Tag Archives: #riskon

Buying With Zeal

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

Source: Bloomberg

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

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

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

Good luck and stay safe
Adf

Dreams All Come True

Posted on by

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
Adf

It’s Over

Posted on by

“It’s over”, Navarro replied
When asked if the trade deal had died
The stock market’s dump
Forced President Trump
To tweet the deal’s still verified

What we learned last night is that the market is still highly focused on the trade situation between the US and China. Peter Navarro, the Director of Trade and Manufacturing Policy, was interviewed and when asked if, given all the issues that have been ongoing between the two countries, the trade deal was over, he replied, “it’s over, yes.” The market response was swift, with US equity futures plummeting nearly 2% in minutes, with similar price action seen in Tokyo and Sydney, before the president jumped on Twitter to explain that the deal was “fully intact.”

One possible lesson to be gleaned from this story is that the market has clearly moved on from the coronavirus, per se, and instead is now focusing on the ramifications of all the virus has already wrought. The latest forecasts from the OECD show trade volumes are expected to plummet by between 10% and 15% this year, although are expected to rebound sharply in 2021. The key is that infection counts and fatality rates are no longer market drivers. Instead, we are back to economic data points.

Arguably, this is a much better scenario for investors as these variables have been studied far more extensively with their impact on economic activity reasonably well understood. It is with this in mind that I would humbly suggest we have moved into a new phase of the Covid impact on the world; from fear, initially, to panicked government response, and now on to economic fallout. Its not that the economic impact was unimportant before, but it came as an afterthought to the human impact. Now, despite the seeming resurgence in infections in many spots around the world, at least from the global market’s perspective, we are back to trade data and economic stories.

This was also made evident by all the talk regarding today’s preliminary PMI data out of Europe, which showed French numbers above 50 and the Eurozone, as a whole, back to a 47.5 reading on the Composite index. However, this strikes me as a significant misunderstanding of what this data describes. Remember, the PMI question is, are things better, worse or the same as last month? Now, while April was the nadir of depression-like economic activity, last month represented the second worst set of numbers recorded amidst global shutdowns across many industries. It is not a great stretch to believe that this month is better than last. But this does not indicate in any manner that the economy is back to any semblance of normal. After all, if we were back to normal, would we all still be working from home and wearing masks everywhere? So yes, things are better than the worst readings from April and May, but as we will learn when the hard data arrives, the economic situation remains dire worldwide.

But while the economic numbers may be awful, that has not stopped investors traders Robinhooders from taking the bull by the horns and pouring more energy into driving stocks higher still. Of course, they are goaded on by the President, but they seem to have plenty of determination on their own. Here’s an interesting tidbit, the market cap of the three largest companies, Apple, Microsoft and Amazon now represents more than 20% of US GDP! To many, that seems a tad excessive, and will be pointed to, after prices correct, as one of the greatest excesses created in this market.

And today is no different, with the risk bit in their teeth, equity markets are once again trading higher across the board. Once the little trade hiccup had passed, buyers came out of the woodwork and we saw Asia (Nikkei +0.5%, Hang Seng +1.6%, Shanghai +0.2%) and Europe (DAX +2.7%, CAC +1.6%, FTSE 100 +1.2%) all steam higher. US futures are also pointing in that direction, currently up between 0.6% and 0.8%. Treasury yields are edging higher as haven assets continue to lose their allure, with 10-year Treasury yields up another basis point and 2bp rises seen throughout European markets. Interestingly, there is one haven that is performing well today, gold, which is up just 0.15% this morning, but has rallied more than 5% in the past two weeks and is back to levels not seen since 2012.

Of course, the gold explanation is likely to reside in the dollar, which in a more typical risk-on environment like we are currently experiencing, is sliding with gusto. Yesterday’s weakness has continued today with most G10 currencies firmer led by NOK (+0.9%) and SEK (+0.75%) on the back of oil’s ongoing rebound and general optimism about future growth. It should be no surprise that the yen has declined again, but its 0.1% fall is hardly earth shattering. Of more interest is the pound (-0.3%) which after an early surge on the back of the UK PMI data (Mfg 50.1), has given it all back and then some as talk of the UK economy faring worse than either the US or Europe is making the rounds.

In the EMG bloc, the dollar’s weakness is broad-based with MXN and KRW (+0.6% each) leading the way but INR an PLN (+0.5% each) close behind. As can be seen, there is no one geographic area either leading or lagging which is simply indicative of the fact that this is a dollar story, not a currency one.

On the data front in the US, while we also get the PMI data, it has never been seen as quite as important as the ISM data due next week. However, expectations are for a 50.0 reading in the Manufacturing and 48.0 in the Services indices. We also see New Home Sales (exp 640K) which follow yesterday’s disastrous Existing Home Sales data (3.91M, exp 4.09M and the worst print since 2010 right after the GFC.) We hear from another Fed speaker today, James Bullard the dove, but I have to admit that Chairman Powell has everybody on the FOMC singing from the same hymnal, so don’t expect any surprises there.

Instead, today is very clearly risk-on implying that the dollar ought to continue to trade a bit lower. My hypothesis about the dollar leading stocks last week has clearly come a cropper, and we are, instead, back to the way things were. Risk on means a weaker dollar and vice versa.

Good luck and stay safe
Adf

Looking Distressed

Posted on by

The market was looking distressed
So, Jay clearly thought it was best
To tell everyone
The Fed had begun
To buy corporates at his behest

Frankly, I’m stunned. Anyone who believes that the Fed is focusing on any variable other than the S&P 500 was completely disabused of that notion yesterday. While I know it seems like it was weeks ago, yesterday morning there was concern that Chairman Powell’s comments last week about a long, tough road to recovery were still top of mind to market participants. Concerns over a rising infection rate in some states and countries were growing thus driving investors to react negatively. After all, if the mooted second wave of Covid comes and the nascent economic revival is squashed at the outset, the case for the V-shaped recovery and stratospheric stock prices would quickly die. And so, Chairman Powell responded by explaining that the Fed would expand the SMCCF* program to start buying individual bonds today. Remember, the initial story was ETF’s were the only purchases to be made. Now, the Fed is effectively cherry-picking which investors it wants to help as certainly the companies whose bonds the Fed buys will not be getting any of that money. Or will they? Perhaps the hope is that if the Fed owns individual corporate bonds, in the coming debt jubilee, they will tear up those bonds as well as their Treasuries, thus reducing leverage in a trice.

A debt jubilee, for those who are unfamiliar with the term, is a government sanctioned erasure of outstanding debts. Its origins are in the book of Deuteronomy in the Old Testament, when every 50 years there was a call for the release of all debts, both monetary and personal (indenture). Of course, in the modern world it is a bit more difficult to accomplish as all creditors would be severely impacted by the concept. All creditors except one, that is, a nation’s central bank.

Now that we are in a fiat currency system where central banks create money from nothing (paraphrasing Dire Straits), any public debt that they hold on their balance sheets can simply be forgiven by decree, thus reducing the leverage outstanding. While there would seem to be some inflationary consequences to the action (after all, an awful lot of funds would be instantly freed up to chase after other goods, services and investments), the modern central bank viewpoint on inflation is that it is dangerously low and a problem at current levels, so those consequences are likely to be quickly rationalized away. Thus, if the Fed owns individual corporate bonds, especially of highly indebted companies, they will be able forgive those, reduce leverage and support those companies’ prospects to maintain a full-sized staff. You see, the rationalization is it will support employment, not help investors.

To be clear, there is no official plan for a debt jubilee, but it is something that is gaining credence amongst a subset of the economics community. Especially because of the inherent concerns over near- and medium-term growth due to Covid-19, as future consumer behavior is likely to be very different than past consumer behavior, I expect that a debt jubilee is something about which we will hear a great deal more going forward. Nonstop printing of money by the world’s central banks is not a sustainable activity in the long run. Neither is it sustainable for governments to run deficits well in excess of GDP. A debt jubilee is a potential solution to both those problems, and if it can be accomplished by simply having central banks tear up debt, other creditors will not be destroyed. Truly a (frightening) win-win.

It can be no surprise that the stock market reacted positively to the news, turning around morning losses to close higher by 0.85% in the US with the sharpest part of the move happening immediately upon the statement’s release at 2:15 yesterday. This euphoria carried over into Asia with remarkable effect as the Nikkei (+4.9%) and KOSPI (+5.3%) exploded higher while the rest of the region merely saw strong gains of between 1.4% (Shanghai) and 3.9% (Australia). And naturally, Europe is a beneficiary as well, with the DAX (+2.8%) leading the way, but virtually every market higher by more than 2.0%. US futures? Not to worry, all three indices are currently higher by more than 1.1%.

In keeping with the risk-on attitude, we also saw Treasury bonds sell off in the afternoon with yields rising a bit more than 4bps since the announcement. In Europe, bund yields are higher as are gilts, both by 2.5bps, but the PIGS are basking in the knowledge that their future may well be brighter as we are seeing Portugal (-2bps), Italy (-5.5bps), Greece (-6.5bps) and Spain (-3bps) all rallying nicely.

And finally, the dollar, which had started to show some strength yesterday, has also reversed most of those gains and is broadly, though not deeply, softer this morning. In the G10, the pound is the leader, higher by 0.45%, as the market ignored Jobless Claims in the UK falling by 529K, only the second worst level on record after last month’s numbers, and instead took heart that a Brexit deal could well be reached after positive comments from both Boris Johnson and the EU leadership following a videoconference call earlier today. While nothing is confirmed, this is the best tone we have heard in a while. However, away from the pound gains are limited to less than 0.25% with some currencies even declining slightly.

In the emerging markets, the leading gainer is KRW (+0.75%) despite the fact that North Korea blew up the Joint Office overnight. That office was the sight of ongoing discussions between the two nations and its destruction marks a significant rise in hostility by the North. In my view, the market is remarkably sanguine about the story, especially in light of its response to the news out of India, where Chinese soldiers ostensibly attacked and killed three Indian soldiers in the disputed border zone. There, the rupee fell 0.25% on the report as concerns grow over an escalation of tensions between the two nations. But aside from those two currencies, there were many more gainers in APAC currencies as funds flowed into local stock markets on the Fed inspired risk appetite.

On the data front, we see Retail Sales (exp 8.4%, 5.5% ex autos) as well as IP (3.0%) and Capacity Utilization (66.9%), with all three numbers rebounding sharply from their lows set in April. We saw a similar rebound in German ZEW Expectations (63.4 and its highest since 2006), but recall, that is based on the change of view month to month.

Chairman Powell testifies to the Senate this morning, so all ears will be listening at 10:00. Yesterday we heard from two Fed speakers, Dallas’s Kaplan and San Francisco’s Daly, both of whom expressed the view that a rebound was coming, that YCC was not appropriate at this time and that the Fed still had plenty they could do, as they made evident with yesterday afternoon’s announcement.

While equity markets continue to react very positively to the central bank activities, the dollar seems to be finding a floor. In the end, investment flows into the US still seem to be larger than elsewhere and continue to be a key driver for the dollar. Despite a positive risk appetite, it appears the dollar has limited room to fall further.

Good luck and stay safe
Adf

*Secondary Market Corporate Credit Facility

Yesterday’s News

Posted on by

The first bit of data we’ve seen
Has shown what economists mean
When most business stops
And GDP drops
Reacting to Covid – 19

This data describes people’s fear
Another wave just might appear
But right now those views
Are yesterday’s news
And ‘buy the dip’ traders are here

The UK is an interesting study regarding GDP growth because they actually publish monthly numbers, rather than only quarterly data like the rest of the developed world. So, this morning, the UK reported that GDP activity in April declined 20.4% from March, which had declined 5.8% from February when the first impact of Covid-19 was felt. This has resulted in the UK economy shrinking back to levels last seen in 2002. Eighteen years of growth removed in two months! Of course, when things recover, and they will recover as the lockdowns are eased around the world, we will also get to see the fastest growth numbers in history. However, we must remember that a 20% decline will require a 25% rebound to get back to where we started. Keep that in mind when we start to see large positive numbers in the summer (hopefully) or the autumn if people decide that the risks of Covid outweigh the benefits of returning to previous activities.

Needless to say, this has been an unprecedented decline, on a monthly basis, in the economy for both its depth and speed. But the more remarkable thing, is that despite this extraordinary economic disruption, a look at financial markets shows a somewhat different story. For example, on February 28, the FTSE 100 closed at 6580.61 and the pound finished the session at 1.2823. On April 30, after the worst two-month economic decline in the UK’s history, its main stock market had declined 10.3% while the pound had fallen just 1.8%. Granted, both did trade at substantially lower levels in the interim, bottoming in the third week of March before rebounding. But it seems to me that those are pretty good performances given the size of the economic dislocation. And since then, both the FTSE 100 and the pound have rallied a bit further.

The question is, how can this have occurred? Part of the answer is the fact that on a contemporaneous basis, investors could not imagine the depths of the economic decline that was taking place. While there were daily stories of lockdowns and death counts, it is still hard for anyone to have truly understood the unprecedented magnitude of what occurred. And, of course, part of the answer was this did not happen in a vacuum as policymakers responded admirably quickly with the BOE cutting rates by a total of 0.65% in the period while expanding their balance sheet by £150 billion (and still growing). And the UK government quickly put together stimulus packages worth 5% of then measured GDP. Obviously, those measures were crucial in preventing a complete financial market collapse.

Another thing to remember is that the FTSE 100 was trading at a P/E ratio of approximately 15 ahead of the crisis, which in the long-term scheme of things was actually below its average. So, stock prices in the UK were nowhere near as frothy as in the US and arguably had less reason to fall.

As to the pound, well, currencies are a relative game, and the same things that were happening in the UK were happening elsewhere as well to various degrees. March saw the dollar’s haven status at its peak, at which point the pound traded below 1.15. But as policymakers worldwide responded quite quickly, and almost in unison, the worst fears passed and the ‘need’ to own dollars ebbed. Hence, we have seen a strong rebound since, and in truth a very modest net decline.

The questions going forward will be all about how the recovery actually unfolds, both in timing and magnitude. The one thing that seems clear is that the uniformity of decline and policy response that we saw will not be repeated on the rebound. Different countries will reduce safety measures at different paces, and populations will respond differently to those measures. In other words, as confusing as data may have been before Covid, it will be more so going forward.

Now, quickly, to markets. Yesterday’s equity market price action in the US was certainly dramatic, with the Dow falling nearly 7% and even the NASDAQ falling 5.25%. The best explanation I can offer is that reflection on Chairman Powell’s press conference by investors left them feeling less confident than before. As I wrote in the wake of the ECB meeting last week, the only way for a central banker to do their job (in the market’s eyes) these days is to exceed expectations. While analysts did not expect any policy changes, there was a great deal of talk on trading desks floors chatrooms about the next step widely seen as YCC. The fact that Jay did not deliver was seen as quite disappointing. In fact, it would not be surprising to me that if stock markets continued to decline sharply, the Fed would respond.

But that is not happening as buying the dip is back in fashion with European markets higher by roughly 1.5% and US futures also pointing higher. Meanwhile, with risk back in favor, Treasury yields have backed up 3bps and the dollar is under pressure.

On the FX front, the G10 is a classic depiction of risk-on with the yen (-0.5%) and Swiss franc (-0.3%) both declining while the rest of the bloc is higher led by CAD and AUD, both up 0.5%. In truth, this has the feeling of a bounce from yesterday’s dollar strength, rather than the beginning of a new trend, but that will depend on the broader risk sentiment. If equity market ebullience this morning fades as the session progresses, look for the dollar to take back its overnight losses.

Meanwhile, EMG markets are having a more mixed session with APAC currencies all having fallen last night in the wake of the US equity rout. APAC equities were modestly lower to unchanged but had started the session under far more pressure. At the same time, the CE4, with the benefit of the European equity rebound and higher US futures are mostly firmer led by PLN (+0.6%). But the biggest winner today in this space is MXN, which has rebounded 0.7% from yesterday’s levels, although that represented a nearly 4% decline! In other words, the defining characteristic of the peso these days is not its rate but its volatility. For example, 10-day historic volatility in the peso is currently 28.37%, up from 13.4% last Friday and 21.96% in the middle of May when we were looking at daily 3% moves. Do not be surprised if we see another bout of significant peso volatility, especially given the ongoing concerns over AMLO’s handling of Covid.

On the data front, only Michigan Sentiment (exp 75.0) is on the docket today, which may have an impact if it is surprisingly better than expected, but I don’t anticipate much movement. Rather, FX remains beholden to the overall risk sentiment as determined by the US equity markets. If the rebound continues, the dollar will remain under pressure. If the rebound fails, look for the dollar to resume yesterday’s trend.

Good luck, good weekend and stay safe
Adf

 

Buy With More Zeal

Posted on by

The stimulus story is clear
Expect more throughout the whole year
C bankers are scared
And war they’ve declared
On bears, who now all live in fear

Thus, Wednesday the Fed will reveal
They’ll not stop til they hear the squeal
Of covering shorts
While Powell exhorts
Investors to buy with more zeal!

The market is biding its time as traders and investors await Wednesday’s FOMC statement and the press conference from Chairman Powell that follows. Patterns that we have seen over the past week are continuing, albeit on a more modest path. This means that the dollar is softer, but certainly not collapsing; treasury yields are higher, and those bonds almost seem like they are collapsing; commodity prices continue to mostly move higher; and equity markets are mixed, with pockets of strength and weakness. This is all part and parcel of the V-shaped recovery story which has completely dominated the narrative, at least in financial markets.

Friday’s payroll report was truly surprising as the NFP number was more than 10 million jobs higher than estimated. This led to a surprisingly better than expected, although still awful, Unemployment Rate of 13.3%. However, this report sowed its own controversy when the Labor Department happened to mention, at the bottom of the release, that there was a little problem with the count whereby 4.9 million respondents were misclassified as still working and temporarily absent rather than unemployed. Had these people been accounted for properly, the results would have been an NFP outcome of -2.4 million while the Unemployment rate would have been about 3% higher. Of course, this immediately raised questions about the propriety of all government statistics and whether the administration is trying to cook the books. However, Occam’s Razor would point you in another direction, that it is simply really difficult to collect accurate data during the current pan(dem)ic.

What is, perhaps, more interesting is that the financial press has largely ignored the story. It seems the press is far more interested in fostering the bullish case and this number was a perfect rebuttal to all the bears who continue to highlight things like the coming wave of bankruptcies that are almost certain to crest as soon as the Fed (and other central banks) stop adding money to the pot every day. Of course, perhaps the central banking community will never stop adding money to the pot thus permanently supporting higher equity valuations. Alas, that is the precise recipe for fiat currency devaluation, perhaps not against every other fiat currency, but against real stuff, like gold, real estate, and even food. So, while FX rates may all stay bounded, inflation would become a much greater problem for us all.

At this point, the universal central bank view is that deflation remains the primary concern, and inflation is easily tamed if it should appear. But ask yourself this, if central banks have spent trillions of dollars to drive rates lower to support the economy, how much appetite will they have to raise rates to fight inflation at the risk of slowing the economy? Exactly.

So, let’s take a look at today’s markets. After Friday’s blowout performance by US equities, which helped drive the dollar lower and Treasury yields higher, Asia was actually very quiet with only the Nikkei (+1.4%) showing any life at all. And that came after a surprisingly good Q1 GDP report showing Japan shrank only 2.2% in Q1, not the -3.4% originally reported. This also represents a data controversy as Capex data appeared far more robust than originally estimated. However, this too, seems to be a case of the government having a difficult time getting accurate data with most economists expecting the GDP result to be revised lower. But the rest of Asia was basically flat in equity space.

Meanwhile, European bourses are mixed with the DAX (-0.4%) and CAC (-0.5%) leading the way lower although we continue to see strength in Spain (+0.7%) and Italy (+0.2%). The ongoing belief that the largest portion of ECB stimulus will be used to support the latter two nations remains a powerful incentive for investors to keep buying into their markets.

On the bond front, Treasury yields, after having risen 25bps last week, in the 10-year, are higher by a further 2bps this morning. 30-year yields are rising even faster, up 3.5bps so far today. This, too, is all part of the same narrative; the V-shaped recovery means that lower rates will no longer be the norm going forward. This is setting up quite the confrontation with the Fed and is seen as a key reason that yield-curve control (YCC) is on the horizon. The last thing the Fed wants is for the market to undermine all their efforts at economic recovery by anticipating their success and driving yields higher. Thus, YCC could be the perfect means for the Fed to stop that price action in its tracks.

As to the dollar, it is having a more mixed performance today as opposed to the broad-based weakness we saw last week. In the G10, SEK and NOK (+0.4% each) are the best performers although we are seeing modest 0.15%-0.2% gains across the Commonwealth currencies as well as the yen. NOK is clearly following oil prices higher, while SEK continues to benefit from the fact that its rising yields are attracting more investment after reporting positive Q1 growth last week. On the downside, the pound is the leading decliner, -0.25%, although the euro is weakening by 0.15% as well. While the pound started the session firmer on the back of easing lockdown restrictions, it has since turned tail amid concerns that this dollar decline is reaching its limits.

In the EMG bloc, RUB (+0.65%) is the clear leader today, also on oil’s ongoing rally, although there are a number of currencies that have seen very modest gains as well. On the downside, TRY and PHP (-0.25% each) are the leading decliners, but here, too, there is a list of currencies that have small losses. As I said, overall, there is no real trend here.

While this week brings us the FOMC meeting, there is actually very little other data to note:

Tuesday NFIB Small Biz Sentiment 92.2
  JPLT’s Job Openings 5.75M
Wednesday CPI 0.0% (0.3% Y/Y)
  -ex food & energy 0.0% (1.3% Y/Y)
  FOMC Rate Decision  0.25%
Thursday Initial Claims 1.55M
  Continuing Claims 20.6M
  PPI 0.1% (-1.3% Y/Y)
  -ex food & energy -0.1% (0.5% Y/Y)
Friday Michigan Sentiment 75.0

Source: Bloomberg

While we can be pretty sure the Fed will not feel compelled to change policy at this meeting, you can expect that there will be many questions in the press conference regarding the future, whether about forward guidance or YCC. As they continue to reduce their daily QE injections, down to just $4 billion/day, I fear the equity market may start to feel a bit overdone up here, and a short-term reversal seems quite realistic. For now, risk is still on, but don’t be surprised if it stumbles for a while going forward. And that means the dollar is likely to show some strength.

Good luck and stay safe
Adf

Fear of Deflation

Posted on by

The ECB’s fear of deflation
Inspired more euro creation
They’ll keep buying bonds
Until growth responds
In every EU member nation

Investors responded by buying
As much as they could while still trying
To claim, it’s quite clear
That early next year
Economies all will be flying

Madame Lagarde is clearly getting the hang of what it means to be a central banker these days, at least at a major central bank. The key to success is to listen to how much easing the pundits are expecting and deliver significantly more than that. In the mold of Chairman Powell back in March, Lagarde yesterday exceeded all expectations. The ECB increased its PEPP by €600 billion, extended the minimum deadline to June 2021 and explained they would be reinvesting the proceeds of all maturing purchases until at least the end of 2022. They, of course, kept their other programs on autopilot, so the APP (their first QE program) will still be purchasing €20 billion per month through at least the end of this year. And finally, they left the interest rate structure on hold, so the deposit rate remains at -0.50%, but more importantly, they didn’t adjust the tiering. Tiering is the ECB’s way of limiting the amount of bank reserves that ‘earn’ negative interest rates. So, if the ECB decides that rates need to be cut even lower, they will be able to adjust the tiering levels to help minimize the damage to bank balance sheets. This is key in Europe because banks remain far more important in the transmission of monetary policy than in the US and negative rates have been killing them.

With this increase in accommodation, the Eurozone has finally created a support structure that is in concert with the size of the Eurozone economy. Adding up the pieces shows the ECB buying €1.5 trillion in assets, the EU having already created a €500 billion cheap lending program and now close to agreeing on an additional €750 billion program with joint borrowing and grants as well as loans. Add to that the individual national support (remember Germany just plumped for €130 billion yesterday) and the total is now well over €3 trillion. That is real money and should help at least mitigate the worst impacts of the economic shutdowns across the continent.

And so, can anybody be surprised that markets responded favorably to the news. Equity markets throughout Europe are higher this morning with the DAX (+1.8%), CAC (+2.3%) and the rest of the continental bourses all looking forward to more free money. Of course, the risk-on attitude has investors swapping their haven bonds for stocks and risky bonds, so bund yields have risen 1.5bps (Dutch bonds are up 2.5bps) while Greek yields have fallen 3bps. Italy and Spain are unchanged on the day, as there is no real selling, but just more interest in equities in the two nations. Finally, the euro, although currently slightly softer on the day (-0.15%) traded to a new high for this move at 1.1384. Except for two days in early March, as the virus story was disrupting markets, this is the highest level for the single currency since last July.

Technically, it is pretty easy to make the case that the euro is breaking out of a multi-year downtrend, although that is not confirmed. When viewing fundamentals, the question at hand is whether the Fed or ECB has more accommodative monetary policy. Clearly, despite the recent EU package, the US has been far more accommodative fiscally. And while the longer end of the US yield curve continues to sell off (10-year yields are now up to 0.85%, 20 bps this week, with 30-year yields at 1.66%, also 20bps higher on the week), the 2-year T-note remains anchored at 0.2% with a real yield firmly negative. Recall, there is a strong correlation between real 2-year yields and the value of the dollar, so those negative yields are clearly weighing on the buck. While it will not be a straight line, as long as the market continues to believe that central banks will not allow a market correction, the dollar should continue to slide.

Away from the euro, the dollar is soft almost across the board again today, with only PLN (-0.5%) having fallen any distance in the EMG bloc, and the Swiss franc (-0.3%) the only real loser in the G10. The Swiss story seems to be a technical one as the EURCHF cross has broken higher technically after the ECB announcement yesterday and continued with a little momentum. Poland is a bit more mystifying as there does not appear to be any specific news that would have led to selling, although the trend for the past 3 weeks remains clearly higher.

On the plus side, the big winner today is IDR (+1.55%) after the central bank governor, Perry Warjiyo, commented that the rupiah remains undervalued amid low inflation and a declining current account deficit.

With this as a backdrop, this morning brings the US payroll report with the following forecasts:

Nonfarm Payrolls -7.5M
Private Payrolls -6.75M
Manufacturing Payrolls -400K
Unemployment Rate 19.1%
Average Hourly Earnings 1.0% (8.5% Y/Y)
Average Weekly Hours 34.3
Participation Rate 60.1%

Source: Bloomberg

Remember, Wednesday’s ADP number was much lower than expected at -2.76M, still remarkably awful, but nonetheless surprising. However, data continues to be of secondary importance to the markets. I expect this will be the case until we start to see a recovery in earnest, but for now, we seem to be trying to define the bottom. The dichotomy between the destruction of the economy via lockdowns and the ebullience of the stock markets remains a key concern. The positive spin is that we truly will see a very sharp recovery in Q3 and Q4 with unemployment rolls tumbling back to a more normal recessionary level, and the bulls will have been right. Alas, the other side of that coin is that forecasts of permanent job destruction and decimated corporate earnings will prove too much for the central banks to overcome and we will have a longer-term decline in equity prices as the recession/depression lingers far longer.

For now, the bulls remain in charge. Today’s data is unlikely to change that view, so further dollar weakness seems the best bet. However, be aware of the risk of the other side of the trade, it has not disappeared by any stretch.

Good luck, good weekend and stay safe
Adf

Revert to the Mean

Posted on by

For more than two weeks we have seen
Risk assets all polish their sheen
But now has the bar
Been raised much too far?
And will we revert to the mean?

I read today that recent price action (+42% since March 23) has been the largest 50-day rally in the S&P 500’s long history. Think about that for a moment, the economy has cratered (the Atlanta Fed GDPNow forecast is currently at -52.8% for Q2), unemployment has hit levels not seen since the Great Depression with more than 40 million Americans losing their job in the past three months and the stock market is flying. Well, at least the S&P 500 index is flying as the value of its five largest constituents continues to rise, seemingly inexorably, thus dragging the index along with them. The disconnect between the performance of risk assets and the data representing the economy is truly stunning. And while I understand that equity markets are discounting ‘instruments’ looking ahead to the future, it still beggars belief that most of the companies in the index are going to see earnings recover in anywhere near the time anticipated by the market. Remember, the CBO just published an analysis describing the most likely outcome being a 10-year timeframe before the US economy gets back to the levels seen in 2019.

Part and parcel of this movement in risk assets has been the dollar’s decline, with the Dollar Index (DXY) down more than 5% during the same period. While that is not historic in nature, it is still a very large move for such a short period of time.

And so I must ask, is this movement in risk assets sustainable? Clearly the driving force here has been central bank, (mainly the Fed) largesse as they have pumped trillions of dollars of liquidity into the economy, much of which seems to have found its way into stocks. But remember, the Fed started its unlimited QE by buying $75 billion A DAY of securities. That number is now down to less than $5 billion each day and declining on a weekly basis. In fairness, the Fed got ahead of the curve, recognizing just how devastating the situation was going to be. But the Treasury has caught up and has been issuing debt as quickly as they can. Now the Fed’s liquidity is being funneled directly to the Treasury, rather than finding a home elsewhere, and unless Powell reverses course and starts to increase daily purchases again, there is every chance for equity markets to begin to suffer instead.

One other thing that is missing from this market, and which has been a key driver of the long bull market, is share repurchases by companies. Stock buybacks represented nearly all of the net stock buying seen during the rally. And I assure you, that ship has sailed and is not likely to return to port for many years to come. In fact, it would not be surprising if new laws are enacted that limit or prohibit repurchases going forward. The point I am trying to make is that there are numerous reasons to believe that this remarkable rebound in the stock market, and risk assets in general, is overdone and due for its own correction.

Is today that correction? Well, for a start, it is not an extension of the rally as equity markets in Asia were little changed (Nikkei +0.35%, Hang Seng +0.2%, Shanghai -0.15%) and those in Europe are all in the red (DAX -0.7%, CAC -0.6%, FTSE 100 -0.3%). The DAX performance is quite interesting given the announcement by the German government that they have agreed on a €130 billion stimulus package, 30% larger than anticipated. Meanwhile, US futures are all pointing lower as well, down between 0.2% and 0.5%.

Bond markets continue to lack any informational value as they have become entirely controlled by the central bank community. While yield curve control is only explicit in Japan (for the 10-year) and Australia (for the 2-year) the reality is that every central bank is actively preventing government interest rates from rising out of necessity. After all, given how much borrowing is ongoing, governments cannot afford for interest rates to rise, they would not be able to pay the bills. Perhaps the only exception to this rule is the very long end, 30 years and beyond, where yields continue to rise as curves continue to steepen. (Remember when an inverted yield curve was seen as the death knell of the economy? The reality is the problem comes when it steepens like this! Steepening curves are not so much about future economic growth as much as about higher future inflation.)

And then there is the dollar, which is broadly higher this morning, albeit not in any dramatic fashion. As the market awaits word from Madame Lagarde and her 24 colleagues, we have seen the dollar rise modestly vs. both G10 and EMG counterparts. The biggest retreats have been seen by PLN (-1.25%), where the government just announced an expected 8.5% budget deficit, and MXN (-0.9%), which is suffering as oil sells off a bit. However, both those currencies have seen significant rallies in the past two weeks, so a little reversal is not surprising. As to the rest of the bloc, EEMEA currencies are underperforming APAC currencies, but generally they are all lower.

In the G10, the movement have been much more muted, with GBP, AUD and SEK all lower by 0.4% or so and the rest of the bloc, save the Swiss franc’s 0.1% rally, lower by smaller amounts. Again, it is difficult to point to any one thing as the cause for this movement, arguably it is simply position reductions after a long run.

At this point, all eyes are on the ECB, where expectations have built for an increase in the PEPP of as much as €500 billion. While they have not come close to using the original amount, it seems clear they will need more before the end of the year, and so the market has latched onto the idea it will be announced today. One potential problem with this action is it could reduce pressure on the EU to actually go ahead with their mooted €750 billion fiscal support program that includes joint borrowing, a key feature for the euro’s future. It is clear that as much as the frugal four don’t want to see the ECB distort markets further, they are even more disinclined to give their money to the Italians and Spanish directly. However, in the end, I believe Madame Lagarde will give the market what it wants and raise the PEPP limit.

Today’s data picture brings Initial Claims (exp 1.843M), Continuing Claims (20.0M), the April Trade Balance (-$49.2B), Nonfarm Productivity (-2.7%) and Unit Labor Costs (5.0%). With the monthly NFP report tomorrow, it seems unlikely the market will respond to today’s data in any meaningful way. Earlier we saw Eurozone Retail Sales decline 11.7%, not as bad as feared but still the worst outcome in the history of the series dating back to January 1998. And yet, as we have seen lately, the data is not the driver right now, it is the central banks and sentiment. While we have paused today, sentiment still seems to be for a further rally, but my take is that sentiment is getting old and tired. Beware the reversion to the mean!

Good luck and stay safe
Adf

 

Depression’s Price In

Posted on by

As cities continue to burn
The stock market bears never learn
Depression’s priced in
And to bears’ chagrin
Investors have shown no concern

Once again risk is on fire this morning as every piece of bad news is seen as ancient history, riots across the US are seen as irrelevant and the future is deemed fantastic based on ongoing (permanent?) government economic support and the continued belief that Covid-19 has had its day in the sun and will soon retreat to the back pages. And while the optimistic views on government largesse and the virus’s retreat may be well founded, the evidence still appears to point to an extremely long and slow recovery to the global economy. Just yesterday, the Congressional Budget Office, released a report indicating it will take nearly ten years before GDP in the US will return to its previous trend growth levels. That hardly sounds like they type of economy that warrants ever increasing multiples in the stock market. But hey, I’m just an FX guy.

A look around the world allows us to highlight what seem to be the driving forces in different regions. There are two key assumptions underpinning European asset performance these days; the fact that the EU has finally agreed to joint financing of a budget and mutualized debt issuance and the virtual certainty that the ECB is going to increase the PEPP in their step tomorrow. The flaws in these theories are manifest, although, in fairness, despite themselves the Europeans have generally found a way to get to the goal. However, the EU financing program requires unanimous approval of all 27 members, something that will require a great deal of negotiation given the expressed adamancy of the frugal four (Austria, the Netherlands, Sweden and Denmark) who are not yet convinced that they should be paying for the spendthrift habits of their southern neighbors. And the problem with this is the amount of time it will take to finally agree. Given the urgent need for funding now, a delay may be nearly as bad as no support at all.

At the same time, the ECB, despite having spent only €250 billion of the original €750 billion PEPP monies are now assumed to be ready to announce a significant increase to the size of the program. Not surprisingly, members of the governing council who hail from the frugal four have expressed reluctance on this matter as well. However, after Madame Lagarde’s gaffe in March, when she declared it wasn’t the ECB’s job to protect peripheral nation bond markets (that’s their only job!) I expect that she will steamroll any objections and look for a €500 billion increase.

Clearly, traders and investors are on the same page here as the euro continues to rally, trading higher by 0.3% this morning (+4.2% since mid-May) and back above 1.12 for the first time since March. European equity markets are rocking as well, with the DAX once again leading the way, up 2.4%, despite a breakdown in talks between Chancellor Merkel’s CDU and its coalition partner SPD over the nature of the mooted €100 billion German support program. But the rest of Europe is flying as well, with the CAC up 2.0% and both Italy’s and Spain’s main indices higher by about 2.0%. European government bonds are sliding as haven assets are simply no longer required, at least so it seems.

Meanwhile, in Asia, we have seen substantial gains across most markets with China actually the laggard, essentially flat on the day. But, for example, Indonesia’s rupiah has rallied another 2.2% this morning after a record amount of bidding for a government bond auction showed that investors are clearly comfortable heading back to the EMG bloc again. The stock market there jumped 2.0% as well, and a quick look shows the rupiah has regained almost the entirety of the 22% it lost during the crisis and is now down just 1.6% on the year. What a reversal. But it is not just Indonesia that is seeing gains. KRW (+0.7%, -5.0% YTD), PHP (+0.5%, +1.1% YTD) and MYR (+0.35%, -4.0% YTD) are all gaining today as are their stock markets. And while both KRW and MYR remain lower on the year, each has recouped more than half of the losses seen at the height of the crisis.

So, the story seems great here as well, but can these nations continue to support their economies to help offset the destruction of the shutdowns? That seems to vary depending on the nation. South Korea is well prepared as they announced yet another extra budget to add stimulus, and given the country’s underlying finances, they can afford to do so. But the Philippines is a different story, with far less resources to support themselves, although they have availed themselves of IMF support. And Indonesia? Well, clearly, they have no problem selling bonds to investors, so for the short term, things are great. The risk to all this is that the timeline to recovery is extended far longer than currently perceived, and all of that support needs to be repaid before economic activity is back.

The point of all this is that while there is clearly a bullish story to be made for these markets, there are also numerous risks that the bullish case will not come to fruition, even with the best of intentions.

And what about the US? Looking at the stock market one would think that the economy is going gangbusters and things are great. But reading the news, with every headline focused on the ongoing riots across the nation and the destruction of property and businesses, it is hard to see how the latter will help the economy return to a strong pace of growth in the short run. If anything, it promises to delay the reopening of many small businesses and restaurants, which will only exacerbate the current economic malaise.

The other thing that seems out of step with the politics is the underlying belief that there will be another stimulus bill passed by Congress soon. While the House passed a bill several weeks ago, there has been no action in the Senate, nor does there seem to be appetite in the White House for such a bill at this time with both seeming to believe that enough has been done and ending the lockdowns and reopening businesses will be sufficient. But if there are riots in the streets, will ordinary folks really be willing to resume normal activities like shopping and eating out? That seems a hard case to make. While the cause of the riots was a tragedy, the riots themselves have created their own type of tragedy as well, the delay and destruction of an economic rebound. And that will not help anybody.

So, on a day where the dollar is under pressure across the board, along with all haven assets, we have a bit of data to absorb starting with the ADP Employment number (exp -9.0M) and then ISM Non-Manufacturing (44.4) and Factory Orders (-13.4%). The Services and Composite PMI data from Europe that was released earlier showed still awful levels but marginally better results than the preliminary reports. However, it is hard to look at Eurozone PMI at 31.9 and feel like the economy there is set to rebound sharply. Those levels still imply a deep, deep recession.

However, today is clearly all about adding risk to the portfolio, and that means that equities seem likely to continue their rally while the dollar is set to continue to decline. For receivables hedgers, I think we are getting to pretty interesting levels. If nothing else, leave some orders a bit above the market to take advantage.

Good luck
Adf

 

Negative Views Have Been Banned!

Posted on by

It’s not clear why anyone thought
That Covid, much havoc had wrought
At least based on stocks
Who’s heterodox
Response ignores data quite fraught

Thus, once more with bulls in command
The stock market’s flames have been fanned
So, risk is appealing,
The dollar is reeling
And negative views have been banned!

Acquiring risk continues to be at the top of investor to-do lists as, once again, despite ongoing calamities worldwide, stock markets continue on their mission to recoup all the losses seen in March. It remains difficult for me to understand the idea that company valuations today should be the same as they were in February, before the global economy came to a screeching halt. Aside from the hundreds of millions of people worldwide who have been thrown out of work, millions of companies will disappear forever, whether it is JC Penney (long overdue) or your favorite local bistro (a calamity if there ever was one.) The commonality between the two is that both employed people who were also consumers, and sans an income, they will be consuming much less.

Given that consumption represented more than 60% of the global economy (>68% in the US), all those companies that cater to consumers are going to find it extremely difficult to generate profits if there are no consumers. It is why the hospitality/leisure sectors of the economy have been devastated world-wide, and all the industries that service those companies, like aircraft manufacturing or construction, have also been hit so hard. If you remove the rose-tinted lenses, it appears that the ongoing risk acquisition remains painfully ignorant of the reality on the ground, and that a revaluation seems more likely than not.

One other thing to consider is this, tax rates. US equity markets have been a huge beneficiary of the tax cuts from 2018 with corporate earnings broadly exploding higher. However, even if one looks past the abyss of the next several quarters of economic destruction, it seems quite likely that we are going to see some big picture changes around the world with regard to distribution of income, i.e. higher corporate (and personal) tax rates and lower EPS. Again, my point is that even if, by 2021, economic activity returns to the level seen in 2019, the share of that value that will be attributed to the corporate sector is destined to be much lower, and with after-tax earnings declines ordained it will be extremely difficult to justify high valuations. So, yes, risk is in the ascendancy today, but it continues to feel as though its time is coming to an end.

And with that sobering thought, let us look at just how risk is performing today. Equity markets around the world followed yesterday’s modest US rally higher with both the Nikkei and Hang Seng rallying a bit more than 1.1%, although Shanghai managed only a 0.2% gain. Meanwhile, Europe is feeling quite perky this morning as funds from around the world are flowing into the single currency as well as equity markets throughout the region. The DAX is leading the way higher, up 4.0%, as plans for a mooted €100 billion government support program are all over the tape. And this is in addition to the EU plan for a €750 billion support package. Thus, talk of a cash for clunkers program is supporting the auto manufacturers, while increases in childcare subsidies and employment support are destined to help the rest of the economy.

But the rest of Europe is also rocking, with the CAC +2.2% and both Italy and Spain seeing 2.5% gains in their major indices. Surprisingly, the FTSE 100 is the laggard, up only 1.1%, as concerns over a hard Brexit start to reappear. The current thinking seems to be that even if a hard Brexit causes a poor economic outcome, Boris will be able to blame everything on Covid-19 thus hiding the costs, at least to the bulk of the population. After all, it will not be easy to disentangle the problems caused by Covid from those caused by a hard Brexit for the average bloke.

As I type, US futures are also reversing earlier losses and are now higher by roughly 0.5% across the board. Bond markets, once again, remain extremely uninteresting, at least in the 10-year sector, as yields continue to trade in narrow ranges. In fact, since mid-April, the 10-year Treasury has had a range of just 15bps top to bottom, again, despite extraordinary economic disruption. This same pattern holds true for all the haven bonds as central banks around the world control the activity there and prevent any substantial volatility. In fact, it is becoming increasingly clear that the signaling effect of government bond yields is diminishing rapidly. After all, what information is available regarding investor preferences if yields are pegged by the central bank?

Finally, turning to the dollar we see another day of virtually universal weakness. AUD is the top G10 performer today after the RBA appeared a tad more hawkish last night, leaving policy unchanged but also describing a wait and see approach before making any further decisions. So, while some are calling for further ease Down Under, that does not appear to be on the cards for now. NOK is next on the list, rallying 0.65% as oil prices continue their strong performance of the past 6 weeks. Then comes the pound, up 0.6% this morning after a more than 1% rally yesterday. This is far more perplexing given the growing concerns over a hard Brexit, which will almost certainly result in the pound declining sharply. Remember, as it currently stands, if there is no agreement between the UK and EU by the end of June to extend the current trade negotiations, then a deal must be done by December 31, 2020 or it’s a hard Brexit. Discussions with traders leads me to believe that we have seen a massive short squeeze in the pound vs. both the euro and the dollar. If this is the case, then we are likely looking at some pretty good levels for hedgers to take advantage.

In the EMG space, the board is almost entirely green as well, with IDR (+1.35%) atop the list with MYR (+1.0%) and MXN (+0.9%) following close behind. The rupiah has gained as Indonesia is preparing plans to reopen the economy as soon as they can, deciding that the economic devastation is worse than the disease. Meanwhile, both MYR and MXN are beneficiaries of the oil rally with the ruble (+0.65%) not far behind. In fact, the entire space save the TWD (-0.15%) is firmer this morning. As an aside, TWD seems to be feeling a little pressure from the ongoing US-China trade spat, but despite its modest decline, it has been extremely stable overall.

There is no US data on the schedule for today, so FX markets will continue to take their cues from equities. At this point, that still points in the direction of a weaker dollar as risk continues to be acquired. Despite the currency rallies we have seen in the past weeks, most currencies are still lower vs. the greenback YTD. If you are convinced that the worst is behind us, then the dollar has further to fall. But any reversion to a risk-off sentiment is likely to see the dollar reassert itself, and potentially quite quickly.

Good luck and stay safe
Adf