Tag Archives: #QE

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
Adf

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
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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
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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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They’re Trying

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The Kiwis have doubled QE
The Brits saw collapsed GDP
The Fed keeps on buying
More bonds as they’re trying
To preempt a debt jubilee

The RBNZ was the leading economic story overnight as at their meeting, though they left interest rates unchanged at 0.25%, they virtually doubled the amount of QE purchases they will be executing, taking it up to NZ$60 billion. Not only that, they promised to consider even lower interest rates if deemed necessary. Of course, with rates already near zero, that means we could be looking at the next nation to head through the interest rate looking glass. It should be no surprise that NZD fell on the release, and it is currently lower by 0.9%, the worst performing currency of the day.

Meanwhile, the UK released a raft of data early this morning, all of which was unequivocally awful. Before I highlight the numbers, remember that the UK was already suffering from its Brexit hangover, so looking at slow 2020 growth in any case. GDP data showed that the economy shrank 5.8% in March and 2.0% in Q1 overall. The frightening thing is that the UK didn’t really implement any lockdown measures until the last week of March. This bodes particularly ill for the April and Q2 data. IP fell 4.2% and Consumption fell 1.7%. Thus, what we know is that the UK economy is quite weak.

There is, however, a different way to view the data. Virtually every release was “better” than the median forecast. One of the truly consistent features of analysts’ forecasts about any economy is that they are far more volatile than the actual outcome. The pattern is generally one where analysts understate a large move because their models are not well equipped for exogenous events. Then, once an event occurs, those models extrapolate out at the initial rate of change, which typically overstates the negative news. For example, if you recall, the early prognostications for the US employment data in March called for a loss of 100K jobs, which ultimately printed at -713K. By last week’s release of the April data, the analyst community had gone completely the other way, anticipating more than 22M job losses, with the -20.5M number seeming better by comparison. So, we are now firmly in the overshooting phase of economic forecasts. The thing about the current situation though, is that there is so much uncertainty over the next steps by governments, that current forecasts still have enormous error bars. In other words, they are unlikely to be even remotely accurate on a consistent basis, regardless of who is forecasting. Keep that in mind when looking at the data.

In fact, the one truism is that on an absolute basis, the economic situation is currently horrendous. A payroll report of -20.5M instead of -22.0M is not a triumph of policymaking, it is a humanitarian disaster. And it is this consideration, that regardless of data outcomes vs. forecasts, the data is awful, that informs the view that equity markets are unrealistically priced. Thus, the battle continues between those who look at the economy and see significant concerns and those who look at the central bank support and see blue skies ahead. This author is in the former camp but would certainly love to be wrong. Regardless, please remember that data that beats a terrible forecast by being a little less terrible is not the solution to the current crisis. I fear it will be many months before we see actual positive data.

Turning to this morning’s session, the modest risk aversion seen in equity (DAX -1.5%, CAC -1.7%) and bond (Treasuries -1bp, Bunds -2bps) markets is less clear in the FX world. In fact, other than the NZD, the rest of the G10 is firmer this morning led by NOK (+0.7%) on the strength of the continuing rebound in the oil market. Saudi Arabia’s announcement that they will unilaterally cut output by a further 1 million bpd starting in June has helped support crude. In addition, another thesis is making the rounds, that mass transit will have lost its appeal for many people in the wake of Covid-19, thus those folks will be returning to their private vehicles and using more gasoline, not less. This should also bode well for the Big 3 auto manufacturers and their supply chains if it does describe the post-covid reality. It should be no surprise that in the G10, the second-best performer is CAD (+0.4%) nor that in the EMG bloc, it is MXN (+1.0%) and RUB (+0.5%) atop the leaderboard.

Other than the oil linked currencies, though, there has been very little movement overall, with more gainers than losers, but most movement less than 0.25%. the one exception to this is HUF, which has fallen 0.5%, after news that President Orban is changing the tax rules regarding city governments (which coincidentally are controlled by his opponents) and pushing tax revenues to the county level (which happen to be controlled by his own party). This nakedly political maneuvering is not seen as a positive for the forint. But other than that, there is little else to tell.

On the data front, this morning brings PPI data (exp -0.4%, 0.8% ex food & energy) but given we already saw CPI yesterday, and more importantly, inflation issues are not even on the Fed’s agenda right now, this is likely irrelevant. Of more importance will be the 9:00 comments from Chairman Powell as market participants will want to hear about his views on the economy and of likely future activity. Will there be more focused forward guidance? Are negative rates possible? What other assets might they consider buying? While all of these are critical questions, it does seem unlikely he will go there today. Instead, I would look for platitudes about the Fed doing everything they can, and that they have plenty of capacity, and willpower, to do more.

And that’s really it for what is starting as a quiet day. The dollar is under modest pressure but remains much closer to recent highs than recent lows. As long as investors continue to accept that the Fed and its central bank brethren are on top of the situation, I imagine that we can see further gains in equity markets and further weakness in the dollar. I just don’t think it can go on that much longer.

Good luck and stay safe
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Overkill

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The talk in the market is still
‘Bout German high court overkill
While pundits debate
The bond program’s fate
The euro is heading downhill

Amid ongoing dreadful economic data, the top story continues to be the German Constitutional Court’s ruling on (rebuke of?) the ECB’s Public Sector Purchase Program, better known as QE. The issue that drew the court’s attention was whether the ECB’s actions to help support the Eurozone overall are eroding the sovereignty of its member states. Consider, if any of the bonds that are bought by the central banks default, it is the individual nations that will need to pay the cost out of their respective budgets. That means that the unelected officials at the ECB are making potential claims on sovereign nations’ finances, a place more rightly accorded to national legislatures. This is a serious issue, and a very valid point. (The same point has been made about Fed programs). However, despite the magnitude of the issues raised, the court gave the ECB just three months to respond, and if they are not satisfied with that response, they will bar the Bundesbank from participating in any further QE programs. And that, my friends, would be the end. The end of the euro, the end of the Eurozone, and quite possibly the end of the EU.

Remember, unlike the Fed, which actually executes its monetary policy decisions directly in the market, the ECB relies on each member nation’s central bank to enter the market and purchase the appropriate assets. So, the ECB’s balance sheet is really just a compilation of the balance sheets of all the national central banks. If the Bundesbank is prevented from implementing ECB policy on this score, given Germany’s status as the largest nation, and thus largest buyer in the program, the effectiveness of any further ECB programs would immediately be called into question, as would the legitimacy of the entire institution. This is the very definition of an existential threat to the single currency, and one that the market is now starting to consider more carefully. It is clearly the driving force behind the euro’s further decline this morning, down another 0.5% which makes 1.5% thus far in May. In fact, while we saw broad dollar weakness in April, as equity markets rallied and risk was embraced, the euro has now ceded all of those gains. And I assure you, if there is any doubt that the ECB will be able to answer the questions posed by the court, the euro will decline much further.

The euro is not the only instrument under pressure from this ruling, the entire European government bond market is falling today. Now, granted, the declines are not that sharp, but they are universal, with every member of the Eurozone seeing bond prices fall and yields tick higher. This certainly makes sense overall, as the ECB has been the buyer of (first and) last resort in government bond markets, and the idea that they may be prevented from acting in the future is a serious concern. Simply consider how much more debt all Eurozone nations are going to need to issue in order to pay for their fiscal programs. Across the entire Eurozone, forecasts now point to in excess of €1 trillion of new bonds this year, already larger than the ECB’s PEPP. And if there is a second wave of the virus, forcing a reclosing of economies with a longer period of lockdown, that number is only going to increase further. Without the ECB to absorb the bulk of that debt, yields in Eurozone debt will have much further to climb. The point is that this issue, which was initially seen as minor and technical, may actually be far more important than anything else. And while the odds are still with the ECB to continue with business as usual, the probability of a disruption is clearly non-zero.

Away from the technicalities of the German Constitutional Court, there is far less of interest in the markets overall. Equity markets are mixed, with gainers and losers in both the Asian session as well as Europe. US futures, at this time, are pointing higher, with all three indices looking toward 1% gains at the open. And the dollar is broadly, though not universally, higher.

Aside from the euro’s decline, we have also seen weakness in the pound (-0.4%) after the Construction PMI (the least impactful of the PMI measures) collapsed to a reading of 8.2, from last month’s dreadful 39.2. This merely reinforces what type of hit the UK economy is going to take. On the plus side, the yen is higher by 0.3%, seemingly on the back of position adjustments as given the other risk signals, I would not characterize today as a risk-off session.

In the EMG space, there are far more losers than gainers today, led by the Turkish lira (-1.0%) and the Russian ruble (-0.8%). The lira is under pressure after new economic projections point to a larger economic contraction this year of as much as 3.4%. This currency weakness is despite the central bank’s boosting of FX swaps in an effort to prevent a further decline. Meanwhile, despite oil’s ongoing rebound (WTI +3.6%) the ruble seems to be reacting to recent gains and feeling some technical selling pressure. Elsewhere in the space, we have seen losses on the order of 0.3%-0.5% across most APAC and CE4 currencies. The one exception to the rule is KRW, which rallied 0.6% overnight as expectations grow that South Korea is going to be able to reopen the bulk of its economy soon. One other positive there is that demand for USD loans (via Fed swap lines) has diminished so much the BOK is stopping the auctions for now. That is a clear indication that financial stress in the nation has fallen.

On the data front, this morning brings the ADP Employment number (exp -21.0M), which will be the latest hint regarding Friday’s payroll data. Clearly, a month of huge Initial Claims data will have taken its toll. Yesterday’s Fed speakers didn’t tell us very much new, but merely highlighted the fact that each member has their own view of how things may evolve and none of them are confident in those views. Uncertainty remains the word of the day.

For now, the narratives of the past several weeks don’t seem to have quite the strength that they did, and I would say that the focus is on the process of economies reopening. While that is very good news, the concern lies after they have reopened, and the carnage becomes clearer. Just how many jobs have been permanently erased because of the changes that are coming to our world in the wake of Covid-19? It is that feature, as well as the nature of economic activity afterwards, that will drive the long-term outcome, and as of now, no clear path is in sight. The opportunity for further market dislocations remains quite high, and hedgers need to maintain their programs, especially during these times.

Good luck and stay safe
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To Aid and Abet

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The treaties that built the EU
Explain what each nation should do
The German high court
Ruled that to comport
A challenge was in their purview

But politics trumps all the laws
And so Lagarde won’t even pause
In buying up debt
To aid and abet
The PIGS for a much greater cause

Arguably, the biggest story overnight was just not that big. The German Constitutional Court (GCC) ruled that the Bundesbank was wrong not to challenge the implementation of the first QE program in 2015 on the basis that the Asset Purchase Program (APP) was a form of monetary support explicitly prohibited. Back when the euro first came into existence, Germany’s biggest fear was that the ECB would finance profligate governments and that the Germans would ultimately have to pay the bill. In fact, this remains their biggest fear. While technically, QE is not actually debt monetization, that is only true if central banks allow their balance sheets to shrink back to pre-QE sizes. However, what we have learned since the GFC in 2008-09 is that central bank balance sheets are permanently larger, thus those emergency purchases of government debt now form an integral part of the ECB structure. In other words, that debt has effectively been monetized. The essence of this ruling is that the German government should have challenged QE from the start, as it is an explicit breach of the rules preventing the ECB from financing governments.

The funny thing is, while the court ruled in this manner, it is not clear to me what the outcome will be. At this point, it is very clear that the ECB is not going to be changing their programs, either APP or PEPP, and so no remedy is obvious. Arguably, the biggest risk in the ruling is that the GCC will have issued a binding opinion that will essentially be ignored, thus diminishing the power of their future rulings. Undoubtedly, there will be some comments within the three-month timeline laid out by the GCC, but there will be no effective changes to ECB policy. In other words, like every other central bank, the ECB has found themselves officially above the law.

While the actuality of the story may not have much impact on ECB activities, the FX market did respond by selling the euro. This morning it is lower by 0.5%, which takes its decline this month to 1.2% and earns it the crown, currently, of worst performing G10 currency. The thought process seems to be that there is nothing to stop the ECB in its efforts to debase the euro, so the path of least resistance remains lower.

Beyond the GCC story though, there is little new in the way of news. Equity markets have a better tone on the strength of oil’s continuing rebound, up nearly 10% this morning as I type, as production cuts begin to take hold, as well as, I would contend, the GCC ruling. In essence, despite numerous claims that central banks have overstepped their bounds, it is quite clear that nobody can stop them from buying up an ever larger group of financial assets and supporting markets. So, yesterday’s late day US rally led to a constructive tone overnight (Hang Seng +1.1%, Australia +1.6%, China and Japan are both closed for holidays) which has been extended through the European session (both DAX and CAC +1.8%, FTSE 100 +1.4%) with US futures pointing higher as well.

In the government bond market, Treasury yields are 3.5bps higher, but the real story seems to be in Europe. Bund yields have also rallied a bit, 2bps, but that can easily be attributed to the risk-on mentality that is permeating the market this morning. However, I would have expected Italian and Spanish yields to have fallen on the ruling. After all, they have become risk assets, not havens, and yet both have seen price declines of note with Italian yields higher by 10bps and Spanish (and Portuguese) higher by 5bps. Once again, we see the equity and bond markets looking at the same news in very different lights.

As to the FX market, it is a mixed picture this morning. While the Swiss franc is tracking the euro lower, also down by 0.5% this morning, we are seeing NOK (+0.4%) and CAD (+0.2%) seeming to benefit from the oil price rally. Aussie, too, is in better shape this morning, up 0.2% on the broad risk-on appetite and news that more countries are trying to reopen after their Covid inspired shutdowns.

The EMG space is similarly mixed with ZAR (+1.25%), RUB (+1.0%) and MXN (+0.6%) the leading gainers. While the ruble’s support is obviously oil, ZAR has benefitted from the overall risk appetite. This morning, the South African government issued ZAR 4.5 billion of bonds in three maturities and received bid-to-cover ratios of 6.8x on average. With yields there still so much higher than elsewhere (>8.0%), investors are willing to take the risk despite the recent credit rating downgrade. Finally, the peso is clearly benefitting from the oil price as well as the broad risk-on movement. The peso remains remarkably volatile these days, having gained and lost upwards of 5% several times in the past month, often seeing daily ranges of more than 3%. Today simply happens to be a plus day.

On the downside, the damage is far less severe with CE4 currencies all down around the same 0.5% as the euro. When there are no specific stories, those currencies tend to track the euro pretty tightly. As to the rest of APAC, there were very modest gains to be seen, but nothing of consequence.

On the data front, yesterday’s Factory Orders data was even worse than expected at -10.3% but did not have much impact. This morning brings the Trade Balance (exp -$44.2B) as well as ISM Non-Manufacturing (37.9). At this point, everybody knows that the data is going to look awful compared to historical releases, so it appears that bad numbers have lost their shock value. At least that is likely to be true until the payroll data later this week. The RBA left rates unchanged last night, as expected, although they have reduced the pace of QE according to their read of what is necessary to keep markets functioning well there. And finally, we will hear from three Fed speakers today, Evans, Bostic and Bullard, but again, it seems hard to believe they will say anything really new.

Overall, risk appetite has grown a bit overnight, but for the dollar, it is not clear to me that it has a short-term direction. Choppiness until the next key piece of news seems the most likely outcome. Let’s see how things behave come Friday.

Good luck and stay safe
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