Tag Archives: #RBA

Extinct

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Down Under the RBA blinked
Regarding their policy linked
To Yield Curve Control
Which seemed, on the whole
To crumble and now is extinct

The question’s now how will the Fed
Address what’s become more widespread?
As prices keep rising
The market’s surmising
That rate hikes will soon go ahead

Here’s the thing, how is it that the Fed, and virtually every central bank in the developed world, have all been so incredibly wrong regarding inflation’s persistence while virtually every private economist (and markets) have been spot on regarding this issue?  Are the economists at the Fed and the other central banks really bad at their jobs?  Are the models they use that flawed?  Or, perhaps, have the central banks been knowingly trying to mislead both markets and citizens as they recognize they have no good options left regarding policy?

It is a sad situation that my fervent desire is they are simply incompetent.  Alas, I fear that central bank policy has evolved from trying to prevent excessive economic outcomes to trying to drive them.  After all, how else could one describe the goal of maximum employment other than as an extreme?  At any rate, as the saying goes, these chickens are finally coming home to roost.  The latest central bank to concede that their previous forecasts were misguided and their policy settings inappropriate was the RBA which last night ended its 20-month efforts at yield curve control while explaining,

“Given that other market interest rates have moved in response to the increased likelihood of higher inflation and lower unemployment, the effectiveness of the yield target in holding down the general structure of interest rates in Australia has diminished.”

And that is how a central bank cries ‘uncle!’

Recall, the RBA targeted the April 2024 AGB to keep it at a yield of, first 0.25%, and then after more lockdowns and concerns over the impact on the economy, they lowered that level to 0.10%.  Initially, it had success in that effort as after the announcement, the yield declined from 0.55% to 0.285% in the first days and hovered either side of 0.25% until they adjusted things lower.  In fact, just this past September, the yield was right near 0.0%.  But then, reality intervened and inflation data around the world started demonstrating its persistence.  On October 25, the yield was 0.125%, still behaving as the RBA desired.  By October 29, the end of last week, the yield had skyrocketed to 0.775%!  In truth, last night’s RBA decision was made by the market, not by the RBA.  This is key to remember, however much control you may believe central banks have, the market is still bigger and will force the central bank’s hand when necessary.

Which of course, brings us to the FOMC meeting that starts this morning and whose results will be announced tomorrow afternoon at 2:00pm.  Has the market done enough to force the Fed’s hand into adjusting (read tightening) policy even faster than they have expressed?  Will the Fed find themselves forced to raise rates immediately upon completing the taper or will they be able to wait an extended length of time before acting?  The latter has been their claim all along.  Thus far, bond traders and investors have driven yields in the front end higher by 25bps in the 2-year and 35bps in the 3-year over the past 6 weeks.  Clearly, the belief is the Fed will be raising rates much sooner than had previously been considered.

The problem for the Fed is that the economic data is not showing the robust growth that they so fervently desire in order to raise interest rates.  While inflation is burning, growth seems to be slowing.  Raising rates into that environment could easily lead to even slower growth while having only a minimal impact on prices, the worst of all worlds for the Fed.  If this is the outcome, it also seems likely that risk assets may suffer, especially given their extremely extended valuations.  One must be very careful in managing portfolio risk into this situation as things could easily get out of hand quickly.  As the RBA demonstrated last night, their control over interest rates was illusory and the Fed’s may well be the same.

With those cheery thoughts in our heads, a look at markets this morning shows that risk is generally being shed, which cannot be that surprising.  In Asia, equity markets were all in the red (Nikkei -0.4%, Hang Seng -0.2%, Shanghai -1.1%) as the euphoria over the LDP election in Japan was short-lived and the market took fright at the closure of 18 schools in China over the increased spread of Covid.  In Europe, equity markets are mixed with the DAX (+0.5%) and CAC (+0.4%) both firmer on confirmation of solid PMI Manufacturing data, but the FTSE 100 (-0.5%) is suffering a bit as investors grow concerned the BOE will actually raise the base rate tomorrow.

Speaking of interest rates, given the risk-off tendencies seen today, it should be no surprise that bond yields are lower.  While Treasury yields are unchanged as traders await the FOMC, in Europe, yields are tumbling.  Bunds (-3.5bps) and OATs (-5.6bps) may be the largest markets but Italian BTPs (-10.7bps) are the biggest mover as investors seem to believe that the ECB will remain as dovish as possible after last week’s ECB confab.  Only Gilts (-0.4bps) are not joining the party, but then the BOE seems set to crash it with a rate hike, so there is no surprise there.

Once again, commodity prices are mixed this morning, with strong gains in the agricultural space (wheat >$8.00/bushel for the first time since 2008) and NatGas also firmer (+3.0%), but oil (-0.35%). Gold (-0.1%), copper (-0.5%) and the rest of the base metals softer.  In other words, there is no theme here.

Finally, the dollar is having a pretty good day, at least in the G10 as risk-off is the attitude.  AUD (-0.85%) is the worst performing currency as positions get unwound after the RBA’s actions last night.  This has dragged kiwi (-0.7%) down with it.  But NOK (-0.6%) on lower oil prices and CAD (-0.3%) on the same are also under pressure.  In fact, only JPY (+0.35%) has managed to rally as a traditional haven asset.  In emerging markets, the outlier was THB (+0.6%) which has rallied on a sharp decline in Covid cases leading to equity inflows, while the other currency gainers have all seen only marginal strength.  On the downside, RUB (-0.5%) is feeling the oil heat while ZAR (-0.2%) and MXN (-0.2%) both suffer from the metals’ markets malaise.

There is absolutely no data today, nor Fed speakers as all eyes now turn toward ADP Employment tomorrow morning and the FOMC statement and following press conference tomorrow afternoon.  At this point, my sense remains that the market perception is the Fed will be the most hawkish of all central banks in the transition from QE infinity to the end of QE.  That should generally help support the dollar for now.  however, over time, the evolution of inflation and policy remains less clear, and if, as I suspect, the Fed decides that higher inflation is better than weakening growth, the dollar could well come under much greater pressure.  I just don’t think that is on the cards for at least another six months.

Good luck and stay safe
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Qui Vive!

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“Inflation, inflation, inflation”
Lagarde explained might have duration
That’s somewhat extended
Before it has ended
But truly tis an aberration

Yet traders have come to believe
That Madame Lagarde is naïve
Though she’s been dogmatic
That rates will stay static
Investors are shouting qui vive!

It appears that, if anything, the gathering storm of interest rate hikes has done nothing but strengthen in my absence.  Inflation continues to be THE hot topic in markets, and central banks are finding themselves in uncomfortable positions accordingly.  Some, like the RBA, BOC and BOE, have either given up the ghost on the transitory idea and are moving or preparing to do so in order to address what has clearly become a much bigger problem.  Others, notably the ECB, remain ostrich-like and refuse to accept the idea that their policy responses to the pandemic induced government shutdowns and fiscal policy boosts have actually been quite inflationary.  In the face of the ever-increasing inflation numbers around the world, investors are flattening yield curves aggressively, with 2-year yields skyrocketing while 10-year and beyond yields drift lower.  At this point, yield curve inversion remains only a distant possibility, but one that is far more likely than had been the case just two weeks ago.  Ultimately, the market’s collective concern is that despite a slowing growth impulse, central banks will be forced to respond to the inflation data thus crimping future growth.  The major risk is they will ultimately slow growth with only a limited impact on prices thus exacerbating the situation.  Right now, it is not that much fun to be a central banker.

A quick recap shows that last week, Madame Lagarde pooh-poohed the idea that the market knew what it was doing by driving rates higher.  She whined that traders were not listening to the ECB’s forward guidance, which she claims shows rates are in no danger of being raised anytime soon.  However, futures traders in Europe are pricing in a 10bp rate hike by next summer, shortly after the PEPP expires.  Meanwhile, 10-year Bund yields, which have been negative since May 2019, have rallied to -0.10% and seem on the verge of returning to positive territory.  Of course, 2-year Bund yields have risen 30bps in the past 3 months as that curve flattens as well.  (As an aside, the FX market had a little hiccup here as well, with the euro rallying sharply after the Lagarde comments, only to give all that back and then some on Friday in the wake of higher than forecast PCE data from the US which has traders betting on more than 50bps of Fed Funds hikes in 2022 and another 100 basis points in 2023.

With that as backdrop, we have two major and one lesser central bank meetings this week, the RBA tonight, the FOMC on Wednesday and the BOE on Thursday.  While we will discuss the latter two at further length over the next several days, the current thinking is that the Fed will announce the timing of the tapering of QE while the market has the BOE as a 50-50 proposition to actually raise the base rate by 0.15%, returning it to 0.25%.

Beyond the central bank drama, we continue to see troubling economic statistics with US GDP growth slowing to 2.0% in Q3, a far cry from its 6.7% Q2 rate, while Chinese Manufacturing PMI fell to 49.2 and German Retail Sales fell -2.5% in September.  On the whole, the stagflation story continues to be the hottest ticket around both anecdotally and based on Google Trends.

As you can see, there is much to be discussed as the week progresses, but for now, let’s take a look at today’s markets.  Despite all the concerns over stagflation, which should theoretically be awful for equities, the US stock market knows no top and that continues to pull most other markets along for the ride.  In fact, last night, the only real issues were in China where the Hang Seng (-0.9%) and Shanghai (-0.1%) suffered as yet another Chinese real estate development company (Yango Group) is on the verge of defaulting on its debts.  However, the Nikkei (+2.6%) rallied strongly on the back of the LDP’s surprising retention of a majority (albeit reduced) of the Diet in weekend elections.  In Europe, though, there is nothing holding back equity investors with all markets in the green (DAX +0.85%, CAC +1.0%, FTSE 100 +0.5%) as bad data is ignored.  While Q3 earnings have been solid, it does seem that prospects going forward are more limited, however investors seem unconcerned for now.  And don’t worry, US futures are all firmly in the green, higher by around 0.4% at this point in the morning.

Given the risk on attitude that we have seen this morning, it is no surprise that bonds are selling off with yields backing up a bit.  Treasury yields (+2.3bps) are a bit higher but still well off the highs seen two weeks’ ago.  Across Europe, sovereign yields (Bunds +1.4bps, OATs +1.7bps and Gilts (+3.0bps) are also firmer in sync with the risk attitude as we see the entire continent’s bonds come under pressure.  One other noteworthy mover were Australian bonds (-18.3bps) which retraced 2/3 of the yield spike from last week as the market prepares for the RBA meeting tonight. You may recall that the RBA had been implementing YCC in the 3yr, seeking to hold that yield at 0.10%.  However, as inflation rose, so did that yield, finally spiking last week as market participants decided the RBA would change tactics, and the RBA did not push back.  Governor Lowe has his work cut out for him this tonight in explaining what the RBA will be doing next.

Turning to commodities, oil prices (+0.5%) are rising this morning and seem to be getting set to break the recent highs and start a new leg toward, dare I say it, $100/bbl.  Overall, however, the commodity complex is directionless today with NatGas (-1.4%) lower, gold (+0.2%) higher, copper (-0.1%) lower, the ags mixed as well as the other non-ferrous metals.  In other words, today seems to be far more noise than signal.

Finally, the dollar, too, seems confused today, with both gainers and losers abounding in both the G10 and EMG spaces.  In the G10, NOK (+0.25%) is the leader as it responds to oil’s rally, while JPY (-0.3%) is the laggard, I assume responding to the election results and the broader positive risk sentiment.  The rest of the bloc is well within those bounds and other than the data mentioned, doesn’t seem to have much short-term direction.

EMG currencies have shown a bit more movement, with TRY (+0.7%) the leader followed by CZK (+0.45%).  The Turkish story seems confused as the two data points showed PMI falling compared to last month and Inflation rising, neither of which would seem to benefit the lira, but there you go!  Meanwhile, the Czech budget deficit is expected to shrink somewhat as traders push the currency higher.  On the downside, there are a few more from which to choose as THB (-0.8%) is the worst performer followed by KRW (-0.7%) and ZAR (-0.6%).  The baht suffered as international investors sold stocks and bonds locally and repatriated currency.  Korea’s won seemed to suffer on broader based dollar strength despite decent export data, but talk is the future looks dimmer as growth around the world slows.  Meanwhile, the rand fell over ongoing concerns that the SARB, when it meets later this month, will disappoint on the rate rise front.

It is, of course, a big data week between the Fed and Friday’s NFP report:

Today ISM Manufacturing 60.5
IS Prices Paid 82.0
Wednesday ADP Employment 400K
ISM Services 62.0
Factory Orders 0.0%
FOMC Rate decision 0.00%-0.25%
Thursday Initial Claims 275K
Continuing Claims 2136K
Nonfarm Productivity -3.2%
Unit Labor Costs 6.9%
Trade Balance -$79.9B
Friday Nonfarm Payrolls 450K
Private Payrolls 400K
Manufacturing Payrolls 28K
Unemployment Rate 4.7%
Average Hourly Earnings 0.4% (4.9% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.8%

Source: Bloomberg

Obviously, the FOMC on Wednesday is the primary focus closely followed by Friday’s payroll report.  Before then, tonight’s RBA meeting will have the market’s attention and we cannot forget the BOE on Thursday.  All in all, it could be quite an eventful week.  As to the dollar, for now, especially against the euro, it feels like there is further room for appreciation as the market continues to see the Fed as far more hawkish than the ECB.  Quite frankly, I think both sides of that discussion will be comfortable with the outcome as a stronger dollar should help check inflation while a weaker euro can help rekindle the export engine.  Look for it to continue.

Good luck and stay safe
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Stop It

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There are several central banks which
Are starting to look at a switch
From policy ease
To tight, if you please
As QE they now want to ditch

The Old Lady and RBA
Are two that seem ready to say
Inflation’s too high
And so we must try
To stop it ere it runs away

The dollar is under pressure this morning as investors and traders start to look elsewhere in the world for the next example of policy tightening.  The story of tapering in the US is, quite frankly, getting long in the tooth as it has been a topic of discussion for the past six months and every inflation reading points to the fact that, despite their protestations, FOMC members realize they need to do something.  But in essence, that is already a given in the market, so short of Chairman Powell explaining in his Friday appearance that the FOMC is likely to end QE entirely next month, this is no longer market moving activity.  The dollar has already benefitted from the relatively higher yields that are extant in the Treasury market, and expectations for a further run up are limited.

However, the same is not true elsewhere in the world as central bank plans are only recently crystalizing alongside the universally higher inflation prints.  So, the BOE, which has been more vocal than most, seems to be working hard to prepare markets for a rate hike and the market has taken the ball and run with it.  Thus, UK yields in the short end of the curve have moved rapidly higher with 3-year gilt yields higher by 53 basis points in the past 6 weeks and 15 bps in the past three sessions.  On Sunday we heard from BOE Governor Bailey that they will “have to act” soon to address rapidly rising inflation, and traders continue to push UK yields higher and take the pound along with it.  This morning, pound Sterling is higher by 0.75% and amongst the leading FX gainers on this ongoing activity.

Perhaps more interesting is the market reaction to the RBA Minutes last night, where discussion regarding rising real estate prices and the need to do something about them has encouraged the investment community to push yields much higher, challenging the RBA’s YCC in the 3-year AGB.  In fact, despite the RBA explicitly reiterating that conditions for raising rates “will not be met before 2024”, yields continue to rise sharply as fears that inflation will outpace current RBA expectations grow widespread.  Given this price action, one cannot be surprised that the Aussie dollar (+0.85%) has also risen quite sharply this morning.

The thing is, there are a number of conundrums here as well.  For instance, the euro is performing well this morning, up 0.4%, and there has been absolutely zero indication that the ECB is considering tighter monetary policy.  It is widely known that the PEPP will expire in March, but it is also very clear that the previous QE program, the APP, is going to be expanded and extended in some manner to make up for the PEPP.  The only question here is exactly what form it will take.  Similarly, there is no indication that the BOJ is even considering the end of QE or NIRP or YCC, yet the yen has managed to gain 0.3% this morning as well.

In fact, today’s price action is looking much more like broad-based dollar weakness abetted by some other idiosyncratic features rather than other stories driving the market.  This becomes clearer when viewing the commodity markets where virtually every commodity price is higher this morning led by oil (+1.25%), gold (+0.75%), copper (+1.15%) and aluminum (+1.6%).  Today is very much a classic risk-on type session with the dollar under pressure and other assets performing well in sync.

For instance, equity markets are in the green everywhere (Nikkei +0.65%, Hang Seng +1.5%, Shanghai +0.7%, DAX +0.2%, FTSE 100 +0.1%) with US futures also pointing higher by roughly 0.4% across the board.  At the same time, bond yields are creeping higher (Bunds +1.8bps, OATs +2.1bps, Gilts +1.8bps) as investors jettison their haven assets in order to jump on the risk bandwagon.  Treasury yields, though, are unchanged on the day although still trending higher from the levels seen late last week.

Adding it up; rising equity prices, rising commodity prices, falling bond prices, and a weaker dollar (with EMG currencies also firmer across the board) results in a clear risk-on framework.  This will warm the cockles of every central bankers’ heart as they will all see it as a vote of confidence in the job they are doing.  Whether that is an accurate representation is another question entirely, but you can’t fight the tape.  Risk is clearly in vogue today.

It is, however, worth asking if this positive attitude is misplaced.  After all, the recent data has hardly been the stuff of dreams.  Yesterday’s US releases were uniformly awful (IP -1.3%, Capacity Utilization 75.2%) with both significantly worse than forecast.  The upshot is that the Atlanta Fed GDPNow number fell to 1.165%, another step lower and an indication that despite (because of?) high inflation, growth is slowing more rapidly.  Meanwhile, Eurozone Construction Output fell -1.3% in August, continuing the down trend that began in March of this year.

I recognize it is earnings season and the initial releases for Q2 have been quite positive.  But I ask, is slowing growth and rising inflation really a recipe for continued earnings growth?  History tells us the answer is no, and I see no reason to believe this time is different.  Today’s price action seems anomalous to the big picture ideas, so be cognizant of that fact.  While markets can remain irrational longer than we can remain solvent, that does not mean it is sensible to go ‘all-in’ on risk because there is one very positive market day.  Tread carefully.

This morning’s US data brings Housing Starts (exp 1613K) and Building Permits (1680K) and that is all.  Though these are unlikely to get the market excited, we also hear from four Fed speakers, Daly, Barkin, Bostic and Waller, where efforts at recapturing the narrative will be primary.  It is growing increasingly clear that the Fed is annoyed that the persistent inflation narrative is gaining traction as it may force their hand in tightening policy before they would like.  Just remember, as important as the Fed is (and every central bank in their own economy), the market is much bigger.  And if the market determines that the Fed is no longer leading the way, or will soon need to change tack, it will force the issue.  On this you can depend.

While today everything is coming up roses, the lesson is that the Fed’s control over markets is beginning to wane.  Eventually that will be quite a negative for the dollar, but for now, despite today’s decline, I think the trend remains for a higher dollar.

Good luck and stay safe
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Quite Unforeseen

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When OPEC, a group of fifteen

Producers, all gathered in Wien

Nobody assumed

The meeting was doomed

To failure, t’was quite unforeseen

Alas, for the group overall

The UAE prince had the gall

To strongly demand

Their quota expand

The Saudis, though, wouldn’t play ball

The big story this morning revolves around the failure to agree, by OPEC+, on new production quotas going forward.  While expansion of output was on the agenda as each member was keen to take advantage of the rising price of crude and its products, it seems the UAE demanded a much larger share of the increase than the Saudis wanted to give.  Ordinarily, this type of horse trading takes place in the background as OPEC likes to show its unity, but for some reason, this particular situation burst into plain sight.  Undoubtedly there are many underlying issues between Saudi Arabia and the UAE, but right now, this is the one that matters.  The result has been that oil continues to rise sharply, up another 1.75% this morning taking the gains this year to nearly 60%.  As is frequently the case in a bullish commodity market, the price curve is in steep backwardation, with the front month contracts being significantly more expensive than the outer months.  This is an indication of a lack of short-term supply, something borne out by the continued drawdown of reserves in storage.

What makes this situation so interesting is the fact that the dollar has not fallen sharply while the price of oil has risen.  Historically, rising commodity prices go hand in hand with a weaker dollar, at least versus its counterpart currencies, but that is not really the case this time.  Thus, for those nations that import oil, their local costs have increased more than proportionally as the lack of dollar weakness means it costs much more local currency to procure each barrel.  For instance, since the start of 2021, the Japanese yen has weakened 6.8% and the Swiss franc has fallen 4.1% while oil’s price has soared.  Neither of these nations produces a drop of oil, so their energy costs have climbed substantially.  In the emerging markets, TRY (-14.1%), ARS (-12.2%), PEN (-8.0%) and THB (-7.0%) are the worst performers this year, none of whom have a significant oil industry and all of whom rely on imports for the bulk of their usage.  A weaker currency and higher oil prices are very damaging to those economies.

The question at hand is whether or not this internecine spat will end soon, with some sort of compromise, or if the UAE will stand its ground under increasing pressure.  One thing to consider is that the US shale producers are not likely to come to the market’s rescue in the near term, if ever, as it appears that even at these prices, the capital flowing into the sector to increase production has not expanded, and if anything, given the green initiatives and demands to stop funding fossil fuel production, is likely to decrease.  We may be approaching a scenario where the US, which continues to pump about 11 million barrels/day, will find itself in very good stead relative to many other developed nations that import a higher percentage of their energy needs.  Arguably, this will help the dollar, which means that for some countries, things are only going to get tougher.

As an aside, there is another commodity that has been performing pretty well despite the dollar’s strength, gold.  Here, too, history has shown that a rising dollar price of gold is highly correlated with a weaker dollar on the foreign exchange markets.  But that is not the current situation, as after a very short-term drop in the wake of the FOMC meeting’s alleged hawkishness, gold has rebounded while the dollar has retained virtually all of its gains from the same meeting.  My sense is that there are larger underlying changes in market perception, one of which is that inflation expectations are becoming embedded.

Of course, that is not evident in the bond market, where Treasury yields remain in their downtrend that began in early May in the wake of the massively disappointing NFP report that month.  Since then, yields have fallen more than 20 basis points and show no sign of slowing down.  Oddly, if the market was pricing in a tapering by the Fed, I would have anticipated bond yields to rise somewhat, so this is simply another conundrum in the market right now.  

Turning to the overnight session, one might argue we are looking at a very modest risk-off session.  Equity markets have been desultory with Asia (Nikkei +0.15%, Hang Seng -0.25%, Shanghai -0.1%) not showing much activity while European bourses (DAX -0.4%, CAC -0.3%, FTSE 100 -0.15%) are a bit softer.  Arguably, the European markets have responded to much weaker than expected German data with Factory Orders falling -3.7% ad the ZEW Expectations Survey falling to 63.3, well below the expected 75.2 reading.  Questions about whether or not the global economy has peaked are starting to be asked as stimulus measures fade away.  By the way, US futures are essentially unchanged at this hour.

While today’s Treasury movement has been nil, we are seeing yields decline across Europe with Bunds (-1.5bps), OATs (1.9bps) and Gilts (-1.1bps) all seeing a bit of demand on the back of waning risk appetite.  Remember, too, that the inflation impulse in Europe remains far less substantial than that in the US.

Aside from oil (+1.75%) and gold (+0.8%), the rest of the commodity bloc is also pretty firm this morning with Copper (+1.5%) and Iron ore (+1.6%) leading the base metals higher.

Finally, in the FX market, the best way to describe things would be mixed.  The RBA met last night and was more hawkish than anticipated.  They not only indicated they were going to reduce the amount of QE purchases when the current program comes up for renewal, but they appear to be ending YCC as well, explaining that they would not be supporting the November 2024 bonds when they become the 3-year maturity.  Not surprisingly, we saw AUD (+0.6%) rally, which dragged NZD (+0.8%) up even more as traders speculate the RBNZ is going to raise rates as well.  Away from that, though, the bulk of the G10 bloc was softer led by NOK (-0.55%), which given oil’s continued rise makes little sense.  At this point, I will chalk it up to trading technicals as I see no strong rationale.  As to the rest of the bloc, modest declines are the name of the game.

Emerging markets have also seen similar mixed price action with ZAR (+0.25%) the leading gainer on the back of gold’s strength while HUF (-0.65%) is the laggard as the market awaits comments from the central bank regarding its green policy ideas.  The next weakest currency in this bloc is PHP (-0.5%) as the central bank confirmed it would not be reducing stimulus until it had further confidence the economy there would be picking up.

On the data front, there are only a few releases due although we do see the FOMC Minutes tomorrow.

TodayISM Services63.5
WednesdayJOLTs Job Applications9313K
 FOMC Minutes 
ThursdayInitial Claims350K
 Continuing Claims3325K

Source: Bloomberg

Aside from this limited information, we hear from just one Fed speaker tomorrow.  Perhaps the market will have the opportunity to make up its own mind about where things are going to go.

At this point, the Fed narrative remains that inflation is transitory and that they will continue to support the economy going forward.  However, there is a group of FOMC members who clearly believe that it is time to cut back on QE.  That will be the major discussion for the next several months, to taper or not, and if so, how quickly it will occur.  My view continues to be that the core of the Fed is not nearly prepared to taper QE purchases as they know that the ongoing expansion of Federal debt will require the Fed to remain an active part of the market lest things get more concerning for bond traders.

As to the dollar, it remains in its trading range having reached the top of that range last week.  I would not be surprised to see a bit of dollar weakness overall, if for no other reason than the dollar is likely to slip back toward the middle of its range.

Good luck and stay safe

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The Specter of Growth

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The specter of growth’s in the air
So, pundits now try to compare
Which central bank will
Be next to instill
The discipline they did forswear

In Canada, they moved last week
On Thursday, Sir Bailey will speak
Now some pundits wonder
In June, from Down Under
The RBA will, easing, tweak

But what of Lagarde and Chair Jay
Will either of them ever say
Our goals are achieved
And so, we’re relieved
We’ve no need to buy bonds each day

On lips around the world is the question du jour, has growth rebounded enough for central banks to consider tapering QE and reining in monetary policy?  Certainly, the data continues to be impressive, even when considering that Y/Y comparisons are distorted by the government-imposed shutdowns last Spring.  PMI data points to robust growth ahead, as well as robust price rises.  Hard data, like Retail Sales and Personal Consumption show that as more and more lockdowns end, people are spending at least some portion of the savings accumulated during the past year. Meanwhile, bottlenecks in supply chains and lack of investment in capacity expansion has resulted in steadily rising prices adding the specter of inflation to that of growth.

While no developed market central bank head has yet displayed any concern over rising prices, at some point, that discussion will be forced by the investor community.  The only question is at what level yields will be sitting when central banks can no longer sidestep the question.  But after the Bank of Canada’s surprise move to reduce the amount of weekly purchases at their last meeting, analysts are now focusing on the Bank of England’s meeting this Thursday as the next potential shoe to drop.  Between the impressive rate of vaccination and the substantial amount of government stimulus, the UK data has been amongst the best in the world.  Add to that the imminent prospect of the ending of the lockdowns on individual movement and you have the makings of an overheating economy.  The current consensus is that the BOE may slow the pace of purchases but will not reduce the promised amount.  Baby steps.

Last night, the RBA left policy on hold, as universally expected, but the analyst community there is now looking for some changes as well.  Again, the economy continues to rebound sharply, with job growth outstripping estimates, PMI data pointing to a robust future and inflation starting to edge higher.  While the inoculation rate in Australia has been surprisingly low, the case rate Down Under has been miniscule, with less than 30,000 confirmed cases amid a population of nearly 26 million. The point is, the economy is clearly rebounding and, as elsewhere, the question of whether the RBA needs to continue to add such massive support has been raised.  Remember, the RBA is also engaged in YCC, holding 3-year yields to 0.10%, exactly the same as the O/N rate.  The current guidance is this will remain the case until 2024, but with growth rebounding so quickly, the market is unlikely to continue to accept that as reality.

These peripheral economies are interesting, especially for those who have exposures in them, but the big question remains here in the US, how long can the Fed ignore rising prices and surging growth.  Just last week Chairman Powell was clear that a key part of his belief that any inflation would be transitory was because inflation expectations were well anchored.  Well, Jay, about that…5-year Inflation breakevens just printed at 2.6%, their highest level since 2008.  A look at the chart shows a near vertical line indicating that they have further to run.  I fear the Fed’s inflation anchor has become unmoored.  While 10-year Treasury yields (+2.3bps today) have been rangebound for the past two months, the combination of rising prices and massively increased debt issuance implies one of two things, either yields have further to climb (2.0% anyone?) or the Fed is going to step in to prevent that from occurring.  If the former, look for the dollar to resume its Q1 climb.  If the latter, Katy bar the door as the dollar will fall sharply as any long positions will look to exit as quickly as possible.  Pressure on the Fed seems set to increase over the next several months, so increased volatility may well result.  Be aware.

As to today’s session, market movement is mostly risk-on but the dollar seems to be iconoclastic this morning.  For instance, equity markets are generally in good shape (Hang Seng +0.7%, CAC+0.5%, FTSE 100 +0.6%) although the DAX (-0.35%) is lagging.  China and Japan remain on holiday.  US futures, however, are a bit under the weather with NASDAQ (-0.4%) unable to shake yesterday’s weak performance while the other two main indices hover around unchanged.

Sovereign bond markets have latched onto the risk-on theme by selling off a bit.  While Treasuries lead the way, we are seeing small yield gains in Europe (Bunds +0.5bps, OATs +0.6bps, Gilts +0.5bps) after similar gains in Australia overnight.

Commodity markets continue to power higher with oil (+1.9%), Aluminum (+0.4%) and Tin (+1.0%) all strong although Copper (-0.1%) is taking a breather.  Agricultural products are also firmer but precious metals are suffering this morning, after a massive rally yesterday, with gold (-0.5%) the worst of the bunch.

Of course, the gold story can be no surprise when looking at the FX markets, where the dollar is significantly stronger across the board.  For instance, despite ongoing commodity strength, and the rally in oil, NZD (-0.9%), AUD (-0.6%) and NOK (-0.5%) are leading the way down, with GBP (-0.25%) the best performer of the day.  The pound’s outperformance seems linked to the story of a modest tapering of monetary policy, but overall, the dollar is just quite strong today.

The same is true versus the EMG bloc, where TRY (-1.0%) is the worst performer, but the CE4 are all weaker by at least 0.4% and SGD (-0.5%) has fallen after announcing plans for a super strict 3-week lockdown period in an effort to halt the recent spread of Covid in its tracks.  The only gainer of note is RUB (+0.4%) which is simply following oil higher.

Data this morning brings the Trade Balance (exp -$74.3B) as well as Factory Orders (1.3%, 1.8% ex transport), both of which continue to show economic strength and neither of which is likely to cause any market ructions.

Two more Fed speakers today, Daly and Kaplan, round out the messaging, with the possibility of Mr Kaplan shaking things up, in my view.  He has been one of the more hawkish views on the FOMC and is on record as describing the rise in yields as justified and perhaps a harbinger of less Fed activity.  However, he is not a current voter, and Powell has just told us clearly that there are no changes in the offing.  Ultimately, this is the $64 trillion question, will the Fed blink in the face of rising Treasury yields?  Answer that correctly and you have a good idea what to expect going forward.  At this point, I continue to take Powell at his word, meaning no change to policy, but if things continue in this direction, that could certainly change.  In the meantime, nothing has changed my view that the dollar will follow Treasury yields for the foreseeable future.

Good luck and stay safe
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Their Bond Vigilantes

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Down Under, the RBA bought
Four billion in bonds as they fought
Their bond vigilantes
Who came back from Dante’s
Ninth circle with havoc they wrought

Investors responded by buying
More bonds and more stocks fortifying
The view central banks
All still deserve thanks
For making sure markets keep flying

Atop the reading list of every G10 central banker is the book written by Mario Draghi in 2012 and titled, How to Keep Interest Rates Lower for Longer*, and every one of those bankers is glued to page one.  At this point, there is no indication that higher interest rates will be tolerated for any length of time, and while jawboning is always the preferred method of moving markets in the desired direction, sometimes these bankers realize they must act.  And act they did, well at least Phillip Lowe, the RBA Governor, did.  Last night, the RBA bought $4 billion in 3-year ACGB’s, doubling the normal and expected amount of purchases as he fought back against the idea that the RBA would not be able to maintain control of the yield curve as they have announced.  The response must have been quite gratifying as not only did 3-year yields nose back below 0.10%, the target, but 10-year yields tumbled 0.25% as investors regained their confidence and took advantage of the sudden increase in yields available to increase their holdings.

So, last week’s price action is now deemed to have been nothing more than a hiccup, or a bad dream, with market activity today seen as the reality.  At least that is the story all the world’s central banks keep telling themselves, and arguably will continue to do for as long as possible.  It seems that the fact the RBA was willing to be so aggressive was seen by investors as a harbinger of what other central banks are willing and capable of enacting with the result being a massive asset rally worldwide.  Think about that for a moment, the purchase of an extra $1.5 billion of ACGBs has resulted in asset price increases on the order of $1 trillion worldwide.  That, my friends, is bang for your buck!

Of course, the question that remains is, will investors continue to accept this worldview, or will data, and ever-increasing debt supply, return us to last week’s market volatility and force a much bigger response by much bigger players?  My money is on the latter, as there is no sign that deficit spending is being reined in, and the signs of higher inflation remain clear, even in Europe!

But clearly, today is not one for calling out central bankers.  While ongoing conversations in Tokyo highlight the question of whether the BOJ needs to intervene ahead of their mid-month meeting when they are to present their Policy Review, and ECB members continue to warn about unwarranted tightening of financial conditions, thus far, we have not seen any increase in activity by either central bank.  However, at 9:45 this morning we will see the latest data from the ECB regarding their purchases during the last week in the PEPP, and it will be instructive to see if those purchases increased, or if they simply maintained their regular pace of activity.  An increase could be taken positively, shoring up investor belief that the ECB has their back, but given how poorly the European government bond market performed last week, it could also be seen as a sign that the ECB is losing its sway in markets.

The one truism is that market volatility, despite central banks’ fervent desire for it to decrease, remains on a higher trajectory as the possible economic outcomes for the world as a whole, as well as for individual countries, diverge.  And this is, perhaps, the hardest thing for investors to accept and understand; after a forty year period of declining inflation and volatility, if the cycle is turning back higher for both of these characteristics, which have a high correlation, then the future will be more difficult to navigate than the recent past.

So, just how impressive was the RBA’s action?  Pretty impressive.  For instance, equity markets in Asia all rose sharply (Nikkei +2.4%, Hang Sent +1.6%, Shanghai +1.2%) and are all higher in Europe as well (DAX +0.7%, CAC +1.1%, FTSE 100 +1.0%).  US futures, meanwhile, are powering ahead by approximately 1.0% across the board.

As to bonds, while the ACGB move was the most impressive, we did see a halt to the rise in 10-year JGB yields, and in Europe, the rally is powerful with Bunds (-5.0bps), OATs (-5.5bps) and Gilts (-4.1bps) all paring back those yield hikes from last week.  Interestingly, Treasury yields (+2.2bps) are not holding to this analysis, as perhaps the news that the $1.9 trillion stimulus package passed the House this weekend has investors a bit more nervous.  After all, passage implies increased issuance of $1.9 trillion, and it remains an open question as to how much demand there will be for these new bonds, especially after last week’s disastrous 7-year auction.  And that’s really the key question, will there be natural demand for all this additional paper, or will the Fed need to expand QE in order to prevent yields from rising further?

On the commodity front, we are seeing strength across the board with oil (+1.0%) leading energy higher on the reflation idea, both base and precious metals markets rallying and agricultural products seeing their ongoing rallies continue.  Stuff continues to cost more, despite the Fed’s claims of low inflation.

As to the dollar, it is mixed this morning, with commodity currencies performing well (NOK +0.4%, CAD +0.35%, AUD +0.3%) while the European commodity users are all under pressure (SEK -0.5%, CHF -0.5%, EUR -0.25%).  The euro’s weakness seems a bit strange given the manufacturing PMI data released this morning was positive and better than expected.  As well, German CPI, which is released on a state by state basis, is showing a continued gradual increase.

In the emerging markets, TRY (+2.5%) is the runaway leader as the lira offers the highest real yields around and as fear recedes, hot money flows there quickest.  But away from that, RUB (+0.6%) on the back of oil’s rally, and CLP (+0.45%) on the back of copper’s ongoing rally are the best performers.  With the euro softer, the CE4 are all weaker and we saw desultory price action in Asian currencies overnight.

On the data front, this is a big week, culminating in the payroll report.

Today ISM Manufacturing 58.6
ISM Prices Paid 80.0
Wednesday ADP Unemployment 180K
ISM Services 58.6
Fed’s Beige Book
Thursday Initial Claims 755K
Continuing Claims 4.3M
Nonfarm Productivity -4.7%
Unit Labor Costs 6.7%
Factory Orders 1.8%
Friday Nonfarm Payrolls 180K
Private Payrolls 190K
Manufacturing Payrolls 10K
Unemployment Rate 6.4%
Participation Rate 61.4%
Average Hourly Earnings 0.2% (5.3% Y/Y)
Average Weekly Hours 34.9
Trade Balance -$67.4B
Consumer Credit $12.0B

Source: Bloomberg

In addition to all this, we hear from Chairman Powell on Thursday, as well as six other Fed speakers a total of nine times this week.  But we already know what they are going to say, rising long end yields are a positive sign of growth and with unemployment so high, we are a long way from changing our policy.  History shows that the market will test those comments, especially once the Fed goes into its quiet period at the end of the week.

As for today, risk is quite clearly ‘on’ and it seems unlikely that will change without a completely new catalyst.  The RBA has fired the shot across the bow of the pessimists, and for now it is working.  While the euro seems to be under pressure on the assumption the ECB will act as well, as long as commodities continue to rally, that is likely to support the growth story and commodity currencies.

Good luck and stay safe
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*a fictional work conceived by the author

Votes in the States

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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
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Hope Springs Eternal

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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
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Fear Has Diminished

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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
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Has Panic Subsided?

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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
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