Tag Archives: #risk-off

Fear’s Stranglehold

Posted on by

All week the poor dollar’s been sold
As traders break fear’s stranglehold
How far can it fall?
The popular call
Is very, though ‘twill be controlled

Once again the dollar is under pressure this morning, although interestingly, we are not seeing equity market strength. Up til now, this week has proven decidedly risk-on with equity markets rallying, commodity prices performing well, and long dollar positions, established during the past months due to fears of impaired liquidity, getting reduced. After all, there is no need to hold a forex position if you can borrow dollars without paying a huge premium. But this morning, there is a bit of a conundrum in the markets as equity prices are falling around the world, but the dollar is continuing its decline.

The popular risk narrative focuses on increasing tensions between the US and China in the wake of China’s recent passage of a law increasing its control over Hong Kong. That simply adds to the general fears that the constant butting of heads between the two nations could escalate to a more significant confrontation. Certainly, this action by the Chinese is not a risk positive, but there is no evidence that funds are rapidly flowing out of Hong Kong because of the situation. This has been made clear by both the exchange rate, where HKD remains right at the top of its band with the dollar and the Hang Seng, which while down 18% YTD, remains well above the lows seen in the global crash in March, and hardly seems in danger of collapse.

Rather, given that it is month end, it appears far more likely that today’s price action in equities is being driven by portfolio rebalancing. After all, asset allocators are now longer equities relative to debt and so will be selling stocks to put themselves back to their target levels. As to the dollar, it too is likely to be feeling the impact of portfolio rebalancing as money continues to flow out of overweight US equity positions to other geographies.

After all, the rate structure has hardly changed at all this month, with yields having remained quite stable in general. For instance, 10-year Treasury yields had an 11 basis point range all month while the havens in Europe saw a similar lack of volatility. Only the PIGS saw their yields trade more dramatically, and for all of them, it was a straight line higher in prices, with yields falling accordingly, in the wake of the EU announcement of steps toward debt mutualization. With this in mind, one can hardly blame relative rate changes for the dollar’s month-long weakness.

On the economic front, the data has been very consistent around the world as well. It is uniformly awful, but it is also beginning its slow rebound from the nadir reached in late March/early April. As Covid-19 spread around the world, different countries have been impacted at different times, but the pattern everywhere is quite similar. In fact, this is the driving market narrative, that economic activity is set to rebound sharply and that as lockdowns around the world are lifted, all will be back to where it was prior to the spread of Covid. And perhaps this will, in fact, be the case. However, the destruction of economic activity combined with the forced changes in working conditions certainly raises the possibility that the rebound will not be nearly as robust as currently anticipated by markets. In other words, do not rule out another repricing of risk. But despite some lingering fears, the general mood in markets remains positive.

Turning to today’s session, as mentioned, we are seeing red across the board in the equity markets with Asia soft (Nikkei -0.2%), Hang Seng (-0.7%), Europe under pressure (DAX -1.0%, CAC -0.8%, FTSE 100 -0.9%) and US futures also declining (DJIA -0.4%, SPX and NASDAQ -0.3%). Also, given the overall lack of volatility seen all month in the bond market, it should be no surprise that Treasury yields are only modestly changed, down 2bps, with German, French and UK yields similarly lower. Meanwhile, oil prices, which have rallied more than 65% this month, are slightly softer today, down 3% and the price of gold, which has had a choppy month, is adding 0.5% to achieve its MTD gain of 1.5%. (As an aside, the gold story is one of great conviction on both sides as the bulls look at the amount of new money in the system without a corresponding increase in production, actually a significant decline there, and wonder how hard assets cannot increase in value. Meanwhile, the bears point to the absence of demand for goods, looking at things like crashing retail sales and rising savings rates, and see deflation on the horizon and no reason to hold anything other than fixed income in this environment.)

As to the dollar, it is almost uniformly lower this morning, with the entire G10 firmer led by Sweden’s krona, up 1.0%, after the country released a surprisingly positive Q1 GDP growth outcome of +0.1%, far better than the anticipated -0.3%, and helping to maintain positive Y/Y growth. That has clearly energized NOK (+0.7%) as well as EUR (+0.5%). But in reality, a great deal of this activity is dollar weakness, rather than specific country strength.

In the EMG bloc, the dollar is under pressure across the space with only the Turkish lira declining on the day, and that by just 0.2%. On the positive side, the CE4 are leading the way with CZK (+0.8%) and HUF (+0.7%) atop the leaderboard. The other noteworthy mover has been IDR (+0.7%) after comments from the central bank governor, Perry Warjiyo, indicated his belief that the rupiah was undervalued and could appreciate somewhat with no problems to the economy.

On the data front, yesterday saw the first decline in Continuing Claims data since the onset of Covid-19, with a surprisingly low print of 21.0M. Initial Claims continue to slide as well, rising ‘only’ 2.1M last week. GDP data were revised slightly lower, to -5.0% annualized for Q1, although there remains a contest to see whose depiction of Q2, with current forecasts between -20% and -50%, will be closest to the mark. This morning we see Personal Income (exp -6.0%), Personal Spending (-12.8%), Core PCE (1.1%), Chicago PMI (40.0) and Michigan Sentiment (74.0). The April income and spending data will be much worse than the previous print, as that encompasses the worst of the shutdown. But the May data is forecast to rebound from its worst levels, consistent with what we are seeing around the world.

As long as fear is in abeyance, I expect that dollar demand will remain more muted than we had seen during the past several months. The big picture story of a more unified Europe with mutual debt, and my ongoing expectations of negative real interest rates in the US points to further dollar weakness over time. This is not going to be a collapse, but rather a steady grind lower.

Good luck, good weekend and stay safe
Adf

Will Powell React?

Posted on by

The Treasury curve is implying
That growth as we knew it is dying
Will Powell react?
Or just be attacked
For stasis while claiming he’s trying?

Scanning markets this morning shows everything is a mess. Scanning headlines this morning shows that fear clearly outpolls greed as the driving force behind trading activity. The question at hand is, ‘Have things gone too far or is this just the beginning?’

Treasury and Bund yields are the best place to start when discussing the relative merits of fear and greed, and this morning, fear is in command. Yields on 10-year Treasuries have fallen to 2.23% and 10-year Bunds are down to -0.17%, both probing levels not seen in nearly two years. The proximate causes are numerous. First there is the continued concern over the trade war between the US and China with no sign that talks are ongoing and the market now focusing on a mooted meeting between President’s Trump and Xi at the G20 in June. While there is no chance the two of them will agree a deal, as we saw in December, it is entirely possible they can get the talks restarted, something that would help mitigate the current market stress.

However, this is not only about trade. Economic data around the world continues to drift broadly lower with the latest surprise being this morning’s German Unemployment rate rising to 5.0% as 60,000 more Germans than expected found themselves out of work. We have also been ‘treated’ to the news that layoffs by US companies (Ford and GE among others) are starting to increase. The auto sector looks like it is getting hit particularly hard as inventories build on dealer lots despite what appears to be robust consumer confidence. This dichotomy is also evident in the US housing market where despite strong employment, rising wages and declining mortgage rates, home prices are stagnant to falling, depending on the sector, and home sales have been declining for the past fourteen months in a row.

The point is that the economic fundamentals are no longer the reliable support for markets they had been in the recent past. Remember, the US is looking at its longest economic expansion in history, but its vigor is clearly waning.

Then there are the political ructions ongoing. Brexit is a well-worn story, yet one that has no end in sight. The pound remains under pressure (-0.1%, -3.0% in May) and UK stocks are falling sharply (-1.3%, -3.3% in May). As the Tory leadership contest takes shape, Boris Johnson remains the frontrunner, but Parliament will not easily cede any power to allow a no-deal Brexit if that is what Johnson wants. And to add to the mess, Scotland is aiming to hold a second independence referendum as they are very keen to remain within the EU. (Just think, the opportunity for another border issue could be coming our way soon!)

Then there is the aftermath of the EU elections where all the parties that currently are in power in EU nations did poorly, yet the current national leadership is tasked with finding new EU-wide leaders, including an ECB President as well as European Commission and European Council presidents. So, there is a great deal of horse-trading ongoing, with competence for the role seen as a distant fifth requirement compared to nationality, regional location (north vs. south), home country size (large vs. small) and gender. Meanwhile, Italy has been put on notice that its current financial plans for fiscal stimulus are outside the Eurozone stability framework but are not taking the news sitting down. It actually makes no sense that an economy crawling out of recession like Italy should be asked to tighten fiscal policy by raising taxes and cutting spending, rather than encouraged to reinvigorate growth. But hey, the Teutonic view of the world is austerity is always and everywhere the best policy! One cannot be surprised that Italian stocks are falling (-1.3%, -8.0% this month).

At any rate, the euro also remains under pressure, falling yesterday by 0.3%, a further 0.1% this morning and a little more than 1% this month. One point made by many is that whoever follows Signor Draghi in the ECB President’s chair is likely to be more hawkish, by default, than Draghi himself. With that in mind, later this year, when a new ECB leader is named, if not yet installed, the euro has the chance to rally. This is especially so if the Fed has begun to cut rates by then, something the futures market already has in its price.

Other mayhem can be seen in South Africa, where the rand has broken below its six-month trading range, having fallen nearly 3% this week as President Ramaphosa has yet to name a new cabinet, sowing concern in the market as to whether he will be able to pull the country out of its deep economic malaise (GDP -2.0% in Q1). And a last piece of news comes from Venezuela, where the central bank surprised one and all by publishing economic statistics showing that GDP shrank 19.2% in the first nine months of 2018 while inflation ran at 130,060% last year. That is not a misprint, that is the very definition of hyperinflation.

Turning to today’s session, there is no US data of note nor are any Fed members scheduled to speak. Given the overnight price action, with risk clearly being cast aside, it certainly appears that markets will open that way. Equity futures are pointing to losses of 0.6% in the US, and right now it appears things are going to remain in risk-off mode. Barring a surprise positive story (or Presidential tweet), it feels like investors are going to continue to pare back risk positions for now. As such, the dollar is likely to maintain its current bid, although I don’t see much cause for it to extend its gains at this time.

Finally, to answer the question I posed at the beginning, there is room for equity markets to continue to fall while haven bonds rally so things have not yet gone too far.

Good luck
Adf

 

Conditions Have Tightened

Posted on by

The Treasury market is frightened
As risk of inflation has heightened
So 10-year yields jumped
The dollar got pumped
And credit conditions have tightened

The dollar rallied yesterday on the back of a sharp rise in US Treasury yields. The 10-year rose 13bps, jumping to its highest level since 2014. The 30-year rose even more, 15bps, and both have seen those yield rallies continue this morning. The catalyst was much stronger than expected US data, both ADP and ISM Non-Manufacturing were quite strong, and further comments by Chairman Powell that indicated the Fed would remain data dependent and while they didn’t expect inflation to rise sharply, effectively they are prepared to act if it does.

Adding to the inflation story was the Amazon news about raising the minimum wage at the company to $15/hour, and don’t forget the trade war with China, where tariffs will clearly add upward pressure on prices. All this makes tomorrow’s payroll report that much more important, as all eyes will be on the Average Hourly Earnings number. We have a fairly recent analogy of this type of market condition, the first two weeks of February this year, when the January AHE number jumped unexpectedly, and within a week, equities had fallen 10% while the dollar rallied sharply as risk was jettisoned with abandon. While I am not forecasting a repeat of those events, it is best to be aware of the possibility.

And quite frankly, that has been THE story of the market. It cannot be that surprising that the dollar has been the big beneficiary, as this has turned into a classic risk-off scenario. EMG currencies are under increasing pressure, and even the G10 is suffering, save the yen, which has rallied slightly vs. the dollar. At this point, there is no obvious reason for this trend to stop until tomorrow’s data release. If AHE data is firm (current expectations are for a 0.3% rise on the month translating into a 2.8% Y/Y rise), look for this bond rout to continue, with the concurrent impact of a stronger dollar and weaker equities. But since that is not until tomorrow, my sense is that today is going to be a session of modest further movement as positions get squared ahead of the big news.

Good luck
Adf