The UK’s Current Plight

In England, the doves are in flight
Explaining that NIRP is alright
But hawks keep maintaining
That zero’s restraining
Despite the UK’s current plight

What we’ve learned thus far in 2021 is that Monday is risk-off day, at least, so far.  Yesterday, for the second consecutive week, risk was under pressure as equity markets everywhere fell, while the dollar rallied sharply.  But just like last week, where risk was avidly sought once Monday passed, this morning has seen a rebound in many equity markets, as well as renewed pressure on the dollar.

But aside from a very early assessment of a potential pattern forming, this morning brings a dearth of market-moving news.  Perhaps the most interesting is the battle playing out inside the BOE, where Silvana Tenreyo, one of the more dovish MPC members, has been making the case that in the current situation, the UK should cut the base rate into negative territory.  Her analysis, as well as that of other central banks like the ECB, SNB and Danish central bank, have shown that there are many benefits to the policy and that it has been quite effective.  Of course, those are three of four central banks (the BOJ is the other) that currently maintain negative rates, so it would be pretty remarkable if those studies said NIRP was a failure.  The claim is that NIRP increases the amount of lending that banks extend, thus encouraging spending and investment as well as weakening the currency to help the export industries in the various countries.  And the studies go on to explain that all these factors help drive inflation higher, a key goal of each of those central banks.

Now, there is no question that those are the theoretical underpinnings of NIRP, alas, it is hard to find the data to support this.  Rather, these studies tend to give counterfactual analyses, that indicate if the central banks had not gone negative, things would have been worse.  For instance, let’s look at CPI in the Eurozone (-0.3%), Switzerland (-0.8%) and Denmark (+0.5%).  Not for nothing, but those hardly seem like data that indicate inflation has been supported.  In fact, in each of these countries, inflation was going nowhere fast before the pandemic, although I will grant that Covid has depressed the numbers further to date.  And how about the currency?  Well, one of the biggest stories of the past six months has been how the dollar has declined nearly 10% against these currencies.  Once again, the concept of a weaker currency seems misplaced.

The point here is that the discussion is heating up in the UK, with the independent MPC members pushing for a move below zero, while the BOE insiders are far more reluctant, explaining that the banking system would see serious harm.  (I think if one looks at the banking system in Europe, it is a fair statement that the banks there are not performing all that well, despite (because of?) 6 years of NIRP.  The BOE counterpoint was made this morning by Governor Bailey who explained there were still many issues to be addressed and implied NIRP was not likely to be implemented in the near future.  With all this as background, it should be no surprise that the pound has been the best performer in the G10 today, rising 0.6%, after Bailey’s comments squashed ideas NIRP was on its way soon.

But the dollar, overall, is softer today, not nearly reversing yesterday’s gains (except vs. the pound), but generally under pressure.  However, there is precious little that seems to be driving markets this morning, other than longer term stories regarding fiscal stimulus and Covid-19.

So, a quick tour of markets shows that Asian equity markets shook off the weakness in the US yesterday and rallied nicely.  The Nikkei (+0.1%) was the laggard, as the Hang Seng (+1.3%) and Shanghai (+2.1%) showed real strength.  Europe, on the other hand, is showing a much more mixed picture, wit the DAX (+0.1%) actually the best performer of the big 3, while the CAC (0.0%) and FTSE 100 (-0.6%) are searching for buying interests.  The FTSE is likely being negatively impacted by the pound’s strength, as there is a narrative that the large exporters in the index are helped by a weak pound and so there is a negative correlation between the pound and the FTSE.  The problem with that is when running the correlation analysis, over the past two years, the correlation is just 0.08% and the sign is positive, meaning they move together, not oppositely.  But it is a nice story!  And one more thing, US futures are green, up about 0.25% or so.

Bond markets are selling off this morning as yields continue to rise on expectations that the future is bright.  10-year Treasury yields are up to 1.16%, which is a new high for the move, having rallied a further 1.2bps this morning.  But we are seeing the same type of price action throughout Europe, with yields higher by between 1.7 bps (Bunds) and 4.0bps (Italian BTP’s), with Gilts (+2.3bps) and OATs (+2.0bps) firmly in between.  What I find interesting about this movement is the constant refrain that H1 2021 is going to be much worse than expected, with the Eurozone heading into a double dip recession and the US seeing much slower than previously expected growth as many analysts have downgraded their estimates to 1.0% from 4.0% before.  At the same time, the message from the Fed continues to be that tighter policy is outcome based, and there is no indication they are anywhere near thinking about raising rates.  With that as background, the best explanation I can give for higher yields is concerns over inflation.  Remember, CPI is released tomorrow morning, and since the summer, almost every release was higher than forecast.  As I have written before, the Fed is going to be tested as to their tolerance for above target inflation far sooner than they believe.

The inflation story is supported, as well, but this morning’s commodity price moves, with oil higher by 1.3% and gold higher by 0.8%.  In fact, I believe that inflation is going to become an increasingly bigger story as the year progresses, perhaps reaching front page news before the end of 2021.

Finally, as mentioned above, the dollar is under broad-based, but generally modest pressure this morning.  After the pound, AUD (+0.35%) and CAD (+0.25%) are the leading gainers, responding to the firmer commodity prices, although NOK (0.0%) is not seeing any benefit from oil’s rise.  In the EMG space, it is also the commodity linked currencies that are leading the way, with ZAR (+0.9%), RUB (+0.8%) and MXN (+0.5%) topping the list.  Also, of note is the CNY (+0.3%) which is back to levels last seen in June 2018, as the strengthening trend their continues.

On the data front, the NFIB Small Business Optimism index showed less optimism, falling to 95.9, well below expectations, again pointing to a slowing growth story in H1.  The only other data point from the US is JOLT’s Job Openings (exp 6.4M), which rarely has any impact.  I would like to highlight, in the inflation theme, that Brazilian inflation was released this morning at a higher than expected 4.52% in December, which is taking it back above target and to levels last seen in early 2019.  If this continues, BRL may become a high yielder again.

Finally, we hear from 6 different Fed speakers today, but again, unless they all start to indicate tighter policy, not just better economic outcomes, in H2, while the dollar may benefit slightly, it will not turn the current trend.  And that’s really the story, the medium-term trend in the dollar remains lower, but for now, absent a catalyst for the next leg (something like discussion of YCC or increased QE), I expect a bit of choppiness.

Good luck and stay safe
Adf

Perfect Right Here

Said Harker, by end of this year
A taper could be drawing near
But Mester explained
No cash would be drained
As policy’s perfect right here

Ahead of this morning’s payroll report, I believe it worthwhile to recap what we have been hearing from the FOMC members who have been speaking lately.  After all, the Fed continues to be the major force in the market, so maintaining a clear understanding of their thought process can only be a benefit.

The most surprising thing we heard was from Philadelphia Fed president Harker, who intimated that while he saw no reason to change things right now, he could see the Fed beginning to taper their asset purchases by the end of 2021 or early 2022.  Granted, that still implies an additional $1 trillion plus of purchases, but is actually quite hawkish in the current environment where expectations are for rates to remain near zero for at least the next three years.  Given what will almost certainly be a significant increase in Treasury issuance this year, if the Fed were to step back from the market, we could see significantly higher rates in the back end of the curve.  And, of course, it has become quite clear that will not be allowed as the government simply cannot afford to pay higher rates on its debt.   As well, Dallas Fed President Kaplan also explained his view that if the yield curve steepened because of an improved growth situation in the US, that would be natural, and he would not want to stop it.

But not to worry, the market basically ignored those comments as evidenced by the fact that the equity market, which will clearly not take kindly to higher interest rates in any form, rallied further yesterday to yet more new all-time highs.

At the same time, three other Fed speakers, one of whom has consistently been the most hawkish voice on the committee, explained they saw no reason at all to adjust policy anytime soon.  Regional Fed presidents from Cleveland (Loretta Mester), Chicago (Charles Evans) and St Louis (James Bullard) were all quite clear that it was premature to consider adjusting policy as a response to the Georgia election results and the assumed increases in fiscal stimulus that are mooted to be on the way.

Recapping the comments, it is clear that there is no intention to adjust policy, meaning either the Fed Funds rate or the size of QE purchases, anytime soon, certainly not before Q4.  And if you consider Kaplan’s comments more fully, he did not indicate a preference to reduce support, just that higher long-term rates ought to be expected in a well-performing economy.  Vice-Chairman Clarida speaks this morning, but it remains difficult to believe that he will indicate any changes either.  As I continue to maintain, the government’s ability to withstand higher interest rates on a growing amount of debt is limited, at best, and the only way to prevent that is by the Fed capping yields.  Remember, while the Fed has adjusted its view on inflation, now targeting an average inflation rate, they said nothing about allowing yields to rise alongside that increased inflation.  Again, the dollar’s performance this year will be closely tied to real (nominal – inflation) yields, and as inflation rises in a market with capped yields, the dollar will decline.

Turning to this morning’s payroll release, remember, Wednesday saw the ADP Employment number significantly disappoint, printing at -123K, nearly 200K below expectations.  As of now, the current median forecasts are as follows:

Nonfarm Payrolls 50K
Private Payrolls 13K
Manufacturing Payrolls 16K
Unemployment Rate 6.8%
Average Hourly Earnings 0.2% (4.5% Y/Y)
Average Weekly Hours 34.8
Participation Rate 61.5%
Consumer Credit $9.0B

Source: Bloomberg

These numbers are hardly representative of a robustly recovering economy, which given the cresting second wave of Covid infections and the lockdowns that have been imposed in response, ought not be that surprising.  The question remains, will administration of the vaccine be sufficient to change the trajectory?  While much has been written about pent up demand for things like travel and movies, and that is likely the case, there has been no indication that governments are going to roll back the current rules on things like social distancing and wearing masks.  One needs to consider whether those rules will continue to discourage those very activities, and thus, crimp the expected recovery.  Tying it together, a slower than expected recovery implies ongoing stimulus

But you don’t need me to explain that permanent stimulus remains the basic premise, just look at market behavior.  After yesterday’s US equity rally, we have seen a continuation around the world with Japan’s Nikkei (+2.35%) leading the way in Asia, but strength in the Hang Seng (+1.2%) and Australia (+0.7%), although Shanghai (-0.2%) didn’t really participate.  Europe, too, is all green, albeit in more measured tones, with the DAX (+0.8%) leading the way but gains in the CAC (+0.5%) and FTSE 100 (+0.2%) as well as throughout the rest of the continent.  And finally, US futures are all pointing higher at this hour, with all three indices up by 0.25%-0.35%.

The Treasury market, which has sold off sharply in the past few sessions, is unchanged this morning, with the yield on the 10-year sitting at 1.08%.  In Europe, haven assets like bunds, OATs and gilts are little changed this morning, but the yields on the PIGS are all lower, between 1.6bps (Spain) and 3.9bps (Italy).  Again, those bonds behave more like equities than debt, at least in the broad narrative.

In the commodity space, oil continues to rally, up another 1.3% this morning, and we continue to see strength in base metals and ags, but gold is under the gun, down 1.1%, and clearly in disfavor in this new narrative of significant new stimulus and growth.  Interestingly, bitcoin, which many believe as a substitute for gold has continued to rally, vaulting through $41k this morning.

And lastly, the dollar, which everyone hates for this year, is ending the week on a mixed note.  In the G10, NOK (+0.3%) is the best performer, as both oil’s rise and much better than expected IP data have investors expecting continued strength there.  But after that, the rest of the bloc is +/- 0.2% or less, implying there is no driving force here, rather that we are seeing position adjustments and, perhaps, real flows as the drivers.

In the emerging markets, ZAR (+1.2%) and BRL (+0.6%) are the leading gainers, while IDR (-0.8%) and CLP (-0.6%) are the laggards.  In fact, other than those, the bloc is also split, like the G10, with winners and losers of very minor magnitude.  Looking first at the rand, today’s gains appear to be position related as ZAR has been under pressure all week, declining more than 5.6% prior to today’s session.  BRL, too, is having a similar, albeit more modest, correction to a week where it has declined more than 5% ahead of today’s opening.  Both those currencies are feeling strain from weakening domestic activity, so today’s gains seem likely to be short-lived.  On the downside, IDR seems to be suffering from rising US yields, as the attractiveness of its own debt starts to wane on a relative basis.  As to Chile, rising inflation seems to be weighing on the currency as there is no expectation for yields to rise in concert, thus real yields there are under pressure.

And that’s really it for the day.  We have seen some significant movement this week, as well as significant new news with the outcome of the Georgia election, so the narrative has had to adjust slightly.  But in the end, it is still reflation leads to higher equities and a lower dollar.  Plus ça change, plus ça meme chose!

Good luck, good weekend and stay safe
Adf

Infinite Easing

Until “further progress” is made
On joblessness, Jay won’t be swayed
From infinite easing
Which stocks should find pleasing
Explaining how he will get paid

As well, one more time he inferred
That Congress was being absurd
By not passing bills
With plenty of frills
So fiscal relief can be spurred

We’re going to keep policy highly accommodative until the expansion is well down the tracks.”  This statement from Chairman Powell in yesterday’s post-meeting press conference pretty much says it all with respect to the Fed’s current collective mindset.  While the Fed left the policy rate unchanged, as universally expected, they did hint at the idea that additional QE is still being considered with a subtle change in the language of their statement.  Rather than explaining they will increase their holdings of Treasuries and mortgage-backed securities “at least at the current pace”, they now promise to do so by “at least $80 billion per month” in Treasuries and “at least $40 billion per month” in mortgages.  And they will do this until the economy reaches some still unknown level of unemployment alongside their average 2% inflation target.

What is even more interesting is that the Fed’s official economic forecasts were raised, as GDP growth is now forecast at 4.2% for 2021 and 3.2% for 2022, each of these being raised by 0.2% from their September forecasts.  At the same time, Unemployment is expected to fall to 5.0% in 2021 and 4.2% in 2022, again substantially better than September’s outlook of 5.5% and 4.6% respectively.  As to PCE Inflation, the forecasts were raised slightly, by 0.1% for both years, but remain below their 2% target.

Put it all together and you come away with a picture of the Fed feeling better about the economy overall, albeit with some major risks still in the shadows, but also prepared to, as Mario Draghi declared in 2012, “do whatever it takes” to achieve their still hazy target of full employment and average inflation of 2%.  For the equity bulls out there, this is exactly what they want to hear, more growth without tighter policy.  For dollar bears, this is also what they want to hear, a steady supply increase of dollars that need to wash through the market, driving the value of the dollar lower.  For the reflatonistas out there, those who are looking for a steeper yield curve, they took heart that the Fed did not extend the duration of their purchases, and clearly feel better about the more upbeat growth forecasts, but the ongoing lack of inflation, at least according to the Fed, means that the rationale for higher bond yields is not quite as clear.

After all, high growth with low inflation would not drive yields higher, especially in the current world with all that liquidity currently available.  And one other thing argues against much higher Treasury yields, the fact that the government cannot afford them.  With the debt/GDP ratio rising to 127% this year, and set to go higher based on the ongoing deficit spending, higher yields would soak up an ever increasing share of government revenues, thus crowding out spending on other things like the entitlement programs or defense, as well as all discretionary spending.  With this in mind, you can be sure the Fed is going to prevent yields from going very high at all, for a very long time.

Summing up, the last FOMC meeting of the year reconfirmed what we already knew, the Fed is not going to tighten monetary policy for many years to come.  For their sake, and ours, I sure hope inflation remains as tame as they forecast, because in the event it were to rise more sharply, it could become very uncomfortable at the Mariner Eccles Building.

In the meantime, this morning brings the last BOE rate decision of the year, with market expectations universal that no changes will be forthcoming.  That makes perfect sense given the ongoing uncertainty over Brexit, although this morning we heard from the EU’s top negotiator, Michel Barnier, that good progress has been made, with only the last stumbling blocks regarding fishing to be agreed.  However, in the event no trade deal is reached, the BOE will want to have as much ammunition as possible available to address what will almost certainly be some major market dislocations.  As I type, the pound is trading above 1.36 (+0.8% on the day) for the first time since April 2018 and shows no signs of breaking its recent trend.  I continue to believe that a successful Brexit negotiation is not fully priced in, so there is room for a jump if (when?) a deal is announced.

And that’s really it for the day, which has seen a continuation of the risk-on meme overall.  Looking at equity markets, Asia saw strength across the board (Nikkei +0.2%, Hang Seng +0.8%, Shanghai +1.1%), although Europe has not been quite as universally positive (DAX +0.8%, CAC +0.4%, FTSE 100 0.0%).  US futures markets are pointing higher again, with all three indices looking at 0.5%ish gains at this time.

The bond market is showing more of a mixed session with Treasuries off 2 ticks and the yield rising 0.7bps, while European bond markets have all rallied slightly, with yields declining across the board between 1 and 2 basis points. Again, if inflation is not coming to the US, and the Fed clearly believes that to be the case, the rationale for higher Treasury yields remains absent.

Commodity markets are feeling good this morning with gold continuing its recent run, +0.7%, while oil prices have edged up by 0.3%.  And finally, the dollar is on its heels vs. essentially all its counterparts this morning, in both G10 and EMG blocs.  Starting with the G10, NOK (+1.0%) is the leader, although AUD and NZD (+0.8% each) are benefitting from their commodity focus along with the dollar’s overall weakness.  In fact, the euro (+0.3%) is the laggard here, while even JPY (+0.4%) is rising despite the risk-on theme.  This simply shows you how strong dollar bearishness is, if it overcomes the typical yen weakness attendant to risk appetite.

In the emerging markets, it is also the commodity focused currencies that are leading the way, with ZAR (+0.9%) and CLP (+0.75%) on top of the leaderboard, but strong gains in RUB (+0.7%), BRL (+0.6%) and MXN (+0.5%) as well.  The CE4, have been a bit less buoyant, although all are stronger on the day.  But this is all of a piece, stronger commodity prices leading to a weaker dollar.

On the data front, I think we are in an asymmetric reaction function, where strong data will be ignored while weak data will become the rationale for further risk appetite.  This morning we see Initial Claims (exp 815K), Continuing Claims (5.7M), Housing Starts (1535K), Building Permits (1560K), and Philly Fed (20.0).  Yesterday saw a much weaker than expected Retail Sales outcome (-1.1%, -0.9% ex autos) although the PMI data was a bit better than expected.  But now that the Fed has essentially said they are on a course regardless of the data, with the only possible variation to be additional easing, data is secondary.  The dollar downtrend is firmly entrenched at this time, and while we will see reversals periodically, and the trend is not a collapse, there is no reason to believe it is going to end anytime soon.

Good luck and stay safe
Adf

Unrequited

It cannot be very surprising
That Boris and friends keep devising
More reasons to talk
Yet both sides still balk
At genuinely compromising

For now, though, the market’s delighted
With risk appetite reignited
Pound Sterling has soared
With stocks ‘cross the board
Though bond love has been unrequited

Aahh, sweet temptation.  I’m sure most of us know, firsthand, how difficult it can be to impose self-control when it comes to something we really want, but know we shouldn’t have, like that extra cookie after dinner.  Or perhaps, it is the situation of something we really don’t want, but know we need, like that trip to the dentist.  In either case, getting ourselves to do the right thing can be an extraordinary struggle.  That is the best analogy I can find for the countless Brexit trade talk deadlines that have been made and passed since the actual Brexit agreement was signed on January 31, 2020.

You may recall last Thursday’s dinner date between Boris and Ursula, where the outcome was a declaration that if a deal could not be reached by the weekend’s close (yesterday), none would ever come.  The thing about Brexit deadlines, however, is that they only exist in the mind of the individual setting them.  It appears to be a tool designed to impose self-control on the speaker.  However, like so many of us, when we claim we will eat only one cookie, we find the temptation to eat another too great to ignore.  This appears to be the same situation when it comes to establishing Brexit talk deadlines, both sides really want a deal, and hope that a deadline will be the ticket to finding one that can be agreed.  But in the end, the only true deadline is the one inscribed in the Brexit agreement, which is December 31, 2020.  And with that as prelude, it is quite clear that the latest deadline has been ignored, and both sides have explained that a deal is within reach and they will continue talking, right up until New Year’s Eve if necessary.

This past Friday, there were rumors rampant that the whole situation would fall apart, and that risk would be jettisoned as soon as markets opened in Asia last night.  Expectations were for a huge Treasury rally, with sharp declines in stock markets.  But for now, that situation remains on hold, and the good news has inspired further risk acquisition, with most equity markets solidly higher along with oil while bonds are selling off along with the dollar.

As I have maintained for the past several months, despite all the rhetoric on both sides, the most likely outcome remains a successful conclusion to the talks.  It is unambiguously in both sides’ interest to agree a deal, and everything that we have seen has been for each sides’ domestic constituents as proof they fought to the last possible second and got the best deal possible.  In fact, part of me believes a deal has already been agreed, it just hasn’t yet been revealed as the timing is not propitious for both sides.  Whatever the situation, though, for now, the market has been satisfied that there is nothing imminent that is going to stop the risk rally.

And that pretty much sums up the session, there is nothing imminent that is going to stop the risk rally.  Looking ahead for the week, Retail Sales on Wednesday morning is arguably the most important data point, but of more importance is the FOMC meeting that same day, with the afternoon statement and press conference.  We will focus on that tomorrow and Wednesday, but as of now, there is no change expected in either the interest rate structure or quantity of QE, but there is some discussion of a change in tenor of QE purchases.

With all that in mind, then, let us look at markets overnight.  As discussed, risk appetite is growing as a combination of the positive Brexit story and the first rollouts of the Covid vaccine encourage the outlook that the timeline for reigniting economic growth is nearing.  Adding to this story is the news that a US fiscal stimulus bill may be close to being agreed, and, naturally, we know that every central bank will continue to add liquidity to the markets for as long as they deem fit, which currently seems to be indefinitely.  Interestingly, this is all occurring despite Germany imposing renewed harsh lockdowns through January, and word that we are going to see the same in Italy, Spain and the UK.

But here’s what we have seen.  Asian equity markets were generally positive (Nikkei +0.3%, Shanghai +0.7%) although the Hang Seng (-0.4%) lagged.  European markets are all higher, with some pretty good gains (DAX +1.25%, CAC +1.1%) although the FTSE 100 (+0.4%) is lagging on the strength of the pound, which negatively impacts so many companies in the index.  And finally, US futures are all green with gains between 0.6% and 0.9%.

Bond markets are selling off, which should be no surprise, with Treasury yields higher by 2.5 bps, although most of Europe has seen more moderate price declines, with yields higher by less than 2 basis points across the board.  With one exception, UK gilts have seen yields rise 6.7 basis points, as hopes for a Brexit deal have led to a lot of unwinding of Friday’s rally.

Meanwhile, oil prices are firmer (WTI +1.1%) but gold is actually softer (-0.7%) despite the dollar’s broad weakness.  In the G10 space, GBP (+1.5%) is the leader by far, as renewed hope has forced some short covering.  But the entire bloc is firmer with NOK (+1.1%) benefitting from oil’s rise, while the rest of the group has gained on a more general risk appetite with gains between 0.2% (CAD) and 0.6% (SEK).  The surprise here is JPY (+0.3%) which given the risk attitude, would have been expected to decline as well.

EMG currencies are mostly firmer, but the move seems to have ignored peripheral APAC currencies, where a group have seen very modest declines of 0.1% or so.  On the plus side, however, ZAR (+1.0%) leads the way, despite weaker gold prices, as Consumer Confidence data was released at a strong gain compared to Q3.  Elsewhere, BRL (+0.7%) and PLN (+0.7%) are the next best performers, with broad dollar sentiment the clear driver.  In fact, the entire CE4 is strong, as they demonstrate their ongoing high beta performance compared to the euro (+0.35%).

Data this week is really concentrated on Wednesday, but is as follows:

Tuesday Empire Manufacturing 6.9
IP 0.3%
Capacity Utilization 70.3%
Wednesday Retail Sales -0.3%
-ex autos 0.1%
FOMC Rate Decision 0.00% – 0.25%
Thursday Initial Claims 823K
Continuing Claims 5.7M
Philly Fed 20.0
Housing Starts 1533K
Building Permits 1558K
Friday Leading Indicators 0.4%

Source: Bloomberg

So, really, all eyes will be turned toward Washington and Chairman Powell as we await any indication that the Fed is going to change policy further.  Expectations are growing around new forward guidance, for explicit economic targets to be achieved before adjusting rates, but in any case, there is no expectation for rates to rise before the end of 2023.  Perhaps new forecasts and the new dot plot will add some new information, but I doubt it.

For now, risk remains in vogue, and as long as that remains the case, the dollar will remain under pressure.  But don’t expect a collapse, instead a modest decline, at least vs. the G10.  Certainly, there are some emerging currencies, notably BRL, which I think have room to run a bit more.

Good luck and stay safe
Adf

The Table is Set

In Brussels, the table is set
As Boris and Ursula bet
That dinner together
Will be the bellwether
To ending the hard Brexit threat

So, appetite for risk is whet
With central banks sure to abet
More equity buying
As they keep on trying
To buy every last piece of debt

There hasn’t been this much interest in a meal in Europe since the one painted by DaVinci some 530 years ago.  Clearly, the big story is this evening’s dinner date between UK PM Boris Johnson and European Commission President Ursula von der Leyen, where they will make what appears to be the final attempt to get some political agreement on the last issues outstanding in order to complete the Brexit trade deal.  With just over three weeks before the UK exits the EU, time is clearly of the essence at this stage.  I remain confident that an agreement will be reached as it is in both sides’ collective interest to do so.  Rather, the current political theater is seen as necessary, again for both sides, in order to demonstrate they did everything they could to achieve the best possible outcome.  After all, Boris is going to have to cede some portion of UK sovereignty, and the EU is going to have to cede some adherence to their extraordinarily large canon of laws.

The FX market seems to share my opinion as the pound has rallied more than 1% since I wrote yesterday and is currently firmer by 0.7% since yesterday’s close.  As I wrote last week, I remain convinced that the market has not actually priced in a successful completion of a deal, rather that the pound’s performance over the past several months, a nearly 10% rise since July 1st, has simply been reflective of the broad dollar decline and not a bet on a positive Brexit outcome.  As such, I believe there is a good amount of upside potential for the pound in the event of a positive result, perhaps as much as 3% right away, and 5%-6% over time.  Similarly, if a deal is not reached, a 5% decline is in the cards.  But, for now, all we can do is wait to hear the outcome.  Dinner is at 8pm in Brussels, so likely there will be little news before 4pm this afternoon.

Away from the Brexit story, however, the market discussion continues to revolve around prospects for a quick implementation of the Covid-19 vaccine and the resumption of pre-pandemic economic activity.  One of the conundrums in this regard is that despite what appears to be a growing belief that the vaccine will solve the covid crisis, thus enabling a return to economic growth, the central banking community will continue to inject unfathomable sums of liquidity into banks, (and by extension markets and maybe even the economy), to support economic growth.  It seems a bit duplicative to me, but then I’m just an FX salesman sans PhD.  After all, if the vaccine will allow people to revert to their former selves, what need is there for central banks to keep buying bonds?  (And in some cases, equities.  As an aside, yesterday the BOJ reached a milestone as the largest equity holder in Japan, outstripping the government pension fund, GPIF, and now in possession of nearly 8% of the entire market there.)

The thing is, there is no prospect that this behavior is going to change.  For instance, tomorrow the ECB’s final meeting of the year will conclude, and they are expected to expand the PEPP by at least €500 billion and extend the tenor of the program between six months and a year.  In addition, they are expected to expand the TLTRO III program (targeted long-term refinancing operations) by another year, and there were even some hints at a rate cut there.  The latter would be extraordinary as the current rate is -1.0%.  This means that European banks that borrow funds in this program pay -1.0% (receive 1.0% pa) as long as they lend these funds on to corporate and business clients, with no restrictions on what they can charge.  Balances in this program have fallen from €1.3 trillion to just €180 billion since the summer, so it is believable that the rate will change.  The ECB particularly likes this program as they believe it really encourages business loans.

Something else to watch in tomorrow’s meeting is whether either the statement, or Madame Lagarde in her press conference opening, discusses the exchange rate.  Since the euro first traded above 1.20 back in September, which brought an immediate response from the ECB via some jawboning, the single currency had really done very little, until November, when the latest move higher began.  Now, after a 4% rally, it would not be surprising for the ECB to once again mention the importance of a “competitive” (read: weak) euro.  With inflation in the Eurozone remaining negative, Lagarde and company simply cannot afford for the euro to rise much further.  And none of this discussion includes what may well come from the FOMC next week!

But on to today’s activity.  Risk appetite continues to be strong where equity markets in Asia (Nikkei +1.3%, Hang Seng +0.75%) and Europe (DAX +0.8%, CAC +0.2%, FTSE 100 +0.4%) are all continuing yesterday’s modest gains.  The one exception here is Shanghai (-1.3%) which seemed to respond to inflation data overnight (CPI -0.5%).  The cause here seems to be declining pork prices (remember last year the Asian Swine Flu resulted in the culling of Chinese herds and dramatic price rises) but also the expectation that the PBOC is not going to change course with respect to forcing the deleveraging of the real estate sector and concomitant bubble there.

Bond markets are behaving as one would expect in a risk-on scenario, with Treasury yields reversing yesterday’s 2bp decline, while Bunds and OATs have both seen yields edge higher by 1 basis point.  Oil prices have rallied 1.5%, partly on risk attitude and partly on the story of an attack on Iraqi oil assets disrupting supply.  Finally, gold, which has really been rebounding since the end of last month, has given up 0.65% this morning.

Lastly, the dollar is generally softer today, against most G10 and EMG currencies.  AUD (+0.9%) is the leader this morning after the Westpac Consumer Confidence Survey printed at a much higher than expected 112.0.  For reference, that was the highest print since October 2010!  But as mentioned, the pound is firmer, as is virtually the entire bloc, albeit with less impressive moves.

In emerging markets, HUF (+0.8%) is the leading gainer, followed by PLN (+0.7%) and CZK (+.4%), all of which are far outperforming the euro (+0.1%).  It seems that the EU Stimulus deal, which was being held up by Hungary and Poland over language regarding the rule of law, has finally been agreed by all parties, with those three nations set to receive a significant boost when it is finally implemented next year.  On the flip side, TWD (-0.4%) was the worst performer as a late session sell-off wiped out early gains.  At this point, there is no obvious catalyst for the move, which looks very much like a large order going through an illiquid market onshore.

There is no data of note this morning and no speakers either.  Risk appetite remains the driver, with not only vaccine euphoria, but also hopes for a US stimulus bill rising as well.  In other words, everything is fantastic!  What could possibly go wrong?

As long as equities continue to rally, the dollar is likely to remain under pressure, but with the ECB on tap for tomorrow, I don’t expect a breakout, unless something really positive (or negative) comes out of dinner in Brussels.

Good luck and stay safe
Adf

Nothing but Cheerful

While yesterday traders were fearful
Today they are nothing but cheerful
The vaccine is coming
While Bitcoin is humming
It’s only the bears who are tearful

Risk is back baby!!  That is this morning’s message as a broad-based risk-on scenario is playing out across all markets.  Well, almost all markets, oil is struggling slightly, but since according to those in the know (whoever they may be) we have reached so-called ‘peak oil’, the oil market doesn’t matter anymore.  So, if it cannot rally on a day when other risk assets are doing so, it is of no consequence.

Of course, this begs the question, what is driving the reversal of yesterday’s theme?  The most logical answer is the release of the newest batch of Manufacturing PMI data from around the world, which while not universally better, is certainly trending in the right direction.  Starting last night in Asia, we saw strength in Australia (55.8), Indonesia (50.6), South Korea (52.9), India (56.3) and China (Caixin 54.9).  In fact, the only weak print was from Japan (49.0), which while still in contractionary territory has improved compared to last month.  With this much renewed manufacturing enthusiasm, it should be no surprise that equity markets in Asia were all bright green.  The Nikkei (+1.35%), Hang Seng (+0.85%) and Shanghai (+1.75%) led the way with New Zealand the only country not to join in the fun.

Turning to European data, it has been largely the same story, with Germany (57.8) leading the way, but strong performances by the UK (55.6) and the Eurozone (53.8) although Italy (51.5) fell short of expectations and France (49.6) while beating expectations remained below the key 50.0 level.  Spain (49.8), too, was weak failing to reach expectations, but clearly, the rest of the Continent was quite perky in order for the area wide index to improve.  Equity markets on the Continent are also bright green led by the FTSE 100 (+1.95%) but with strong performances by the DAX (+1.0%) and CAC (+1.1%) as well.  In fact, here, not a single market is lower.  Even Russian stocks are higher despite the weakest PMI performance of all (46.3).

The point is, there is no risk asset that is not welcome in a portfolio today.  However, while the broad sweep of PMI data is certainly positive, it seems unlikely, given the market’s history of ignoring both good and bad data from this series, that this is the only catalyst.  In fairness, there was some other positive data.  For example, German Unemployment fell to 6.1%, a tick below last month and 2 ticks below expectations.  At the same time, Eurozone CPI was released at a slightly worse than expected -0.3% Y/Y in November, which only encourages the bullish view that the ECB is going to wow us next week when they unveil their latest adjustments to PEPP.

And perhaps, that is a large part of the story, expectations for ongoing central bank largesse to support financial markets continue to be strong.  After all, the buzz in the US is that the combination of Fed Chair Jay Powell alongside former Fed Chair Janet Yellen as Treasury Secretary means that come January or February, the taps will once again open in the US with more fiscal and monetary assistance.  Alas, what we know is that the bulk of that assistance winds up in the equity markets, at least that has been the case to date, so just how much this new money will help the economy itself remains in question.

But well before that, we have a number of key events upcoming, notably next week’s ECB meeting and the Fed meeting the following week.  Focusing first on Frankfurt, recall that Madame Lagarde essentially promised action at their late October get together, and the market wasted no time putting numbers on those expectations.  While no rate cut is anticipated, at least not in the headline Deposit rate (currently -0.50%), the PEPP is expected to be increased by up to €600 billion with its tenor expected to be extended by an additional six months through the end of 2021.  However, before we get too used to that type of expansion, perhaps we should heed the words of Isabel Schnabel, the German ECB Executive Board member who today explained that while further support would be forthcoming, thoughts that the ECB would take the Mario Draghi approach of exceeding all expectations should be tempered.  Of course, the question is whether a disappointing outcome next week, say just €250 billion additional purchases, would have such a detrimental impact on the markets economy.  Remember, while Madame Lagarde has a great deal of political nous, she has thus far demonstrated a tin ear when it comes to market signals.  The other topic on which she opined was the TLTRO program, which she seems to like more than PEPP, and which she implied could see both expansion and even a further rate cut from the current -1.00%.

And perhaps, that is all that is needed to get the juices flowing again, a little encouragement that more money is on its way.  Certainly, the bond markets are exhibiting risk on tendencies, although yield increases of between 0.2bps (Germany) and 1.1bps (Treasuries) are hardly earth shattering.  They are certainly no indication of the reflation trade that had gotten so much press just a month ago.

And finally, the dollar, which is definitely softer this morning, but only after having rallied all day yesterday, so is in fact higher vs. yesterday morning’s opening levels.  The short dollar trade remains one of the true conviction trades in the market right now and one where positioning is showing no signs of abating.  Almost daily there seems to be another bank analyst declaring that the dollar is destined for a great fall in 2021.  Perhaps they are correct, but as I have repeatedly pointed out, no other central bank, certainly not the ECB or BOJ is going to allow the dollar to decline sharply without some action on their part to try to slow or reverse it.

A tour of the market this morning shows that CHF (+0.4%) is the leading gainer in the G10, although followed closely by SEK (+0.4%) and EUR (+0.35%).  Of course, if you look at the movement since Friday, CHF and EUR are higher by less than 0.1% and SEK is actually lower by 0.45%.  In other words, do not believe that the dollar decline is a straight-line affair.

Emerging markets are seeing similar price action, although as the session has progressed, we have seen more currency strength.  Currently, CLP (+0.9%), ZAR (+0.85%) and BRL (+0.8%) are leading the way here, all three reliant on commodity markets, which have, other than oil, performed well overnight.  The CE4 are also higher (HUF +0.6%, CZK +0.5%), tracking the euro’s strength, and Asian currencies had a fair run overnight as well, with INR (+0.5%) the best performer as a beneficiary of an uptick in stock and bond investments made their way into the country.

On the data front, today brings ISM Manufacturing (exp 58.0) and Construction Spending (0.8%), with the former certainly of more interest than the latter.  This is especially so given the PMI data overnight and the market response.  But arguably, of far more importance is Chairman Powell’s Senate testimony starting at 10:00 this morning, which will certainly overshadow comments from the other three Fed speakers due later.

Yesterday at this hour, with the dollar under pressure, it seemed we were going to take out some key technical levels and weaken further.  Of course, that did not happen.  With the dollar at similar levels to yesterday morning, and another dollar weakening sentiment, will today be the day that we break 1.20 in the euro convincingly?  As long as CNY remains strong, it is certainly possible, but I am not yet convinced.  Receivables hedgers, these are the best levels seen in two years, so it may not be a bad time to step in.

Good luck and stay safe
Adf

Cloaked in Fog

***Moderna vaccine indicated at 94.5% effective** – 6:56am

The rebound in growth
Set records. But the future
Remains cloaked in fog

Similar to what we have seen in every major economy, Q3 GDP growth in Japan recorded the highest ever rate since statistics were first collected and calculated in 1980.  The 21.4% annualized growth in Q3 (5.0% Q/Q), however, was substantially below the levels seen in the US (7.5% Q/Q), France (18.2% Q/Q), Germany (8.2% Q/Q) and the UK (15.5%).  Perhaps the bigger concern for Japan is the fact that it has recouped barely half the economic losses derived from the onset of Covid-19.  And adding to that concern is the recent resurgence in Covid cases, both in Japan and its major export markets, means that Q4 growth is unlikely to continue this trend, and could very well fall back into negative territory, depending on just how long shutdowns are in place around the world.

Investors, however, embraced the news (or embraced some news if not this) as the Nikkei continued its recent rally, rising 2.05% overnight amidst an overall risk-on setting.  In fact, since the close on October 30, the Nikkei has rallied nearly 13% despite relatively unimpressive data.  Not only that, given the BOJ is already at max support, it is unclear what else they can be expected to do to support the economy.  And yet, the equity market would have you believe the future is bright!  The one market not participating in this is FX, where the yen remains unchanged on the session, seemingly unable to decline despite the risk rally, but unable to advance in a weak dollar environment.

As calendar pages keep turning
There’s something that is quite concerning
The Brexit morass
Has reached an impasse
With neither side, for a deal, yearning

While there is no question that deals like the one currently needed to achieve a smooth Brexit on December 31st are always pushed off until there is no more time to delay, it certainly appears that we are getting awfully close to that time.  The big news last week was that Dominic Cummings, one of PM Johnson’s key advisors and a major architect of the entire Brexit campaign, resigned from his post.  Pundits immediately expected the UK to soften their position on state aid, which along with fishing rights for EU (mainly French) fleets are the two big issues remaining to be sorted.  But so far, that is not the case, with the UK’s chief negotiator, David Frost, explaining today that the UK “will not be changing” their positions as the next round of negotiations begins in Brussels.  And yet, markets remain entirely sanguine about the results, clearly expecting a deal to be reached and approved in time.  This is evident in the fact that the pound has actually rallied slightly today, 0.1%, and remains well-ensconced in its recent uptrend.  Similarly, the FTSE 100 continues its recent rally, rising 0.7% and is 14% higher than its close at the end of October.  Gilt yields?  Essentially unchanged on the day at 0.34%.  The point is, there is very little concern that a hard Brexit is in our future.  Either that, or the market is completely convinced that if one comes, the BOE will be able to do something about it. FWIW, the latter seems a bad bet.

Ultimately, the story of today’s session is that risk is a wonderful thing, and those who seek to manage risk or exhibit prudence with their positioning will be left behind again.  In the growth vs. value debate, value still has no value, it’s all about growth.  As an aside, perhaps economist Herbert Stein said it best with his observation now known as Stein’s Law; “If something cannot go on forever, it will stop.”  Bull markets cannot go on forever, so beware!

But they continue this morning with risk everywhere rallying.  Elsewhere in Asia, the Hang Seng rose 0.9% and Shanghai 1.1% after Chinese data showed IP slightly better than expected in October (6.9% Y/Y) although Retail Sales disappointed at 4.3% (exp 5.0%).  However, not only did equity markets there rally, so did the renminbi, rising a further 0.35% overnight and back to its strongest level since June 2018.

In fact, even before the Moderna vaccine news hit the tape, equities were all in the green in Europe (DAX (+0.5%, CAC +1.2%) and US futures were jumping (DOW +1.0%, SPX +0.7%, NASDAQ +0.7%), and they have risen further in the wake of the headline.  Perhaps everything is rosy and we are set to return to some sense of normalcy.  Of course, if that’s the case, will central banks worldwide still need to provide so much support?  And if they don’t provide that support, will markets be able to continue to rally on their own?  Just something to consider.

But at this time, the good vibes are everywhere, with oil markets (+2.5%) encouraged by the idea that the return to normal lies just around the corner, while gold, which had been higher earlier, seems no longer to be necessary in this brave new world, and has fallen 0.8% on the day (1% since the headline.)

Meanwhile, FX markets are in full risk-on mode.  In the G10 bloc, NOK (+0.9%) is the leading gainer, benefitting from the combination of overall risk appetite and the rise in oil prices.  After that, there is a group of commodity currencies (AUD, NZD and CAD all +0.4%) rising on the back of stronger commodity prices.  The euro and pound have both edged higher by 0.1%, and in the wake of the Moderna news, the yen has actually fallen back, (-0.3%), with risk metrics clearly dominating the dollar story now.

In the EMG bloc, BRL has opened much stronger (+1.5%) and we are seeing strength in the commodity focused currencies here as well; RUB (+1.25%), MXN (+1.1%), ZAR (+1.0%).  The rest of the bloc, excepting the Turkish lira (-1.0%) which remains beholden to the inconsistencies of Erdogan’s policies, is also generally firmer but not quite to the same extent.  However, the entire story is risk is ON.

On the data front, Retail Sales dominate the week,:

Today Empire Manufacturing 13.8
Tuesday Retail Sales 0.5%
-ex autos 0.6%
IP 1.0%
Capacity Utilization 72.3%
Business Inventories 0.6%
Wednesday Housing Starts 1455K
Building Permits 1567K
Thursday Initial Claims 700K
Continuing Claims 6.4M
Philly Fed 22.0
Leading Indicators 0.7%
Existing Home Sales 6.45M

Source: Bloomberg

But if the risk appetite is going to be as strong as this morning indicates, none of the data is going to matter.  Nor will anything that the dozen Fed speakers upcoming this week have to say.  Instead, this is all about the vaccine, growth and FOMO.  In this environment, the dollar is likely to remain under modest pressure, but at the end of the day, there is no reason to believe it will decline sharply.

Good luck and stay safe
Adf

Over the Moon

Investors are over the moon
And singing a happy new tune
As Pfizer’s vaccine
Has come on the scene
And raised hope we’ll soon be immune

The market responded with glee
As pundits now seem to agree
With gridlock ahead
The vaccine, instead
Will rescue our economy

Frankly, it is hard to keep up with the narrative shifts between yesterday and today as there have been so many new opinions about how the future will unfold.  As I was completing this missive yesterday morning the Pfizer vaccine news hit the tape.  Certainly, the market was unprepared for an announcement that a vaccine with 90% efficacy was in late stage trials, implying that it could soon be approved, and distribution begun.  Hopes for a vaccine had been a key driver of markets on many days in the past several months, although market rallies were ostensibly keyed by hopes for many things like a blue wave, gridlock, and if you go back far enough, a trade deal.  However, the news of the success triggered a stupendous rally in equity markets and risk assets in general while haven assets, especially Treasuries, Bunds and Gilts, along with the yen, Swiss francs and gold, all sold off sharply.  Yesterday, I was cynical regarding the end of the pandemic being at hand, but this morning, that outcome has far more promise.

Of course, the real question is, if this vaccine truly does work, and is distributed widely enough to instill confidence in the general population, how much has the economy actually changed and to what degree are those changes permanent?

Clearly, the biggest change has been the recognition that working from home, for many jobs, is quite viable.  Technology has reached the point where meetings via Webex or Zoom or Partners seem to be quite productive (at least as productive as any meetings ever are.)  My personal experience is that I have gone from driving nearly 2000 miles per month, largely for commuting, to having driven 3000 miles in the past seven months.  Not only have I used significantly less fuel, but my car has seen dramatically less wear and tear, and thus any replacement has been postponed accordingly.  And that is just one facet of the changes.  Commercial real estate and office buildings will likely need to be repurposed going forward as the requirement for corporate staffs to all gather in a single premise has been shown to be unnecessary.

But what about travel and entertainment?  With a vaccine, does that mean people will be jumping back on airplanes to visit clients or relatives or go on vacation again?  Is the movie theater experience ever going to be as desirable again?  After all, given the remarkable array of streaming entertainment services, and the fact that TV’s have grown so remarkably large, watching at home has many advantages over going out, so what percentage of the population will be heading back out soon?  In truth, the one segment I expect to really benefit is restaurants, as while it appears people embraced preparing food at home, I expect the ability to go out, eat and not have to wash the dishes has real appeal to a majority of the population.

My point is the dynamics of economic activity going forward are likely to be very different than that which we remember from before the pandemic and its attendant lockdowns and disruptions.

Of more importance to our discussion here, what does this mean for the central banks going forward.  Remember, Chairman Powell has essentially promised not to raise interest rates until 2023, a minimum of 2+ years from now.  But what if economic activity takes off, as people find a new mix of activities and regain the confidence to gather when desired.  If growth rebounds and inflation (which is already picking up) continues to rise, will they stand pat because of that promise?  Will the ECB?  The BOJ?  The BOE?  Quite frankly, I believe the central bank community was quite happy with the current situation.  They were largely lauded as heroes for preventing even worse outcomes, they had significantly increased their power and sway within governments, and the playbook was easy, print lots of money and buy bonds (or other assets) to support market functioning.  Not only that, they could carp at governments for not implementing fiscal stimulus and the intelligentsia all agreed!

But if this vaccine really is the difference maker, and people return to some semblance of their pre-covid activities, suddenly, central bank largesse may no longer be needed.  And if they continue their current policies and inflation starts to really pick up, they will be the ones being lambasted for their actions or delayed reactions.  While it is very early day(s) in this new story, it is the first time since before the financial crisis where central bankers may find themselves the targets of wrath, rather than the saviors of the world.  (People wonder whether Chairman Powell will be reappointed; quite frankly he may not want the job!)

With all that in mind, how have markets behaved since the news hit the tape?  Yesterday’s equity market performance was quite interesting, as the early euphoria (DOW 29933) reversed and stocks wound up closing much lower, with the NASDAQ actually falling 1.5% on the day.  There was also a huge rotation from the previous winners (Mega cap tech companies) into the previous losers (value and transportation stocks).  Asia followed suit with a mixed session (Nikkei +0.25%, Hang Seng +1.1%, Shanghai -0.5%) and Europe has also lacked some direction.  For instance, the DAX is unchanged on the day while the CAC has rallied 1.1% despite horrific IP and Labor data.  Spain is much firmer (+2.2%) and Italy has fallen (-0.25%).  In other words, this is not a vaccine driven market, rather it has to do with some pretty lousy data out of Europe.  The US dichotomy continues with DOW futures higher by 0.6%, SPX futures basically unchanged and NASDAQ futures lower by -1.6%. Perhaps there was a bubble in some of those stocks after all.

Bond markets continue to sell off everywhere, except Greece, as the narrative here is quite clear; vaccine => rebounding economic growth => less central bank policy ease => higher rates.  So, this morning 10-year Treasury yields are up to 0.94%, 2 basis points higher than yesterday after a 10-basis point rise yesterday.  But we are seeing yields higher between 1 and 3 basis points throughout Europe as well.  The question to ask is, Is the ‘new vaccine makes everything better’ narrative realistic or overdone, and just how long before economic activity actually starts to rebound?

Finally, the dollar can only be described as mixed, but leaning stronger.  Ignoring TRY (-2.0%) which is what we should always be doing, the EMG markets have more losers than winners with ZAR (-0.7%) and PLN (-0.6%) leading the way.  On the flip side, THB (+0.5%) and CNY (+0.3%) are both performing reasonably well.  If anything, it is hard to cobble together a consistent story as to why any of these currencies are moving in their current direction given the inconsistencies.

As to the G10 space, there have been two gainers of note, GBP (+0.65%) and NOK (+0.5%), with only CHF (-0.3%) showing any real weakness.  The rest of the bloc is little changed overall.  NOK is benefitting from the ongoing rally in oil prices, up another 1.5% this morning, which takes the move since Thursday to a 5% gain.  As to the pound, comments from the BOE’s Chief Economist, Andy Haldane yesterday seemed to change the market’s view as to the possibility of negative rates in the future.  By calling the vaccine a “game changer” he implied future central bank actions were likely to be less aggressive.

On the data front, the NFIB Small Business indicator was released right on expectations of 104.0.  Beyond that, we only see the JOLT’s Job Openings data, but that is for September, so has very limited appeal in a market that is seeing massive changes daily.  As mentioned above, Eurozone data was generally lousy, with both French (-6.0% Y/Y) and Italian (-5.1% Y/Y) Industrial Production disappointing and French Unemployment rising to 9.0%, its highest level since 2018.  As well, German ZEW Surveys were quite weak, with Expectations falling to 39.0, far lower than expected.

And so we have a market that needs to look through worsening recent data to the potential for a dramatic change regarding the vaccine and its ability to help economic activity find a new normal.  My view is we have seen significant excesses in many markets during the past several months and years, and there is every chance a significant amount gets unwound.  I do believe volatility will remain with us for a while, as there are many possible outcomes.  But in the end, while the dollar will have bouts of both strength and weakness, the one thing that will not happen is a collapse.

Good luck and stay safe
Adf

All Colored Rose

With spectacles all colored rose
Investors see only the pros
While cons may exist
They’ve all been dismissed
Thus, risk appetite only grows

It is good to be alive!!  That seems to be the mantra in markets this morning as despite ongoing vote recounts in a number of states, the mainstream media have declared Joe Biden the winner of the election.  This has unleashed a wave of buying (albeit not a blue wave) which has pushed both equity and commodity prices higher, as well as, interestingly enough, bond prices.  While I rarely, if ever, quote from another organization’s research, I will make an exception today as I feel it encapsulates the mindset that appears to have taken hold.  Citibank published a note over the weekend with the following: “..[the] trifecta of knowing who the next president will be, that the end of the pandemic is at hand and that sufficient economic stimulus will be available for the interim will mark the bright start of the New Economic Cycle in 2021.”  Perhaps, reading this comment you may understand why I have become such a skeptic over time.

Let us deconstruct this trifecta.  At this time, there are recounts in several key battleground states where the margin of victory was extremely narrow, including Pennsylvania, Nevada, Michigan and Georgia, and although the bulk of the media continue to claim this will not change the outcome, stranger things have happened.  However, let us assume this is the case.  The second leg is “the end of the pandemic is at hand”.  This statement seems a bit disingenuous. Every day there is a headline about the rising number of cases worldwide, which have now topped 50 million since this began in March and are spiking rapidly into the second wave.  In addition, we know that Europe has essentially closed down half its economy for the month of November.  In the meantime, one of the forecast benefits of a Biden victory was a new, national and sensible approach to addressing the pandemic.  It strikes me that if the end of the pandemic were at hand, the rise in new daily cases would be heading toward zero, or some extremely low number, certainly not the 472+K reported yesterday or 600K the day before, nor would there be a need for a new and sensible policy as the pandemic was already ending.  Finally, with the presumed Republican majority in the Senate, and with Majority Leader McConnell having indicated that the next stimulus bill should not be more than $500 billion, either the definition of sufficient has changed (prior to the election the punditry insisted that at least $2 trillion was necessary), or more cynically, Citibank is simply talking their book, trying to encourage more investment and economic activity, especially utilizing their services.

However, it is clear that market participants are willing to accept that trifecta at face value, and so this morning, we are seeing a powerful risk rally across all asset classes.  Starting with equity markets, which are clearly the drivers of risk sentiment, not only is my screen completely green, but powerfully so.  Asia started the process with significant gains (Nikkei +2.1%, Hang Seng +1.2%, Shanghai +1.9%), and Europe has taken up the mantle with gusto (DAX +1.9%, CAC +1.6%, FTSE 100 +1.4%).  Remember, all this positivity exists despite the fact that the Brexit negotiations remain quite far apart and ostensibly need to be completed by Sunday coming.  But today, that is irrelevant.  Lest you were concerned US markets were not participating, futures here are much higher as well (DOW and SPC +1.45%, NASDAQ +1.8%).  In other words, all is right with the world.

The bond market’s behavior is far more interesting, however, although perhaps there is a cogent explanation.  As we all know, a risk-on day, especially one as powerful as this, typically sees haven assets like government bonds sold off to free up capital to invest in stocks.  But this morning, Treasury yields are lower by 1 basis point while European markets are seeing yield declines (price rises) of between 2 and 3 basis points (with Greek 10-year yields lower by 8 basis points.)  While Greek yields make sense, after all their bonds are risk assets, not havens, it is surprising to see Bunds, OATS and Gilts rallying so much.  Perhaps the rationale behind this movement is the belief that we are set to see an increase in QE, especially in Europe, as Madame Lagarde has made clear that the ECB is going to be doing more come the December meeting.  The only concern with this thought process is that we have known that to be the case for two weeks, so why would these rallies suddenly pick up steam today?

Commodity markets are definitely feeling the love with oil rallying 3+% and both precious and base metals all higher on the day.  In other words, optimism reigns here.

Finally, the dollar is under pressure against most of its counterparts in the EMG space this morning although is having a mixed performance versus the G10.  Starting with the G10, perhaps the most surprising thing is that NOK (+0.15%) has gained so little given the strong rebound in oil.  Instead, the Commonwealth currencies are the leaders, with NZD (+0.4%) on top followed by CAD and AUD (both +0.2%).  All four of those currencies are beneficiaries of firmer commodity prices.  Meanwhile, JPY (-0.45%) is the leading decliner, which in a risk-on scenario is just what would be expected.  As well, weakness in CHF (-0.2%) is also no surprise.  But the pound (-0.2%) is under a bit of pressure, and neither the euro (-0.1%) nor SEK (-0.2%) have been able to gain during this session, which is somewhat surprising, especially given Stockie’s high beta to risk assets.

In the Emerging markets, TRY (+5.5%) is far and away the big winner today after the central bank governor was replaced and the economics minister (Erdogan’s son-in-law) stepped down.  It seems the market believes that the new central bank governor is going to raise rates to try to shore up the currency.  After that, we have seen solid strength in IDR (+1.0%), MXN (+0.8%) and KRW (+0.65%), although the bulk of the bloc is somewhat higher.  In the case of IDR, the rupiah has been the beneficiary of stock market inflows overnight with Korea’s won feeling the same sort of love.  Of course, MXN benefits when oil rallies, as does RUB (+0.3%) just not that much today.  In fact, the only red numbers come from the CE4 (HUF -0.5% with the others just marginally lower), and that only recently after the euro slid to a loss on the day.

On the data front, there is precious little released this week, with CPI the clear highlight.

Tuesday NFIB Small Biz Optimism 104.4
JOLT’s Job Openings 6.5M
Thursday Initial Claims 730K
Continuing Claims 6.75M
CPI 0.2% (1.3% Y/Y)
-ex food & energy 0.2% (1.7% Y/Y)
Friday PPI 0.2% (0.4% Y/Y)
-ex food & energy 0.2% (1.2% Y/Y)
Michigan Sentiment 81.8

Source: Bloomberg

However, while there may not be much data of note, we do get to hear from loads more Fed speakers this week, with thirteen different events, although only nine different speakers (Dallas’s Kaplan will be hoarse after his four different speeches).  One of these, though, on Thursday, will be Chairman Powell at the ECB Forum, where we will also hear from Madame Lagarde and the BOE Governor Andrew Bailey.

Breaking news just hit the tape about a Pfizer vaccine that was quite efficacious and that has encouraged even more risk taking, so equities are even stronger.  At this stage, there is nothing to stop the risk rally, and thus, nothing to help the dollar today.  While it won’t collapse, it will likely remain under pressure all day.

Good luck and stay safe
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Most Pundits Agree

No matter what skeptics might say
The Old Lady didn’t delay
They boosted QE
So, Sunak, Rishi
Can spend more each night and each day

But here, when the FOMC
Meets later, most pundits agree
They will not arrange
A policy change
Instead, for more fiscal they’ll plea

As markets are wont to do, they have effectively moved beyond the uncertainty of the US election outcome to the next big thing, in this case central bank activity.  You may recall that on Tuesday morning we learned the RBA cut interest rates again, down to 0.10% and installed a QE program of A$100 billion.  And while these days, A$100 billion may not seem like much, it does represent more than 5% of the Australian economy.  Of course, that action was mostly lost in the election fever that gripped markets at that time.  However, that fever has broken, and the market has come to terms with the fact there is no blue wave.  This has forced participants to collectively create a new narrative which seems to go as follows: gridlock in the US is good for markets because the Fed will be required to do even more, and thus monetary policy will remain easy for an even longer time.  This, as well as the expected lack of a massive stimulus package, is the driver behind the Treasury rally, which is continuing this morning as 10-year yields have fallen a further 3 basis points (30-year yields have fallen even more as the curve continues to flatten.)

Helping along the new narrative, and right on cue, the Bank of England stepped in and increased their QE program by a more than expected £150 billion this morning, allowing Chancellor of the Exchequer, Rishi Sunak, the leeway to expand fiscal support for the economy as the government there imposes a month long lockdown to try to arrest the spread of Covid-19.  Thus, in the UK, the monetary and fiscal policies are aligned in their efforts to prevent an economic collapse while fighting the effects of Covid.  Naturally, markets have voted in favor of further central bank largesse, and as expectations grow for even more support to come, equity investors are buying as quickly as they can.

Which leads us to the FOMC meeting today.  Cagily, they arranged for this meeting to be two days after the election, as they clearly don’t want to become the big story.  Rather, I’m certain that despite each members’ penchant to speak constantly, this is one time they will be as quiet as possible.  Part of this is due to the fact that there is exactly zero expectation that there will be any change in policy.  Rates are already at the effective lower bound, and thus far the Fed has not been willing to countenance the idea of negative rates.  Not only that, their forward guidance has been clear that rates will not be ‘normalized’ until at least 2023, and then, only if it makes sense to do so.  As to QE, they are already engaged in an unbounded program, purchasing $80 billion of Treasuries and $40 billion of Mortgage-backed securities each month.  Certainly, they could increase those numbers, but given the US Treasury has just significantly revised their expected issuance lower, (given the lack of a stimulus bill to fund), the Fed is already scooping up a huge percentage of the paper that exists.  With all that in place, what more can they do?  After all, if they say they won’t raise rates until 2024, will that actually matter?  I think not.  Instead, the one thing on which we can count is that the Statement, and Chairman Powell in the press conference, will repeat the point that more fiscal stimulus is what is needed.

The upshot is that, the most important par of the election outcome, is with regards to the Senate, which while it seems clear the Republicans have held their majority, could possibly turn blue.  But unless that happens, at this stage, the market has clearly turned its attention beyond the election and is voting favorably for more central bank support.  So, let’s see how things are behaving this morning.

After a strong US rally yesterday, especially in the NASDAQ, Asia took the baton and sprinted ahead as well with the Nikkei (+1.7%), Hang Seng (+3.25%) and Shanghai (+1.3%) all having strong sessions.  In fact, as I look through every APAC market, only Vietnam and Laos had negative days, otherwise every Asian nation rallied across every one of their indices.  Europe is no different, with every market in the green (DAX +1.7%, CAC +1.25%, FTSE 100 +0.5%, as well as all the sundry others), and US futures (DOW +1.4%, SPX +1.9%, NASDAQ +2.6%) are pointing to another big day here.

Bonds, as mentioned above, are also still feeling the love as only the UK appears to be adding to the fiscal mix and so central bank support will continue to drive activity until that changes.  This means that while Bunds, OATS and Gilts are all only marginally changed, the PIGS are seeing substantial demand with yields falling 3 basis points for all of them

Gold is doing well, up $15/oz on what seems to be the idea that fiat currencies will continuously be devalued and so something else will serve as a better store of value.  (Bitcoin, by the way, is also rallying sharply, +5% this morning, as many continue to see it as an alternative to gold.)  Oil, on the other hand, is a bit lower this morning, -1.0%, although that is after having rallied nearly 16% so far this week, so a modest correction doesn’t seem out of order.

Finally, the big loser today has been the dollar, which is weaker vs. essentially every other currency.  In the G10, NOK (+1.1%) is the leader, despite the fact that oil is correcting.  More interestingly, EUR (+0.7%) is rallying despite the fact that there is no expectation for Fed activity, and the relative stances of the Fed and ECB remains unchanged.  Now if there is not going to be a blue wave, and therefore no massive fiscal expansion in the US, I’m at a loss as to why the dollar should be sold.  Today, however, selling dollars is the story.

The same is true in the EMG bloc, with RUB (+2.2%) the runaway leader, but 1% or greater gains seen throughout EMEA and LATAM currencies.  Even IDR (+1.3%) which last night posted worse than expected GDP growth, has seen strength.  As long as the narrative continues to be that election uncertainty is a dollar negative, it appears the dollar has further to fall.  That said, I see no cause for a collapse of any type.

Aside from the FOMC today, we see some data as follows: Initial Claims (exp 735K), Continuing Claims (7.2M), Nonfarm Productivity (5.6%) and Unit Labor Costs (-11.0%).  Yesterday, amidst the election discussion, we missed the fact that ADP Employment rose a much less than expected 365K, and the ISM Services number printed at a worse than expected 56.6.  Perhaps, belatedly, that negative news has been impacting the dollar.  But my sense is this is narrative driven and unless the Fed truly shocks one and all, I expect the dollar can drift lower still for the rest of the session.

Good luck and stay safe
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