Tag Archives: #riskon

Some Despair

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In Germany, data revealed
That growth there’s apparently healed
But data elsewhere
Implied some despair
As problems, porcine, are concealed

Risk is back in vogue this morning as the market appears to be responding positively to a much better than expected PMI reading from Germany (Services PMI 50.6, up from 49.1 Flash reading, Composite 54.7, up from 53.7 Flash) and a modestly better outcome for the Eurozone (48.0 vs. 47.6 for Services, 50.4 vs. 50.1 for Composite) as a whole.  At least that’s the surface story I keep reading.  The problem with this version is that markets in Asia were also highly risk-centric and that was well before the PMI data hit the tape.  Which begs the question, what is really driving the risk narrative today?

When President Trump was infected
The thing that most people expected
Was two weeks before
He’d walk out the door
Explaining he wasn’t affected

A different, and timelier, explanation for today’s positive risk sentiment stems from the ongoing story of President Trump’s covid infection and his ability to recuperate quickly.  While the standing assumption had been that there is a two-week timeline from infection to recovery, the President has consistently indicated that he feels fine, as have his doctors, and the story is that he will be released today from his weekend stay at Walter Reed Memorial Hospital.  In other words, any concerns that attended the announcement of his illness from Friday, when we did see equity markets suffer, is in the process of being unwound this morning.  The rationale here seems to be twofold.  First, the President is set to be back at the White House and in control, something which matters greatly from a national security perspective.  But second, the fact that he, as a 74-year-old man, was able to recover so quickly from the infection speaks to the reduced impact covid is likely to have on the population as a whole.  And arguably, that may even have a bigger impact.  While we continue to hear of new lockdown’s being announced in certain places, NYC, Spain and France to name just three, if the potency of the infection is waning such that it is a short-term event with limited side effects, that could well lead to an increase in confidence amongst the population.  And, of course, confidence is the one thing that the economy is searching for desperately.

The problem is that since virtually everything has become political theater lately, it is difficult to discern the facts in this situation.  As such, it seems hard to believe that overall confidence has been lifted that significantly, at least as of this morning.  However, if President Trump remains active and vigorous this week, it will certainly put a dent into the thesis that covid is incredibly debilitating.  We will need to watch how things evolve.

Interestingly, there is one issue that seems to be getting short shrift this morning, the growing concern that there will be no Brexit deal reached in the next ten days.  Recall that Boris and Ursula had a virtual lunch date on Saturday, and both claimed that a deal was close, but there were a couple of issues left to address.  The two key differences remain the issue of acceptable state aid by the UK government and, the big one, the type of access that European (read French) fishing vessels will have to UK waters.  It seems that French President Macron is adamant that the UK give the French a (large) annual quota and be done with it, while Boris is of the mind that they should agree to meet annually and discuss the issue based on the available fish stocks and conditions.  It also seems that the rest of Europe is getting a bit annoyed at Macron as for them, the issue is not that significant.  This fact is what speaks to an eventual climb-down by Macron, but, as yet, he has not been willing to budge on the matter.  Based on the price of the pound and its recent performance (+0.2% today, +1.0% in the past week), the market clearly believes a deal will be reached.  However, that also foretells a more significant decline in the event both sides fail to reach said agreement.

So, now let’s take a look at the bullishness in markets today.  Asia saw strength across the board with the Nikkei(+1.25%) and Hang Seng (+1.3%) nicely higher and Australia (+2.6%) really showing strength.  (China remains closed virtually all week for a series of national holidays).  European indices are all green as well, albeit not quite as enthusiastic as Asia.  Thus, we have seen solid gains from the three major indices, DAX, CAC and FTSE 100, all higher by 0.7%.  And finally, US futures are pointing to a stronger opening, with current pricing showing gains of between 0.7% and 1.0%.

It should be no surprise that bond marks are under some pressure with 10-year Treasury yields up to 0.71% this morning, higher by 1 basis point on the session and 6 bps in the past week.  In fact, yields are back at their highest level in a month.  European bonds are also broadly softer (higher yields) but the movement remains muted as well, about 1bp where they have risen.  And it should also not be surprising that Italy, Portugal and Greece have seen yields decline, as those three certainly qualify as risk assets these days.

Oil prices are firmer, again taking their cue from the confidence that is infusing markets overall, while precious metals prices are flat.  And finally, the dollar is definitely softer, except against the yen, which continues to be one of the best risk indicators around.  So, in the G10 space, NOK (+0.7%) is the leader, following oil as well as benefitting from the general dollar weakness.  Next on the list is CHF (+0.5%) where data showed ongoing growth in sight deposits, an indication that capital flows continue to enter the country, despite today’s risk attitude.  But broadly speaking, the whole space is firmer.

As to EMG currencies, ZAR (+0.7%) is the leader today, with firmer commodity prices and still the highest real interest rates around keeping the rand attractive in a risk-on environment.  But it is almost the entire bloc with the CE4 (CZK +0.55%, PLN +0.45%, HUF +0.45%) showing their high EUR beta characteristics and MXN (+0.45%) also performing well, again benefitting from both firmer oil prices as well as a weaker dollar.  The one exception here is RUB (-0.5%), which appears to be suffering from the effects of the ongoing conflict in Nagorno-Karabakh and how much it is going to cost Russia to maintain its support for Armenia.

On the data front, it is a relatively quiet week with only a handful of numbers to be released:

Today ISM Services 56.2
Tuesday Trade Balance -$66.2B
JOLTs Job Openings 6.5M
Wednesday FOMC Minutes
Thursday Initial Claims 820K
Continuing Claims 11.4M

Source: Bloomberg

However, what we lack in data we make up for with Fedspeak, as eight different speakers, including Chairman Powell tomorrow, speak at 13 different events.  What we have heard lately is there is a growing difference of opinion by some FOMC members regarding the robustness of the US economic rebound.  However, despite those differences, the universal request is for further fiscal stimulus.  Given the dearth of data this week, I expect that Chairman Powell’s speech tomorrow morning is likely to be the most important thing we hear, barring a Brexit breakthrough or something else from the White House.

Good luck and stay safe
Adf

Spring Remains Distant

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From Brussels, a letter was sent
To London, with which the intent
Was telling the British
The EU’s not skittish
So, don’t try, rules, to circumvent

The pound is under pressure this morning, -0.6%, after it was revealed that the EU is inaugurating legal proceedings against the UK for beaching international law.  The details revolve around how the draft Internal Market Bill, that has recently passed through the House of Commons, is inconsistent with the Brexit agreement signed last year.  The specific issue has to do with the status of Northern Ireland and whether it will be beholden to EU law or UK law, the latter requiring a border be erected between Ireland, still an EU member, and its only land neighbor, Northern Ireland, part of the UK.  Apparently, despite the breathless headlines, the EU sends these letters to member countries on a regular basis when they believe an EU law has been breached.  As well, it apparently takes a very long time before anything comes of these letters, and so the UK seems relatively nonplussed over the issue.  In fact, given that the House of Lords, which is not in Tory control, is expected to savage the bill, it remains quite unclear as to whether or not this will be anything more than a blip on the Brexit trajectory.

However, what it did highlight was that market participants have grown increasingly certain that an agreement will be reached, hence the pound’s recent solid performance, and that this new wrinkle was enough for weak hands to be scared from their positions.  At this point, almost everything that both sides are doing publicly is simply intended to achieve negotiating leverage as time runs out on reaching a deal.  Alas for Boris, I feel that his biggest enemy is Covid, not Brussels, as the EU is far more concerned over the pandemic impact and how to respond there.  At the margin, while a hard Brexit is not preferred, the fear of the fallout in Brussels has clearly diminished, and so the opportunity for a hard Brexit to be realized has risen commensurately.  And the pound will fall further if that is the outcome.  The current thinking is there are two weeks left for a deal to be reached so expect more headlines in the interim.

The Tankan painted
A picture in black and white
Spring remains distant

Meanwhile, it is still quite cloudy in the land of the rising sun, at least as described by the Tankan surveys.  While every measure of the surveys, both small and large manufacturing and non-manufacturing indices, improved from last quarter by a bit, every one of them fell short of expectations.  The implication is that PM Suga has his work cut out for him in his efforts to get economic activity back up and running.  You may recall that CPI data on Monday showed deflation remains the norm, and weak sentiment is not going to help the situation there.  At the same time, capital flows continue to show significant foreign outflows in both stock and bond markets there.  It was only two weeks ago that the JPY (-0.1% today) appeared set to break through the 104 level with the dollar set to test longer term low levels.  Of course, at that time, the market narrative was all about the dollar falling sharply.  Well, both of those narratives have evolved, and if capital continues to flow out of Japan, it is hard to make the case for yen strength.  Remember, the BOJ is never going to be seen as relatively tighter in its policy stance, so a firmer yen would require other drivers.  Right now, they are not in evidence.

And frankly, those are the two most interesting stories in the market today.  Arguably, the one other theme that has gained traction is the rise in layoffs by large corporations in the US.  Yesterday nearly 40,000 were announced, which is at odds with the idea that the economy here is going to rebound sharply.  On an individual basis, it is easy to understand why any given company is reducing its workforce in the current economic situation.  Unfortunately, the picture it paints for the immediate future of the economy writ large is one of significant short-term pain.  Given this situation, it is also easy to understand why so many are desperate for Congress to agree a new stimulus bill in order to support the economy.  And it’s not just elected officials who are desperate, it is also the entire bullish equity thesis.  Because, if the economy turns sharply lower, at some point, regardless of Fed actions, equity markets will reprice lower as well.

But that is not happening today.  As a matter of fact, equities are looking pretty decent, yet again.  China is closed for a series of holidays, but the overnight session saw strength in Australia (+1.0%) although the Nikkei (0.0%) couldn’t shake off the Tankan blues.  Europe, however, is all green led by the FTSE 100 (+0.9% despite that letter) with the CAC (+0.65%) and DAX (+0.1%) also positive.  US futures are all pointing higher with gains ranging from 0.8%-1.25%.

Bond markets actually moved yesterday, at least a little bit, with 10-year Treasury yields now at 0.70%.  Yesterday saw a 3.5 basis point move with the balance occurring overnight.  Given yesterday’s equity rally, this should not be that surprising, but given the recent remarkable lack of movement in the bond market, it still seems a bit odd.  European bond markets are behaving in a full risk on manner as well, with havens like Bunds, OATS and Gilts all seeing yields edge higher by about 1bp, while Italy and Greece are seeing increased demand with modestly lower yields.

As to the dollar overall, despite the pound’s (and yen’s) weakness, it is the dollar that is under pressure today against both G10 and EMG currencies.  Today’s leader in the G10 clubhouse is NOK (+0.55%) which is a bit odd given oil’s 1.0% decline during the session.  But after that, the movement has been far less enthusiastic, between 0.1% and 0.3%, which feels more like dollar softness than currency strength.

EMG currencies, however, are showing some real oomph this morning with the CE4 well represented (HUF +1.15%, PLN +0.85%) as well as MXN (+1.05%) and INR (+0.85%).  The HUF story revolves around the central bank leaving its policy rate on hold after a surprise 0.15% rise last week.  This was taken as a bullish sign by investors as the central bank continues to focus on above-target inflation there.  Meanwhile, inflation in Poland rose 3.2% in a surprise, above their target and has encouraged views that the central bank may need to tighten policy further, hence the zloty’s strength today.  The India story revolves around the government not increasing their borrowing needs, despite their response to Covid, which helped drive government bond investor inflows and rupee strength.  Finally, the peso seems the beneficiary of the overall risk-on attitude as well as expectations for an uptick in foreign remittances, which by definition are peso positive.

On the data front, yesterday saw ADP surprise higher by 100K, at 749K.  As well, Chicago PMI, at 62.4, was MUCH stronger than expected.  This morning brings Initial Claims (exp 850K), Continuing Claims (12.2M), Personal Income (-2.5%), Personal Spending (0.8%), Core PCE (1.4%) and ISM Manufacturing (56.4).  US data, despite the layoff story, has clearly been better than expected lately, and this can be seen in the increasingly positive expectations for much of the data.  While European PMI data this morning was right on the button, the numbers remain lower than those seen in the US.  In addition, the second wave is clearly hitting Europe at this time, with Covid cases growing more rapidly there than back in March and April when it first hit.  As much as many people want to hate the dollar and decry its debasement (an argument I understand) it is hard to make the case that currently, the euro is a better place to be.  While the dollar is soft today, I believe we are much closer to the medium-term bottom which means hedgers should be considering how to take advantage of this move.

Good luck and stay safe
Adf

Signs of Dissension

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In China they claim that firms grew
Their profits and gross revenue
Encouraged by this
The bulls added risk
While bears had to rethink their view

Quite frankly, it has been a fairly dull session overnight with virtually no data and only a handful of comments.  Risk appetite is in the ascension after the Chinese reported, Saturday night, that Industrial Profits rose 19.1% Y/Y.  What’s truly remarkable about that statistic, and perhaps what makes it difficult to accept, is that throughout most of 2019, those numbers were negative.  In other words, prior to the outbreak of Covid-19, Chinese firms were struggling mightily to make money.  But since the very sharp dip in March, the rebound there, at least in this statistic, has been substantial.  While it is certainly possible that organic growth is the reason for this sharp rebound, it seems far more likely that PBOC support has been a key factor.  Remember, while they don’t get as much press as the Fed or ECB, they are extremely involved in the economy as well as financial markets.  After all, there is no semblance of independence from the government.

According to those in the know
The ECB’s starting to show
Some signs of dissension
Amid apprehension
The rate of inflation’s too low

In one camp the PIGS all believe
More money they ought to receive
But further up north
The hawks have put forth
The view PEPP should end New Year’s Eve

Meanwhile, the other story that is building is the growing split in the ECB between the hawks and doves regarding how to react to the evolving situation.  The breakdown is exactly as expected, with Italian, Spanish and Portuguese members calling for more support, via an expansion of the PEPP by December, latest, in order to assure those economies still suffering the aftereffects of the Covid shutdowns, that the ECB will prevent borrowing costs from rising.  Meanwhile, the hawkish set, led by Yves Mersch, the Luxembourgish ECB governor, sees the glass half full and has explained there is no need for further action as the economy looks much better.  Naturally, German, Dutch and Austrian members are on board with the latter view.  Madame Lagarde, the consensus builder, certainly has her work cut out to get policy agreement by the next meeting at the end of October.

Adding to the difficulty for the ECB is the apparent strength of the second wave of the virus that is truly sweeping the Continent.  While France has been the worst hit, with more than 11,000 new cases reported yesterday, the Netherlands, Belgium, Italy and Germany are all seeing caseloads as high, or higher, than the initial wave back in March.  European governments are reluctant to force another shutdown as the economic consequences are too severe, but they feel the need to do something that will demonstrate they are in control of the situation.  Look for more rules, but no mandatory shutdowns.

And remarkably, those are the only economically focused stories of the session.  The ongoing US presidential campaigns, especially now that the first debate is nearly upon us, has captured the bulk of the US press’s attention, although the angst over the Supreme Court nomination of Judge Amy Coney Barrett has probably been the cause of more spilled digital ink in the past several days.

So, a turn toward markets shows that Asian markets generally performed well (Nikkei +1.3%, Hang Seng +1.0%) although interestingly, despite the Chinese profits data, Shanghai actually fell -0.1%.  Europe, on the other hand, is uniformly green, led by the DAX (+2.7%) and CAC (+2.0%), with the FTSE 100 higher by a mere 1.5%.  US futures have taken their cues from all this and are currently pointing to openings nearly 1.5% higher than Friday’s closing levels.

Bond markets continue to offer little in the way of price signals as central bank activity continues to be the dominant force.  I find it laughable that Fed members are explaining they don’t want to increase QE because they don’t want to have an impact on the bond market.  Really?  Between the Fed and the ECB, the one thing in which both have been successful is preventing virtually any movement, up or down, in yields.  This morning sees the risk-on characteristic of a rise in Treasury and Bund yields, but by just 1.5bps each, and both remain well within their recent trading ranges.  Yield curve control is here in all but name.

As to the dollar, it is softer vs. its G10 counterparts with the pound (+1.25%) rising sharply in the past few minutes as the tone leading up to the restart of Brexit negotiations tomorrow has suddenly become quite conciliatory on both sides.  But we have also seen solid gains in SEK (+0.7%), NOK (+0.6%) and AUD (+0.5%).  The Stocky story has to do with the fact that the Riksbank did not receive any bids for credit by the banking community, implying the situation in the economy is improving.  As to NOK and AUD, a reversal in oil and commodity prices has been seen as a positive in both these currencies.

In the emerging markets, the picture is a bit more mixed with ZAR (+0.3%) as the leading gainer, although given the relative movement in the G10 space, one would have expected something more exciting.  On the downside, TRY (-1.65%) and RUB (-0.85%) are outliers as the declaration of war between Armenia (Russian-backed) and Azerbaijan (Turkish-backed), has raised further concerns about both nations’ financial capabilities to wage a hot war at this time.

On the data front, while the week has started off slowly, we have a lot to absorb culminating in Friday’s NFP numbers.

Tuesday Case Shiller Home Prices 3.60%
Consumer Confidence 90.0
Wednesday ADP Employment 630K
Q2 GDP -31.7%
Chicago PMI 52.0
Thursday Initial Claims 850K
Continuing Claims 12.25M
Personal Income -2.5%
Personal Spending 0.8%
Core PCE 0.3% (1.4% Y/Y)
Construction Spending 0.7%
ISM Manufacturing 56.3
ISM Prices Paid 59.0
Friday Non Farm Payrolls 850K
Private Payrolls 850K
Manufacturing Payrolls 38K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Michigan Sentiment 78.9
Factory Orders 1.0%

Source: Bloomberg

On top of the data, we have thirteen Fed speeches by eight different Fed speakers, although the Chairman is mute this week.  It seems unlikely that we will get a mixed message from this group, but it is not impossible.  After all, we have both the most hawkish (Mester today) and the most dovish (Kashkari on Wednesday) due, so the chance for some disagreement there.  As to the data, it would appear that the payroll data will be most important, but do not ignore the PCE data.  Remember, both PPI and CPI have been surprising on the high side the past two months, so a surprise here might get some tongues wagging, although I wouldn’t expect a policy change, that’s for sure.

Net, with a positive risk backdrop, it is no surprise to see the dollar under pressure.  However, I expect that we are more likely to see a modest reversal than a large extension of the move unless stocks can go up sharply from their already elevated levels.

Good luck and stay safe
Adf

A Shot of Caffeine

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It’s true that, eternal, hope springs
And sessions like this give it wings
The news, seemingly
Is twixt Trump and Xi
Less angst will lead to better things

As well, hope has grown, a vaccine
Is likely, this year, to be seen
Now bulls rule the roost
Thus, giving a boost
To stocks like a shot of caffeine

Another day, another round of stories seemingly designed solely to boost equity markets around the world.  The first of these is a bit oblique, as the word from ‘insiders’ is that the Trump administration, despite its increasingly vocal hard line vs. the Chinese, is maintaining back channel communications, specifically regarding the WeChat app, and US companies’ ability to continue to use it in their advertising and marketing campaigns in China.  This is important as WeChat is a critical advertising venue for virtually every company in China, and if the mooted ban by the Trump administration in the US was a world-wide ban, most US companies would see their Chinese businesses devastated. If we forget, for a moment, the convenient timing of these leaked comments, this is, unarguably, good news for those US companies active in China.  Certainly, this is worth some added value to equity prices.

But let’s unpack the second story, the one about the vaccine.  While this weekend saw an announcement for the approval of another treatment, convalescent plasma injections, the big prize remains a working vaccine that is both safe and efficacious.  Briefly, the idea behind the plasma injections is that individuals who have recovered from the disease have antibodies in their blood, which can be separated and injected into severely ill patients in an effort to boost the patient’s own disease fighting capability.  As in everything to do with Covid-19, it remains experimental and there is controversy as to how well the therapy may work.  But given the desperation of some patients to get something done, the President has decided to overrule other voices and give emergency clearance.  However, this is a treatment, not a preventative.

The vaccine remains the holy grail.  To date, there are on the order of 180 different vaccines in various stages of development, 10 of which are in Phase 3 or have been given limited approvals.  Clearly, pharmaceutical companies see this as the newest potential blockbuster drug.  But the real question seems to be, even when (if) a vaccine is created, will it really change the nature of the spread of Covid-19 by that much?  It is unambiguous that the market narrative’s answer to that question is a resounding yes.  However, perhaps it is worth casting a skeptical eye on the idea.

Using influenza as our model, as it is the closest thing we have with respect to its contagion and even the structure of the disease and working under the assumption that human nature remains constant, the numbers don’t point to a vaccine as panacea.

Consider, in the US, roughly 45% of the population receives the flu vaccine each year.  In addition, it is only effective for, at most, two-thirds of those who do receive the vaccine.  Thus, the protective ‘shield’ that the flu vaccine creates is effective for roughly 30% of the population.  One of the reasons we consistently hear so much every year about getting the flu vaccine via PSA’s is that the virology community calculates we need a greater percentage of the population vaccinated to achieve a herd immunity.  And yet, the 45% inoculation rate has been pretty steady for years.  Human nature is pretty hard to change.

This begs the question, will the take-up of a Covid-19 vaccine be higher than that for the flu?  And if so, will it reach the level’s necessary to achieve herd immunity, thus encouraging governments to relax many of the current restrictions and people to resume some semblance of their former lives?

The argument for a higher take-up rate is that the media has gone out of its way to highlight the deadliness of Covid-19, in some cases exaggerating the numbers for effect, in what appears to be an attempt to sow fear in the population.  The underlying belief to this strategy is to convince a large portion of the population of the criticality of receiving the vaccine once it becomes available.  And perhaps this will be a successful strategy.  But human nature has taken a long time to evolve to where it currently resides, and the case for a flu-like take-up rate, and thus a failure to achieve herd immunity, is based on the idea that unless one has been sickened already, or personally knows someone who has, it is hard to make the case that inoculation rates will increase over those of the flu vaccine.

Alas, my money is on the under.  However, will that matter for the markets?  That is an entirely different question, and one which speaks to confidence, not data.  At this time, I would contend the underlying market belief is that a vaccine is going to be approved, and be effective, within the next twelve months.  The result will be an end to the lockdowns and a resumption in economic activity worldwide that is much closer to the pre-Covid time.  But if this is so, one needs to be careful that we are not looking at the biggest ‘but the rumor’ reaction in history, and that the approval of a safe vaccine could well be the proverbial bell for the top of the equity market.  Remember, economic growth is still a product of population growth and productivity, and there is nothing about a Covid vaccine that will have increased either of those from pre-Covid days.

That exceptionally long discussion was driven by the remarkable ongoing rally in risk assets seen this morning.  Equity markets in Asia were all higher (Nikkei +0.3%, Hang Seng +1.75%) and Europe is really on fire (DAX +2.3%, CAC +2.15%).  US futures are currently 1.0% higher and climbing.  Bonds are under modest pressure, with 10-year yields higher by 1 basis point in the US and most of Europe.  Oil prices, along with gold, are higher by 0.5%-0.7%, modest by their recent standards.  And the dollar is definitely under a bit of pressure.

In the G10 space, SEK and AUD lead the way, both higher by 0.5%, although the gains are fairly solid across the board.  In fact, despite extending the lockdown in Auckland, NZ, kiwi has retraced early losses and is higher by 0.25%.  In the EMG bloc, ZAR leads the way, up 1.2%, as the combination of risk positive stories and higher commodity prices continues to encourage investors to buy South African bonds.  But virtually the entire space is firmer this morning with two outliers, KRW (-0.25%) which fell after the central bank downgraded the economic outlook further, and TRY (-0.8%), which continue to see capital flee as the central bank is prevented by President Erdogan from raising rates.

There has been virtually no data today, and in truth, all eyes will be on Chairman Powell Thursday morning, when he speaks at the virtual Jackson Hole gathering.  Expectations are he is going to outline the new Fed framework, with a higher inflation target, and other potential changes.  But we will look into that later this week.  As for today, I see no reason to believe that the current risk attitude is going to change, so further dollar weakness is likely on the cards.

Good luck and stay safe
Adf

Faded Away

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It started when Trump hinted that
The capital gains tax was at
A rate much too high
And cuts were close by
His words, thus, a rally begat

Then Germany joined in the fray
As data from their ZEW survey
Exploded much higher
Now stocks are on fire
While havens have faded away

It used to be that you could determine the nature of a nation’s government by their response time to major events. So, autocratic nations were able to respond extremely quickly to negative events because a single man (and it was always a man) made the decisions and those who didn’t follow orders found themselves removed from the situation. Conscientious objection was not a viable alternative. Meanwhile, democratically elected governments always took more time to react because the inherent nature of democratic debate was slow and messy, with everyone needing to make their case, and then a majority formed to move forward.

This broad view of government decision-making was generally true for as long as economies were based on the production of real goods and services. However, that economic model has been essentially retired and replaced by the new concept of financialization. This is the process by which private actors recognize there is more value to be obtained (and with less risk!) if they spend their time and effort re-engineering their balance sheet rather than investing in their underlying business.

The upshot of the financialization of economies is that government response times to crises have been shortened remarkably. (It is important to understand that in this context, central banks, despite their “independence”, are part of the government). So, now even democratically elected governments can respond with alacrity to ongoing crises. This begs the question of whether democratically elected governments have become more autocratic (lockdowns anyone?), or whether this is simply the natural evolution of the democratic process when combined with media tools like Facebook and Twitter, where responses can be formulated and disseminated in minutes.

At any rate, the key observation is that government officials everywhere have taken the combination of financialization and high-speed response quite seriously, and we now get policies floated and implemented in a fraction of the time it used to take. The main reason this can be done is because policies that address financial questions are much easier to implement than policies that address production bottlenecks. After all, it is a lot easier for the Fed to decide to buy Fallen Angels than it is for 535 people, many of whom hate each other, to agree on a package of policies that might help support small businesses and shop owners.

This has been a build-up to help understand the key theme today: risk is back!! Or perhaps, the proper statement is risk-on is back. Last evening, President Trump floated the idea that a capital gains tax cut was just the remedy to help the US economy get back on its feet. But the reality is that the only thing a capital gains tax cut will accomplish is to help boost the stock market further. After all, the S&P 500, after yesterday’s modest 0.3% rally, is still 1.0% below its all-time high. Such lagging performance cannot be tolerated apparently, hence the genesis of this idea. But it was enough to achieve its goal, a further boost in equity markets worldwide.

A quick look at markets overnight shows the Nikkei (+1.9%) and Hang Seng (+2.1%) followed the bullish sentiment, although surprisingly, Shanghai (-1.1%) could not hold onto early gains. Even with that decline, the Shanghai Composite is up more than 5% in the past two weeks, hardly a true laggard. Meanwhile, Europe has really taken the bit in its teeth and is flying this morning, getting a good start from the Asian movement and then responding extremely positively to the German ZEW survey results where the Expectations component printed at 71.5, its highest level since December 2003. So, despite the growth in Covid cases in Germany, the business community is looking forward to robust times in the near future. This was all equity traders and investors needed to see to get going and virtually every European bourse is higher by more than 2.2% this morning. Of course, it would not be a successful outcome if US markets didn’t rise as well, and futures this morning are all green, pointing to between 0.5% (NASDAQ) and 1.0% (DJIA) gains on the opening.

Naturally, the risk on environment has resulted in Treasury bond sales. After all, there is no need to own something as pedantic as a bond when not only are stocks available, but the tax rate on your gains is going to be reduced! And so, 10-year Treasury yields have risen 3bps this morning, and are back at 0.60%, 10bps higher than the new lows seen just one week ago today. And that price behavior is common amongst all European government bond markets, with German bund yields higher by 3.3bps and UK gilts nearly 4bps higher.

But the biggest victim of this move has clearly been gold, which has tumbled 2% this morning and is back below $2000/oz for the first time in a week. There is no question that precious metals markets have been getting a bit frothy, so this pullback is likely simple profit taking and not a change in any trend.

Finally, as we turn to the dollar, the risk-on attitude is playing out in its traditional fashion this morning, with the buck falling against 9 of its G10 counterparts with only the yen weaker versus the dollar. NOK (+0.8%) is the big gainer, rallying on the back of the ongoing rally in oil prices (WTI +2.5%), but we are seeing solid gains of roughly 0.4% across most of the rest of the bloc. The one laggard, aside form JPY (-0.14%), is the pound where the UK released employment data today that simply demonstrated how difficult things are there. This seems to have held the pound back as it is only higher by 0.2% this morning.

In the EMG space, RUB and ZAR (both +0.8%) are the leaders with the former clearly an oil beneficiary, while the latter, despite gold’s decline, has been the beneficiary of the hunt for yield as South Africa continues to have amongst the highest real yields in the world. But pretty much the whole bloc is in the green today as the simple concept of risk-on is the driver.

On the data front, the NFIB Small Business Index disappointed at 98.8, a clear indication that a capital gains tax cut does not seem to be the best solution for the economy. At 8:30 we get PPI (exp -0.7% Y/Y, +0.1% Y/Y core) but not only is this data backwards looking, the Fed has basically told us they don’t care about inflation at all anymore. We also hear from two Fed speakers, Barkin and Daly, but again, there is very little new that is likely to come from their comments.

Today is a risk-on day and after a brief consolidation, the dollar feels like it has further room to decline. Versus the euro, I imagine a test of 1.20 is coming soon, but it is not clear to me how much further we can go from there. As such, for receivables hedgers, adding a little to the mix at current levels is likely to be a good strategy.

Good luck and stay safe
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Riddle Me This

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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

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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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck, good weekend and stay safe
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No Use Delaying

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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
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Stocks Dare Not Wane

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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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