Tag Archives: #riskoff

No Antidote

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In Georgia, today’s runoff vote
For Senate is no antidote
To nationwide fears
The quartet of years
To come, more unease, will promote

Investors expressed their dismay
By selling stocks all yesterday
As well, though, they sold
The buck and bought gold
Uncertainty’s with us to stay

Markets certainly got off to an inauspicious start yesterday as a number of concerns regarding upcoming events, as well as the possibility that some markets are overextended, combined to induce a bit of risk reduction.  Clearly, the top story is today’s runoff election in Georgia, where both US Senate seats are up for grabs.  The Republicans currently hold a 50-48 majority, but if both seats are won by the Democratic candidates, the resulting 50-50 tie will effectively give the Democrats control of the Senate as any tie votes will be broken by the Vice-President.  In that event, the Democrats should be able to institute their platform which, ostensibly, includes infrastructure spending, the Green New Deal, or parts thereof, and more substantial stimulus to address the impact of the coronavirus.

This blue wave redux has been a key topic in markets of late.  You may recall that heading into the election in November, when the polls were calling for the original blue wave, the market anticipated a huge amount of fiscal stimulus driving significantly larger Federal budget deficits.  The ensuing Treasury bond issuance required to fund all this spending was expected to result in a much steeper yield curve, a continuing rally in the stock market as the economy recovered (and this was before the vaccine) and a declining dollar.  As the runoff election approached, markets started to replay that scenario which has, until yesterday, led to successive new all-time high closes in equity indices as well as a steeper Treasury yield curve.  As well, the dollar has remained under pressure, as that remains one of the strongest conviction trades of 2021.

But yesterday, and so far this morning, we are seeing a potential change of heart, or perhaps just a note of caution.  Because if the Republicans retain one of the two seats, that will put paid to the entire blue wave hypothesis.

Of course, there is another possibility that is driving investor caution, and that is the idea that markets, especially equity markets, remain extremely frothy at current levels.  Certainly, on a historical basis, valuation indicators like P/E or Shiller’s CAPE, or Price/Book or even Total Market Cap/GDP are at historically high extremes.  Is it possible that the market has already priced in every conceivable positive event to come?  There are those who would make that argument, and if they are correct, then the required catalyst for a correction of some sorts is likely not that large.  For instance, if the Republicans win even one seat, the entire stimulus bandwagon may never get going, let alone any of the more widescale projects.  And that could well be enough to force a rethinking of the endless stimulus theory with a resultant revaluation of investment risks.

One of the things that always bothered me about the blue wave hypothesis was the idea that the Treasury yield curve would steepen, and the dollar would decline.  Historically, a steeper yield curve has indicated a strengthening US economy which has drawn investment and strengthened the dollar.  I don’t believe that relationship will change, however, a weaker dollar does make sense if you consider how the Fed is likely to respond to rising Treasury yields; namely with Yield Curve Control (YCC).  The US government cannot afford for interest rates to rise substantially, especially as the amount of debt issued continues to grow rapidly.  In fact, the only way it can continue to pay interest on the growing pile of debt is to make sure that interest rates remain at historically low levels.  The implication is that if the Treasury continues to flood the market with issuance, the Fed will be required to buy all of it, and then some, in order to prevent yields from rising.  And whether it is explicit, or implicit, that YCC is going to result in increasingly negative real yields in the US (as inflation is almost certainly going higher).  Now, if you wanted a catalyst to drive the dollar lower, increasing negative real yields is a perfect solution.  While that may not be such a benefit for investors and savers, it will help the Fed retain the upper hand in the global policy ease race, and with it, help undermine the value of the dollar.  It is, in fact, the basis for my views this year.  All that from the Georgia run-off elections!  Who would have thunk?

As to markets this morning, yesterday’s weakness remains fairly widespread in the equity space, as all European bourses are lower (DAX -0.4%, CAC -0.5%, FTSE 100 -0.1%) after a mixed Asian session (Nikkei -0.4%, Hang Seng +0.6%, Shanghai +0.7%).  In fact, Shanghai reached its highest level since August 2015, the previous bubble we saw there.  US futures, meanwhile, are little changed at this hour as traders await the first indications from the Georgia elections.

Bond markets are broadly lower this morning, with Treasury yields higher by 1.3bps and most European bonds showing similar rises in their yields.  On the one hand this is unusual, as bonds generally benefit from a risk off mood.  On the other hand, if I am correct about the move toward negative real yields, bonds will not be a favored investment either and could well underperform going forward, at least until the central banks increase their purchases.

Another beneficiary of negative real yields in the US is gold, which rallied sharply yesterday, more than 2%, and is up a further 0.3% this morning, back at $1950/oz.  Oil, meanwhile, is starting to move higher as well, up 1.8%, as some optimism over the outcome of the OPEC+ meeting is adding to the broad commodity rally.

And finally, the dollar is generally weaker this morning, down against all its G10 counterparts and many of its EMG counterparts as well.  In the G10, SEK (+0.6%) is the leader, which appears to simply be an example of its higher beta relative to the euro or pound vs. the dollar. But we are also seeing the commodity bloc perform well (AUD +0.5%, CAD +0.3%, NOK +0.3%) alongside their main exports.  However, this is clearly a dollar weakness story as the yen (+0.25%) is rallying alongside the rest of the bloc.

Interestingly, in the EMG group, ZAR (-1.35%) is the worst performer, followed by RUB (-0.6%), neither of which makes sense based on the G10 performance as well as that of commodities.  However, it is important to remember that short dollar is one of the most overindulged positions in markets, and the carry trade has been a favorite with both these currencies benefitting from that view.  This looks like a bit of position unwinding more than anything else.  On the positive side in this bloc, the CE4 remain solid and are leading the way, while LATAM currencies are little changed on the open.

On the data front, this week brings a lot of new information culminating in the payroll report on Friday.

Today ISM Manufacturing 56.7
ISM Prices Paid 65.0
Wednesday ADP Employment 50K
Factory Orders 0.7%
FOMC Minutes
Thursday Initial Claims 803K
Continuing Claims 5.1M
Trade Balance -$67.3B
ISM Services 54.5
Friday Nonfarm Payrolls 50K
Private Payrolls 50K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

Last Thursday saw a stronger than expected Chicago PMI and yesterday’s PMI data was strong as well, so the economy remains a bit enigmatic, with manufacturing still robust, but services in the dumps.  The payroll expectations are hardly inspiring, and with lockdowns growing in the States, as well as worldwide, it doesn’t bode well for Q1 at least, in terms of GDP growth.  We also hear from seven Fed speakers this week, which could well be interesting if anyone is set to change their tune regarding how long easy money will remain the norm.  However, I doubt that will happen.

The dollar remains on its back foot here, and I see no reason for it to rebound in the short run absent a change in the underlying framework.  By that I mean, something that will imply real yields in the US are set to rise.  Alas, I don’t see that happening in the near future.

Good luck and stay safe
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Grovel and Kneel

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Said Boris, prepare for the worst
Despite all our efforts, the first
Of Jan may result
In quite a tumult
If Europe’s stance isn’t reversed

Said Ursula, we want a deal
But England must grovel and kneel
If French boats can’t fish
Wherever they wish
This rift will have no chance to heal

Brexit remains the top story in the markets as we have heard from both sides that preparations for a no-deal outcome are necessary.  From what I can glean, it appears the fishing rights issue is the final sticking point.  And, in fairness, it is pretty easy to see both sides’ point of view.  From the UK’s perspective, these are their territorial waters, and if Brexit was about nothing else, it was about regaining complete sovereignty over itself, including its canon of laws, and the disposition of its territory.  I’m pretty confident that had the roles been reversed, and British fishing boats were making their living in French waters, the French would be equally adamant about controlling access.  On the flip side, given the UK has been a member of the EU since 1973, there are two generations of French fishermen who have only known unfettered access to UK waters, and assumed it was their birthright.  Losing that access will obviously be a devastating blow to their livelihoods, and one in which they played no part of the decision.  Of course, with that in mind, it still seems like a periodic review of access would be able to satisfy both sides.  Alas, that has not yet been agreed.

The upshot of this change in tone is that the market has begun to price in a more serious probability of a no-deal outcome.  This is obviously evident in the pound, which has fallen a further 0.8% this morning and is now back to levels last seen a month ago.  In fact, versus the euro, the pound is at its weakest since mid-September, although still several percent below the pandemic lows, and more than 6% from its all-time lows seen in the wake of the GFC.  But we are seeing this change in the interest rate markets as well, where UK debt yields are tumbling across the curve. For instance, 10-year Gilt yields have fallen 4.5 basis points today and now sit at 0.15%, just a few ticks above their all-time lows seen in August.  And all shorter maturities have turned negative, with 7-year breaking below 0.0% this morning.  As to the short end, the market is now pricing a base rate cut to 0.0% by the February meeting latest, and a further cut, into negative territory by next summer.

This Brexit gloom also seems to be seeping into other markets as we are seeing a pretty widespread risk-off move today, with European equity markets all pretty substantially lower and US futures pointing in the same direction. Perhaps part of this gloom is the fact that the ECB arguably disappointed markets yesterday.  While Madame Lagarde lived up to her word regarding recalibrating the ECB programs, there was no shock or awe, something markets learned to anticipate under the previous regime.  The PEPP was increased, but by exactly the amount expected.  It was also extended in time, but all that was offset by the comment that it may not need to be fully utilized.  But there was no addition to the asset mix, no junk bonds or equities, anything to demonstrate that the ECB was going to continue to support the markets aggressively.  And with that missing, and growing concern over Brexit, it appears investors are deciding to hunker down a bit going into the weekend.

At this point, both sides in the Brexit talks claim Sunday is the final deadline, so perhaps we will see something this weekend to move markets on Monday.  But right now, there is a palpable air of despair in the markets.

Touring all markets this morning shows that Asian equities were mostly lower (Nikkei -0.4%, Shanghai -0.8%) although the Hang Seng (+0.35%) managed a gain.  However, that is really the only green number on the boards this morning as every European exchange is lower, led by the DAX (-2.0%) and followed by the CAC (-1.3%) and FTSE 100 (-1.1%).  The idea that the FTSE 100 will benefit from a no-deal Brexit seems sketchy, at best, given whatever benefit may come from a weaker pound Sterling, it would seem to be offset by the larger economic hit to the UK economy as well as the thought that many of those companies may find their export markets crimped without a deal, and therefore their profits negatively impacted.  As to the US, futures markets have been trending lower all evening and are now pointing down about 0.8% across the board.

Bond markets are on the same page, with rallies everywhere as yields decline.  Treasury yields are lower by 2 basis points, and all of Europe has seen yield declines of between 1 and 4 basis points, with the PIGS the laggards here.  You may notice I never discuss JGB’s but that is only because the BOJ has effectively closed that market, now owning nearly 50% of outstanding securities, and thus yields there never really move as almost no volume transacts on any given day.

Commodity markets are showing very minor declines with both oil and gold looking at dips of just 0.2% or so.  In other words, this is more about financial issues than economic ones.

And finally, the dollar is definitely stronger this morning, with only the yen (+0.15%) outperforming in the G10 space.  While the pound is the leading decliner, NOK (-0.8%) is right there with it.  This is a bit surprising, as not only has oil not really moved today, but Brent crude rose back above $50/bbl yesterday for the first time since the initial Covid panic in March and remains there this morning.  Given growing expectations that next year is going to bring a lot of growth, it would seem that NOK has a lot of positives on its side.  As to the rest of the bloc, the losses are more moderate, ranging from AUD (-0.15%) to SEK (-0.35%), and all simply following the risk story.

Emerging market currencies are also largely weaker, led by BRL (-0.95%) which really appears to be a reaction to yesterday’s remarkable 3.0% rally.  With spot approaching 5.00, there seems to be a lot of two-way activity in the currency.  But the other laggards are all commodity based, which fits with the overall risk-off theme.  So, ZAR (-0.8%) and MXN (-0.65%) are leading the pack while the bulk of the bloc has declined a more manageable 0.2%-0.3%.  On the flip side TWD (+0.7%) is the biggest gainer despite modest foreign equity outflows.  This is especially odd given the ongoing decline in TWD bond yields.  But whatever the driver, demand for TWD remains robust.

Yesterday’s CPI data was a tick higher than expected, which has become the norm for the second half of the year.  This morning we get PPI (exp 0.7%, 1.5% ex food & energy) although given CPI has already been released, it will largely be ignored.  Perhaps the 10:00 preliminary Michigan Confidence (76.0) reading will garner more interest.  but in the end, neither seems likely to move the needle.  Rather, with risk appetite waning, and concerns over Brexit growing, it does feel like the dollar has further room to run today.

Good luck, good weekend and stay safe
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A New Paradigm

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Awaiting a new paradigm
The market is biding its time
Will Brexit be hard?
Or will Ms. Lagarde
Do something that’s truly sublime?

And what of next week and the Fed?
Are traders now looking ahead?
Will Jay make a change?
And thus rearrange
The views that are now so widespread

Come with me now, on a trip down memory lane.  Back to a time when hope (for a vaccine) sprung eternal, the blue wave was cresting, and investors were sidling up to the all-you-can-eat risk buffet with a bottomless appetite.  You remember, November.  Reflation was on the menu, along with a massive fiscal stimulus bill; progress was concrete with respect to Brexit negotiations; and the prospect of another wave of government shutdowns, worldwide, was just a gleam in petty tyrants’ politicians’ eyes.  Well, it turns out that those expectations were somewhat misplaced.  While we did, indeed, get that vaccine announcement, with the milestone first injection made today in the UK, many of those views turned out differently than expected.  As we are all aware, there was no blue wave in the US election.  Regarding Brexit, it appears that the time has finally come for the leaders of both sides to sit down and hash things out.  This morning brought news that Boris and Ursula will be meeting tomorrow to see if they can agree on what each side is willing to accept as their top negotiators have clearly reached their limits.

As to risk appetite, certainly November was beyond impressive, with massive risk rallies in equities around the world while haven assets, notably Treasuries and gold, suffered significant losses.  Since then, however, the euphoria has been far less prevalent, with some sessions even winding up in the red.  Lockdowns?  Alas, those have returned in spades, with seemingly new orders each and every day by various governmental authorities around the world.

The upshot of this mixture of news is that the market is now searching for the next big thing.  Don’t misunderstand, the 2021 conviction trades remain on the table.  Thus, expectations for a much weaker dollar, huge returns in emerging markets, both bonds and stocks, and continued strength in the US market are rife.  Just not right now.  The short-term view is more muddled which is why the price action we are currently experiencing is so mixed and until that new view develops, choppy markets with no net directional movement is the most likely outcome.  For instance, let’s look at today’s activity, which is a perfect example of the situation.

Equity markets around the world are softer, but not aggressively so.  Asian markets sold off modestly last night (Nikkei -0.3%, Hang Seng -0.75%, Shanghai -0.3%), but look simply to be consolidating what have been impressive gains since the beginning of November.  European markets are also a bit softer this morning, led by the CAC (-0.65%) although the DAX (-0.3%) and FTSE 100 (-0.4%) are drifting lower as well.  We did see some data from Europe, with ZEW readings from Germany turning out bi-polar (Expectations were strong at 55.0, Current Situation was weak at -66.5), thus showing how financial markets continue to focus on the post-covid economy while ignoring the current situation.  Meanwhile, US futures are all pointing a bit lower, between 0.4%-0.5%, after a mixed performance yesterday.  In other words, all that risk appetite from last month appears to have been satisfied for now, although we are, by no means, seeing serious risk reduction.

In the bond market, surprisingly, 10-year Treasury yields have actually edged higher by 0.7bps this morning, despite the modest risk-off theme, whereas in Europe, we see marginal yield declines across Germany, France and the UK. Bonds from the PIGS, however, are definitely feeling a little stress as they are trading with yields nearly 2bps higher than yesterday.  And that is a bit surprising given that Thursday, the ECB is going to announce their latest expansion of monetary policy, thus guaranteeing to buy yet more debt from these nations.  (We will cover the ECB tomorrow).

Commodities?  Well, gold has been rocking since its nadir on November 30, having rebounded more than 6% since then, and while unchanged on the day, remains in a short-term uptrend.  Oil, meanwhile, is ever so slightly softer this morning, just 0.5%, but also remains in its powerful uptrend, which has seen it rally more than 33% since its nadir on November 2nd.  In fact, metals and energy overall remain well bid and in strong uptrends.  Clearly, they are looking ahead to stronger growth (or possibly higher inflation) once the pandemic finally fades.

And lastly, the dollar, which can best be described as mixed today, remains the linchpin for many market expectations in 2021.  Remember this; given the dollar’s place in the world economy, as the financing vehicle of choice, a too strong dollar is generally associated with broad economic underperformance.  As debt loads worldwide have exploded, even at remarkably low interest rates, the need for foreign issuers, whether private or government, to acquire dollars to service that debt is perpetual.  When the dollar is strong, it crimps the ability of those foreign debtors to both invest and repay the outstanding debt, with investment suffering.  So, while a strong dollar may signal growth in the US economy, given that the US economy now represents only about 20% of the global economy, well down from its previous levels, and that trade continues to represent such a small portion of the US economy, just 12%, these days, a strong dollar simply hurts foreign economies without the previous benefits of knock-on global growth.  This is the key link between the views of a weaker USD and strong EMG performance next year, the two are tightly linked on a fundamental basis.

But as for today, the proper description of the dollar would be mixed.  In the G10, SEK (-0.45%) and GBP (-0.45%) are the leading decliners, with the latter clearly under pressure from the ongoing concerns over Brexit while the former seems to be feeling the sting of hints from the Riksbank that ZIRP will remain longer than previously expected.  On the plus side, the gains are less impressive, with CHF (+0.2%) the leader, while the euro has edged higher by 0.1%.  However, trying to explain a movement that small is a waste of time.

EMG currencies, on the other hand, are showing a little life, led by ZAR (+0.55%) and RUB (+0.5%) as commodity prices continue to hold the bulk of their gains.  INR (+0.5%) also had a good evening after the FinMin there explained that there would be no reduction in fiscal support for the economy for the foreseeable future, and that the government would continue to work with the RBI to insure a return to sustainable growth.  On the downside, KRW (-0.3%) is the laggard after the president there urged people to cancel holiday plans and stay home.

On the data front, NFIB Small Business Optimism fell to 101.4, a bit weaker than expected, but given the stories of closures around the nation, this cannot be that surprising.  A little later we get Nonfarm Productivity (exp 4.9%) and Unit Labor Costs (-8.9%), although neither is likely to excite the market.  There are no speakers on the docket, so the dollar will be taking its cues from the equity markets in all likelihood.  Right now, with futures pointing lower, that implies the dollar may have a bit of a rebound coming.  However, until that new narrative forms, I don’t anticipate too much movement.

Good luck and stay safe
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Slipping Away

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Last week it appeared conversations
On Brexit, had built expectations
To broker a deal
That both sides would feel
Was fruitful for all Europe’s nations

Alas, based on headlines today
That good will is slipping away
Concern has now grown
That both sides condone
No deal, to the market’s dismay

Apparently, Brexit talks have reached their denouement, with the weekend efforts of PM Johnson and European Commission President Von der Leyen unable to bridge the final gaps.  The key issues regarding fishing in UK waters and state support for UK companies remain outstanding and neither side has yet been willing to budge.  There is clearly a great deal of brinksmanship ongoing here, but with the timeline so compressed, the chance for a No-deal outcome is still remarkably high.  In fact, as of a bit past 6am in NY, the headlines claim that negotiations might end by this evening in Europe, after one final call between the two leaders.

So, is this the end?  Is Brexit upon us, three weeks early?  And if so, what can we expect going forward?

The first thing to remember about international negotiations is they are never over, even when they have ended, especially in a situation of this nature.  The economic impact in both the UK and throughout Europe will be significant in a no-deal outcome, and this is something that neither side really wants to occur, despite any rhetoric to the contrary.  The most recent analyst estimates indicate that the UK’s economy will suffer a long-term reduction of 3.0% in GDP compared to the situation if a deal is completed.  Meanwhile, the EU’s impact will be a much smaller 0.5% of GDP, but that impact will be unevenly distributed, with Ireland expected to suffer a 6% decline in economic activity, while various other nations see much smaller effects.  Germany, too, will feel the pain, as German auto exports to the UK are one of the most lucrative parts of German industry, and with tariffs imposed, they will certainly decline.

And, ultimately, that is why the best bet remains that a deal will be done.  Especially given the economic disruption of the pandemic, the ability for either the UK or EU to blithely sit by and allow a critical trade relationship to crumble is virtually nil.  So, even if the talks ostensibly end later today, they will not have ended.  Both sides will still be seeking a deal, as both sides desperately need one.

However, investors are clearly worried, as evidenced by this morning’s price action across markets.  Perhaps the most obvious outcome is that of the pound, which has fallen 1.3% on the news.  Last week I was making the case that the market had not fully priced in a positive deal, and any agreement was likely to see the pound rally.  At the same time, a true collapse in talks with a no-deal outcome is likely to see a further decline, with 5%-7% seen as a reasonable result.  This morning’s movement is just a down payment on that, if no deal actually is the outcome.

But this news seems to have forced investors across markets to reconsider their current positioning and potential market responses to negative news.  Perhaps you are not old enough to remember what negative news actually is, so I will give a brief refresher here.  Negative news is a situation where not only is the economic impact indisputably harmful to a (country, company, currency), but that a central bank response of further policy ease will be unable to change the outcome.  Thus, Friday’s weaker than expected NFP number was not really negative because it encouraged the view that the Fed will ease further next week, thus offsetting any bad economics.  But Brexit changes the structure, not just the data, and no matter what the BOE does, customs checks are still going to slow down trade and commerce.

It is with this in mind that we look at markets this morning and see that risk is broadly being reduced.  Asian equity markets started the move as the Nikkei (-0.75%), Hang Seng (-1.25%) and Shanghai (-0.8%) all showed solid declines.  And this was despite Chinese data showing that exports from the mainland had increased a much greater than expected 21% and fostered a record large trade surplus.  In Europe, the situation is similar with one real exception.  The DAX (-0.3%) and CAC (-0.8%) are leading the Continent lower as investors react to the potential crimp in economic activity.  However, the FTSE 100 (+0.5%) is higher as most members of the index will benefit greatly from a weaker pound, and so are responding to the pound’s market leading decline.

Speaking of the pound, it has fallen 1.3% from Friday’s closing levels and is the leading decliner across all major currencies.  But weakness is evident in the commodity bloc as AUD (-0.5%), NZD (-0.4%) and CAD (-0.2%) are all suffering alongside oil (WTI -0.9%) and gold (-0.4%).  EUR (-0.1%) has been a relative outperformer as the market continues to estimate a much smaller impact of a no-deal scenario.  Meanwhile, in the EMG bloc, losses are virtually universal, but the magnitude is not that substantial.  For example, MXN (-0.7%) is the worst performer today, obviously suffering from oil’s decline, but we have also seen weakness throughout the CE4 (HUF -0.4%, CZK -0.3%, PLN -0.2%) along with ZAR and RUB, both having fallen 0.3%.  In fact, the one bloc that has outperformed today is APAC, where only two currencies (MYR -0.2% and SGD -0.15%) are in the red.  Given the genesis of the problems is in Europe, this should not be that surprising.

Bond markets are taking the risk-off theme seriously with Treasury yields lower by 2.2 basis points and European govvies seeing substantial demand.  Gilts lead the way, with a 5.6bps decline, but Bunds (-3.0bps) and OAT’s (-2.6bps) are also rallying nicely.  Remember, too, that the ECB meets Thursday with expectations built in for a €500 billion increase in PEPP as well as a maturity extension of between six and twelve months in addition to an increase in the TLTRO program, with a maturity extension there as well.  One other thing to watch from the ECB is whether or not they mention the euro and its recent rally.  Madame Lagarde and her colleagues cannot countenance a significant rally from current levels, and I expect they will make that clear.

As to data this week, aside from the ECB, CPI is the biggest thing in the US:

Tuesday NFIB Small Business 102.5
Nonfarm Productivity 4.9%
Unit Labor Costs -8.9%
Wednesday JOLTs Job Openings 6.325M
Thursday Initial Claims 725K
Continuing Claims 5.27M
CPI 0.1% (1.1% Y/Y)
-ex food & energy 0.1% (1.6% Y/Y)
Friday PPI 0.1% (0.7% Y/Y)
-ex food & energy 0.2% (1.5% Y/Y)
Michigan Sentiment 76.0

Source: Bloomberg

With the last FOMC meeting of the year next Wednesday, the Fed is in their quiet period so there will be no commentary on that front.  With this in mind, the dollar, which continues to trend lower, will likely need some new catalyst to take the next step.  At this point, the biggest surprise is likely to be a positive conclusion to the Brexit talks, but given what we have seen over the past eight months, it is pretty clear that investors remain hugely bullish on the idea of the post-pandemic economy and will not be denied in their belief that stocks can only go up.  My gut tells me that US equities, where futures are currently lower by 0.3% or so, will finish the day higher, and the dollar will cede much of its overnight gains, even without a deal.

Good luck and stay safe
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Post-Covid Themes

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With Thanksgiving now in the past
And Christmas approaching quite fast
The only thing clear
Through end of the year
Is dollar shorts have been amassed

For many, conviction is strong
That currencies, they need be long
The idea, it seems
Is post-Covid themes
Mean risk averse views are now wrong

Having been away for a week, the most interesting thing this morning is the rising conviction in the view that the dollar has much further to decline in 2021.  Much is made of the fact that since its Covid induced highs in March, the dollar has fallen by more than 12% vs the Dollar Index (DXY) which is basically the euro.  Of course, that is nothing compared to the recoveries seen by the commodity currencies like NOK (+33.2%), AUD (+27.6%) and NZD (+23.6%) over the same period.  Yet when viewed on a year-to-date basis, the movement is far less impressive, with NOK actually unchanged on the year, and the leader, SEK, higher by 10.8%.  It is also worth remembering that the euro has rallied by a relatively modest 6.9% thus far in 2020, hardly worthy of the term dollar collapse.

In addition, as I have written before, but given the growing dollar bearish sentiment, I feel worth repeating, is that in the broad scheme of things, the dollar is essentially right in the middle of its long-term trading range.  For instance, from the day the euro came into existence, January 1, 1999, the average daily FX rate, according to Bloomberg, has been 1.1999, almost exactly where it currently trades.  It has ranged from a low of 0.8230 in October 2000 to a high of 1.6038 the summer before the GFC hit.  The point is EURUSD at 1.20 is hardly unusual, neither can it be considered weak nor strong.

Unpacking the rationale, as best I understand it, for the dollar’s imminent decline, we see that a great deal of faith is put upon the idea of a continuing risk rally over the next months as the global economy recovers with the advent of the Covid vaccines that seem likely to be approved within weeks.  The sequence of events in mind is that the distribution of the vaccine will have the dual impact of dramatically reducing the Covid caseloads while simultaneously reinvigorating confidence in the population to resume pre-Covid activities like going out to restaurants, bars and the movies, as well as resuming their travel plans.  The ensuing burst of activity will result in a return to pre-Covid levels of economic activity and all will be right with the world.  (PS  pre-Covid economic activity was a desultory 1.5% GDP growth with low inflation that caused the central bank community to maintain ultra-low interest rates for a decade!)

Equity markets, which are seemingly already priced for this utopian existence, will continue to rally based on the never-ending stream of central bank liquidity…or is it based on the massive growth in earnings given the near certainty of higher taxes and higher interest rates in the future.  No, it can’t be the second view, as higher taxes and higher interest rates are traditionally equity negatives.  So perhaps, equity markets will continue to rally as the prospect of future growth will remain just close enough to seem real, but far enough away to discourage policymakers from changing the rules now.  Perhaps this is what is meant by the Goldilocks recovery.

Of course, while commodity markets have bought into the story hook, line and sinker, it must be recalled that they have been the greatest underperforming segment of markets for the past decade.  Since December 1, 2010, the Goldman Sachs Commodity Index (GSCI) has fallen 36.5%, while the S&P500 has rallied 191%.  My point is the fact that commodity markets are performing well with the prospects of incipient economic growth ought not be that surprising.

The fly in the ointment, however, is the bond market, where despite all the ink spilled regarding the reflation trade and the steepening of the US Treasury yield curve, 10-year Treasuries refuse to confirm the glowing views of the future. At least, while they may be agnostic on growth, there is certainly little concern over a rekindling of inflation, despite the earnest promises of every central banker in the world to stoke the fires and bring measured inflation back to their targets.  As I type this morning, 10-year Treasury yields are 0.85%, right in the middle of its range since the US election.  You remember that, the event that was to usher in the great reflation?

In the end, while sentiment has clearly been growing toward a stronger recovery next year, encouraging risk appetites in both G10 and, especially, EMG economies, as yet, the data has not matched expectations, and positioning remains based on hope rather than evidence.

Now a quick tour around today’s markets shows that the equity rally has paused, at the very least, with weakness in Asia (Nikkei -0.8%, Hang Seng -2.1%, Shanghai -0.5%) despite stronger than expected economic data from both Japan (IP +3.8%) and China (Mfg PMI 52.1, non-Mfg PMI 56.4).  European markets are also mostly in the red, although the DAX (+0.2%) is the exception to the rule.  However, the CAC (-0.4%) and FTSE 100 (-0.15%) have joined the rest of the continent lower despite positive comments regarding a Brexit deal being within reach this week.  US futures have a bit of gloom about themselves as well, with both DOW and SPX futures pointing to 0.5% declines at the open, although NASDAQ futures are little changed at this hour.

Surprisingly, despite the soft tone in the equity markets, European government bond yields are all edging higher, with Bunds (+1.6bps) pretty much defining the day’s activity as most other major markets are seeing similar moves, including Treasuries (+1.8 bps).  Commodity prices are under pressure with oil (-1.3%) and gold (-0.9%) both suffering although Bitcoin seems to be regaining its footing, rallying 2.3% this morning.

Finally, the dollar, is under a modicum of pressure this morning with G10 currencies mostly a bit firmer (NOK and SEK +0.4%) GBP (+0.3%), although AUD (-0.1%) seems to be getting nosebleeds as it approaches its highest level in two years.  Potentially, word that China has slapped more tariffs on Australian wines, as the acrimony between those two nations escalates, could be removing the rose-colored tint there.  Meanwhile, in the EMG bloc, there is a mix of activity, with some gainers (HUF +0.8%) and BRL (+0.65%), and some losers (ZAR -0.3%), KRW (-0.25%).  Broadly, the commodity focused currencies here are feeling a little pressure from the underperformance in oil and metals, while the CE4 are tracking the euro nicely.

It is an important data week, and we also hear from numerous central bankers.

Today Chicago PMI 59.0
Tuesday ISM Manufacturing 58.0
Construction Spending 0.8%
Wednesday ADP Employment 420K
Fed Beige Book
Thursday Initial Claims 765K
Continuing Claims 5.81M
ISM Services 57.6
Friday Nonfarm Payrolls 500K
Private Payrolls 608K
Manufacturing Payrolls 46K
Unemployment Rate 6.8%
Average Hourly Earnings 0.1% (4.2% Y/Y)
Average Weekly Hours 34.8
Trade Balance -$64.8B
Factory Orders 0.8%

Source: Bloomberg

In addition, we have seven Fed speakers this week, including most importantly, Chairman Powell’s testimony to the Senate Banking Committee tomorrow and the House Finance Panel on Wednesday.  We also hear from Madame Lagarde twice this week, and with the euro hovering just below 1.20, be prepared for her to mention that a too-strong euro is counterproductive.  You may recall in early September, the last time the euro was at these levels, that both she and Philip Lane, ECB Chief Economist, were quickly on the tape talking down the single currency.  Although since that time CNY has rallied strongly (+4%) thus removing some of the pressure on the ECB, there is still no way they want to see the euro rally sharply from here.

But do not be surprised to see the market test those euro highs today or tomorrow, if only to see the ECB response and pain threshold.  Clearly, momentum is against the greenback lately, and today is no exception, but I do not buy the dramatic decline story, if only because no other central bank will sit idly by and allow it.

Good luck and stay safe
Adf

Appalled

Posted on by

As Covid continues to spread
In Europe, it’s come to a head
Relief has been stalled
‘Cause most are appalled
That Hungary, old norms, has shred

It seems like only yesterday when the market was talking about the shape of future monetary support by the ECB and how that would fit with the EU’s fiscal package and help the continent recover from the Covid induced recession.  While current lockdowns throughout Europe are painful, with a vaccine on the horizon and the historic agreement on joint liability, the future of Europe seemed bright and adding to risk profiles was seen as appropriate.  And perhaps that is because it was only yesterday when that was the market’s theme.  At least yesterday morning’s theme.  But as Dinah Washington first sang to us in 1959, “What a difference a day makes!”  This morning, the optimists have lost the spring in their step as risk appetite has waned.  It seems that the news that Hungary and Poland are digging in their heels with respect to the EU rescue package has suddenly been recognized as a problem.

For those of you who thought that the only place where there was political discord was in the US, that has never been the case.  The EU has also seen the type of political division seen here; it just takes a different form in Europe.  Rather than red and blue states, Europe has red and blue countries, with Hungary and Poland being the reddest of them all, at least in US terminology.  The governments of both these nations have objected to much of the EU agenda since 2015 and the flood of refugees entering the continent from the Middle East and Northern Africa in the wake of several civil wars ongoing then (and still).  It seems the folks in Brussels wanted to dictate how many refugees each nation in the EU needed to absorb, and given both these country’s geographic location, amongst the first countries any refugee from the Levant would enter, they were instructed to take a disproportionate number.  At least, disproportionate in their eyes.  And that didn’t sit well with the citizenship in both countries, who then elected nationalist/populist leadership.  Since that time, both nations have sought to roll back numerous EU edicts regarding various issues like the judiciary and immigration.  This has caused serious griping in Brussels as well as in Budapest and Warsaw.

Fast forward to the current situation, where the EU is seeking to pass their €1.8 trillion Covid relief package (their version of our CARES package from March).  The problem is that EU law states support must be unanimous, and these two nations are fighting back against a provision in the text about recipients of aid following the “rule of law”.  That innocuous sounding statement is code for the EU leadership’s insistence that laws restricting immigration, or an independent judiciary are verboten.  The upshot is the relief package is written so that any nation that does not follow the “rule of law” will not be entitled to any funding.  Naturally, Hungary and Poland want the money, but they, as yet, have been unwilling to give ground on the issue, hence the stalemate.  Now, like most political stand-offs, this one had seemed likely to be resolved before it got too heated.  However, as of this morning, it seems market participants are beginning to question if a package will get approved.  And there is another issue in the background as well, Brexit.  By that, I mean with the UK just about gone from the EU, if two other nations were to opt out of the bloc, what would that do to the EU as a whole, as well as to confidence in the political leadership across the continent.  This is not to say that either Hungary or Poland is on the way out.  It is merely a recognition that the post Brexit EU will not be all sunshine and rainbows.

And apparently, that has been enough for investors to decide that profit-taking is a prudent move.  Which leads us to this morning’s risk-off session.  Despite more forceful comments from Madame Lagarde, and news that there is now a third vaccine that has proven effective, it seems that fear is creeping back into the picture.  We saw it late in the US session yesterday, with all three major indices closing about 1% lower and on session lows.  It was followed in Asia by the Nikkei (-0.35%) falling for a third consecutive session and the Hang Seng (-0.7%).  Shanghai (+0.5%), however, broke the mold as the Chinese government’s ability to issue euro-denominated debt at negative yields in the 5-year added to recent enthusiasm that China’s growth story remains unimpinged by Covid.

Turning to Europe, which is, after all, the epicenter of today’s angst, it is no surprise that all markets are in the red, with the DAX, CAC and FTSE 100 all lower by roughly 1.0%.  As to the US futures complex, larger losses earlier have been pared, but we are still looking at declines on the order of 0.25%-0.4%.

Bond yields are generally lower, as expected, with Treasuries down by 1.5bps, a similar move to both Bunds and French OATS.  In fact, the only European bond market in the red is Greece, where yields have backed up by 4bps.  In the meantime, oil (WTI -1.0%) and gold (-0.5%) are leading the entire commodity bloc lower.

In the FX markets, the dollar reigns supreme this morning, higher against all its G10 counterparts.  That said, the magnitude of movement has been modest with AUD (-0.4%), NZD (-0.4%) and SEK (-0.3%) the leading decliners.  Clearly, pressure on commodities is undermining the former two, while SEK tends to move in the same direction as the bloc, just in larger increments.  (As an aside, USDSEK option volatility has consistently traded at a 2.5% premium to EURUSD volatility for the past eight months.)

In the emerging markets, a space that has received a lot of positive press of late, only one currency has rallied vs. the dollar this morning, TRY (+1.4%) after the Turkish central bank raised short-term interest rates by 4.75% to help support the currency as well as fight inflation, which is running at nearly 12% there.  But the rest of the bloc is weaker, led by KRW (-1.0%) and IDR (-0.6%), with even CNY (-0.4%) suffering on the day.  The won sold off after FinMin Hong Nam-ki said that they could step in to stabilize (read sell won) the market at “any time”.  A clear threat to speculators, and one well-heeded, at least today.  The rupiah fell after the central bank there cut rates by 25 basis points in a surprise move, as the country continues to try to cope with rising infections and thus is willing to add further support.  As to CNY, given the spectacular run it has had lately, a modest pullback needs no explanation.

Data has been sparse overnight, with only Australian job growth a bit higher than expected after the Victoria lockdown was eased.  This morning brings a few key readings here starting with Initial Claims (exp 700K) and Continuing Claims (6.4M).  Also, at 8:30 we see Philly Fed (23.0) then Leading Indicators (+0.7%) and Existing Home Sales (6.47M) at 10:00am.  While the Initial Claims numbers remain paramount, recall that Empire Manufacturing on Monday was much weaker than expected, so we may see clues as to just how Q4 is turning out.  For what it’s worth, the Atlanta Fed’s GDPNow forecast is currently sitting at 5.6% for Q4, so still a pretty positive outlook.

Two more Fed speakers today are likely to continue to tell us that we need more fiscal stimulus but that they have plenty of ammo left.  And that’s really it.  The early fear seems to be abating somewhat as I finish just past 7am.  As such, it wouldn’t be that surprising to see a late day equity rally and the dollar cede its gains.  But absent some other piece of news, large movement seems unlikely.

Good luck and stay safe
Adf

More Money They’ll Print

Posted on by

While stock markets make all-time highs
The world’s central banks still advise
More money they’ll print
In case there’s a hint
That prices will simply not rise

In a chicken and egg type question, it is worth asking; is the fact that equity markets continue to rally (yet another all-time high was recorded yesterday, this time by the Dow) despite the fact that economies worldwide remain in chaos and operating at a fraction of their capacity, as governments impose another wave of lockdowns throughout Europe, the UK and many US states, logical?  Obviously, the link between those dichotomous outcomes is the support provided by the central banking community.  Perhaps the way to frame the question is, if markets have already seen past the end of the pandemic, and are willing to fund the business community right now, why do central banks feel they need to, not merely continue with their programs, but promise to increase them going forward?

This was made clear, yet again, when Fed Vice-Chair, Richard Clarida, explained that the FOMC is carefully evaluating the current situation and will not hesitate to use all available tools to help support the economy.  The punditry sees this as a code for an increase in the size of the asset purchase program, from the current $120 billion each month (split $80 billion Treasuries and $40 billion mortgages) to as much as $160 billion each month, with the new money focused on Treasuries.  At the same time, ECB Chief Economist, Philip Lane, explained that the central bank will provide enough monetary stimulus to make sure governments, companies and households have access to cheap credit throughout the coronavirus crisis.

And perhaps, that is the crux of the problem we face.  Despite investor optimism that the future is bright, and despite central banks’ proven inability to get funding to those most in need, namely individual households, those same central banks continue to do the only thing they know how to do, print more money, and by extension fund governments and large companies, who already have access to funding.  As the saying goes, the rich get richer.

The cycle goes as follows: central banks cut interest rates => investors move out the risk curve seeking returns => corporations and governments issue more debt at cheaper levels => an excess (and ultimately unsustainable) amount of debt outstanding.  Currently, that number, globally, is approaching 400% of GDP, and on current trends, has further to go.  The problem is, repayment of this debt can only be achieved in one of two ways, realistically, neither of which will be pleasant.  Either, inflation actually begins to rise sufficiently to diminish the real value of the debt or we get to a debt jubilee, where significant portions are simply written off.

If you were ever wondering why central banks are desperate for higher inflation, this is your answer.  While they are mostly economists, they still recognize that inflation is exactly the kind of debt destructive force necessary to eventually balance the books.  It will take time, even if they can manage the rate of inflation, but their firmly held belief is if they could just get inflation percolating, all that debt would become less of a problem.  At least for the debtors. Creditors may not feel the same excitement.

On the other hand, the debt jubilee idea is being bandied about in many forms these days, with the latest being the cancellation of student debt outstanding.  That’s $1.6 trillion that could be dissolved with the signing of a law.  Now, who would pay for that?  Well, I assure you it is not a free lunch.  In fact, the case could be made that it is this type of action that will lead to the central banks’ desired inflation outcome.  Consider, wiping out that debt would leave $1.6 trillion in the economy with no corresponding liabilities.  That’s a lot of spending power which would suddenly be used to chase after a still restricted supply of goods and services.  And that is just one small segment of the $100’s of trillions of dollars of debt outstanding.  The point is, there are still many hard decisions yet to be made and there are going to be winners and losers based on those decisions.  Covid-19 did not cause these issues to arise, it merely served as a catalyst to make them more widely known, and potentially, will push us toward the endgame.  Be prepared!

But that is all just background information to help us try to understand market activity a bit better.  Instead, let’s take a look at the market today, where yesterday’s risk appetite seems to have developed a bit of indigestion.  Overnight saw a mixed equity picture (Nikkei +0.4%, Hang Seng +0.1%, Shanghai -0.2%) with the magnitude of movements more muted than recent activity.  Europe, on the other hand, has been largely in the red (DAX -0.35%, CAC -0.3%, FTSE -1.15%) as apparently Mr Lane’s comments were not seen as supportive enough, or, more likely, markets are simply overbought after some enormous runs this month, and are seeing a bit of profit taking.  US futures are mixed at this point, with the DOW and S&P both down -0.5%, while the NASDAQ is up about 0.3%.  The biggest stock market story is S&P’s decision to add Tesla to the S&P500 index starting next month, which has helped goose the stock higher by another 10%.

Bond markets this morning are a tale of three regions.  Asian hours saw Australian and New Zealand bonds fall sharply with 10-year yields rising about 7 basis points, as the RBA’s YCC in the 3-year space is starting to really distort markets there.  However, in Europe, we are seeing a very modest bond rally, with yields slightly softer, about 1 basis point throughout the continent, and Treasuries have seen yields slip 1.5 basis points so far in the session. Clearly, a bit of risk-off attitude here.

FX markets, however, are not viewing the world quite the same way as the dollar, at least vs. its G10 counterparts, is somewhat softer, although has seen a more mixed session vs. EMG currencies.  Leading the way in the G10 is GBP (+0.5%) as stories make the rounds that a Brexit deal will be agreed next week.  Now, they are just stories, with no official comments, but that is the current driver.  Next in line is JPY (+0.3%) which perhaps we can attribute to a risk-off attitude, especially as CHF (+0.25%) is moving the same way.  As to the rest of the bloc, gains have been much smaller, and there has been absolutely zero data released this morning.

In the EMG bloc, EEMEA currencies have been the weak spot, with HUF (-0.5%) the worst performer, although weakness in PLN (-0.3%) and RUB (-0.25%) is also clear.  This story has to do with the Hungarian and Polish vetoes of the EU budget and virus recovery fund, as they will not accept the rule of law conditions attached by Brussels.  You may have heard about the concerns Brussels has over these two nations move toward a more nationalist viewpoint on many issues like immigration and judicial framework, something Brussels abhors.  On the positive side, BRL (+0.5%) has opened strongly, and CNY (+0.45%) led the Asian bloc higher overnight.  The China story continues to focus on the apparent strength of their economic rebound as well as the fact that interest rates there are substantially higher than elsewhere in the world and drawing in significant amounts of investor capital.  As to BRL, it seems the central bank has hinted they will be increasing the amount of dollars available to the market, thus adding to pressure on the dollar.

On the data front, yesterday saw a weaker than expected Empire Mfg number, but this morning is really the week’s big number, Retail Sales (exp 0.5%, 0.6% ex autos) as well as IP (1.0%) and Capacity Utilization (72.3%) a little later. On the Fed front, we have Chairman Powell speaking at 1:00, but not a speech, part of a panel, as well as another five Fed members on the tape at 3:00.  However, I anticipate the only thing we will learn is that the entire group will back up Vice-Chair Clarida regarding additional actions.

Despite the lack of risk appetite, the dollar is on its back foot this morning.  Ironically, I expect that we will see a rebound in risk appetite, rather than a rebound in the dollar as the session unfolds.

Good luck and stay safe
Adf

Growth’s Pace Declining

Posted on by

Lagarde said, ‘what we have detected’
“More rapidly than [we] expected”
Is growth’s pace declining
And so, we’re designing
New ways for cash to be injected

The pundits were right about the ECB as they left policy unchanged but essentially promised they would be doing more in December.  In fact, Madame Lagarde emphasized that ALL their tools were available, which has been widely interpreted to mean they are considering a cut to the deposit rate as well as adding to their QE menu of APP, PEPP and TLTRO programs.  Interviewed after the meeting, Austrian central bank president, Robert Holtzmann, generally considered one of the most hawkish ECB members, confirmed that more stimulus was coming, although dismissed the idea of an inter-meeting move.  He also seemed to indicate that a further rate cut was pointless (agreed) but that they were working on even newer tools to utilize.  Meanwhile, Lagarde once again emphasized the need for more fiscal stimulus, which has been the clarion call of every central banker in the Western world.

As an aside, when considering central bank activities during the pandemic, the lesson we should have learned is; not only are they not omnipotent, neither are they independent.  The myth of central bank independence is quickly dissipating, and arguably the consequences of this process are going to be long-lasting and detrimental to us all.  The natural endgame of this sequence will be central bank financing of government spending, a situation which, historically, has resulted in the likes of; Zimbabwe, Venezuela and the Weimar Republic.

Now, back to our regularly scheduled programming.

Meanwhile, this morning brought the first set of European GDP data, following yesterday’s US Q3 print.  By now, you have surely heard that the US number was the highest ever recorded, +33.1% annualized, which works out to about +7.4% rise in the quarter.  While this was slightly better than expected, it still leaves the economy about 8.7% below its pre-Covid levels.  As to Europe, France (+18.2%), Germany (+8.2%), Italy (+16.1%) and the Eurozone as a whole (+12.7%) all beat expectations.  On the surface this all sounds great.  Alas, as we have discussed numerous times in the past, GDP data is very backward looking.  As we finish the first month of Q4, with lockdowns being reimposed across most of Europe, it is abundantly clear that Q4 will not continue this trend.  Rather, the latest forecasts are for another negative quarter of growth, adding to the woes of the global economy.

Keeping yesterday’s activities in mind, it cannot be surprising that the euro was the weakest performer around.  In fact, other than NOK, which suffered from the sharp decline in oil prices, even the Turkish lira outperformed the single currency.  If the ECB is promising to open the taps even wider than they are already, the euro has further to fall.  This has been my rebuttal to the ‘dollar is going to collapse’ crowd all along; whatever you think the Fed will do, there is literally a zero probability that the ECB will not respond in kind.  Europe cannot afford for the euro to strengthen substantially, and the ECB will do everything in its power to prevent that from happening, right up to, and including, straight intervention in the FX markets should the euro trade above some fail-safe level.  As it is, we are nowhere near that situation, but just remember, the euro is capped.

Turning to markets this morning, risk appetite remains muted, at best.  Asian equity markets ignored the US rebound and sold off across the board with the Hang Seng (-1.95%) leading the way lower, but closely followed by both the Nikkei and Shanghai, at -1.5% each.  European markets are trying to make the best of the GDP data, as well as the idea that the ECB is going to offer support, but that has resulted in a lackluster performance, which is, I guess, better than a sharp decline.  The DAX (-0.4%) and FTSE 100 (-0.35%) are both under a bit more pressure than the CAC (+0.1%), but the French index is hardly inspiring.  As to US futures, the screen is dark red, with all three futures gauges down about 1.0% at this hour.  One other thing to watch here is the technical picture.  US equity markets certainly appear to have put in a short-term double top, which for the S&P 500 is at 3600.  Care must be taken as many traders will be looking to square up positions, especially given that today is month end, and a break of 3200, which, granted, is still 3% away, could well open up a much more significant correction.

Once again, bond market behavior has been out of sync with stocks as in Europe this morning we see bonds under some pressure and yields climbing about 1 basis point in most jurisdictions despite the lackluster equity performance.  And despite the virtual promise by the ECB to buy even more bonds. Treasuries, meanwhile, are unchanged this morning, but that is after a sharp price decline (yield rally) yesterday, which took the 10-year back to 0.82%.  With the US election next week, it appears there are many investors who are reducing exposures given the uncertainty of the outcome.  But, other than a strong Blue wave, where market participants will assume a massive stimulus bill and much steeper yield curve, the chance for a more normal risk-off performance in Treasuries, seems high.  After all, while growth in Q3 represented the summer reopening of the economy, we continue to hear of regional shutdowns in the US as well, which will have a detrimental impact on the numbers.

And lastly, the dollar, which today is mixed to slightly softer.  Of course, this is after a week of widespread strength.  In fact, the only G10 currency that outperformed the greenback this week is the yen, which remains a true haven in most participants’ eyes.  Today, however, we are seeing SEK (+0.4%) leading the way higher followed by GBP (+0.3%) and NOK (+0.2%).  Nokkie is consolidating its more than 3% losses this week and being helped by the fact that the oil price, while not really rallying, is not falling either.  The pound, too, looks to be a trading bounce, as it fell sharply yesterday, and traders have taken the Nationwide House price Index data (+5.8% Y/Y) as a positive that the economy there is not collapsing.  Finally, SEK seems to be benefitting from the fact that Sweden is not being impacted as severely by the second wave of the virus, and so, not forced to shut down the economy.

In the emerging markets, the picture is mixed, with about a 50:50 split in performance.  Gainers of note are ZAR (+0.7%), which seems to be a combination of trading rebound and the benefit from gold’s modest rebound, and CNY (+0.4%), which continues to power ahead as confidence grows that the Chinese economy is virtually back to where it was pre-pandemic.  On the downside, TRY (-0.5%) continues to be troubled by President Erdogan’s current belligerency to the EU and the US, as well as his unwillingness to allow the central bank to raise rates.  Meanwhile, RUB (-0.35%) is continuing its weeklong decline as, remember, Russia continues to get discussed as interfering in the US elections and may be subject to further sanctions in their wake.

Once again, we have important data this morning, led by Personal Income (exp +0.4%) and Personal Spending (+1.0%); Core PCE (1.7% Y/Y); Chicago PMI (58.0) and Michigan Sentiment (81.2).  Arguably, the PCE data is what the Fed will be watching.  It has been rising rapidly, although this month saw CPI data stall, and that is the expectation here as well.  Now, the Fed has been pretty clear that inflation will have to really pick up before they even think about thinking about raising rates, but that doesn’t mean they aren’t paying attention, nor that the market won’t respond to an awkwardly higher print.  If inflation is running hotter than expected, it has the potential to mean the Fed will be less inclined to ease further, and that is likely to help the dollar overall.  However, barring a sharp equity market decline today, and given the dollar’s strength all week, I expect we will see continued consolidation with very limited further USD strength.

Good luck, good weekend and stay safe
Adf

There is Trouble

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It seems that the virus mutated
In Spain, which has now complicated
The efforts by France
To alter their stance
On lockdowns, with new ones created

In Germany, too, there is trouble
With cases, this week, set to double
So, Madame Lagarde
Will simply discard
Her fears, and inflate the bond bubble

The second wave of infections, or perhaps the third, is clearly washing over Europe with Covid-19 cases surging across the continent.  The situation has deteriorated so rapidly that, in short order, both Germany and France have ordered lockdowns, closing restaurants, bars, gyms and theaters for the next month.  Public gatherings are being restricted to ten people drawn from only two families as hospital beds throughout both nations fill up quickly.  Research to be released this morning has identified a new strain of the virus that apparently originated in Spanish farm workers during the summer and has been the main version in the latest outbreak.  It seems that it was spread by people returning to their homelands from Spanish holidays.

Meanwhile, Spain and Italy are also contemplating nationwide lockdowns as infections surge there, and even countries that saw a limited outbreak last spring, like the Czech Republic, are under severe pressure now.  Add it all up and you have a recipe for a fourth quarter of negative growth on the continent.  Seemingly, the only part of the Eurozone economy that is performing well are German capital goods exporters as their main market, China, has been rebounding.

With this as background, now consider that you are Christine Lagarde and chairing the ECB policy meeting today.  While the ECB has made significant efforts to support every Eurozone nation during the current crisis, clearly the situation remains fraught.  Is there anything that she can do to shore up confidence?

The punditry is pretty united in their views at this time, not expecting any policy changes at today’s meeting in the belief that the council will want to wait for updated economic forecasts in December before adding to the PEPP. Estimates for an increase in that QE program have coalesced around €500 billion.  If anything, the only expectations for today are for Lagarde to essentially promise that the ECB will announce the expansion of their policy accommodation in December.  While this may well be the outcome, if there is one thing we should have learned from Signor Draghi’s time in Lagarde’s chair, it is that acting sooner than expected and larger than expected are the only ways for the ECB to alter the narrative.  And right now, the narrative is leaning toward the ECB is powerless to prevent the next downturn.

With this in mind, and recognizing that Lagarde, while perhaps not the most sophisticated economic mind on the council, is clearly the best politician, and with the new gloom and doom reports coming in daily, if not hourly, I think there is a decent probability that the ECB acts today.  After all, if they are certain they are going to increase the PEPP program in December, what is the advantage to waiting.  And while I don’t think that a rate cut is in the cards yet, there is a non-zero probability of that too.  News earlier this week, that didn’t get much press in the US, highlighted that small German banks, of which there are nearly 1800, have started to charge depositors to maintain deposits from the first euro.  So, savings accounts are going to be taxed subject to negative interest.  If banks are starting to pass on the costs of ECB monetary policy, then the ECB is likely to be far more comfortable in cutting rates further as they recognize that the banking system there is likely to have halted the decline in lending spreads.  Hence, my out of consensus view is we see some definitive action from the ECB this morning.

Leading up to that meeting, with the announcement to be made at 8:45 this morning (Daylight Savings time has already occurred there), markets are rebounding modestly from yesterday’s risk reducing session.  I’m sure you are all aware of he size of the decline in stock market indices yesterday, with US markets falling ~3.5%, their worst single day performance since June.  What was quite interesting about the session, though, was while equity risk was abandoned, haven assets, which had a bid early in the session, lost their luster as well.  In fact, Treasury bonds wound up the day unchanged, and yields there are actually almost a basis point higher this morning.

A quick tour of equity markets shows that Asian markets were somewhat lower (Nikkei -0.4%, Hang Seng -0.5%, Shanghai +0.1%), although they all closed well off the worst levels of the session.  European bourses are ever so slightly higher, on average, with the DAX (+0.4%), CAC (+0.1%) and FTSE 100 (+0.3%) all in the green.  The big outlier here is Spain’s MIB (-0.95%), which is feeling the pain of the latest story about the genesis of the new strain of the virus, as well as responding to the announcement by PM Sanchez that the national state of emergency has been extended for six months, meaning lockdowns are almost certainly coming there soon.  US futures, meanwhile, are currently up about 0.5%-0.7%, although that is well off the earlier session highs.  The question remains is this a modest trading bounce, or was yesterday an aberration?

Unlike the Treasury market, with a modest uptick in yields, Bunds and OATs are both rallying with 1 basis point declines.  It seems I am not the only one who thinks the ECB may act today, as any early action should see an uptick in demand for European paper.  Oil, on the other hand, is having another tough day, down 3.5%, and at $36/bbl, WTI is back to its lowest level since mid-June.  Fears over slipping demand alongside growing supply are infiltrating the market.

As to the dollar, early price activity was mixed, but it is seeing some demand in the past hour and is now largely higher on the day.  NOK (-0.95%) is the laggard again, following oil lower, but we are seeing weakness, albeit modest weakness, from SEK (-0.4%) and EUR (-0.2%).  Certainly, if I am correct in my view on the ECB, we should see the euro decline further.  On the plus side, only JPY (+0.25%) is gaining on the greenback as the BOJ’s lack of policy action combined with a background of fear over the new lockdowns and their impact on economic activity, has some Japanese investors taking their money home.  This is a trend that has legs.

EMG currencies have also turned from a mixed bag to a nearly universal decline, although the losses are not enormous.  For a change of pace, MXN (-0.7%) is the laggard today, suffering from the ongoing oil price declines, and pushing TRY (-0.6%) back to only the second worst performing currency.  But EEMEA currencies are all lower in the 0.3%-0.5% range.  In fact, the only gainer today is CNY (+0.25%) which continues to benefit from investment inflows as the Chinese economy continues to be the world’s top performer.

On the data front, today we see the most important points of the week.  Initial Claims (exp 770K) and Continuing Claims (7.775M) have been falling but remain substantially higher than even during the worst recessions in the past 75 years.  Of possibly more interest will be this morning’s first reading of Q3 GDP (exp 32.0%), which while it will be a record, will not make up for the loss in Q2.  And right after those are released, we hear from the ECB, so the 30 minutes between 8:30 and 9:00 have the chance for some fireworks.

In the end, it appears to me that risk will continue to be shed leading up to the election, and with that activity, we will see the dollar (and yen) grind higher.

Good luck and stay safe
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Giddy and Squiffed

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The narrative’s starting to shift
As good news is getting short shrift
From ‘Here comes the boom’
To darkness and gloom
Short sellers are giddy and squiffed

In Europe the data is fading
While Covid continues invading
At home in the States
All our interest rates
Are falling amidst active trading

Just two weeks ago, equity markets were pushing higher, and despite the growing resurgence in Covid cases worldwide, it looked like new all-time highs were in store for investors.  After all, there was so much optimism that a stimulus package would be enacted before the election, and there was so much optimism that a vaccine would be approved in short order, with the combination of those events resulting in the final leg of that elusive V-shaped recovery.  There was hope on the Brexit front, and the story of the blue wave in the US election was everywhere, which seemed (for some reason) to be seen as a positive for risk assets.  Ah…the good old days.

But that is soooo two weeks ago!  This morning, the world looks a different place.  Seemingly, every headline revolves around either government reactions to quickly inflating Covid case counts (Curfews in Spain, German restaurants, bars, clubs and gyms to be closed for a month, Chicago closing restaurants for a month), or central bank responses to these issues (Bank of Canada to reiterate lower forever for longer, ECB to describe expansion in PEPP).  And guess what?  Investors are no longer feeling the love of the longest bull market in history.  Risk assets, overall, are being tossed out as quickly as possible and haven assets are in demand.  While yesterday had many risk-off features, today is the textbook definition of a risk-off session.

Let’s dive into the equity market first, the asset class that most associate with risk appetite.  While Asian markets were mixed (Nikkei -0.3%, Hang Seng -0.3%, Shanghai +0.45%), Europe really spit the bit this morning, with the FTSE 100 (-1.7%) the best performer of the lot.  The DAX (-3.2%) and the CAC (-2.9%) are both under significant pressure, as is Spain’s MIB (-2.9%) after the curfew announcement.  Not only have all these markets fallen below key moving averages, but the DAX (-11% from the recent high) and CAC (-9% from recent high) have either entered or are nearing correction territory.  The big difference between European markets and those in the US has been that post-Covid, European markets never came close to regaining the pre-Covid highs.  So, these declines are quite painful.  As to US futures markets, all are much lower, with DOW futures down by more than 1.5%, and even NASDAQ futures down by more than 1.0%.  In other words, equity investors are running scared today.

What about bond markets, you may ask?  We couldn’t have a more classic risk-off session in government bond markets than we are seeing today.  Treasury yields are down 2 basis points in the 10-year, which takes the move since Friday’s highs to 11 basis points.  Perhaps that much steeper curve is not in our immediate future.  Meanwhile, in Europe, Bunds are 2.5bps lower, now trading at their lowest yield (-0.64%) since the spike in March.  But we are seeing buying interest in OAT’s (-1.2bps) and Gilts (-2.3bps) as well.  At the same time, the PIGS are showing their true colors, government bonds that are risk assets, not havens.  This morning, Portugal (+1.4bps), Italy (+4.4bps), Greece (+5.3bps) and Spain (+1.0bps) have all seen selling interest, with the two countries with the biggest debt loads seeing the worst outcome.  I would also note that Canadian Treasury yields have fallen 3 basis points this morning as investors prepare to hear from Governor Tiff Macklem at 11:00, after the BOC announcement, with near universal expectations that he will reiterate the fact that the BOC will not be raising rates for many years to come, as they seek to sustainably achieve 2.0% inflation.

Nobody will be surprised that commodity markets are under pressure this morning, with oil really suffering (WTI -3.8%), and the metals and agricultural complexes also feeling the heat.

Finally, as we turn to the FX market, we once again see classic risk-off behavior, with the dollar higher against all its G10 brethren except the yen (+0.2%).  Leading the way lower is NOK (-1.5%) as the weak oil price is taking a significant toll on the krone, but also SEK (-1.0%), NZD (-0.65%) and GBP (-0.55%) are under serious pressure.  Prior to today’s decline, SEK had rallied more than 5% over the past month and was the top performing G10 currency during that time.  Sweden’s approach to Covid, while blasted in the press back in March, turned out to have been pretty successful, as they are the only country in Europe not suffering a second wave of note.  As such, their economy has outperformed the rest of Europe, and the currency benefitted accordingly.  But not today, when risk is out the window.  As to Kiwi, the news that the government is forcibly removing infected people from their homes and placing them in government run facilities has certainly tarnished the image of the country being a free land.  The resurgence in the UK, and truthfully throughout all of Europe, as well as the government responses is making clear the idea that whatever economic gains were made in Q3, they are likely to be reversed in Q4.  So, while things are no picnic in the US, the situation here seems to be better than there.

In the emerging markets, we are also seeing a significant sell-off in most currencies.  TRY (-1.3%), MXN (-1.25%) and RUB (-1.15%) are the worst performers, with the latter two clearly under pressure from declining oil prices while Turkey continues to suffer capital flight as the President Erdogan courts more sanctions from Europe and the central bank is forbidden restricted from raising rates to protect a free-falling currency by the president.  But the weakness is pervasive as the CE4 are all much weaker, led by PLN (-1.1%) and HUF (-1.0%) and the rand (-0.85%) and even KRW (-0.45%) are falling.  LATAM currencies have yet to open, but after yesterday’s performance (BRL -1.45%), they are all called lower at this hour.

Interestingly, there has been no data of note released anywhere in the world, and we are not expecting any here in the US either.  So, this market movement is far more about market positioning and market sentiment, two things which are the direct consequences of the narrative.  We have discussed the record short positions in Treasury bond futures as the narrative had focused on the assumed Biden victory in the election resulting in massive fiscal stimulus and correspondingly massive debt issuance driving bond prices lower and yields higher.  The thing is, the trajectory of recent polls shows that the certainty of a Biden victory is fading, which would naturally change that piece of the narrative.  It is critical to remember, as one is managing risk, that markets move for many reasons, with clear catalysts like data points or election results, driving a minority of the activity.  Most movement comes from narrative shifts and position adjustments as well as particular flows in a currency or other instrument.  The point is, if the narrative is shifting like I described, and I do believe it is doing so, then we have further risk reduction in store.

Good luck and stay safe
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