Outrageous

The ECB’s fin’lly decided
That limits were badly misguided
So, starting today
All bonds are in play
To purchase, Lagarde has confided

As well, in the Senate, at last
The stimulus bill has been passed
Amidst all its pages
The Fed got outrageous
New powers, and hawks were aghast

Recent price action in risk assets demonstrated the classic, ‘buy the rumor, sell the news’ concept as equity market activity in the past two sessions had been strongly positive on the back of the anticipated passage of a huge stimulus bill in the US. And last night, the Senate finally got over their procedural bickering and hurdles and did just that. As such, it should be no great surprise that risk assets are under pressure today, with only much less positive news on the horizon. Instead, we can now look forward to death tolls and bickering about government responses to the quickly evolving crisis. If that’s not a reason to sell stocks, I don’t know what is!

But taking a break from descriptions of market activity, I think it is worthwhile to discuss two other features of the total government response to this crisis. And remember, once government powers are enacted, it is extremely difficult to remove them.

The first is from the US stimulus bill, where there is a $500 billion portion of the bill that is earmarked for support of the business community. $75 billion is to go to shore up airlines and the aerospace infrastructure, but the other $425 billion is added to the Treasury’s reserve fund which they can use to backstop, at a 10:1 leverage ratio, Fed lending. In other words, all of the programs about which we have been hearing, including the CP backstop, the primary dealer backstop, and discussion of purchases of municipal and corporate bonds as well as even equities, will now have the funding in place to the tune of $4.25 trillion. This means that we can expect the Fed balance sheet to balloon toward at least $9 trillion before long, perhaps as quickly as the end of the year. Interestingly, just last year we consistently heard from mainstream economists as well as Chairman Powell and Secretary Mnuchin, how Modern Monetary Theory (MMT) was a crock and a mistake to consider. And yet, here we are at a point where it is now the best option available and about to effectively be enshrined in law. It seems this crisis will indeed be quite transformational with the death of the Austrian School of economics complete, and the new math of MMT at the forefront of the dismal science.

Meanwhile, Madame Lagarde could not tolerate for Europe to be left behind in this monetary expansion and so the ECB scrapped their own eligibility rules regarding purchases of assets to help support the Eurozone member economies. This means that the capital key, the guideline the ECB used to make sure they didn’t favor one nation over another, but rather executed their previous QE on a proportional basis relative to the size of each economy, is dead. This morning the ECB announced that they can buy whatever they please and they will do so in size, at least €750 billion, for the rest of this year and beyond if they deem it necessary. This goes hand in hand with the recent German repudiation of their fiscal prudence, as no measure is deemed unreasonable in an effort to fight Covid-19. In addition to this, the OMT program (Outright Monetary Transactions) which was created by Signor Draghi in the wake of the Eurozone bond crisis in 2012 but never utilized, may have a new lease on life. The problem had been that in order for a country (Italy) to avail themselves of the ECB hoovering up their debt, the country needed to sign up for specific programs aimed at addressing underlying structural problems in said country. But it seems that wrinkle is about to be ironed out as well, and that OMT will finally be utilized, most likely for Italian bonds.

While neither the Fed nor ECB will be purchasing bonds in the primary market, you can be sure that is not even remotely a hindrance. In fact, buying through the secondary market ensures that the bank intermediaries make a profit as well, another little considered, but important benefit of these programs.

The upshot is that when this crisis passes, and it will do so at some point, governments and central banks will have even more impact and control on all decisions made, whether business or personal. Remember what we learned from Milton Friedman, “nothing is so permanent as a temporary government program.”

Now back to market behavior today. It is certainly fair to describe the session as a risk-off day, with equity markets have been under pressure since the beginning of trading. Asia was lower (Nikkei -4.5%, Hang Seng -0.75%), Europe has been declining (DAX -2.3%, CAC -1.8%, FTSE 100 -2.1%) and US futures are lower (SPU’s -1.4%, Dow -1.0%). Meanwhile, Treasury yields have fallen 6bps, and European government bonds are all rallying on the back of the ECB announcement. After all, the only price insensitive buyer has just said they are coming back in SIZE. Commodity prices are soft, with WTI falling 2%, and agriculturals softer across the board although the price of gold continues to be a star, as it is little changed this morning but that means it is holding onto its recent 11% gain.

And finally, in the FX markets, while G10 currencies are all looking robust vs. the dollar, led by the yen’s 1.2% gain and Norway’s continued benefit from recent intervention helping it to rally a further 0.75%, EMG currencies are more mixed. ZAR is the worst of the day, down 0.9% as an impending lockdown in the country to fight Covid-19, is combining with its looming credit rating cut to junk by Moody’s to discourage buying of the currency. We’ve also seen weakness in an eclectic mix of EMG currencies with HUF (-0.35%), KRW (-0.25%) and MXN (-0.2%) all softer this morning. In fairness, the peso had a gangbusters rally yesterday, jumping nearly 3.5%, so a little weakness is hardly concerning. On the plus side, APAC currencies are the leaders with MYR, IDR and INR all firmer by 1.2% on the strength of their own stimulus (India’s $22.6 billiion package) or optimism over the impact of the US stimulus.

Perhaps the biggest thing on the docket this morning is Initial Claims (exp 1.64M) which would be a record number. But so you understand how uncertain this forecast is, the range of forecasts is from 360K to 4.40M, so nobody really has any idea how bad it will be. My fear is we will be worse than the median, but perhaps not as high as the 4.4M guess. And really, that’s the only data that matters. The rest of it is backward looking and will not inform any views of the near future.

We have seen two consecutive days of a risk rally, the first two consecutive equity rallies in more than a month, but I expect that there are many more down days in our future. The dollar’s weakness in the past two sessions is temporary in my view, so if you have short term receivables to hedge, now is a good time. One other thing to remember is that bid-ask spreads continue to be much wider than we are used to, so do not be shocked when you begin your month-end balance sheet activity today.

Good luck and stay safe
Adf

 

Many a Penny

The stock market had been for many
A place to make many a penny
But lately they’ve seen
Bright red on their screen
It’s best if they practice their zen (ny)

Meanwhile though the Fed seems quite clear
A rate cut will not soon appear
The market is stressing
And Jay will be pressing
For twenty-five quite soon this year

It’s not clear to me whether the top story is the dramatic decline in global stock markets or the increasing spread of Covid-19. Obviously, they are directly related to each other, and one would have to assume that the causality runs from Covid to stocks, but if you read the paper, stocks get top billing. Coming a close second is the bond market, where 10-year Treasury yields (1.20%) have hit new historic lows every day since Tuesday while discussion of other markets takes a back seat. And, oh yeah, it looks like Turkey and Russia might go to war in Syria!

As is often written, the two great drivers of financial markets are fear and greed. Greed leads to FOMO, which is a pretty solid description of what we have seen, at least in the US equity markets, since 2009. Fear, however, is what happens when excessive greed, also known as complacency, meets the notorious black swan, in this case, Covid-19. And historically, the longer the period of greed, the sharper is fear’s retaliation. With equity markets around the world having fallen by 10% or more this week, there is no question that we could have a session or two where things steady. And given what the futures market is now pricing with respect to central bank activity, it seems reasonable that the market will respond positively to those imminent actions. But I fear that there is a lot of excess in this market, and that stock prices everywhere can fall much further before this is all done.

Let’s look at futures market pricing for central banks this morning vs. last week and last month. This is the number of 25bp rate cuts priced by the end of 2020:

Country Feb 28 Feb 21 Jan 31
US 3.5 1.8 2.0
Canada 2.5 1.6 1.4
Eurozone (10 bps) 1.3 0.7 0.6
UK 1.5 0.8 1.1
Australia 2.1 1.5 1.5
Japan (10 bps) 1.3 0.8 0.8

Source: Bloomberg

Part of the difference is the fact that only the US and Canada have room for more than 2 cuts before reaching the zero-bound, but the market is screaming out for central banks to come to the rescue. This should be no surprise as central banks have been doing this since 1987 when Chairman Greenspan, the maestro himself, stepped in after Black Monday and said he would support markets. It is a little bit late for central bankers to complain that they cannot help things given their actions, around the world, for the past thirty years, which has really stepped up since the financial crisis in 2008. At this point, if equity markets crater this morning in the US (and futures are pointing that way with all three indices currently lower by 1.3%), I expect an “emergency rate cut” by the Fed before stock markets open on Monday. One man’s view.

So how about the dollar? What is happening there? Well, the dollar is having a mixed session this morning, stronger vs. a number of emerging market currencies, as well as Aussie and Kiwi, but weaker vs. the yen and Swiss franc, and a bit more surprisingly, vs. the euro. The euro is an interesting case, and a situation we have seen before.

Consider, if you were a hedge fund investor and looking to fund positions. Where would you seek to fund things? Clearly, the currency with the lowest interest rates is the place to start. Now, knowing the history of the Swiss franc, and the fact that it is not that large a market, CHF is likely not a place to be. But euros, on the other hand, were a perfect funding vehicle, hugely liquid and negative interest rates. And that is what we saw for months and months, hedge funds shorting euro and buying MXN, INR, ZAR and any other currency with real yield. Well, now in the panic situation currently engulfing markets, these positions are being closed rapidly, and that means that hedge funds are aggressively buying euros while selling those other currencies. Hence, the euro’s performance this week has been relatively stellar, +1.35%, although it has recently backed off its highs this morning and is now unchanged on the day.

And where did we see this before? Prior to the financial crisis in 2008, JPY was the only currency that had zero interest rates and was the funding currency of choice for the hedge fund community. Extremely large yen shorts existed vs. the same high yielding currencies of today. And when the crisis struck, hedge funds were forced to buy yen as well as dollars driving it much higher. This was the genesis of the yen as a haven asset, although its consistent current account surplus has done a lot to help the story since then.

As to the rest of the FX market today, yen is the top performer, +0.75%, and CHF is also ahead of the game, +0.2%, but the rest of the G10 is under pressure. The laggard is NZD (-1.1%) as the first Covid-19 case was identified there and markets anticipate the RBNZ to cut rates soon. In the EMG space, with oil crashing again (WTI -2.6%), it is no surprise to see RUB (-1.5%) and MXN (-1.0%) lower. But today’s worst performing EMG currency is IDR (-2.05%) after the first Covid cases were identified and talk of rate cuts there circulated. Interestingly, CNY has been a solid performer today, rising 0.3%, although remember, it is under tight control by the PBOC.

On the data front today we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (1.7%), Chicago PMI (46.0) and Michigan Sentiment (100.7). While PCE had been the most important data in the past, I think all eyes will be on the Chicago and Michigan numbers, as they are forward looking. Also, of tremendous interest to the market will be tonight’s China PMI data, with estimates ranging from 30.0 to 50.0. My money is on the low side here.

Two things argue for a bounce in equities in the US today, first, simply the fact that they have fallen so much in such a short period of time and a trading bounce is due. But second, given their significant decline, portfolio rebalancing is likely to see buyers today, which can be quite substantial in the short run. But a bounce is just that, and unless we see dramatic central bank activity by Monday, I anticipate we are not nearly done with this move.

Good luck and good weekend
Adf

Rate Cuts They May Soon Espouse

The Chairman explained to the House
The virus could truthfully dowse
Their growth expectation
As well as inflation
Thus rate cuts they may soon espouse

Chairman Powell testified before the House Financial Services Committee yesterday and there were absolutely no surprises. According to him, the economy remains in a “good place” and current policy settings are appropriate. He did, however, explain that the coronavirus outbreak in China did pose a new risk to their forecasts and has added significant uncertainty overall. He also left no doubt that in the event the economic data started to turn lower due to virus linked issues (or arguably any other issues), the Fed was ready to act as appropriate to support the economy. In other words, they will cut rates in a heartbeat if they think their targets are in danger of being missed. In the meantime, they continue to buy $60 billion of T-bills each month and will do so at least until April, and they continue to expand the balance sheet further via term repos, pumping ever more liquidity into the system and ultimately supporting global equity markets.

If you think about it, that is really what defines the market these days. It is the battle between questions and fears over the spread of the coronavirus and its negative impacts on Chinese and global economic activity vs. central bank largesse and the positive impacts of ever more cash being created and seeking a home by investors. And let’s face it, up until now; except for two days in late January, bookending the Lunar New Year when equity markets fell sharply, the central banks have been dominant.

Will they continue to have success? At this point, there is no reason to believe they won’t in the short run, but ultimately, it will depend on just how deep the shock to China’s economy actually turns out to be. Remember, a key discussion point about China prior to the virus outbreak was the fragility of a large swathe of Chinese industries given their highly leveraged stance. While I imagine we will never learn the true extent of how much the economy there slows, analysts will infer a great deal based on how many companies wind up failing, or at least restructuring their debt. As I have said before, interest remains due even when revenues cease to occur. But for now, the market is backing Powell and his central bank comrades and thus risk appetite continues to grow.

Thus, turning out attention to this morning’s market activity, equity markets are in the green everywhere after solid overnight performance in Asia. Haven assets, notably Treasuries and the yen, are under pressure, and overall, the dollar is on its back foot.

Last night, the RBNZ left rates on hold at 1.0% and explained that while the virus could well have a longer term negative impact, for now, they see no reason to cut rates any time soon. Interest rate markets, which had been pricing in a 40% probability of a rate cut this year, rebalanced to no rate changes and the kiwi dollar jumped 1.2%. Not surprisingly, Aussie is also performing well, up 0.5%, as investors recognize that the two nations are inextricably linked economically, and if New Zealand is feeling better, odds are Australia will be soon as well.

Last night the Swedish Riksbank also left rates on hold, at 0.0%, as widely expected, despite lowering their inflation expectations. You may recall Sweden raising rates by 25bps in December as they sought to exit the NIRP world after concluding it was doing more harm than good. While lowered inflation expectations might seem a reason to reduce rates, the fact that the catalyst for that has been the sharp decline in energy prices due to the virtual closure of China’s economy, allows Riksbank members to cogently make the case that this is a temporary shock, and they need to look through it. This morning, SEK is firmer by 0.2% vs. the dollar after the Riksbank announcement. NOK is higher by 0.4% as oil prices firm up again on a more positive general tone, and the pound is higher by 0.2% as it continues its rebound from last week’s sharp decline, and there was nothing new from the PM regarding a hard Brexit.

You may have noticed that I failed to mention the euro, which is essentially flat on the day, arguably the second biggest underperformer vs. the dollar. Early in the session, it too was firmer as the dollar has few friends during a risk-on session, but then they released Eurozone IP at -2.1%, worse than expected and the worst print in four years. Subsequent trade saw more sellers emerge, weighing on the single currency, which has been under pretty steady pressure for the past week and a half. Madame Lagarde testified to the European Parliament yesterday and basically begged countries to step up their fiscal response as it becomes ever clearer that the ECB has no more bullets.

In the emerging markets, the Russian ruble is the leader of the pack, up 0.5%, also benefitting from oil’s rebound from the lows seen earlier this week. Away from this, there are far more gainers in the space (CLP +0.4%, THB +0.35%, ZAR +0.3%) than losers (TRY -0.4%, HUF -0.3%), but as you can see by the magnitude of the movements, there is not much of interest ongoing. Ultimately, as long as the risk-on attitude prevails, I expect the higher yielding currencies (ZAR, MXN, INR, etc.) should perform well as investors continue to hunt for yield.

There is no data to be released today, but we do hear Chairman Powell in front of the Senate, as well as some comments from Philly Fed President Patrick Harker, arguably one of the more centrist FOMC members. Yesterday’s comments from the bevy of doves who were on the tape were just as expected. Things are fine, but more accommodation is available and if inflation were to rise, they would be comfortable with letting it run hot for a while before acting.

And that’s really all there is. I see no reason for the dollar to change its current trajectory, which is modestly lower this morning. And since we already know what Powell is going to say, unless some Senator pins him down on something, I suspect we will see yet another day of limited movement overall.

Good luck
Adf

 

Til All Is Clear

There’s certainly no need to fear
A global pandemic is here
Cause central banks will
Continue to fill
Their balance sheets ‘til all is clear

Once again, investors and traders (and algorithms) have surveyed the landscape, read the government reports, and determined that there’s nothing to see in China and that any impact on economic output from the still spreading coronavirus is diminishing and unimportant in the long run. And who knows, maybe that is the correct attitude. Perhaps all the worrywarts are just that, hanging their hat on the latest potential problem while ignoring how fantastic things are right in front of them.

Or…maybe things are not quite as rosy as government officials would have you believe and the impact on economic output is going to be much more severe than anyone is willing to admit at this time. In fairness, ruling governments are pretty unlikely to release bad news to their constituents for obvious reasons. In fact, this is what causes cover-ups all the time, and why the fallout, when the truth eventually does reveal itself, is so devastating for that government. Added to this reality is that the veracity of information that emanates from China has been called into question for many years, so it is quite easy to believe that the official coronavirus figures are not accurate.

With that in mind, I urge everyone to read the attached link (https://www.epsilontheory.com/body-count/) as Dr. Ben Hunt does a very effective job (far more effective than I ever could) of explaining just how the numbers can be massaged to indicate a slowing rate of infection that ‘seems’ believable, but is in fact complete hogwash. However, as long as this is the official line, and it defines the data that is reported, then trading algorithms will utilize the data and trade accordingly. Right now, any slowdown in reported deaths is clearly seen as a sign that the worst is behind us and with all the monetary stimulus still sloshing around the system, risk needs to be acquired. And that is what we are seeing again today. Clearly, last Friday was an aberration, though when it comes to equities these days, caveat emptor!

Taking this into account, let’s take a tour of markets this morning to see how things are doing. Risk is clearly in favor as equity markets around the world continue to rally following yesterday’s record-setting session in the US. While Japan was closed for National Foundation Day, the rest of Asia rallied pretty nicely with the Hang Seng rising 1.25% and Shanghai + 0.4%. European markets have followed suit (DAX +0.85%, CAC +0.45%, FTSE100 +0.85%) and US futures are all pointing higher as well. Bond markets are on the soft side, although hardly collapsing as 10-year yields in the US are trading at 1.58% as I type, and the dollar is arguably a bit softer rather than firmer this morning. In fact the only two currencies weaker than the dollar this morning are the Swiss franc and Japanese yen, although each has declined by less than 0.10%.

The UK has been the source of the most new information as there was a significant data dump, almost all of which was seen as a positive for the UK, and by extension the pound. Q4 GDP printed at 0.0%, as expected, but the December number was a better than expected 0.3% and the Y/Y number did not fall as expected, but instead printed unchanged at 1.1%. Now, while these are hardly stellar numbers in the broad scheme of things, they are substantially better than the Eurozone story, and more importantly, better than expectations. Exports rose 4.1%, the Trade Balance ticked into a ₤845M surplus, which is actually the largest surplus in the series’ history dating back to 1955! While IP was a little softer than expected at +0.1%, the overall picture was of a UK that is prepared to weather Brexit quite well. And the pound is slightly higher on the day, but just 0.15%.

Rather, the two biggest gainers in the G10 today are NOK (+0.4%) and AUD (+0.3%). The former is benefitting from the rebound in oil on the back of the idea that the coronavirus problem has passed its peak, and the latter is benefitting on the same idea. In fact, all the currencies that have been negatively impacted by the coronavirus story, mostly commodity exporting countries like Australia, Brazil and South Africa, are higher this morning on this idea that things are going great in China. I sure hope that’s the case, but I remain a skeptic.

Today’s other noteworthy event will be the testimony by Chairman Powell to the House Financial Services Committee, starting at 10:00. I’m sure his prepared remarks will simply rehash that the economy is in a good place and that the Fed remains vigilant. He is also likely to mention that the virus is a potential risk to the economy, but one that they feel confident they can handle. (After all, cutting rates and printing money seems to be the cure for everything under the sun.) However, given the distinct lack of financial and economic nous that our duly elected Representatives have continuously shown they possess, I think the Q&A will be more interesting, although ultimately I imagine that Powell will simply have to explain his opening statement in more simplistic terms for them to understand.

We have already seen the NFIB Small Business Optimism Index rise to 104.3, a better than expected outcome and certainly a positive fillip to the risk attitude. Right when Powell begins to speak we will see the JOLTs Jobs Report as well (exp 6.925M) which many see as an important indicator of labor market conditions. In addition to Powell, we will hear from SF Fed President Daly as well as Quarles, Bullard and Kashkari, amongst the most dovish of all Fed members, and so be prepared for more discussion of allowing inflation to run hot and the need for quick action in the event the currently reported Chinese data is not complete.

Overall, the dollar is under very modest pressure today, but it would be fair to call it unchanged in the broad scheme of things. Unless Powell makes a gaffe, something which seems less and less likely given his experience now, as long as risk is being acquired, I think EMG currencies are likely to perform well, but vs. the G10, the dollar may maintain its recent momentum.

Good luck
Adf

Sanguinity Reigns

Despite growth in Chinese infections
And turmoil in Irish elections
Sanguinity reigns
As Powell takes pains
To help prevent any corrections

Once upon a time, people used to describe the President of the United States as ‘the most powerful man in the world’, on the back of the idea that he oversaw the richest and most powerful nation in the world. But these days, it has become pretty clear that the most powerful man in the world is Fed Chairman Jerome Powell. After all, not only is he in command of the US economy, but he is tasked with shielding us all from the impacts of non-financial issues like the coronavirus and climate change. And many people believe, not only can he do that, but it is imperative that he stops both of those things in their tracks.

And yet, the coronavirus continues to spread as virologists and doctors learn more about it each day and seemingly continue to fall further behind the curve. For example, initially, it had been believed that the incubation period for the virus was 14 days, implying that was an appropriate amount of time for any quarantine of suspected cases. But now, the data is showing it may be as long as 24 days, which means that formerly quarantined individuals who were cleared, may actually be infected, and thus the spread of the disease accelerated. As of this morning, more than 40,000 cases have been documented with more than 900 deceased. The human toll continues to rise, and quite frankly, shows no signs of abating yet. Stories of complete lockdowns of cities in Hubei province, where people were literally welded shut inside their homes to enforce the quarantine, and videos showing large scale disinfectant spraying are remarkable, as well as horrifying. And none of this leads to greater trust in the official information that is published by the Chinese government. In other words, this situation is by no means coming to an end and the impacts on economies worldwide as well as financial markets are just beginning to be felt.

From an economic perspective, China has largely been shut for nearly three weeks now, since the beginning of the Lunar New Year holiday in January, which means that all those companies that had built supply chains that run through China while implementing just-in-time delivery have found themselves with major problems. Hubei province is a key center for automotive, technology, pharmaceutical and chemical production. Major global firms, like Foxconn, PSA (Peugeot), Honda and others have all seen production elsewhere impacted as parts that come from the area are no longer being delivered. In fact, Hyundai Motors has closed its operations in South Korea for lack of parts supply. My point is, the economic impact is going to be very widespread and likely quite significant. While there is no way to accurately assess that impact at this time, simple math implies that the fact China will have essentially been closed for 25% of Q1, at least, means that GDP data will be severely impacted, arguably by at least a full percentage point. And what about highly leveraged companies? Interest is still due even if they are not selling products and earning revenue. Trust me; things will get worse before they get better.

And yet…financial markets remain remarkably nonplussed over the potential ultimate impact of this. Yes, equity markets slipped on Friday, but a 0.5% decline is hardly indicative of a significant amount of fear. And overnight, while the Nikkei (-0.6%) and Hang Seng (-0.6%) both fell, somehow the Shanghai Composite rose 0.6%. Yes, the PBOC injected more stimulus, but there is a remarkable amount of faith that the impact of this virus is going to be completely transitory. That seems like a big bet to me, and one with decidedly ordinary odds.

European markets are in the same space, with very modest declines (DAX -0.25%, CAC -0.3%, FTSE -0.15%) and US futures are now little changed to higher. Apparently, economic growth is no longer an important input into the valuation of equities.

And that is the crux of the matter. Since the financial crisis in 2008-09, central banks around the world have, in essence, monetized the entire global economy. If growth appears to be slowing they simply print more cash. If things are going well, they also simply print more cash, although perhaps not quite as much as in the case of a slowdown. And companies everywhere, at least large, listed ones, borrow as much as possible to restructure their balance sheets, retiring equity and increasing leverage. Alas, that does not foster economic activity, and ultimately, that is the gist of the disconnect between financial market strength and the ongoing growth of populist and nationalist political parties. Welcome to the 2020’s.

So, with all that said, risk is modestly off this morning, but by no means universally so. Yes, Treasury yields are lower, down another basis point to 1.57%, but that does not speak to unmitigated fear. And in the currency market, the impact of the overnight story has been largely muted. In fact, the biggest mover today has been Norwegian krone, which has rallied 0.75% after its inflation data surprised on the high side (CPI +1.8% Y/Y in January) which has helped convince traders that Norway may be inclined to tighten policy going forward. While I don’t see that outcome, it likely takes any rate cuts off the table for the immediate future. But elsewhere in the G10, the pound’s modest 0.3% rally is the next largest move, and that has all the earmarks of a simple trading rebound after a 2.5% decline last week. Otherwise, this space has been dull, and looks set to remain so. In the EMG bloc, the picture is mixed as well, with CLP weakening furthest, -0.55% on the open, as traders bet on policy ease by the central bank, while we have seen a series of currencies, notably CNY, rally a modest 0.3%, as fears abate over a worsening outcome from the virus.

This week’s upcoming highlight is likely to be Fed Chair Powell’s testimony to the House and Senate, but we do see both CPI and Retail Sales data late in the week as well.

Tuesday NFIB Small Biz Optimism 103.3
JOLTS Job Openings 6.85M
Powell House Testimony
Wednesday Powell Senate Testimony
Thursday CPI 0.2% (2.4% Y/Y)
-ex food & energy 0.2% (2.2% Y/Y)
Initial Claims 211K
Friday Retail Sales 0.3%
-ex autos 0.3%
IP -0.2%
Capacity Utilization 76.8%
Michigan Sentiment 99.3

Source: Bloomberg

Aside from Powell’s two days in the spotlight, there will be eight other Fed speakers as well, with my guess being that all the interest will be regarding the impact of the virus. So far, there is no indication that the Fed is ready to react, but it also seems abundantly clear that they will not hesitate to cut rates again in the event that things rapidly deteriorate on that front. Ultimately, the dollar remains extremely well bid as the bid for Treasuries continues to drive flows, but nothing has changed my medium term view that the dollar will eventually weaken on the back of Not QE4.

Good luck
Adf

Strength in Their Ranks

Around the world, all central banks
Are to whom we need to give thanks
By dint of their easing
All shorts they are squeezing
Who knew they’d such strength in their ranks?

Every day that passes it becomes clearer and clearer that central banks truly are omnipotent. Not only do they possess the ability to support economies (or at least stock markets), but apparently, easing monetary policy cures the coronavirus infection. Who knew they had such wide-ranging powers? At least that is certainly the way things seem if you look through a market focused lens.

Let’s recap:

Date # cases / # deceased S&P 500 Close 10-Year Treasury EURUSD USDJPY
31 Dec 1 / 0 3230 1.917% 1.1213 108.61
6 Jan 60 / 0 3246 1.809% 1.1197 108.37
10 Jan 41 / 1 3265 1.82% 1.1121 109.95
20 Jan 219 / 3 3320 1.774% 1.1095 110.18
22 Jan 500 / 17 3321 1.769% 1.1093 109.84
24 Jan 1320 / 41 3295 1.684% 1.1025 108.90
28 Jan 4515 / 107 3276 1.656% 1.1022 109.15
30 Jan 7783 / 170 3283 1.586% 1.1032 108.96
3 Feb 17,386 / 362 3248 1.527% 1.1060 108.69
4 Feb 24,257 / 492 3297 1.599% 1.1044 109.59

Sources: https://www.pharmaceutical-technology.com/news/coronavirus-a-timeline-of-how-the-deadly-outbreak-evolved/and Bloomberg

Now obviously, they are not actually creating a medical cure for this latest human affliction (I think), but once it became clear that the coronavirus was going to have a significant impact on the Chinese, and by extension, global economies, they jumped into action. While it was no surprise that the PBOC immediately eased policy to head off an even larger stock market rout upon the (delayed) return from the Lunar New Year holidays, I think there was a larger impact from Chairman Powell, who at the Fed press conference last week, made it clear that the Fed stood ready to react (read cut rates) if the coronavirus impact expanded. And then, just like that, the coronavirus was relegated to the agate type of newspapers.

What is really amazing is how the narrative has been altered from, ‘oh my gosh, we are on the cusp of a global pandemic so sell all risky assets’ to ‘the flu is actually a much bigger problem globally and this coronavirus is small potatoes and will be quickly forgotten, so buy those risky assets back’.

The point here is that market players lead very sheltered lives and really see the world as a binary function, is risk on or is risk off? And as long as the central banks continue to assure traders and investors that they will do whatever it takes to prevent stock markets from declining, at least for any length of time, those central banks will continue to control the narrative.

So, with that as preamble, what is new overnight? In a modest surprise, at least on the timing, the Bank of Thailand cut rates by 25bps to a record low 1.00%. The stated reason was as a prophylactic to prevent economic weakness as the coronavirus spreads. Too, the MAS explained that they have plenty of room to ease policy further (which for them means weakening the SGD) if they deem the potential coronavirus impacts to call for such action. It should be no surprise that SGD is today’s weakest link, having fallen 0.75% but we also saw immediate weakness in THB overnight, with the baht falling nearly 1.0% before a late day recovery on the back of flows into the Thai stock exchange. As to the rest of the EMG space, PHP is also modestly weaker after the central bank there indicated that they would cut rates as needed, but we have seen more strength across the space in general. RUB is leading the pack, up 0.8% on the back of a strong rebound in oil prices (WTI +2.3%), but we are also seeing strength throughout LATAM as CLP (+0.7%), BRL (+0.55%) and MXN (+0.4%) all rebound on renewed risk appetite. ZAR has also had a banner day, rising 0.7% on the positive commodity tone to markets.

In the G10 space, things are a bit less interesting. It should be no surprise that AUD is the top performer, rising 0.4%, as it has the strongest beta relationship to China and risk. NOK is also gaining, +0.25%, with oil’s recovery. On the other side of the blotter, CHF (-0.3%) and JPY -0.15%, but -1.0% since yesterday morning) are taking their lumps as haven assets no longer hold appeal to the investment community. This idea has been reinforced by the 10-year Treasury, which has seen its yield rise from 1.507% on Friday to 1.63% this morning.

And don’t worry, your 401K’s are all green again today with equity markets around the world back on the elevator to the penthouse.

Turning to today’s US session, we start to get some more serious data with ADP Employment (exp 157K), the Trade Balance (-$48.2B) and ISM Non-Manufacturing (55.1). Earlier this morning we saw Services PMI data from both Europe and the UK. Eurozone PMI data was mixed (France weak and Italy strong), while the UK saw a strong rebound. We also saw Eurozone Retail Sales, which were quite disappointing, falling 1.6% in December, and seemingly being the catalyst for the euro’s tepid performance today, -0.2%. Remember, Monday’s US ISM data was much better than expected, and there is no question that the market is willing to believe that today’s data will follow suit.

In sum, continued strong performance by the US economy, at least relative to its peers, as well as the working assumption that should the data start to falter, the Fed will be slashing rates immediately, will continue to support risk assets. At this point, that seems to be taking the form of buying high yield currencies (MXN, ZAR, INR) while buying the dollar to increase positions in the S&P500 (or maybe just in Tesla ). As such, I look for the dollar to hold its own vs. the bulk of the G10, but soften vs. much of the EMG bloc.

Good luck
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Just Look What You’ve Wrought!

On Monday it seems we all thought
That crises were sold and not bought
On Tuesday we learned
Those sellers got burned
Chair Powell; just look what you’ve wrought!

hubris: noun
hu·bris | \’hyü-brƏs \
Definition of hubris : exaggerated pride or self-confidence
Example of hubris in a sentence
//It takes remarkable hubris to survey the ongoing situation regarding the 2019-nCoV virus and decide that Monday’s 1.5% decline in the S&P 500 was a buy signal.

I saw a note on Twitter this morning that really crystalized the current market condition. All prices are based on flow, not value. It is a fool’s errand to try to determine what the underlying value of any financial asset is these days, as it has no relevance regarding the price of that asset. This is most evident in the equity markets, but is equally true in the currency markets as well. So for all of us who are trying to determine what possible future paths are for market movements, the primary focus should be on how favored they are, for whatever reason, compared to the rest of the investment universe. In fact, this is the key outcome of the financialization of the global economy. And while this is just fine, maybe even great, when flows are driving equity prices, and other assets, higher, it will be orders of magnitude worse going the other way.

But the bigger issue is the financialization of the economy. Prior to the financial crisis and recession of 2008-2009, there seemed to be a reasonable balance between finance and production within the global economy. In other words, financial questions represented a minority of the impact on how companies were managed and on how much of anything was produced. This balance, which I would have put at 80% production / 20% finance, give or take a nickel, was what underpinned the entire economics profession. Finance was simply a relatively small part of every productive endeavor with the goal of insuring production could continue.

But in the wake of that recession, the fear of allowing massively overpriced markets to actually clear resulted in central banks stepping in and essentially taking over. The initial corporate reaction was to take advantage of the remarkably low interest rates and refinance their businesses completely. The problem was that since markets never cleared, there was still a dearth of demand on an overall basis. This is what led to a decade of subpar growth. Remember, the average annual GDP growth in the decade following the GFC was about 1.5%, well below the previous decade’s 3.0%. At the same time, the ongoing shortening of attention spans, especially for investors, forced corporate management to figure out how to make more money. Unfortunately, the fact that slow GDP growth prevented an actual increase in profits forced senior management to look elsewhere. And this is when it quickly became clear that levering up corporate balance sheets, while ZIRP and NIRP were official policy, made a great deal of sense. If a company couldn’t actually make more money, it sure could make it seem that way by issuing debt and buying back stock, thus reducing the denominator in the key metric, EPS.

And that is where we are today, in an economy that continues to grow at a much slower pace than prior to the financial crisis, but at the same time allows ongoing growth in a key metric, EPS, through financial engineering.

Which brings me back to the idea of flow. It is financial flows that determine the future paths of all assets, so the more money that is made available by the central banking community (currently about $100 billion per month of new cash), the higher the price assets will fetch. Let me say that they better not stop providing that new cash anytime soon.

With that as a (rather long) preamble, today’s market discussion is all about the Fed. This afternoon at 2:00 we will get the latest communique and then Chairman Powell will meet the press at 2:30. Current expectations are for no policy changes although there seems to be a growing view that the ongoing coronavirus situation, and its likely negative impact on Chinese/global GDP growth, will force a more dovish hue to both the statement and the press conference. Remember, the Fed is currently going through a major policy review, similar to that of the ECB, as they try to determine what tools are best to manage the economy achieve their mandated goals going forward. Given that ongoing policy review, it would take a remarkable catalyst to drive a near-term policy change, and apparently a global pandemic doesn’t rise to that standard.

Oh yeah, what about that coronavirus? Well, the death toll is now above 130, and the number of cases is touching 10,000, far more than seen in the SARS outbreak of 2003. (And I ask, if so many are skeptical of Chinese economic data, why would we believe that this data is accurate, especially as it would not reflect China in a positive light?) At any rate, while the Hang Seng fell sharply last night, its first session back since last week, the rest of the global equity market seems pretty comfortable. And hey, Apple earnings beat big time (congrats), so all is right with the world!!

What will this do to flows in the FX market? Broadly speaking, the dollar continues to see small gains vs. its G10 brethren as US rates remain the highest around. Granted Canadian rates are in the same place, but with oil’s recent decline, and growing concern over the housing bubble in Canada’s main cities, it seems like the dollar is safer to earn those rates. At the same time, many emerging markets currently carry rates that are far higher than in the US, and what we saw yesterday was significant interest in owning those currencies, especially MXN, RUB, BRL and COP, all of which gained between 0.5% and 1.0% in yesterday’s session. While those currencies have edged lower this morning, the flow story remains the key driver, and if markets maintain their hubris, the carry trade will quickly return.

On the data front, yesterday’s US Consumer Confidence number was much better than expected at 131.6. This morning we saw slightly better than expected GfK Consumer Confidence in Germany (9.9 vs. 9.6 exp) and better than expected French Consumer Confidence (104 vs 102). That is certainly a positive, but it remains to be seen if the spread of the coronavirus ultimately has a negative impact here. Ahead of the Fed, there is no important US data, so we are really in thrall to the ongoing earnings parade until Chairman Powell steps up to the mic. As to the dollar, it continues to perform well, and until the Fed, that seems likely to continue.

Good luck
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