Their Siren Song

The trend ‘gainst the dollar is strong
With bears playing their siren song
As long as real rates
Are in dire straits
‘Twould be a mistake to go long

While there is usually some interesting tidbit on which to focus regarding market behavior that is not specifically FX related, this morning that does not seem to be the case. In fact, today’s most noteworthy story is that the dollar continues to drive lower vs. almost all its counterparts. As there was no specific news or data that appears to be driving other currencies higher, I can only attribute this broad resumption of the dollar downtrend to the fact that real interest rates in the US have turned back lower.

Looking back a few weeks, 10-year US real interest rates (nominal – CPI) bottomed at -1.08% on August 6th. That coincided with the peak price in gold, as well as the euro’s local high. But then Treasury yields began to back up as the bond market started getting indigestion from the Treasury issuance schedule ($316 billion total since then, of which $112 billion were Notes and Bonds.) The problem is that not merely is the size of the issuance unprecedented, but that it shows no signs of slowing down as the government continues to run massive deficits.

At any rate, real yields backed up by 14 basis points in the ensuing week, which resulted in both a sharp correction in the price of gold, and support for the dollar. But it seems that phase of the market may be behind us as Treasury yields have been sliding on both a nominal and real basis, and we have seen gold (and silver) recoup those losses while the dollar has ceded its gains and then some.

At this point, the question becomes, what is driving real yields? Is it fears of rising inflation? Is it hope that the Fed will maintain ultra-easy monetary policy even if the economy recovers strongly? Or is it something else?

Regarding the pace of inflation, while last week’s CPI data was certainly a shock to most eyes, it doesn’t seem as though it is the driver. I only point this out because the nadir in real yields occurred a week before the CPI data was released. Now it is certainly possible that bond investors were anticipating a higher inflation print, but there was absolutely no indication it would be as high as it turned out to be. In fact, based on the CPI release, I would have anticipated real yields to fall further, as the combination of higher inflation and a Fed that is essentially ignoring inflation at the current time is a recipe for further declines there. Remember, everything we have heard from the Fed is that not merely are they unconcerned with inflation, but that they welcome it and are comfortable allowing it to run hotter than their target for a time going forward.

This latter commentary implies that there is not going to be any change in the Fed’s policy stance in the near future either. Rather, Chairman Powell has made it clear that the Fed is going to provide ongoing support and liquidity to the markets economy for as long as they deem it necessary. Oh, and by the way, they have plenty of tools left with which to do so.

If these are not viable explanations for the change in trend, one other possible driver is the vagaries of the ongoing pandemic. Perhaps there is a relationship between increases in infection rates and investor assessments of the future. Logically, that would not be far-fetched, and there is growing evidence that there is a correlation between market behavior and covid news. Specifically, when it appears that covid is in retreat, bond yields tend to rise, and so real rates have been moving in lockstep. As well, when the news indicates that the virus is resurgent, the yield complex tends to head lower. Thus, in a convoluted way, perhaps the dollar bearishness that has become so pervasive is being driven by the idea that the US continues to suffer the most from Covid-19, and as long as that remains the case, this trend will remain intact.

Now, I would not want to base all my trading and hedging decisions on this idea, but it is certainly worth keeping in mind when looking at short-term risk exposures and potential timing to manage them.

But as I said at the top, overall, there is very little of note in the financial press and not surprisingly, market activity has been fairly muted. For example, equity markets in Asia basically finished either side of unchanged on the day (Nikkei -0.2%, Hang Seng +0.1%, Shanghai +0.3%). Europe, which had been largely unchanged all morning has been on a late run and is now nicely higher (DAX +0.9%, CAC +0.6%) and US futures have also edged up from earlier unchanged levels. As discussed, Treasury yields continue to drift lower (-1.5 basis points) and gold is rocking (+1.0% and back over $2000/oz.)

And the dollar? Well, it is definitely on its back foot this morning, with the entire G10 complex firmer led by GBP (+0.5%) on the strength of optimism over the resumption of Brexit talks and JPY (+0.45%) which seems to be benefitting from the ongoing premium for owning JGB’s and swapping back to USD.

In the EMG bloc, RUB (+0.8%) is the leader today, followed by ZAR (+0.7%) and MXN (+0.65%). All of these are benefitting from firmer commodity prices which, naturally are helped by the dollar’s broad weakness. But other than TRY (-0.2%) which has fallen in nine of the past ten sessions as President Erdogan and the central bank undermine the lira, and IDR (-0.3%), which has also seen a string of suffering, but this based on difficulty dealing with Covid effectively, the rest of the bloc is modestly firmer vs. the greenback.

On the data front, this morning brings Housing Starts (exp 1245K) and Building Permits (1326K), which if wildly different than expectations could have a market impact, although are likely to be ignored by traders. Rather, the trend in the dollar remains lower, with the euro actually setting new highs for the move this morning, and until we see a change in the rate structure, either by US real rates rising, or other real rates falling more aggressively, I expect this trend will continue. Hedgers, choose your spots, but don’t miss out.

Good luck and stay safe
Adf

Struck by the Flu

If you think that Jay even thought
‘bout thinking ‘bout thinking he ought
To raise interest rates
He’ll not tempt the fates
Despite all the havoc ZIRP’s wrought

Meanwhile, ‘cross the pond what we learned
Is Germany ought be concerned
Their growth in Q2
Was struck by the flu
As exports, their customers, spurned

(Note to self; dust off “QE is Our Fate” on September 16, as that now seems a much more likely time to anticipate how the Fed is going to adjust their forward guidance.) Yesterday we simply learned that rates are going to remain low for the still indeterminate, very long time. Clearly, the bond market has gotten the message as yields along the Treasury curve press to lows in every tenor out through 7-year notes while the 10-year sits just 1.5 bps above the lows seen in March at the height of the initial panic. This should be no surprise as the FOMC statement and ensuing press conference by Chairman Powell made plain that the Fed is committed to use all their available tools to support the economy. Negative rates are not on the table, yield curve control is already there, effectively, so the reality is they only have more QE and forward guidance left in their toolkit. Powell promised that QE would be maintained at least at the current level, and the question of forward guidance is tied up with the internal discussions on the Fed’s overall policy framework. Those discussions have been delayed by the pandemic but are expected to be completed by the September meeting. Perhaps, at that time, they will let us know what they plan to do about their inflation mandate. The smart money is betting on a commitment to allow inflation to overshoot their target for an extended period in order to make up for the ground lost over the past decade, when inflation was consistently below target. I guess you need to be a macroeconomist to understand why rising prices helps Main Street, because, certainly from the cheap seats, I don’t see the benefit!

The market response was in line with what would be expected, as yields fell a bit further, the dollar fell a bit further and stocks rallied a bit further. But that is soooo yesterday. Let’s step forward into today’s activities.

Things started on a positive note with Japanese Retail Sales jumping far more than expected (+13.1%) in June which took the Y/Y number to just -1.2%. That means that Japanese Retail Sales are almost back to where things were prior to the outbreak. Unfortunately, this was not enough to help the Nikkei (-0.3%) and had very little impact on the yen, which continues to trade either side of 105.00. Perhaps it was the uptick in virus cases in Japan which has resulted in further restrictions being imposed on bars and restaurants that is sapping confidence there.

Speaking of the virus, Australia, too, is dealing with a surge in cases, as Victoria and Melbourne have seen significant jumps. As it is winter in the Southern Hemisphere, there is growing concern that when the weather cools off here, we are going to see a much bigger surge in cases as well, and based on the current government response to outbreaks, that bodes ill for economic activity in the US come the fall.

But then, Germany reported their Q2 GDP data and it was much worse than expected at -10.1%. Analysts had all forecast a less severe decline because Germany seemed to have had a shorter shutdown and many fewer unemployed due to their labor policies where the government pays companies to not lay-off workers. So, if the shining star of Europe turned out worse than expected, what hope does that leave us for the other major economies there, France, Italy and Spain, all of which are forecast to see declines in Q2 GDP in excess of 15%. That data is released tomorrow, but the FX market wasted no time in selling the euro off from its recent peak. This morning, the single currency is lower by 0.35%, although its short-term future will also be highly dependent on the US GDP data due at 8:30.

Turning to this morning’s US data, today is the day we get the most important numbers, as the combination of GDP (exp -34.5%), to see just how bad things were in Q2, and Initial (1.445M) and Continuing (16.2M) Claims, to see how bad things are currently, are to be released at 8:30. After the combination of weak German data and resurgence in virus cases in areas thought to have addressed the issue, it should be no surprise that today is a conclusively risk-off session.

We have seen that in equity markets, where both the Hang Seng (-0.7%) and Shanghai (-0.25%) joined the Nikkei lower in Asia while European bourses are all in the red led by the DAX (-2.3%) and Italy’s FTSE MIB (-2.2%). And don’t worry, US futures are all declining, with all three major indices currently pointing to 1% declines at the open.

We have already discussed the bond market, where yields are lower in the US and across all of Europe as well with risk being pared around the world. A quick word on gold, which is lower by 0.8%, and which may seem surprising to some. But while gold is definitely a long-term risk aversion asset, its day to day fluctuations are far more closely related to the movement in the dollar and today, the dollar reigns supreme.

In the G10 bloc, NOK is the laggard, falling 1.0% as oil prices come under pressure given the weak economic data, but we have seen substantial weakness throughout the entire commodity bloc with AUD (-0.6%) and CAD (-0.57%) also suffering. In fact, the only currency able to hold its own this morning is the pound, which is essentially unchanged on the day. In the EMG bloc, there are several major declines with ZAR (-1.6%), RUB (-1.4%) and MXN (-1.0%) leading the way down. The contributing factor to all three of these currencies is the weakness in the commodity space and corresponding broad-based dollar strength. But the CE4 are all lower by between 0.3% and 0.6%, and most Asian currencies also saw modest weakness overnight. In other words, today is a dollar day.

And that is really the story. At this point, we need to wait for the data releases at 8:30 to get our next cues on movement. My view is that the Initial Claims data remains the single most important data point right now. Today’s expectation is for a higher print than last week, which the market may well read as the beginning of a reversal of the three-month trend of declines. A higher than expected number here is likely to result in a much more negative equity day, and correspondingly help the dollar recoup even more of its recent losses.

Good luck and stay safe
Adf

QE is Our Fate

The Fed Chair, a banker named Jay
Will meet with his comrades today
Though no one expects
A change, it’s what’s next
That has traders set to make hay

Will guidance be tied to the rate
Of joblessness? Or will they state
Inflation is key
And ‘til there we see
Advances, QE is our fate

Today’s primary feature in the markets is the FOMC meeting where at 2:00 they will release their latest policy statement, and then at 2:30 Chairman Powell will hold a virtual press conference. As is often the case, market activity ahead of the meeting is muted as investors and traders are wary of taking on new positions ahead of a possible change in policy.

However, the punditry is nearly unanimous in its belief that there will be no policy changes today, and that the statement will be nearly identical to the previous version, with just some updates relating to the data that has been released since then. The big question is whether or not Chairman Powell will give an indication of what the next steps by the Fed are likely to be.

A quick review of the current policy shows that the Fed has a half dozen lending programs outstanding, which they extended to run through the end of 2020 in an announcement yesterday, and which are focused on corporate bonds, both IG and junk, municipal securities and small business loans. Of course, they continue to buy both Treasury and mortgage-backed securities as part of their more ordinary QE measures. And the Fed Funds rate remains at the zero bound. Consensus is that none of this will change.

The problem for the Fed is, short of simply writing everyone in the country a check (which is really fiscal policy) they are already buying all the debt securities that exist. While eventually, they may move on to purchasing equities, like the BOJ or SNB, at this point, that remains illegal. So, the thinking now goes that Forward Guidance is the most likely next step, essentially making a set of promises to the market about the future of policy and tying those promises to specific outcomes in the economic data. Given their mandate of full employment and stable prices, it is pretty clear they will tie rate movements to either the Unemployment Rate or the inflation rate. You may recall in the wake of the GFC, then Chairman Bernanke did just this, tying the eventual removal of policy accommodation to the Unemployment Rate. Alas, this did not work as well as the Fed had hoped. The first problem was that as the unemployment rate declined, it did not lead to the expected rise in inflation, so the Fed kept having to move its target lower. This did not inspire credibility in the central bank’s handling of the situation, nor its models. But the bigger problem is that the market became addicted to ZIRP and QE, and when Bernanke mentioned, off hand, in Congressional testimony, that some day the Fed would start to remove accommodation, he inspired what is now called the ‘Taper Tantrum’ where 10-year Treasury yields rose 1.3% in just over three months

You can be certain that Powell does not want to set up this type of situation, but, if anything, I would argue the market is more addicted to QE now than it was back then. At any rate, given the Fed’s need to show they are doing something, you can be sure that tied forward guidance is in our future. The question is, to what statistic will they tie policy? It is here where the pundits differ. There is a range of guesses as follows: policy will be unchanged until, 1) inflation is steadily trending to our 2.0% target, 2) inflation reaches out 2.0% target, or 3) inflation spends time above our 2% target in an effort to ‘catch up’ for previous low readings. This in order of most hawkish to least. Of course, they could focus on the Unemployment rate, and choose a level at which they believe full employment will be reached and thus start to pressure inflation higher.

The problem with the inflation target is that they have been trying to achieve their 2.0% target, based on core PCE, and have failed to do so consistently for the past 10 years. It is not clear why a claim they are going to continue to maintain easy money until they reach it now, let alone surpass that target, would have any credibility. On the Unemployment front, given what are certainly dramatic changes in the nature of the US economy in the wake of Covid-19, it beggars belief that there is any confidence in what the appropriate level of full employment is today. Again, it is hard to believe that their models have any semblance of accuracy in this area either.

And one other thing, most pundits don’t anticipate the announcement of new forward guidance until the September meeting, so this is all anticipation of something unlikely to occur for a while yet. But, as a pundit myself, we do need to have something to discuss on a day when markets remain uninteresting.

So, let’s take a quick look at today’s market activities. Equity markets remain mixed with both gainers (Shanghai +2.1%) and losers (Nikkei -1.2%) in Asia and in Europe (CAC +0.7%, DAX 0.0%, Italy -0.8%). US futures are edging higher, but not with any enthusiasm. Bond markets are all within a basis point of yesterday’s closing levels, although Treasuries did rally in the mild risk-off session we saw Tuesday with 10-year yields back below 0.60%. Yesterday, gold had a wild day, making new highs early in the overnight session and falling back 4% in NY before rebounding to close at $1960/oz. This morning it is little changed, but the trend remains higher.

Finally, the dollar is softer this morning, although yesterday saw a mixed session. The pound (+0.25%) has been a steady performer lately and is pressing toward 1.30 for the first time since early March, pre-Covid. While there was UK data on lending and money supply, this movement appears to be more technical in nature, with the added benefit that the dollar remains under pressure against all currencies. Elsewhere in the G10, oil’s strength this morning is helping NOK (+0.5%), while the rest of the bloc is just marginally firmer vs. the dollar.

In the emerging markets, the big winner today was THB (+0.8%) where the central bank is trying to make a change in the local gold market. Interestingly, gold traded in baht is a huge market, and one where the recent flows have resulted in excess baht strength. As such, the central bank is trying to change the market into a USD based gold market, which should remove upward pressure from the currency. But away from that, while the bulk of the bloc is firmer, the movement is 0.3% or less, hardly the stuff of dreams, and with no coherent message other than the dollar is soft.

And that’s really it for the day. There is no data of note to be released and so all eyes are on the FOMC. My money is on inflation based forward guidance, likely the most dovish type shooting for above target outcomes, but not to be put in place until September. And that means, the dollar’s recent downtrend is likely to continue to be the situation for the immediate future.

Good luck and stay safe
Adf

A Vaccine’s Required

Mnuchin and Powell explained
That Congress ought not be restrained
In spending more cash
Or else, in a flash
The rebound might not be maintained

Meanwhile, as the quarter expired
The data show growth is still mired
Within a great slump
And hopes for a jump
Are high, but a vaccine’s required

I continue to read commentary after commentary that explains the future will be brighter once a Covid-19 vaccine has been created. This seems to be based on the idea that so many people are terrified of contracting the disease they they will only consider venturing out of their homes once they believe the population at large is not contagious. While this subgroup will clearly get vaccinated, that is not likely to be majority behavior. If we consider the flu and its vaccine as a model, only 43% of the population gets the flu shot each year. Surveys regarding a Covid vaccine show a similar response rate.

Consider, there is a large minority of the population who are adamantly against any types of vaccines, not just influenza. As well, for many people, the calculation seems to be that the risk of contracting the flu is small enough that the effort to go and get the shot is not worth their time. Ask yourself if those people, who are generally healthy, are going to change their behavior for what appears to be a new form of the flu. My observation is that human nature is pretty consistent in this regard, so Covid is no scarier than the flu for many folks. The point is that the idea that the creation of a vaccine will solve the economy’s problems seems a bit far-fetched. Hundreds of thousands of small businesses have already closed permanently because of the economic disruption, and we are all well acquainted with the extraordinary job loss numbers. No vaccine is going to reopen those businesses nor bring millions back to work.

And yet, the vaccine is a key part of the narrative that continues to drive risk asset prices higher. While we cannot ignore central bank activities as a key driver of equity and bond market rallies, the V-shaped recovery is highly dependent on the idea that things will be back to normal soon. But if a vaccine is created and approved for use, will it really have the impact the market is currently anticipating? Unless we start to see something akin to a health passport in this country, a document that certifies the holder has obtained a Covid-19 shot, why would anyone believe a stranger is not contagious and alter their newly learned covid-based behaviors. History shows that the American people are not fond of being told what to do when it comes to restricting their rights of movement. Will this time really be different?

However, challenging the narrative remains a difficult proposition these days as we continue to see the equity bulls in charge of all market behavior. As we enter Q3, a quick recap of last quarter shows the S&P’s 20% rally as its best quarterly performance since Q4 1998. Will we see a repeat in Q3? Seems unlikely and the risk of a reversal seems substantial, especially if the recent increase in Covid cases forces more closures in more states. In any event, uncertainty appears especially high which implies price volatility is likely to continue to rise across all markets.

But turning to today’s session, equity markets had a mixed session in Asia (Nikkei -0.75%, Hang Seng +0.5%) despite the imposition of the new, more draconian law in Hong Kong with regard to China’s ability to control dissent there. Meanwhile, small early European bourse gains have turned into growing losses with the DAX now lower by 1.5%, the CAC down by 1.4% and the FTSE 100 down by 1.0%. While PMI data released showed that things were continuing on a slow trajectory higher, we have just had word from German Chancellor Merkel that “EU members [are] still far apart on recovery fund [and the] budget.” If you recall, there is a great deal of credence put into the idea that the EU is going to jointly support the nations most severely afflicted by the pandemic’s impacts. However, despite both German and French support, the Frugal Four seem to be standing their ground. It should be no surprise that the euro has turned lower on the news as well, as early modest gains have now turned into a 0.3% decline. One of the underlying supports for the single currency, of late, has been the idea that the joint financing of a significant budget at the EU level will be the beginning of a coherent fiscal policy to be coordinated with the ECB’s monetary policy. If they cannot agree these terms, then the euro’s existence can once again be called into question.

Perhaps what is more interesting is that as European equity markets turn lower, and US futures with them, the bond market is under modest pressure as well this morning. 10-year Treasury yields are higher by more than 2bps and in Europe we are seeing yields rise by between 3bps and 4bps. This is hardly risk-off behavior and once again begs the question which market is leading which. In the long run, bond investors seem to have a better handle on things, but on a day to day basis, it is anyone’s guess.

Finally, turning to the dollar shows that early weakness here has turned into broad dollar strength with only two currencies in the G10 higher at this point, the haven JPY (+0.4%) and NOK (+0.2%), which has benefitted from oil’s rally this morning with WTI up by about 1% and back above $40/bbl. In the emerging markets, only ZAR has managed any gains of note, rising 0.4%, after its PMI data printed at a surprisingly higher 53.9. On the flip side, PLN (-0.6%) is the laggard, although almost all EMG currencies are softer, as PMI data there continue to disappoint (47.2) and concerns over a change in political leadership seep into investor thoughts.

On the data front, we start to see some much more important data here today with ADP Employment (exp 2.9M), ISM Manufacturing (49.7) and Prices Paid (44.6) and finally, FOMC Minutes to be released at 2:00. Yesterday we saw some thought provoking numbers as Chicago PMI disappointed at 36.6, much lower than expected, while Case Shiller House Prices rose to 3.98%, certainly not indicating a deflationary surge.

Yesterday we also heard the second part of Chairman Powell’s testimony to Congress, where alongside Treasury Secretary Mnuchin, he said that the Fed remained committed to doing all that is necessary, that rates will remain low for as long as is deemed necessary, and that it would be a mistake if Congress did not continue to support the economy with further fiscal fuel. None of that was surprising and, quite frankly, it had no impact on markets anywhere.

At this point, today looks set to see a little reversal to last quarter’s extremely bullish sentiment so beware further dollar strength.

Good luck and stay safe
Adf

 

Overthrow

Health data are starting to show
A second wave might overthrow
The rebound we’ve seen
From Covid-19
Which clearly will cause growth to slow

Risk is under pressure this morning as market participants continue to read the headlines regarding the rising rate of Covid infections in some of the largest US states, as well as throughout a number of emerging market nations. While this is concerning, in and of itself, it has been made more so by the fact that virtually every government official has warned that a second wave will undermine the progress that has been made with respect to the economic rebound worldwide. However, what seems to be clear is that more than three months into a series of government ordered shut downs that have resulted in $trillions of economic damage around the world, people in many places have decided that the risk from the virus is not as great as the risk to their personal economic well-being.

And that is the crux of the matter everywhere. Just how long can governments continue to impose restrictions on people without a wholesale rebellion? After all, there have been many missteps by governments everywhere, from initially downplaying the impact of the virus to moving to virtual marital law, with early prognostications vastly overstating the fatality rate of the virus and seemingly designed simply to sow panic and exert government control. It cannot be surprising that at some point, people around the world decided to take matters into their own hands, which means they are no longer willing to adhere to government rules.

The problem for markets, especially the equity markets, is that their recovery seems to be based on the idea that not only is a recovery right around the corner, but that economies are going to recoup all of their pandemic related losses and go right back to trend activity. Thus, a second wave interferes with that narrative. As evidence starts to grow that the caseload is no longer shrinking, but instead is growing rapidly, and that governments are back to shutting down economic activity again, those rosy forecasts for a sharp rebound are harder and harder to justify. And this is why we have seen the equity market rebound stumble for the past three weeks. In that time, we have seen twice as many down sessions as up sessions and the net result has been a 5.5% decline in the S&P500, with similar declines elsewhere.

So, what comes next? It is very hard to read the news about the growing list of bankruptcies as well as the significant write-downs of asset values and order cancelations without seeing the bear case. The ongoing dichotomy between the stock market rally and the economic distress remains very hard to justify in the long run. Of course, opposing the real economic news is the cabal of global central banks, who are doing everything they can think of collectively, to keep markets in functioning order and hoping that, if markets don’t panic, the economy can find its footing. This is what has brought us ZIRP, NIRP and QE with all its variations on which assets central banks can purchase. Alas, if central bankers really believe that markets are functioning ‘normally’ after $trillions of interference, that is a sad commentary on those central bankers’ understanding of how markets function, or at least have functioned historically. But the one thing on which we can count is that there is virtually no chance that any central bank will pull back from its current policy stance. And so, that dichotomy is going to have to resolve itself despite central bank actions. That, my friends, will be even more painful, I can assure you.

So, on a day with ordinary news flow, like today, we find ourselves in a risk-off frame of mind. Yesterday’s US equity rally was followed with modest strength in Asia. This was helped by Chinese PMI data which showed that the rebound there was continuing (Mfg PMI 50.9, Non-mfg PMI 54.4), although weakness in both Japanese ( higher Jobless Rate and weaker housing data) and South Korean (IP -9.6% Y/Y) data detracted from the recovery story. Of course, as we continue to see everywhere, weak data means ongoing central bank largesse, which at this point still leads to equity market support.

Europe, on the other hand, has not seen the same boost as equity markets there are mostly lower, although the DAX (+0.4%) and CAC (+0.2%) are the two exceptions to the rule. UK data has been the most prevalent with final Q1 GDP readings getting revised a bit lower (-2.2% Q/Q from -2.0%) while every other sub-metric was slightly worse as well. Meanwhile, PM Johnson is scrambling to present a coherent plan to support the nation fiscally until the Covid threat passes, although on that score, he is not doing all that well. And we cannot forget Brexit, where today’s passage without an extension deal means that December 31, 2020 is the ultimate line in the sand. It cannot be a surprise that the pound has been the worst performing G10 currency over the past week and month, having ceded 2.0% since last Tuesday. With the BOE seriously considering NIRP, the pound literally has nothing going for it in the short run. Awful economic activity, questionable government response to Covid and now NIRP on the horizon. If you are expecting to receive pounds in the near future, sell them now!

Away from the pound, which is down 0.3% today, NOK (-0.6%) is the worst performer in the G10, and that is really a result of, not only oil’s modest price decline (-1.3%), but more importantly the news that Royal Dutch Shell is writing down $22 billion of assets, a move similar to what we have seen from the other majors (BP and Exxon) and an indication that the future value (not just its price) of oil is likely to be greatly diminished. While we are still a long way from the end of the internal combustion engine, the value proposition is changing. And this speaks to just how hard it is to have an economic recovery if one of the largest industries that was adding significant value to the global economy is being downgraded. What is going to take its place?

The oil story is confirmed in the EMG space as RUB is the clear underperformer today, down 1.4% as Russia is far more reliant on oil than even Norway. However, elsewhere in the EMG bloc, virtually the entire space is under pressure to a much more limited extent. The thing is, if we start to see risk discarded and equity markets come under further pressure, these currencies are going to extend their declines.

This morning’s US data is second tier, with Case Shiller Home Prices (exp +3.8%), Chicago PMI (45.0) and Consumer Confidence (91.4). The latter two remain far below their pre-covid levels and likely have quite some time before they can return to those levels. Meantime, Fed speakers are out in force today, led by Chair Powell speaking before a Congressional panel alongside Treasury Secretary Mnuchin. His pre-released opening remarks harp on the risk of a second wave as well as the uncertainty over the future trajectory of growth because of that. As well, he continues to promise the Fed will do whatever is necessary to support the economy. And in truth, we have continued to hear that message from every single Fed speaker for the past two months’ at least. What we know for sure is that the Fed is not going to change its tune anytime soon.

For today, unless Powell describes yet another new program, if he remains in his mode of warning of disaster unless the government does more, it is hard to see how investors get excited. Risk is currently on the back foot and I see nothing to change that view today.

Good luck and stay safe
Adf

Making More Hay

The Chairman explained yesterday
That more help would be on the way
If things turned out worse
Thus he’s not averse
To Congress soon making more hay

Chairman Powell testified before the Senate Banking Committee yesterday and continued to proffer the message that while the worst may be behind us, there is still a long way to go before the recovery is complete. He continued to highlight the job losses, especially in minority communities, and how the Fed will not rest until they have been able to foster sufficient economic growth to enable unemployment to fall back to where it was prior to the onset of the Covid crisis. He maintains, as does the entire FOMC, that there are still plenty of additional things the Fed can do to support the economy, if necessary, but that he hopes they don’t have to take further measures. He also agreed that further fiscal stimulus might still be appropriate, although he wouldn’t actually use those words in his effort to maintain the fiction that the Fed is independent of the rest of the government. (They’re not in case you were wondering.) In other words, same old, same old.

The market’s response to the Chairman’s testimony was actually somewhat mixed. Equity prices continue to overperform, although they did retreat from their intraday highs by the close, but the dollar, despite what was clearly an increasing risk appetite, reversed early weakness and strengthened further. Initially, that dollar strength was attributed to a blow-out Retail Sales number, +17.7%, but that piece of the rally faded in minutes. However, as the day progressed, dollar buyers were in evidence as the greenback ignored traditional sell signals and continued to forge a bottom.

Recently, there seems to have been an increase in discussion about the dollar’s imminent decline and the end of its days as the global reserve currency. Economists point to the massive current account deficit, the debasement by the Fed as it monetizes debt and the concern that the current administration will not embrace previous global norms. My rebuttal of this is simple: what would replace the dollar as the global monetary asset that would be universally accepted and trusted to maintain some semblance of its value? The answer is, there is nothing at this time, that could possible do the job. The euro? Hah! Not only is it still dealing with existential issues, but the fact that there is no European fiscal policy will necessarily result in missing support when needed. The renminbi? Hah! The idea that the free world would rely on a currency controlled by the largest communist regime is laughable. The Swiss franc? Too small. Bitcoin? Hahahahah! ‘Nuff said. Gold? Those who are calling the end of the dollar’s importance in the world are not the same people calling for a return to the gold standard. In fact, the views of those two groups are diametrically opposed. For now, the dollar remains the only viable candidate for the role, and that is likely to remain the case for a very long time. As such, while it will definitely rise and fall over short- and medium-term windows, do not believe the idea of a coming dollar collapse.

Meanwhile, ‘cross the pond in the land
Where Boris is still in command
Inflation is sinking
While Bailey is thinking
He ought, the B/S, to expand

Turning to more immediate market concerns, UK data this morning showed CPI falling to 0.5% Y/Y, well below the BOE’s target of 2.0%. With the BOE on tap for tomorrow, the market feels quite confident that Governor Bailey will be increasing QE purchases by £100 billion, taking the total to £745 billion, or slightly more than one-third of the UK economy. The thing is, it is not clear that QE lifts prices of anything other than stocks. I understand that central banks are limited by monetary tools, but if we have learned anything since the GFC in 2008-09, it is that monetary tools are not very effective when addressing the real economy. There is no evidence that this time will be different in the UK than it has been everywhere else in the world forever. The pound, however, has suffered in the wake of the current UK combination of events. So rapidly declining inflation along with expectations of further monetary policy ease have been more than enough to offset yesterday’s positive Brexit comments explaining that both sides believe a deal is possible. Perhaps the question we ought to be asking is, even if hard Brexit is avoided, should the pound really rally that much? My view remains that while a hard Brexit would definitely be a huge negative, the pound has enough troubles on its own to avoid rising significantly from current levels. I still cannot make a case for 1.30, not in the current situation.

As to the rest of the FX market, it is having a mixed session today, with both gainers and losers, although no very large movers in either direction. For instance, the best G10 performer today is NOK, which has rallied just 0.3% despite oil’s lackluster performance today. Meanwhile, the worst performer is the euro, which has fallen 0.2%. The point is, movement like this does not need a specific explanation, and is simply a product of position adjustments over time.

Emerging market currency activity has been no different, really, with MXN the best performer (you don’t hear that much) but having rallied just 0.35%. the most positive story I’ve seen was that the Mexican president, AMLO, has promised to try to work more closely with the business community there to help address the still raging virus outbreak. On the downside, KRW, yesterday’s best performer, is today’s worst, falling 0.55%. This seems to be a response to the increasingly aggressive rhetoric from the North, who is now set to deploy troops to the border, scrapping previous pledges to maintain a demilitarized zone between the nations. However, it would be wrong not to mention yesterday’s BRL price action, where the real fell 1.7%, taking its decline over the past week to more than 5.1%. The situation on the ground there seems to be deteriorating rapidly as the coronavirus is spreading rapidly, more than 37K new cases were reported yesterday, and investors are taking note.

On the data front this morning, we see Housing Starts (exp 1100K) and Building Permits (1245K), neither of which seems likely to be a market mover. The Chairman testifies before the House today, but it is only the Q&A that will be different, as his speech is canned. We also hear from the Uber-hawk, Loretta Mester, but these days, even she is on board for all the easing that is ongoing, so don’t look for anything new there.

Ultimately, I continue to look at the price action and feel the dollar is finding its footing, regardless of the risk attitude. Don’t be too greedy if you are a receivables hedger, there is every chance for the dollar to strengthen further from here.

Good luck and stay safe
Adf

 

Looking Distressed

The market was looking distressed
So, Jay clearly thought it was best
To tell everyone
The Fed had begun
To buy corporates at his behest

Frankly, I’m stunned. Anyone who believes that the Fed is focusing on any variable other than the S&P 500 was completely disabused of that notion yesterday. While I know it seems like it was weeks ago, yesterday morning there was concern that Chairman Powell’s comments last week about a long, tough road to recovery were still top of mind to market participants. Concerns over a rising infection rate in some states and countries were growing thus driving investors to react negatively. After all, if the mooted second wave of Covid comes and the nascent economic revival is squashed at the outset, the case for the V-shaped recovery and stratospheric stock prices would quickly die. And so, Chairman Powell responded by explaining that the Fed would expand the SMCCF* program to start buying individual bonds today. Remember, the initial story was ETF’s were the only purchases to be made. Now, the Fed is effectively cherry-picking which investors it wants to help as certainly the companies whose bonds the Fed buys will not be getting any of that money. Or will they? Perhaps the hope is that if the Fed owns individual corporate bonds, in the coming debt jubilee, they will tear up those bonds as well as their Treasuries, thus reducing leverage in a trice.

A debt jubilee, for those who are unfamiliar with the term, is a government sanctioned erasure of outstanding debts. Its origins are in the book of Deuteronomy in the Old Testament, when every 50 years there was a call for the release of all debts, both monetary and personal (indenture). Of course, in the modern world it is a bit more difficult to accomplish as all creditors would be severely impacted by the concept. All creditors except one, that is, a nation’s central bank.

Now that we are in a fiat currency system where central banks create money from nothing (paraphrasing Dire Straits), any public debt that they hold on their balance sheets can simply be forgiven by decree, thus reducing the leverage outstanding. While there would seem to be some inflationary consequences to the action (after all, an awful lot of funds would be instantly freed up to chase after other goods, services and investments), the modern central bank viewpoint on inflation is that it is dangerously low and a problem at current levels, so those consequences are likely to be quickly rationalized away. Thus, if the Fed owns individual corporate bonds, especially of highly indebted companies, they will be able forgive those, reduce leverage and support those companies’ prospects to maintain a full-sized staff. You see, the rationalization is it will support employment, not help investors.

To be clear, there is no official plan for a debt jubilee, but it is something that is gaining credence amongst a subset of the economics community. Especially because of the inherent concerns over near- and medium-term growth due to Covid-19, as future consumer behavior is likely to be very different than past consumer behavior, I expect that a debt jubilee is something about which we will hear a great deal more going forward. Nonstop printing of money by the world’s central banks is not a sustainable activity in the long run. Neither is it sustainable for governments to run deficits well in excess of GDP. A debt jubilee is a potential solution to both those problems, and if it can be accomplished by simply having central banks tear up debt, other creditors will not be destroyed. Truly a (frightening) win-win.

It can be no surprise that the stock market reacted positively to the news, turning around morning losses to close higher by 0.85% in the US with the sharpest part of the move happening immediately upon the statement’s release at 2:15 yesterday. This euphoria carried over into Asia with remarkable effect as the Nikkei (+4.9%) and KOSPI (+5.3%) exploded higher while the rest of the region merely saw strong gains of between 1.4% (Shanghai) and 3.9% (Australia). And naturally, Europe is a beneficiary as well, with the DAX (+2.8%) leading the way, but virtually every market higher by more than 2.0%. US futures? Not to worry, all three indices are currently higher by more than 1.1%.

In keeping with the risk-on attitude, we also saw Treasury bonds sell off in the afternoon with yields rising a bit more than 4bps since the announcement. In Europe, bund yields are higher as are gilts, both by 2.5bps, but the PIGS are basking in the knowledge that their future may well be brighter as we are seeing Portugal (-2bps), Italy (-5.5bps), Greece (-6.5bps) and Spain (-3bps) all rallying nicely.

And finally, the dollar, which had started to show some strength yesterday, has also reversed most of those gains and is broadly, though not deeply, softer this morning. In the G10, the pound is the leader, higher by 0.45%, as the market ignored Jobless Claims in the UK falling by 529K, only the second worst level on record after last month’s numbers, and instead took heart that a Brexit deal could well be reached after positive comments from both Boris Johnson and the EU leadership following a videoconference call earlier today. While nothing is confirmed, this is the best tone we have heard in a while. However, away from the pound gains are limited to less than 0.25% with some currencies even declining slightly.

In the emerging markets, the leading gainer is KRW (+0.75%) despite the fact that North Korea blew up the Joint Office overnight. That office was the sight of ongoing discussions between the two nations and its destruction marks a significant rise in hostility by the North. In my view, the market is remarkably sanguine about the story, especially in light of its response to the news out of India, where Chinese soldiers ostensibly attacked and killed three Indian soldiers in the disputed border zone. There, the rupee fell 0.25% on the report as concerns grow over an escalation of tensions between the two nations. But aside from those two currencies, there were many more gainers in APAC currencies as funds flowed into local stock markets on the Fed inspired risk appetite.

On the data front, we see Retail Sales (exp 8.4%, 5.5% ex autos) as well as IP (3.0%) and Capacity Utilization (66.9%), with all three numbers rebounding sharply from their lows set in April. We saw a similar rebound in German ZEW Expectations (63.4 and its highest since 2006), but recall, that is based on the change of view month to month.

Chairman Powell testifies to the Senate this morning, so all ears will be listening at 10:00. Yesterday we heard from two Fed speakers, Dallas’s Kaplan and San Francisco’s Daly, both of whom expressed the view that a rebound was coming, that YCC was not appropriate at this time and that the Fed still had plenty they could do, as they made evident with yesterday afternoon’s announcement.

While equity markets continue to react very positively to the central bank activities, the dollar seems to be finding a floor. In the end, investment flows into the US still seem to be larger than elsewhere and continue to be a key driver for the dollar. Despite a positive risk appetite, it appears the dollar has limited room to fall further.

Good luck and stay safe
Adf

*Secondary Market Corporate Credit Facility

Money to Burn

If Covid is back on the rise
It’s likely it will compromise
The mooted return
Of money to burn
Instead, growth it will tranquilize

For the past two or three months, market behavior has been driven by the belief that a V-shaped recovery was in the offing as a combination of massive fiscal and monetary stimulus alongside a flatter infection curve and the reopening of economies would bring everything back close to where it was prior to the outbreak of Covid-19. However, since last Thursday, that narrative has lost more than a few adherents with the growing concern that the dreaded second wave of infections was starting to crest and would force economies, that were just starting to reopen, back into hibernation.

The most recent piece of evidence for the new storyline comes from Beijing, where the weekend saw the reporting of 100 new infections after several weeks of, allegedly, zero infections in the country. This has resulted in the Chinese government re-imposing some restrictions as well as massively increasing testing again. Chinese data last night showed that the economy remains under significant pressure, although analysts fell on both sides of the bullish-bearish spectrum. The four key data points are Retail Sales (-13.5% YTD, up from April’s -16.2% and right on the economic estimates); IP (-2.8% YTD, up from -4.9% and slightly better than -3.0% expected); Fixed Asset Investment (-6.3% YTD vs. -10.3% last month and -6.0% expected); and the Jobless Rate (5.9%, as expected and down from 6.0% last month). My read is that the Chinese economy remains quite troubled, although arguably it has left the worst behind it. The PBOC continues to inject liquidity into the market and the Chinese government continues to add fiscal support. Unfortunately for President Xi, China remains an export led economy and given the complete demand destruction that has occurred everywhere else in the world, the near-term prospects for Chinese growth would seem to be muted at best.

For political leaders everywhere, this is not the story that they want to tell. Rather, the narrative of the V-shaped recovery was crucial to maintaining some level of confidence for their populations as well as for their own popularity. Remember, at the government level, everything is political, so crafting a story that people believe accept is just as important, if not more so, than actually implementing policies that work to address the problems.

Another chink in the narrative’s armor is the fact that despite the approach of the summer solstice, and the northern hemisphere warming that accompanies it, infection levels are growing in many different places; not only Beijing, but Korea, Japan, California, Texas and Florida, all locations that had begun to reopen their respective economies due to reduced infections. Remember, a key part of the narrative has been that the virus, like the ordinary flu, thrives in cold weather, and warmth would be a natural disinfectant, if you will. While it remains too early to claim this is not the case, the recent flare-ups are not helping that storyline.

Ultimately, what is abundantly clear is we still don’t know that much about the virus and its potential and weaknesses. While we will certainly see more businesses reopen over the next weeks, it is unclear how long it will take for actual economic activity to start to revert to any semblance of normal. Equity markets have been wearing rose-colored glasses for at least two months. Beware of those slipping off and haven assets regaining their bid quite quickly.

So, a quick look at markets this morning simply reinforces the changing narrative, with equity markets lower around the world, bond markets rallying and the dollar reasserting itself. Overnight, Asian markets all fell pretty sharply, led by the Nikkei’s 3.5% decline, but also seeing weakness in the Hang Seng (-2.2%) and Shanghai (-1.0%). European indices are also bleeding this morning, with the DAX (-0.9%) and CAC (-0.8%) slipping on increasing concerns over the growth of the second wave. US futures will not miss this party, with all three indices sharply lower, between 1.5% and 2.0%.

In the bond market, Treasury yields are sliding, down 3 basis points, as haven assets are in demand. We are seeing increased demand across European bond markets as well, surprisingly even in the PIGS, although that seems more in anticipation of the almost certain increase in the pace of ECB QE. What is clear, however, is that we are seeing a rotation from stocks to bonds this morning.

Finally, the dollar is feeling its oats this morning, rallying against the high-beta G10 currencies with AUD the leading decliner (-0.9%) followed by NOK (-0.6%) and CAD (-0.5%). The latter two are clearly feeling the pressure from oil’s declining price, down 1.75% as I type, although it had been even lower earlier in the session. While we do see both JPY and CHF slightly firmer, the emphasis is on slightly, with both less than 0.1% higher than Friday’s closing levels. Meanwhile the euro and pound are both slightly softer, also less than 0.1% off Friday’s levels, which simply implies a great deal of uncertainty over the next big move. This is corroborated by price action in the option market, where implied volatility continues to climb, as 1mo EURUSD volatility is up 1.3 points in the past week. Of perhaps more interest is the fact that the 1mo risk reversal has flipped from 0.5 for euro calls to 0.35 for euro puts in the same time frame. Clearly, concern is growing that all is not right with the world.

As to the EMG bloc, one would not be surprised to see the Mexican peso as the biggest laggard this morning, down 1.5% as the combination of declining oil prices, increasing infections and risk reduction all play into the move. Asian currencies did not have a good evening, led by KRW (-1.0%) which suffered from a combination of concern over the US-Korean alliance (as the US withdrew some troops unexpectedly and continues to demand more payment for protection) as well as some warmongering from the North. But we have also seen weakness across the rest of the region, with declines in the 0.2%-0.5% range nearly universal. Too, the rand is under pressure this morning, falling 1.0%, on what appears to be broad-based risk reduction as there are no specific stories to note there.

Data this week is on the light side with Retail Sales tomorrow likely to garner the most attention.

Today Empire Manufacturing -30.0
Tuesday Retail Sales 8.0%
  -ex autos 5.3%
  IP 3.0%
  Capacity Utilization 66.9%
Wednesday Housing Starts 1100K
  Building Permits 1250K
Thursday Initial Claims 1.29M
  Continuing Claims 19.65M
  Philly Fed -25.0
  Leading Indicators 2.4%

Source: Bloomberg

We also hear from six Fed speakers in addition to the Chairman’s congressional testimony on Tuesday and Wednesday. Clearly, it will be the latter that keeps everyone most interested. There are those who complain that Powell should have done more last week, starting YCC or adding more stimulus, but that remains a slight minority view. Most mainstream economists seem to believe that we are fast approaching the point where excessive central bank largesse is going to create much bigger problems down the road. In fact, ironically, I believe that is one of the reasons we are in risk-off mode overall, growing concerns that the future is not as bright as markets have priced to date.

My sense is that the dollar is set to end its slide overall and start to regain traction as the reality that the V-shaped recovery is not coming begins to hit home. Hedgers beware, and don’t miss these opportunities.

Good luck and stay safe
Adf

Jay Was Thinking

If anyone thought Jay was thinking
‘Bout raising rates while growth was sinking
The chairman was clear
That long past next year
Their balance sheet will not be shrinking

The money quote: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” said Mr. Powell.  And this pretty much sums up the Fed stance for the time being.  While there are those who are disappointed that the Fed did not add to any programs or announce something like YCC or, perhaps, more targeted forward guidance, arguably the above quote is even more powerful than one of those choices.  Frequently it is the uncertainty over a policy’s duration that is useful, not the policy itself.  Uncertainty prevents investors from anticipating a change and moving markets contrary to policymakers’ goals.  So, for now, there is no realistic way to anticipate the timing of the next rate hike.  Perhaps the proper question is as follows: is timing the next hike impossible because of the lack of clear targets?  Or is it impossible because there will never be another rate hike?

What the Fed did tell us (via the dot plot) is that only two of the seventeen FOMC members believe interest rates will be above 0.0% in 2022 (my money is on Esther and Mester, the two most hawkish members), but mercifully, not a single dot in the dot plot was in negative territory.  They also expressed a pretty dour view of the economy as follows:

 

  2020 2021 2022
Real GDP -6.5% 5.0% 3.5%
Core PCE 1.0% 1.5% 1.7%
Unemployment 9.3% 6.5% 5.5%

Source: Bloomberg

It is, of course, the 11.5% gain from 2020 to 2021 that encourages the concept of the V-shaped recovery as evidenced by simply plotting the numbers (including 2019’s 2.3% to start).

Screen Shot 2020-06-11 at 9.30.05 AM

So, perhaps the bulls are correct, perhaps the stock market is a screaming buy as growth will soon return and interest rates will remain zero for as far as the eye can see.  There is, however, a caveat to this view, the fact that the Fed is notoriously bad at forecasting GDP growth over time.  In fact, they are amongst the worst when compared with Wall Street in general.  But hey, at least we understand the thesis.

Another interesting outcome of the meeting was the tone of the press conference, where Chairman Jay sounded anything but ebullient over the current economic situation, especially the employment situation.  And it is this takeaway that had the biggest market impact.  After the press conference, equity markets in the US sold off from earlier highs (the NASDAQ set another all-time high intraday) and Treasuries rallied with yields falling again.  In other words, despite the prospect of Forever ZIRP (FZ), equity investors seemed to lose a bit of their bullishness.  This price action has been in place ever since with Asian equity markets all falling (Nikkei -2.8%, Hang Seng -2.3%, Shanghai – 0.8%) and Europe definitely under pressure (DAX -2.1%, CAC -2.2%, FTSE 100 -2.0%).  US futures are also lower with the Dow (-1.9%) currently the laggard, but even NASDAQ futures are lower by 1.1% at this hour.

It should be no surprise that bond markets around the world are rallying in sync with these equity declines as the combination of risk-off and the prospect for FZ lead to the inevitable conclusion that lower long term rates are in our future.  This also highlights the fact that the Fed’s concern over the second part of its mandate, stable prices, has essentially been set aside for another era.  The belief that inflation will remain extremely low forever is clearly a part of the current mindset.  Yesterday’s CPI (0.1%, 1.2% core) was simply further evidence that the Fed will ignore prices going forward.  So, 10-year Treasury yields are back to 0.7% this morning, 20 basis points below last Friday’s closing levels.  In other words, the impact of last Friday’s NFP number has been erased in four sessions.  But we are seeing investors rotate from stocks to bonds around the world, perhaps getting a bit nervous about the frothiness of the recent rallies.  (Even Hertz, the darling of the Robinhooders, is looking like Icarus.)

With risk clearly being jettisoned around the world, it should be no surprise that the dollar has stopped falling, and in fact is beginning to rally against almost all its counterparts.  While haven assets like CHF (+0.2%) and JPY (+0.1%) are modestly higher, NOK (-0.9%) and AUD (-0.85%) are leading the bulk of the G10 lower.  Norway is suffering on, not only broad dollar strength, but oil’s weakness this morning, with WTI -3.1% on the session.  As to Aussie, the combination of weaker commodity prices, the strong dollar, and market technicals as it once again failed to hold the 0.70 level, have led to today’s decline.

Emerging market activity is also what you would expect in a risk-off session, with MXN (-1.6%), ZAR (-1.1%) and RUB (-0.7%) leading the way lower.  Obviously, oil is driving both MXN and RUB, while ZAR is suffering from the weakness in the rest of the commodity complex.  I think the reason that the peso has fallen so much further than the ruble is that MXN has seen remarkable gains over the past month, more than 13% at its peak, and so seems overdue for a correction.  One notable exception to this price action today is THB, which is higher by 0.65% on a combination of reports of a fourth stimulus package and a breach of the 200-day moving average which got technicians excited.

This morning’s data brings the latest Initial Claims data (exp 1.55M), as well as Continuing Claims (20.0M) and PPI (-1.2%, 0.4% core).  While nobody will care about the latter, there will be ongoing intense scrutiny on the former as Chairman Jay made it abundantly clear that employment is the only thing the Fed is focused on for now.  With the FOMC meeting behind us, we can expect to start to hear from its members again, but on the schedule, nothing happens until next week.

It is not hard to make the case that both the euro and pound have been a bit toppish at recent levels, and with risk decidedly off today, further declines there seem quite viable.

 

Good luck and stay safe

Adf

Unless Lowered Instead

All eyes have now turned to the Fed
As pundits expect Jay will spread
The message that rates,
Until future dates,
Are fixed, unless lowered instead

Most market activity is muted this morning as traders and investors await the latest words of wisdom from Chairman Jay and his compadres. The key questions in the air are:

1. What will the Fed’s new forecasts describe?
2. What will the dot plot (remember that?) look like?
3. Will there be any change in current forward guidance?
4. Will there be any mention of yield curve control (YCC)?

Let’s quickly try to unpack these and see what they mean.

1. The Fed ordinarily updates its economic forecasts quarterly, but wisely, in my view, skipped March’s update given the incredible uncertainty that existed due to the beginnings of the Covid-19 impact. Three months later, the breadth of economic destruction has become clearer, but it will be interesting to learn their current views on the topic. For comparison, last week the ECB forecast a central scenario of Eurozone GDP as follows: 2020 -8.7%, 2021 +5.2%, 2022 +3.3%. The OECD forecast global GDP at -6.0% this year and US GDP at -7.3% this year assuming no second wave of infections. Those numbers fall to -7.6% and -8.5% respectively if there is a second wave of Covid infections. No matter how you slice it, 2020 is set to report negative GDP growth, but the question is, will the Fed demonstrate relative optimism or not?

2. The dot plot, as you may recall, was the biggest issue for a long time, as it was the Fed’s non-verbal way of offering forward guidance. The idea was that each FOMC member would offer his/her own views of the future level of rates and the median forecast was seen as a proxy of the Fed’s views. While it is abundantly clear that the view for 2020 will remain 0.00%, the real question is what the timeline anticipated by the FOMC will be as to when rates can start to rise again. It strikes me that while there will be some divergence, as always, we are likely to see only very gradual increases expressed, with a real possibility that 2021’s median will also be 0.00% and rates only beginning to rise in 2022. This begs the question…

3. How will they proffer their forward guidance? Current language is as follows: “The Committee expects to maintain this target (0.00%-0.25%) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Current thoughts are they could become more specific with respect to the timeline, (e.g. saying rates would remain at current levels until the end of 2022) or with respect to data (e.g. until Unemployment is at 5.0% and Inflation is back to 2.0%). Of course, the lesson from Chairman Bernanke is that if they go the latter route, they can easily change the level as they see fit. But for now, the longer the timeline, the more confidence that would seem to be imparted. At least, that’s the theory.

4. Finally, there has been a great deal of discussion regarding YCC and whether the Fed will announce a program akin to the BOJ (10-year) or RBA (3-year) where they target a rate on a specific maturity of the Treasury curve. Most analysts, as well as Cleveland Fed President Mester, believe it is too early to make a pronouncement on this subject, but there are those who believe that despite the equity market’s recent frothiness, they may want to step harder on the gas pedal to make sure they keep up what little momentum seems to have started. To me, this is the biggest story of the afternoon, and the one with the opportunity for the most market impact. It is not fully priced in, by any means, and so would likely see a huge rally in both bonds and stocks as the dollar fell sharply if they were to announce a program like this. I like gold on this move as well.

So, plenty to look forward to this afternoon, which explains why market activity has been so limited overall so far today. Equity markets in Asia were barely changed, although in the past few hours we have seen European bourses start to decline from early modest gains. At this point the DAX (-0.8% and CAC (-0.6%) are fully representative of the entire Eurozone space. At the same time, US futures have turned mixed from earlier modest gains with Dow e-minis down 0.3% although NASAAQ futures are actually higher by a similar amount.

Bond markets are generally anticipating something from the Fed as the 10-year has rallied and yields declined a further 3bps which now takes the decline since Friday’s close to 10bps. Bunds and Gilts are both firmer as well, with modestly lower yields while the PIGS are mixed as Greek yields have tumbled 9bps while Spain (+3bps) and Portugal (+4.5bps) see rising yields instead.

And finally, the dollar is definitely on its back foot this morning. In fact, it is lower vs. the entire G10 bloc with Aussie and Kiwi leading the way with 0.5% gains. Right now, the Aussie story looks more technical than fundamental, as it approaches, but cannot really hold 0.70, its highest point in almost a year. But overall, what is interesting about this movement is that despite yesterday’s desultory equity performance and this morning’s modest one as well, the dollar is behaving in a risk-on manner. Something else is afoot, but I have not yet been able to suss it out. I will though!

In the EMG space, the dollar is lower against virtually all its counterparts with IDR as the major exception. The rupiah fell 0.65% last night, actually recouping larger earlier losses at the end of the session, after the central bank explained they would be capping any strength in an effort to help Indonesian exporters. On the plus side is a range of currencies from all three blocs, which is evidence of pure dollar weakness rather than specific positive currency stories.

On the data front, overnight we learned that Chinese PPI was weaker than expected, reflecting weakness in its export markets and not boding well for that elusive V-shaped recovery. We also saw horrific April French IP data (-34.2% Y/Y), but that was pretty much as expected. This morning we get the latest CPI data from the US (exp 0.3%, 1.3% ex food & energy), but inflation remains a secondary concern to the Fed for now. Rather, there is far more focus on the employment data at the Mariner Eccles Building, so really, for now it is all about waiting for the Fed. If pressed, I think they will be more likely to offer some new, more dovish, guidance as it appears they will not want to lose any positive momentum. That means the dollar should remain under pressure for a little while longer.

Good luck and stay safe
Adf