest of the bloc, the truth is given the euro’s weakness yesterday, a little reversal ought to be no surprise.  EMG currencies show a similar split of half weaker and half stronger this morning. On the plus side, other than TRY (+1.2%) which continues to be roiled by the changes at the central bank, the gains are all modest and heavily focused on the CE4 currencies, which are simply following the euro higher.  On the downside, IDR (-0.6%) and KRW (-0.45%) are the weakest of the lot, with both these currencies seeming to see a bit of profit-taking from recent gains.

On the data front, we do get important numbers this morning, all at 8:30.  Initial Claims (exp 731K), Continuing Claims (6.825M) and CPI (1.3%, 1.7% ex food & energy) are on the docket with the first two still giving us our best real time data on economic activity.  Also, we cannot forget that Chairman Powell, along with Madame Lagarde and BOE Governor Bailey, will be speaking later this morning, at 11:45, at an ECB forum, with the outcome almost certainly to be a plea for fiscal stimulus by governments one and all.

In the end, the lack of a compelling narrative implies to me a lack of direction is in store.  As such, I expect little in the way of a resolution in the near future, and thus choppy dollar price action is the best bet.

Good luck and stay safe
Adf

Haven’t a Doubt

The Fed, yesterday, made the case
That fiscal support they’d embrace
But even without
They haven’t a doubt
The dollar they still can debase
Their toolbox can help growth keep pace

As of yet, there is no winner declared in the Presidential election, although it seems to be trending toward a Biden victory.  The Senate, as well, remains in doubt, although is still assumed, at least by the market, to be held by the Republicans.  But as we discussed yesterday, the narrative has been able to shift from a blue wave is good for stocks to gridlock is good for stocks.  And essentially, that remains the situation because the Fed continues to support the market.

With this in mind, yesterday’s FOMC meeting was the market focus all afternoon.  However, the reality is we didn’t really learn too much that was new.  While universal expectations were for policy to remain unchanged, and they were, Chairman Powell discussed two things in the press conference; the need for fiscal stimulus from the government as quickly as possible; and the composition of their QE program.  Certainly, given all we have heard from Powell, as well as the other FOMC members over the past months, it is not surprising that he continues to plea for a fiscal response from Congress.  As I have written before, they clearly recognize that their toolkit has basically done all it can for the economy, although it can still support stock and bond markets.

It is a bit more interesting that Powell was as forthright regarding the discussion on the nature of the current asset purchase program, meaning both the size of purchases and the tenor of the bonds they are buying.  Currently, they remain focused on short-term Treasuries rather than buying all along the curve.  Their argument is that their purchases are doing a fine job of maintaining low interest rates throughout the Treasury market.  However, it seems that this question was the big one during the meeting, as clearly there are some advocates for extending the tenor of purchases, which would be akin to yield curve control.  The fact that this has been such an important topic internally, and the fact that the erstwhile monetary hawks are on board, or seem to be, implies that we could see a change to longer term purchases in December, especially if no new fiscal stimulus bill is enacted and the data starts to turn back lower.  This may well be the only way that the Fed can ease policy further, given their (well-founded) reluctance to consider negative interest rates.  If this is the case, it would certainly work against the dollar in the near-term, at least until we heard the responses from the other central banks.

But that was yesterday.  The Friday session started off in Asia with limited movement.  While the Nikkei (+0.9%) managed to continue to rally, both the Hang Seng (+0.1%) and Shanghai (-0.25%) had much less interesting performances.  Europe, on the other hand, started off with a serious bout of profit taking, as early on, both the DAX and CAC had fallen about 1.5%.  But in the past two hours, they have clawed back around half of those losses to where the DAX (-0.9%) and CAC (-0.6%) are lower but still within spitting distance of their recent highs.  US futures have shown similar behavior, having been lower by between 1.5% and 2.0% earlier in the session, and now showing losses of just 0.5% across the board.  One cannot be surprised that there was some profit taking as the gains in markets this week have been extraordinary, with the S&P up more than 8% heading into today, the NASDAQ more than 9% and even the DAX and CAC up by similar amounts.

The Treasury rally, too, has stalled this morning with the 10-year yield one basis point higher, although we are seeing continued buying interest throughout European markets, especially in the PIGS, where ongoing ECB support is the most important.  Helping the bond market cause has been the continued disappointment in European data, where for example, German IP was released at a worse than expected -7.3%Y/Y this morning.  Given the increasingly rapid spread of Covid infections throughout Europe, with more than 300K new infections reported yesterday, and the fact that essentially every nation in the EU is going back on lockdown for the month of November, it can be no surprise that bond yields here are falling.  Prospects for growth and inflation remain bleak and all the ECB can do is buy more bonds.

On the commodity front, oil is slipping again today, down around 3% as the twin concerns of weaker growth and potentially more supply from OPEC+ weigh on the market.  Gold however, had a monster day yesterday, rallying 2.5%, and is continuing this morning, up another 0.3%.  This is one market that I believe has much further to run.

Finally, looking at the dollar, it is definitely under pressure overall, although there are some underperformers as well.  For instance, in the G10, SEK (+0.6%), CHF (+0.5%) and NOK (+0.5%) are all nicely higher with NOK being the biggest surprise given the decline in oil prices.  The euro, too, is performing well, higher by 0.45% as I type.  Arguably, this is a response to the idea that Powell’s discussion of buying longer tenors is a precursor to that activity, thus easier money in the US.  However, the Commonwealth currencies are all a bit softer this morning, led by AUD (-0.15%) which also looks a lot like a profit-taking move, given Aussie’s 4.2% gain so far this week.

In the emerging markets, APAC currencies were all the rage overnight, led by IDR (+1.2%) and THB (+0.95%) with both currencies the beneficiaries of an increase in investment inflows to their respective bond markets.  But we are also seeing the CE4 perform well this morning, which given the euro’s strength, should be no surprise at all.  On the flipside, TRY (-1.2%) continues to be the worst performing currency in the world, as its combination of monetary policy and international gamesmanship is encouraging investors to flee as quickly as possible.  The other losers are RUB (-0.5%) and MXN (-0.3%), both of which are clearly feeling the heat from oil’s decline.

This morning, we get the payroll data, which given everything else that is ongoing, just doesn’t seem as important as usual.  However, here is what the market is looking for:

Nonfarm Payrolls 593K
Private Payrolls 685K
Manufacturing Payrolls 55K
Unemployment Rate 7.6%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.7
Participation Rate 61.5%

Source: Bloomberg

You may recall that the ADP number was much weaker than expected, although it was buried under the election news wave.  I fear we are going to see a decline in this data as the Initial Claims data continues its excruciatingly slow decline and we continue to hear about more layoffs.  The question is, will the market care?  And the answer is, I think this is a situation where bad news will be good as it will be assumed the Fed will be that much more aggressive.

As such, it seems like another day with dollar underperformance is in our future.

Good luck, good weekend and stay safe
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