Tag Archives: #QE

Was It Ever?

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The BOJ asked
Is QE still effective?
Or…was it ever?

One of the constants in financial markets since 2012 has been the BOJ’s massive intervention in Japanese markets.  They were the first major central bank to utilize QE, although they call it QQE (Quantitative and Qualitative Easing – not sure what quality it brings) and have now reached a point where the BOJ owns more than 51% of the JGB market.  In fact, given their buy and hold strategy removes those bonds from trading, the liquidity in the JGB market has suffered greatly.  Remember, too, that JGB issuance is greater than 230% of the Japanese GDP, which means the BOJ’s balance sheet is larger than the Japanese economy, currently sitting at ~$6.74 Trillion or 133.2%.

But they don’t only purchase JGB’s, they are also actively buying equity ETF’s in Japan, and by using their infinite printing press have now become the largest single shareholder in the country with holdings of ~$435 Billion, or roughly 7.5% of all the equities outstanding in the country.  And you thought the Fed was pursuing an activist monetary policy!

The thing is, it is not hard to describe all these efforts as utter failures in achieving their aims.  Those aims were to support growth and push inflation up to 2.0%.  (As an aside, it is remarkable how 2.0% has become the ‘magic’ number for the right amount of inflation in central banking circles.  Thank you Donald Brash.)  However, a quick look at the history of inflation in Japan since Kuroda-san’s appointment to Governor of the BOJ in March 2013, and the latest surge in activist monetary policy, shows that the average inflation rate during his tenure as been 0.73%.  Inflation peaked in May 2014, in the wake of the GST hike (a tax rise on consumption) at 3.7%, and spent 12 months above the 2.0% level as that impact was felt, but then the baseline was permanently higher and inflation quickly fell back below 1.0%, never to consider another rise to that level.

Looking at growth, the picture is similar, with the average Q/Q GDP growth during Kuroda-san’s tenure just 0.1%.  It is abundantly clear that central bankers are no Einsteins, as they seem constantly surprised that the same strategies they have been using for years do not produce new results.  Perhaps you must be insane to become a central banker.

What makes this relevant today is that last night, it was learned that BOJ policymakers are considering some changes to their policies.   It’s current policy of YCC has short-term rates at -0.1% and a target for 10-year yields of 0.00% +/- 0.20% leeway.  They also currently purchase ¥12 Trillion ($115 Billion) of equity ETF’s per year.  However, their new plans indicate that they are going to change the mix of JGB purchases, extending the tenor and cutting back purchases of short-term bonds, while also allowing more flexibility in the movement of 10-year yields, with hints it could widen that band from the current 40bps to as much as 60bps.  While that may not seem like a lot, given the minimal adjustments that have been made to these policies over the past 8 years, any movement at all is a lot.

And the market took heed quickly, with JPY (-0.5%) falling to its weakest point vs. the dollar since mid-November.  Technically, USDJPY has broken through some key resistance levels and the prospects are for further USD appreciation, at least in the short run.

In China, the PBOC
Is worried that bubbles will key
More problems ahead
And to punters’ dread
Have drained out more liquidity

China is the other noteworthy story this morning, where the central bank has aggressively drained liquidity from the market as they remain extremely wary of inflating bubbles.  Overnight funding costs rose 29bps last night, to their highest level since March 2015.  Not surprisingly, Chinese equity markets suffered with Shanghai (-0.6%) and the Hang Seng (-0.95%) both unable to follow yesterday’s US rally.  (The Nikkei (-1.9%) also suffered as concerns were raised that the BOJ, in their revamp of policy, may choose to buy less equities.)  What is so interesting about this action is that if you ask any Western central banker about bubbles you get two general responses; first, they cannot tell when a bubble exists; and second, anyway, even if they could, it is not their job to deflate them.  Yet, the PBOC is very clear that not only can they spot a bubble, but they will address it.

I think it is fair to say that given the recent activity in certain stocks like GameStop and AMC, the US market is really exhibiting bubble-like tendencies.  Rampant speculation by individual investors is always a sign of a bubble.  We saw that in 1999-2000 during the Tech bubble, when people quit their day jobs to become stock traders and we saw that in the housing bubble of 2007-8, when people quit their day jobs to speculate in real estate and flip houses.   It also seems pretty clear that the combination of current monetary and fiscal policies has resulted in equity markets being the final repository of that cash.  Having lived, and traded, through the previous two bubbles, I can affirm the current situation exhibits all the same hallmarks, with one exception, the fact that central banks are explicitly targeting asset purchases.  However, this situation cannot extend forever, and at least one part of the financial framework will falter. When that starts, price action will become extremely volatile, similar to what we saw last March, but for a longer period of time, and market liquidity, which has already suffered, will get even worse.  All this points to the idea that hedging financial risk remains critical.  Do not be dissuaded by some volatility, because I assure you, it can get worse.

Anyway, a quick tour of markets shows some real confusion today.  Equities, which we saw fell sharply in Asia, are falling across Europe as well (DAX -0.8%), CAC (-0.9%), FTSE 100 (-1.0%) despite the fact that preliminary GDP data from the continent indicated growth in Q4 was merely flat, not negative. US futures are all pointing lower as well, between 0.5% and 0.9%.

Bonds, however, are all being sold as well, with Treasury yields rising 2.6bps, and European market seeing even greater rate rises (Bunds +3.3bps, OATs +3.3bps, Gilts +3.9bps).  So, investors are selling both stocks and bonds.  What are they buying?

Commodities are in favor this morning, with oil (+0.5%) and the ags rising, but precious metals are in even greater favor (Gold +1.1%, Silver +3.25%).  And finally, the dollar, is under broad pressure, with only the yen really underperforming today.  NOK (+0.9%) is leading the way in the G10, while the rest of the bloc, though higher, is less enthusiastic with gains ranging from 0.1%-0.3%.  Emerging market currencies are having a much better day, led by ZAR (+1.3%) on the back of the commodity rally, followed by TRY (+0.85%) and MXN (+0.45%).  CNY (+0.25%) has rallied on the back of the Chinese monetary actions and BRL (-0.1%) is the only laggard in the bloc as bets on rate hikes, that had been implemented earlier in the week, seem to be getting unwound.

There is important data this morning as well, led by Personal Income (exp 0.1%) and Personal Spending (-0.4%), but also Core PCE (1.3%), Chicago PMI (58.5) and Michigan Sentiment (79.3).  The PCE data has the best chance of being the most interesting, as a higher than expected print will get tongues wagging once more regarding the reflation trade and higher bond yields.

But, when looking at the markets in their totality, there is no specific theme.  Risk is neither on, nor off, but looks more confused.  If I had to describe things, I would say that fiat linked items are under pressure while real items are in demand.  Alas, given current monetary policy globally, I fear that is the future in a nutshell.  As to the dollar, relative to other currencies, clearly, today it is under the gun, but arguably, it is really just consolidating its recent modest gains.

Good luck, good weekend and stay safe
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The Largesse They Bestow

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The status is clearly still quo
For central bank policy so
All rates are on hold
And markets consoled
By all the largesse they bestow

But Covid continues to spread
And Q1 growth seems to be dead
So, Christine and Jay
Will soon have to say
More QE is coming ahead

It has been an active week for central banks so far, at least with respect to the number of meetings being held.  By the end of today we will have heard from six different major central banks from around the world (Canada, Brazil, Japan, Indonesia, Norway and the ECB) although not one of them has changed policy one iota.  The implication is that monetary policy has found an equilibrium for now, with settings properly attuned to the current economic realities.

A summary of current central bank policies basically shows that whatever the absolute level of interest rates being targeted, it is almost universally at historically low levels, with 14 key banks having rates 0.25% or lower.  The point is, a central bank’s main tool is interest rate policy, and while negative nominal rates are clearly viable, after all the SNB, ECB and BOJ currently maintain them, central banks are clearly running out of ammunition.  (PS; the efficacy of negative rates has been widely argued and remains unproven.)  Interestingly, prior to this crisis, reserve requirements were seen as an important central banking tool, with a broad ability to inject more liquidity into the markets or remove it if so desired.  However, in the wake of the GFC, when banks worldwide were shown to be too-highly levered, it seems central banks are a bit more reluctant to open those floodgates.  Even if they did, though, it is unclear if it would make a difference.  Perhaps the lesson we should all learn from the Covid crisis, especially the central banks themselves, is that monetary policy is very good at slowing down economies all by itself, but when it comes to helping them pick up, they need help.

So, with interest rate policy basically at its limit, central banks have been forced to implement new and different tools in their quest to support their respective economies, with QE at the forefront.  Of course, at this point, QE has also become old hat, and has yet to be shown to support the economy.  It has, however, done a bang-up job supporting equity markets around the world, as well as other risk assets like commodities.  And that is exactly what it was designed to do.  QE’s transmission mechanism was to be a trickle-down philosophy, where the ongoing search for yield by investors pushed capital into riskier ventures, helping to support increased investment and more economic growth.  Alas, the only thing QE has really served to do is inflate a number of asset bubbles.  This was never clearer than when the data showed more money was spent by corporations on stock repurchases than on R&D.  Thus, if the stated goal of QE was to support economic growth, it is fair to say it has failed at that task.

At any rate, a recap of the central bank comments shows that economic forecasts and expectations have been tweaked lower for Q1 and higher for Q2 and Q3 with a universal assumption that the widespread inoculation of the population via the new vaccines will help reopen economies all over.  And yet, if anything, we continue to hear of more and more draconian measures being put into place to slow the spread of Covid.  This certainly confirms the idea of a weak Q1 growth pattern, but the leap to a stronger Q2 is harder to make in my mind.

Add it all up and it appears that central banks, globally, are pretty much all in the same position, promulgating extremely easy monetary policy with limited hope that it will, by itself, reignite economic growth.  In effect, until it is shown that the vaccines are really changing people’s behavior, assuming governments allow people back out of the house, central banks can do all they want, and it will not have much impact on the economy.  Markets, however, are a different story, as all that monetary largesse will continue to flow to the riskiest, highest yielding assets around.  Until they don’t!  It will not be pretty when this bubble deflates.

So, is that happening today?  Not even close.  Equity markets continue to rise almost universally, with the Nikkei (+0.8%) and Shanghai (+0.8%) leading the way in Asia.  Europe, meanwhile, is not quite as robust, but still largely in the green led by the DAX (+0.5%) and FTSE 100 (+0.25%) although the CAC (-0.1%) is lagging a bit.  And not surprisingly, US markets continue to power ahead on the ongoing belief that there will be yet more stimulus coming, so futures are all higher by roughly 0.3% or so.

Bond markets are playing their part as well, with 10-year yields higher in all the major markets, with Treasuries, Bunds, OATs and Gilts all seeing yields climb about 1 basis point.  The interesting thing about Treasuries, and truthfully all these markets, is that since the Georgia run-off election, when the market assumption for more stimulus was cemented, the yield has barely moved.  Let me say that the reflation trade seems to be on hold, at least for now.

For a change, oil prices have edged a bit lower this morning, with WTI down 0.6%, as it consolidates its spectacular gains since November.  Gold is little changed, although it had a big day yesterday, rising 1.5% as inflation concerns seem to be percolating.  And finally, as perhaps a harbinger of that deflating bubble, Bitcoin is lower this morning and has been falling pretty steadily, if with still spectacular volatility, for the past 2 weeks, and is now down 24% from its recent highs.

Finally, the dollar is under clear pressure this morning, falling against all its G10 peers and all but one of its EMG peers.  In G10, NOK (+0.8%) leads the way as the Norgesbank did not cut rates which some had expected and were less negative on the economy than expected as well.  But NZD (+0.7%) and SEK (+0.6%) are also putting in fine performances amid stronger commodities and hopes for more stimulus.  In fact, CAD (+0.15%) is the laggard, although it had a strong performance yesterday (+0.7%) after the BOC left rates on hold rather than performing a microcut (10 bps) as some analysts had expected.

In the EMG space, CLP (+1.15%) and BRL (+1.1%) lead the way with the former benefitting from strong investor demand in USD and EUR denominated government bonds, leading to a positive outlook, while the latter seems to be responding to hints that tighter policy may be coming soon given rising inflation forecasts.   But really, the dollar’s weakness is pervasive across all three major blocs.

We finally see some data today as follows: Initial Claims (exp 935K), Continuing Claims (5.3M), Housing Starts (1560K), Building Permits (1608K) and Philly Fed (11.8).  The Claims data has certainly deteriorated during the past several weeks given the renewed lockdowns around the country, which doesn’t bode well for the NFP report in 2 weeks’ time.  The housing market remains on fire given the ongoing exodus to the suburbs from large cities and the historically low mortgage rates.  Meanwhile, Philly Fed should show the strength of the manufacturing sector, which continues to far outperform services.

Still no Fed speakers, so beyond the data, which is all at 8:30, we will also hear from Madame Lagarde in her press conference at the same time.  The risk, to me, is that she comes off more dovish than the market anticipates, thus halting the euro’s modest rebound.  But otherwise, there is no obvious catalyst to stop the risk-on meme and dollar’s renewed decline.

Good luck and stay safe
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Pending A-pocalypse

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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What Will the Fed Do?

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To taper, or not, is the new
Discussion.  What will the Fed do?
One group sees next winter
As when the Fed printer
Will slow down if forecasts come true

But yesterday doves answered back
It’s premature to take that tack
There’s no need to shrink
QE, the doves think
‘Til growth has absorbed all the slack

Remember just last month when the Fed tightened the wording in the FOMC statement to explain they would buy “at least $80 billion per month” of Treasuries and “at least $40 billion per month” of agency mortgage-backed securities “until substantial further progress has been made toward the Committee’s maximum employment and price stability goals.”  This was clearly more specific than their previous guidance of buying securities at “the current pace” to achieve the same ends.  It would be easy to read that December statement and conclude that reducing asset purchases was quite a long way off in the future, arguably years.  This is especially so when considering the fact that the US government cannot afford for interest rates to rise very far given the extraordinarily large amount of debt they have outstanding and need to service.  After all, it is much easier to service debt when interest rates are 0.25% than when they are 2.5%.

Granted, the first Covid vaccine had just been approved the weekend before that meeting, so the question of how it would be rolled out was still open, but it had to be clear that the vaccine was going to become widely available in the following months.  And yet, the statement seems to imply QE could increase going forward if there was to be any change at all.  Yet here we are just four weeks later, and we have heard a virtual chorus of Fed regional presidents explaining that tapering purchases may be appropriate before the end of the year.  In the past seven days, Chicago’s Evans, Philly’s Harker, Dallas’s Kaplan and Atlanta’s Bostic all said tapering purchases would be appropriate soon, with Harker explaining it could easily be this year.

That’s pretty powerful stuff, if the Fed is truly considering changing its stance on policy and the ramifications are huge.  Arguably, if the Fed truly announced they were going to be reducing purchases, the bond market would sell off much harder than recently, the stock market would sell off quite hard and the dollar would reverse course and rally sharply.  But of those three reactions, the only thing ongoing is the steepening of the yield curve, with stocks continuing their slow move higher and the dollar, while consolidating for the past week, hardly on a tear.

Naturally, there is a counterpoint which was reiterated by St Louis’s Bullard and Boston’s Rosengren yesterday, and earlier this week by Cleveland’s uber-hawk, Loretta Mester and Fed vice-Chair Richard Clarida, that there is no sign a taper is appropriate any time soon, and that the Fed will have the printing presses running at full tilt until the pandemic is behind us.

So, which is it?  Well, that is the question that will be debated in and by the markets for the foreseeable future, or at least until the Fed tells us.  This week, we will hear from nine more Fed speakers, including Chairman Powell, but then the quiet period starts and there will be no word until the FOMC meeting two weeks from today.  The list of speakers spans the spectrum from hawkish to dovish, but arguably, all eyes will be on Powell.  Many analysts have highlighted the 2013 Taper Tantrum, which resulted after then Fed Chair Bernanke mentioned that the Fed would not be buying bonds forever.  The market response then was to drive 10-year Treasury yields from 1.62% on May 1 2013 to 2.99% on September 15 2013!  I find it incredibly hard to believe that the current Fed will allow anything like that at all.  As I pointed out earlier, the US government simply cannot afford that outcome, and the Fed will prevent it from happening.  The implication is that at some point soon, the Fed is going to discuss yield curve control, likely as a method to help finance all the mooted infrastructure spending that is supposed to be coming from the new Administration and Congress.  Or something like that.  But they will not allow yields to rise that much more, they simply can’t.

How has this argument discussion played out in the markets today?  The picture has been mixed, at best, with perhaps a tendency to reduce risk becoming the theme.  Looking at equities, the Nikkei (+1.0%) was the outstanding performer overnight, while we saw marginal declines in the Hang Seng (-0.2%) and Shanghai (-0.3%).  European bourses, which had been slightly higher earlier in the session, have slipped back to either side of unchanged with the DAX (-0.15%) and FTSE 100 (-0.1%) a touch lower while the CAC (+0.1%) has edged higher.  The CAC has been supported by the news that Alimentation Couche-Tarde is bidding for Carrefours, the French grocery store chain, and a key member of the index.  In truth, this performance is a bit disappointing as well, given comments from ECB member Villeroy that they would be supporting the economy with easy money as long as necessary, and that they were carefully watching the exchange rate of the euro. (more on this later).  Finally, US futures, which had been slightly higher earlier in the session, are all slightly lower now, but less than 0.1% each.

As to the bond market, safety is clearly in demand, at least in Europe, where yields have fallen by between 1.8bps (Gilts) and 2.7bps (Bunds) with most other markets somewhere in between.  Treasuries, meanwhile, have edged higher by just a tick with the yield a scant 0.3bps lower at this time.  As I said, this is going to be the battle royal going forward.

In the commodity space, oil is basically unchanged this morning, holding on to recent gains, while gold is also unchanged, holding on to recent losses.

And finally, the dollar is somewhat higher this morning, seeming to take on its traditional role of haven asset.  It should be no surprise the euro (-0.3%) is under pressure, which is exactly what the ECB wants to see.  Remember, the other sure thing is that the ECB cannot afford for the euro to rally very far as it will negatively impact the Eurozone export community as well as import deflation, something they have been trying to fight for years.  Elsewhere in the G10, SEK (-0.95%) is the worst performer after the Riksbank announced they would be selling SEK 5 billion per month to buy foreign currency reserves, and coincidentally weaken their currency.  And they will be doing this until December 2023, which means they will be creating an additional SEK 180 billion in the market, a solid 13.5% of GDP.  Look for further relative weakness here.  But beyond SEK, the rest of the G10 has seen lesser moves, all of a piece with broad dollar strength.

In the emerging markets, CLP (-2.1%) is today’s big loser after announcing that they, too, would be selling CLP each day to increase their FX reserves to the tune of 5% of the Chilean economy.  Of course, liquidity in CLP is far worse than that in SEK, so a larger move is no surprise.  Regardless, we can expect continued pressure on this peso for a while.  But away from this story, the overnight session saw modest strength in most APAC currencies led by IDR (+0.5%) and KRW (+0.4%), while the morning session has seen CE4 currencies suffer alongside the euro, and LATAM currencies give up some ground as well.  BRL (-0.6%) seems to be responding to the extremely high inflation print seen yesterday, while HUF (-0.7%) is reacting to the news of an increase in QE there as the central bank expanded its corporate bond purchases to HUF 1.15 trillion from HUF 750 billion previously.

On the data front, today brings CPI (exp 0.4% M/M, 0.1% core) and the afternoon brings the Fed’s Beige Book.  With the inflation story gaining traction everywhere, all eyes will be on the data there.  If we see a higher than expected print, the pressure will increase on the Fed, but so far, they have been quite clear they are unconcerned with rising prices and are likely to stay that way for quite a while.  Ultimately, I fear that is one of the biggest risks out there, rising inflation.

Looking ahead, I believe the dollar’s consolidation of its losses will continue but would be surprised if it rallied much more at all.  Rather, a choppy day seems to be in store.

Good luck and stay safe
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Not Whether but When

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The question’s not whether but when
The Fed adds more money again
With Congress unable
To reach cross the table
It’s up to Jay and his (wo)men

For the first time in months, the top stories today are simply a rehash of the top stories yesterday.  In other words, there is nothing new under the sun, at least with respect to market activities.  There has been nothing new regarding Brexit (talks continue but no word on an outcome); nothing new regarding US fiscal stimulus (talks continue but no word on an outcome);  and nothing new regarding Covid-19 (vaccines have begun to be administered, but lockdowns continue to be the primary tool to fight the spread of the infection).

True, we received some data from China overnight describing an economy that continues to recover, but one whose pace of recovery is barely accelerating and certainly not exceeding expectations.  We saw some data from the UK that described the employment situation as less dire than forecast, but still a mess.  And we saw some inflation data from both Italy and France describing the complete lack of an inflationary impulse on the Continent.  The point is, none of this could be called new information, and so investor response has been extremely muted.

Rather, the story that is developing traction seems to be the question of what the FOMC is going to do when they meet tomorrow.  There seem to be two questions of note; first, will they leave everything just as it is, reiterating their current forward guidance to continue to support the economy until it is deemed capable of recovering on its own, or will they start to attach some metrics to their views; and second, will they leave their current asset purchase program unchanged, or will they alter either the size or tenor?

The bigger picture on this issue needs to consider what we have heard from various Fed speakers prior to the quiet period.  To a (wo)man, they all explained that more fiscal stimulus was critical in helping the economy to recover, and so the fact that none has been forthcoming must be weighing on their views of the future.  This would seem to bias a call for action, not inaction.

Regarding the first question, if we learned anything from the FOMC Minutes three weeks’ ago, it was that there seemed to be movement in the direction of applying metrics to their hitherto vague statements regarding when they will act.  The concern with this approach is that in the wake of the financial crisis, they did just this, explaining that rates would remain near zero until the Unemployment Rate reached their then-current view of full employment, which initially was pegged at 5.0%.  That target was changed several times until it was finally abandoned, as it turned out their models weren’t all that accurate.  Which begs the question, do they want to put themselves in the same position of defining a position and subsequently finding out their initial assumptions were wrong, so they need to change that position?  Remember, credibility is one of a central bank’s most crucial assets and moving targets on policy because of model or forecast errors does not enhance credibility.  In the end, it seems more likely they will not apply hard numbers to their targets, rather much softer views like, full employment rather than a specific unemployment rate; or trend inflation rather than a specific average inflation rate with a timeline attached.

As to the second question, based on positioning indicators, current expectations are pretty evenly distributed as to a change (either more purchases or a Twist) or standing pat.  Again, based on the commentary that fiscal stimulus is crucial and its failure to be agreed, I would lean toward the side of more stimulus to be announced now, perhaps stoking the Christmas rally in equities.  (After all, half the time it seems stoking equity rallies is their entire focus.)

But away from that conversation, there is precious little else to discuss today.  A quick tour of markets shows that after yesterday afternoon’s US equity selloff, Asian equities followed suit with modest declines across the board (Nikkei -0.2%, Hang Seng -0.7%, Shanghai -0.1%).  European bourses, which had been modestly higher earlier, are starting to fade a bit, although the DAX (+0.6%) and CAC (+0.3%) remain in the green.  However, the FTSE 100 (-0.3%) has turned lower as the pound has recently started to edge higher.  US futures are all pointing higher, though, with gains of around 0.6% across the board.

Bond prices are mixed, with Treasuries very slightly softer and yields there higher by less than 1 basis point, but European markets starting to find a bid with yields declining modestly across the board.  The outperformers right now are the PIGS, with yield declines of between 1.5 and 4 basis points, while the rest of Europe’s markets are looking at smaller price gains.

Commodities are reversing yesterday’s price action with oil virtually unchanged while gold has rallied 1.0% this morning.  And finally, the best way to describe the dollar is modestly, but not universally, softer.  In the G10, as I write, GBP (+0.4%) has rallied in the past hour although there has been nothing on the tape that would seem to account for the price action.  But most of the bloc is modestly firmer, between 0.1% and 0.2%, with only two laggards, AUD and NZD (both lower by -0.1%) which have responded to China’s announcement they would be banning shipments of coal from Australia going forward.

EMG currencies are also somewhat firmer in general, led by LATAM (BRL, MXN and CLP all +0.50%) with two others showing similar strength (ZAR and RUB).  As to the rest of the bloc, gains and losses are less than 0.2%, which is another way of saying there is no new information there either.  Broadly speaking, this bloc is going to take its cues from the G10 space, and while the consensus for 2021 remains a much weaker dollar, today that is not taking shape.

On the data front, we see Empire Manufacturing (exp 6.3), IP (0.3%) and Capacity Utilization (73.0%) this morning, although none of these seem likely to change any views.  As such, at this point, it seems the best bet is the FX market will follow the broad risk theme, assuming one develops, or will respond to news, perhaps a fiscal stimulus breakthrough will come today, which is likely to lead to further dollar weakness.  But we will have to wait for that.

Good luck and stay safe
Adf

Haven’t a Doubt

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

Good luck, good weekend and stay safe
Adf

QE’s Not Constrained

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For everyone who seems to think
The dollar will steadily sink
This weekend disclosed
The world is opposed
To letting the buck’s value shrink

In China they eased the restrictions
On short sales in all jurisdictions
While Europe explained
QE’s not constrained
And further rate cuts are not fictions

It cannot be a surprise that we are beginning to see a more concerted response to dollar weakness from major central banks.  As I have written consistently, at the current time, no nation wants their currency to be strong.  Each is convinced that a weak currency will help obtain the twin goals of improved export performance leading to economic growth and higher inflation.  While financial theory does show that, in a closed system, those are two natural consequences of a weak currency, the evidence over the past twelve years has been less convincing.  Of course, as with every economic theory, a key assumption is ‘ceteris paribus’ or all else being equal.  But all else is never equal.  A strong argument can be made that in addition to the global recession undermining pricing power, the world is in the midst of a debt deflation.  This is the situation where a high and rising level of overall debt outstanding directs cash flow to repayment and reduces the available funding for other economic activity.  That missing demand results in price declines and hence, the debt deflation.  History has shown a strong correlation between high levels of debt and deflation, something many observers fail to recognize.

However, central banks, as with most large institutions, are always fighting the last war.  The central bank playbook, which had been effective from Bretton Woods, in 1944 until, arguably, sometime just before the Great Financial Crisis in 2008-09, explained that the reflexive response to economic weakness was to cut interest rates and ease financing conditions.  This would have the dual effect of encouraging borrowing for more activity while at the same time weakening the currency and making the export community more competitive internationally, thus boosting growth further.  And finally, a weaker currency would result in imported inflation, as importers would be forced to raise prices.

The Great Financial Crisis, though, essentially broke that model, as both the economic and market responses to central bank activities did not fit that theoretical framework.  Instead, adhering to the playbook saw interest rates cut to zero, and then below zero throughout Europe and Japan, additional policy ease via QE and yet still extremely modest economic activity.  And, perhaps, that was the problem.  Every central bank enacted their policies at the same time, thus there was no large relative change in policy.  After all, if every central bank cut interest rates, then the theoretical positive outcomes are negated.  In other words, ceteris isn’t paribus.

Alas, central banks have proven they are incapable of independent thought, and they have been acting in concert ever since.  Thus, rate cuts by one beget rate cuts by another, sometimes explicitly (Denmark and Switzerland cutting rates after the ECB acts) and sometimes implicitly (the ECB, BOE and BOC cutting rates after the Fed acts).  In the end, the results are that the relative policy settings remain very close to unchanged and thus, the only beneficiary is the equity market, where all that excess money eventually flows in the great hunt for positive returns.

Keeping the central bank mindset at the fore, we have an easy time understanding the weekend actions and comments from the PBOC and the ECB.  The PBOC adjusted a reserve policy that had been aimed at preventing rampant selling speculation against the renminbi.  For the past two plus years, all Chinese banks had been required to keep a 20% reserve against any short forward CNY positions they executed on behalf of customers.  This made shorting CNY prohibitively expensive, thus reducing the incentive to do so and helped support the currency.  However, the recent price action in CNY has been strongly positive, with the renminbi having appreciated nearly 7% between late May and Friday.  For a country like China, that sells a great many low margin products to the rest of the world, a strong currency is a clear impediment to their economic plans.  The PBOC action this weekend, removing that reserve requirement completely, is perfectly in keeping with the mindset of a weaker currency will help support exports and by extension economic growth.  Now there is no penalty to short CNY, so you can expect more traders to do so.  Especially since the fixing last night was at a weaker CNY level than expected by the market.  Look for further CNY (-0.8% overnight) weakness going forward.

As to the ECB, their actions were less concrete, but no less real.  ECB Chief Economist Philip Lane, the member with the most respected policy chops, was on the tape explaining that the Eurozone faces a rocky patch after the initial rebound from Covid.  He added, “I do not see that the ECB has a structurally tighter orientation for monetary policy[than the Federal Reserve].  Anyone who pays attention to our policies and forward guidance knows that we will not tighten policy without inflation solidly appearing in the data.”  Lastly, he indicated that both scaling up QE purchases and further rate cuts are on the table.

Again, it should be no surprise that the ECB is unwilling to allow the euro to simply rally unabated in the current environment.  The playbook is clear, a strong currency needs to be addressed, i.e. weakened. This weekend simply demonstrated that all the major central banks view the world in exactly the same manner.

Turning to the markets on this holiday-shortened session, we see that Chinese equities were huge beneficiaries of the PBOC action with Shanghai (+2.65%) and the Hang Seng (+2.0%) both strongly higher although the Nikkei (-0.25%) did not share the market’s enthusiasm.  European markets are firming up as I type, overcoming some early weakness and now green across the board.  So, while the FTSE 100 (+0.1%) is the laggard, both the DAX (+0.45%) and CAC (+0.75%) are starting to make some nice gains.  As to US futures, they, too, are now all in the green with NASDAQ (+ 1.3%) far and away the leader.  Despite the federal holiday in the US, the stock market is, in fact, open today.

Banks, however, are closed and the Treasury market is closed with them.  So, while there is no movement there, we are seeing ongoing buying interest across the European government bond markets as traders prepare for increased ECB QE activity.  After all, if banks don’t own the bonds the ECB wants to buy, they will not be able to mark them up and sell them to the only price insensitive buyer in the European government bond market.  So, yields here are lower by about 1 basis point across the board.

As to the dollar, it is broadly, but mildly stronger this morning.  Only the yen (-0.15%) is weaker in the G10 space as the rest of the block is responding to the belief that all the central banks are going to loosen policy further, a la the ECB.  As to the EMG bloc, CZK is actually the biggest loser, falling 0.9% after CPI there surprised the market by falling slightly, to 3.2%, rather than extending its recent string of gains.  This has the market looking for further central bank ease going forward, something that had been questioned as CPI rose.  Otherwise, as we see the prices of both oil and gold decline, we are seeing MXN (-0.6%), ZAR (-0.5%) and RUB (-0.5%) all fall in line.  On the flip side, only KRW (+0.55%) has shown any strength as foreign investors continue to pile into the stock market there on the back of Chinese hopes.

We do get some important data this week as follows:

Tuesday CPI 0.2% (1.4% Y/Y)
-ex food & energy 0.2% (1.7% Y/Y)
Wednesday PPI 0.2% (0.2% Y/Y)
-ex food & energy 0.2% (0.9% Y/Y)
Thursday Empire Manufacturing 14.0
Initial Claims 825K
Continuing Claims 10.4M
Philly Fed 14.0
Friday Retail Sales 0.8%
-ex autos 0.4%
IP 0.6%
Capacity Utilization 71.9%
Michigan Sentiment 80.5

Source: Bloomberg

Remember, we have seen five consecutive higher than expected CPI prints, so there will be a lot of scrutiny there, but ultimately, the data continues to point to a slowing recovery with job growth still a major problem.  We also hear from nine more Fed speakers, but again, this message is already clear, ZIRP forever and Congress needs to pass stimulus.

In the end, I find no case for the dollar to weaken appreciably from current levels, and expect that if anything, modest strength is the most likely path going forward, at least until the election.

Good luck and stay safe
Adf

A New Paradigm

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As mid-year approaches, it’s time
To ponder the central bank clime
Will negative rates
Appear in the States
And welcome a new paradigm?

With the end of the first half of 2020 approaching, perhaps it’s time to recap what an extraordinary six months it has been as well as consider what the immediate future may hold.

If you can recall what January was like, the big story was the Phase One trade deal, which was announced as almost completed at least half a dozen times, essentially every time the stock market started to decline, before it was finally signed. In hindsight, the fact that it was signed right at the beginning of the Lunar New Year celebrations in China, which coincided with the recognition that the novel coronavirus was actually becoming a problem, is somewhat ironic. After all, it was deemed THE most important thing in January and by mid-February nobody even cared about it anymore. Of course, by that time, Covid-19 had been named and was officially declared a pandemic.

As Covid spread around the world, the monetary responses were impressive for both their speed of implementation and their size. The Fed was the unquestioned leader, cutting rates 150bps in two emergency meetings during the first half of March while prepping the market for QE4. They then delivered in spades, hoovering up Treasuries, mortgage-backed bonds, investment grade corporate bonds and junk bonds (via ETF’s) and then more investment grade bonds, this time purchasing actual securities, not ETF’s. Their balance sheet has grown more than $3 trillion (from $4.1 trillion to $7.1 trillion) in just four months and they have promised to maintain policy at least this easy until the economy can sustainably get back to their inflation and employment goals.

On the fiscal front, government response was quite a bit slower, and aside from the US CARES act, signed into law in late March, most other nations have been less able to conjure up enough spending to make much of a difference. There was important news from the EU, where they announced, but have not yet enacted, a policy that was akin to mutualization of debt across the entire bloc. If they can come to agreement on this, and there are four nations who remain adamantly opposed (Sweden, Austria, Denmark and the Netherlands), this would truly change the nature of the EU and by extension the Eurozone. Allowing transfers from the richer northern states to the struggling Mediterranean countries would result in a boon for the PIGS as they could finally break the doom-loop of their own nation’s banks owning the bulk of their own sovereign debt. But despite the support of both France and Germany, this is not a done deal. Now, history shows that Europe will finally get something along these lines enacted, but it is likely to be a significantly watered-down version and likely to take long enough that it will not be impactful in the current circumstance.

Of course, the ECB, after a few early stumbles, has embraced the idea of spending money from nothing and is in the process of implementing a €1.35 trillion QE program called PEPP in addition to their ongoing QE program.

Elsewhere around the world we have seen a second implementation of yield curve control (YCC), this time by Australia which is managing its 3-year yields to 0.25%, the same level as its overnight money. There is much talk that the Fed is considering YCC as well, although they will only admit to having had a discussion on the topic. Of course, a quick look at the US yield curve shows that they have already essentially done so, at least up to the 10-year maturity, as the volatility of yields has plummeted. For example, since May 1, the range of 3-year yields has been just 10bps (0.18%-0.28%) while aside from a one-week spike in early June, 10-year yields have had an 11bp range. The point is, it doesn’t seem that hard to make the case the Fed is already implementing YCC.

Which then begs the question, what would they do next? Negative rates have been strongly opposed by Chairman Powell so far, but remember, President Trump is a big fan. And we cannot forget that over the course of the past two years, it was the President’s view on rates that prevailed. At this time, there is no reason to believe that negative rates are in the offing, but in the event that the initial rebound in economic data starts to stumble as infection counts rise, this cannot be ruled out. This is especially so if we see the equity market turn back lower, something which the Fed seemingly cannot countenance. Needless to say, we have not finished this story by a long shot, and I would contend there is a very good chance we see additional Fed programs, including purchasing equity ETF’s.

Of course, the reason I focused on a retrospective is because market activity today has been extremely dull. Friday’s equity rout in the US saw follow through in Asia (Nikkei -2.3%, Hang Seng -1.0%) although Europe has moved from flat to slightly higher (DAX +0.5%, CAC +0.25%, FTSE 100 +0.5%). US futures are mixed, with the surprising outcome of Dow and S&P futures higher by a few tenths of a percent while NASDAQ futures are lower by 0.3%. The bond market story is that of watching paint dry, a favorite Fed metaphor, with modest support for bonds, but yields in all the haven bonds within 1bp of Friday’s levels.

And finally, the dollar is arguably a bit softer this morning, with the euro the leading gainer in the G10, +0.5%, and only the pound (-0.2%) falling on the day. It seems that there are a number of algorithmic models out selling dollars broadly today, and the euro is the big winner. In the EMG bloc, the pattern is the same, with most currencies gaining led by PLN(+0.65%) after the weekend elections promised continuity in the government there, and ZAR (+0.55%) which is simply benefitting from broad dollar weakness. The exception to the rule is RUB, which has fallen 0.25% on the back of weakening oil prices.

On the data front, despite nothing of note today, we have a full calendar, especially on Thursday with the early release of payroll data given Friday’s quasi holiday

Tuesday Case Shiller Home Prices 3.70%
  Chicago PMI 44.0
  Consumer Confidence 90.5
Wednesday ADP Employment 2.95M
  ISM Manufacturing 49.5
  ISM Prices Paid 45.0
  FOMC Minutes  
Thursday Initial Claims 1.336M
  Continuing Claims 18.904M
  Nonfarm Payrolls 3.0M
  Private Payrolls 2.519M
  Manufacturing Payrolls 425K
  Unemployment Rate 12.4%
  Average Hourly Earnings -0.8% (5.3% Y/Y)
  Average Weekly Hours 34.5
  Participation Rate 61.2%
  Trade Balance -$53.0B
  Factory Orders 7.9%
  Durable Goods 15.8%
  -ex transport 4.0%

Source: Bloomberg

So, as you can see, a full slate for the week. Obviously, all eyes will be on the employment data on Wednesday and Thursday. At this point, it seems we are going to continue to see data pointing to a sharp recovery, the so-called V, but the question remains, how much longer this can go on. However, this is clearly today’s underlying meme, and the ensuing risk appetite is likely to continue to undermine the dollar, at least for the day. We will have to see how the data this week stacks up against the ongoing growth in Covid infections and the re-shutting down of portions of the US economy. The latter was the equity market’s nemesis last week. Will this week be any different?

Good luck and stay safe
Adf

Tremors of Dread

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This weekend we learned nothing new
‘Bout what central bankers will do
As they look ahead
With tremors of dread
That QE’s a major miscue

There is a bit of a conundrum developing as headlines shout about a surge in new cases of the coronavirus at the same time that countries around the world continue to reopen from their previous lockdowns. It has become increasingly apparent that governments everywhere have determined that the economic damage of the shutdown in response to Covid now outweighs the human cost of further fatalities from the disease. Of course, three months on from when the epidemic really began to rage in the West, there is also a much better understanding of who is most vulnerable and how to maintain higher levels of safe behavior, notably social distancing and wearing masks. And so, while there are still extremely vocal views on both sides of the argument about the wisdom of reopening, it is very clear economies are going to reopen.

Meanwhile, central banks continue to bask in the glow of broadly positive press that their actions have been instrumental in propping up the stock market preventing an even greater contraction of economic activity than what has actually played out. The constant refrain from every central bank speaker has been that cutting rates and expanding their balance sheets has been very effective. Oh, they are also prepared to do even more of both if they deem such action necessary because it turns out it wasn’t effective.

However, despite these encomiums about central bank perspicacity, investors find themselves at a crossroads these days. Risk assets continue to perform extremely well overall, with stocks having recouped most of their losses from March, but haven assets continue to demonstrate significant concern over the future as long-term government bond yields continue to point to near-recessionary economic activity over the medium and long term. At the end of the day, however, I think the only universal truth is that the global economy, and certainly financial markets, have become addicted to QE, and the central banks are not about to stop providing that liquidity no matter what else happens.

On this subject, this morning we had two very different visions espoused, with BOE Governor Bailey explaining that when things get better, QT will be the first response, not a raising of rates. Of course, we all remember the “paint drying” effect of QT in the US in 2018, and how it turns out removing that liquidity is really hard without causing a financial earthquake. At the same time, the ECB’s Madame Lagarde and her minions have been enthusiastically describing just how proportionate their QE purchases have been in response to the German Constitutional Court ruling from last month. Frankly, it would be easy for the ECB to point out the proportionality of buying more Italian debt given there is much more Italian debt than any other type in the EU. But I don’t think that was the German court’s viewpoint. At any rate, there is no reason to expect anything but ongoing QE for the foreseeable future. In fact, the only thing that can stop it is a significant uptick in measured inflation, but that has not yet occurred, nor does it seem likely in the next couple of quarters. So, the presses will continue to roll.

With this as background, a turn to the markets shows a fairly benign session overall. Equity market in Asia were very modestly lower (Nikkei -0.2%, Hang Seng -0.5%, Shanghai flat) while European markets are also a touch softer (DAX -0.1%, CAC -0.2%, FTSE 100 flat) although US futures are pointing higher, with all three indices up about 0.75% as I type. Meanwhile, bond markets are also showing muted price action, although the tendency is toward slightly lower yields as Treasuries have decline 1bp and Bunds 2bps. While the direction here is consistent with a risk off session, the very slight magnitude of the moves makes it less convincing.

As to the dollar, it is definitely on its back foot this morning, falling against most G10 and many EMG currencies. Kiwi is atop the leaderboard this morning, rallying 0.6% with Aussie just behind at 0.5%, as both currencies recoup a bit of the past two week’s losses. In fact, that seems to be the story behind most of the G10 today, we are seeing a rebound from the dollar’s last two weeks of strength. The only exception is the yen, which is essentially unchanged, after its own solid recent performance, and NOK, which has edged lower by 0.15% on the back of a little oil price weakness.

In the EMG bloc, the picture is a bit more mixed with APAC currencies having suffered last night, led by KRW (-0.5%) as tensions with the North increase, and IDR (-0.35%) as the market demonstrated some concern over the future trajectory of growth and interest rates there. On the positive side, it is the CE4 that is showing the best gains today with PLN (+0.8%) far and away the best performer after posting a much better than expected Retail Sales number of +14.5%, which prompted the government to highlight the opportunity for a v-shaped recovery.

Looking ahead to data this week, nothing jumps out as likely to have a big impact.

Today Existing Home Sales 4.09M
Tuesday PMI Manufacturing 50.8
  PMI Services 48.0
  New Home Sales 635K
Thursday Initial Claims 1.35M
  Continuing Claims 19.85M
  Durable Goods 10.9%
  -ex transport 2.3%
  GDP Q1 -5.0%
Friday Personal Income -6.0%
  Personal Spending 8.8%
  Core PCE 0.0% (0.9% Y/Y)
  Michigan Sentiment 79.0

Source: Bloomberg

The thing about the PMI data is that interpretation of the data is more difficult these days as a rebound from depression levels may not be indicative of real strength, rather just less weakness. In fact, the bigger concern for policymakers these days is that the Initial Claims data is not declining very rapidly. After that huge spike in March, we have seen a substantial decline, but the pace of that decline has slowed alarmingly. It seems that we may be witnessing a second wave of layoffs as companies re-evaluate just how many employees they need to operate effectively, especially in a much slower growth environment. And remember, if employment doesn’t rebound more sharply, the US economy, which is 70% consumption based, is going to be in for a much longer period of slow or negative growth. I assure you that is not the scenario currently priced into the equity markets, so beware.

As to the dollar today, recent price activity has not been consistent with the historic risk appetite, and it is not clear to me which is leading which, stocks leading the dollar or vice versa. For now, it appears that the day is pointing to maintaining the overnight weakness, but I see no reason for this to extend in any major way.

Good luck and stay safe
Adf

Sand on the Beach

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The central bank known as the Fed
Injected more funds, it is said
Than sand on the beach
While they did beseech
The banks, all that money to spread

But lately the numbers have shown
Liquidity, less, they condone
Thus traders have bid
For dollars, not quid
Nor euros in every time zone

A funny thing seems to be happening in markets lately, which first became evident when the dollar decoupled from equity markets a few days ago. It seemed odd that the dollar managed to rally despite continued strength in equity markets as the traditional risk-on stance was buy stocks, sell bonds, dollars and the yen. But lately, we are seeing stock prices continue higher, albeit with a bit tougher sledding, while the dollar has seemingly forged a bottom, at least on the charts.

The first lesson from this is that markets are remarkably capable at sussing out changes in underlying fundamentals, certainly far more capable than individuals. But of far more importance, at least with respect to understanding what is happening in the FX market, is that dollar liquidity, something the Fed has been proffering by the trillion over the past three months, is starting to, ever so slightly, tighten. This is evident in the fact that the Fed’s balance sheet actually shrunk this week, to “only” $7.14 trillion from last week’s $7.22 trillion. While this represents just a 1% shrinkage, and seemingly wouldn’t have that big an impact, it is actually quite a major change in the market.

Think back to the period in March when the worst seemed upon us, equity markets were bottoming, and central banks were panicking. The dollar was exploding higher at that time as both companies and countries around the world suddenly found their revenue streams drying up and their ability to service and repay their trillions of dollars of outstanding debt severely impaired. That was the genesis of the Fed’s dollar swap lines to other central banks, as Chairman Jay wanted to insure that other countries would have temporary access to those needed dollars. At that time, we also saw the basis swap bottom out, as borrowing dollars became prohibitively expensive, and in the end, many institutions decided to simply buy dollars on the foreign exchange markets as a means of securing their payments.

However, once those swap lines were in place, and the Fed announced all their programs and started growing the balance sheet by $75 billion/day, those apocalyptic fears ebbed, investors decided the end was not nigh and took those funds and bought stocks. This explains the massive rebound in the equity markets, as well as the dollar’s weakness that has been evident since late March. In fact, the dollar peaked and the stock market bottomed on the same day!

But as the recovery starts to gather some steam, with recent data showing that while things are still awful, they are not as bad as they were in April or early May, the Fed is reducing the frequency of their dollar swap operations to three times per week, rather than daily. They have reduced their QE purchases to less than $4 billion/day, and essentially, they are mopping up some of that excess liquidity. FX markets have figured this out, which is why the dollar has been pretty steadily strengthening for the past seven sessions. As long as the Fed continues down this path, I think we can expect the dollar to continue to perform.

And this is true regardless of what other central banks or nations do. For example, yesterday’s BOE action, increasing QE by £100 billion, was widely expected, but interestingly, is likely to be the last of their moves. First, it was not a unanimous vote as Chief Economist, Andy Haldane, voted for no change. The other thing is that expectations for future government Gilt issuance hover in the £70 billion range, which means that the BOE will have successfully monetized the entire amount of government issuance necessary to address the Covid crash. But regardless of whether this appears GBP bullish, it is dwarfed by the Fed activities. Positive Brexit news could not support the pound, and now it is starting to pick up steam to the downside. As I type, it is lower by 0.3% on the day which follows yesterday’s greater than 1% decline and takes the move since its recent peak to more than 3.4%.

What about the euro, you may ask? Well, it too has been suffering as not only is the Fed beginning to withdraw some USD liquidity, but the ECB, via yesterday’s TLTRO loans has injected yet another €1.3 trillion into the market. While the single currency is essentially unchanged today, it is down 2.0% from its peak on the 10th of June. And this pattern has repeated itself across all currencies, both G10 and EMG. Except, of course, for the yen, which has rallied a bit more than 1% since that same day.

Of course, in the emerging markets, the movement has been a bit more exciting as MXN has fallen more than 5.25% since that day and BRL nearly 10%. But the point is, this pattern is unlikely to stop until the Fed stops withdrawing liquidity from the markets. Since they clearly take their cues from the equity markets, as long as stocks continue to rally, so will the dollar right now. Of course, if stocks turn tail, the dollar is likely to rally even harder right up until the Fed blinks and starts to turn on the taps again. But for now, this is a dollar story, and one where central bank activity is the primary driver.

I apologize for the rather long-winded start but given the lack of interesting idiosyncratic stories in the market today, I thought it was a good time for the analysis. Turning to today’s session, FX market movement has been generally quite muted with, if anything, a bias for modest dollar strength. In fact, across both blocs, no currency has moved more than 0.5%, a clear indication of a lack of new drivers. The liquidity story is a background feature, not headline news…at least not yet.

Other markets, too, have been quiet, with equity markets around the world very slightly firmer, bond markets very modestly softer (higher yields) and commodity markets generally in decent shape. On the data front, the only noteworthy release was UK Retail Sales, which rebounded 10.2% in May but were still lower by 9.8% Y/Y. This is the exact pattern we have seen in virtually every data point this month. As it happens, there are no US data points today, but we do hear from four Fed speakers, Rosengren, Quarles, Mester and the Chairman. However, they have not changed their tune since the meeting last week, and certainly there has been no data or other news which would have given them an impetus to do so.

The final interesting story is that China has apparently recommitted to honoring the phase one trade deal which means they will be buying a lot of soybeans pretty soon. The thing is, I doubt it is because of the trade deal as much as it is a comment on their harvest and the fact they need them. But the markets have largely ignored the story. In the end, at this point, all things continue to lead to a stronger dollar, so hedgers, take note.

Good luck, good weekend and stay safe
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