Tag Archives: #Powell

Nations Regress

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When two weeks ago I last wrote
The narrative was to promote
A dollar decline
Which did intertwine
With hatred for Trump ere the vote

But since then the dollar’s rebounded
While experts galore are confounded
Poor Europe’s a mess
While nations regress
On Covid, where hope had been founded

I told you so?  Before my mandatory leave began, the market narrative was that the dollar was not merely falling, but “collapsing” as everything about the US was deemed negative.  The background story continued to be about US politics and how global investors were steadily exiting the US, ostensibly because of the current administration.  Adding to that was Chairman Powell’s speech at the virtual Jackson Hole symposium outlining average inflation targeting, which implied that the Fed was not going to respond to incipient inflation by raising rates until measured inflation was significantly higher and remained there sufficiently long to offset the past decade’s period of undershooting inflation.  In other words, if (when) inflation rises, US interest rates will remain pegged to the floor, thus offering no support for the dollar.  While there were a few voices in the wilderness arguing the point, this outcome seemed assured.

And the dollar did decline with the euro finally breeching the 1.20 level, ever so briefly, back on September 1st.  But as I argued before leaving, there was no way the ECB was going to sit by idly and watch the euro continue to rally without a policy response.  ECB Chief economist Philip Lane was the first to start verbal intervention, which was sufficient to take the wind out of the euro’s sails right after it touched 1.20.  Since then, the ECB meeting last week was noteworthy for not discussing the euro at all, with market participants, once again, quickly accepting that the ECB would allow the single currency to rally further.  But this weekend saw the second volley of verbal intervention, this time by Madame Lagarde, VP Guindos, Ollie Rehn and Mr Lane, yet again.  Expect this pattern to be repeated regularly, every euro rally will be met with more verbal intervention.

Of course, over time, verbal intervention will not be enough to do the job, which implies that at some point in the future, we will see a more intensive effort by the ECB to help pump up inflation.  In order of appearance look for a significant increase in QE via the PEPP program, stronger forward guidance regarding the timing of any incipient rate hikes (never!), a further cut to interest rates and finally, actual intervention.  In the end, there is absolutely no way that the ECB is going to allow the euro to rally very much further than it already has.  After all, CPI in the Eurozone is sitting at -0.2% (core +0.4%), so far below target that they must do more.  And a stronger euro is not going to help the cause.

Speaking of inflation, I think it is worth mentioning the US situation, where for the second straight month, CPI data was much higher than expected.  While many analysts are convinced that the Fed’s rampant asset purchases and expansion of the money supply are unlikely to drive inflation going forward, I beg to differ.  The lesson we learned from the GFC and the Fed’s first gargantuan expansion of money supply and their balance sheet was that if all that money sits in excess reserves on commercial bank balance sheets, velocity of money declines and inflation is absent.  This time, however, the new funds are not simply sitting on the banks’ collective balance sheets but are rather being spent by the recipients of Federal government largesse.  This is driving velocity higher, and with it, inflation.  Now, whatever one may think of Chairman Powell and his Fed brethren, they are not stupid.  The Jackson Hole speech, I believe, served two purposes.  First, it was to help investors understand the Fed’s reaction function going forward, i.e. higher inflation does not mean higher interest rates.  But second, and something that has seen a lot less press, is that the Fed has just moved the goalposts ahead of what they see as a rising tide of inflation.  Now, if (when) inflation runs hot over the next 12-24 months, the Fed will have already explained that they do not need to respond as the average inflation rate has not yet achieved 2.0%.  It is this outcome that will eventually undermine the dollar’s value, higher inflation with no monetary response, but we are still many months away from that outcome.

Turning to today’s activity, after two weeks of broad dollar strength, as well as some equity market pyrotechnics, we are seeing a bit of a dollar sell-off today.  It would be hard to characterize the markets as risk-on given the fact that European bourses are essentially flat on the day (DAX -0.1%, CAC +0.1%) while Asian equity markets showed only modest strength at best (Nikkei, Hang Seng and Shanghai all +0.6%).  Yes, US futures are pointing higher by 1.0%, but that seems more to do with the two large M&A deals announced than anything else.

In the meantime, bond markets have shown no indication of risk being on, with 10-year Treasury yields essentially unchanged since Friday at 0.67%, and effectively unchanged since I last wrote on August 28!  The same is largely true across European government bond markets, with, if anything, a bias for risk-off as most of those have seen yields slide one to two basis points.

And finally, the dollar’s specifics show GBP (+0.6%) to be the top G10 performer, which given its recent performance, down more than 4% since I last wrote, seems to be a bit of a breather rather than anything positive per se.  In the UK, today sees the beginning of the Parliamentary debate regarding PM Johnson’s proposed rewrite of aspects of Brexit legislation, which many think, if passed, will insure a hard Brexit.  As to the rest of the bloc, gains are mostly in the 0.25% range, with the most common theme the uptick in economists’ collective forecasts for economic prospects compared with last month.

Interestingly, in the EMG bloc, movement is less pronounced, with MXN (+0.4%) the biggest gainer, while RUB (-0.4%) is the laggard.  Clearly, as both are oil related, oil is not the driver.  However, when EMG currencies move less than 0.5%, it is hard to get too excited overall.

On the data front this week, the big story is, of course, the FOMC meeting on Wednesday, but we have a bunch of things to absorb.

Tuesday Empire Manufacturing 6.0
IP 1.0%
Capacity Utilization 71.4%
Wednesday Retail Sales 1.0%
-ex autos 1.0%
Business Inventories 0.2%
FOMC Rate Decision 0.00%-0.25%
Thursday Initial Claims 850K
Continuing Claims 13.0M
Housing Starts 1480K
Building Permits 1520K
Friday Leading Indicators 1.3%
Michigan Sentiment 75.0

Source: Bloomberg

What we have seen lately is the lagging indicators showing that the bounce after the reopening of the economy was stronger than expected, but there is growing concern that it may not be sustainable.  At the same time, the only thing interesting about the FOMC meeting will be the new forecasts as well as the dot plot.  After all, Jay just told us what they are going to do for the foreseeable future (nothing) two weeks ago.

Good luck and stay safe
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Casting a Pall

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The Chairman explained to us all
Deflation is casting a pall
On future advances
While NIRP’s what enhances
Our prospects throughout the long haul

The bond market listened to Jay
And hammered the long end all day
The dollar was sold
While buyers of gold
Returned, with aplomb, to the fray

An announcement to begin the day; I will be taking my mandatory two-week leave starting on Monday, so the next poetry will be in your inbox on September 14th.

Ultimately, the market was completely correct to focus all their attention on Chairman Powell’s speech yesterday because he established a new set of ground rules as to how the Fed will behave going forward.  By now, most of you are aware that the Fed will be targeting average inflation over time, meaning that they are happy to accept periods of higher than 2.0% inflation in order to make up for the last eight years of lower than 2.0% inflation.

In Mr. Powell’s own words, “…our new statement indicates that we will seek to achieve inflation that averages 2 percent over time. Therefore, following periods when inflation has been running below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.”

You may have noticed that Powell adds no specificity to this new policy, with absolutely no definition of ‘some time’ nor what ‘moderately above’ means.  But there was more for us, which many may have missed because it was a) subtle, and b) not directly about inflation.

“In addition, our revised statement says that our policy decision will be informed by our “assessments of the shortfalls of employment from its maximum level” rather than by “deviations from its maximum level” as in our previous statement.”

This is the rationale for their new willingness to let inflation run hot, the fact that the benefits of full employment outweigh those of stable prices.  The lesson they learned from the aftermath of the GFC in 2008-9 was that declining unemployment did not lead to higher general inflation.  Of course, they, along with many mainstream economists, attribute that to the breakdown of the Phillips curve relationship.  But the Phillips curve was not about general inflation, rather it was about wage inflation.  Phillips noted the relationship between falling unemployment and rising wages in the UK for the century from 1861-1957.  In fact, Phillips never claimed there was a causality, that was done by Paul Samuelson later and Samuelson extended the idea from wage to general inflation.  Eventually Milton Friedman created a theoretical underpinning for the claim unemployment and general inflation were inversely related.

Arguably, the question must be asked whether the labor market situation in the UK a century ago was really a valid model for the current US economy.  As it turns out, the time of Downton Abbey may not be a viable analogy.  Who would’ve thought that?

Regardless, Powell made it clear that with this new framework, the Fed has more flexibility to address what they perceive as any problems in the economy, and they will use that flexibility as they see fit.  In the end, the market response was only to be expected.

Starting with the bond market, apparently, I wasn’t the only one who thought that owning a fixed income instrument yielding just 1.4% for 30 years when the Fed has explicitly stated they are going to seek to drive inflation above 2.0% for some time was a bad idea.  The Treasury curve steepened sharply yesterday with the 10-year falling one point (yield higher by 6.5bps) while the 30-year fell more than three points and the yield jumped by more than 10 basis points.  My sense is we will continue to see the back end of the Treasury curve sell off, arguably until the 30-year yields at least 2.0% and probably more.  This morning the steepening is continuing, albeit at a bit slower pace.

As to the dollar, it took a while for traders to figure out what they should do.  As soon as Powell started speaking, the euro jumped 0.75%, but about 5 minutes into the speech, it plummeted nearly 1.2% as traders were uncertain how to proceed.  In the end, the euro recouped its losses slowly during the rest of the day, and has risen smartly overnight, up 0.7% as I type.  In fact, this is a solid representation of the entire FX market.  Essentially, FX traders and investors have parsed the Chairman’s words and decided that US monetary policy is going to remain uber easy for as far in the future as they can imagine.  And if that is true, a weaker dollar is a natural response.  So, today’s broad-based dollar decline should be no surprise.  In fact, it makes no sense to try to explain specific currency movements as the dollar story is the clear driver.

However, that does not mean there is not another important story, this time in Japan.

Abe has ulcers
Who can blame him with Japan’s
Second wave rising?

PM Shinzo Abe has announced that he has ulcerative colitis and will be stepping down as PM after a record long run in the role.  Initially, there was a great deal of excitement about his Abe-nomics plan to reflate the Japanese economy, but essentially, the only thing it accomplished was a weakening of the yen from 85.00 to 105.00 during the past eight years.  Otherwise, inflation remains MIA and the economy remains highly regulated.  The market reaction to the announcement was to buy yen, and it is higher by 1.15% this morning, although much of that is in response to the Fed.  However, it does appear that one of the frontrunners for his replacement (former Defense Minister Shigeru Ishiba) has populist tendencies, which may result in risk aversion and a stronger yen.

As to the equity market, the Nikkei (-1.4%) did not appreciate the Abe news, but Shanghai (+1.6%) seemed to feel that a more dovish Fed was a net benefit, especially for all those Chinese companies with USD debt.  Europe has been a little less positive (DAX -0.3%, CAC -0.1%) as there is now a growing concern that the euro will have much further to run.  Remember, most Eurozone economies are far more reliant on exports than the US, and a strong euro will have definite repercussions across the continent.  My forecast is that Madame Lagarde will be announcing the ECB’s policy framework review in the near future, perhaps as soon as their September meeting, and there will be an extremely dovish tone.  As I have written before, the absolute last thing the ECB wants or needs is a strong euro.  If they perceive that the Fed has just insured further dollar weakness, they will respond in kind.

Turning to the data, we see a plethora of numbers this morning.  Personal Income (exp -0.2%), Personal Spending (1.6%) and Core PCE (1.2%) lead us off at 8:30.  Then later, we see Chicago PMI (52.6) and Michigan Sentiment (72.8).  The thing is, none of these matters for now.  In fact, arguably, the only number that matters going forward is Core PCE.  If it remains mired near its current levels, the dollar will continue to suffer as not only will there be no tightening, but it seems possible the Fed will look to do more to drive it higher.  On the other hand, if it starts to climb, until it is over 2.0%, the Fed will be standing pat.  And as we have seen, getting Core PCE above 2.0% is not something at which the Fed has had much success.  For now, the dollar is likely to follow its recent path and soften further.  At least until the ECB has its say!

Good luck, good weekend and stay safe
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Waiting for Jay

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Investors are waiting for Jay
Their fears, about rates, to allay
They want it made clear
That rates will be here
From now ‘til we reach judgement day

From the market’s perspective, the world has essentially stopped spinning, at least until we finally hear the words of wisdom due from Chairman Powell beginning at 9:10 this morning.  Trading volumes across products are currently running at 50%-70% of recent average activity, highlighting just how little is ongoing.  And remember, too, as it is the last week of August, summer holidays are in full swing with most trading desks, on both the buy and sell sides, more lightly staffed than usual.  In other words, liquidity is clearly impaired right now, although by 10:00 this morning I expect that things will be back closer to normal.

As discussed yesterday, the working assumption of most analysts and investors is that Jay is going to explain the benefits of targeting average inflation over time.  The implication being that the Fed’s new policy framework, when officially announced later this year, is going to include that as a KPI.  Of course, the big question about this policy is the average over exactly which period.

Consider, it has been 102 months since then-Chairman Bernanke established the target for core PCE at 2.0%.  During that time, core PCE has been between 1.9% and 2.1% just 12 times with 89 of the other 90 readings below 1.9% and a single print above 2.1%, which happens to have been the first print after the announcement.  Meanwhile, this past April’s reading of 0.931% is the lowest reading.  The average of the two extremes is 1.53%.  Is the Fed going to be happy if core PCE jumps to 2.47% and stays there for a while?  The average of all periods since January 2012 is 1.633%, does that mean we can expect the Fed to target 2.367% core PCE readings for the next eight plus years? The point is, without some specificity on what average inflation means, it is very difficult to understand how to incorporate the idea into investment and trading decisions.

But what if Chairman Powell does not bring clarity to the discussion, merely saying that average inflation over time seems like a good future benchmark.  How might different markets react to such a lack of specificity?

Starting with equity markets, certainly those in the US will rally because…well that’s all they do these days.  Good news, bad news, no news, none of that matters.  The rationale will be stocks are a good inflation hedge if inflation goes higher (they’re not) or stocks will benefit from ongoing low interest rates if inflation remains below target.  Parabolic markets are frightening, but there is no indication that Powell’s comments are going to change that situation.  We need a different catalyst here.

Now let’s look at the bond market and what might happen there.  Specificity on how much higher the Fed is going to target inflation is going to be a pretty distinct negative.  If you own 10-year Treasuries that are yielding 0.68% (today -1bp), and the Fed explains that they are going to push inflation above 2.0%, there is going to be a pretty spectacular decline in the price of your bond should they achieve their goal.  Will investors be willing to hold paper through that type of decline?  It would not be a surprise to see a pretty sharp sell-off in Treasuries on that type of news.  Remember, too, that Treasury yields have backed up nearly 20 basis points in the past three weeks, perhaps in anticipation of today’s comments.  If Powell delivers, there is likely far more room to run.  If he doesn’t, and there is no clarity, bond investors will be back to reading the economic tea leaves, which continues to be remarkably difficult at this time.

How about the gold market?  Well, here I think the case is quite straight forward.  Clarity as to the Fed’s efforts to drive inflation higher will result in anticipation of lower real yields, and that will be an unalloyed benefit (pun intended).  A lack of clarity and gold will likely continue to consolidate its recent gains.

And finally, what about the dollar?  How will it respond to the Chairman’s speech?  Consider that despite the dollar’s recent rebound, short dollar positions remain at near record levels against both the euro and the DXY futures.  The market scuttlebutt is that the hedge fund community, which was instrumental in the dollar’s recent modest strength as they pared short dollar positions, is ready and raring to buy euros on the idea that higher US inflation will lead to a weaker dollar à la economic theory.  Certainly, if Treasuries sell off, the dollar will see some downward pressure, but one of the things that does not get as much press in the FX market is the equity market impact.  Namely, as long as US equity indices continue to set records, international investors are going to continue to buy them, which will underpin the dollar.

But what if the speech is a dud?  If there is no clarity forthcoming, then the dollar story will revert to its recent past. The bear case continues to be that the Fed’s largesse will dwarf all other nations’ policy easing and so the dollar should resume its decline.  The bull case is that the US economy, at least by recent data, appears to continue to be outperforming its major counterparts, and thus inward investment flows will continue.  That current account deficit is only a problem if international investors don’t want to fund it, and with US equity markets amongst the best performing asset classes globally, that funding is easy to find.  I know I’m not a technician, but recent price action certainly appears to have created a top at the highs from last week, and a further pullback toward 1.1650 seems quite viable.

It is difficult to draw many conclusions from today’s market activity, which is why I have largely ignored it.  Equity markets are leaning a bit lower, although the movement is not large, less than 1%, and the dollar is mixed against both the G10 and EMG blocs.

Arguably, the biggest market risk is that Powell doesn’t tip his hand at all, and that we are no wiser at 10:10 than we are now.  If that is the case, I think the dollar’s consolidation will continue, and by the end of the day, I imagine stock prices will have recouped their early losses.

But for today, it is all about Jay.

Good luck and stay safe
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The Chairman Regales

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Tomorrow the Chairman regales
Us all with the latest details
Of ways that the Fed,
When looking ahead,
Might ever consider bond sales

The one thing of which we are sure
Is ZIRP, for some years, will endure
The worry is Jay
Has nothing to say
On what he’ll do when there’s a cure

Markets have been biding their time overnight and seem likely to do so for the rest of today’s session as investors and traders await the wisdom of Chairman Powell.  Tomorrow morning’s speech is expected to define the basics of the new Fed operating framework.  In other words, it will describe their latest views on how to achieve their Congressional mandate of achieving “…maximum employment, stable prices and moderate long-term interest rates.”

It was in 2012 when the FOMC decided that 2.0% inflation was the definition of stable prices and formalized that number as their target. (Interestingly, the history of the 2.0% inflation target starts back in New Zealand in the late 1980’s, when inflation there was consistently between 15%-20%.  Donald Brash was appointed RBNZ governor and in one of his first actions decided that 2.0% inflation represented a good compromise between rampant inflation and price stability.  There was neither academic literature nor empirical data that supported this view, it was simply his feeling.  But it has since become the watchword in central banking with respect to price stability.  Remember, at 2.0% annual inflation, the real value of things halves every 20 years. Many argue that does not define price stability.)  Fortunately for us all, the Fed has been largely unable to reach their target, with measured inflation averaging 1.6% since then.  Of course, there are issues with the way inflation is measured as well, especially the Fed’s preferred gauge of Core PCE.

But regardless of any issues with the measurement of inflation, that process is not due for adjustment.  Rather, this is all about how the Fed is going to approach the problem of achieving something they have not been able to do consistently since they began the process.

The consensus view is that the Fed is now going to target the average inflation rate over time, although over what time period seems to be left unsaid.  The rationale seems to be that with the Philips Curve relationship now assumed dead (the Phillips curve is the model that explains as unemployment falls, inflation rises), and given the current dire economic situation with unemployment in double digits, the Fed wants to assure everyone that they are not going to do anything to prevent an economic recovery from not only taking off, but extending well into the future.  Thus, the idea is that even when the recovery starts to pick up steam, and presumably inflation rises alongside that recovery, the Fed will happily allow higher prices in order to help to continue to drive unemployment lower.  In other words, the famous dictum of ‘removing the punch bowl just as the party gets started’ is to be assigned to the trash heap of history.

The reason this matters to us all is that future path of inflation, and just as importantly expectations about that path, are what drive interest rates in the market, especially at the long end of the curve.  While the Fed can exert significant control over interest rates out to 2 years, and arguably out to 5 years, once you get past that, it becomes far more difficult for them to do so.  And given the fact that ZIRP and NIRP reign supreme throughout G10 economies, the long end of the curve is the only place where any yield is available.

The problem for investors is that with 30-year Treasuries yielding 1.4%, if the Fed is successful at getting inflation back above 2.0%, the real return on those bonds will be negative, and significantly so.  The alternative, of course, is for investors to sell their current holdings of those bonds, driving down prices and correspondingly raising yields to levels that are assumed to take into account the mooted higher rate of inflation.  The problem there is that the US government, who has been issuing bonds at record rates to fund the spending for Covid programs as well as to make up for lost tax revenue from the economic slowdown, will have to pay a lot more for their money.  That, too, is something that the Fed will want to prevent.  In other words, there are no really good solutions here.

However, what we have begun to see in markets is that investors are expressing concern over a rise in inflation, and so Treasury yields, as well as bond yields elsewhere, are beginning to rise.  Now, nobody would ever call 0.7% on the 10-year a high yield, but that is 0.2% higher than where it was just three weeks ago.  The same is true in the 30-year space, with similar moves seen throughout the rest of the G10 bond markets.  While deflation concerns remain the primary focus of central bankers everywhere, bond markets are beginning to look the other way.  And that, my friends, will be felt in every market around the world; equities, commodities and FX.

So, a quick look at markets this morning shows us that equities in Asia had a mixed to weaker session (Nikkei +0.0%, Hang Seng +0.0%, Shanghai -1.3%) while European bourses are mostly very modestly higher (DAX +0.5%, CAC +0.3%, FTSE 100 -0.2%).  US futures are mixed as well, although NASDAQ (+0.5%) futures continue to power ahead, the Dow and S&P are essentially unchanged.

Bond markets continue to slowly sell off as they are seeming to price in the idea that if the Fed is willing to accept higher inflation going forward, so will every other central bank.  Thus, another 3bp rise this morning in 10-year Treasuries, Bunds and Gilts has been seen.  Meanwhile, as interest rates go higher, gold is losing some of its luster, having fallen another 0.6% today which takes it nearly 8% below its recent historic peak.

And finally, the dollar is having what can only be described as a mixed session.  Versus the G10, it has gained slightly against the Euro, Danish krone and Swiss franc, and edged lower vs NZD.  Those movements are on the order of just 0.2%-0.3%, with the rest of the bloc +/- 0.1% and offering no information.  Emerging market currencies have seen similar price action, albeit with a bit more oomph, as HUF (-0.8%) and CZK (-0.6%) demonstrate their higher beta characteristics compared to the euro, while ZAR (+0.5%) continues to find buyers for their still highest yielding debt available.

As I said at the top, markets appear to be biding their time for the Chairman’s speech tomorrow morning at 9:15 NY time.  On the data front, this morning only brings Durable Goods (exp 4.8%, 2.0% ex Transport), which while generally important, will unlikely be enough to shake up the trading or investment community.  For now, the dollar’s medium-term trend lower has been halted.  Its future direction will depend largely on Mr Powell and what he has to tell us tomorrow.  Until then, don’t look for very much movement at all.

Good luck and stay safe
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A Shot of Caffeine

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It’s true that, eternal, hope springs
And sessions like this give it wings
The news, seemingly
Is twixt Trump and Xi
Less angst will lead to better things

As well, hope has grown, a vaccine
Is likely, this year, to be seen
Now bulls rule the roost
Thus, giving a boost
To stocks like a shot of caffeine

Another day, another round of stories seemingly designed solely to boost equity markets around the world.  The first of these is a bit oblique, as the word from ‘insiders’ is that the Trump administration, despite its increasingly vocal hard line vs. the Chinese, is maintaining back channel communications, specifically regarding the WeChat app, and US companies’ ability to continue to use it in their advertising and marketing campaigns in China.  This is important as WeChat is a critical advertising venue for virtually every company in China, and if the mooted ban by the Trump administration in the US was a world-wide ban, most US companies would see their Chinese businesses devastated. If we forget, for a moment, the convenient timing of these leaked comments, this is, unarguably, good news for those US companies active in China.  Certainly, this is worth some added value to equity prices.

But let’s unpack the second story, the one about the vaccine.  While this weekend saw an announcement for the approval of another treatment, convalescent plasma injections, the big prize remains a working vaccine that is both safe and efficacious.  Briefly, the idea behind the plasma injections is that individuals who have recovered from the disease have antibodies in their blood, which can be separated and injected into severely ill patients in an effort to boost the patient’s own disease fighting capability.  As in everything to do with Covid-19, it remains experimental and there is controversy as to how well the therapy may work.  But given the desperation of some patients to get something done, the President has decided to overrule other voices and give emergency clearance.  However, this is a treatment, not a preventative.

The vaccine remains the holy grail.  To date, there are on the order of 180 different vaccines in various stages of development, 10 of which are in Phase 3 or have been given limited approvals.  Clearly, pharmaceutical companies see this as the newest potential blockbuster drug.  But the real question seems to be, even when (if) a vaccine is created, will it really change the nature of the spread of Covid-19 by that much?  It is unambiguous that the market narrative’s answer to that question is a resounding yes.  However, perhaps it is worth casting a skeptical eye on the idea.

Using influenza as our model, as it is the closest thing we have with respect to its contagion and even the structure of the disease and working under the assumption that human nature remains constant, the numbers don’t point to a vaccine as panacea.

Consider, in the US, roughly 45% of the population receives the flu vaccine each year.  In addition, it is only effective for, at most, two-thirds of those who do receive the vaccine.  Thus, the protective ‘shield’ that the flu vaccine creates is effective for roughly 30% of the population.  One of the reasons we consistently hear so much every year about getting the flu vaccine via PSA’s is that the virology community calculates we need a greater percentage of the population vaccinated to achieve a herd immunity.  And yet, the 45% inoculation rate has been pretty steady for years.  Human nature is pretty hard to change.

This begs the question, will the take-up of a Covid-19 vaccine be higher than that for the flu?  And if so, will it reach the level’s necessary to achieve herd immunity, thus encouraging governments to relax many of the current restrictions and people to resume some semblance of their former lives?

The argument for a higher take-up rate is that the media has gone out of its way to highlight the deadliness of Covid-19, in some cases exaggerating the numbers for effect, in what appears to be an attempt to sow fear in the population.  The underlying belief to this strategy is to convince a large portion of the population of the criticality of receiving the vaccine once it becomes available.  And perhaps this will be a successful strategy.  But human nature has taken a long time to evolve to where it currently resides, and the case for a flu-like take-up rate, and thus a failure to achieve herd immunity, is based on the idea that unless one has been sickened already, or personally knows someone who has, it is hard to make the case that inoculation rates will increase over those of the flu vaccine.

Alas, my money is on the under.  However, will that matter for the markets?  That is an entirely different question, and one which speaks to confidence, not data.  At this time, I would contend the underlying market belief is that a vaccine is going to be approved, and be effective, within the next twelve months.  The result will be an end to the lockdowns and a resumption in economic activity worldwide that is much closer to the pre-Covid time.  But if this is so, one needs to be careful that we are not looking at the biggest ‘but the rumor’ reaction in history, and that the approval of a safe vaccine could well be the proverbial bell for the top of the equity market.  Remember, economic growth is still a product of population growth and productivity, and there is nothing about a Covid vaccine that will have increased either of those from pre-Covid days.

That exceptionally long discussion was driven by the remarkable ongoing rally in risk assets seen this morning.  Equity markets in Asia were all higher (Nikkei +0.3%, Hang Seng +1.75%) and Europe is really on fire (DAX +2.3%, CAC +2.15%).  US futures are currently 1.0% higher and climbing.  Bonds are under modest pressure, with 10-year yields higher by 1 basis point in the US and most of Europe.  Oil prices, along with gold, are higher by 0.5%-0.7%, modest by their recent standards.  And the dollar is definitely under a bit of pressure.

In the G10 space, SEK and AUD lead the way, both higher by 0.5%, although the gains are fairly solid across the board.  In fact, despite extending the lockdown in Auckland, NZ, kiwi has retraced early losses and is higher by 0.25%.  In the EMG bloc, ZAR leads the way, up 1.2%, as the combination of risk positive stories and higher commodity prices continues to encourage investors to buy South African bonds.  But virtually the entire space is firmer this morning with two outliers, KRW (-0.25%) which fell after the central bank downgraded the economic outlook further, and TRY (-0.8%), which continue to see capital flee as the central bank is prevented by President Erdogan from raising rates.

There has been virtually no data today, and in truth, all eyes will be on Chairman Powell Thursday morning, when he speaks at the virtual Jackson Hole gathering.  Expectations are he is going to outline the new Fed framework, with a higher inflation target, and other potential changes.  But we will look into that later this week.  As for today, I see no reason to believe that the current risk attitude is going to change, so further dollar weakness is likely on the cards.

Good luck and stay safe
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Their Siren Song

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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

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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

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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

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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

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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