Virus Malaise

It seemed, for a couple of days
That the stock market’s virus malaise
Had finally broken
But now, not unspoken,
Concerns grow in multiple ways

The upshot is risk’s in retreat
And currencies cannot compete
With strength in the greenback
Which this week’s been on track
For, every prediction, to beat

As we head into another weekend, investors and traders have once again demonstrated concern over a shock change in the Covid-19 story and correspondingly have reduced their risk holdings in most markets. While the Chinese government continues to try to pump massive amounts of stimulus into their economy, the actual results may not be as impressive as the numbers suggest. For example, last night the PBOC released their Money supply data, granted a number that has lost much of its luster over the years, but one which still helps explain what is happening in the monetary system there. After all, without a robust monetary system, real economic growth is virtually impossible. And M1, the narrow measure, registered “growth” of 0.0% in January, which means it was at the same level as January 2019. That was a shockingly low outcome (forecasts were for 4.5% growth) and likely indicative of just how little economic activity is occurring in China right now. The other nasty data point was auto sales, which fell, wait for it, 92% in the first half of February. Remember, China is the world’s largest auto market, with annual sales having approached 25 million in 2017, although that number slipped to 21.5 million last year. But a 92% decline, if it persists for another month only, implies that sales will fall below 20 million, and if things don’t get better soon, that number can be much lower. The point is regardless of how much stimulus the Chinese government pumps into the economy, if people remain quarantined and cannot go out and spend it, the economy is going to suffer for a long time.

On top of the Chinese data, the other growing fear is that Covid-19 is starting to spread more widely outside of China. To date, the bulk of the infections have been in Hubei province, although the entire nation is on alert. But last night we heard of more infections in both South Korea and Japan, while the death toll continues to climb alongside the overall infection count. And for the 3rd time this month, the Chinese changed the way they count infections, which pretty much guarantees that whatever numbers they release are hogwash. I fear the virus is much more widespread than publicized, and that it will take far longer than another month for things to return to any semblance of normal in China. There is no ‘V’ shaped recovery coming in Q2, I don’t even think there is a ‘U’ shaped one on the horizon. I fear the Chinese recovery, at least for 2020, may well be ‘L’ shaped.

So, with those cheerful thoughts in mind, let’s look at markets and what they have done both overnight, and all week. Starting with equity markets, last night saw weakness in Asia (Nikkei -0.4%, Hang Seng -1.1%, KOSPI -1.5%) which took their weekly losses to -1.3%, -1.8% and -3.6% respectively. Shanghai, on the other hand, was slightly positive overnight (+0.3%) taking its weekly advance to 4.2%. Of course, Shanghai is the epicenter of a massive inflow of liquidity, so while the real economy may be cratering, new monetary stimulus can easily find its way into the stock market as people trade from home.

European markets have fared somewhat better, with the DAX (0.0%, -0.6% this week), CAC (-0.1%, -0.3%) and FTSE 100 (-0.2%, +0.2%) all biding their time as none of these countries have yet been severely impacted by the virus directly, although obviously, exports to China will have suffered greatly. Meanwhile, in the US, leading up to today’s session, the DJIA has fallen 1.1% this week and the S&P 500 is -0.2%, although the NASDAQ is actually higher by 0.25%. That said, futures markets in all three are pointing lower this morning.

Other key risk indicators are also showing significant gains this week, notably gold (+0.9% today, +3.2% this week) and Treasury bonds, where the 10-year yield is at 1.49% (-2.5bps this morning and 9bps this week).

Finally there is the dollar, which has outperformed virtually every currency this week, with only the Swiss franc even breaking even. In the rest of the G10 space, the yen is the week’s big loser, having fallen 2.0%, a true blow to its status as a safe haven. As I wrote yesterday, it appears that Japanese exporters have stepped away from the market, while leading up to fiscal year end in Japan, there has been an increase in outward investment on an unhedged basis, meaning Japanese lifers and pension funds are buying dollars to buy USD assets and unconcerned about the dollar falling. But both AUD (-1.6%) and NZD (-1.9%) also had a rough week, as the fact that China seems to have come to a virtual standstill will have an immediate negative impact on both those economies.

In the EMG bloc, LATAM currencies have been under the most pressure this week, with BRL (-2.5%), CLP (-2.35%) and MXN (-2.3%) all feeling the impacts of slowing growth in China as the first two are reliant on exports to China for a significant amount of economic activity, while Mexico, which has been holding up extremely well until this week, seems to be feeling the pain of overly extended carry positions amid a risk reduction period. MXN futures are the largest outstanding long positions on the IMM, as many investors seek to earn the 500bps of positive carry. However, as can be seen from the movement just yesterday and today, all that carry can be offset in the blink of an eye when things turn. Given how large the long MXN positions still are, do not be surprised to see the peso weaken much further going forward.

Away from LATAM, it can be no surprise that KRW (-2.1% this week) and THB (-1.6% this week) are also under pressure as the direct Covid-19 impact is greatest in those nations that do the most business with China. And not to be outdone, CNY (-0.65% this week) is trading well back through the 7.00 level and seems unlikely to reverse course until we get unequivocally better news regarding Covid-19.

On the data front, yesterday’s Philly Fed number was spectacular, 36.7 vs. 11.0 forecast, indicating that the US growth story has not yet felt any real effects of the virus. Overnight saw weakness in Australian and Japanese PMI data, again no real surprise, but better than expected results out of Europe and the UK. It seems that the signing of the phase one trade deal was seen as quite a positive, and while Eurozone (and German and French) Manufacturing all remain in contraction with PMI’s below 50.0, the levels have rebounded significantly from their low prints several months ago. This morning brings the US PMI (exp 51.5 for Manufacturing, 53.4 for Services) although this market is far more focused on next week’s ISM data. We also see Existing Home Sales (5.44M) which continue to perform well given the combination of incredibly low Unemployment and incredibly low mortgage rates.

On the day, the dollar is more mixed, having ceded some of its weekly gains vs. the euro and pound, but sentiment appears to continue to point to further risk reduction and further dollar strength as the week comes to a close.

Good luck
Adf

Forecasts to Hell

The company named like a fruit
Said Covid was going to shoot
Its forecasts to hell
So risk assets fell
And havens all rallied to boot

Essentially, since the beginning of the Lunar New Year, there have been two competing narratives. First was the idea that the spread of the Covid virus would have a significantly detrimental impact on the global economy, reducing both production, due to the interruption of supply chains, and consumption, as the world’s second largest economy went into lockdown. This would result in a risk-off theme with haven assets in significant demand. The second was that, just like the SARS virus from 2003, this would be a temporary phenomenon and the fact that central banks around the world have been ramping up policy support by cutting rates and buying assets means that risk assets would continue their relentless march higher. And quite frankly, while there were a handful of days where the first thesis held sway, generally speaking, equity markets at least, are all-in on the second thesis.

At least that was true until today, when THE bellwether stock in the global equity markets explained that Q1 sales would miss forecasts due not only to production delays caused by supply chain interruptions, but to reduced sales as well. This news certainly put a crimp in the bull theory that the virus impact will be temporary and we have seen equity markets around the world suffer, while Treasuries rally, as fears are reignited over the ultimate impact of the CoVid virus.

While this author is no virologist, and does not pretend to have any special insight into how things with Covid evolve from here, long experience informs me that government efforts have been far more focused on controlling the message than controlling the virus. Confidence plays such an important part in today’s economy, and if the first narrative above is the one that takes hold, then there is very little that governments will be able to do to prevent a more substantial downturn and likely recession. Remember, at least in the G10, most central banks are basically out of ammunition with respect to their abilities to pump up the economy, so if the populace hunkers down because of fear, things could get ugly pretty quickly. And with that cheerful thought, let’s take a tour of the markets this morning.

It turns out the tax
On goods and services was
A growth disaster

During the US holiday weekend, we received a stunningly bad Q4 GDP report from Japan, with a -1.6% Q/Q result which turned into a -6.3% annualized number. Not only was that significantly worse than expected, but it was the worst outturn since the last time the Japanese government raised the GST in 2014. So, in their effort to be fiscally prudent, they blew an even bigger hole in their budget! But the yen didn’t really mind, as it remains a key safe haven, and while it weakened ever so slightly yesterday, this morning’s fear based markets has allowed it to recoup those losses and then some. So as I type, the yen is stronger by 0.15% today. Certainly, selling yen is a fraught operation in a market with as big a potential fear catalyst as currently exists.

Meanwhile, that other erstwhile growth engine, Germany, once again demonstrated that the idea of a rebound this year is on extremely shaky ground. Early this morning the ZEW surveys were released with the Expectations reading falling sharply to 8.7, while Current Situations fell to -15.7. While the numbers themselves have no independent meaning, both results were far worse than expected and crushed the modest rebound that had been seen in December. The euro has been under pressure since the release of the data, falling to a new low for the move and continuing its streak of down days, now up to 10 of the past twelve sessions, with the other two sessions closing essentially flat. The euro story has shown no signs of turning around on its own, and for the euro to stop declining we will need to see the dollar story change. Right now, that seems unlikely.

And generally speaking, the dollar is simply outperforming all other currencies. Versus the EMG bloc, the dollar is higher across the board, with not a single one of these currencies able to rally against the greenback. Today’s biggest decliners are the RUB (-0.6%) as oil prices fall, KRW (-0.5%) as concerns grow over Covid, and ZAR (-0.45%) as both commodity prices decline and global growth fears increase. In the G10 space, it should be no surprise that both AUD (-0.5%) and NZD (-0.7%) are the worst performers (China related) as well as NOK (-0.7%) as oil suffers over concerns of slowing global growth. It seems like we’ve heard this story before.

The one currency doing well today, other than the yen, is the British pound (+0.2%) as UK Employment data, released early this morning, was generally better than expected, with the 3M/3M Employment Change slipping a much less than expected 28K to 180K, a still quite robust number. Interestingly, yesterday saw the pound under pressure as PM Johnson’s Europe Advisor, David Frost, laid out the UK’s goals as ditching all EU social constructs and simply focusing on trade. That is at odds with the hinted at EU view, which is they want the UK to follow all their edicts even though they are no longer in the club. Look for more fireworks as we go forward on this subject.

Looking ahead to this week, the US data is generally second-tier, although we will see FOMC Minutes tomorrow.

Today Empire Manufacturing 5.0
Wednesday Housing Starts 1420K
  Building Permits 1450K
  PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.1% (1.3% Y/Y)
  FOMC Minutes  
Thursday Initial Claims 210K
  Philly Fed 11.0
Friday Leading Indicators 0.4%
  Existing Home Sales 5.45M

Source: Bloomberg

So lots of housing data, which given the interest rate structure should be pretty decent. Of course, the problem is the reason the interest rate structure is so attractive to home buyers is the plethora of problems elsewhere in the economy. In addition, we have seven Fed speakers during the rest of the week with a nice mix of hawks and doves. Although it seems unlikely that anybody will change their views, be alert to Dallas Fed President Kaplan’s comments tomorrow and Friday as he is the only FOMC member who has admitted that continuing to pump up the balance sheet could cause excesses in risk taking.

At this point, there is nothing on the horizon that indicates the dollar’s run is over. Regarding the euro, technically there is nothing between current levels and the early 2017 lows of 1.0341 although I would expect some congestion at 1.0500.

Good luck
Adf

Burdened With Shame

There once was a president, Xi
Who ruled with a fist of F E
But there’s now a nit
That cares not a whit
‘Bout politics while running free

So mandarins now take the blame
For playing along with Xi’s game
Their jobs they have lost
And soon they’ll be tossed
In jail, as they’re burdened with shame

Apparently, at least some of the rumors of undercounting coronavirus infections seem to have been true as last night the latest data showed an extraordinary jump in total cases to nearly 60,000 with a regrettable mortality rate of 2.3%, meaning more than 1350 people have passed away from its effects. Last week, much was made about how this was not very different than the simple flu, but that is just not the case. The mortality rate of the flu is 0.1%, an order of magnitude lower. At any rate, officials in Hubei Province revised the way they were calculating cases (i.e. they started admitting to higher numbers) and suddenly there were nearly 15,000 more cases just like that. In typical dictatorial fashion, the previous Hubei leadership, whose job was to prevent the truth from escaping, has been summarily sacked, and President Xi has a new man on the job, with a clean(er) slate. Talk about a thankless job!

At this point, what has become clear is that the dynamics of the spread of the virus remain uncertain and despite significant efforts by the Chinese, it appears premature to declare the situation under control. Recent market activity, where risk assets were aggressively acquired leading to record high stock prices, may now need to be rethought. Consider that the narrative that had been developing, especially after it appeared the growth of the virus was slowing, was that any impact would be temporary and confined to Q1. If that were the case, then it certainly was reasonable to think that ongoing central bank largesse would continue to push risk assets ever higher. But today it seems as though the definition of temporary may need to be adjusted somewhat, and investors are treading more cautiously. This is a terrible human tragedy and the most concerning aspect is that due to the politics in China, efforts to address it using the broadest array of expertise from the WHO and CDC is not being utilized. The likely outcome of these decisions is that many more will die from the coronavirus’s effects, and economic growth worldwide will be pretty significantly impacted.

And that is the background for this morning’s market across all assets. Risk is very definitely off today as can be seen in equity markets in Europe (DAX -1.1%, CAC -1.2%, FTSE100 -1.6%) and US equity futures, all of which are down between 0.7% and 0.9%. Treasury bonds have been in demand, rising half a point with yields falling 4bps to 1.59% while gold is higher by 0.5%. In the FX markets, the yen is today’s top performer, rallying 0.35% while the dollar outperforms virtually every other currency. And finally, oil prices have been slumping again as the IEA has just issued a report estimating that oil demand would actually shrink in 2020, the first time that has happened since the financial crisis and global recession of 2008-09. The latter certainly makes sense given that China has been the largest user of petroleum and its products. Consider that not only has travel to and from China fallen dramatically, over 100 million people are on lockdown in the country, and industrial output has slowed dramatically given there are no factory workers available to get to the factories.

The initial estimates of Chinese Q1 GDP were reduced to 4.5%-5.0%, but lately I have seen estimates falling to 0.0% for Q1 which would have a pretty severe impact on the global economy. And one of the problems is that data from China doesn’t come out quite as regularly as it does here in the US or in Europe, so there are long periods with no new information. Consider also that the Chinese simply didn’t release the January trade figures (they must be AWFUL) and it would not be surprising if they delay the release of much important data going forward. My point here is that we will have an increasingly difficult time understanding the actual situation on the ground in China, although it will become more apparent as those companies and countries that do the most business there report their data. The greater the deterioration of that data, the greater the problem on the mainland.

Turning to individual currency movers this morning, RUB and NOK, the two currencies most closely linked to the price of oil, are the biggest laggards in the EMG and G10 spaces respectively. Aside from the yen’s gains, the pound just jumped 0.3% after reports that Chancellor of the Exchequer, Sajid Javid, has resigned. Apparently the market was unimpressed with his performance. Boris is actively reshuffling his cabinet today, so there are other moves as well, but this was the only one that moved the market. But elsewhere in the G10, the dollar reigns supreme.

In the EMG space, HUF is today’s biggest winner, rising 0.45% after January’s CPI data jumped to 4.7% annually, well above their 3.0% target, and the central bank said they are ready to use all tools to rein it in. Clearly that implies rate hikes are coming to Hungary. (As an aside, I wonder if Powell, Lagarde or Kuroda are going to be ringing up the central bank there asking how they were able to create inflation.) But away from HUF, any gainers have moved so little as to be effectively unchanged, while the rest of the space, notably LATAM, is under pressure on the back of the weaker China story.

Data this morning brings Initial Claims (exp 210K) and CPI (2.4%, 2.2% ex food & energy), with the latter likely to be closely watched. Weakness in this print will only increase the odds of a rate cut here in the US, likely driving the market to price one in by July (currently a 72% probability). Chairman Powell didn’t teach us anything new yesterday, simply rehashing Tuesday’s testimony and no Senators raised anything noteworthy. Today we get two more Fed speakers, Kaplan and Williams, with Kaplan needing to be closely watched. After all, he is the only FOMC member who has admitted that the growth of the Fed’s balance sheet is having an impact on markets, and could prove to be problematic over time.

But it is a risk off day, which means that further yen strength is likely, and the dollar should continue to perform well overall.

Good luck
Adf

Sanguinity Reigns

Despite growth in Chinese infections
And turmoil in Irish elections
Sanguinity reigns
As Powell takes pains
To help prevent any corrections

Once upon a time, people used to describe the President of the United States as ‘the most powerful man in the world’, on the back of the idea that he oversaw the richest and most powerful nation in the world. But these days, it has become pretty clear that the most powerful man in the world is Fed Chairman Jerome Powell. After all, not only is he in command of the US economy, but he is tasked with shielding us all from the impacts of non-financial issues like the coronavirus and climate change. And many people believe, not only can he do that, but it is imperative that he stops both of those things in their tracks.

And yet, the coronavirus continues to spread as virologists and doctors learn more about it each day and seemingly continue to fall further behind the curve. For example, initially, it had been believed that the incubation period for the virus was 14 days, implying that was an appropriate amount of time for any quarantine of suspected cases. But now, the data is showing it may be as long as 24 days, which means that formerly quarantined individuals who were cleared, may actually be infected, and thus the spread of the disease accelerated. As of this morning, more than 40,000 cases have been documented with more than 900 deceased. The human toll continues to rise, and quite frankly, shows no signs of abating yet. Stories of complete lockdowns of cities in Hubei province, where people were literally welded shut inside their homes to enforce the quarantine, and videos showing large scale disinfectant spraying are remarkable, as well as horrifying. And none of this leads to greater trust in the official information that is published by the Chinese government. In other words, this situation is by no means coming to an end and the impacts on economies worldwide as well as financial markets are just beginning to be felt.

From an economic perspective, China has largely been shut for nearly three weeks now, since the beginning of the Lunar New Year holiday in January, which means that all those companies that had built supply chains that run through China while implementing just-in-time delivery have found themselves with major problems. Hubei province is a key center for automotive, technology, pharmaceutical and chemical production. Major global firms, like Foxconn, PSA (Peugeot), Honda and others have all seen production elsewhere impacted as parts that come from the area are no longer being delivered. In fact, Hyundai Motors has closed its operations in South Korea for lack of parts supply. My point is, the economic impact is going to be very widespread and likely quite significant. While there is no way to accurately assess that impact at this time, simple math implies that the fact China will have essentially been closed for 25% of Q1, at least, means that GDP data will be severely impacted, arguably by at least a full percentage point. And what about highly leveraged companies? Interest is still due even if they are not selling products and earning revenue. Trust me; things will get worse before they get better.

And yet…financial markets remain remarkably nonplussed over the potential ultimate impact of this. Yes, equity markets slipped on Friday, but a 0.5% decline is hardly indicative of a significant amount of fear. And overnight, while the Nikkei (-0.6%) and Hang Seng (-0.6%) both fell, somehow the Shanghai Composite rose 0.6%. Yes, the PBOC injected more stimulus, but there is a remarkable amount of faith that the impact of this virus is going to be completely transitory. That seems like a big bet to me, and one with decidedly ordinary odds.

European markets are in the same space, with very modest declines (DAX -0.25%, CAC -0.3%, FTSE -0.15%) and US futures are now little changed to higher. Apparently, economic growth is no longer an important input into the valuation of equities.

And that is the crux of the matter. Since the financial crisis in 2008-09, central banks around the world have, in essence, monetized the entire global economy. If growth appears to be slowing they simply print more cash. If things are going well, they also simply print more cash, although perhaps not quite as much as in the case of a slowdown. And companies everywhere, at least large, listed ones, borrow as much as possible to restructure their balance sheets, retiring equity and increasing leverage. Alas, that does not foster economic activity, and ultimately, that is the gist of the disconnect between financial market strength and the ongoing growth of populist and nationalist political parties. Welcome to the 2020’s.

So, with all that said, risk is modestly off this morning, but by no means universally so. Yes, Treasury yields are lower, down another basis point to 1.57%, but that does not speak to unmitigated fear. And in the currency market, the impact of the overnight story has been largely muted. In fact, the biggest mover today has been Norwegian krone, which has rallied 0.75% after its inflation data surprised on the high side (CPI +1.8% Y/Y in January) which has helped convince traders that Norway may be inclined to tighten policy going forward. While I don’t see that outcome, it likely takes any rate cuts off the table for the immediate future. But elsewhere in the G10, the pound’s modest 0.3% rally is the next largest move, and that has all the earmarks of a simple trading rebound after a 2.5% decline last week. Otherwise, this space has been dull, and looks set to remain so. In the EMG bloc, the picture is mixed as well, with CLP weakening furthest, -0.55% on the open, as traders bet on policy ease by the central bank, while we have seen a series of currencies, notably CNY, rally a modest 0.3%, as fears abate over a worsening outcome from the virus.

This week’s upcoming highlight is likely to be Fed Chair Powell’s testimony to the House and Senate, but we do see both CPI and Retail Sales data late in the week as well.

Tuesday NFIB Small Biz Optimism 103.3
JOLTS Job Openings 6.85M
Powell House Testimony
Wednesday Powell Senate Testimony
Thursday CPI 0.2% (2.4% Y/Y)
-ex food & energy 0.2% (2.2% Y/Y)
Initial Claims 211K
Friday Retail Sales 0.3%
-ex autos 0.3%
IP -0.2%
Capacity Utilization 76.8%
Michigan Sentiment 99.3

Source: Bloomberg

Aside from Powell’s two days in the spotlight, there will be eight other Fed speakers as well, with my guess being that all the interest will be regarding the impact of the virus. So far, there is no indication that the Fed is ready to react, but it also seems abundantly clear that they will not hesitate to cut rates again in the event that things rapidly deteriorate on that front. Ultimately, the dollar remains extremely well bid as the bid for Treasuries continues to drive flows, but nothing has changed my medium term view that the dollar will eventually weaken on the back of Not QE4.

Good luck
Adf

Coming Up Short

All week what the market has said
Is fears in re China are dead
But last night it seems
The latest of memes
Showed fear is still somewhat widespread

This morning the payroll report
If strong, ought, the dollar, support
The US this week
Has been on a streak
While Europe keeps coming up short

After a week where early fears about the spread of the coronavirus morphed into a belief that any issues would be contained and have only a short term impact on the global economy, it seems that some investors and traders are having second thoughts. For the first time since last Friday, equity markets around the world have fallen, albeit not very far, and risk is starting to be unloaded. Certainly, this could well be short-term profit taking. After all, since Friday’s close on the S&P 500, the index was higher by nearly 4% as of last night, and pretty much in a straight line. The remarkable thing about the equity rally, which was truly global in nature, was that it very studiously ignored the ongoing growth of the epidemic and its economic impacts.

Last night, however, it seems the announcements by Toyota and Honda that they would extend their mainland Chinese factory shutdowns by another week, as well as the force majeure declarations by Chinese energy and copper companies have served to highlight just how severely economic activity in China is slowing. Alas, the human impact continues its steady climb higher, with more than 600 deaths now attributed to the virus and more than 31,000 cases confirmed. It certainly appears as the situation has not yet reached anything near a peak, which implies that more market impacts are still to come.

One of the things we are beginning to see is a more significant reduction in expectations for Chinese economic activity this year. Last night, several more analysts reduced their expectations for Q1 GDP growth there by more than 2%. Given the fact that China has quarantined some 90 million people at this point, which is a remarkable 6.5% of the population, I expect that before all is said and done, Q1 GDP growth in China is going to be much lower, probably on the order of 2% annualized. In fact, I would not be surprised if the Chinese don’t release a Q1 number at all. There is precedent for this as just last night, the customs administration there announced that there would be no January trade data release, and that the numbers would be merged with February’s data to smooth out the impact of the Lunar New Year. Assuming the virus situation is under control by the end of Q1, it would be well within the Chinese prerogative to do the same with that data, hopefully masking just how bad things were.

In the end, there was nothing positive to be learned from Asia last night, which was confirmed by weakness in both equity markets throughout the region as well as the FX markets, where every currency in the APAC group fell. And all of this movement is directly attributable to the virus story.

Moving westward to Europe, things are looking no better there this morning, with equity markets lower across the board and their currencies also under pressure. NOK is the worst performer, down 0.6% as fears over further weakness in the oil market are weighing on the currency. But, the euro is feeling more heat today as well; down 0.25% after IP data from everywhere in the Eurozone was markedly disappointing. Germany (-3.5%), France (-2.8%), Spain (-1.4%) and the Netherlands (-1.7%) demonstrated that a risk of a recession remains quite real on the continent. In fact, you may recall how Germany barely dodged that recession status in Q4, when GDP rose 0.1% in a bit of a surprise. Well, right now, Q1 looks like it is going to be negative again. It seems to me that if a country has three negative GDP prints in six quarters, with the other three quarters printing around +0.1%, that could easily be defined as a recession. But regardless of how it is described in print, the reality is that Germany has not come out of its funk yet, and it may be dragging the rest of Europe down with it.

But there is something else ongoing in the euro which is likely to have been a significant part of the currency’s recent weakness. Recall that LVMH has agreed to buy Tiffany’s for ~$16.5 billion. Well, LVMH issued both EUR (7.5 billion) and GBP (1.5 billion) bonds this week to pay for the purchase, which means that there was a massive conversion in both currencies that is a one-way flow. And as large as these markets are, a significant dollar purchase like that is going to have a major impact. As I wrote earlier this week, the euro is leaning heavily on support at 1.0950, and if it manages to break through, there is nothing technically in the way until 1.0850. If you are a payables hedger, this could be an excellent opportunity.

Turning to the US, this morning is payrolls day. After Wednesday’s blowout 291K number for ADP Employment, expectations are running high that things are going to be quite good. The current median forecasts are as follows:

Nonfarm Payrolls 165K
Private Payrolls 155K
Manufacturing Payrolls -2K
Unemployment Rate 3.5%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.3
Participation Rate 63.2%

Source: Bloomberg

A quick look at the revisions in NFP estimates since the ADP number shows that the average is now 180K. As I said, expectations are running high. And given the strength of US data we have seen all week, if we do get a strong number, I expect to see the dollar break higher, likely taking out technical resistance in a number of currencies.

To recap, we have a risk-off session leading up to a key economic indicator. It will be interesting to see if strong US data can offset the growing fear of further negative news from china, but ironically, I think that the dollar is likely to be in demand regardless of the outcome. A weak number implies a potential negative impact from the virus, and risk-off which helps the dollar. A strong number means that the US remains above the fray, and that US investments are poised to continue to lead the world, thus drawing in more dollar buyers. Either way, the dollar seems primed to rally further today.

Good luck and good weekend
Adf

Another Cut’s Quite Apropos

The Chair said, ‘inflation’s too low
And there’s something you all need to know
Lest prices soon rise
We’ll not compromise
Thus another cut’s quite apropos

There are a number of discussion topics in the market this morning so let’s get right to it.

First the Fed surprised exactly nobody yesterday afternoon by leaving policy unchanged, (except for a ‘technical’ adjustment to IOER, which they raised by the expected 5bps). However, the talk this morning is all about the tone of the statement and the ensuing press conference. In the end, it appears that the Fed is leaning slightly more dovish than they had seemed to be previously, with a still greater focus on inflation. Powell and friends appear to be increasingly concerned that inflation expectations are still declining, and are terrified of an ultimate outcome similar to the past two decades in Japan. As such, it appears they are getting set to move from an inflation target to a price level target. This means that if inflation runs below target for a period of time, as it has been doing ever since it was officially announced in 2012, they will be comfortable allowing it to run above target in order to make up ground. The conclusion is that the bar to raising rates is now impossibly high, at least assuming prices don’t follow the lead of Argentina or Venezuela. And if anything, especially with the impact of the coronavirus still just being discussed and modeled, the likelihood is for more rate cuts before the end of the year.

Speaking of the coronavirus, the WHO has suddenly figured out what the rest of the world has known for a week, this is a serious problem that is spreading quickly. The death toll is over 170 and the number of cases is quickly approaching 8000. The economic impact is growing as more and more companies halt activity in China, more flights are canceled to and from all cities in China, and fear spreads further. Last night, Taiwan’s stock market reopened for the first time in a week and fell 5.75%. Meanwhile the Taiwan dollar fell 1.0%. And the renminbi? Well onshore markets are still closed, and will be so through Monday, at least, but the CNH traded below 7.00 (dollar higher) in London early this morning and remains within basis points of that level as NY walks in. As I wrote on Monday, this will be the best indicator of sentiment as it is the only thing that can actively trade that reflects opinions on the mainland. It should be no surprise that the other Asian equity markets that were open also fell sharply (Nikkei -1.7%, Hang Seng -3.1%, KOSPI -1.7%) as investors just don’t know what to do at this stage. Fear remains the key driver, and will continue to be until there is some sense that the infection rate is slowing down. To date, that has not been the case.

And finally, the Old Lady just announced no change in the base rate, which according to the futures market had been a 50:50 chance. The pound’s response was an immediate pop and it is now higher by 0.4% on the day, making it the best performing G10 currency. Data early in the month prompted a number of dovish comments from three BOE members, including Governor Carney himself, but the data we have seen recently has shown much more positive momentum in the wake of PM Johnson’s December electoral victory. Clearly, a number of fears have receded and tomorrow is the big day, when the UK officially leaves the EU. The EU Parliament voted overwhelmingly to approve the deal, as the UK’s Parliament did last week. So the UK has reclaimed its total sovereignty and now must make its own way in the world. As I have said all along, while there is a risk that no trade deal is agreed by year end, I think the odds are vanishingly small that Boris will risk his current political strength by pushing things to that level. Come summer, a short delay will be agreed and eventually a deal will be signed. Meanwhile, the US will be seeking a deal as well. Overall, I like the pound throughout the year on the twin features of an increasingly weaker USD (QE related) and the positivity of the situation on the ground there.

And those are the three big stories of the morning. We did get some data, notably the German employment report which showed the Unemployment Rate remained unchanged at 5.0%, while the number of people unemployed fell by…2k. This was better than the expected 5k increase in unemployment, but can we step back for a moment and consider what this actually means. Do you know how many people are employed in Germany? I didn’t think so. But the answer is 41.73 million. So, this morning’s data, showing a net change of 7k vs. expectations represents exactly a 0.0167% improvement. In other words, IT DOESN’T MATTER. And I think we need to consider this issue on a regular basis. So much is made of a number being better or worse than expected when most of the time it is well within the margin of error of any estimate. Nonetheless, the euro has edged higher this morning, by just 0.15%, but my goodness it has been stable of late. And quite frankly, in the short term, barring a massive uptick in coronavirus cases which changes broad risk sentiment, I see no reason for it to do much. Ultimately, I still like the single currency to edge higher throughout the year on the back of my weaker dollar call.

This morning brings two more data points in the US, with Initial Claims (exp 215K) and Q4 GDP (2.0%) released at 8:30. However, unless the GDP number is significantly different from expectations, the market focus will remain on the coronavirus issue. Equity markets in Europe are under pressure (DAX -1.1%, CAC -1.4%) and US futures are pointing in the same direction, with all 3 indices leaning about 0.75% lower. Meanwhile, Treasury yields continue to fall with the 10-year now at 1.56%, its lowest level in three months. With no Fed speakers on the docket, today is a risk day, and that arrow is pointing lower. Look for EMG currencies to suffer, while the yen benefits.

Good luck
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Truly a Curse

In China, it’s gotten much worse
This virus that’s truly a curse
How fast will it spread?
And how many dead?
Ere treatment helps it to disperse.

Despite the fact that we have two important central bank meetings this week, the Fed and the BOE, the market is focused on one thing only, 2019-nCoV, aka the coronavirus. The weekend saw the number of confirmed infections rise to more than 2800, with 81 deaths as of this moment. In the US, there are 5 confirmed cases, but the key concern is the news that prior to the city of Wuhan (the epicenter of the outbreak) #fom locked down, more than 5 million people left town at the beginning of the Lunar New Year holiday. While I am not an epidemiologist, I feel confident in saying that this will seem worse before things finally settle down.

And it’s important to remember that the reason the markets are responding has nothing to do with the human tragedy, per se, but rather that the economic impact has the potential to be quite significant. At this point, risk is decidedly off with every haven asset well bid (JPY +0.35%, 10-year Treasury yields -7bps, gold +0.8%) while risk assets have been quickly repriced lower (Nikkei -2.0%, DAX -2.0%, CAC -2.1%, FTSE 100 -2.1%, DJIA futures -1.4%, SPX futures -1.4%, WTI -3.0%).

Economists and analysts are feverishly trying to model the size of the impact to economic activity. However, that is a Sisyphean task at this point given the combination of the recency of the onset of the disease as well as the timing, at the very beginning of the Lunar New year, one of the most active commercial times in China. The Chinese government has extended the holiday to February 2nd (it had been slated to end on January 30th), and they are advising businesses in China not to reopen until February 9th. And remember, China was struggling to overcome a serious slowdown before all this happened.

It should be no surprise that one of the worst performing currencies this morning is the off-shore renminbi, which has fallen 0.8% as of 7:00am. In fact, I think this will be a key indicator of what is happening in China as it is the closest thing to a real time barometer of sentiment there given the fact that the rest of the Chinese financial system is closed. CNH is typically a very low volatility currency, so a movement of this magnitude is quite significant. In fact, if it continues to fall sharply, I would not be surprised if the PBOC decided to intervene in order to prevent what it is likely to believe is a short-term problem. There has been no sign yet, but we will watch carefully.

And in truth, this is today’s story, the potential ramifications to the global economy of the spreading infection. With that in mind, though, we should not forget some other featured news. The weekend brought a modestly surprising outcome from Italian regional elections, where Matteo Salvini, the populist leader of the League, could not overcome the history of center-left strength in Emilia-Romagna and so the current coalition government got a reprieve from potential collapse. Salvini leads in the national polls there, and the belief was if his party could win the weekend, it would force the governing coalition to collapse and new elections to be held ushering in Salvini as the new PM. However, that was not to be. The market response has been for Italian BTP’s (their government bonds) to rally sharply, with 10-year yields tumbling 18bps. This has not been enough to offset the risk-off mentality in equity markets there, but still a ray of hope.

We also saw German IFO data significantly underperform expectations (Business Climate 95.9, Expectations 92.9) with both readings lower than the December data. This is merely a reminder that things in Germany, while perhaps not accelerating lower, are certainly not accelerating higher. The euro, however, is unchanged on the day, as market participants are having a difficult time determining which currency they want to hold as a haven, the dollar or the euro. Elsewhere in the G10, it should be no surprise that AUD and NZD are the laggards (-0.85% and -0.65% respectively) as both are reliant on the Chinese economy for economic activity. Remember, China is the largest export destination for both nations, as well as the source of a significant amount of inbound tourism. But the dollar remains strong throughout the space.

Emerging markets are showing similar activity with weakness throughout the space led by the South African rand (-1.0%) on the back of concerns over the disposition of state-owned Eskom Holdings, the troubled utility, as well as the general macroeconomic concerns over the coronavirus outbreak and its ultimate impact on the South African economy. Meanwhile, the sharp decline in the price of oil has weighed on the Russian ruble, -0.9%.

As I mentioned above, we do have two key central bank meetings this week, as well as a significant amount of data as follows:

Today New Home Sales 730K
  Dallas Fed Manufacturing -1.8
Tuesday Durable Goods 0.5%
  -ex Transport 0.3%
  Case Shiller Home Prices 2.40%
  Consumer Confidence 128.0
Wednesday Advance Goods Trade Balance -$65.0B
  FOMC Rate Decision 1.75% (unchanged)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 215K
  GDP (Q4) 2.1%
Friday Personal Income 0.3%
  Personal Spending 0.3%
  Core PCE Deflator 1.6%
  Chicago PMI 49.0
  Michigan Sentiment 99.1

Source: Bloomberg
Regarding the BOE meeting, the futures market is back to pricing in a 60% probability of a rate cut, up from 47% on Friday, which seems to be based on the idea that the coronavirus is going to have a significant enough impact to require further monetary easing by central banks. As to the Fed, there is far more discussion about what they may be able to do in the future as they continue to review their policies, rather than what they will do on Wednesday. Looking at the spread of data this week, we should get a pretty good idea as to whether the pace of economic activity in the US has changed, although forecasts continue to be for 2.0%-2.5% GDP growth this year.

And that’s really it for the day. Until further notice, the growing epidemic in China remains the number one story for all players, and risk assets are likely to remain under pressure until there is some clarity as to when it may stop spreading.

Good luck
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