Further To Go

The contrast could not be more clear
Twixt Powell and Christine this year
The Fed jumped in first
But now they’ve disbursed
As much aid as like to appear

Meanwhile Ms Lagarde in Berlin
Was clearly quite slow to begin
But Europe depends
On banks to extend
Its aid, so can still underpin

More growth by increasing the flow
Of cash, through TLTRO
Thus, traders now see
The buck vis-à-vis
The euro, has further to go

It was less than two months ago when the most prominent theme in the market was the imminent demise of the dollar, not merely in the short-term, but in the long run.  The idea that was being circulated was that because of the US’s excessive and growing twin deficits (Budget and Current Account), investors would soon decide that holding dollar’s would be too risky and thus demand a different unit of account and store of value.  During this period, we did see the dollar sell off, with the greenback falling nearly 6.5% vs. the euro during the month of July.  But that was basically that.  It was a great story, and probably a good trade for some early movers, but explaining short term market volatility by referring to ultra-long-term financial theory was always destined to fail.  And fail it has.  After all, since then, the dollar has actually appreciated (+2.2% vs. the euro) and yet, if anything, the US has seen its budget and current account deficits widen further.

Rather, short-term dollar movement tends to be driven by things like relative monetary policy and relative macroeconomic performance.  Looking back at that time, the prevailing sentiment was that the Fed, despite having already implemented an unfathomable amount of monetary ease already, was preparing to do even more.  Recall, leading up to, and through, the Jackson Hole symposium, market participants were sure that the Fed was going to not merely allow inflation to run hot, but help it do so.  Meanwhile, the ECB, in its typical plodding manner, was very quiet and the punditry saw little in the way of additional ease on the horizon.  In fact, there were complaints that the ECB was not doing nearly enough.

However, as seems to happen quite frequently, the punditry turns out to have gotten things backwards.  Last week, the Fed announced their new policy goals, counting on average inflation targeting to help them achieve significantly lower unemployment, although they still couldn’t didn’t explain how they were going to achieve said higher inflation.  And then earlier this week, Chairman Powell, in as much, admitted that the Fed has done all they can and that it was up to Congress to expand fiscal stimulus in order to give the economy the support it needed to cope with the Covid inspired recession.  In other words, the Fed is out of bullets.

One of the problems the Fed has is that transmission of monetary policy is effected by banks, that is the way the system is designed.  But the bulk of the Fed programs have only supported markets, by them buying Treasuries, Mortgage-backed securities, Corporates (IG and Junk) and Munis.  But for small companies who don’t access the capital markets directly, virtually none of the Fed’s activities have had an impact as the bank’s are reluctant to lend in this environment of economic uncertainty.  Europe, on the other hand, relies on banks for the majority of capital flow to its economy, as European corporate debt markets remain much smaller and more fragmented across countries.  So, when the ECB created the TLTRO, targeted lending facility, where they PAY banks 1.00% to lend money to companies, who also pay the banks interest, it turns out to be a more efficient way to prosecute monetary policy ease.  And this morning, the latest tranche of this program saw an additional €174.5 billion taken up.  This is on top of the €1.3 trillion that was taken up last time there was a tender, three months ago.

The point is, suddenly investors and traders are figuring out that the ECB has the ability to promulgate policy ease more effectively than the Fed, and just as importantly, are doing so.  Add it all up and you have ECB policy looking easier than Fed policy at the margin, a clear recipe for the euro’s decline.  This move in the euro is just beginning, and it would not be surprising to see the single currency head back toward 1.12 before the end of the year.  As I have written in the past, there was no way the ECB would sit back and allow the dollar to fall unhindered.  They simply cannot afford that outcome to occur.

Which brings us to today’s session, where risk is being jettisoned across equity markets globally, although several European markets are starting to turn things around.  Overnight, following a very weak US session, Asia was red across the board led by the Hang Seng (-1.8%), but with weakness in Shanghai (-1.7%) and the Nikkei (-1.1%). Europe, however, while starting lower in every market has now seen a little positivity as the DAX (+0.15%) and Italy’s FTSE MIB (+0.7%) are offsetting increasingly modest weakness in the CAC (-0.1%) and FTSE 100 (-0.4%).  Finally, US futures, which had also been lower by more than 0.5% earlier in the session, have rebounded to flat.

The bond market, however, remains enigmatic lately, with yields continuing to trade in extremely tight ranges regardless of the movement in risk assets.  At this time, Treasury yields are unchanged, after remaining essentially unchanged during yesterday’s US equity sell-off.  Bunds have seen yields edge lower by 1.5 basis points, while Gilt yields have edged higher by less than a basis point.  It seems that the bond markets, globally, are unwilling to follow every twist and turn of the recent stock market manias.

As to the dollar, it is firmer vs. most of its counterparts, but just like we are seeing in European equities, we are beginning to see a bit of a rebound in some currencies as well.  In the G10, the biggest story is NOK (-0.65%) where the Norgesbank disappointed one and all by seeming to be more dovish than anticipated.  Many had come to believe they would be putting a timeline on raising interest rates, but they did no such thing, thus the krone has continued its recent poor performance (-5.8% vs. the dollar in the past month).  But we are seeing weakness elsewhere with SEK (-0.8%) actually the worst performer, albeit absent any specific news, and both NZD (-0.5%) and AUD (-0.3%) suffering at this point.

In the EMG bloc, overnight saw weakness across the Asian currencies led by KRW (-0.7%) and THB, IDR and TWD (all -0.5%) as risk was shed across the board.  But with the recent turn in events, early losses by ZAR (+0.7%) and MXN (+0.3%) have turned to gains.  It is those two currencies, however, which remain the most volatile around, so be careful if hedging there.

On the data front, yesterday’s US PMI data was right on expectations and showed continued progress in the economy, a sharp contrast to the European situation.  This morning saw modestly weaker than expected German IFO data (Expectations 97.7), which is not helping the euro.  Later today we see Initial Claims (exp 840K), Continuing Claims (12.275M) and finally New Home Sales (890K) at 10:00.  Once again, the tapes will be painted with Fedspeak, led by Powell at 10:00 in front of the Senate Banking Committee, but also hearing from six more FOMC members. While I would not be surprised if Powell tried to walk back his comments about the Fed being done, it’s not clear he will be able to do so.

For now, the dollar’s trend remains pretty solid, and I expect that it will continue to grind higher until we get a substantive change in policies.

Good luck and stay safe
Adf

Absent Demand

With Autumn’s arrival at hand
The virus has taken a stand
It won’t be defeated
Nor barely depleted
Thus, markets are absent demand

Risk is definitely on the back foot this morning as concerns grow over the increase in Covid-19 cases around the world.  Adding to the downward pressure on risk assets is the news that a number of major global banks are under increased scrutiny for their inability (unwillingness?) to stop aiding and abetting money laundering.  And, of course, in the background is the growing sense that monetary authorities around the world, notably the Fed, have run out of ammunition in their ongoing efforts to support economic growth in the wake of the government imposed shutdowns.  All in all, things look pretty dire this morning.

Starting with the virus, you may recall that one of the fears voiced early on was that, like the flu, it would fade somewhat in the summer and then reassert itself as the weather cooled.  Well, it appears that was a pretty accurate analysis as we have definitely seen the number of new cases rising in numerous countries around the world.  Europe finds itself in particularly difficult straits as the early self-congratulatory talk about how well they handled things vis-à-vis the US seems to be coming undone.  India has taken the lead with respect to the growth in cases, with more than 130,000 reported in the past two days.  The big concern is that government’s around the world are going to reimpose new lockdowns to try to stifle growth in the number of cases, but we all know how severely that can impact the economy.  So, the question with which the markets are grappling is, will the potential long-term benefit of a lockdown, which may reduce the overall caseload outweigh the short-term distress to the economy, profits and solvency?

At least for today, investors and traders are coming down on the side that the lockdowns are more destructive than the disease and so we have seen equity markets around the world come under pressure, with Europe really feeling the pain.  Last night saw the Hang Seng (-2.1%) and Shanghai (-0.6%) sell off pretty steadily.  (The Nikkei was closed for Autumnal Equinox Day.)  But the situation in Europe has been far more severe with the DAX (-3.2%), CAC (-3.1%) and FTSE 100 (-3.5%) all under severe pressure.  All three of those nations are stressing from an increase in Covid cases, but this is where we are seeing a second catalyst, the story about major banks and their money laundering habits.  A new report has been released that describes movement of more than $2 trillion in illicit funds by major (many European) banks, even after sanctions and fines have been imposed.  It can be no surprise that bank stocks throughout Europe are lower, nor that pre-market activity in the US is pointing in the same direction.  As such, US future markets showing declines of 1.5%-2.0% are right in line with reasonable expectations.

And finally, we cannot ignore Chairman Powell and the Fed.  The Chairman will be speaking before Congress three times this week, on both the need for more fiscal stimulus as well as the impact of Covid on the economy.  Now we already know that the Fed has implemented “powerful” new tools to help support the US, after all, Powell told us that about ten times last week in his press conference.  Unfortunately, the market is a bit less confident in the power of those tools.  At the same time, it seems the ECB has launched a review of its PEPP program, to try to determine if it has been effective and how much longer it should continue.  One other question they will address is whether the original QE program, APP, should be modified to be more like PEPP.  It is not hard to guess what the answers will be; PEPP has been a huge success, it should be expanded and extended because of its success, and more consideration will be given to changing APP to be like PEPP (no capital key).  After all, the ECB cannot sit by idly and watch the Fed ease policy more aggressively and allow the euro to appreciate in value, that would be truly catastrophic to their stated goal of raising the cost of living inflation on the Continent.

With all that in mind, a look at FX markets highlights that the traditional risk-off movement is the order of the day.  In other words, the dollar is broadly stronger vs. just about everything except the yen.  For instance, in the G10 space, NOK (-1.45%) is falling sharply as the combination of risk aversion and a sharply lower oil price (WTI -2.5%) has taken the wind out of the krone’s sails.  But the weakness here is across the board as SEK (-0.8%) and the big two, GBP (-0.5%) and EUR (-0.45%) are all under pressure.  It’s funny, it wasn’t that long ago when the entire world was convinced that the dollar was about to collapse.  Perhaps that attitude was a bit premature.  In fact, the euro bulls need to hope that 1.1765 (50-day moving average) holds because if the technicians jump in, we could see the single currency fall a lot more.

As to the emerging markets, the story is the same, the dollar is broadly higher with recent large gainers; ZAR (-2.0%) and MXN (-1.4%), leading the way lower.  But the weakness is broad-based as the CE4 are all under pressure (CZK -1.3%, HUF -1.1%, PLN -0.95%) and even CNY (-0.2%) which has been rallying steadily since its nadir at the end of May, has suffered.  In fact, the only positive was KRW (+0.2%) which benefitted from data showing that exports finally grew, rising above 0.0% for the first time since before Covid.

As to the data this week, it is quite light with just the following to watch:

Tuesday Existing Home Sales 6.01M
Wednesday PMI Manufacturing (Prelim) 53.3
Thursday Initial Claims 840K
Continuing Claims 12.45M
New Home Sales 890K
Friday Durable Goods 1.1%
-ex Transport 1.0%

Source: Bloomberg

The market will be far more interested in Powell’s statements, as well as his answers in the Q&A from both the House and Senate.  The thing is, we already know what he is going to say.  The Fed has plenty of ammunition, but with interest rates already at zero, monetary policy needs help from fiscal policy.  In addition to Powell, nine other Fed members speak a total of twelve times this week.  But with Powell as the headliner, it is unlikely they will have an impact.

The risk meme is today’s story.  If US equity markets play out as the futures indicate, and follow Europe lower, there is no reason to expect the dollar to do anything but continue to rally.  After all, while short dollar positions are not at record highs, they are within spitting distance of being so, which means there is plenty of ammunition for a dollar rally as shorts get covered.

Good luck and stay safe
Adf

Riddle Me This

On Monday, the dollar went higher
Though stocks, people still did acquire
So riddle me this
Is something amiss?
Or did links twixt markets expire?

The risk-on/risk-off framework has been critical in helping market participants understand, and anticipate, market movements.  The idea stems from the fact that market psychology can be gleaned from the herd behavior of investors.  As a recap, observation has shown that a risk-off market is one where haven assets rally while those perceived as riskier decline.  This means that Treasury bonds, Japanese yen, Swiss francs, US dollars and oftentimes gold are seen as stable stores of value and see significant demand during periods of fear.  Similarly, equities, credit and most commodities are seen as much riskier, with less staying power and tend to suffer during those times.  Correspondingly, a risk-on framework is typified by the exact opposite market movements, as investors are unconcerned over potential problems and greed drives their activities.

What made this framework so useful was that for those who interacted with the market only periodically, for example corporate hedgers, they could take a measure of the market tone and get a sense of when the best time might be to execute their needed activities.  (It also helped pundits because a quick look at the screens would help explain the bulk of the movement across all markets.)  And, in truth, we have been living in a risk-on/risk-off world since the Asia crisis and Long Term Capital bankruptcy in 1998.  That was also the true genesis of the Powell (nee Greenspan) Put where the Fed was quick to respond to any downward movement in equity markets (risk coming off) by easing monetary policy.  Not surprisingly, once the market forced the Fed’s hand into easing policy, it would revert to snapping up as much risk as possible.

Of course, what we have seen over the past two plus decades is that the size of each downdraft has grown, and in turn, given the law of diminishing returns, the size of the monetary response has grown even more, perhaps exponentially.

Overall, market participants have become quite comfortable with this operating framework as it made decision-making easier and created profit opportunities for the nimblest players.  After all, in either framework, a movement in a stock index was almost assured to see a specific movement in both bonds and the dollar.  Given that stocks are typically seen as the most visible risk signal, causality almost always moved in that direction.

But lately, this broad framework is being called into question.  Yesterday was a perfect example, where stock markets performed admirably, rising between 0.75% and 2.5% throughout the G10 economies and at the same time, the dollar rose along with bond yields.  Now I grant you that neither increase was hugely significant, and in fact it faded somewhat toward the end of the session, but nonetheless, the correlations had the wrong sign.  And yesterday was not the first time we have seen that price action, it has been happening more frequently over the past several months.

So, the question is, has something fundamental changed?  Or is this merely a quirk of recent markets?  Looking at the nature of the assets in question, I think it is safe to say that both equities and credit remain risk assets which are solidly representative of investors’ overall risk appetite.  In fact, I challenge anyone to make the case in any other way.  If this is the case, then it points to a change in the nature of the haven assets.

Regarding bonds, specifically Treasuries, there is a growing dispersion of views as to their ultimate use as a safe haven.  I don’t believe anyone is actually concerned with being repaid, the Fed will print the dollars necessary to do so, but rather with the safety of holding an asset with almost no return (10-year yields at 0.54%, real yields at -1.0%), that correspondingly has massive convexity.  This means that in the event bonds start to sell off, every basis point higher results in a much more significant capital depreciation, exactly the opposite of what one would be seeking in a haven asset.  Quite frankly, I don’t think this issue gets enough press, but it is also not the purview of this commentary.

Which takes us to the dollar, and the yen and Swiss franc.  Here the narrative continues to evolve toward the idea that given the extraordinary amount of monetary and fiscal ease promulgated by the US, the dollar’s value as a haven asset ought to diminish.  Ironically, I believe that the narrative argument is exactly backwards.  In fact, the creation of all those dollars (which by the way has been in response to extraordinary foreign demand) makes the dollar that much more critical in times of stress and should reinforce the idea of the dollar as a safe haven.  The one thing of which you can be certain is that the dollar will be there and allow the holder to acquire other things.  And after all, isn’t that what a haven is supposed to do?  A haven asset is one which will maintain its value during times of stress.  This encompasses its value as a medium of exchange, as well as a store of value.  Dollars, at this point, will always be accepted for payment of debt, and that is real value.  In the end, I expect that recent market activity is anomalous and that we are going to see a return to the basic risk-on/risk-off framework by the Autumn.

Today, however, continues to show market ambivalence.  Other than Asian equity markets, which were generally strong on the back of yesterday’s US performance, the picture today is mixed.  European bourses show no pattern (DAX -0.4%, CAC +0.1%), US futures are ever so slightly softer and bond markets are very modestly firmer (yields lower) with 10-year Treasuries down 1.5bps.

However, along with these movements, the dollar and yen are generally a bit softer. Or perhaps a better description is that the dollar is mixed.  We have seen dollar strength vs. some EMG currencies (ZAR -1.35%, RUB -0.9%, MXN -0.5%) all of which are feeling the strains of declining commodity prices (WTI and Brent both -1.5%).  But several Asian currencies along with the CE4 have all continued to perform well this morning, notably THB (+0.45%) as investor demand for baht bonds continues to grow.  In the G10 space, the picture is mixed as well, with the pound the worst performer (-0.3%) and the Swiss franc the best (+0.25%).  The thing is, given the modest amount of movement, it is difficult to spin much of a story in either case.  If we continue to see eqity market weakness today, I do expect the dollar will improved slightly as the session progresses.

As to data for the rest of the week, there is plenty with payrolls the piece de resistance on Friday:

Today Factory Orders 5.0%
Wednesday ADP Employment 1.2M
  Trade Balance -$50.2B
  ISM Services Index 55.0
Thursday Initial Claims 1.414M
  Continuing Claims 16.9M
Friday Nonfarm Payrolls 1.5M
  Private Payrolls 1.35M
  Manufacturing Payrolls 280K
  Unemployment Rate 10.5%
  Average Hourly Earnings -0.5% (4.2% Y/Y)
  Average Weekly Hours 34.4
  Participation Rate 61.8%
  Consumer Credit $10.0B

Source: Bloomberg

The thing is, while all eyes will be on the payroll report on Friday, I still believe Thursday’s Initial Claims number is more important as it gives a much timelier indication of the current economic situation.  If we continue to plateau at 1.4 million lost jobs a week, that is quite a negative sign for the economy.  Meanwhile, there are no Fed speakers today, although yesterday we heard a chorus of, ‘rates will be lower for longer and if inflation runs hot there are no concerns’.  Certainly, that type of discussion will undermine the dollar vs. some other currencies but does not presage a collapse (after all, the BOJ has been saying the same thing for more than two decades and the yen hasn’t collapsed!).  For the day, I expect that the market is getting just a bit nervous and we may see a modest decline in stocks and a modest rally in the dollar.

Finally, I am taking several days off so there will be no poetry until Monday, August 10.

Good luck, stay safe and have a good rest of the week

Adf

 

Deferred

In Europe, despite what you’ve heard
The rebound could well be deferred
The ECB told
The banks there to hold
More capital lest they’re interred

It seems that the ECB is still a bit concerned about the future of the Eurozone economy.  Perhaps it was the news that the Unemployment rate in Spain jumped up to 15.3%.  Or perhaps it was the news that cases of Covid are growing again in various hot spots across the Continent.  But whatever the reason, the ECB has just informed the Eurozone banking community that dividends are taboo, at least for the rest of 2020, and that they need to continue to bolster their capital ratios.  Now, granted, European banks have been having a difficult time for many years as the fallout from Negative interest rates has been accumulating each year.  So, not only have lending spreads shrunk, but given the Eurozone economy has been so slothful for so long, the opportunities for those banks to lend and earn even that spread have been reduced.  It should be no surprise that the banking community there is in difficult shape.

However, from the banks’ perspective, this is a major problem.  Their equity performance has been dismal, and cutting dividends is not about to help them.  So, the cost of raising more capital continues to rise while the potential profit in the business continues to fall.  This strikes me as a losing proposition, and one that is likely to lead to another wave of European bank mergers.  Do not be surprised if, in a few years, each major country in Europe has only two significant banks, and both are partly owned by the state.  Banking is no longer a private industry, but over the course of the past decade, since the GFC, has become a utility.  But unlike utilities that make a solid return on capital and are known for their steady dividend payouts, these are going to be owned and directed by the state, with any profits going back to the state.  I foresee the conservatorship model the US Treasury used for FNMA and FHLMC as the future of European banking.

The reason I bring this up is because amidst all the cooing about how the EU has finally changed the trajectory of Europe with their groundbreaking Pandemic relief package, and how this will establish the opportunity for the euro to become the world’s favored reserve currency, there are still many fundamental flaws in Europe, and specifically in the Eurozone, which will effectively prevent this from happening.  In fact, there was a recent study by Invesco Ltd, that showed central banks around the world expect to increase their reserve allocation to USD in the next year, not reduce those allocations.  This has been a key plank for the dollar bears, the idea that the world will no longer want dollars as a reserve asset.  Whatever one thinks about the US banking community and whether they serve a valuable purpose properly, the one truth is that they are basically the strongest banks in the world from a capital perspective.  And in the current environment, no country can be dominant without a strong banking sector.

In fact, this may be the strongest argument for the dollar to remain overpriced compared to all those econometric models that focus on the current account and trade flows.  A quick look at China’s banks shows they are likely all insolvent, with massive amounts of unreported, but uncollectable loans outstanding.  China has been the most active user of the extend and pretend model, rolling loans over to insolvent state companies in order to make it appear those loans will eventually be repaid.  Only US banks have the ability to write off significant amounts of their loan portfolio (remember, in Q2 the number was $38 billion) and remain viable and active institutions.  In fact, this is one of the main reasons the US economy has outperformed Europe for the past decade.  Covid or no, European banks will continue to drag the European economy down, mark my words.  And with that, the euro’s opportunity for significant gains will be limited.

But that is a much longer-term view.  Let us look at today’s markets now.  If pressed, I would describe them as ever so slightly risk-off, but the evidence is not that convincing.  Equity markets in around the world have been mixed, with few being able to follow the US markets continued strength.  For example, last night saw the Nikkei (-0.25%) slide along with Sydney (-0.4%) while both Shanghai and the Hang Seng rallied a solid 0.7%.  Europe, on the other hand has much more red than green, with the DAX (-0.35%) and CAC (-0.75%) leading the way, although Spain’s IBEX (+0.3%) seems to be rebounding from yesterday’s losses despite the employment data.  Meanwhile US futures, which were essentially unchanged all evening, have just turned modestly lower.

The bond market, though, is a little out of kilter with the stock market, as yields throughout Europe have moved higher despite the stock market performances there.  Meanwhile, Treasury yields are a half basis point lower than yesterday’s close, although yesterday saw the 10-year yield rise 4bps as risk fears diminished.  Gold and silver are consolidating this morning, with the former down 0.85% as I type, and the latter down 5.0%.  But in the overnight session, gold did trade to a new all-time high, at $1981/oz.  The rally in gold has been extremely impressive this year, and after touching new highs, there are now a few analysts who are growing concerned a correction is imminent.  From a trading perspective, that certainly makes sense, but in the end, the underlying story remains quite positive, and is likely to do so as long as central banks believe it is their duty to print as much money as they can as quickly as they can.

As to the dollar, it is broadly firmer this morning, although the movement has not been that impressive.  In the G10, kiwi is the biggest loser, down 0.5%, as talk of additional QE is heating up there.  But other than SEK (-0.4%), the rest of the block is just a bit softer, with CHF and JPY actually 0.1% firmer at this time.  Emerging market activity shows RUB (-0.8%) as the weakest of the lot, although we are also seeing softness in TRY and ZAR (-0.6% each) and MXN (-0.5%).  Softening oil and commodity prices are clearly not helping either the rand or peso, but as to TRY, it remains unclear what is driving it these days.

On the data front, yesterday saw Durable Goods print largely as expected, showing the initial bounce in the economy.  This morning brings Case Shiller Home Prices (exp 4.05%) and Consumer Confidence (95.0), neither of which seems likely to move the needle.  With the Fed on tap for tomorrow, despite the fact they are likely to leave well enough alone, there will be much ink spilled over the meeting.

In the end, the short-term trend remains for the dollar to soften further, today notwithstanding, but I don’t believe in the dollar collapse theory.  As such, receivables hedgers should really be looking for places to step in and add to your programs.

Good luck and stay safe

Adf

 

 

 

Hardly a Sign

The thing that I don’t understand
Is why people think it’s not planned
The dollar’s decline
Is hardly a sign
The FOMC’s lost command

Based on the breathless commentary over the weekend and this morning, one would have thought that the dollar is in freefall.  It’s not!  Yes, the dollar has been sliding for the past two months, but that is a blink of an eye compared to the fact that it has been trending higher since its nadir a bit more than twelve years ago.  In fact, if one uses the euro as a proxy, which many people do, at its current level, 1.1725 as I type, the single currency remains below the average rate over its entire life since January 1999.  The point is, the current situation is hardly unprecedented nor even significant historically, it is simply a time when the dollar is weakening.

It is, however, instructive to consider what is happening that has the punditry in such a tizzy.  Arguably, the key reason the dollar has been declining lately is because real US interest rates have been falling more rapidly than real rates elsewhere.  After all, the Eurozone has had negative nominal rates since 2014.  10-year German bunds went negative in May 2019 and have remained there ever since.  Given that inflation has been positive, albeit weak, there real rates have been negative for years so the world is quite familiar with negative rates in Europe.  The US story, however, is quite different.  While nominal rates have not yet crossed the rubicon, real rates have moved from positive to negative quite recently and done so rapidly.  So, what we are really witnessing is the FX market responding to this relative change in rates, at least for the most part.  Undoubtedly, there are dollar sellers who are bearish because of their concerns over the macro growth story in the US, the second wave of Covid infections in the South and West and because of the growth in US debt issuance.  But history has shown that the most enduring impacts on a currency’s value are driven by relative interest rates and their movement.  And that is what we are seeing, US rates are falling relative to others and so the dollar is falling alongside them.

In other words, the current price action is quite normal in the broad scheme of things, and not worthy of the delirium it seems to be inspiring.  As I mentioned Friday, this is also what is driving the precious metals complex, which has seen further strength this morning (XAU +$40 or 2.1%, XAG +$1.50 or 6.7%).  And it must be noted that gold is now at a new, all-time nominal high of $1943/oz.  But since we are focusing on the concept of real valuation, while the price is higher than we saw in 2011 on a nominal basis, when adjusted for inflation it still lags pretty substantially, by about 18%, and both current and 2011 levels are significantly below gold’s inflation adjusted price seen in 1980 right after the second oil crisis.

However, the fact that the current reporting of the situation appears somewhat overhyped does not mean that the dollar cannot fall further.  And in fact, I expect that to be the case for as long as the Fed continues to add liquidity, in any form, to the economy.  Markets move at the margin, and the current marginal change is the decline in US real interest rates, hence the dollar is likely to continue to fall if US rates do as well.

The current dollar weakness begs the question about overall risk attitude.  So, a quick look around equity markets globally today shows a mixed picture at best, certainly not a strong view in either direction.  For instance, last night saw the Nikkei edge lower by 0.2% (after having been closed since Wednesday) and the Hang Seng (-0.4%) also slide.  But Shanghai (+0.25%) managed to eke out small gains.  In Europe, the DAX (+0.3%) is pushing ahead after the IFO figures bounced back much further than expected, although the CAC and FTSE 100 (-0.2% each) have both suffered slightly.  A special mention needs to be made for Spain’s IBEX (-1.3%) as the sharp increase in Covid infections seen in Catalonia has resulted in several European nations, notably the UK and Sweden, reimposing a 14-day quarantine period on people returning from Spain on holiday.  Naturally, the result is holidays that had been booked are being quickly canceled.  As to US futures, they are currently in the green, with the NASDAQ up 1.0%, although the others are far less enthusiastic.

Bond markets continue to show declining yields, with Treasuries down another basis point plus and now yielding 0.57%.  Bunds, too, are seeing demand, with yields there down 3 bps, although both Spanish and Italian debt are being sold off with yields edging higher.  In other words, the bond market is not pointing to a risk-on session.

Finally, the dollar is weak across the board, against both G10 and EMG currencies.  In the latter bloc, ZAR is the leader, up 1.3% on the back of the huge rally in precious metals, but we are also seeing the CE4 currencies all keeping pace with the euro, which is higher by 0.6% this morning.  As a group, those four currencies are higher by about 0.65%.  Asian currencies also performed well, but not quite to the standards of the European set, but it is hard to find a currency that declined overnight.  In G10 space, the SEK is the leader, rising 1.0%, cementing its role as the highest beta G10 currency.  But we cannot forget about the yen, which has rallied 0.75% so far this morning, and is now back to its lowest level since the Covid spike, and before that, prices not seen since last August.  A longer-term look at the yen shows that 105 has generally been very strong support with only the extraordinary events of this past March driving it below that level for the first time in four years.  Keep on the lookout for a move toward those Covid inspired lows of 102, although much further seems hard to believe at this point.

On the data front, this week’s highlight is undoubtedly the FOMC meeting on Wednesday, but there is plenty to see.

Today Durable Goods 7.0%
  -ex Transport 3.6%
Tuesday Case Shiller Home Prices 4.10%
  Consumer Confidence 94.4
Wednesday FOMC Rate Decision 0.0% – 0.25%
Thursday GDP Q2 -35.0%
  Personal Consumption -34.5%
  Initial Claims 1.445M
  Continuing Claims 16.3M
Friday Personal Income -0.5%
  Personal Spending 5.4%
  Core PCE 0.2% (1.0% Y/Y)
  Chicago PMI 43.9
  Michigan Sentiment 72.8

Source: Bloomberg

Of course, the GDP data on Thursday will be eye opening, as a print anywhere near forecasts will be the largest quarterly decline in history.  However, that is backward looking.  Of more importance, after the Fed of course, will be the Initial Claims data, which last week stopped trending lower.  Another tick higher there and the V-shaped recovery narrative is likely to be mortally wounded.  As to the Fed, while we will discuss it at length later this week, it seems unlikely they will do or say anything that is going to change the current market sentiment.  And that sentiment continues to be to sell dollars.

Good luck and stay safe

Adf

 

 

 

About to Retrace

The question investors must face
Is what type of risk to embrace
Are we in a movie
Where things turn out groovy?
Or are stocks about to retrace?

The risk narrative is having a harder time these days as previous rules of engagement seem to have changed. For instance, historically, when risk was ‘off’, stock prices fell, government bond markets rallied, although credit spreads would widen, the dollar and the yen, and to an extent the Swiss franc, would all out perform the rest of the currency world and gold would outperform the rest of the commodity complex. Risk on would see the opposite movement in all these markets. Trading any product successfully mostly required one to understand the narrative and then respond mechanically. Those were the days!

Lately, the risk narrative has been in flux, as a combination of massive central bank interference across most markets and evolving views on the nature of the global geopolitical framework have called into question many of the previous market assumptions.

The adjustments have been greatest within the bond markets as global debt issuance has exploded higher ever since the GFC in 2009, taking an even sharper turn up in the wake of Covid-19. Of course, central banks have been so heavily involved in the market via QE purchases that it is no longer clear what the bond market is describing. Classical economics explained that countries that issued excessive debt ultimately saw their interest rates rise and their currencies devalue amidst an inflationary spike. However, it seems that theory must be discarded because the empirical evidence has shown that massive government debt issuance has resulted in low inflation and relative currency stability for most nations.

The MMT crowd will explain this is the natural response and should be expected because government spending is an unalloyed good that can be expanded indefinitely with nary a consequence. Meanwhile, the Austrians are hyperventilating over the idea that the ongoing expansion of both government spending and debt issuance will result in a debt deflation and anemic growth for as long as that debt remains a weight on the economy.

These days, the distortion in the bond markets has rendered them unrecognizable to investors with any longevity. Central banks are actively buying not only their own government debt, but corporate debt (IG and junk) and municipal debt. Thus, credit spreads have been compressed to record low levels despite the fact that the current economic situation is one of a cataclysmic collapse in activity. Bankruptcies are growing, but debt continues to be sought by investors worldwide. At some point, this final dichotomy will reconcile itself, but for now, central banks rule the roost.

Equity markets have taken a slightly different tack; when things are positive, buy the FANGMAT group of stocks before anything else, although other purchases are allowed. But when it is time to be concerned because the economic story is in question, simply buy FANGMAT and don’t touch any other stocks. If you remove those seven stocks from the indices, the result is that the S&P and NASDAQ have done virtually nothing since the crash in March, and US markets have actually underperformed their European brethren. Of course, those stocks are in the indices, so cannot be ignored, but the question that must be asked is, based on their current valuation of >$6.8 trillion, are they really worth more than the GDP of Germany and the UK combined? While yesterday saw a modest sell-off in the US, which has continued overnight (Hang Seng -2.2%, Shanghai -3.9%, DAX -1.5%, CAC -1.3%) the fact remains stock markets continue to price in a V-shaped recovery and nothing less. And since stock markets tend to drive the overall narrative, if that story changes, beware the movement elsewhere.

It should be noted that yesterday’s Initial Claims data, printing at 1.41M, the first rise in the data point since March, bodes ill for the idea that growth is going to quickly return to pre-Covid levels. And given the uncertainty over how long that recovery will take, stocks may soon be telling us a different story. Just stay alert.

While idioms tell us what’s bold
Is brass, we must all now behold
The barbarous relic
Whose rise seems angelic
Of course, I’m referring to gold!

Turning to precious metals as risk indicators, price action in both gold and silver indicates a great deal of underlying concern in the current market framework. Gold, as you cannot have missed, is fast approaching $1900/oz and its record high level of $1921 is in sight. Silver, while still well below its all-time highs of $49.80/oz, has rallied more than 24% in July, and is gaining more and more adherents. The key unknown is whether this is due to an impending fear of economic calamity, or simply the fact that real interest rates have turned negative throughout the G10 nations and so the cost of owning gold is de minimis.

For the conspiracy theorists, the concern is that ongoing central bank money printing is going to ultimately debase the value of all currencies, so while they may remain relatively stable in the FX markets, their value in purchasing real goods will greatly diminish. In other words, inflation, that the central banks so fervently desire, will reveal itself as a much greater threat than currently imagined by most. Here, too, the geopolitics comes into play, as there is growing concern that the current tit-for-tat squabbles between the US and China will escalate into a more dangerous situation, one where shots are fired in anger, at which times gold is seen as the ultimate safe haven. Personally, I do not believe the US-China situation deteriorates into a hot war as while both presidents need to show they are strong and tough against their rivals, thus the rhetoric and diplomatic squabbles, neither can afford a war.

And finally, to the FX market, where the dollar has clearly lost its luster as the ultimate safe haven, a title it held as recently as two month’s ago. While today’s movement is relatively benign across all currencies, what we have seen this month is a dollar declining against the entire G10 bloc and the bulk of the EMG bloc as well, with several currencies (CLP +7.0%, HUF +5.4%, SEK +5.2%) showing impressive gains. If we think back to the narrative heading into the July 4th holiday, it was focused on the upcoming payroll release and the recent FOMC meeting which had everyone buying into the risk-on narrative. That came from the fact that the payroll data was MUCH better than expected and the Fed made clear they were going to stand ready to continue to add liquidity to markets forever, if they deemed it necessary. Back then, the euro was trading just above 1.12, and its future path seemed uncertain to most. But now, here we are just three weeks later, and the euro has been rising steadily despite the fact that concerns continue to grow over the growth narrative.

Is the euro becoming the new haven currency of last resort? That seems a bit premature, although the EU’s recent agreement to issue mutual debt and inaugurate a more fulsome EU-wide fiscal policy will be an important part of that story in the future. But for now, it seems that there is an almost willful blindness on the part of the investor community as they pay lip service to worries about the recovery’s shape but continue to find succor in (previous) risk-on assets.

While the dollar today is mixed with limited movement in any currency, there is no doubt the FX narrative is evolving toward ‘the dollar has much further to fall between the political chaos and the still positive view of the economy’s future. But remember this, while the dollar has traded to its weakest point in about two years, it is far away from any level that could be considered weak. Current momentum is against the dollar, and if the euro were to trade to resistance between 1.17-1.18, it would not be surprising, but already the pace of its decline has been ebbing, so I do not expect a collapse of any sort, rather a further gradual decline seems the best bet for now.

Good luck, good weekend and stay safe
Adf

 

Quite Dramatic

The Chinese report ‘bout Q2
Showed growth has rebounded, it’s true
But things there remain
Subject to more pain
Til elsewhere bids Covid adieu

The market’s response was emphatic
With Shanghai’s decline quite dramatic
Thus, risk appetite
Today is quite slight
Which means bears are now just ecstatic

It is no surprise that the Chinese reported a rebound to positive GDP growth in Q2 as, after all, the nation was the epicenter of Covid-19 and they, both shut down and reopened their economy first. The numbers, however, were mixed at best, with the GDP number rebounding a more than expected 3.2% Y/Y, but their Retail Sales data failing to keep up, printing at -1.8% Y/Y, rather than the expected 0.5% gain. The lesson to be learned here is that while Chinese industry seems to be heading back to a pre-Covid pace, domestic consumption is not keeping up. This is a problem for China for two reasons; first, they have made an enormous effort to adjust the mix of their economy from entirely export oriented to a much greater proportion of consumption led growth. Thus, weak Retail Sales implies that those efforts are now likely to restrict the nation’s growth going forward. Secondly, the fact that the rest of the world is months behind China in this cycle, with many emerging markets still in the closing process, not nearly ready to reopen, implies that while industry in China may have retooled, their export markets are a long way from robust.

The other interesting thing that came out of China last night, that had a more direct impact on markets there, was yet another round of stories published about the evils of speculation and how Chinese financial institutions would be selling more stocks. You may recall last week, when the Chinese government had an article published singing the praises of a strong stock market, encouraging retail investors to drive a more than 6.0% gain in the Shanghai Composite. Just a few days later, they reversed course, decrying the evils of speculation with a corresponding sharp decline. Well, it seems that speculators are still evil, as last night’s message was unequivocally negative pushing Shanghai lower by 4.5% and finally removing all those initial speculative gains. It seems the PBOC and the government are both concerned about inflating bubbles as they well remember the pain of 2015, when they tried to deflate their last one.

But this activity set the tone for all Asian markets, with red numbers everywhere, albeit not quite to the extent seen on the mainland. For instance, the Nikkei slipped 0.75% and the Hang Seng, fell 2.0%.

Europe has its own set of issues this morning, although clearly the weakness in Asia has not helped their situation. Equity markets throughout the Continent are lower with the DAX (-0.5%) and CAC (-0.7%) representative of the losses everywhere. While traders there await the ECB meeting outcome, the focus seems to be on the UK announcement that they will be increasing their debt issuance by £110 billion in Q3 to help fund all the fiscal stimulus. This will take the debt/GDP ratio above 100%, ending any chance of retaining fiscal prudence.

It’s remarkable how things can change in a short period of time. During the Eurozone debt crisis, less than 10 years ago, when Greece was on the cusp of leaving the euro, they were constantly lambasted for having a debt/GDP ratio of 150% or more while Italy, who was puttering along at 125% was also regularly excoriated by the EU and the IMF. But these days, those entities are singing a different tune, where suddenly, government borrowing is seen as quite appropriate, regardless of the underlying fiscal concerns, with the supranational bodies calling for additional fiscal stimulus and the borrowing that goes along with it. At any rate, there is certainly no sign that the current mantra of issuing debt and spending massive amounts of money to support the economy is about to change. Fiscal prudence is now completely passé.

With that as a backdrop, it should be no surprise that risk is being pared back across all markets. Having already discussed equities, we can look at bond markets and see yields virtually everywhere lower today as investors seek out haven assets. Interestingly, despite the new issuance announced in the UK, Gilts lead the way with a 2.5bp decline, while Treasuries and Bunds have both seen yields decline a more modest 1bp. Oil prices have fallen again, which is weighing on both NOK (-0.65%) and RUB (-0.4%) the two currencies most closely linked to its price. But of course, lower oil prices are indicative of weaker overall sentiment.

As such, it is also no surprise that every one of the currencies in the G10 and major emerging markets is weaker vs. the dollar this morning. While the trendy view remains that the dollar is going to continue to decline, and that has been expressed with near record short dollar positions in futures markets, the greenback is not playing along today.

At this point, I think it is important to remind everyone that a key part of the weak dollar thesis is the ongoing expansion of the Fed’s balance sheet adding more liquidity to the system and thus easing dollar policy further. But for the past 5 weeks, the Fed’s balance sheet has actually shrunk by $250 billion, a not inconsiderable 3.5%, as repo transactions have matured and not been replaced. It appears that for now, the market is flush with cash. So, given the combination of major short dollar positions extant and short term fundamental monetary details pointing to dollar strength, do not be surprised if we see a short squeeze in the buck over the next week or two.

This morning brings the bulk of the week’s data, certainly its most important readings, and it all comes at 8:30. Retail Sales (exp 5.0%, 5.0% ex autos), Philly Fed (20.0), Initial Claims (1.25M) and Continuing Claims (17.5M) will hopefully give us a clearer picture of how the US economy is progressing. One of the problems with this data is that it is mostly backward looking (Philly Fed excepted) and so probably does not capture the apparent second wave of infections seen in Florida, Texas and California, three of the most populous states. So, even if we do see somewhat better than expected data, it could easily slip back next week/month. In fact, this is why the Claims data is so important, it is the timeliest of all the major economic releases, and given the ongoing uncertainty surrounding the current economic situation, it is likely the most helpful. So, while the trend in Initial Claims has been lower, it remains at extremely problematic levels and is indicative of many more businesses retrenching and letting staff go. It has certainly been my go-to data point for the pulse of the economy.

Recent data points have been better than forecast, but nobody doubts that things are still in dire shape. Unfortunately, it appears we are still a long way from recouping all the lost economic activity we have suffered over the past months. But FX remains a relative game, and arguably, so is everyone else.

Good luck and stay safe
Adf

Out of Hand

The Chinese are starting to learn
The things for which all people yearn
A chance to succeed
Their families to feed
As well, stocks to never, down, turn

But sometimes things get out of hand
Despite how they’re carefully planned
So last night we heard
Officialdom’s word
The rally is now to be banned!

It seems like it was only yesterday that the Chinese state-run media were exhorting the population to buy stocks in order to create economic growth.  New equity accounts were being opened in record numbers and the retail investors felt invincible.  Well… it was just this past Monday, so I guess that’s why it feels that way.  Of course, that’s what makes it so surprising that last night, the Chinese government directed its key pension funds to sell stocks in order to cool off the rally!  For anyone who still thought that equity market movement was the result of millions of individual buying and selling decisions helping to determine the value of a company’s business, I hope this disabuses you of that notion once and for all.  That is a quaint philosophy that certainly did exist back in antediluvian times, you know, before 1987.  But ever since then, government’s around the world have realized that a rising stock market is an important measuring stick of their success as a government.  This is true even in countries where elections are foregone conclusions, like Russia, or don’t exist, like China.  Human greed is universal, regardless of the political system ruling a country.

And so, we have observed increasing interference in equity markets by governments ever since Black Monday, October 19, 1987.  While one can understand how the Western world would be drawn to this process, as government’s regularly must “sing for their supper”, it is far more surprising that ostensibly communist nations behave in exactly the same manner.  Clearly, part of every government’s legitimacy (well, Venezuela excluded) is the economic welfare of the population.  Essentially, the stock market today has become analogous to the Roman’s concept of bread and circuses.  Distract the people with something they like, growing account balances, while enacting legislation to enhance the government’s power, and by extension, politicians own wealth.

But one thing the Chinese have as a culture is a long memory.  And while most traders in the Western world can no longer remember what markets were like in January, the Chinese government is keenly aware of what happened five years ago, when their last equity bubble popped, they were forced to devalue the renminbi, and a tidal wave capital flowed out of the country.  And they do not want to repeat that scenario.  So contrary to the protestations of Western central bankers, that identifying a bubble is impossible and so they cannot be held responsible if one inflates and then pops, the Chinese recognized what was happening (after all, they were driving it) and decided that things were moving too far too fast.  Hence, not merely did Chinese pension funds sell stocks, they announced exactly what they were going to do ahead of time, to make certain that the army of individual speculators got the message.

And so, it should be no surprise that equity markets around the world have been under pressure all evening as risk is set aside heading into the weekend.  The results in Asia showed the Nikkei fall 1.1%, the Hang Seng fall 1.8% and Shanghai fall 2.0%.  European markets have not suffered in quite the same way but are essentially flat to higher by just 0.1% and US futures are pointing lower by roughly 0.5% at this early hour (6:30am).

Interestingly, perhaps a better indicator of the risk mood is the bond market, which has rallied steadily all week, with 10-year Treasuries now yielding just 0.58%, 10bps lower than Monday’s yields and within 4bps of the historic lows seen in March.  Clearly, my impression that central banks have removed the signaling power of bond markets needs to be revisited.  It seems that the incipient second wave of Covid infections in the US is starting to weigh on some investor’s sentiment regarding the V-shaped recovery.  So perhaps, the signal strength is reduced, but not gone completely.  European bond markets are showing similar behavior with the haven bonds all seeing lower yields while PIGS bonds are being sold off and yields are moving higher.

And finally, turning to the FX markets, the dollar is broadly, albeit mildly, firmer this morning although the biggest gainer is the yen, which has seen significant flows and is up by 0.4% today taking the movement this week up to a 1.0% gain.  Despite certain equity markets continuing to perform well (I’m talking to you NASDAQ), fear is percolating beneath the surface for a lot of people.  Confirmation of this is the ongoing rally in gold, which is higher by another 0.25% this morning and is now firmly above $1800/oz.

Looking more closely at specific currency activity shows that the commodity currencies, both G10 and EMG, are under pressure as oil prices retreat by more than 2% and fall back below $40/bbl.  MXN (-0.6%), RUB (-0.3%) and NOK (-0.2%) are all moving in the direction you would expect.  But we are also seeing weakness in ZAR (-0.5%) and AUD (-0.1%), completing a broad sweep of those currencies linked to commodity markets.  It appears that the fear over a second wave, and the negative economic impact this will have, has been a key driver for all risk assets, and these currencies are direct casualties.  But it’s not just those currencies under pressure, other second order impacts are being felt.  For example, KRW (-0.75%) was the worst performer of all overnight, as traders grow concerned over reports of increased infections in South Korea, as well as Japan and China, which is forcing secondary closures of parts of those economies.  In fact, the EMG space writ large is behaving in exactly the same manner, just some currencies are feeling the brunt a bit more than others.

Ultimately, markets continue to be guided by broad-based risk sentiment, and as concerns rise about a second wave of Covid infections spreading, investors are quick to retreat to the safety of havens like Treasuries, bunds, the dollar and the yen.

Turning to the data story, yesterday saw both Initial (1.314M) and Continuing (18.062M) Claims print at lower than expected numbers.  While that was good news, there still has to be significant concern that the pace of decline remains so slow.  After all, a V-shaped recovery would argue for a much quicker return to more ‘normal’ numbers in this series.  Today brings only PPI (exp -0.2% Y/Y, +0.4% Y/Y ex food & energy), but the inflation story remains secondary in central bank views these days, so I don’t anticipate any market reaction, regardless of the outcome.

There are no Fed speakers, but then, they have been saying the same thing for the past three months, so it is not clear to me what additional value they bring at this point.  I see no reason for this modest risk-off approach to end, especially as heading into the weekend, most traders will be happy to square up positions.

Good luck, good weekend and stay safe

Adf

 

Over and Done

Our planet, third rock from the sun
Has had a remarkable run
For ten years, at least
No famine, just feast
But now that streak’s over and done

The IMF said, yesterday
This year will see growth go away
For ‘Twenty, it’s clear
While next year they fear
A second wave, growth will delay

Fear was the order of the day yesterday amid several related stories. Headlines continue to highlight the resurgence in reported Covid cases in the US, notably in those states that have begun to reopen more aggressively. So, California, Texas and Florida have all seen a big jump in infections which many are saying requires a second lockdown. While no orders of that nature have yet been issued, it is clear there is a risk they will be deemed necessary. That would be quite the body blow to the US economy, as well as to the equity markets which are pretty clearly pricing in that elusive V-shaped recovery. If we see second order lockdowns, you can be pretty confident that the equity market will suffer significantly. Simply consider yesterday’s performance, with the three US indices all falling at least 2.2% without having to deal with any actual change in regulations.

Adding insult to injury was the IMF, which released its updated global GDP forecasts and is now looking for a more severe global recession with growth falling 4.9% in 2020. That is down from the -3.0% expectation in April. As well, they reduced their forecasts for 2021, albeit not as dramatically, to +5.4%, down 0.4% from the April forecasts. However, they warned that should a second wave manifest itself, 2021 could see essentially zero growth globally as unemployment worldwide explodes and poverty levels in the emerging markets explodes with it. In other words, they don’t really think we are out of the woods yet.

With that one-two punch, it is no surprise that we saw risk jettisoned yesterday as not only did equity markets suffer, but we saw demand for bonds (Treasury yields -4bps yesterday and another 1.5bps this morning) while the dollar saw broad-based demand, with the DXY rising 0.6% on the day. If nothing else, this is strong evidence that all markets are anticipating quite a strong recovery, and that anything that may disrupt that process is going to have a negative impact on risk asset prices.

Adding to the fun yesterday was oil’s 6% decline on data showing inventories growing more than expected, which of course means that demand remains lackluster. Certainly, I know that while I used to fill up the tank of my car every week, I have done so only once in the past three months! While that is good for my budget, it is not helping support economic activity.

The point is, the risk asset rally has been built on shaky foundations. Equity fundamentals like revenues and earnings are (likely) in the process of bottoming out, but the rally is based on expectations of a V. Every data point that indicates the V is actually a U or a W or, worst of all, an L, will add pressure on the bulls to continue to act solely because the Fed keeps purchasing assets. History has shown that at some point, that will not be enough, and a more thorough repricing of risk assets will occur. Part of that process will almost certainly be a very sharp USD rally, which is, of course, what matters in the context of this note.

Looking at how today’s session has evolved shows that Asian equity markets had a down session, with the Nikkei taking its cues from the US and falling 1.2%, and Australia suffering even more, down 2.5%. China and Hong Kong were closed while they celebrated Dragon Boat Day. European bourses are in the green this morning, but just barely, with the average gain just 0.15% at this hour following yesterday’s 1.3%-2.0% declines. And US futures have turned lower at this time after spending much of the overnight session in the green.

As mentioned, bond markets are rallying with yields falling correspondingly, while the dollar continues to climb even after yesterday’s broad-based strength. So, in the G10 space, the euro is today’s worst performer, down 0.4%, amid overall growing concerns of a slower rebound. While the German GfK Consumer Confidence survey printed better than expected (-9.6), it was still the second worst print in the series history after last month’s. Aside from the euro, perhaps the most interesting thing is that both CHF and JPY have fallen 0.2%, despite the demand for havens. There is no news from either nation that might hint at why these currencies are underperforming from their general risk stance, but as I wrote last week, it may well be that the demand for dollars is leading the global markets these days, rather than acting as a relief valve like usual.

Emerging market currencies are seeing a more broad-based decline, simply following on yesterday’s price action. I cannot ignore the 3.6% fall in BRL yesterday, as the Covid situation grows increasingly out of control there. While the market has not opened there yet, indications are that the real’s decline will continue. Meanwhile, today’s worst performer is HUF, down 1.3%, although here, too, there is no obvious catalyst for the decline other than the dollar’s strength. Now, from its weakest point in April, HUF had managed to rally nearly 12% through the beginning of the month but has given back 5.3% of that since. On a fundamental basis, HUF is highly reliant on the Eurozone economies performing well as so much of their economic activity is generated directly on the back of Europe. Worries over the Eurozone’s trajectory will naturally hit all of the CE4. And that is true today with CZK (-0.7%) and PLN (-0.55%) also amongst the worst performers. APAC currencies suffered overnight, but not to the extent we are seeing this morning, and LATAM seems set to pick up where yesterday’s declines left off.

On the data front, this morning brings the bulk of the week’s important data. Initial Claims (exp 1.32M) and Continuing Claims (20.0M) remain critical data points in the market’s collective eyes. Anything that indicates the employment situation is not getting better will have a direct, and swift, negative impact on risk assets. We also see Durable Goods (10.5%, 2.1% ex transport) and the second revision of Q1 GDP (-5.0%). One other lesser data point that might get noticed is Retail Inventories (-2.8%) which has been falling after a sharp rise in March, but if it starts to rise again may also be a red flag toward future growth.

Two more Fed speakers are on the docket, Kaplan and Bostic, but there is nothing new coming from the Fed unless they announce a new program, and that will only come from the Chairman. So, at this stage, I see no reason to focus on those speeches. Instead, lacking an exogenous catalyst, like another Fed announcement (buying stocks maybe?) it feels like risk will remain on the defensive for the day.

Good luck and stay safe
Adf

 

Off to the Races

Though headlines describe the new cases
Of Covid, in so many places
The market’s real fear
Is later this year
The trade war is off to the races

Risk is under pressure today as, once again, concerns grow that increased trade tensions will derail the rebound from the Covid inspired global recession. You may recall yesterday’s fireworks in Asia after Peter Navarro seemed to describe the phase one trade deal as over. (Remember, too, President Trump quickly remedied that via Twitter.) This morning has seen a somewhat less dramatic market impact, although it has shown more staying power, after the Trump Administration explained that it was targeting $3.1 billion of European and UK goods for tariffs in a WTO sanctioned response to the EU’s illegal Airbus subsidies. Of course, the fact that they are sanctioned does not make them any less damaging to the economic rebound. Pretty much the last thing the global economy needs right now is something else to impede the flow of business. According to reports, the targeted goods will be luxury goods and high-end liquors, so the cost of that Hendricks and Tonic just might be going up soon. Naturally, the EU immediately responded that they would have to retaliate, although they have not released a list of their targets.

Needless to say, even the unbridled optimism over a central bank induced recovery was dented by these announcements as they are a direct attack on the idea that growth will rebound to previous levels quickly. Now, those tariffs are not yet in place, and the US has said they are interested in negotiating a better solution, but investors and traders (and most importantly, algorithms) are programmed to read tariffs as a negative and sell stocks. And so, what we have seen this morning is a solid decline across European bourses led by the DAX (-2.1%) and FTSE 100 (-2.3%) although the rest of the continent is looking at declines between of 1.25% and 1.75%. It is a bit surprising that the bond market has not seen things in quite the same light, with 10-year Treasury yields almost unchanged at this hour, as are German bund yields, and only Italian BTP’s seeing any real movement as yields there rise (prices fall) by 2bps. Of course, we recognize that BTP’s are more akin to stocks than bonds these days.

In the background, though, we continue to hear of a resurgence in Covid cases in many places throughout the world. In the US, newly reported infections are rising in many of the states that are going through a slow reopening process. There are also numerous reports of cases popping up in places that had seemed to have eliminated the virus, like Hong Kong, China and Japan. And then, there are areas, notably LATAM nations, that are seeing significant growth in the caseload and are clearly struggling to effectively mitigate the impact. The major market risk to this story is that economies around the world will be forced to stage a second shutdown with all the ensuing economic and financial problems that would entail. Remember, too, that if a second shutdown is in our future, governments, which have already spent $trillions they don’t have, will need to find $trillions more. At some point, that is also likely to become a major problem, with emerging market economies likely to be impacted more severely than developed nations.

So, with those unappetizing prospects in store, let us turn our attention to this morning’s markets. As I mentioned, risk is clearly under pressure and that has manifest itself in the foreign exchange markets as modest dollar strength. In the G10 space, NZD is the laggard, falling 0.9% after the RBNZ, while leaving policy on hold, promised to do more to support the economy (ease further via QE) if necessary. Apparently, the market believes it will be necessary, hence the kiwi’s weakness. But away from that, the dollar’s strength has been far more muted, with gains on the order of 0.2%-0.3% against the higher beta currencies (SEK, AUD and CAD) while the euro, yen and pound are virtually unchanged on the day.

In the EMG bloc, it has been a tale of two sessions with APAC currencies mostly gaining overnight led by KRW (+0.8%), which seemed to be responding to yesterday’s news of sunshine, lollipops and roses modestly improving economic data leading toward an end to the global recession. Alas, all those who bought KRW and its brethren APAC currencies will be feeling a bit less comfited now that the trade war appears to be heating up again. This is made evident by the fact that the CE4 currencies are all lower this morning, led by HUF (-0.6%) and CZK (-0.4%). In no uncertain terms, increased trade tensions between the US and Europe will be bad for that entire bloc of economies, so weaker currencies make a great deal of sense. As to LATAM, they too are under pressure, with MXN (-0.5%) the only one open right now, but all indications for further weakness amid the combination of the spreading virus and the trade tensions.

On the data front, we did see German IFO data print mildly better than expected, notably the Expectations number which rose to 91.4 from last month’s reading of 80.1. But for context, it is important to understand that prior to the onset of Covid-19, these readings were routinely between 105 and 110, so we are still a long way from ‘normal’. The euro has not responded to the data, although the trade story is likely far more important right now.

In the US we have no data of note today, and just two Fed speakers, Chicago’s Evans and St Louis’ Bullard. However, as I have pointed out in the recent past, every Fed speaker says the same thing; the current situation is unprecedented and awful but the future is likely to see a sharp rebound and in the meantime, the Fed will continue to expand their balance sheet and add monetary support to the economy.

And that’s really all there is today. US futures are pointing lower, on the order of 0.75% as I type, so it seems to be a question of watching and waiting. Retail equity investors continue to pile into the stock market driving it higher, so based on recent history, they will see the current decline as another opportunity to buy. I see no reason for the dollar to strengthen much further barring yet another trade announcement from the White House, and if my suspicions about the stock market rebounding are correct, a weaker dollar by the end of the day is likely in store.

Good luck and stay safe
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