Votes in the States

The second wave’s not the infection
Nor, either, is it the election
Instead, central banks
Will fire more blanks
As each makes a massive injection

But meantime, the world now awaits
The outcome from votes in the States
Most polls point toward Blue
Which many construe
As time to add risk to their plates

Election day has finally arrived, and the market is positively giddy over the prospects, or at least so it seems.  Equity markets worldwide are rising dramatically, haven assets are selling off, so Treasuries and bunds have fallen, and the dollar is under pressure versus every currency except the Turkish lira.  Most polls continue to point to a Biden victory, although there are several, interestsingly those that predicted Trump’s victory four years ago, calling for him to be reelected.  It is interesting that risk is being acquired so aggressively at this time given a key part of the narrative has been the relatively high probability of a contested election with no winner declared for weeks, if not longer driving major uncertainty in markets.  In addition, several big cities have been taking precautions against anticipated violence and rioting, with storefronts being boarded up and additional police called to duty.  Again, that hardly seems like a signal to be adding risk, but then this is the 2020’s, when everything you thought you knew turns out to have been wrong.

I guess the real question is, can the risk rally be sustained?  Well, if central banks have anything to say on the subject, and clearly they will try, the answer is a qualified yes.  Qualified because the longevity of the rally is still subject to debate.

While we all know that both the Fed and Bank of England will be meeting on Thursday, last night we got our first central bank meeting of the week, when the RBA convened Down Under.  As was widely expected, they cut their Cash Rate Target to 0.10% and they lowered the yield target on 3-year government bonds to 0.10% (that is their yield curve control program) but they also surprised the market by expanding their QE by A$100 billion.  This last is in addition to their unlimited purchases to maintain the 3-year rate at 0.10%.  The market response was quite positive, but it’s not clear whether that would have happened regardless, or whether it was dependent on the RBA’s actions.  But whatever the case, the ASX 200 rose 1.9% and AUD rose more than a penny and is higher by 0.9% at this hour.

But what of the rest of the world?  Why is risk being gobbled up so aggressively today?  For instance, despite a complete lack of new data from Europe, we are seeing broad-based strength in Continental equity markets.  The DAX (+1.75%), the CAC (+2.0%) and the FTSE 100 (+1.65%) are all firmly in the green, as are every other Eurozone market.  Perhaps they are continuing to react to last week’s ECB meeting where Madame Lagarde promised to “recalibrate” ECB policy in order to do more.  In other words, the creativity of central bankers will be on full display.  Consider, right now, all they can do is print money and buy bonds.  Perhaps they will start to buy other assets (equities anyone?), or perhaps, the frequently discussed digital euro will be announced, with every Eurozone citizen eligible to open an account at the central bank that will be replenished with cash funds regularly.  Or is it simply the European asset management crowd voting that if the polls are correct, the economy will recover quickly?  While there is no obvious catalyst, market sentiment has turned quite positive this week, especially after last week’s doom and gloom.

But it’s not just Europe.  We saw strength in Asia (Nikkei +1.4%, Hang Seng +2.0%, Shanghai +1.4%) and US futures are rocking as well with DOW (+1.5%) leading the way, though both the SPX (+1.2%) and NASDAQ (+0.75%) remain firmly positive.  Again, other than the RBA news, there was nothing out of Asia, and of course it is far too early to have anything from the US.  In fairness, yesterday did see a blowout ISM number 59.3 vs. 56.0 expected, so the data in the US continues to be impressive.  But it beggars belief that equities are rallying today based on that information.  In the end, it remains all about the election.

One thing that we have seen really build up lately is the view that the US yield curve is going to steepen dramatically.  That is evident in the record short position in long bond futures in Chicago (>260K), as well as the massive outflows the from ETF’s TLT and LQD, the biggest government bond and IG corporate bond ETF’s respectively.  The view seems to be that regardless of who wins the election, the US is going to see higher interest rates in the back end as the massive amount of Treasury issuance that will be required to fund the growing budget deficit will overwhelm the market.  And that makes perfect sense.  Of course, making sense and making money are two very different things.  If the market is excessively skewed in one direction in anticipation of an event, it is the very definition of the ‘buy the rumor, sell the news’ set-up that happens time and again.  My take here is that while a year from now, we may well see much higher Treasury yields in the 30-year, that will not be the first move once the election is over.  Not only will the Fed have something to say on the subject, but positions will get stale and unwound, and we could easily see a significant Treasury rally, especially if the economy falters.

One last thing to mention is the oil market, which saw a massive rebound yesterday on the story that the OPEC+ production cuts are likely to remain in place, rather than their expected ending.  In the end, oil prices remain a function of supply and demand, and any economic growth, for now, will still require oil.  The future may well be renewables, but in this case, the future is quite a few years away.

But that is really the story heading into the election.  It is surprising to me that we have seen as much movement as we have this morning, but since election results won’t be released until 7:00pm Eastern time, today is no different than yesterday in terms of new information.  I sincerely doubt that Factory Orders (exp 1.0%) are going to change any views, and given the Fed meeting Thursday, we still have silence from the FOMC.  While I would not fight the tape today, I still do not see the appeal of a short dollar position for the medium term.

Good luck and stay safe
Adf

Hope Springs Eternal

The White House and Congress have talked
‘Bout stimulus but both sides balked
Still, hope springs eternal
That both sides infernal
Intransigence will get unblocked

Throughout 2019, it seemed every other day was a discussion of the trade deal with China, which morphed into the Phase one trade deal, which was, eventually, signed early this year.  But each day, the headlines were the market drivers, with stories about constructive talks leading to stock rallies and risk accumulation, while the periodic breakdowns in talks would result in pretty sharp selloffs.  I’m certain we all remember those days.  I only bring them up because the stimulus talks are the markets’ latest version of those trade talks.  When headlines seem positive that a deal will get done, stock markets rally in the US, and by extension, elsewhere in the world.  But, when there is concern that the stimulus talks will break down, investors head for the exits.  Or at least algorithms head for the exits, its not clear if investors are following yet.

Yesterday was one of those breakdown days, where despite reports of ongoing discussions between Treasury Secretary Mnuchin and House Speaker Pelosi, the vibes were negative with growing concern that no deal would be reached ahead of the election.  Of course, adding to the problem is the fact that Senate Majority Leader McConnell has already said that the numbers being discussed by the House and Congress are far too large to pass the Senate.  Handicapping the probability of a deal being reached is extremely difficult, but I would weigh in on the side of no action.  This seems far more like political posturing ahead of the election than an attempt to address some of the current economic concerns in the country.

Yet, despite yesterday’s negativity, and the ostensible deadline of today imposed by Speaker Pelosi (we all know how little deadlines mean in politics, just ask Boris), this morning has seen a return of hope that a deal will, in fact get done, and that the impact will be a huge boost to the economy, and by extension to the stock market.  So generally, today is a risk-on session, at least so far, with most Asian markets performing nicely and most of Europe in the green, despite rapidly rising infection counts in Europe’s second wave.  Remember, though, when markets become beholden to a political narrative like this, it is extremely difficult to anticipate short-term movements.

Down Under, the RBA said
We’re thinking, while looking ahead
A negative rate
Is still on the plate
So traders, their Aussie, did shed

While the politics is clearly the top story, given the risk-on nature of markets today, and the corresponding general weakness in the dollar, it was necessary to highlight the outliers, in this case, AUD (-0.4%) and NZD (-0.5%), which are clearly ignoring the bigger narrative.  However, there is a solid explanation here.  Last night, between the RBA’s Minutes and comments from Deputy Governor Kent, the market learned that the RBA is now considering negative interest rates.  Previously, the RBA had been clear that the current overnight rate level of 0.25% was the lower bound, and that negative rates did not make sense in Australia (in fairness, they don’t make sense anywhere.)  But given the sluggish state of the recovery from the initial Covid driven recession, the RBA has decided that negative rates may well be just the ticket to goose growth once covid lockdowns are lifted.  It is no surprise that Aussie fell, and traders extended the idea to New Zealand as well, assuming that if Australia goes negative, New Zealand would have no choice but to do so as well.  Hence the decline in both currencies overnight.

But really, those are the only stories of note this morning, in an otherwise dull session.  As I mentioned, risk is ‘on’ but not aggressively so.  While the Nikkei (-0.4%) did slip, we saw modest gains in Shanghai (+0.5%) and Hong Kong (+0.1%).  Europe, too, is somewhat higher, but not excessively so.  Spain’s IBEX (+0.85%) is the leader on the continent, although we are seeing gains in the CAC (+0.4%) and the FTSE 100 (+0.3%) as well.  The DAX (-0.3%), however, is unloved today as Covid cases rise back to early April levels and lockdowns are being considered throughout the country.  Finally, the rose-tinted glasses have been put back on by US equity futures traders with all three indices higher by a bit more than 0.5% at this hour.

Bond markets, however, are following the risk narrative a bit more closely and have sold off mildly across the board.  Well mildly except for the PIGS, who have seen another day with average rises in yield of around 3 basis points.  But for havens, yields have risen just 1 basis point in the US, Germany and the UK.

Commodity prices are little changed on the session, seemingly caught between hopes for a stimulus deal and fears over increased covid cases.

And lastly, the dollar is arguably a bit softer overall, but not by that much.  Aside from Aussie and Kiwi mentioned above, only the yen (-0.15%) is lower vs. the dollar, which is classic risk-on behavior.  On the plus side, SEK and NOK (both +0.5%) are leading the way higher, although the euro has been grinding higher all session and is now up 0.4% compared to yesterday’s close.  There has been no news of note from either Sweden or Norway to drive the gains, thus the most likely situation is that both currencies are simply benefitting from their relatively high betas and the general trend of the day.  As to the euro, the technicians are in command today, calling for a move higher due to an expected (hoped for?) break of a symmetrical triangle position.  Away from these three, though, gains are extremely modest.

In the emerging markets, CZK (+0.7%) is the outlier on the high side, although there is no obvious driver as there have been neither comments by officials nor new data released.  In fact, given that Covid infections seem to be growing disproportionally rapidly there, one might have thought the Koruna would have fallen instead.  But the rest of the CE4 are also firmer, simply tracking the euro this morning as they are up by between 0.3%-0.4%.  There have been some modest losers in the space as well, with THB (-0.25%) leading the charge in that direction.  The Thai story is a combination over concerns about further stimulus there not materializing and anxiety over the political unrest and student protests gaining strength throughout the nation.

On the data front, this morning brings Housing Starts (exp 1465K) and Building Permits (1520K), as well as four more Fed speakers.  Yesterday, Chairman Powell was not focused on monetary policy per se, but rather on the concept of digital currencies, and specifically, central bank digital currencies.  This is something that is clearly coming our way, but the timing remains unclear.  One thing to keep in mind is that when they arrive, interest rates will be negative, at least in the front end, forever.  But that is a story for another day.

Today, we are beholden to the stimulus talks.  Positive news should see further risk accumulation, while a breakdown will see stocks fall and the dollar rebound.

Good luck and stay safe
Adf

Fear Has Diminished

From Asia, last night, what we learned
Was China, the corner, has turned
The lockdowns are finished
And fear has diminished
Thus spending, in spades, has returned

The major news overnight comes from China, where the monthly release of data on IP, investment and Retail Sales showed that the Chinese economy is clearly regaining strength.  Arguably, the most noteworthy number was Retail Sales, which while still lower by -8.6% YTD, has rebounded to be 0.5% higher than August of last year.  Anecdotally, movie theaters there have seen attendance return to ~90% of pre-Covid levels, obviously far above anything seen here or in most of Europe.  In addition to the Retail Sales data, IP there rose 5.6% Y/Y and Property Investment rose a greater than forecast 4.6% on a YTD basis.  Overall, while these numbers are still well below the data China had been reporting pre-Covid, they point to Q3 GDP growth in excess of 3.0%, with some analysts now expecting GDP to grow as much as 6% in the third quarter.

With this unalloyed good economic news, it should be no surprise that the renminbi has performed well, and in fact, CNY is one of the top performers today, rising 0.5% and trading to levels not seen since May of last year.  While there are still numerous concerns regarding different aspects of China’s economy, notably that its banking sector is insolvent amid massively underreported bad loans, on the surface, things look better than almost anywhere else in the world.  Perhaps what is more surprising is that the equity market in Shanghai, which rose 0.5% overnight, did not have a better day.

Down Under, the RBA noted
That Aussie, though not really bloated
Would be better off
In more of a trough
Thus, helping growth there be promoted

Meanwhile, the Minutes of the most recent RBA meeting showed that while they couldn’t complain that the Aussie dollar was overvalued, especially given the recent rebound in commodity prices, they sure would like to see it lower to help the export sector of the economy.  However, despite reaffirming they would continue to support the economy, and that yield curve control wasn’t going anywhere, they gave no indication they were about to increase their support.  As such, AUD (+0.6%) is the top G10 performer of the session, and it is now pushing back to the 2-year highs seen earlier this month.

Turning to Europe, the two stories of note come from the UK and the ECB.  In Parliament, PM Johnson had the first reading of his bill that is set to unilaterally rewrite the Brexit deal with the EU, and it passed handily.  It appears that Boris believes he needs even more leverage to force the EU to accede to whatever demands remain in the negotiations, and he is comfortable playing hardball to achieve his ends.  The Europeans, however, continue to believe they have the upper hand and claim they are prepared to have the UK leave with no deal.  Politics being what it is, I imagine we won’t know the outcome until the last possible date, which is ostensibly next month at the EU Summit.

In the meantime, the market is starting to get concerned that a hard Brexit is back on the table and that the pound has much more to fall if that is the outcome.  While the market is not at record long GBP position levels, it is still quite long pounds.  The options market has been pricing more aggressively, with implied volatility around 12% for year-end (compared to 3-month historic volatility of just 9%) and risk reversals 2.5 points for the GBP puts.  While the pound has fallen a bit more than 4% since its peak on September 1st, it is still well above levels seen when fears of a hard Brexit were more prevalent.  As this new bill makes its way through Parliament, I suspect the pound will have further to decline.

As to the ECB, we have had yet more verbal intervention, this time from Italian Executive Board member, Fabio Panetta, who repeated that the ECB needs to remain vigilant and that though they have done a great job so far, they still may need to do more (i.e. ease further) in order to achieve their inflation goals.  The euro, however, continues to drift higher, up another 0.25% this morning, as the market appears to be preparing for a more aggressive FOMC statement and implicit further easing by the Fed.  While I believe it is too early for the Fed to more clearly outline their explicit plans on how to achieve average inflation of 2.0%, clearly there are many market participants who believe the Fed will be the most aggressive central bank going forward and that the dollar will suffer accordingly.  We shall see, but as I have repeatedly indicated, and Signor Panetta helped reiterate, the ECB will not stand idly by and allow the euro to rally unabated.

And those are really today’s stories.  Risk appetite continues to be fed by perceptions of further easy money from all central banks and we have seen equity markets continue their rebound from the short correction at the beginning of the month.  While Asia was mixed, Europe is in the green and US futures are pointing higher as well.  Treasuries are a touch lower, with yields up about 1 basis point, but the reality here is that yields have been in a very tight range for the past month.  In fact, the idea that the Fed needs to introduce yield control is laughable as it appears to already be in place.

As to the rest of the FX market, the dollar is under pressure everywhere, although Aussie and cable are the two leaders in the G10 space.  Elsewhere, there appears to be less conviction, or at least less rationale to buy the currency aggressively.  In the EMG bloc, ZAR is the leader, rising 1.2% this morning, continuing its strengthening trend that began back in August and has seen a nearly 7% appreciation in the interim.  Otherwise, there has been less excitement, with more modest gains on the back of generic USD weakness.

For today, we see Empire Manufacturing (exp 6.9) this morning as well as IP (1.0%) and Capacity Utilization (71.4%).  Alas, with the Fed meeting tomorrow and all eyes pointed to Washington, it seems unlikely that the market will respond to any of this data.  Instead, with the market clearly comfortable selling dollars right now, I see no reason for the buck to do anything but drift lower on the day.

Good luck and stay safe
Adf

Has Panic Subsided?

This morning a look at the screen
Shows everything coming up green
Has panic subsided?
Or is it misguided
To think that a bottom’s been seen?

It certainly feels less frightening in markets this morning as assets of all nature, equity, commodity and fixed income, are rallying nicely and the panic buying of dollars seems to have ended for the time being. Of course, this is an interesting outcome if one reads the news, given that virus stories have not only continued apace, but the statistics and government responses are getting more draconian. Arguably, the biggest story is that the entire state of California, with its population of 40 million, has been put on lockdown, with stay-at-home restrictions imposed by the Governor. By itself, California is, famously, the fifth largest economy in the world, just ahead of the UK, so the idea that economic activity there is going to come screeching to a halt cannot be seen as a positive. At least not in the short term. In addition, virus related deaths in Italy have now surpassed those from China, and further personal restrictions are being contemplated by PM Conte in order to get a handle on the situation. Thus, the fact remains that Italy is in dire straits from an economic perspective, again at least in the short term. Yet the FTSE MIB (the main Italian stock market index) is higher by 3.8% as I type this morning.

This all begs the question, why are markets reversing course from what has been several hellacious weeks of price declines? Let’s consider a few possible reasons:

It could be that the combination of expanded central bank and government activity around the world has finally achieved a point where investors believe that apocalyptic scenarios overstate the case.

While this is possible, it seems a bit far-fetched to believe that in the course of 36 hours, investors have suddenly decided to accept all the actions, and there have been many, have done the job.

A recap of the major actions shows:
• ECB creates €750 billion PEPP as additional QE measures
• Fed extends USD swap lines to 9 additional central banks to allow USD liquidity to reach all G10 nations and several more developed EMG nations like South Korea
• Fed creates money market fund liquidity backstop to insure that CP issuance by US corporates is able to continue and companies are able to fund operations
• BOJ added ¥5.3 trillion in liquidity to markets while snapping up ¥201 billion of new ETF’s
• RBA cut rates by 0.25%, added new liquidity to markets and started a QE program to control the 3-year AGB at a rate of 0.25%

There is no question that this is an impressive list of actions put into place in very short order which demonstrates just how seriously governments are taking the Covid-19 outbreak. And this doesn’t include any of the fiscal stimulus packages which either have been enacted or are on the cusp of being so. In fact, a total of 31 central banks around the world have cut rates, added liquidity or started QE programs in the past week in order to stem the tide. (I have to add that the Danish central bank actually raised its base rate by 0.15%, to -0.60%, yesterday morning in a truly shocking move. Apparently there was growing concern that with the ongoing problems in Italy, investors were flocking to DKK from EUR and driving that cross, which the central bank uses as its monetary benchmark, strongly in favor of the krona. In this instance, strongly represents a 3.5 basis point move, which has since been reversed.) And perhaps the market is telling us, they’ve done enough. But I doubt it.

Remember, the problem is not financial at its heart, it is a medical issue and efforts to contain the virus remain only partially effective thus far. The medical news, however, continues to get worse, at least in Europe and the US, as the caseload continues to increase rapidly, as well as the death toll, and governments are imposing stricter and stricter regulations on the population. So along with California’s action, New York has mandated that no more than 25% of a company’s workforce is allowed to work at the office (at SMBC we are below 15%), while New Jersey has closed all personal service businesses, like hair salons, exercise facilities and tattoo parlors. And these are just the most recent ones that I have seen because of where I live and work. I know there are countless measures throughout the US and Europe. And all of those measures inflict significant pain on the economy.

Yesterday’s Initial Claims number jumped to 281K, significantly higher than model forecasts, but just a fraction of what we are likely to see going forward as small service businesses like restaurants and hair salons and so many others are forced to close for now and cannot afford to continue paying their staff. Hence I’ve seen estimates that we could see those numbers jump as high as 2 million! So while it is not an economic or financial condition at its heart, it is certainly having that impact.

A second thought, one which I think has more substance to it is that during the past three weeks we have seen a substantial amount of position liquidation by highly leveraged fund managers who were forced to sell assets (or cover shorts) at ANY price due to margin calls. The only way to get market movements of 5%-10% or more is to have market participants be price insensitive. In other words, sales (short covers) were mandated, not by choice. However, once those positions are closed, and the evidence is that most have been so, markets revert to price discovery in the normal fashion, with buyers and sellers putting their money to work based on views of the asset. So while there is still significant trepidation by investors, my gut tells me that we have seen the worst of the financial market activity and volatility. It will still be quite a while before things truly settle down, and there is every chance that as the economic data comes over the next weeks and months and shows just how badly things were impacted, we will see sharp market downdrafts. So I am not calling a bottom per se, but think that going forward it will be less dramatic than we have seen during the first three weeks of March.

A quick recap of this morning’s markets shows equity markets around the world higher, with many substantially so (CAC +5.1%, DAX +4.2%, Hang Seng +5.0%); government bond markets also rallying nicely with yields almost everywhere falling (Treasuries -14bps, Gilts -14bps, Bunds -9bps); commodity prices rallying virtually across the board (WTI +2.4%,Copper +1.7%, Gold +2.3%); and finally, the dollar selling off virtually universally, with some of the worst recent performers regaining the most. So KRW (+3.0%), AUD (+2.6%) and GBP (+2.3%) are all unwinding some of the excess movement we saw in the past weeks. If I am correct and the worst has passed, I expect the dollar will cede more of its recent gains. However, given my timeline of May, I expect it will be another month before we see that in any material way. So, if you are a payables hedger, these are likely to be some of the best opportunities you are going to see for quite a while. Don’t miss out!

Good luck, good weekend and please all stay safe and socially distant
Adf

All the PIGS in Her Fief

Said Madame Lagarde, ‘Well I guess
Things really are in quite a mess’
And so up we’ll step
To introduce PEPP
As we try to deal with the stress

The market’s response was relief
That Europe’s new central bank chief
Has realized at last
The time is long past
To help all the PIGS in her fief

Another day, another bunch of new programs! First, though, a quick observation about the overall situation right now. There is no panic in the streets (after all the streets are mostly empty due to shelter-in-home and self-quarantining) but there is panic in… Washington DC, London, Bonn, Frankfurt, Paris, Madrid, etc. And that panic emanates from the fact that all those elected politicians are facing the biggest crisis of all…they might not get reelected because of Covid-19. I believe it is the belated realization that their jobs are on the line that has seen a significant acceleration in the number of new programs being proposed and introduced around the world.

Central banks, which had borne the brunt of the heavy lifting, are starting to get help from fiscal policy actions, but those central banks are still on the front lines. To wit, in an unprecedented intermeeting action, last night the ECB unveiled a new QE program called the Pandemic Emergency Purchase Program (PEPP) which will authorize the purchase of €750 billion of public and private assets for the rest of the year, or longer if deemed necessary. This time they are including Greek government bonds, which the ongoing QE program would not touch due to the credit rating, they are ignoring the capital key, which means they can purchase far more Italian debt than Italy’s share of the Eurozone economy would dictate, and they are expanding the corporate purchases to non-financial CP. And the market liked what they heard with European government bonds rallying sharply pushing 10-year benchmark yields down by 47bps in Portugal, 71bps in Italy, 167bps in Greece and 45bps in Spain. Equity markets in Europe have stopped collapsing, but we still see pressure in Germany and the UK, while the PIGS are all higher. One other thing about Germany was the release of the IFO Expectations Index which fell to 82.0, its lowest point since the financial crisis in 2008. Certainly short-term prospects seem dire there.

And what about the euro you may ask? Well, it continues to slide, down 1.0% this morning, but is actually about middle of the pack in the G10. If you want to see real carnage, look no further than Norway, where the krone has fallen another 2.75% as I type, but that is only after it had been lower by nearly 7.5% at 6:00 this morning, which forced a response from the Norgesbank that they would be intervening if things got worse. Looking over price action during the past month, when oil prices collapsed from $53.78 to as low as $20.06 (currently $22.88), which has been a 57% decline, the worst performing currencies have been; MXN (-23.8%), RUB (-21.2%), NOK (-19.7%) and COP (-17.3%). Two caveats on this list are Norway was down much further earlier this morning, and Colombia hasn’t opened yet today, so has room for a further decline. The only positive I can take from this is that the correlation between the currencies of oil producers and the price of oil remains intact. At least we know what to expect!

But there was plenty of other activity as well. For instance, the RBA cut rates again, by 25bps, taking their base rate to a historic low of 0.25%. In addition they have implemented their first QE plan where they are targeting the yield on 3-year AGB’s at 0.25%. The problem is that the 10-year bond got hammered on the news with yields there jumping 23bps overnight, taking the move since Monday to 57bps. Look for the RBA to do more, and probably soon. And the Aussie dog dollar? Down a further 1% this morning, which takes the decline in the past month to 14.3% and it is now trading at levels not seen since 2003.

And let’s not forget South Korea, which is stepping into the market to buy KRW 1.5 trillion (~$1.1 billion) of government bonds, as it prepares both bond and stock stabilization funds to help support markets there. In other words, the government is going to be buying equities to stop the slide. The KRW response? -3.2%!

Japan would not be left out of this parade, buying a new record ¥201.6 billion of ETF’s last night while injecting ¥5.3 trillion yen in new liquidity to the money markets. Unfortunately, the Nikkei continued its decline, although fell only 1.0%, arguably an improvement over recent performance. The yen has no haven characteristics this morning, falling 1.50%, which is actually now the worst performing currency as NOK continues to rebound as I type on the back of Norgesbank activity.

Finally, I would be remiss if I didn’t mention that the Fed has unveiled yet another program, this time to backstop money market funds, a key part of the US financial plumbing system, and one that when it broke in 2008 after Lehman’s bankruptcy, resulted in financial markets seizing up entirely. The fund is there to make liquidity available to funds to meet increased redemptions without having to sell their holdings. Instead, they will pledge them as collateral and receive cash from the Fed.

This note is too short to go through every action taken, but we continue to see other central bank rate cuts and we continue to see fiscal packages starting to get enacted. In fact, President Trump signed into law the latest yesterday, to support paid sick leave and increased unemployment benefits, and now Congress turns to the MOAS (mother of all stimuli) packages which may include helicopter money as well as bailouts of airlines and hospitality businesses that have been decimated by the virus response. Mooted price tag…$1.3 trillion, but my bet is it winds up larger than that.

Meanwhile, the dollar remains the single place to be. It has rallied against everything yet again as holding cash is seen as the only response to the current situation. And the cash everyone wants to hold is green. Foreign borrowers are scrambling and struggling as their local currencies collapse and swap spreads blow out. And domestic borrowers are wondering how they are going to repay or roll over their debt given the absolute collapse in economic activity.

For now, this is likely to continue to be the situation, as there is no obvious end in site. However, the growing sense of urgency in those national capitals leads me to believe that we are going to start to see much bigger fiscal packages and a newfound belief that printing money and giving it out is a better solution than allowing economic activity to seize up completely. As I said last week, the MMT proponents have won the day. It has just not yet been made explicit.

Good luck and stay safe
Adf

 

A Lack of Well-Being

Down Under the RBA eased
And Aussie bulls have gotten squeezed
In Europe they’re seeing
A lack of well-being
Which has politicians displeased

The RBA cut rates by 25bps last night, as fully expected by the interest rate markets, and they indicated that despite the fact that their base rate was now at a record low of 0.75%, they were considering further easing in the future. The Aussie dollar suffered on the news and is the worst performer in the G10 today, down 0.80%. In fact, Aussie is now at its lowest level since the financial crisis and, in truth, the trend certainly looks like it has further to fall. Australia continues to suffer from the combination of China’s slowing growth as well as the fall-out from the US-China trade war. Alas for the Australians, there is precious little they can do to insulate themselves from those things given they have literally built their economy over the past twenty-five years on the back of Chinese growth. Given the US dollar’s overall trend higher, I see nothing that would change this in the near term. Receivables hedgers beware.

Adding to the global gloom was the release of the Eurozone Manufacturing PMI data which continues to point to a manufacturing recession there. Germany’s was actually slightly better than forecast, but at 41.7 remains far and away the worst of the bunch. The overall Eurozone reading was at 45.7, essentially unchanged from last month and showing no signs of improvement whatsoever. In fact, the sub-indices showed that both new orders and prices paid are falling even faster. Given this news it can be no surprise that Eurozone CPI was released at a weaker than forecast 0.9% this morning as well. It is easy to see why Signor Draghi has been keen to add stimulus to the Eurozone economy, but it will take some time for the most recent activities to work their way into the data, which implies that things are going to get worse before they get better. Interestingly, after an early dip on the data, the euro has clawed back those losses and is now essentially unchanged on the day. Of course, the euro remains in a very clear downtrend and is lower by 1.9% since the ECB’s last policy meeting where they cut rates and restarted QE. Looking back a bit further into the summer, since last June, the single currency has fallen more than 4.6%. This trend, too, has legs.

As a harbinger of the narrative, the WTO released updated forecasts for growth in global trade this morning and the reading was not pretty. The new forecast is for global trade to grow just 1.2% in 2019 and 2.7% in 2020. This compares to growth of 3.0% in 2018, and its last forecasts of 2.6% and 3.0% for this year and next. At this point, the market is sharpening its focus on the upcoming trade negotiations due to begin in Washington on October 10th. Everybody is hoping for a positive outcome, but from everything that has been reported so far, it appears the two sides remain far apart on a number of issues, and though a deal will be beneficial for both, it remains a distant prospect I fear.

Turning our attention to Japan, last night the government auctioned a new tranche of 10-year JGB’s with pretty disastrous results. A day after explaining they will be reducing the amount of purchases in the back end in order to steepen the yield curve, they were true to their word. Yields there climbed 5bps with the bid-to-cover ratio a very weak 3.42, the lowest since 2016. This price action had a knock-on effect everywhere in the world as Treasury prices fell (yields +6bps) with a similar story in Germany (+4.5bps) and the UK (+7bps). For our purposes, the impact was in USDJPY, which is higher by 0.25% this morning, extending its bounce of the last month. Once again, the current market does not appear to be risk sensitive per se, this is simply dollar outperformance.

A quick look at the rest of the FX world shows SEK a key underperformer this morning, falling 0.55% as the market continues to focus on the change in tone from the Riksbank. They had been working hard to ‘normalize’ interest rates over the past year, but the data there continues to undermine their case with this morning’s PMI release of 46.3 dramatically lower than forecasts and the weakest reading since 2012. Instead, they are far more likely going to need to cut rates again, hence the krone’s weakness.

In the EMG sphere, ZAR is the biggest loser today, falling 1.0% on the back of two related stories; first Fitch cut the credit rating of Eskom, the troubled government-owned utility, to CCC-, essentially dead. This situation has been weighing on economic growth there for quite a while, and the bigger concern is that it forces a countrywide credit downgrade. South Africa is currently under review by Moody’s, and another cut would put them in junk territory forcing a significant amount of ZAR bond sales by international investors (with some estimates as high as $15 billion worth), and correspondingly, driving the rand even lower. But if you look across the board, while ZAR is the worst performer, the dollar is higher against virtually the entire space.

Turning to the upcoming session, we are looking forward to ISM Manufacturing data (exp 50.0) after a very weak Chicago PMI number yesterday (47.1). We also get to hear from three Fed speakers, Evans, Clarida and Bowman, although the last of these, Governor Bowman, rarely speaks of monetary policy with her focus on community banking. Beyond this, the bigger trend remains a higher dollar and there is nothing to indicate that trend is changing.

Good luck
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Be Prepare for Mayhem

Next week when the former PM
Steps down be prepared for mayhem
Both Johnson and Hunt
Are willing to punt
May’s deal, which they’re quick to condemn

Remember, back in the day, when I suggested that the probability of a hard Brexit was much higher than the market was assuming? In fact, I have been highlighting this fact pretty consistently since, at least, January heading up to the original deadline. Well, now, it appears that the market is figuring out that the probability of a hard Brexit is higher than they previously assumed. Last night, in a debate between the two candidates for PM, front-runner Boris Johnson and Jeremy Hunt, both were clear that the Irish backstop was dead in the water, and both were clear that they would be willing to walk away with no deal. Ongoing negotiations have become more difficult as the UK is making more demands and the EU is now complaining that the UK is trying to “bully” them! This is the funniest statement that I have ever seen. For two years, the EU essentially bullied PM May into agreeing to things that were unpalatable, including the Irish backstop. Now all of a sudden, the EU’s tender feelings have been hurt by the UK pushing back!

Since the original vote, pundits around the world have assumed that the UK would bear the brunt of the fallout from Brexit. After all, the rest of the EU is the UK’s largest trading partner, and the UK only represents something like 10% of EU exports. But as the EU dips back into recession with monetary policy already stretched, it is becoming clearer that the EU will suffer greatly in a no-deal Brexit. Just ask Germany how its auto manufacturers will be impacted when suddenly there are tariffs on BMW’s in the UK. The point is that both sides are likely to feel pain, although it seems the UK has already absorbed part of it, while the rest of the EU has been laboring under the assumption that the UK would cave in eventually. My view is there is no chance of a deal at this point and there are only two possible outcomes; no-deal Brexit or no Brexit. However, there seems to be limited willingness to hold a second referendum to try to overturn the first one, with major splits within both main parties there. And that leads to a no-deal Brexit. Be prepared.

It should be no surprise that this has had a pretty big impact on the pound this morning, which has fallen by 0.75% to its lowest level since January 2017. And this is despite better than expected employment data where wages grew a stronger than expected 3.6% in May, while the Unemployment rate remained at 45-year lows of 3.8%. While the UK economy seems to be holding up reasonably well, I continue to look for the BOE to cut rates in November after the hard Brexit occurs, if only as a precaution for a quick slowdown. Meanwhile, the pound is likely to continue to decline between now and then, testing 1.20 before long. However, vs. the euro, where the pound has also been sliding, I expect that trend to stabilize and even reverse. This is due to the fact that the Eurozone is going to suffer far more than currently anticipated from a hard Brexit. Right now, the cross is trading at 0.9030. I would look for a move in the euro to 1.05-1.06 and the cross to head down to 0.88.

Away from the Brexit story, things are a bit less exciting on the currency front. Broadly the dollar is strong today, as weaker Eurozone data (German ZEW Sentiment fell more than expected to -24.5) has pundits discussing a recession in Germany and confirming a more aggressive policy ease from the ECB. As such, the euro is lower by 0.3% this morning, as all the dovishness from the Fed is being offset by all the dovishness from ECB members.

Down Under, the RBA Minutes continue to highlight the need to keep policy accommodative as they, too, recognize that their old models need tweaking and that lower rates will not lead directly to further inflation. Aussie, which has actually performed pretty well overall since Powell’s first testimony last week, is lower by 0.2%. While the RBA is likely to remain on hold for now, look for more cuts as soon as the Fed starts to cut.

And those have really been the key drivers in the market today. Looking at the CE4, all of them have fallen roughly the same 0.3% as the euro meaning there is no new information to be gleaned. LATAM currencies are barely budged and APAC has also seen very limited movement overnight. The same can be said of global equity markets, which have seen very limited movement, on the order of 0.2% as investors await the next big story. Arguably, that story will start to be told next week by the ECB, with the punchline added by the FOMC at the end of the month. In the meantime, earnings season is beginning, so individual equity prices are likely to see movement, but it is hard to get excited about a macro move in the near term. And bonds? Well, they have stopped falling as the overly aggressive long positions seem to have been unwound. I expect they will start to rally again, albeit at a slower pace than we saw at the beginning of the month.

This morning brings the most interesting data of the week, Retail Sales (exp 0.1%, 0.1% ex autos), as well as a spate of Fed speakers including Chairman Powell at 1:00 this afternoon. If Retail Sales disappoint already low expectations, look for bonds to rally along with stocks as the dollar falls. If they are quite strong, I think the market is far less prone to react as the July rate cut is still a done deal. It just will have a much smaller probability of being a 50bp cut.

Good luck
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Still Writing Obits

The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
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Cold Sweats

The President’s tactic of threats
On trade talks gave some the cold sweats
So equities fell
But then by the bell
Those sellers had many regrets

Stock prices rebounded with verve
But bonds, if you look at the curve
Continue to price
A fools’ paradise
And cuts by the Federal Reserve

One of the most interesting dichotomies that we see these days is the completely different views of the global economy by stock markets and bond markets. Stock prices continue to see every glass as at least three-quarters full, willing to look past any potential bad news and rally. Yesterday saw a rout in the Far East after the President’s tweets regarding the raising of tariff rates by the end of this week. Europe continued the trend, closing down sharply as concerns grew that a change in tactics by the US could result in a renewed focus on the European auto sector and, not surprisingly, US equity markets opened sharply lower. But within a few hours, buyers emerged as the story morphed from ‘the US-China trade talks were about to collapse’ to ‘this is just a negotiating tactic by President Trump and everything is still on track for a successful (and fully priced) completion of these negotiations.’ And overnight, equity markets in Asia steadied with generally modest gains, although not nearly enough to offset Monday’s price action. Overall, equity markets remain quite optimistic.

At the same time, Treasury yields have fallen further and are back below 2.50% in the 10-year for the first time in a month. The implication is that bond investors and traders are now far less sanguine over the outcome of these talks. Certainly, if the trade talks do collapse, markets would be severely impacted with equity prices likely to see sharp declines and risk assets, in general under pressure. Treasuries (and Bunds) however, would very likely see a significant uptick in demand and it would not be hard to envision another period of a yield curve inversion. My point is it almost appears as if equity investors and bond investors are reading different stories about current events. I guess the reality is that bond investors are inherently more risk averse, so any hint of trouble forces a response. And of course, equity investors are the ones who continue to highly value ‘zombie’ companies, those firms whose profits cannot cover interest payments and who stay in business by the grace of Federal Reserve largesse.

The upshot is that risk seeking behavior remains the dominant theme in markets. As long as central banks continue to add liquidity to the mix (which despite the Fed having stopped, the BOJ and ECB continue to add as does the PBOC), that money needs to find a home somewhere. And stock markets have been the primary destination for the past ten years.

The interesting thing about the willingness to seek risk is that the dollar continues to outperform most other currencies. For the longest time, during periods of strong global growth, the dollar would soften as investment flowed to other nations and drove economic activity. However, the current situation shows a willingness to take risk and yet a simultaneous desire to hold dollars. For instance, a look at the Dollar Index (DXY) which is a broad measure against a number of currencies, shows that the dollar remains near its highest level in two years and the trend remains higher. All I’m saying is that there seems to be a disconnect between the three key global markets with both FX and bonds seeing a much darker future than equity markets.

Looking at the overnight activity, the RBA left rates on hold, which was mildly surprising as at least half the analyst community was looking for a rate cut. In the end, AUD rallied 0.4% and is, by far, the best performer of the day. As it happens, the RBNZ meets tonight and is widely expected to cut rates by 25bps thus the kiwi is lower by 0.25%. The euro and pound are essentially unchanged as there has been precious little in the way of new information either data wise or regarding the ongoing Brexit fiasco. And the rest of the G10 seems to be under very modest pressure with CAD and CHF both softer by about 0.15%.

In the emerging market space, CNY continues to fall, down a further 0.15% this morning and we continue to see pressure on LATAM currencies (MXN -0.2%). TRY is also under pressure (-1.0%) as the investors exit both stock and bond markets there in the wake of the decision to rerun the Istanbul mayoral election and the further erosion of democracy in Turkey. In APAC, MYR is little changed in the wake of the widely anticipated 25bp rate cut by the central bank there, although it has been falling steadily for the past two weeks in anticipation. But otherwise, in truth, it has been quiet.

Data today brings just the JOLTs Jobs Report (exp 7.24M) and we hear from Randal Quarles, the Fed governor overseeing regulations. Yesterday’s Fed talk was largely in line with the view that the recent dip in inflation is ‘transitory’ and that they continue to watch the data for information to help them make their next move. Overall, it is shaping up as a pretty dull session, and unless we hear something else on the trade front, I expect limited movement in most markets.

Good luck
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