Riddle Me This

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

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

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

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Poison Pens

The headlines all weekend have shouted
The dollar is sure to be routed
If Covid-19
Remains on the scene
A rebound just cannot be touted

But ask yourself this my good friends
Have nations elsewhere changed their trends?
Infections are rising
Despite moralizing
By pundits who wield poison pens

Based on the weekend’s press, as well as the weekly analysis recaps, the future of the dollar is bleak. Not only is it about to collapse, but it will soon lose its status as the world’s reserve currency, although no one has yet figured out what will replace it in that role. This is evident in the sheer number of articles that claim the dollar is sure to decline (for those of you with a Twitter account, @pineconemacro had a great compilation of 28 recent headlines either describing the dollar’s decline or calling for a further fall), as well as the magnitude of the short dollar positions in the market, as measured by CFTC data. As of last week, there are record long EUR positions and near-record shorts in the DXY.

So, the question is, why does everybody hate the dollar so much? It seems there are two reasons mentioned most frequently; the impact of unbridled fiscal and monetary stimulus and the inability of the US to get Covid-19 under control. Let’s address them in order.

There is no question that the Fed and the Treasury, at the behest of Congress, have expended extraordinary amounts of money to respond to the Covid crisis. The Fed’s balance sheet has grown from $4.2 trillion to $7.0 trillion in the course of four months. And of course, the Fed has basically bought everything except your used Toyota in an effort to support market functionality. And it is important to recognize that what they continue to explain is that they are not supporting asset prices per se, rather they are simply insuring that financial markets work smoothly. (Of course, their definition of working smoothly is asset prices always go higher.) Nonetheless, the Fed has been, by far, the most active central bank in the world with respect to monetary support. At the same time, the US government has authorized about $3.5 trillion, so far, of fiscal support, although there is much anxiety now that the CARES act increase in unemployment benefits lapsed last Friday and there is still a wide divergence between the House and Senate with respect to what to do next.

But consider this; while the US is excoriated for borrowing too much and expanding both the budget deficit and the amount of debt issued, the EU was celebrated for coming to agreement on…borrowing €2 trillion to expand the budget deficit and support the economies of each nation in the bloc. Debt mutualization, we have been assured, is an unalloyed good and will help the EU’s overall economic prospects by allowing the transfer of wealth from the rich northern nations to the less well-off southern nations. And of course, given the collective strength of the EU, they will be able to borrow virtually infinite sums from the market. Perhaps it is just me, but the stories seem pretty similar despite the spin as to which is good, and which is bad.

The second issue for the dollar, and the one that is getting more press now, is the fact that the US has not been able to contain Covid infections and so we are seeing a second wave of economic shutdowns across numerous states. You know, states like; Victoria, Australia; Melbourne, Australia; Tokyo, Japan; the United Kingdom and other large areas. This does not even address the ongoing spread of the disease through the emerging markets where India and Brazil have risen to the top of the worldwide caseload over the past two months. Again, my point is that despite reinstituted lockdowns in many places throughout the world, it is the US which the narrative points out as the problem.

It is fair to describe the dollar’s reaction function as follows: it tends to strengthen when either the US economy is outperforming other G10 economies (a situation that prevailed pretty much the entire time since the GFC) or when there is unbridled fear that the world is coming to an end and USD assets are the most desirable in the world given its history of laws and fair treatment of investors. In contrast, when the US economy is underperforming, it is no surprise that the dollar would tend to weaken. Well the data from Q2 is in and what we saw was that despite the worst ever quarterly decline in the US, it was dwarfed by the major European economies. At this time, the story being told seems to be that in Q3, the rest of the world will rapidly outpace the US, and perhaps it will. But that is a pretty difficult case to make when, first, Covid inspired lockdowns are popping up all around the world and second, the consumer of last resort (the US population) has lost their appetite to consume, or if not lost, at least reduced.

Once again, I will highlight that the dollar, while definitely in a short-term weakening trend, is far from a collapse, and rather is essentially right in the middle of its long-term range. This is not to say that the dollar cannot fall further, it certainly can, but do not think that the dollar is soon to become the Venezuelan bolivar.

And with that rather long-winded defense of the dollar behind us, let’s take a look at markets today. Equity markets continue to enjoy central bank support and have had an overall strong session. Asia saw gains in the Nikkei (+2.25%) and Shanghai (+1.75%) although the Hang Seng (-0.55%) couldn’t keep up with the big dogs. Europe’s board is no completely green, led by the DAX (+2.05%) although the CAC, which was lower earlier, is now higher by 1.0%. And US futures, which had spent the evening in the red are now higher as well.

Bond markets are embracing the risk-on attitude as Treasury yields back up 2bps, although are still below 0.55% in the 10-year. In Europe, the picture is mixed, and a bit confusing, as bund yields are actually 1bp lower, while Italian BTP’s are higher by 2bps. That is exactly the opposite of what you would expect for a risk-on session. But then, the bond market has not agreed with the stock market since Covid broke out.

And finally, the dollar, is having a pretty strong session today, perhaps seeing a bit of a short squeeze, as I’m sure the narrative has not yet changed. In the G10, all currencies are softer vs. the greenback, led by CHF (-0.6%) and AUD (-0.55%), although the pound (-0.5%) which has been soaring lately, is taking a rest as well. What is interesting about this move is that the only data released overnight was the monthly PMI data and it was broadly speaking, slightly better than expected and pointed to a continuing rebound.

EMG currencies are also largely under pressure, led by ZAR (-1.15%) and then the CE4 (on average -0.7%) with almost the entire bloc softer. In fact, the outlier is RUB (+0.8%), which seems to be the beneficiary of a reduction in demand for dollars to pay dividends to international investors, and despite the fact that oil prices have declined this morning on fears that the OPEC+ production cuts are starting to be flouted.

It is, of course, a huge data week, culminating in the payroll report on Friday, but today brings only ISM Manufacturing (exp 53.6) with the New Orders (55.2) and Prices Paid (52.0) components all expected to show continued growth in the economy.

With the FOMC meeting now behind us, we can look forward, as well, to a non-stop gabfest from Fed members, with three today, Bullard, Barkin and Evans, all set to espouse their views. The thing is, we already know that the Fed is not going to touch rates for at least two years, and is discussing how to try to push inflation higher. On the latter point, I don’t think they will have to worry, as it will get there soon enough, but their models haven’t told them that yet. At any rate, the dollar has been under serious pressure for the past several months. Not only that, most of the selling seems to come in the US session, which leads me to believe that while the dollar is having a pretty good day so far, I imagine it will soften before we log out this evening.

Good luck and stay safe
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About to Retrace

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
Adf

 

No Use Delaying

In Europe, the powers that be
Are feeling quite smug, don’t you see
Not only have they
Held Covid at bay
But also, they borrow for free

Thus, Italy now wants to spend
More money, recession, to end
If Germany’s paying
There’s no use delaying
With Merkel now Conte’s best friend

The euro is continuing its climb this morning, as it mounts a second attack on 1.1600, the highest level it has traded since October 2018. While the overall news cycle has been relatively muted, one thing did jump out today. It should be no surprise, but Italy is the first nation to take advantage of the new EU spending plans as they passed a supplemental €25 billion budget to help support their economy.

Now, it must be remembered that prior to the pandemic, Italy was in pretty bad shape already, at least when looking at both fiscal and economic indicators. For instance, Italy was in recession as of Q4 2019, before Covid, and it was maintaining a debt/GDP ratio of more than 130%. Unemployment was in double digits and there was ongoing political turmoil as the government was fighting for its life vs. the growing popularity of the conservative movement, The League, led by Matteo Salvini. Amongst his supporters were a large number of Euroskeptics, many of whom wanted to follow in the UK’s footsteps and leave the EU. (Quitaly, not Italexit!) However, it seems that the economic devastation of Covid-19 may have altered the equation, and while Salvini’s League still has the most support, at 26%, it has fallen significantly since the outbreak when it was polling more than 10 points higher. Of course, when the government in power can spend money without limits, which is the current situation, that tends to help that government stay in power. And that is the current situation. The EU has suspended its budget restrictions (deficits <3.0%) during the pandemic, and Italy clearly believes, and are probably correct, that the EU is ultimately going to federalize all EU member national debt.

It seems the growing consensus is that federalization of EU fiscal policies will be a true benefit. Of course, it remains to be seen if the 8 EU nations that are not part of the Eurozone will be forced to join, or if the EU will find a way to keep things intact. My money is on the EU forcing the issue and setting a deadline for conversion to the euro as a requisite for remaining in the club. Of course, this is all looking far in the future as not only are these monumental national decisions, but Europe takes a very long time to move forward on pretty much everything.

This story, though, is important as background information to developing sentiment regarding the euro, which is clearly improving. In fairness, there are shorter term positives for the single currency’s value, notably that real interest rates in the rest of the world are falling rapidly, with many others, including the US, now plumbing the depths of negative real rates. Thus, the rates disadvantage the euro suffered is dissipating. At the same time, as we have seen over the past several months, there is clearly very little fear in the market these days, with equity prices relentlessly marching higher on an almost daily basis. Thus, the dollar’s value as a safe haven has greatly diminished as well. And finally, the appearance of what seems to be a second wave of Covid infections in the US, which, to date, has not been duplicated as widely in Europe, has added to confidence in the Eurozone and the euro by extension.

With all this in mind, it should be no surprise that the euro continues to rally, and quite frankly, has room for further gains, at least as long as the economic indicators continue to rebound. And that is the big unknown. If the economic rebound starts to falter, which may well be the case based on some high-frequency data, it is entirely likely that there will be some changes to some of the narrative, most notably the idea that risk will continue to be eagerly absorbed, and the euro may well find itself without all its recent supports.

But for now, the euro remains in the driver’s seat, or perhaps more accurately, the dollar remains in the trunk. Once again, risk is on the move with equity markets having gained modestly in Asia (Hang Seng +0.8%, Sydney +0.3%, Nikkei was closed), while European bourses have also seen modest gains, on the order of 0.5% across the board. US futures are also pointing higher, as there is no reason to be worried for now. Bond markets have behaved as you would expect, with Treasuries and bunds little changed (although Treasuries remain at levels pointing to significant future economic weakness) while bonds from the PIGS are seeing more demand and yields there are falling a few basis points each. Oil is higher on optimism over economic growth, and gold continues to rally, preparing to set new all-time highs as it trades just below $1900/oz. The gold (and silver) story really revolves around the fact that negative real interest rates are becoming more widespread, thus the opportunity cost of holding that barbarous relic have fallen dramatically. Certainly, amongst the market punditry, gold is a very hot topic these days.

As to the rest of the currency space, there are two noteworthy decliners in the G10, NOK (-0.5%) and GBP (-0.25%). The former, despite rising oil prices, fell following the release of much worse than expected employment data. After all, rising unemployment is hardly the sign of an economic rebound. The pound, on the other hand, has suffered just recently after comments by both sides regarding Brexit negotiations, where the essence was that they are no nearer a positive conclusion than they were several months ago. Brexit has been a background issue for quite a few months, as most market players clearly assume a deal will be done, and that is a fair assumption. But that only means that there is the potential for a significant repricing lower in the pound if the situation falls apart there. Otherwise, the G10 is broadly, but modestly firmer.

In the emerging markets, the picture is a bit more mixed with the CE4 tracking the euro higher, but most other currencies ceding earlier session gains. IDR is the one exception, having rallied 0.5% for a second day as equity inflows helped to support the rupiah. On the downside, KRW (-0.2%) suffered after GDP data was released at a worse than expected -3.4%, confirming Korea is in a recession. Meanwhile, the weakest performer has been ZAR (-0.6%) as traders anticipate a rate cut by the SARB later today.

Data in the US this morning includes the ever-important Initial Claims (exp 1.3M) and Continuing Claims (17.1M), as well as Leading Indicators (2.1%). But all eyes will be on the Claims data as the consensus view is weakness there implies the rebound is over and the economic situation may slide back again. Counterintuitively, that could well help the dollar as it spreads fear that the V-shaped recovery is out of the question. However, assuming the estimates are close, I would look for the current trends to continue, so modestly higher equities and a modestly weaker dollar.

Good luck and stay safe
Adf

Stocks Dare Not Wane

Can someone, to me, please explain
The reason that stocks dare not wane?
If this is to be
Then how come we see
Both silver and gold, new heights gain?

It seems like the narrative is becoming more difficult to explain these days. On the one hand, risk appetite appears to be gaining as evidenced by the ongoing rally in equity markets, the continued rebound in oil prices and the dollar’s steady decline. The rationale continues to be one where hope springs eternal for the elusive Covid vaccine and that fiscal stimulus will continue to be pumped into the global economy until said vaccine arrives driving a V-shaped recovery. Meanwhile, paying for that fiscal stimulus will be global central banks, who are printing money as quickly as possible in order to mop up all the newly issued bonds. (I would wager that the ECB will purchase at least 50% of the new EU bonds when they are finally issued.)

The potential flaw in this theory is the price behavior of haven assets, notably gold, silver and Treasuries, all of which have continued to rally right alongside risk assets. Now, it is certainly possible that the continuous flood of new money into the global economy has simply resulted in all assets rising in price, including the haven assets, but it would be a mistake to ignore the signals those haven assets are flashing. For instance, 10-year Treasury yields have fallen back below 0.60% today for the first time since establishing their historic low at 0.569% in mid-April. Historically, the message of low 10-year yields has been slow growth ahead. It seems to me that doesn’t jive very well with the V-shaped recovery story that appears to be driving equity prices. Of course, the issue here could easily be that the Fed’s purchases are simply distorting the market thus removing any signaling power from 10-year yields, but they have assured us repeatedly that is not the case. Rather, their purchases are designed to insure the opposite, that the market functions normally.

Turning to precious metals, both gold and silver have been on a tear of late, with silver really turning it on in July, rising 21%, while gold has seen steady buying and is higher by 4.3% so far this month. Granted, this could simply be part of the dollar weakness effect, where a declining dollar lifts the value of all commodities. But you cannot rule out the idea that this price movement is a signal of growing concerns over the value of all fiat currencies as central banks around the world work overtime to provide liquidity to markets.

From the perspective of the narrative, it is important to accept that this time it’s different, and that these haven asset signals are merely noise in the new world order. And maybe they are. Maybe the fact that central banks around the world have added nearly $20 trillion of liquidity to global markets without corresponding economic growth is of no real concern and will not result in consequences like rising inflation or growth in inequality. Unfortunately, the one thing that we have learned during this crisis is that central banks have a single playbook regardless of the situation…print more money. Like a man with a hammer, to whom every problem looks like a nail, central bankers see a problem and respond in one way only… turn on the presses. I certainly hope the Fed et al, know what they are doing, but the evidence is that their models are no longer reflective of reality, and that is the big problem. Any model is only as good as its data, but good data doesn’t make a bad model good, in fact it is more likely to give misinformation instead.

So, let us now turn to the market’s activities this morning to see if there is anything new under the sun. While equity markets around the world are under pressure, the losses are relatively small and arguably just a reflex response to what has been a strong run for the past several sessions. Government bonds continue to rally ever so slowly in both the US and Europe, but the truly interesting things are happening in the FX world.

To start, the euro has well and truly broken out of its range, easily taking out resistance at 1.1495 during its 0.7% climb yesterday. This morning, it has added to those gains, up another 0.4% and trading at levels last seen in October 2018. Momentum is on its side and as I mentioned yesterday, I see no real resistance until at least 1.17, meaning another 1.0%-2.0% is quite within reason. At this stage, there doesn’t need to be a narrative, just the acceptance that the current trend is strong. But yesterday saw the entire G10 space rally, led by AUD (+1.6%) and NOK (+1.3%) with the former benefitting from a serious short squeeze while the latter had oil to thank for its gains. But even the yen (+0.45% yesterday) showed real strength, despite no concern about risk.

But the real story was in the EMG space, where virtually the entire bloc was firmer, although none so impressively as BRL, which rocketed 3.1% during the day. It seems that a combination of general positivity from the EU’s announced deal and the specifics of the introduction of the long-awaited new tax reform by the Bolsonaro administration were enough to get the juices flowing. Technically, it appears that barring any significant negative news, this could continue until USDBRL tests 5.00, or even the 4.85 lows seen in mid-June.

But the entire EMG bloc was on fire, with the CE4 far outperforming the euro (CZK +1.95%, HUF +1.90%, PLN +1.6%) but also strength elsewhere in LATAM (CLP +1.75%, COP +0.75%). In fact, APAC currencies were the laggards, although most of them did rise modestly. This morning’s price action has been a bit more muted, although we have seen IDR (+0.6%) halt what has been an impressive weakening trend. It seems that a local company is planning to move into Covid vaccine trials next month which has encouraged optimists to believe the second wave of infections there may be addressed soon.

Arguably, the one truly interesting thing today is the weakness in CNY (-0.2%) which seems to be a response to the story that the US has closed the Chinese consulate in Houston. The Chinese are now threatening to close the US consulate in Wuhan (who would want to work in that office anyway?) with the real concern that the ongoing cold war between the two nations shows no signs of abating. In fact, if you want a rationale for owning haven assets, this situation offers plenty of scope.

Turning to the data today, we get our first from the US in the form of Existing Home Sales (exp 4.75M) which would represent a 21% gain from last month. Of course, the level remains far below the pre-Covid situation where 5.5M was the norm for more than 5 years. The Fed remains in its quiet period as the market will eventually turn their attention to next Wednesday’s meeting, but for now, the market doesn’t need any further impetus. The story is the dollar is falling and risk is to be acquired. While the latter idea might be a little bit of a concern, the former, a weaker dollar, seems a fait accompli for now.

Good luck and stay safe
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A Blank Check

While much of the nation’s a wreck
The good news is there’s still Big Tech
Whose prices ne’er fall
Thus, keeping in thrall
Investors who wrote a blank check

One cannot but be impressed with the performance of the tech sector in US equity markets.  It seems that no matter what else happens anywhere in the world, a small group of companies has unearthed the secret to infinite value, or at least a never-ending rally in their share prices. Yesterday’s price action was instructive in that a group of just seven companies, all tech titans, added nearly $300 billion in value, which was greater than the entire NASDAQ’s 2.5% gain. While we all are happy to see equity markets continue to rally, it certainly is beginning to appear as though some of these valuations are unsustainable, especially if the V-shaped recovery doesn’t materialize. One other thing to consider about the values of these companies is that if there is a change in the White House, it is almost certain to bring with it significantly higher corporate taxes (39.6% anyone?), which will almost certainly result in a repricing of the future stream of earnings available to shareholders. But for now, clearly nothing matters but the fact that these companies are market darlings and are set to continue to rally…until they stop.

In Europe, those twenty plus nations
(Ahead of their summer vacations)
Have finally agreed
To help those in need
With billions in brand new donations

However, arguably the biggest story in the markets today is that the EU finally did agree to a spending plan to help those nations most severely impacted by the Covid recession. It was inevitable that this would be the result as the political imperative was too great for four smaller nations to prevent its completion. To hear the frugal four, though, is quite amusing. They seem to believe that their “principled” stand, where they each get a larger rebate from the general pool of funds (each is a net payer into the EU budget), and their demands that this is a one-time solution to an extraordinary event means that in the future, debt mutualization will not expand. If there is one thing that we know about government programs, it is that they always expand, and they never die. There is no such thing as a one-time program. Debt mutualization is now the standard in the EU, and one should expect nothing less. Redistribution from the North to the South of the continent is now a permanent feature.

The market reaction to this news is mostly what one would have expected. European equity markets have rallied, with those in Italy (+2.2%) and Spain (+1.9%) leading the way higher, although the strength is broad-based. As well, European government bond markets are also performing appropriately, with the havens seeing a modest rise in yields while the risk bonds, like Italian and Greek debt, falling as investors have greater assurances that they will now be repaid. After all, with debt mutualization, Greek and German debt are basically the same!

Finally, looking at the FX markets, we find the euro slightly softer on the session, having briefly traded higher, but now falling victim to what appears to be a buy the rumor, sell the news type event. But the euro has been a stellar performer for the past two months, rising 4.5% in that period as the market narrative has turned back to some previously discredited themes. Notably, we continue to hear a great deal about the dollar’s twin deficit issue and how that will undermine the greenback. In addition, given the ongoing risk rally, the idea of needing a safe haven currency, has simply faded from existence. In fact, this morning there is now talk that the euro, with its new solidarity, is really a haven asset. PPP models continue to point to the euro being undervalued at current levels with forecasts creeping ever higher. In fact, one large bank is out calling for 1.30 in the euro by the end of next year.

Of course, there is a great irony in the discussion of a stronger euro, the fact it is the absolute last thing Madame Lagarde and her ECB compatriots want (or need). After all, one of the key reasons for them to cut interest rates below zero was to undermine the euro in order to both import inflation and help European exporters become more price competitive. You can be sure that if the euro does start to break higher, we will hear a great deal more about the inappropriate price action of a rising euro. For now, all eyes are on 1.1495, which was the spike high seen in March, and which is currently serving as a resistance point for the technicians. A break there is likely to see a test of the 1.17-1.18 level before the end of the summer.

As to the dollar overall, it continues its recent weakening trend, with only a handful of currencies modestly softer and some decent moves the other way. For instance, Aussie is the top pick in the G10 this morning, rising 0.85%, as a combination of risk appetite and a short squeeze is doing the job nicely. But we are also seeing strength in NOK (+0.6%) and CAD (+0.5%), both of which are benefitting from oil’s rally today (WTI +2.8%). In the EMG space, it should be no surprise that RUB and ZAR (both +0.8%) are the leaders as the oil and commodity price rallies are clear supports. In fact, the bulk of this bloc is firmer this morning with only a handful of currencies (RON, CNY, SGD) in the red, and there just by a few basis points. Overall, it is fair to say the dollar is on its back foot again today.

With no data due today, and none of note released overnight, the FX market seems set to take its cues from the equity space and the broad risk themes. And it is pretty clear that the broad risk theme today is…buy more risk!

Herbert Stein, a very well-respected economist in the 1960’s was quoted as saying, “that which cannot continue, will not continue.” His point was that while exuberance may manifest itself periodically, it always ends when reality intrudes. Right now, it feels like risk assets, especially that formidable group of tech names, is completely disconnected with the economic reality and best-case prospects. The implication is this cannot go on. But that doesn’t mean it won’t go further before it ends. The narrative is risk assets are the thing to own, and as long as that is the case, the dollar is likely to remain under pressure.

Good luck and stay safe
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Buying is Brisk

Apparently, there is no fear
As it’s become patently clear
The shape we will see
Of growth is a ‘V’
As long as that vaccine is near

So, don’t talk to me about risk
Who cares ‘bout the federal fisc?
A hot war in Asia?
That’s bearish fantasia
Instead, retail buying is brisk!

If you are not adding to your risk positions this morning, you are clearly not paying attention. Virtually unbridled bullishness has gripped markets on word that a vaccine has had very promising results and is soon heading into Phase 3 trials. This news is more than sufficient to overwhelm pedantic issues like increasing tensions between the US and China playing out in Hong Kong; US bank results showing a massive increase in loan-loss reserves as expectations of defaults climb; or the complete lack of activity by the Senate regarding the potential extension of extraordinary unemployment benefits that are due to lapse on July 31.

Historically, issues like the US-China tension, or arguably more importantly, the signal from banks about the pending collapse of loan repayments, would have played out with more investor trepidation. While risk asset prices might not have collapsed, they certainly would not have shown the strength they have of late. But then, the central bank community has done their very best to rewrite history, or perhaps demonstrate that they have learned from history, by expanding their balance sheets dramatically and injecting trillions of dollars’ worth of liquidity into the global economy. It should be no surprise that those trillions have made their way into markets, rather than the real economy, given the trend of financialization that has played out over the past two decades.

Curmudgeons would argue that no central bank is supposed to care about markets per se, rather their role is to foster price stability primarily, with a number, including the Fed, having been tasked with insuring full employment. But nowhere is it written that supporting equity markets is part of the mandate. And yet, that is essentially where the situation now stands. Equity market displacements are met with increased central bank activity. In fact, this is so ingrained in investor attitudes that we now have equity rallies on bad news under the assumption that the relevant central bank will be forced to add more liquidity by buying more risk assets.

There is, however, one market that seems to be paying attention to the historic storyline; government bonds. Treasury yields continue to grind lower (10-year at 0.61%) as a certain class of investors seem to see a less rosy future. Of course, one could make the argument that bonds are rallying because the Fed is buying them, but the problem with that story right now is the Fed’s balance sheet has actually been slowly shrinking over the past several weeks, by something on the order of $300 billion. Instead, this appears to be a genuine concern over future risks, something that is completely absent from the equity space.

So, which market is correct? Are the equity bulls prescient, implying there is a V-shaped recovery in our future? Or are the fixed income buyers seeing more clearly, recognizing that the economy is rebounding, but the pace will be much slower than desired? If we look to an outside agency to help us, the FX market, for example, recent price action is aligned with adding to risk appetites. But then, the ultimate haven asset, gold, is also continuing to rally. Being a curmudgeon myself, I tend toward the view that the next several years are going to be much tougher than currently expected by the risk bulls. But for now, they remain in control!

With this in mind, it should be no surprise that the dollar is under pressure this morning. In the G10 space, NOK is the leader, up 1.0%, as a combination of broad-based dollar weakness and higher oil (WTI +1.4%) has seen demand increase. But all the high beta currencies (SEK, AUD, NZD) are higher as well, on the order of 0.6%. Even the yen is stronger into this mix, rising 0.3%, as distaste for the dollar spreads.

At this point, I cannot ignore the euro. While today’s movement is a modest 0.3% gain, it has been on a mission of late, rising 1.7% since Friday. There are many subplots here, with discussions about the relative stance of the ECB vs. the Fed, short-term risk-on knee-jerk reactions to buy euros, and perhaps most importantly, the questions over the long-term viability of the US government running enormous twin deficits (budget and current account) and how those are going to get financed. For now, the Fed has been the financier for the government, but debt monetization has never been the path to a stronger currency, rather just the opposite. What is interesting is that this longer-term discussion is being dusted off by analysts once again, with many newly revamped calls for the dollar to continue its decline for the rest of the year.

One thing that would definitely support this thesis would be if the EU actually moved forward on mutualization of debt. You will recall several weeks ago that Merkel and Macron announced they both agreed on a €500 billion EU support program that was to be funded by 30-year and 40-year EU bond issuance, jointly payable by the entire bloc. This has been held up by a minority of countries, the so-called frugal four, as they are uninterested in paying for Southern Europe’s profligate history. But word this morning from France indicated a belief that a deal was to be completed at this week’s EU Summit. If this is the case, that is an unambiguous euro positive. But if we know anything about the EU, it is that nothing proceeds smoothly, even when everyone there agrees. We shall see, but the story has definitely helped the single currency.

In the EMG bloc, ZAR is the runaway leader, rising 1.3% on the general story as well as higher gold and commodity prices. What is interesting is that this continues despite news that Eskom, the national utility, is going to reduce power production, certainly not a sign of economic strength. But we are seeing gains almost universally in this bloc as HUF (+0.9%), MXN (+0.8%) and the rest of the CE4 all perform quite well. In other words, there is no need for dollars to assuage fears. The one exception here is IDR (-1.0%), which suffered overnight as traders anticipate the central bank to cut rates more than 25bps tonight, while the pace of infection growth there increases, leading many to believe there will be another economic shutdown.

The strong risk positive attitude has also manifested itself across equity markets (Nikkei +1.6%, DAX +1.6%, CAC +1.9%), with US futures pointing sharply higher as well (Dow and S&P e-minis both higher by 1.3%). And finally, while the trend in Treasury yields is certainly lower, today has seen a modest back up across all bond markets (Bunds +1bp, Gilts +2.5bps, Treasuries +2bps).

Turning to the morning’s session, we have only modest data releases; Empire Manufacturing (exp 10.0), IP (4.3%) and Capacity Utilization (67.8%). Then at 2:00 comes the Fed’s Beige Book, which should be an interesting look at the progress of the reopening of the economy. There is only one Fed Speaker, Philly Fed President Harker, but what has been interesting lately is the dissent in views between various FOMC members regarding the pace of the recovery. And that is why the data is still important.

But for now, the risk bulls are running the show, so do not be surprised if the dollar weakness trend continues.

Good luck and stay safe
Adf

 

Shareholders’ Dreams

The contrast is hard to ignore
Twixt growth, which is still on the floor
And market extremes
Where shareholders’ dreams
Of gains help them come back for more

“There’s no way I can lose.  Right now, I’m feeling invincible.”

This quote from a Bloomberg article about the massive rally in the Chinese stock markets could just as easily come from a US investor as well.  It is a perfect encapsulation of the view that the current situation is one where government support of both the economy and the markets is going to be with us for quite a while yet, and so, stock prices can only go higher.  So far, of course, that view has been spot on, at least since March 23rd, when the US markets bottomed.

The question this idea raises, though, is how long can this situation endure?  There is no denying the argument that ongoing monetary support for economies is flowing into asset markets.  One need only look at the correlation between the gain in the value of global equity markets since things bottomed, and the amount of monetary stimulus that has been implemented.  It is no coincidence that both numbers are on the order of $15 trillion.  But as we watch bankruptcy after bankruptcy get announced, Brooks Brothers was yesterday’s big-name event, it becomes harder and harder to see how market valuations can maintain their current levels without central bank support.  Thus, if equity market values are important to central banks, and I would argue they are, actually, their leading indicator, it leads to the idea that central banks will continue to add liquidity to the economy forever.  In other words, MMT has arrived.

Magical Money Tree Modern Monetary Theory is the controversial idea that, as long as governments print their own money, like the US does with dollars, as opposed to how euros are created by an “independent” authority, there is nothing to stop governments from spending whatever they want, budgets be damned.  After all, they can either issue debt, and print the money needed to repay it, or skip the issuance step and simply print what they need when they need it.  The proponents explain that the only hitch is inflation, which they claim would be the moderator on overprinting.  Thus, if inflation starts to rise, they can slow down the presses.

Originally, this was deemed a left leaning strategy as their idea was to print more money to pay for social programs.  But like every good (?) idea, it has been co-opted by the political opposition in a slightly different form.  Thus, printing money to buy financial assets (which is exactly what the Fed has been doing since 2009’s first bout of QE, is the right leaning application of this view.  To date, the Fed has only purchased bonds, but you can see the evolution toward stocks is underway. At first it was only Treasuries and then mortgage-backed bonds, which was designed to aid the collapsing housing market.  But now we are on to Munis (at least they are government entities) and investment grade corporate ETF’s, then extending to junk bond ETF’s and then individual corporate bonds.  It is not hard to see that the next step will be SPYders and DIAmonds and finally individual stocks.

It is also not hard to discern the impact on equity prices as we go forward in this scenario, much higher.  But ask yourself this; is this a good long-term outcome?  Consider the classic definition of Socialism:

      noun:   a political and economic theory of social organization which advocates that the means of production, distribution, and exchange should be owned or regulated by the state.

Would it not be the case that if the central bank owns equities, they are taking ownership of the means of production?  Would the Fed not be voting their shareholder rights?  And wouldn’t they be deciding winners and losers based on political issues, not economic ones?  Is this really where we want to go?

The EU is already on the way, with a new plan to take equity stakes in SME’s, the economic sector that has been least aided by PEPP and the ECB versions of QE.  And already the discussion there is of which companies to help; only those that meet current ‘proper’ criteria, such as climate neutrality and social cohesion.  The point is that the future is shaping up to turn out quite differently than the recent past, at least when it comes to the financial/economic models that drive political decisions.  Stay alert to these changes as they are almost certainly on their way.

Once again, I drifted into a non-market discussion because the market discussion is so incredibly boring.  Equity markets continue their climb, based on ongoing financial largesse by central banks.  Bond markets remain mired in tight ranges and the dollar continues to consolidate after a massive rally in March led to a more gradual unwinding of haven asset positions.  But lately, the story is just not that interesting.

Arguably, the dollar’s recent trend lower is still intact, it has just flattened out a great deal.  So we continue to see very gradual weakness in the greenback, just not necessarily every day.  For example, in the past three weeks, the euro has climbed 1.25%, but had an equal number of up and down days during this span.  In other words, if you look hard enough, you can discern a trend, it is just not a steep one.  In fact, as I type, it has turned modest overnight gains into modest losses, but is certainly not showing signs of a breakout in either direction.  And this is a pretty fair description of the entire G10 bloc, modest movement in both directions over the course of a few weeks, but net slightly firmer vs. the dollar.

Today, the pound is the big winner, although it has only gained 0.25%, coming on the back of the government’s announcement of an additional £30 billion of fiscal support for the UK economy focused on wages, job retention and small businesses.  As to the rest of the G10, SEK is firmer by 0.2%, although there are no stories that would seem to support the movement, while the other eight currencies are less than 0.1% changed from yesterday.

In the emerging markets, the story is somewhat similar with just two outliers, RUB (+0.6% as oil is higher) and ZAR (+0.5% as gold is higher).  In fact, the currency that has truly performed best of all this year is gold, which is higher by nearly 20% YTD, and shows no signs of slowing down.  Arguably, the rand should continue to find support from this situation.

Once again, data is scarce, with today’s Initial and Continuing Claims data the highlights (exp 1.375M and 18.75M respectively).  At this stage, these are probably the most important coincident indicators we have, as any signs of increased layoffs will result in a lot more anxiety, both in markets and the White House.  Of course, if those numbers decline, look for the V-shaped recovery story to gain further traction and stronger equity markets alongside a (slightly) weaker dollar.

Good luck and stay safe

Adf

 

Buying With Zeal

When markets are healthy, they’ve got
Investors who’ve sold and who’ve bought
All based on their views
Of critical news
As profits are actively sought

But these days most governments feel
It’s better that they should conceal
The idea of prices
Reflecting a crisis
And so they are buying with zeal

It remains difficult to understand the enthusiasm with which investors, if it truly is investors, are chasing after stock prices these days. Last night’s version of this story took place in Asia, where the Nikkei was the laggard of the major markets, only rising 1.8%. At the same time, in Hong Kong, home to the biggest recent crackdown on personal freedoms in the world, the stock market jumped 3.8%. Of course, that is nothing compared to China’s Shanghai Index, which rose 5.7% overnight, and is now higher by more than 9% YTD. Interestingly, it appears that the key driver of the equity rally in China was the plethora of headlines essentially telling the population to buy stocks! At this point, it is no longer clear to me that equity market prices contain any information whatsoever regarding the state of the companies listed. Certainly, the idea that they reflect millions of independent views of the future has been discarded. Rather, it appears that governments around the world have come to believe that higher stock prices equate to improved confidence, regardless of how those prices came about.

It is not hard to understand why this idea has gained government adherents, as every government wants its citizens to be confident and happy. The problem is that they have the causality backwards. Historically, the process worked as follows: stock performance reflected the views of millions of individual and institutional investors views on how companies would perform in the future. Expectations about earnings were crucial and those were tied to broad economic performance. Clearly, the level of interest rates played a role in these decisions, but so did issues like the business environment, the competitive environment and government policies on taxes and regulation. At that time, if the underlying features were aligned so that stock prices were rising, it was likely a result of an underlying confidence in the economy and its overall performance. But that is essentially ancient history at this point, having largely ended in 1987.

Ever since Black Monday, October 19,1987, and more importantly, then Fed Chairman Alan Greenspan’s promise to add as much liquidity as necessary to prevent a further collapse, the fundamental ideas of what the stock market describes and explains have been inverted. Governments worldwide have learned that if they support equity markets, it can lead to better economic outcomes, at least until the bubbles burst. But this is why we first got the Tech bubble of 1999-2000, which when it burst saw governments double down to inflate the housing bubble of 2007-09, which when it burst saw governments double down again to inflate the “everything” bubble, that in many ways still exists. A decade of ZIRP and NIRP has distorted any and all signals that equity markets may have offered in the past.

And so, it should be no surprise that governments around the world, who have piled one bad decision on top of another, should look for something they can still do which they believe will have a positive impact on their constituents. Hence, government support for stock markets is likely a permanent feature of the financial markets for the future. It is, of course, ironic that the Chinese Communist Party believes that the way to control their population is through markets, but, hey, whatever works is the mantra.

This, too, will end in tears, but for now, it is the reality with which we all must deal.

With this as preamble, a look around today’s session shows that the Asian (equity) flu has infected every market around the world. In Europe, the DAX and CAC (both +1.7%) are performing nicely, but not quite as well as the FTSE 100 (+1.9%) or nearly as well as Spain’s IBEX (+2.5%). US futures, meanwhile, are just getting warmed up, with current gains of between 1.2%-1.5%. Bond markets, though, are a little less risk drunk, although the 10-year Treasury yield has risen 1.5bps to 0.68%. But in Europe, pretty much every government bond market is seeing demand as yields there fall across the board. Once again, there seems to be a risk disconnect between markets.

While WTI prices are little changed, Brent has pushed higher by 0.5%, again a risk positive. And gold, despite all the equitiphoria, continues to rise, up another $4/oz and pushing ever closer to $1800. And what of the dollar you ask? Clearly on its back foot today, down vs. almost all its G10 brethren, with only CAD and JPY a touch weaker, and both by less than 0.1%. On the positive side, NOK is the big winner, up 0.7%, as it benefits from a combination of modestly higher Brent prices, general risk appetite and the fact that it is the worst performing G10 currency this year, so has the most ground to make up. But we are seeing solid gains in the euro and Swiss franc (0.4% each) as well as Aussie and Stockie. The pound, on the other hand, which is higher, is barely so.

In the EMG bloc, CNY is today’s king, having rallied 0.6% despite the fact that the PBOC fixed the currency weaker overnight. However, given the equity rally there, it cannot be that surprising. But almost the whole bloc is rallying today with MXN (+0.6%) and the CE4 (+0.4% on average) also benefitting from increased risk appetite. In fact, there is only one outlier on the downside, RUB (-0.65%) which despite Brent’s gains, is suffering as the virus continues to run amok in the country.

On the data front this week, there is not very much to excite:

Today ISM Non-Manufacturing 50.0
Tuesday JOLTS Job Openings 4.8M
Wednesday Consumer Credit -$15.0B
Thursday Initial Claims No forecasts yet
  Continuing Claims No forecasts yet
Friday PPI 0.4% (-0.2% Y/Y)
  -ex food & energy 0.1% (0.5% Y/Y)

Source: Bloomberg

Clearly, the most surprising thing is that as of Monday morning, no economist is willing to opine on their Initial Claims views. While it could be due to the holiday, I have a feeling it is more related to the fact that most economists have lost faith in their models’ ability to accurately describe the economy. Certainly, the flattening of this curve calls into question the validity of the V-shaped recovery story, so it will be interesting to see when these estimates start to show up.

We do hear from two Fed members this week, Thomas Barkin and Mary Daly, but that story remains unchanged and will do so until at least the meeting at the end of this month, and probably until the September meeting.

So, to recap, risk is on as governments around the world encourage it as whole-heartedly as they can. And with it, the dollar remains under pressure for now.

Good luck and stay safe
Adf

Dreams All Come True

The Minutes explained that the Fed
Was actively looking ahead
Twixt yield curve control
And guidance, their goal
Might not be achieved, so they said

This morning, though, payrolls are due
And traders, expressing a view
Continue to buy
Risk assets on high
Here’s hoping their dreams all come true!

In the end, it can be no surprise that the Fed spent the bulk of their time in June discussing what to do next. After all, they had to be exhausted from implementing the nine programs already in place and it is certainly reasonable for them to see just how effective these programs have been before taking the next step. Arguably, the best news from the Minutes was that there was virtually no discussion about negative interest rates. NIRP continues to be a remarkable drag on the economies of those countries currently caught in its grasp. We can only hope it never appears on our shores.

Instead, the two policies that got all the attention were forward guidance and yield curve control (YCC). Of course, the former is already part of the active toolkit, but the discussion focused on whether to add an outcome-based aspect to their statements, rather than the more vague, ‘as long as is necessary to achieve our goals of stable prices and full employment.’ The discussion centered on adding a contingency, such as; until inflation reaches a certain level, or Unemployment falls to a certain level; or a time-based contingency such as; rates will remain low until 2023. Some would argue they already have that time-based contingency in place, (through 2022), but perhaps they were leading up to the idea it will be longer than that.

The YCC discussion focused on research done by their staff on the three most well-known instances in recent history; the Fed itself from 1942-1951, where they capped all rates, the BOJ, which has maintained 10-year JGB yields at 0.0% +/- 0.20%, and the RBA, which starting this past March has maintained 3-year Australian yields at 0.25%. As I mentioned last week in “A New Paradigm” however, the Fed is essentially already controlling the yield curve, at least the front end, where movement out to the 5-year maturities has been de minimis for months. Arguably, if they are going to do something here, it will need to be in the 10-year or longer space, and the tone of the Minutes demonstrated some discomfort with that idea.

In the end, my read of the Minutes is that when the FOMC meets next, on July 29, we are going to get a more formalized forward guidance with a contingency added. My guess is it will be an Unemployment rate contingency, not a time contingency, but I expect that we will learn more from the next set of Fed speakers.

Turning to today, as the market awaits the latest payroll report, risk assets continue to be on fire. The destruction in so many areas of the economy, both in the US and around the world, is essentially being completely ignored by investors as they continue to add risk to their portfolios amid abundant central bank provided liquidity. Here are the latest median forecasts as compiled by Bloomberg for today’s data:

Nonfarm Payrolls 3.06M
Private Payrolls 3.0M
Manufacturing Payrolls 438K
Unemployment Rate 12.5%
Average Hourly Earnings -0.7% (5.3% Y/Y)
Average Weekly Hours 34.5
Participation Rate 61.2%
Initial Claims 1.25M
Continuing Claims 19.0M
Trade Balance -$53.2B
Factory Orders 8.7%
Durable Goods 15.8%
-ex Transport 6.5%

Because of the Federal (although not bank) holiday tomorrow, the report is being released this morning. It will be interesting to see if the market responds to the more timely Initial Claims data rather than the NFP report if they offer different messages. Remember, too, that last month’s Unemployment rate has been under much scrutiny because of the misclassification of a large subset of workers which ultimately painted a better picture than it might otherwise have done. Will the BLS be able to correct for this, and more importantly, if they do, how will the market interpret any changes. This is one reason why the Initial and Continuing Claims data may be more important anyway.

But leading up to the release, it is full speed ahead to buy equities as yesterday’s mixed US session was followed by strength throughout Asia (Nikkei +0.1%, Hang Seng +2.85%, Shanghai +2.1%) and in Europe (DAX +1.6%, CAC +1.3%, FTSE 100 +0.6%). US futures are also higher, between 0.4%-0.8%, to complete the virtuous circle. Interestingly, once again bond yields are not trading true to form on this risk-on day, as yields in the US are flat while throughout Europe, bond yields are declining.

But bonds are the outlier here as the commodity space is seeing strength in oil and metals markets and the dollar is under almost universal pressure. For example, in the G10, NZD is the leading gainer, up 0.6%, as its status as a high beta currency has fostered buying interest from the speculative crowd betting on the recovery. But we are also seeing NOK and SEK (both +0.5%) performing well while the euro (+0.3%) and the pound (+0.3%) are just behind them. The UK story seems to be about the great reopening that is due to occur starting Saturday, when pubs and restaurants as well as hotels are to be allowed to reopen their doors to customers. The fear, of course, is that this will foster a second wave of infections. But there is no doubt there is a significant amount of pent up demand for a drink at the local pub.

In the EMG bloc, the ruble is today’s winner, rising 1.2% on the back of oil’s continued rebound. It is interesting, though, as there is a story that Saudi Arabia is having a fight with some other OPEC members, and is close to relaunching a full-scale price war again. It has been the Saudis who have done the lion’s share of production cutting, so if they turn on the taps, oil has a long way to fall. Elsewhere in the space, INR (+0.8%) and ZAR (+0.75%) are having solid days on the back of that commodity strength and recovery hopes. While the bulk of the space is higher, IDR has had a rough session, in fact a rough week, as it has fallen another 0.65% overnight which takes its loss in the past week near 2.0%. Infection rates continue to climb in the country and investors are becoming uncomfortable as equity sales are growing as well.

So, this morning will be a tale of the tape. All eyes will be on the data at 8:30 with the odds stacked for a strong risk session regardless of the outcome. If the data shows the recovery is clearly strengthening, then buying stocks makes sense. On the other hand, if the data is disappointing, and points to a reversal of the early recovery, the working assumption is the Fed will come to the rescue quite quickly, so buying stocks makes sense. In this worldview, the dollar is not seen as critical, so further dollar weakness could well be in our future.

Good luck and stay safe
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