Tag Archives: #riskoff

About to Retrace

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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

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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
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Out of Hand

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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

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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

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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
Adf

 

Money to Burn

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If Covid is back on the rise
It’s likely it will compromise
The mooted return
Of money to burn
Instead, growth it will tranquilize

For the past two or three months, market behavior has been driven by the belief that a V-shaped recovery was in the offing as a combination of massive fiscal and monetary stimulus alongside a flatter infection curve and the reopening of economies would bring everything back close to where it was prior to the outbreak of Covid-19. However, since last Thursday, that narrative has lost more than a few adherents with the growing concern that the dreaded second wave of infections was starting to crest and would force economies, that were just starting to reopen, back into hibernation.

The most recent piece of evidence for the new storyline comes from Beijing, where the weekend saw the reporting of 100 new infections after several weeks of, allegedly, zero infections in the country. This has resulted in the Chinese government re-imposing some restrictions as well as massively increasing testing again. Chinese data last night showed that the economy remains under significant pressure, although analysts fell on both sides of the bullish-bearish spectrum. The four key data points are Retail Sales (-13.5% YTD, up from April’s -16.2% and right on the economic estimates); IP (-2.8% YTD, up from -4.9% and slightly better than -3.0% expected); Fixed Asset Investment (-6.3% YTD vs. -10.3% last month and -6.0% expected); and the Jobless Rate (5.9%, as expected and down from 6.0% last month). My read is that the Chinese economy remains quite troubled, although arguably it has left the worst behind it. The PBOC continues to inject liquidity into the market and the Chinese government continues to add fiscal support. Unfortunately for President Xi, China remains an export led economy and given the complete demand destruction that has occurred everywhere else in the world, the near-term prospects for Chinese growth would seem to be muted at best.

For political leaders everywhere, this is not the story that they want to tell. Rather, the narrative of the V-shaped recovery was crucial to maintaining some level of confidence for their populations as well as for their own popularity. Remember, at the government level, everything is political, so crafting a story that people believe accept is just as important, if not more so, than actually implementing policies that work to address the problems.

Another chink in the narrative’s armor is the fact that despite the approach of the summer solstice, and the northern hemisphere warming that accompanies it, infection levels are growing in many different places; not only Beijing, but Korea, Japan, California, Texas and Florida, all locations that had begun to reopen their respective economies due to reduced infections. Remember, a key part of the narrative has been that the virus, like the ordinary flu, thrives in cold weather, and warmth would be a natural disinfectant, if you will. While it remains too early to claim this is not the case, the recent flare-ups are not helping that storyline.

Ultimately, what is abundantly clear is we still don’t know that much about the virus and its potential and weaknesses. While we will certainly see more businesses reopen over the next weeks, it is unclear how long it will take for actual economic activity to start to revert to any semblance of normal. Equity markets have been wearing rose-colored glasses for at least two months. Beware of those slipping off and haven assets regaining their bid quite quickly.

So, a quick look at markets this morning simply reinforces the changing narrative, with equity markets lower around the world, bond markets rallying and the dollar reasserting itself. Overnight, Asian markets all fell pretty sharply, led by the Nikkei’s 3.5% decline, but also seeing weakness in the Hang Seng (-2.2%) and Shanghai (-1.0%). European indices are also bleeding this morning, with the DAX (-0.9%) and CAC (-0.8%) slipping on increasing concerns over the growth of the second wave. US futures will not miss this party, with all three indices sharply lower, between 1.5% and 2.0%.

In the bond market, Treasury yields are sliding, down 3 basis points, as haven assets are in demand. We are seeing increased demand across European bond markets as well, surprisingly even in the PIGS, although that seems more in anticipation of the almost certain increase in the pace of ECB QE. What is clear, however, is that we are seeing a rotation from stocks to bonds this morning.

Finally, the dollar is feeling its oats this morning, rallying against the high-beta G10 currencies with AUD the leading decliner (-0.9%) followed by NOK (-0.6%) and CAD (-0.5%). The latter two are clearly feeling the pressure from oil’s declining price, down 1.75% as I type, although it had been even lower earlier in the session. While we do see both JPY and CHF slightly firmer, the emphasis is on slightly, with both less than 0.1% higher than Friday’s closing levels. Meanwhile the euro and pound are both slightly softer, also less than 0.1% off Friday’s levels, which simply implies a great deal of uncertainty over the next big move. This is corroborated by price action in the option market, where implied volatility continues to climb, as 1mo EURUSD volatility is up 1.3 points in the past week. Of perhaps more interest is the fact that the 1mo risk reversal has flipped from 0.5 for euro calls to 0.35 for euro puts in the same time frame. Clearly, concern is growing that all is not right with the world.

As to the EMG bloc, one would not be surprised to see the Mexican peso as the biggest laggard this morning, down 1.5% as the combination of declining oil prices, increasing infections and risk reduction all play into the move. Asian currencies did not have a good evening, led by KRW (-1.0%) which suffered from a combination of concern over the US-Korean alliance (as the US withdrew some troops unexpectedly and continues to demand more payment for protection) as well as some warmongering from the North. But we have also seen weakness across the rest of the region, with declines in the 0.2%-0.5% range nearly universal. Too, the rand is under pressure this morning, falling 1.0%, on what appears to be broad-based risk reduction as there are no specific stories to note there.

Data this week is on the light side with Retail Sales tomorrow likely to garner the most attention.

Today Empire Manufacturing -30.0
Tuesday Retail Sales 8.0%
  -ex autos 5.3%
  IP 3.0%
  Capacity Utilization 66.9%
Wednesday Housing Starts 1100K
  Building Permits 1250K
Thursday Initial Claims 1.29M
  Continuing Claims 19.65M
  Philly Fed -25.0
  Leading Indicators 2.4%

Source: Bloomberg

We also hear from six Fed speakers in addition to the Chairman’s congressional testimony on Tuesday and Wednesday. Clearly, it will be the latter that keeps everyone most interested. There are those who complain that Powell should have done more last week, starting YCC or adding more stimulus, but that remains a slight minority view. Most mainstream economists seem to believe that we are fast approaching the point where excessive central bank largesse is going to create much bigger problems down the road. In fact, ironically, I believe that is one of the reasons we are in risk-off mode overall, growing concerns that the future is not as bright as markets have priced to date.

My sense is that the dollar is set to end its slide overall and start to regain traction as the reality that the V-shaped recovery is not coming begins to hit home. Hedgers beware, and don’t miss these opportunities.

Good luck and stay safe
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Jay Was Thinking

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If anyone thought Jay was thinking
‘Bout raising rates while growth was sinking
The chairman was clear
That long past next year
Their balance sheet will not be shrinking

The money quote: “We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates,” said Mr. Powell.  And this pretty much sums up the Fed stance for the time being.  While there are those who are disappointed that the Fed did not add to any programs or announce something like YCC or, perhaps, more targeted forward guidance, arguably the above quote is even more powerful than one of those choices.  Frequently it is the uncertainty over a policy’s duration that is useful, not the policy itself.  Uncertainty prevents investors from anticipating a change and moving markets contrary to policymakers’ goals.  So, for now, there is no realistic way to anticipate the timing of the next rate hike.  Perhaps the proper question is as follows: is timing the next hike impossible because of the lack of clear targets?  Or is it impossible because there will never be another rate hike?

What the Fed did tell us (via the dot plot) is that only two of the seventeen FOMC members believe interest rates will be above 0.0% in 2022 (my money is on Esther and Mester, the two most hawkish members), but mercifully, not a single dot in the dot plot was in negative territory.  They also expressed a pretty dour view of the economy as follows:

 

  2020 2021 2022
Real GDP -6.5% 5.0% 3.5%
Core PCE 1.0% 1.5% 1.7%
Unemployment 9.3% 6.5% 5.5%

Source: Bloomberg

It is, of course, the 11.5% gain from 2020 to 2021 that encourages the concept of the V-shaped recovery as evidenced by simply plotting the numbers (including 2019’s 2.3% to start).

Screen Shot 2020-06-11 at 9.30.05 AM

So, perhaps the bulls are correct, perhaps the stock market is a screaming buy as growth will soon return and interest rates will remain zero for as far as the eye can see.  There is, however, a caveat to this view, the fact that the Fed is notoriously bad at forecasting GDP growth over time.  In fact, they are amongst the worst when compared with Wall Street in general.  But hey, at least we understand the thesis.

Another interesting outcome of the meeting was the tone of the press conference, where Chairman Jay sounded anything but ebullient over the current economic situation, especially the employment situation.  And it is this takeaway that had the biggest market impact.  After the press conference, equity markets in the US sold off from earlier highs (the NASDAQ set another all-time high intraday) and Treasuries rallied with yields falling again.  In other words, despite the prospect of Forever ZIRP (FZ), equity investors seemed to lose a bit of their bullishness.  This price action has been in place ever since with Asian equity markets all falling (Nikkei -2.8%, Hang Seng -2.3%, Shanghai – 0.8%) and Europe definitely under pressure (DAX -2.1%, CAC -2.2%, FTSE 100 -2.0%).  US futures are also lower with the Dow (-1.9%) currently the laggard, but even NASDAQ futures are lower by 1.1% at this hour.

It should be no surprise that bond markets around the world are rallying in sync with these equity declines as the combination of risk-off and the prospect for FZ lead to the inevitable conclusion that lower long term rates are in our future.  This also highlights the fact that the Fed’s concern over the second part of its mandate, stable prices, has essentially been set aside for another era.  The belief that inflation will remain extremely low forever is clearly a part of the current mindset.  Yesterday’s CPI (0.1%, 1.2% core) was simply further evidence that the Fed will ignore prices going forward.  So, 10-year Treasury yields are back to 0.7% this morning, 20 basis points below last Friday’s closing levels.  In other words, the impact of last Friday’s NFP number has been erased in four sessions.  But we are seeing investors rotate from stocks to bonds around the world, perhaps getting a bit nervous about the frothiness of the recent rallies.  (Even Hertz, the darling of the Robinhooders, is looking like Icarus.)

With risk clearly being jettisoned around the world, it should be no surprise that the dollar has stopped falling, and in fact is beginning to rally against almost all its counterparts.  While haven assets like CHF (+0.2%) and JPY (+0.1%) are modestly higher, NOK (-0.9%) and AUD (-0.85%) are leading the bulk of the G10 lower.  Norway is suffering on, not only broad dollar strength, but oil’s weakness this morning, with WTI -3.1% on the session.  As to Aussie, the combination of weaker commodity prices, the strong dollar, and market technicals as it once again failed to hold the 0.70 level, have led to today’s decline.

Emerging market activity is also what you would expect in a risk-off session, with MXN (-1.6%), ZAR (-1.1%) and RUB (-0.7%) leading the way lower.  Obviously, oil is driving both MXN and RUB, while ZAR is suffering from the weakness in the rest of the commodity complex.  I think the reason that the peso has fallen so much further than the ruble is that MXN has seen remarkable gains over the past month, more than 13% at its peak, and so seems overdue for a correction.  One notable exception to this price action today is THB, which is higher by 0.65% on a combination of reports of a fourth stimulus package and a breach of the 200-day moving average which got technicians excited.

This morning’s data brings the latest Initial Claims data (exp 1.55M), as well as Continuing Claims (20.0M) and PPI (-1.2%, 0.4% core).  While nobody will care about the latter, there will be ongoing intense scrutiny on the former as Chairman Jay made it abundantly clear that employment is the only thing the Fed is focused on for now.  With the FOMC meeting behind us, we can expect to start to hear from its members again, but on the schedule, nothing happens until next week.

It is not hard to make the case that both the euro and pound have been a bit toppish at recent levels, and with risk decidedly off today, further declines there seem quite viable.

 

Good luck and stay safe

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Value, Nought

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In college Econ 101
Professors described the long run
As when we all died
Like Keynes had replied
Debating a colleague for fun

However, the rest that they taught
Has turned out to have, value, nought
Their models have failed
While many have railed
That people won’t do what they ought

Observing market activity these days and trying to reconcile price action with the theories so many of us learned in college has become remarkably difficult. While supply and demand still seem to have meaning, pretty much every construct more complex than that turns out to have been a description of a special case and not a general model of behavior. At least, that’s one conclusion to be drawn from the fact that essentially every forecast made these days turns out wrong while major pronouncements, regarding the long-term effect of a given policy, by esteemed economists seem designed to advance a political view rather than enhance our knowledge and allow us to act in the most effective way going forward. Certainly, as merely an armchair economist, my track record is not any better. Of course, the difference is that I mostly try to highlight what is driving markets in the very short term rather than paint a picture of the future and influence policy.

I bring this up as I read yet another article this morning, this by Stephen Roach, a former Chairman of Morgan Stanley Asia and current professor at Yale, about the imminent collapse of the dollar and the end of its status as the world’s reserve currency. He is not the first to call for this, nor the first to call on the roster of models that describe economic activity and determine that because one variable has moved beyond previous boundaries, doom was to follow. In this case growth of the US current account deficit will lead to the end of the dollar’s previous role as reserve currency. Nor will he be the last to do so, but the consistent feature is that every apocalyptic forecast has been wrong over time.

This has been true in Japan, where massive debt issuance by the government and massive debt purchases by the BOJ were destined to drive inflation much higher and weaken the yen substantially. Of course, we all know that the exact opposite has occurred. This has been true around the world where negative interest rates were designed to encourage borrowing and spending, thus driving economic growth higher, when it only got half the equation right, the borrowing increase, but it turns out spending on shares was deemed a better use of funds than spending on investment, despite all the theories that said otherwise.

Ultimately, the point is that despite the economics community having built a long list of very impressive looking and sounding models that are supposed to describe the workings of the economy, those models were built based on observed data rather than on empirical truths. Now that the data has changed, those models are just no longer up for the task. In other words, when it comes to forecasting models, caveat emptor.

Turning to the markets this morning, equity markets seem to have stopped to catch their collective breath after having recouped all of their March losses. In fact, the NASDAQ actually set a new all-time high yesterday, amid an economy that is about to print a GDP number somewhere between -20% and -50% annualized in Q2.

I get the idea of looking past the short-run problems, but it still appears to me that equity traders are ignoring long-run problems that are growing on the horizon. These issues, like the wave of bankruptcies that will significantly reduce the number of available jobs, as well as the potential for behavioral changes that will dramatically reduce the value of entire industries like sports and entertainment, don’t appear to be part of the current investment thesis, or at least have been devalued greatly. And while in the long-run, new companies and activities will replace all these losses, it seems highly unlikely they will replace them by 2021. Yet, yesterday saw US equity indices rally for the 7th day in the past eight. While this morning, futures are pointing a bit lower (SPU’s and Dow both lower by 1.2%, NASDAQ down by 0.7%), that is but a minor hiccup in the recent activity.

European markets are softer this morning as well, with virtually every major index lower by nearly 2% though Asian markets had a bit better showing with the Hang Seng (+1.1%) and Shanghai (+0.6%) both managing gains although the Nikkei (-0.4%) edged lower.

Bond markets are clearly taking a closer look at the current risk euphoria and starting to register concern as Treasury yields have tumbled 5bps this morning after a 4bp decline yesterday. We are seeing similar price action in European markets, albeit to a much lesser extent with bunds seeing yields fall only 2bps since yesterday. But, in true risk-off fashion, bonds from the PIGS have all seen yields rise as they are clearly risk assets, not havens.

And finally, the dollar is broadly stronger this morning with only the other havens; CHF (+0.3%) and JPY (+0.4%) gaining vs. the buck. On the downside, AUD is the laggard, falling 1.4% as a combination of profit taking after a humongous rally, more than 27% from the lows in March, and a warning by China’s education ministry regarding the potential risks for Chinese students returning to university in Australia have weighed on the currency. Not surprisingly, NZD is lower as well, by 1.1%, and on this risk-off day, with oil prices falling 2.5%, NOK has fallen 1.0%. But these currencies’ weakness has an awful lot to do with the dollar’s broad strength.

In the emerging markets, the Mexican peso, which had been the market’s darling for the past month, rallying from 25.00 to below 21.50 (13.5%) has reversed course this morning and is down by 1.4%. But, here too, weakness is broad based with RUB (-0.95%), PLN (-0.7%) and ZAR (-0.6%) all leading the bloc lower. The one exception in this space was KRW (+0.6%) after the announcement of some significant shipbuilding orders for Daewoo and Samsung Heavy Industries improved opinions of the nation’s near-term trade situation.

Turning to the data, although it’s not clear to me it matters much yet, we did see some horrific trade data from Germany, where their surplus fell to €3.5 billion, its smallest surplus in twenty years, and a much worse reading than anticipated as exports collapsed. Meanwhile, Eurozone Q1 GDP data was revised ever so slightly higher, to -3.6% Q/Q, but really, everyone wants to see what is happening in Q2. At home, the NFIB Small Biz Index was just released at a modestly better than expected 94.4 but has been ignored. Later this morning we see the JOLT’s Jobs data (exp 5.75M), but that is for April so seems too backward-looking to matter.

Risk is on its heels today and while hopes are growing that the Fed may do something new tomorrow, for now, given how far risk assets have rallied over the past two weeks, a little more consolidation seems a pretty good bet.

Good luck and stay safe
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Playing Hardball

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Last night China shocked one and all
With two policy shifts not too small
They’ve now become loath
To target their growth
And in Hong Kong they’re playing hardball

It seems President Xi Jinping was pining for the spotlight, at least based on last night’s news from the Middle Kingdom. On the economic front, China abandoned their GDP target for 2020, the first time this has been the case since they began targeting growth in 1994. It ought not be that surprising since trying to accurately assess the country’s growth prospects during the Covid-19 crisis is nigh on impossible. Uncertainty over the damage already done, as well as the future infection situation (remember, they have seen a renewed rise in cases lately) has rendered economists completely unable to model the situation. And recall, the Chinese track record has been remarkable when it comes to hitting their forecast, at least the published numbers have a nearly perfect record of meeting or beating their targets. The reality on the ground has been called into question many times in the past on this particular subject.

The global economic community, of course, will continue to forecast Chinese GDP and current estimates for 2020 GDP growth now hover in the 2.0% range, a far cry from the 6.1% last year and the more than 10% figures seen early in the century. Instead, the Chinese government has turned its focus to unemployment with the latest estimates showing more than 130 million people out of a job. In their own inimitable way, they manage not to count the rural unemployed, meaning the official count is just 26.1M, but that doesn’t mean those folks have jobs. At this time, President Xi is finding himself under much greater pressure than he imagined. 130 million unemployed is exactly the type of thing that leads to revolutions and Xi is well aware of the risks.

In fact, it is this issue that arguably led to the other piece of news from China last night, the newly mooted mainland legislation that will require Hong Kong to enact laws curbing acts of treason, secession, sedition and subversion. In other words, a new law that will bring Hong Kong under more direct sway from Beijing and remove many of the freedoms that have set the island territory apart from the rest of the country. While Covid-19 has prevented the mass protests seen last year from continuing in Hong Kong, the sentiments behind those protests did not disappear. But Xi needs to distract his population from the onslaught of bad news regarding both the virus and the economy, and nothing succeeds in doing that better than igniting a nationalistic view on some subject.

While in the short term, this may work well for President Xi, if he destroys Hong Kong’s raison d’etre as a financial hub, the downside is likely to be much greater over time. Hong Kong remains the financial gateway to China’s economy largely because the legal system their remains far more British than Chinese. It is not clear how much investment will be looking for a home in a Hong Kong that no longer protects private property and can seize both people and assets on a whim.

It should be no surprise that financial markets in Asia, particularly in Hong Kong, suffered last night upon learning of China’s new direction. The Hang Seng fell 5.6%, its largest decline since July 2015. Even Shanghai fell, down 1.9%, which given China’s announcement of further stimulus measures despite the lack of a GDP target, were seen as positive. Meanwhile, in Tokyo, the Nikkei slipped a more modest 0.9% despite pledges by Kuroda-san that the BOJ would implement even more easing measures, this time taking a page from the Fed’s book and supporting small businesses by guaranteeing bank loans made in a new ¥75 trillion (~$700 billion) program. It is possible that markets are slowly becoming inured to even further policy stimulus measures, something that would be extremely difficult for the central banking community to handle going forward.

The story in Europe is a little less dire, although most equity markets there are lower (DAX -0.4%, CAC -0.2%, FTSE 100 -1.0%). Overall, risk is clearly not in favor in most places around the world today which brings us to the FX markets and the dollar. Here, things are behaving exactly as one would expect when investors are fleeing from risky assets. The dollar is stronger vs. every currency except one, the yen.

Looking at the G10 bloc, NOK is the leading decliner, falling 1.1% as the price of oil has reversed some of its recent gains and is down 6% this morning. But other than the yen’s 0.1% gain, the rest of the bloc is feeling it as well, with the pound and euro both lower by 0.4% while the commodity focused currencies, CAD and AUD, are softer by 0.5%. The data releases overnight spotlight the UK, where Retail Sales declined a remarkable 18.1% in April. While this was a bit worse than expectations, I would attribute the pound’s weakness more to the general story than this particular data point.

In the EMG bloc, every market that was open saw their currency decline and there should be no surprise that the leading decliner was RUB, down 1.1% on the oil story. But we have also seen weakness across the board with the CE4 under pressure (CZK -1.0%, HUF -0.75%, PLN -0.5%, RON -0.5%) as well as weakness in ZAR (-0.7%) and MXN (-0.6%). All of these currencies had been performing reasonably well over the past several sessions when the news was more benign, but it should be no surprise that they are lower today. Perhaps the biggest surprise was that HKD was lower by just basis points, despite the fact that it has significant space to decline, even within its tight trading band.

As we head into the holiday weekend here in the US, there is no data scheduled to be released this morning. Yesterday saw Initial Claims decline to 2.44M, which takes the total since late March to over 38 million! Surveys show that 80% of those currently unemployed expect it to be temporary, but that still leaves more than 7.7M permanent job losses. Historically, it takes several years’ worth of economic growth to create that many jobs, so the blow to the economy is likely to be quite long-lasting. We also saw Existing Home Sales plummet to 4.33M from March’s 5.27M, another historic decline taking us back to levels last seen in 2012 and the recovery from the GFC.

Yesterday we also heard from Fed speakers Clarida and Williams, with both saying that things are clearly awful now, but that the Fed stood ready to do whatever is necessary to support the economy. This has been the consistent message and there is no reason to expect it to change anytime soon.

Adding it all up shows that investors seem to be looking at the holiday weekend as an excuse to reduce risk and try to reevaluate the situation as the unofficial beginning to summer approaches. Trading activity is likely to slow down around lunch time so if you need to do something, early in the morning is where you will find the most liquidity.

Good luck, have a good holiday weekend and stay safe
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Enough Wherewithal

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The Chairman explained to us all
The Fed has enough wherewithal
To counter the outbreak
But, too, Congress must take
More actions to halt the shortfall

The US equity markets led global stocks lower after selling off in the wake of comments from Chairman Powell yesterday morning. In what was a surprisingly realistic, and therefore, downbeat assessment, he explained that while the Fed still had plenty of monetary ammunition, further fiscal spending was necessary to prevent an even worse economic and humanitarian crisis. He also explained that any recovery would take time, and that the greatest risk was the erosion of skills that would occur as a huge swathe of the population is out of work. It cannot be a surprise that the equity markets sold off in the wake of those comments, with a weak session ending on its lows. It is also not surprising that Asian markets overnight followed US indices lower (Nikkei -1.75%, Hang Seng -1.45%, Shanghai -1.0%), nor that European markets are all in the red this morning (DAX -1.6%, CAC -1.7%, FTSE 100 -2.2%). What is a bit surprising is that US futures, at least as I type, are mixed, with the NASDAQ actually a touch higher, while both the Dow and S&P 500 see losses of just 0.2%. However, overall, risk is definitely on its back foot this morning.

But the Chairman raised excellent points regarding the timeline for any recovery and the potential negative impacts on economic activity going forward. The inherent conflict between the strategy of social distance and shelter in place vs. the required social interactions of so much economic activity is not a problem easily solved. At what point do government rules preventing businesses from operating have a greater negative impact than the marginal next case of Covid-19? What we have learned since January, when this all began in Wuhan, China, is that the greater the ability of a government to control the movement of its population, the more success that government has had preventing the spread of the disease. Alas, from that perspective, the inherent freedoms built into the US, and much of the Western World, are at extreme odds with those government controls/demands. As I have mentioned in the past, I do not envy policymakers their current role, as no matter the decision, it will be called into question by a large segment of the population.

What, though, are we now to discern about the future? Despite significant fiscal stimulus already enacted by many nations around the world, it is clearly insufficient to replace the breadth of lost activity. Central banks remain the most efficient way to add stimulus, alas they have demonstrated a great deal of difficulty applying it to those most in need. And so, despite marginally positive news regarding the slowing growth rate of infections, the global economy is not merely distraught, but seems unlikely to rebound in a sharp fashion in the near future. Q2 has already been written off by analysts, and markets, but the question that seems to be open is what will happen in Q3 and beyond. While we have seen equity weakness over the past two sessions, broadly speaking equity markets are telling us that things are going to be improving greatly while bond markets continue to point to a virtual lack of growth. Reading between the lines of the Chairman’s comments, he seems to be siding with the bond market for now.

Into this mix, we must now look at the dollar, and its behavior of late. This morning had seen modest movement until about 6:30, when the dollar started to rally vs. most of its G10 counterparts. As I type, NOK, SEK and AUD are all lower by 0.5% or so. The Aussie story is quite straightforward as the employment report saw the loss of nearly 600K jobs, a larger number than expected, with the consequences for the economy seen as potentially dire. While restrictions are beginning to be eased there, the situation remains one of a largely closed economy relying on central bank and government largesse for any semblance of economic activity. As to the Nordic currencies, SEK fell after a weaker than expected CPI report encouraged investors to believe that the Riksbank, which had fought so hard to get their financing rate back to 0.00% from several years in negative territory, may be forced back below zero. NOK, however, is a bit more confusing as there was no data to see, no comments of note, and the other big key, oil, is actually higher this morning by more than 4%. Sometimes, however, FX movement is not easily explained on the surface. It is entirely possible that we are seeing a large order go through the market. Remember, too, that while the krone is the worst performing G10 currency thus far in 2020, it has managed to rally more than 7% since late April, and so we are more likely seeing some ordinary back and forth in the markets.

One other comment of note in the G10 space was from BOE Governor Andrew Bailey, who reiterated that negative interest rates currently have no place in the BOE toolkit and are not necessary. While the comments didn’t impact the pound, which is lower by 0.25% as I type, it continues to be an important distinction as along with Chairman Powell, the US and the UK are the only two G10 nations that refuse to countenance the idea of NIRP, at least so far.

In the emerging markets, what had been a mixed and quiet session earlier has turned into a pretty strong USD performance overall. The worst performer is ZAR, currently down 0.9% the South African yield curve bear-steepens amid continued unloading of 10-year bonds by investors. But it is not just the rand falling this morning, we are seeing weakness in the CE4 (CZK -0.7%, HUF -0.5%, PLN -0.4%) and once again the Mexican peso is finding itself under strain. While the CE4 appear to simply be following the lead of the euro (-0.35%), perhaps with a bit more exuberance, I think the peso continues to be one of the more interesting stories out there.

Both MXN and BRL have been dire performers all year, with the two currencies being the worst two performers in the past three months and having fallen more than 20% each. Both currencies continue to be extremely volatile, with daily ranges averaging in excess of 2% for the past two months. The biggest difference is that BRL has seen a significant amount of direct intervention by the BCB to prevent further weakness, while MXN continues to be a 100% free float. The other thing to recall is that MXN is frequently seen as a proxy for all LATAM because of its relatively better liquidity and availability. The point is, further problems in Brazil (and they are legion as President Bolsonaro struggles to rule amid political fractures and Covid-19) may well result in a much weaker Mexican peso. This is so even if oil prices rebound substantially.

Turning to data, we see the weekly Initial Claims number (exp 2.5M) and Continuing Claims (25.12M), but otherwise that’s really it. While we have three more Fed speakers, Kashkari, Bostic and Kaplan, on the calendar, I think after yesterday’s Powell comments, the market may be happier not to hear their views. All the evidence points to an overbought risk atmosphere that needs to correct at some point. As that occurs, the dollar should retain its bid overall.

Good luck and stay safe
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