Tag Archives: #riskoff

Hawks Acquiesce

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In Germany and the US
The crisis made hawks acquiesce
To spending more dough
Despite and although
Things ultimately will be a mess

There is only one story of note this morning, at least from the market’s collective perspective, and that is the news that the Senate has agreed the details of a stimulus package in the US. The price tag is currently pegged at $2.0 trillion, although it would not surprise me if when this bill gets to the House, they add a bit more lard. Fiscal hawks have been set aside and ignored as the immediate concerns over the virtual halt in the US (and global) economy has taken precedence over everything else. The package offers support for small and medium sized businesses, direct cash payments to individuals and increased allocations to states in order to help them cope with Covid-19. But overall, what it does is demonstrate that the US is not going to sit by and watch as the economy slides into a deep recession.

And that seems to be the signal that markets were awaiting. We have already seen Germany discard decades of fiscal prudence in their effort to address the collapse in business activity there. In fact, their social demands are even greater than in the US, with no groups of more than 2 people allowed to congregate together. While it cannot be a surprise that the IFO indicator was revised lower this morning, with the Expectations Index falling to within a whisker of its financial crisis lows of 79.2. The real question is if the measures invoked to stop the spread of the virus continue for another month, just how low can this reading go? The one thing that is clear is that we are going to continue to see some unprecedented damage to economic statistics as the next several months evolve.

But none of that matters today, at least in the world of finance. The promise of more money being spent has led to some spectacular rallies in equity markets in the past twenty-four hours. By now you are all aware of yesterday’s late day melt-up in the US, where the Dow closed higher by 11.4%, outpacing even the NASDAQ (+8.1%). And overnight, the Nikkei rocketed 8% higher as a follow-through on the US news and despite the news that the 2020 Tokyo Olympics are now going to be the 2021 Tokyo Olympics. The rest of Asia rose as well (Hang Seng +3.8%, Shanghai +2.7%, Australia +5.5%) and Europe started out on fire. But a funny thing happened in the past hour, it seems that more sober heads took over.

European equity indices, which had exploded higher at the opening (DAX +4.4%, CAC +4.9%) have given back most of those early gains and are now mixed with the DAX lower by 0.4% although the CAC clinging to +0.9% gain. US futures, which were similarly much higher earlier, between 2% and 3%, have now erased all those gains and are now marginally lower on the session. In fact, I suspect that this is going to continue to be the situation in equity markets as each piece of new news will need to be absorbed into the pricing matrix. And for now, there is just as much bad news as good, thus driving significant volatility in this asset class going forward.

Bond markets are seeing similar style moves, alternating between risk-on and risk-off, although with much of the leverage having already been wiped out of these markets, and central banks around the world directly supporting them through massive QE purchases, the magnitude of the moves are much smaller. Early this morning, we saw Treasuries under pressure, with yields higher by as much as 4bps, but now they have actually rallied, and the 10-year yield is lower by 1bp. There is similar price action in European government bond markets although the recent rally has not quite reversed all the early losses. Of course, the ECB’s €750 billion program is dwarfed by the Fed’s QE Infinity, so perhaps that should not be a great surprise.

And finally, turning to the FX markets, the dollar remains under pressure, as we have seen all week, as fears over the availability of dollars has diminished somewhat in the wake of the Fed’s actions. This has led to NOK once again being the leader in the clubhouse, rallying a further 2.1% this morning which takes its movement this week to 7.5%! It seems that the first batch of weekly FX flow statistics from the Norgesbank confirm that they did, indeed, intervene earlier this week, which given the price action, can be the only explanation. (I am, however, proud of them for not publicly blaring it, rather simply doing the job and allowing markets to respond.) And given the oil price collapse and the damage that will do to the Norwegian economy, it makes sense that they would want to manage the situation. But most currencies are firmer so far this week, with AUD (+3.8%) and SEK (+2.75%) recouping at least a part of what had been devastating recent losses. As to today’s session, aside from NOK, the pound is the next best performer, rallying 0.9% on the strength of a new liquidity program by the BOE as well as what appears to be hope that recent government pronouncements regarding social distancing and shelter in place rules, seems to demonstrate Boris is finally going to come into line with the rest of the world’s governments on the proper containment strategy.

EMG currencies are also performing well this morning as the broad-based dollar decline lifts most of them. KRW is the best performer today, +1.6%, which is in line with last night’s euphoria over the US stimulus bill. MXN had been sharply higher early but has since given up some of its gains and is now higher by only 1% as I type. The market is not pleased with AMLO’s attitude toward the virus, nor it seems are the Mexican people based on the erosion in his approval ratings. Meanwhile, the other major LATAM economy, Brazil, is poised to see its currency weaken even further as President Bolsonaro also ignores the current protocols of self-quarantine or shelter-in-place and encourages his nation to ignore the virus and go about their lives. I have a feeling that President Bolsonaro is going to be a one-term president. BRL hasn’t opened yet but has fallen more than 2% this week already. I expect more will come.

On the data front, yesterday’s PMI data while awful, was actually not nearly as bad as the data seen in Europe or Asia. This morning brings Durable Goods (exp -1.0%, -0.4% ex transport) although these are February numbers, so will not really tell us much about the current state of the economy. Rather, all eyes are turning to tomorrow’s Initial Claims data, to see just how high that number will climb. There are numerous stories of state employment websites crashing from the overflow in volumes.

In the end, while the stimulus bill is good news, the proof remains in the pudding, as it were, and we need to see if all of that spending will help stabilize, then lift the US economy back to its prior trajectory. If this virtual lockdown lasts past Easter, the economic damage will become much more difficult to reverse and will make the hoped for V-shaped recovery that much harder to achieve. For now, though, we can only watch and wait. The one thing that remains clear is that in the end, the US dollar remains the haven of all havens, no matter the fiscal situation in the US. It will always be preferred to the alternative.

Good luck and stay safe
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No Respite

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This weekend, alas, brought no respite
As markets are still in the cesspit
A worrying trend
While govs try to end
The panic, is that they turn despot

Well, things have not gotten better over the weekend, in fact, arguably they continue to deteriorate rapidly. And I’m not talking markets here, although they are deteriorating as well. More and more countries have determined that the best way to fight this scourge is to lockdown their denizens and prevent gatherings of more than a few people while imposing minimum distance restrictions to be maintained between individuals. And of course, given the crisis at hand, a virulently contagious disease, it makes perfect sense as a way to prevent its further spread. But boy, doesn’t it have connotations of a dictatorship?

The attempt to prevent large groups from gathering is a hallmark of dictators who want to prevent a revolution from upending their rule. The instructions to maintain a certain distance are simply a reminder that the government is more powerful than you and can force you to act in a certain manner. Remember, too, that governments, once they achieve certain powers, are incredibly loathe to give them up willingly. Those in charge want to remain so and will do almost anything to do so. Milton Friedman was spot on when he reminded us that, “nothing is so permanent as a temporary government program.” The point is, while the virus could not be foreseen, the magnitude of the economic impact is directly proportional to the economic policies that preceded it. In other words, a decade of too-easy money led to a massive amount of leverage, which under ‘normal’ market conditions was easily serviceable, but which has suddenly become a millstone around the economy’s neck. And adding more leverage won’t solve the problem. Both the economic and financial crisis have a ways to go yet, although they will certainly take more twists and turns before ending.

None of this, though, has dissuaded governments worldwide from trying every trick suggested to prevent an economic depression. At the same time, pundits and analysts are in an arms race, to make sure they will be heard, in forecasting economic catastrophe. Q2 US GDP growth is now being forecast to decline by anywhere from 5% to 50%! And the high number ostensibly came from St Louis Fed President James Bullard. Now I will be the first to tell you that I have no idea how Q2 will play out, but I also know that given the current circumstances, and the fact that the virus is a truly exogenous event, it strikes me that any macroeconomic model built based on historical precedents is going to be flat out wrong. And remember, too, we are still in Q1. If the draconian measures implemented are effective, recovery could well be underway by May 15 and that would result in a significant rebound in the second half of Q2. Certainly, that’s an optimistic viewpoint, but not impossible. The point is, we simply don’t know how the next several quarters are going to play out.

In the meantime, however, there is one trend that is becoming clearer in the markets; when a country goes into lockdown its equity market gets crushed. India is the latest example, with the Sensex falling 13.1% last night after the government imposed major restrictions on all but essential businesses and reduced transportation services. Not surprisingly, the rupee also suffered, falling 1.2% to a new record low. RBI activity to stem the tide has been marginally effective, at best, and remarkably, it appears that India is lagging even the US in terms of the timeline of Covid-19’s impact. The rupee has further to fall.

Singapore, too, has seen a dramatic weakening in its dollar, falling 0.9% today and trading to its lowest level since 2009. The stock exchange there also tumbled, -7.3%, as the government banned large gatherings and limited the return of working ex-pats.

These are just highlights (lowlights?) of what has been another difficult day in financial markets around the world. The one thing we have seen is that the Fed’s USD swap lines to other central banks have been actively utilized around the world as dollar liquidity remains at a premium. Right now, basis swaps have declined from their worst levels as these central bank activities have reduced some of the worst pressure for now. A big concern is that next Tuesday is quarter end (year end for Japan) and that dollar funding requirements over the accounting period could be extremely large, exacerbating an already difficult situation.

A tour around the FX markets shows that the dollar remains king against most everything although the yen has resumed its haven status, at least for today, by rallying 0.3%. Interestingly, NOK has turned around and is actually the strongest currency as I type, up 0.8% vs. the dollar after having been down as much as 1.3% earlier. This reversal appears to be on the back of currency intervention by the Norgesbank, which is the only thing that can explain the speed and magnitude of the movement ongoing as I type. What that tells me is that when they stop, NOK will resume its trip lower. But the rest of the G10 is on its heels, with kiwi the laggard, -1.25%, after the RBNZ jumped into the QE game and said they would be buying NZD 30 billion throughout the year. AUD and GBP are both lower by nearly 1.0%, as both nations struggle with their Covid responses on the healthcare front, not so much the financial front, as each contemplates more widespread restrictions.

In the emerging markets, IDR is actually the worst performer of all, down 3.7%, as despite central bank provision of USD liquidity, dollars remain in significant demand. This implies there may be a lack of adequate collateral to use to borrow dollars and could presage a much harsher decline in the future. But MXN and KRW are both lower by 1.5%, and remember, South Korea has been held up as a shining example of how to combat the disease. Their problem stems from the fact that as an export driven economy, the fact that the rest of the world is slowing rapidly is going to be devastating in the short-term.

Turning to the data, this week things will start to be interesting again as we see the first numbers that include the wave of shut-downs and limits on activity.

Today Chicago Fed Activity -0.29
Tuesday PMI Manufacturing 44.0
  PMI Services 42.0
  New Home Sales 750K
Wednesday Durable Goods -1.0%
  -ex transport -0.4%
Thursday Initial Claims 1500K
  Q4 GDP 2.1%
Friday Personal Income 0.4%
  Personal Spending 0.2%
  PCE Deflator core 0.2% (1.7% Y/Y)
  Michigan Sentiment 90.0

Source: Bloomberg

Tomorrow’s PMI data and Thursday’s Initial Claims are the first data that will have the impact of the extraordinary measures taken against the virus, so the real question is, just how bad will they be? I fear they could be much worse than expected, and that is not going to help our equity markets. It will, however, perversely help the dollar, as fear grows further.

Forecasting is a mugs game at all times, but especially now. The only thing that is clear is that the dollar continues to be in extreme demand and is likely to be so until we start to hear that the spread of Covid-19 has truly slowed down. That said, the dollar will not rally forever, so payables hedgers should be thinking of places where they can add to their books.

Good luck and stay well
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Risk Assets Betray

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There once was a time in the past
Ere Covid, when risk was amassed
But now every day
Risk assets betray
That fear is still growing quite fast

It is awfully hard to find the bright side of the current situation, whether discussing markets, the economy or the general state of the world. Volatility remains the watchword in markets as yesterday saw the largest US equity decline since Black Monday in October 1987. Globally, economic data that is remotely current continues to show the disastrous impact of Covid-19. The latest print is this morning’s German ZEW Survey where the Expectations reading fell to -49.5, its lowest level since the middle of the Eurozone crisis in 2011. And finally, one need only listen to the number of government pronouncements and edicts including border closures, business closures and curfews to recognize that it will be quite some time before our lives, as we knew them just a few months ago, return to some semblance of normal.

And while it is virtually certain that this situation will ebb over time, we continue to get estimates that are further and further into the future as to when that time will arrive. What had been assumed to be a six-week process is now sounding an awful lot like a six-month process.

But consider this, it is events of this nature that change the zeitgeist and will have much further reaching effects on every industry. For example, given how much of the US (and global) economy has become service oriented, outside of things like food service, I expect that we will see a much greater reliance on telecommuting going forward. Even in bank dealing rooms, a place that I always considered the last bastion of the importance of proximity of workers, we are seeing a pretty effective adjustment to working from remote locations. And you can be sure that whatever issues are currently still impeding the workflow, they will be addressed by technological fixes in short order.

But what does that do to automobile manufacturers and all their supply chains? And while fossil fuels aren’t going to disappear anytime soon, in fact given how much cheaper they have become, they will be able to supplant alternatives for now, at some point, all those industries are going to suffer as well. Ironically, the move toward urbanization that we have seen during the last decade may find itself halted as people decide that not cramming themselves into small apartments with hundreds of other people (mostly strangers) in close proximity, is really a healthier way to live. And certainly, leisure activities are likely to change their nature as well. While the future remains unknown, it certainly does appear that it will look very little like the recent past. Food for thought.

Turning to the markets more specifically, we continue to see a combination of central bank and government activity in increasingly strident efforts to ameliorate the negative economic impacts of Covid-19. So last night the BOJ bought a record amount (¥121.6 billion) of equity ETF’s to help support the stock market. To their credit, the action was able to prevent a further decline in prices there, as the Nikkei closed unchanged on the day. However, it is still lower by 32% since early February’s recent high. In addition, we have seen equity short-selling bans by France, Italy, Spain, South Korea and Belgium as of this morning in an effort to prevent further market declines. Spain is the only market that seems happy about it, rising 2.6% this morning, with the rest of Europe little changed generally. Risk assets are still on the block for sale, its simply a question of the available liquidity for positions to be unwound.

Of greater interest to me are global government bond markets, which are quickly losing their status as haven assets. Despite rate cuts from all over the globe, yields are rising virtually everywhere, even in the US this morning with 10-year Treasuries seeing a 9bp jump. But Bunds have been underperforming for more than a week, with yields on the 10-year there up nearly 50bps in that time. While it makes perfect sense that the PIGS are seeing yields rise in this environment, what I think we are seeing is a combination of two things for ‘safer’ bonds. First, when yields fall this low, a key haven characteristic, limited probability of losing principal, is put at risk, because any reversal in yields will result in very sharp price declines. And second, with the spending commitments that are being made by governments on a daily basis, I think bond investors are starting to price in the idea that there is going to be a massive increase in the supply of bonds starting pretty soon. And asset managers don’t want to get caught in that blitz either. It is the second of these reasons that will continue to drive central banks to promulgate QE measures, and you can be sure we will continue to see those programs coming. In fact, I think the MMTer’s have won the debate, as that is likely to be a very accurate description of monetary policy in the future.

Finally, this morning the dollar has regained its crown and is, by far, the strongest currency around. It has rallied vs. all the G10, and pretty sharply as well. For instance, CAD is the best performer of the bunch today, and it is lower by 0.75%, having found a new home with the dollar above 1.40. SEK and AUD are the worst performers, both down around 1.7%, as the krona is seeing increased speculative betting that they will be forced to go back to negative rates, while Down Under, the Lucky Country has run out of luck with a collapsing Chinese economy crushing commodity prices, and the RBA promising to do more to stop the economy’s slowdown.

In the EMG space, the dollar is also reigning supreme this morning with EEMEA currencies under the most pressure. Given their relative outperformance lately, it cannot be too surprising that we are seeing this type of price action. HUF is today’s laggard, down 2.1%, but PLN (-2.0%), RON (-1.6%) and BGN (-1.2%) are all feeling the pain. Asian currencies are also lower, but generally not by quite as much, although IDR and KRW are both lower by around 1.5%.

Ultimately, the dollar’s strength today is probably best attributed to the absolute blowout in the basis swaps market, where borrowing dollars vs. other currencies has become hugely expensive. Given the way economic activity is contracting so rapidly, and so revenues everywhere are shrinking, all those non-US companies that need to repay dollar debt are desperate to get hold of the buck. Once financing charges rise high enough, the next step is generally outright purchases of dollars on the FX market. And that is what we are seeing this morning. Look for more of that going forward.

It’s ironic, Retail Sales is released this morning (exp 0.2%, 0.1% ex autos) on the same day I received emails that Nordstrom is closing its stores for the next two weeks along with a myriad of other smaller retailers. We also see IP (0.4%), Capacity Utilization (77.1%) and the JOLT’s Jobs Report (6.40M). But again, this data looks backward and in the quickly evolving world today, I doubt it will have an impact. Rather, while risk stabilized somewhat overnight, my sense is this is a temporary situation, and that we are going to see another wave of risk reduction, certainly before the week is over. So, for now, the dollar will continue to find a lot of demand.

Good luck
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Times of Trouble

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In times of trouble
The yen continues to be
Mighty like an oak

Pop quiz! What percentage of the workforce is working at their primary site vs. home or an alternate site? Please respond with where you’re working and your guesstimates. Will publish results of this (completely unscientific) survey on Monday, March 16.

As markets around the world continue to melt down, investors everywhere are looking for a haven to retain capital. For the past 100 years, US Treasuries have been the number one destination in markets. Interestingly, the past two days saw Treasuries sell off aggressively. I think the move was initially based on the relief rally seen on Tuesday, but at this point, the fact that Treasury prices fell alongside yesterday’s stock rout can only be explained by the idea that institutions that need cash are selling the only liquid assets they have, and Treasuries remain quite liquid. And to be clear, 10-year yields are lower by 18bps this morning as that bout of selling seems to have passed and the haven demand has returned in spades.

But since the financial crisis, the second most powerful haven asset has been the Japanese yen. Despite the fact that the nation has basically been in an economic funk for two decades, it continues to run a significant current account surplus. As a consequence, Japanese external investment is huge and when fear is in the air, that money comes running back home. The evolution of the coronavirus spread can be seen in the yen’s movement as in the middle of February, when Japan itself was dealing with the growth in infections, the yen weakened to a point not seen in nearly a year. Since then, however, the yen has strengthened 7.5% (with a peak gain of 9.8% seen Monday) as flows have been decidedly one way. This morning the yen has appreciated 0.7% from yesterday’s close and quite frankly, until the pandemic starts to ebb, I see no reason for it to stop appreciating. Par will pose a short-term psychological support for the dollar, but if this goes on for another two months, 95 is in the cards. With that in mind, though, for all yen receivables hedgers, zero premium collars are looking awfully good here. Let’s talk, at the very least you should be apprised of the pricing.

Interestingly, the Swiss franc has had a somewhat less impressive performance despite its historic haven characteristics. While it has appreciated 4.5% in the same time frame, it has been having much more trouble during the latest equity market decline. And I think that is the reason why. Famously, the Swiss National Bank has 20% of its balance sheet invested in individual equities. This is a very different investment philosophy than virtually every other central bank. The genesis of this came about when the SNB was intervening on a daily basis while trying to cap the franc and ultimately needed a place to put the dollars and euros they were buying. I guess the view was stocks only go up, so let’s make some money too. Whatever the reason, as of December 31 the USD value of their equity portfolio was about $97.6 billion. I’m pretty confident that number is a lot lower today, and perhaps the idea about Swiss franc strength is being called into question. The franc is unchanged today and has been generally unimpressive for the past week.

Meanwhile, all eyes this morning are on Madame Lagarde and the ECB who will be announcing their latest policy initiatives shortly. While it is clearly expected they will do something, other than a 10bp cut in the deposit rate, to -0.60%, there is a great deal of uncertainty. Expectations range from expanding the TLTRO program with much more aggressive rates, as low as -2.00%, to a significant increase in QE to capping government bond yields. All of that would be remarkably dramatic and likely have a short-term positive impact on markets. But will it last? My sense is that until the Fed announces next week, and at this point I think they cut 100bps, markets will still be on edge. After all, the world continues to revolve around USD funding, and in times of crisis, foreign entities need access to USD liquidity. Look for more repo, more swap lines and maybe even a lending scheme although I don’t think the Fed can do something like that within their mandate.

Overall, the dollar is performing as the number two currency haven, after the yen, and has rallied sharply against commodity currencies in both the G10 and EMG spaces. For example, with oil down 5% this morning, NOK has fallen 3.6%, but both AUD and SEK are lower by 1.5% as well. In the emerging markets, Mexican peso continues to be the market’s whipping boy, falling a further 3.2% as I type, which takes its decline since the beginning of the month to 12.2%. meanwhile, the RUB is in similarly dire straits (-2.75% today, -11.5% in March) and we are seeing every single EMG currency lower vs. the dollar today. These are the nations that are desperate for USD liquidity and you can expect their currencies to continue to decline for the foreseeable future.

At this point, data is an afterthought, but it is still being released. Yesterday saw CPI rise a tick more than expected but the more interesting data point was Mortgage Applications, which jumped 55.4% as mortgage rates collapse alongside Treasury yields. This morning brings Initial Claims (exp 220K) and PPI (1.8%, 1.7% core) with far more interest in the former than the latter. Consider, given the enormous economic disruptions, it would be easy to see that number jump substantially, which would just be another signal for the Fed to act as aggressively as possible.

At this point, as the equity meltdown continues, the dollar should remain well supported vs. everything except the yen.

Good luck
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All Screens Are Red

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Last week it was how Covid spread
That filled most investors with dread
This weekend we learned
The Russians had spurned
The Saudis, now all screens are red

Wow!! It has been more than a decade since we have seen market activity like this across the entire spectrum of asset classes, dating back to the Lehman Brothers bankruptcy in September 2008 and the ensuing six months of activity. And just like then, the only thing that is going to change the current investor dynamic is a series of policy responses that are broadly seen as being effective. Unfortunately for most policymakers in the G10, they don’t have nearly enough tools available to be instantly effective. In other words, my sense is that while we will certainly get a series of announcements in the next several days, even coordinated announcements, investors and traders are going to need to actually see that deeds follow the words, and that the deeds have a chance to be effective. After all, as we have already discussed, cutting the Fed funds rate will not slow the spread of the coronavirus, nor will it patch things up between OPEC and Russia. Oftentimes, passage of time is a critical feature of any solution, but that just means that we will live with the current volatility that much longer.

A brief recap shows that markets, which were already fragile due to the unknown ultimate impact of the spread of the coronavirus, received one negative catalyst too many this weekend when the, always suspect, alliance of OPEC and Russia broke down regarding production cuts to shore up the price of oil. The Russians walked out of the negotiations and the Saudis responded by cutting their prices dramatically and opening the taps fully on production thus driving WTI lower by more than 34% at one point earlier this morning, although as I type at 6:35am it is “only” down by 29% to $32.50/bbl.

The financial market response was exactly as one would expect with fear rising exponentially and risk assets sold at any price. Meanwhile, haven assets are bid through the roof. So, stock markets around the world are all lower by at least 3.0% with the worst performers (Australia -7.3%, Thailand -7.9%, Italy -9.4%) down far more. US futures hit their 5.0% circuit breakers immediately upon opening and have been quiet all evening pinned at limit down. Cash market circuit breakers in the US are 7.0% for 15 minutes, 13.0% for 15 minutes and then if we should decline by 20%, trading is halted for the rest of the day. It certainly appears that we will trigger at least the first one around the opening, but after that I hesitate to speculate.

The other thing that is almost certainly going to happen is we are going to get a policy statement, at least from the Fed, if not a joint statement from G7 central bankers, or the Fed and the Treasury or all of the above, as they make every effort to try to assuage investor confidence. But in this environment, it is hard to come up with a statement that will do that. As I said, passage of time will be required to calm things down.

Regarding the bond market, by now you are all aware of the historic nature of the movement with the entire US yield curve now below 1.0%. The futures market is pricing in a 75bp cut next week by the Fed and another 25bps by June. Thursday, we hear from the ECB with the market anticipating a 10bp cut and analysts looking for additional stimulus measures, perhaps widening further the assets they are willing to purchase. And next week, the BOJ meets as well as the Fed, with the market looking for a 10bp cut there as well.

All this leads us to the FX markets, where the dollar is having a mixed day. Mixed but violent! It should be no surprise that the yen is dramatically higher this morning, currently by 3.0% although at its peak it was nearly 4.0% stronger. As we flirt with the idea of par on the yen, we need to go back to 2013 to see a time when the currency was stronger, which was driven by the 2011 Tohoku earthquake and tsunami. The Swiss franc and euro are also firmer this morning, both by about 1.25% as the former sees haven flows while the latter, in my estimation, is seeing the last of the benefits of the Fed’s ability to ease policy more aggressively than the ECB.

On the flip side, NOK has been devastated, down 2.8%, with CAD falling 1.5%, both on the back of oil’s sharp decline. Aussie, Kiwi and the pound are all trading within 0.4% of Friday’s close, although Aussie did see a 5.0% decline early in the session as lack of liquidity combined with algorithmic stop-loss orders to lead to a significant bout of unruliness.

In the EMG space, the champion is MXN, which has fallen 8.5%! This is a new historic low in the currency which is getting decimated by the coming economic slowdown and now the collapse in oil prices. Let’s just say that all those investors who took comfort in the higher interest rate as a cushion are feeling a lot less sanguine this morning. But we have also seen a sharp decline in ZAR (-2.4%) and a number of Asian currencies fell around 1.0% (MYR, IDR and KRW). And we are awaiting the opening in Sao Paolo as my sense is BRL, which has been falling sharply for the past week, down nearly 5.0%, seems likely to weaken much further.

My advice for those with cash flow programs is to pick a level and leave an order as bid-ask spreads will be much wider today and liquidity will be greatly impaired.

Looking ahead to the week, the ECB meeting on Thursday is clearly the highlight. At home, we only get a bit of data, and given what’s going on it doesn’t seem likely to be very impactful. But here it is:

Tuesday NFIB Small Biz Optimism 102.9
Wednesday CPI 0.0% (2.2% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Thursday Initial Claims 219K
  PPI -0.1% (1.8% Y/Y)
  -ex food & energy 0.1% (1.7% Y/Y)
Friday Michigan Sentiment 95.0

Source: Bloomberg

The thing about this week’s data is that it mostly predates both the onset of the spread of Covid as well as this weekend’s OPEC fiasco. In other words, it is unlikely to be very informative of the current world. We already know that going into these problems, the US economy was in pretty decent shape. The $6.4 trillion question is: How will it look in eight months’ time when the nation heads to the polls?

Remember, orders are likely to be the best execution methodology on a day like today.

Good luck
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Values Debase

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It used to be bonds were so boring
That talk induced yawning and snoring
But Covid-19
Is now on the scene
And bonds are the asset that’s soaring

Meanwhile in the equity space
Investors are having a race
To see who has sold
Their stocks and bought gold
As equity values debase

It’s important to understand that Covid-19 is not the cause of the current hysteria in financial markets, it is merely the catalyst that revealed the underlying problems. Arguably, the most critical of these problems, excess leverage, has been building since the financial crisis response in 2009. In fact, it was an explicit part of the response package, cut rates to zero to encourage more borrowing. The unseen, at the time, problem with this strategy, however, is that the vicious cycle virtuous circle that resulted, where investors chasing yield moved up the risk ladder thus encouraging the issuance of more and more risky securities, seems to be reaching its denouement. Welcome to today’s volatility!

Briefly, financialization of the economy has been growing aggressively since the financial crisis. This is the process whereby the corporate sector spends more time and money on managing the balance sheet than on delivering products or services. Thus, banking and financial services grow relative to total economic output. In essence, we produce less stuff but pay more for it. And yes, that is the definition of inflation, which is exactly what we have seen in financial markets. It has just not (yet) appeared in measured inflation indices, as they don’t include stock prices. Financialization has manifested itself in the massive equity repurchase programs, funded by record-breaking issuance of corporate debt, which has been instrumental in driving equity markets to record highs. But when more money is spent on equity repurchase than on R&D, it bodes ill for the longer term. Perhaps Covid-19 is the catalyst that will help us understand the long term has arrived.

As the global economy now is trying to address both a supply and demand shock to the system simultaneously, investors have collectively decided that risk is not as tasty as it was just a few weeks ago. And while many have warned that when this market turned, it would be dramatic, I don’t believe the type of movements possible were well understood. I’m guessing they are a little better understood today.

This process has further to run, regardless of what the central banks or government leaders do or say. Markets that have rallied for ten years do not correct in ten days. It will take much longer and there will be many unforeseen movements by different asset classes going forward.

In fact, the dollar is going to be quite interesting throughout this process. I maintain that its current decline is entirely a result of the market repricing the US rate outlook. Futures markets are currently pricing in another 50bp rate cut by the Fed a week from Wednesday, with a further 37bps by the end of the summer. That is significantly more cutting than is being priced for the ECB (just 10bps) and the BOJ (also 10bps). In other words, as interest rate spreads between the dollar and other G10 economies compress, it is no surprise to see the dollar decline. In fact, this was the genesis of my views at the beginning of the year and what underpinned my calls for the euro to trade to 1.17, the yen to 95 and the pound to 1.40. Of course, I didn’t anticipate anything like this, rather a much more gradual approach.

However, the dollar is also still seen as one of the safest places to be, with Treasury bonds the ultimate safe haven today and one needs dollars to buy Treasuries. The rally in the bond market has been extraordinary with the 10-year falling another 15bps today to yet another new record low. It actually traded below 0.70% briefly this morning but sits at 0.76% as I type. And that is true across the Treasury curve. While other bond markets globally have seen rates decline, nothing has matched the Treasury performance. (And for those of you who did not understand how Greek 10-year yields could trade below US yields, that is no longer the case!)

Meanwhile, havens like the yen (+0.9% today, +6.1% in the past two weeks) and CHF (+1.05% today, 4.9% in two weeks) are the stars of the FX markets. In fact, this bout of risk aversion is beginning to approach what we saw in 2008 and 2009. Today, the dollar is the total underperformer in the G10 space, but that is not the case in the EMG space. There, MXN is the disaster du jour, down 2.1% as it is impacted by the collapse in oil prices, the uptick in coronavirus cases and its reliance on the US, which appears to be heading toward much slower growth, if not a recession. But BRL is lower by 1.0%, and we are seeing most of the APAC and LATAM currencies falling this morning. CE4 currencies are benefitting from their proximity to the euro, but I expect that will change as time passes.

Into all this excitement, we bring this morning’s payroll report with the following expectations:

Nonfarm Payrolls 175K
Private Payrolls 160K
Manufacturing Payrolls -3K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.0% y/Y)
Average Weekly Hours 34.3
Participation Rate 63.4%
Trade Balance -$46.1B

Source: Bloomberg

The thing is, all this took place before Covid-19, so all it can do is give us a final benchmark as to how things were prior to the virus spreading. If we get a bad number, that will be a real problem.

It is hard to overstate just how fragile this market is right now, with liquidity significantly impaired, bid-ask spreads widening and options volatilities rising sharply. Patience is a true virtue in these conditions and leaving orders at levels can be very effective. I maintain that the dollar’s weakness will not be a permanent feature, but rather a transient situation until the rate situation stabilizes. So, receivables hedgers, leave orders to layer into your strategies, it will pay off over time.

Good luck and good weekend
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No Easy Fix

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As fears ‘bout the virus increased
Supply and demand growth have ceased
There’s no easy fix
Or policy mix
But funding soon will be released

Words fail to describe the price action across all markets recently as volatile seems too tame a description. Turbulent? Tumultuous? I’m not sure which implies larger moves. But that is certainly what we have seen for the past two weeks and is likely to be what we see for a while longer. The confluence of events that is ongoing is so far outside what most market participants had become accustomed to over the past decade, that it seems many are simply giving up.

Consider; signing of phase one of the trade deal between the US and China was hailed as a milestone that would allow trading to return to its prior environment which consisted of ongoing monetary support by central banks helping to underpin economic growth with low inflation. As such, we saw equity markets worldwide benefit, we saw haven assets come under some pressure as havens were seen as unnecessary, and we saw the dollar rally as the US equity market led the way and investors everywhere wanted to get in on the party.

But that is basically ancient history now, as the combination of the discovery, evolution and spread of the coronavirus along with a pickup in US electoral excitement essentially destroyed that story. The past two weeks has been the markets’ collective effort to write a new narrative, and so far, they have not agreed on a theme.

The interesting point about Covid-19 economically is that it has created both a supply and a demand shock. The supply shock was the first thing really observed as China shut down throughout February and companies worldwide that relied on China as part of their supply chain realized that their own production would be impaired. So, we had a period where the focus was almost entirely on which multinational companies would be reducing Q1 earnings estimates due to the supply problems. This also encouraged the economics set to assume a “V” shaped recovery which had most investors looking through Q1 earnings warnings and remaining fully invested.

Unfortunately, as Covid-19 spread though, and I think it is now on every continent and spreading more rapidly, governments worldwide have imposed travel restrictions to the hardest hit countries (China, South Korea, Italy). But an even bigger problem is that many companies around the world are imposing their own travel and hiring restrictions, with Ford, famously, halting all business travel alongside a number of major banks (JPM, HSBC, Credit Suisse). In fact, yesterday, I was visiting a client who explained that our meeting would be their last as they are not allowing other companies to visit their headquarters starting today. The point is this is a demand shock. Travel and leisure companies will continue to suffer until an all clear is sounded. Talk of postponing or canceling the Olympics in Tokyo this summer is making the rounds. Talk of sporting events being played in empty arenas has increased. (March Madness with no crowds!) And there are the requisite stories about store shelves being emptied of things like toilet paper, paper towels and hand sanitizer.

The problem for policy makers is that the response to a supply shock and the response to a demand shock are very different. A demand shock is what policymakers have been assuming since the Great Depression, as easing monetary and fiscal policy is designed to increase demand through several different channels. But a supply shock requires a different emphasis. Neither monetary nor fiscal policy can address Covid-19 directly, curing the ill or protecting those still uninfected. The closure of manufacturing capacity as a response to trying to avoid the spread of a disease is going to have a massive negative impact on corporate finances. After all, interest is still due even if a company doesn’t make any sales. To address this, central banks will need to show forbearance on banks’ non-performing loan ratios, as well as incent banks to continue to lend to companies so impacted. It needs to be more finely targeted, something at which central banks have not shown themselves particularly adept.

And of course, after a decade of central bankers teaching markets that if there is a decline of any magnitude, the central bank will step in, policy space is already quite limited. In sum, the next market narrative remains unwritten because we have never seen this confluence of circumstances before and there are millions of different ideas as to what is the right way to behave. Volatility will be with us for a while.

So with that long preamble, turning to the markets sees that after yesterday’s remarkable risk-on rally in the US, arguably catalyzed by the fact that Senator Sanders fared more poorly than expected in Super Tuesday voting, (thus reducing the chance of his eventual election), Asia picked up the baton and rallied. But Europe has not been able to follow along with virtually every European equity market down at least 1.5%. US futures are also suffering, currently lower by 1.75% or so across all three indices. Meanwhile, 10-year yields, which yesterday managed to trade back above 1.0%, are down nearly 10bps this morning as risk is being jettisoned left and right. The yen is rocking, up by 0.6%, with the dollar trading below 107.00 for the first time since October. In fact, the dollar is generally on its back foot this morning, as the market continues to price in further significant rate activity by the Fed, something which essentially none of its counterparty central banks can implement. At this point, the market is pricing in almost 50bps more at the March meeting in two weeks, and a total of 75bps by July. The ECB doesn’t have 75 to cut, neither does the BOJ or the BOE or the RBA. So, for now, the dollar is likely to remain soft. But as the market has priced these cuts in, I would have anticipated the dollar to fall even further. This hints that the dollar’s decline is likely near its end.

On the data front, remarkably, yesterday’s ISM Non-Manufacturing print was stellar at 57.3, but nobody is certain how to interpret that and what impact Covid-19 may have had on the data. Today we see a bit more data here with Initial Claims (exp 215K), Nonfarm Productivity (1.3%), Unit Labor Costs (1.4%) and Factory Orders (-0.1%). My sense is that Initial Claims is the one to watch. Any uptick there could well be interpreted as the beginning of layoffs due to Covid-19, but also as a prelude to weaker overall growth and perhaps a recession. It is still early days, but arguably, Initial Claims data, which is weekly, will be our first look into the evolution of the economy during the virus.

For now, the dollar remains soft, and I doubt any data will change that, but the dollar will not fall forever. Layering in receivables hedges seems like a pretty good plan at this point.

Good luck
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Gone Astray

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There once was a banker named Jay
Who, for a few weeks, had his way
Stock markets rose nicely
But that led precisely
To things that have now gone astray

Protagonists now can’t discern
What’s safe or what assets to spurn
Their hunt for more yield
Has finally revealed
That risk is attached to return

Apparently, when the Fed cuts rates, it is not a guarantee that stock prices will rally. That seems to be yesterday morning’s lesson in the wake of the Fed’s “surprise” 50bp rate cut. After a brief rally, which lasted about 15 minutes, the bottom fell out again as investors and traders decided that things were actually much worse than they feared. In addition, Chairman Jay did himself no favors by opening the kimono a bit and admitting that there was nothing the Fed could do to directly address the current issues.

This is a real problem for the global central bank community because the Fed was the player with the most ammunition left, and they just used one-third of their bullets with a disastrous outcome. Ask yourself what more the ECB can do, with rates already negative and QE ongoing. They have no more bullets left, just the whispering of sweet nothings from Madame Lagarde to Eurozone FinMins to spend more money. If the data turns further south in Europe, which seems almost guaranteed, I would look for a suspension of the Eurozone rules on financing and deficits. After all, Covid-19 was not part of the bargain, and this is clearly an emergency…just ask Jay. Japan? They are already printing yen as fast as they can to buy more assets, and will not stop, but are unable to achieve their goals.

Arguably, the only central bank left that matters, and that has room to move is the PBOC, which has already been active adding liquidity and trying to steer it to SME’s. But if the pressure continues on both the Chinese economy and its markets, they will do more regardless of the long-term debt problems they may exacerbate. We have clearly reached a point where every central bank is all-in to try to stop the current stock market declines. And you thought all they cared about was money supply!

So, what about a fiscal response by the major economies? After all, to a man, every central bank has explained that monetary policy is not the appropriate tool to address the current economic and market concerns. As Chairman Jay explained in his press conference, “A rate cut will not reduce the rate of infection. It won’t fix a broken supply chain. We get that, but we do believe that our action will provide a meaningful boost to the economy.” A cynic might conclude that central banks were trying to force the fiscal authorities’ collective hands, but in reality, I think the issue is simply that, at least in the G7, fiscal issues are political questions that by their very nature take longer to answer. Getting agreement on spending money, especially in the current fractious political environment, is extremely difficult short of a major crisis like the financial market meltdown in 2008. And for now, despite all the press, and some really bad data releases, Covid-19 has not achieved that level of concern.

Is that likely to change soon? My impression based on what we have seen and heard so far is that unless there is another significant uptick in the number of infections, and especially in the mortality rate, we are likely to see relatively small sums of money allocated to this issue. Of course, if economic activity is impeded by travel restrictions and supply chains cannot get back in business by the end of March, we are likely to have a change of heart by these governments, but for now, its central banks or bust.

So, this morning, after yesterday’s rout in US markets, things seem to have stabilized somewhat with most Asian equity markets flat to slightly higher, European markets ahead by about 1% and US futures currently sitting ~2% stronger. Part of the US showing is undoubtedly due to yesterday’s Super Tuesday primaries which showed former VP Joe Biden build on his recently recovered momentum to actually take a slight delegate lead. There is certainly some truth to the idea that part of the US markets’ recent malaise was due to a concern that Senator Sanders was poised to become the Democratic nominee, and that his policy platforms have been extremely antagonistic to private capital.

But despite the equity market activity, which on the whole looks good, there is no shortage of demand for Treasuries, which implies that there is still a great deal of haven demand. Yesterday, the 10-year yield breached 1.00% for the first time in its 150-year history, trading as low as 0.90% before rebounding ahead of the close. But here we are this morning with the yield down a further 5bps, back to 0.95%, and quite frankly there is nothing to indicate this move is over. In fact, futures markets are pricing in another Fed rate cut at their meeting 2 weeks from today, and another three cuts in total by the end of 2020! While German bunds have not seen the same demand, the rest of the European government bond market has rallied with yields everywhere falling between 1bp and 8bps. And don’t forget JGB’s, which have also seen yields decline 2bps, heading further into negative territory despite the BOJ’s efforts to steepen their yield curve. Certainly, a look at the bond market does not inspire confidence that the all clear has been sounded.

And finally, in the FX markets, the dollar remains under general pressure as the market continues to price in further Fed activity which is much greater than anywhere else. Yesterday’s cut took US rates to their narrowest spread vs. Eurozone rates since 2016, when the Fed was in the process of raising rates. It is no coincidence that the euro has recovered to levels seen back then as well. The thing about the dollar’s current weakness, though, is that it seems to be running its course. After all, if the interest rate market is pricing for US rates to fall back to the zero-bound, and there is no indication that the US will ever go negative, how much more room does the euro have to rally? While yesterday’s peak at just above 1.12 may not be the absolute top, I think we are much nearer than further from that point.

A quick look at the EMG bloc shows that today’s winners have largely centered in Asia as those currencies respond belatedly to yesterday’s Fed actions, although we have also seen commodity focused currencies like ZAR (+0.8%), MXN (+0.7%) and RUB (+0.5%) perform well on the rebound in oil and metals prices. I expect that CLP, BRL and COP will also open well on the same thesis.

While yesterday was barren in the US on the data front, this morning we see ADP Employment (exp 170K) and ISM Non-Manufacturing (54.9) as well as the Fed’s Beige Book at 2:00pm. Monday’s ISM Manufacturing data was a touch weak, but it is getting very difficult to read with the Covid-19 situation around. Was this weakness evident prior to the outbreak? I think that’s what most investors want to understand. Also, I would be remiss if I didn’t mention that Chinese auto sales plunged 80% in February and the Caixin PMI data was also disastrous, printing at 27.5.

For now, uncertainty continues to reign and with that comes increased volatility. We have seen that with a substantial rebound in the equity market VIX, and we have seen that with solid rebounds in FX option volatility, which had been trading at historically low levels but are now, in G7 currencies, back to levels not seen since December 2018, when equity markets were correcting and fear was rampant. My take there is that implied vols have further to rally as there is little chance we have seen the end of the current crisis-like situation. Hedgers beware!

Good luck
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A Fig Leaf?

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This morning, the market’s motif
Is central banks’ promised relief
The all-clear has sounded
And stocks have rebounded
But is this more than a fig leaf?

In case you were curious what central bank relief looked or sounded like, I have included the statements from each of the four major central banks addressing Covid-19, starting with the Fed’s statement Friday afternoon that was able to turn the equity market around (all are my emphases). Since then, we have heard from the other three major banks, as per below, and we have also been informed that G7 FinMins would be having a conference call this week to discuss a coordinated response.

“The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

“Global financial and capital markets have been unstable recently with growing uncertainties about the outlook for economic activity due to the spread of the novel coronavirus. The Bank of Japan will closely monitor future developments and will strive to provide ample liquidity and ensure stability in financial markets through appropriate market operations and asset purchases.”

The Bank of England is working with the UK Treasury as well as international partners to ensure all necessary steps are taken to protect financial and monetary stability amid the global outbreak of the coronavirus. The bank continues to monitor developments and is assessing its potential impacts on the global and UK economies and financial systems.

The European Central Bank is vigilant and mobilized when it comes to the fallout from the outbreak of the coronavirus. Any response needs to be calm and proportionate. ECB policy is already very accommodative.

And this has essentially been this morning’s market story, a major relief rally. Friday night, late, China released its PMI data and it was dreadful, with Manufacturing PMI at 35.7 while the Non-manufacturing figure was even worse, at 29.6! This should dispel was any doubts that growth in China has nearly ground to a halt. However, despite the promised support by central banks around the world, and you can be sure pretty much all of them, not just the big four, will be jumping in, if quarantines remain in place as the infection continues to spread, supply lines will remain broken and growth will be feeble. The OECD just released a report regarding the coronavirus with updated GDP forecasts and it is not pretty. Naturally, China is the hardest hit, with Q1 GDP now forecast to turn negative, and 2020 GDP growth to fall to 4.9% before rebounding next year. Meanwhile, global GDP growth is now forecast to fall to 2.4%, its slowest pace since the financial crisis in 2009. And the working assumption is that the virus is contained before the end of Q1. If we continue to see the virus spread, these numbers will be revised still lower.

So, with this as our backdrop, let’s turn our attention to actual market activity. Despite all the promises of support, equity investors remain uncertain as to how to proceed at this time. Support may be helpful, but if companies earnings plummet because of the disruption, then current market valuations are likely still a bit rich. Looking at Asian markets, China was the best performer, with Shanghai rising more than 3.1% as promises of support by the PBOC encouraged investors there. But we also saw the Nikkei (+0.95%) and the Hang Seng (+0.6%) rise although Australia’s ASX 200 (-0.8%) didn’t share in the enthusiasm. Europe has been far less positive with the DAX (-0.45%) and CAC (-0.25%) in the red along with Italy’s FTSE MIB (-2.25%) which is really feeling the brunt of the problems on the continent. The lone equity bright spot is the UK, where the FTSE 100 is higher by 0.5%, largely due to the fact that the pound is today’s worst performing currency, having fallen 0.5% vs. the dollar, and more than 1% vs. the euro.

The British pound story is entirely Brexit related as trade negotiations started today with concerns raised that the red lines both sides have defined may end the chance of any agreement as early as next month. Given the international nature of the FTSE 100 members, a weaker pound is usually a benefit for the stock market. But clearly, if the trade talks collapse, the impact on UK companies would be significant.

But other than the pound, the FX market is the only one that has responded in the manner the central banks were hoping, as the dollar has fallen sharply vs. pretty much every other currency. In the G10 space, SEK (+0.7%) and EUR (+0.65%) are leading the way although even AUD and NZD have managed to gain 0.3% this morning.

In the EMG space, KRW was the BIG winner, rallying 1.7% overnight, but almost every APAC currency jumped on the concerted central bank message. The two exceptions here this morning are INR and MXN, both currently lower by 0.7%, with both suffering from the same disease, new Covid-19 infections where there hadn’t been any before.

Meanwhile, bond markets continue to price in much slower growth as 10-year Treasury yields have tumbled to 1.05%, another new historic low, while German bunds fall to -0.66%, near its historic lows. There is discernment in the market though, as Italian yields have risen 7.5bps as concerns over the safety of those bonds, given Italy’s dubious distinction of being the European country worst hit by the virus, has called into question its financing capabilities.

Adding to all this enjoyment is a very busy data week culminating in the payroll report on Friday.

Today ISM Manufacturing 50.5
  ISM Prices Paid 50.5
  Construction Spending 0.6%
Wednesday ADP Employment 170K
  ISM Non-Manufacturing 55.0
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Nonfarm Productivity 1.4%
  Unit Labor Costs 1.4%
  Factory Orders -0.2%
Friday Trade Balance -$47.0B
  Nonfarm Payrolls 175K
  Private Payrolls 160K
  Manufacturing Payrolls -4K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.3
  Participation Rate 63.4%
  Consumer Credit $17.0B

Source: Bloomberg

At this point, Covid-19 stories are going to be the primary driver of market activity as investors across all markets try to figure out how to react. Havens remain in demand, although the dollar has clearly suffered. Arguably the dollar’s weakness is predicated on the fact that, of all the nations around, the US is the one with the ability to cut rates the furthest. In fact, futures markets are now pricing in 100bps of rate cuts this year, with between 25bps and 50bps for the March meeting in two weeks’ time. Nobody else has that much room, and so the dollar is definitely feeling the pressure. Of course, I continue to believe that if things get much worse, the dollar will rally regardless of the Fed funds rate, as Treasury bonds remain the single safest and most liquid asset available anywhere in the world. For today however, unless there is additional new information, the dollar is likely to remain under pressure, and in truth, that seems likely all week.

Good luck
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Many a Penny

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The stock market had been for many
A place to make many a penny
But lately they’ve seen
Bright red on their screen
It’s best if they practice their zen (ny)

Meanwhile though the Fed seems quite clear
A rate cut will not soon appear
The market is stressing
And Jay will be pressing
For twenty-five quite soon this year

It’s not clear to me whether the top story is the dramatic decline in global stock markets or the increasing spread of Covid-19. Obviously, they are directly related to each other, and one would have to assume that the causality runs from Covid to stocks, but if you read the paper, stocks get top billing. Coming a close second is the bond market, where 10-year Treasury yields (1.20%) have hit new historic lows every day since Tuesday while discussion of other markets takes a back seat. And, oh yeah, it looks like Turkey and Russia might go to war in Syria!

As is often written, the two great drivers of financial markets are fear and greed. Greed leads to FOMO, which is a pretty solid description of what we have seen, at least in the US equity markets, since 2009. Fear, however, is what happens when excessive greed, also known as complacency, meets the notorious black swan, in this case, Covid-19. And historically, the longer the period of greed, the sharper is fear’s retaliation. With equity markets around the world having fallen by 10% or more this week, there is no question that we could have a session or two where things steady. And given what the futures market is now pricing with respect to central bank activity, it seems reasonable that the market will respond positively to those imminent actions. But I fear that there is a lot of excess in this market, and that stock prices everywhere can fall much further before this is all done.

Let’s look at futures market pricing for central banks this morning vs. last week and last month. This is the number of 25bp rate cuts priced by the end of 2020:

Country Feb 28 Feb 21 Jan 31
US 3.5 1.8 2.0
Canada 2.5 1.6 1.4
Eurozone (10 bps) 1.3 0.7 0.6
UK 1.5 0.8 1.1
Australia 2.1 1.5 1.5
Japan (10 bps) 1.3 0.8 0.8

Source: Bloomberg

Part of the difference is the fact that only the US and Canada have room for more than 2 cuts before reaching the zero-bound, but the market is screaming out for central banks to come to the rescue. This should be no surprise as central banks have been doing this since 1987 when Chairman Greenspan, the maestro himself, stepped in after Black Monday and said he would support markets. It is a little bit late for central bankers to complain that they cannot help things given their actions, around the world, for the past thirty years, which has really stepped up since the financial crisis in 2008. At this point, if equity markets crater this morning in the US (and futures are pointing that way with all three indices currently lower by 1.3%), I expect an “emergency rate cut” by the Fed before stock markets open on Monday. One man’s view.

So how about the dollar? What is happening there? Well, the dollar is having a mixed session this morning, stronger vs. a number of emerging market currencies, as well as Aussie and Kiwi, but weaker vs. the yen and Swiss franc, and a bit more surprisingly, vs. the euro. The euro is an interesting case, and a situation we have seen before.

Consider, if you were a hedge fund investor and looking to fund positions. Where would you seek to fund things? Clearly, the currency with the lowest interest rates is the place to start. Now, knowing the history of the Swiss franc, and the fact that it is not that large a market, CHF is likely not a place to be. But euros, on the other hand, were a perfect funding vehicle, hugely liquid and negative interest rates. And that is what we saw for months and months, hedge funds shorting euro and buying MXN, INR, ZAR and any other currency with real yield. Well, now in the panic situation currently engulfing markets, these positions are being closed rapidly, and that means that hedge funds are aggressively buying euros while selling those other currencies. Hence, the euro’s performance this week has been relatively stellar, +1.35%, although it has recently backed off its highs this morning and is now unchanged on the day.

And where did we see this before? Prior to the financial crisis in 2008, JPY was the only currency that had zero interest rates and was the funding currency of choice for the hedge fund community. Extremely large yen shorts existed vs. the same high yielding currencies of today. And when the crisis struck, hedge funds were forced to buy yen as well as dollars driving it much higher. This was the genesis of the yen as a haven asset, although its consistent current account surplus has done a lot to help the story since then.

As to the rest of the FX market today, yen is the top performer, +0.75%, and CHF is also ahead of the game, +0.2%, but the rest of the G10 is under pressure. The laggard is NZD (-1.1%) as the first Covid-19 case was identified there and markets anticipate the RBNZ to cut rates soon. In the EMG space, with oil crashing again (WTI -2.6%), it is no surprise to see RUB (-1.5%) and MXN (-1.0%) lower. But today’s worst performing EMG currency is IDR (-2.05%) after the first Covid cases were identified and talk of rate cuts there circulated. Interestingly, CNY has been a solid performer today, rising 0.3%, although remember, it is under tight control by the PBOC.

On the data front today we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (1.7%), Chicago PMI (46.0) and Michigan Sentiment (100.7). While PCE had been the most important data in the past, I think all eyes will be on the Chicago and Michigan numbers, as they are forward looking. Also, of tremendous interest to the market will be tonight’s China PMI data, with estimates ranging from 30.0 to 50.0. My money is on the low side here.

Two things argue for a bounce in equities in the US today, first, simply the fact that they have fallen so much in such a short period of time and a trading bounce is due. But second, given their significant decline, portfolio rebalancing is likely to see buyers today, which can be quite substantial in the short run. But a bounce is just that, and unless we see dramatic central bank activity by Monday, I anticipate we are not nearly done with this move.

Good luck and good weekend
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