Tag Archives: #riskon

Yesterday’s Mess

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As riots engulf the US
The stock market’s feeling no stress
The bond market’s flat
The dollar’s gone splat
And Covid is yesterday’s mess

Risk is on this morning, and it appears that neither riots across most major cities in the US nor increased tensions between the US and China will do anything to dissuade investors from that mantra. I guess TINA is alive and well and living in every major financial center around the world. Of course, she does have a sugar daddy, the central bank community, who continue to spend on her by pumping massive amounts of liquidity into markets while cutting interest rates ever lower. Since April 1st, when lockdowns were beginning to spread rapidly around the world and social distancing became the watchword for personal interactions, every major equity market worldwide is higher, most by double digit percentages. Even Hong Kong’s Hang Seng Index is higher by 0.5% in that time, despite the fact that China has changed the law regarding the island’s quasi-independent status and certainly undermined a great deal of trust in the sanctity of private property there.

So why should today be any different than what we have seen for the past two months? One thought was all the rioting in the US. While there is absolutely no justification for the behavior of the Minneapolis policeman whose actions triggered this situation, there is also no justification for the looting and destruction of private property across the country. And, consider the timing; just as many businesses were starting to prepare to reopen, along comes a mob with the result being massive destruction of private property. This will certainly slow down the reopening of the economy to everyone’s detriment. I guess using the ‘broken windows’ theory of economics, the repair of all that damage and destruction will increase economic activity and be a net positive. (Alas, in 1850, Frederic Bastiat showed the fallacy in that theory by simply asking what those resources could have been used for had they not been needed to repair something that was perfectly fine beforehand.) The point is, the riots are a clear net negative to the economy.

And yet, after nearly two months of an incapacitated economy, which brought with it record unemployment levels along with record low readings across almost every economic statistic, the idea that equity markets around the world have recouped nearly two-thirds of the losses seen when the impact of Covid-19 was just beginning to be recognized is remarkable. Add to that equation the increasing tensions between the US and China, not merely the Hong Kong situation but also word that China is now halting purchases of US agricultural products and the potential death knell of the phase one trade agreement, and one is left scratching their head as to exactly what basis investors are using to make decisions. Since economic activity is clearly not the current driver, the only other choice is an unshakeable belief that the central banks, notably the Fed, will never allow the stock markets to decline substantially.

But that is where we are this morning, with equity markets in Asia having rallied after Friday’s presidential press conference made only vague threats about US retaliation for China’s actions regarding Hong Kong. In fact, the Hang Seng was the leading gainer, up 3.35%, but Shanghai (+2.2%) and the Nikkei (+0.85%) also enjoyed gains. Europe has generally followed along with both the CAC and FTSE 100 higher by 1.1% this morning. However, the DAX is having a more difficult session, falling 1.6% after final May PMI data showed Germany is lagging the Eurozone’s overall growth response. Meanwhile, US futures are basically flat on the day although they have rallied back from earlier losses in the overnight session.

Bond markets are behaving as one would expect in a risk-on session, with yields generally higher (Treasury +1bp, Bunds +3bps) but risk bonds, like Italian BTP’s seeing buying interest and declining yields (-3bps). In fact, another possible explanation for the DAX’s difficulties is the growing realization that Germany is going to be supporting all of the rest of Europe financially, which likely means that German companies may see less government support.

Finally, FX markets are really showing the diminished concerns regarding risk across all markets. Remember, during the peak of the concerns in March, foreign companies and countries were desperate to get access to dollars to continue servicing the trillions of dollars of USD denominated debt they had outstanding. As the basis moved further against them, they ultimately simply bought dollars in the FX market to satisfy those claims. Naturally, the dollar rallied strongly on all that demand. But to the rescue rode Jay Powell and his $4 trillion of liquidity and, voilá, the need to hoard dollars disappeared. So, with that in mind, one cannot be surprised that the dollar is softer across the board this morning.

Starting with the G10, Aussie is leading the way higher, up 0.95%, after its PMI data printed slightly better than expected and the market turns its attention to the RBA’s meeting this evening, where expectations are for no further policy ease for the time being. But we are also seeing strength in CAD (+0.5%), NZD (+0.4%) and GBP (+0.3%), as a combination of firming commodity prices and modest upward revisions to PMI data have helped underpin sentiment. The rest of the bloc is actually higher, but by 0.1% or less, and hardly worth mentioning.

In the EMG bloc, KRW (+1.1%) leads the way after announcing a $62 billion economic support package to help further mitigate the impact of Covid on the economy. That news was seen as far more important than the fact that their export data continues to crater amid ongoing slowdowns in global trade. But we are also seeing strength in RUB (+0.9%) and MXN (+0.75%) with the ruble benefitting from government encouragement for citizens to vacation in Russia rather than traveling abroad (thus reducing supply of RUB on the market) while the peso seems to simply be following its recent strengthening trend (+11.5% in May) amid an overall sense of dollar weakness. But here, too, the entire bloc is in the green, with the dollar simply under pressure universally.

Turning to the data front, this will be a big week as Friday brings the latest employment picture. But leading up to that, we have plenty to see as follows:

Today ISM Manufacturing 43.7
  ISM Prices Paid 42.0
Wednesday ADP Employment -9.0M
  Factory Orders -14.2%
  ISM Non- Manufacturing 44.5
Thursday Initial Claims 1.8M
  Continuing Claims 19.04M
  Trade Balance -$49.1B
Friday Nonfarm Payrolls -8.0M
  Private Payrolls -7.65M
  Manufacturing Payrolls -400K
  Unemployment Rate 19.6%
  Average Hourly Earnings 0.9% (8.5% Y/Y)
  Average Weekly Hours 34.3

Source: Bloomberg

In addition to this data, tonight we hear from the RBA and Thursday brings the ECB, where expectations are for a €500 billion increase in the PEPP program to go along with the EU’s €750 billion spending program. Meanwhile, the Fed is in their quiet period ahead of the June 10th meeting, so, mercifully, we will not hear from any Fed speakers all week. Obviously, all eyes will be focused on Friday’s employment report in the US, but I sense that the ECB is really this week’s biggest event. Until then, the momentum certainly seems to be in favor of more risk, and accordingly, a softer dollar this week.

Good luck and stay safe
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A Line in the Sand

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The news out of Europe is grand
A virus response is now planned
Except for the fact
It’s not widely backed
It might draw a line in the sand

As well, what the data has shown
Is hope for the future has grown
Most surveys explain
The worst of the pain
Is past, though there’s much to bemoan

Equity markets continue to power ahead in most nations as the ongoing belief remains the worst of the damage from the global shutdowns is past, and that activity will quickly return to pre-virus levels given the extraordinary support promulgated by governments and central banks around the world. For example, Italian Consumer Confidence fell only to 94.3, a far better result than the 90.0 expected. Similarly, Eurozone Economic Confidence edged higher, to 67.5 from April’s revised 64.9 reading, also offering the chance that the worst is behind us. In fact, we have seen this pattern repeatedly over the past several weeks, where May readings (Empire Mfg, Philly Fed, Michigan Sentiment) rebounded from the extraordinary levels seen in March and April, although they remain at levels associated with extremely deep recessions. And maybe, hopefully, that is exactly what this data means. The bottom is in and it is straight up from here. Of course, the slope of this recovery line remains highly uncertain.

This morning we have also learned a bit more detail about the last major economy to announce a support package, as the EU’s mooted €750 billion package will be combined with €1.1 trillion of additional spending by the EU from its own budget…over the next seven years. That’s right, the EU has determined that the best way to support its member nations in the midst of a crisis is to promise to spend some additional money for nearly the next decade. And when you do the math, this stimulus adds up to less than 1% of the EU’s annual GDP, by far the smallest effort made by any major government. Adding injury to this insulting package is the fact that it remains highly uncertain as to whether even this can get enacted.

Remember, the underlying problem in Europe remains that the frugal north has been unwilling to support the profligate south. In fact, the telling comment was from a Dutch diplomat where he said, “Negotiations will take time. It’s difficult to imagine this proposal will be the end-state of those negotiations.” So, the headline spin is Europe is finally getting around to putting up some economic aid directly to those nations in greatest need. But the reality remains far from that outcome. Markets, of course, are happy to believe the words until they are proven wrong, but history suggests that the promised €1.85 trillion in total aid will actually be far less than that in the end.

Will it matter if the money never comes? Perhaps not. Perhaps, the natural course of events will see growth start to pick up again and demands for government support will fade into the background. Of course, it seems equally likely that EU support will be delivered by flying pigs. But hey, you never know!

Turning to markets now, risk remains the place to be for investors as equity rallies continue unabated. After another standout performance in the US yesterday, Asia did well (Nikkei +2.3%, Australia +1.3%), except for Hong Kong, where the Hang Seng fell 0.7% after the Chinese National People’s Congress approved (by 2,878-1) the measure allowing China to crack down directly on Hong Kong’s citizens regarding subversion, secession and terrorism, if deemed to be necessary by Beijing. This has opened yet another front of disagreement between the US and China and simply served to elevate tensions further. As yet, the situation remains a war of words and financial actions (like tariffs), but the situation appears to be edging closer to a point where a more kinetic outcome is possible. If that were the case, you can be sure that Covid headlines would become page 6 news and markets would need to reevaluate their current bullish stance.

Meanwhile, European markets have responded positively to the promise of EU support with all markets there higher by between 0.5% (DAX) and 1.7% (Italy’s FTSE MIB). This makes perfect sense as Italy will certainly be the largest beneficiary of the EU program while Germany will simply be picking up the tab. And finally, as I type, US futures are mixed with the Dow higher by 0.5% while NASDAQ futures are lower by -.4%.

Interestingly, bond markets around the world have rallied alongside stocks with yields edging lower in the US, 10-year Treasury is down 1 basis point, but seeing much greater price gains (yield declines) throughout Europe where France (-5bps), Spain (-4bps) and Greece (-3.5bps) are leading the way. Even bunds have seen yields decline, down 2.5bps, on the back of ongoing weakness in German regional CPI readings.

And what of the dollar, you may ask. In truth, today is the very definition of a mixed session. In the G10, four currencies have edged lower by about 0.1% (CHF, NOK, CAD, AUD) while two have edged higher, SEK +0.2%, NZD +0.1%, and the rest are essentially unchanged. With movement this small, there is no specific story driving things.

The EMG bloc has seen a similar split with gainers and losers, but here there has been a bit more substance to the moves. The worst performer is Turkey, with the lira down 0.6% after data showed Central bank borrowing continued to increase as the country tries to stockpile hard-currency reserves. But we also saw KRW decline 0.45% after the BOK cut rates to 0.50%, a new record low, and promised to do even more if necessary, implying that QE is on the table next. On the plus side, CZK has been the biggest gainer, up 0.4% after their government financing auction drew a bid-to-cover ratio of 10.72, demonstrating real demand for the currency.

On the data front, we see a great deal here at home as follows: Initial Claims (exp 2.1M), Continuing Claims (25.7M), Durable Goods (-19.0%, -15.0% ex transport) and Q1 GDP (-4.8%) all at 8:30. With the market clearly looking forward, not back, despite what will certainly be horrific data, it seems unlikely that there will be much reaction unless there is a real outlier from these expectations. Remember, the working assumption is already that Q2 GDP is going to be record-breaking in its depths, so will any of these really change opinions? My guess is no.

Overall, the dollar has been under pressure for the past two weeks and as long as risk appetite remains robust, I think that situation will apply.

Good luck and stay safe
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More Than a Molehill

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The House passed a stimulus bill
With price tag of more than three trill
Japan’s latest play
Three billion a day
Adds up to more than a molehill

But turning to Europe we find
Their efforts are quite ill-designed
Despite desperate needs
The trouble exceeds
The laws that their treaties enshrined

Apparently, it’s Stimulus Day today, a little-known holiday designed by politicians to announce new fiscal stimulus measures to great fanfare. At least, that’s what it seems like anyway. Last night, Japanese PM Abe announced Japan’s second extra stimulus package in just over a month, this one with a price tag of ¥117 trillion, or roughly $1.1 trillion at today’s exchange rate (which, if you do the math works out to just over $3 billion/day over the course of a year). For an economy with a total GDP of ~$4.9 trillion, that is a huge amount of extra money.

The BOJ has explained that they will not allow JGB yields to rise, which means that they are going to mop up all the issuance and the market (or what’s left of it) clearly believes them as 10-year JGB yields actually fell 1bp last night and are currently trading at -0.006%. It is certainly no imposition for the Japanese government to borrow money from the BOJ as it is essentially a free loan. The impact on the Nikkei was mildly positive, with the index rallying 0.7%, while the yen has edged lower by a mere 0.15% and remains firmly ensconced in its 106-108 range.

And one last thing, Japan lifted its state of emergency, as well, meaning lockdowns continue to dissipate around the world. Of course, the thing about stimulus during the Days of Covid is that it is not designed to boost growth so much as designed to replace activity that was prevented by government lockdowns. Unfortunately, none of the measures announced anywhere in the world will be able to fully offset the impact of all those closures, and so despite governments’ best efforts, the global economy is set to shrink in 2020.

But on this Stimulus Day, we cannot ignore what is likely a far more important piece of news emanating from Europe, the creation of a €750 billion (~$825 billion) fiscal stimulus package consisting of €500 billion of grants and the rest of loans. While the size of this package is dwarfed by the Japanese efforts, despite the fact that the EU represents an economy with GDP of more than €14.3 trillion, the importance stems from the fact that part of the funding will come from joint debt issuance. This, of course, has been the holy grail for the entirety of southern Europe as well as the French. Because this means that the Germans (and Dutch and Austrians) are going to pay for the rest of the continent’s problems. And since those three nations are the only ones that can afford to do so, it is certainly a big deal.

The timing of this cannot be ignored either as ECB President Lagarde, just this morning, informed the world that of the ECB’s GDP forecasts last month, the mild downturn scenario is now “out of date”, with a much greater likelihood that GDP will decline between 8% and 12% in 2020. The market response has been clear with the euro rallying 0.8% on the news and now higher by 0.3% on the day, and back above 1.10. Yields on the debt of the PIGS have also fallen nicely since the news hit the tape, with all four nations seeing a 5-6bp decline. And European equity markets, which seem to have anticipated the news, have climbed a bit further, and are now all higher by more than 1.25% with Spain’s IBEX leading the way, up 2.25%.

I guess the question is will the US Senate join in the festivities (you recall the House already passed a $3 trillion package last week) and agree to at least discuss the idea, although they have made clear the House bill is a non-starter. The thing is, as has been evidenced by the recent stock market performance in the US, there are many that believe no further government stimulus is needed in the US. Optimism in the stock market has been driven by optimism that the gradual reopening of the economy in certain states will start to accelerate and that before too long, the lockdown period will end. Along those lines, Los Angeles mayor, Eric Garcetti, last night decided that small retail stores would be allowed to open today. Similarly, New York mayor Bill DiBlasio has now said that the first steps toward reopening could take place in the second week of June. The point is, if economic activity is going to start to rekindle on its own, why is further stimulus needed.

With this as background, we have seen a pretty substantial reversal in the FX market this morning, mostly since the EU stimulus announcement. While the yen has not moved, the G10 has seen currencies reverse course from a 0.3%-0.5% decline to similar sized gains. In other words, the market has seen this as further evidence that risk is to be acquired at all costs. Certainly, if the EU can figure out how to effectively fund its weakest members without causing a political uproar in the Teutonic trio, then one of the key negative fundamentals for the single currency will have been corrected. This works hand in hand with my view of increasingly negative real interest rates in the US as a driver of medium-term dollar weakness. While I don’t expect the euro to run away higher, this is certainly very positive news.

Meanwhile, those EMG currencies whose markets are open have all reversed course as well, with the CE4 higher by an average of 0.45%, having been lower by a similar amount before the announcement. APAC currencies, which had suffered a bit overnight, have not had a chance to react to the news as their local markets had closed before the report. I expect that, ceteris paribus, they will perform better tonight. The one currency, though, that is not performing well today is the Chinese renminbi, and more specifically CNH, the offshore version. It is lower by -.35%, having fallen early in last night’s session as tensions continue to increase between the US and China. As I have maintained for a very long period, the currency is an important outlet for Chinese economic imbalances and further weakness is a far more likely outcome than a reversal anytime soon.

Yesterday’s housing data in the US was surprisingly robust, with New Home Sales falling far less than expected. Today, the only real release will be the Fed’s Beige Book at 2:00, which might be interesting, but can be expected to paint a very dire picture of the regional economies. But none of that matters anymore. The future is clearly much brighter this morning as the combination of Japanese and EU stimulus along with additional easing of US restrictions has investors primed to use all that stimulus money and pump up asset prices even further. What could possibly go wrong?

Good luck and stay safe
Adf

‘Twas Nothing At All

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Does anyone here still recall
When Covid had cast a great pall
On markets and life
While causing much strife?
Me neither, ‘twas nothing at all!

One can only marvel at the way the financial markets have been able to rally on the same story time and again during the past two years. First it was the trade talks. After an initial bout of concern that growing trade tensions between the US and China would derail the global economy led to a decline in global equity market indices, about every other day we heard from President Trump that talks were going very well, that a Phase One deal was imminent and that everything would be great. And despite virtually no movement on the subject for months, those comments were sufficient to drive stock prices higher every time they were made. Of course, we all know that a phase one deal was, in fact, reached and signed, but it occurred a scant week before the outbreak of the novel coronavirus.

What has been truly remarkable is that the market’s reaction to the virus has followed almost the exact same pattern. Once it became clear that Covid-19 was going to be a big deal, causing significant disruption throughout the world, stock prices tumbled in a series of extraordinary sessions in March and early April. But since then, we have seen a powerful rally back to within a few percent of the all-time highs set in February. And these days, every rally is based on the exact same story; to wit, some company [insert name here] is on the cusp of creating a successful Covid vaccine and things will be back to normal soon.

So, as almost all of us continue to work from home, shelter in place and maintain our social distance, investors (gamblers?) have discerned that everything is just fine, and that economic recovery is on the way. And maybe they are right. Maybe history is going to look back on this time and show it was an extremely large disruption, but an extremely short-term one that had almost no long-term impact. But, boy, that seems like a hard picture to paint if you simply look at the data and understand how economies work.

Every day we see data that describes how extraordinary the impact of government lockdown policies has been, with rampant unemployment, virtual halts in manufacturing, complete halts in group entertainment and bankruptcies of erstwhile venerable companies. And every day the global equity markets rally on the prospect of a new vaccine being discovered. I get that markets are forward looking, but they certainly seem blind to the extent of damage already inflicted and what that means for the future. Even if activities went back to exactly the way they were before the outbreak, the fact remains that many businesses are no longer in existence. They could not withstand the complete absence of revenues for an extended period of time, and so have been permanently shuttered. And while new businesses will rise to take their place, that is not an overnight process. It seems thin gruel to rally on the fact that Germany’s IFO Expectations Index rallied from its historically worst print (69.4) to its second worst print (80.1), but slightly higher than expected. Or that the GfK Consumer Confidence managed the same feat (-23.4 to -18.9). Both of these data points are correlated with extremely deep recessions.

And yet, that is the situation in which we find ourselves. The dichotomy between extremely weak economic activity and a strong belief that not only is the worst behind us, but that the damage inflicted has been modest, at best. Today is a perfect example of that situation with risk firmly in the ascendancy after the long holiday weekend.

Equity markets are on fire, rallying sharply in Asia (Nikkei +2.5%, Hang Seng +1.9%, Shanghai +1.0%) despite the fact that there is evidence that a second wave of infections is growing in China and may once again force the government there to shut down large swathes of the economy. Europe, too, is rocking with the FTSE 100 (+1.2%) leading the way although gains seen across the board (DAX +0.6%, CAC +1.1%). And US futures would not dare to be left out of this rally, with all three indices up around 2.0%. Meanwhile, Treasury yields are higher by 3.5 basis points with German bund yields higher by 6bps. Of course, Italy, Portugal and Greece have all seen their yields slide as those bond markets behave far more like risk assets than havens.

I would be remiss to ignore the commodity markets which have seen oil rally a further 2.25% this morning, back to $34/bbl and the highest point since the gap down at the beginning of this process back in early March. Gold, on the other hand, is a bit softer, down 0.3%, but remains firmly above $1700/oz as many investors continue to look at central bank activity and register concern over the future value of any fiat currency.

And then there is the dollar, which has fallen almost across the board overnight, and is substantially lower than where we left it Friday afternoon. In the G10 space, AUD (+1.3%) and NZD (+1.5%) are the leaders on the back of broadly positive risk sentiment helped by a better than expected Trade Surplus in New Zealand along with a larger than expected rebound in the ANZ Consumer Confidence Index, to its second lowest reading in history. But the pound is higher by 1.1% on prospects of an end to the nationwide lockdown in the UK. And in fact, other than the yen, which is unchanged, the rest of the bloc is firmer by 0.5% or more, largely on the positive risk sentiment.

In the emerging markets, the runaway winner is the Mexican peso, up 2.7% since Friday’s close as a combination of higher oil prices, a more hawkish Banxico than expected and growing belief that the US, its major export partner, is reopening has led to a huge short-squeeze in the FX markets. In the past week, the peso has recouped nearly 7% of its losses this year and is now down a mere 14.5% year-to-date. Helping the story is the just released GDP number for Q1, which showed a decline of only -1.2%, better than the initially reported -1.6%. But we are also seeing strength throughout the EMG bloc, with PLN (+1.8%), BRL (+1.6%) and ZAR (+1.2%) all putting in strong performances. Risk sentiment is clearly strong today.

Into this voracious risk appetite, we will see a great deal of data this holiday-shortened week as follows:

Today Case Shiller Home Prices 3.40%
  New Home Sales 480K
  Consumer Confidence 87.0
Wednesday Fed’s Beige Book  
Thursday Initial Claims 2.1M
  Continuing Claims 25.75M
  Q1 GDP -4.8%
  Q1 Personal Consumption -7.5%
  Durable Goods -19.8%
  -ex transport -15.0%
Friday Personal Income -6.5%
  Personal Spending -12.8%
  Core PCE Deflator -0.3% (1.1% Y/Y)
  Chicago PMI 40.0
  Michigan Sentiment 74.0

Source: Bloomberg

In addition to the plethora of data, we hear from six different Fed speakers, including Chairman Powell on Friday morning. On this front, however, the entire FOMC has been consistent, explaining that they will continue to do what they deem necessary, that they have plenty of ammunition left, and that the immediate future of the economy will be awful, but things will improve over time.

In the end, risk is being snapped up like it is going out of style this morning, as both investors and traders continue to look across the abyss. I hope they are right…I fear they are not. But as long as they continue to behave in this manner, the dollar will remain under pressure. It rallied a lot this year, so there is ample room for it to decline further.

Good luck and stay safe
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Won’t Be Repaid

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Said Merkel and French Prez Macron
This calls for a grant, not a loan
When speaking of aid
That won’t be repaid
By nations where Covid’s full-blown

The euro is firmer this morning, up a further 0.35% after yesterday’s 0.9% rally, as the market responds to the news that German Chancellor Angela Merkel and French President Emanuel Macron have agreed on a plan for EU-wide assistance to all members. This is the first time that there has been German support for a plan that includes grants to nations, not loans to be repaid, and that these grants are to be distributed to the membership, not based on the capital key, but rather based on where the money is needed most. The funding will come from debt issued by the European Commission and paid out of that entity’s budget. In sum, while this is not actually Eurozone bond issuance, it is a clear step in that direction.

Of course, nothing in the EU is easy, and this is no different. Immediately upon the announcement, Austrian Chancellor Kurz explained that there is no path forward for grants, and that Austria is happy to lend money to those countries in need. Too, the Dutch, Danes and Finns are none too happy about this outcome, but with Germany on board, it will be very difficult to fight. Even so, French FinMin LeMaire made it clear that it will take time to complete the procedure (and he is 100% behind the idea) with the first funds not likely available before early 2021.

However, the importance of this step cannot be underestimated. The tension within the Eurozone has always revolved around how much Germany and its frugal northern neighbors would be willing to pay to the more profligate south in order to maintain the euro as a functioning currency. When looking at which nations benefit most from the single currency, Germany tops the list as the euro is certainly weaker than the Deutschemark would have been in its stead, and thus Germany’s export industries, and by extension its economic performance, have benefitted significantly. It appears that Chancellor Merkel and her administration have now done the math and decided that spending some money to maintain that export advantage is a smart investment. While in the past I have been suspect of the euro’s longevity, this appears to be the first step toward a joint fiscal policy resulting in a far stronger basis for the euro. While there will no doubt be rough seas for this process ahead, if Germany and France are on board, they will ultimately drag everyone else along. This is arguably the most bullish long-term euro story since its creation two decades ago.

The other bullish news for markets yesterday was the announcement that a tiny biotech company in Massachusetts, Moderna Inc, with just 25 employees (although a $29 billion market cap) has seen extremely positive results from a Covid vaccine trial. Apparently, it not only does the job, but does so with limited side effects to boot. While it has yet to undergo larger phase 2 and phase 3 trials, it is certainly extremely bullish news.

The combination of these stories was extremely beneficial for risk assets yesterday, which explains the 3+% rallies in US equity indices, the sell-off in Treasuries (10-year yields rose 7bps) and the dollar’s overall weakness. That bullishness followed through overnight with Asian equity markets gaining nicely (Nikkei +1.5%, Hang Seng +1.9%, Shanghai +0.8%) and Europe starting in the green as well. However, those early gains in Europe have turned red now, with what appears to be profit taking after yesterday’s substantial gains. Clearly, European equity markets were the main beneficiaries of the Franco-German announcement on debt although Italian debt has not done too badly either, with yields on 10-year BTP’s falling 22bps since Friday’s close.

Put it all together and we have a very positive backdrop for the near-term. While data continues to be dreadful, with today’s poster child being the 856K jump in Jobless Claims in the UK last month, we already know the market is looking through the bad news toward the recovery. Of much more importance to market sentiment is the prospect for the reopening of economies around the world. This is where the vaccine story supports everything, because undoubtedly, if there was a widely available vaccine, the stories of devastation would diminish and confidence would quickly return. And while there will certainly be changes in the way people behave going forward, they are not likely to be as dramatic as once imagined. After all, if people are confident they are immune to Covid-19 after a vaccination, they will likely return to their previous lifestyle as quickly as they can.

So, with that overall bullish framework, we cannot be surprised that the other key haven assets, the dollar and the yen, are under pressure this morning. Yesterday’s dollar weakness has extended this morning virtually across the board. In the G10 space, it is the high beta currencies, NZD (+0.85%) and SEK (+0.6%) leading the way, but even the pound, after that terrible employment data, is higher by 0.5%. Only the yen (-0.2%) has ceded ground to the dollar this morning in what is clearly a straight risk-on session.

The EMG bloc is much the same, with every currency on the board firmer vs. the dollar this morning led by HUF (+1.4%) and CZK (+1.2%) as clear beneficiaries of the mooted EU financing program. Remember, this €500 billion can be spent anywhere desired by the Commission. But we are also seeing commodity currencies benefit as MXN (+1.0%) and ZAR (+0.8%) continue to perform well. In fact, over the past two sessions, one is hard-pressed to find a currency that has not appreciated vs. the dollar.

On the data front, beyond the awful UK data, we did see a much better than expected German ZEW Expectations outcome, printing at 51.0, although the current conditions index remains horrendous at -93.5. But the future is much brighter this morning, adding to the euro’s strength. At home, we see Housing Starts (exp 900K) and Building Permits (1000K), neither of which is likely to have a big impact, although stronger than expected data would surely add to the overall positive risk feeling this morning.

As well, Chairman Powell will be testifying to the Senate Banking Committee, but after Sunday night’s performance it is not clear what they will ask that he has not already answered. The Fed is all-in to do everything possible to support the economy. Arguably, the bigger question is will they be able to stop once things have evidently turned better. History shows that once government programs get going, they are virtually indestructible. In this instance, that implies ongoing Fed largesse far past when it is needed, thus much lower interest rates than are appropriate. Combine negative real rates in the US with a bullish structural story in the EU and we have the recipe for a much weaker dollar over time. This week could well be the beginning of a new trend.

Good luck and stay safe
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Our Fears

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Said Powell, it may take two years
Ere Covid’s impact finally clears
All central banks pleaded
More spending is needed
But really, it’s down to our fears

Fed Chairman Powell continues to be the face of the global response to the Covid-19 economic disruption. Last night, in a 60 Minutes interview broadcast nationwide, he said, “Assuming there’s not a second wave of the coronavirus, I think you’ll see the economy recover steadily through the second half of this year. For the economy to fully recover, people will have to be fully confident, and that may have to await the arrival of a vaccine.” He also explained that the Fed still has plenty of ammunition to continue supporting the economy, although he was clear that fiscal policy had a hugely important role to play and would welcome further efforts by the government on that score. Tomorrow, he will be testifying before the Senate Banking Committee where the Republican leadership has indicated they would prefer to wait and watch to see how the CARES act has fared before opting to double down.

In the meantime, it does appear that the spread of the virus has slowed more substantially. In addition, we continue to see more state governors reopening parts of their local economies on an ad hoc basis. And globally, restrictions are being lifted throughout Europe and parts of Asia as the infection curve truly seems to be in decline. It is this latter aspect that seems to be the current theory as to why there will be a V-shaped recovery which is supporting equity markets globally.

But when considering the prospects of a V, it is critical to remember this important feature of the math behind investing. A 10% decline requires an 11.1% recovery just to return to the previous level. And as the decline grows in size, the size of the recovery needs to be that much larger. For instance, the Atlanta Fed’s latest GDPNow forecast is calling for a, very precise, 42.81% contraction in Q2. If that were to come to pass, it means that a recovery to the previous level will require a 74.8% rebound! While the down leg of this economic contraction is clearly shaped like the left-hand side of a V, it seems highly unlikely that the speed of the recovery will approach the same pace. The final math lesson is that if Q3 were to rebound 42.81%, it would still leave the economy at just under 82% of its previous level. In other words, still in depression.

However, math is clearly not the strong suit of the investment community these days, as once again this morning, we continue to see a strong equity market performance. In fact, we have seen a strong performance in equities, bonds, gold, oil, and virtually everything else that can be bought. One explanation for this behavior would be that investors are concerned that the current QE Infinity programs across nations are going to debase currencies everywhere and so the best solution is to own assets with a chance for appreciation. While historically, the flaw in that theory would be the bond market, which should be selling off dramatically on this sentiment, it seems that the knowledge that central banks are going to continue to mop up all the excess issuance is seen as reason enough to continue to hold fixed income. With that in mind, I would have to characterize today’s session is a risk grab-a-thon.

The Brits and the EU have met
With no progress really made yet
The British are striving
To just keep trade thriving
The EU’s a different mindset

Meanwhile, remember Brexit? With all the focus on Covid, it is not surprising that this issue had moved to the back of the market’s collective consciousness. It has not, however, disappeared. If you recall, the terms of the UK exit were that a deal needs to be reached by the end of this year and that if there is to be another extension, that must be agreed by the end of June. Well, it seems that Boris is sticking to his guns that he will not countenance an extension and has instructed his negotiators to focus on a trade deal only. The EU, however, apparently still doesn’t accept that Brexit occurred and is seeking a deal that essentially requires the UK to remain beholden to the European Court of Justice as well as to adhere to all EU conditions on issues like the environment and diversity. The result is that the negotiations have become a game of chicken with a very real, and growing, probability that we will still have the feared hard Brexit come December. In a funny way, Covid could be a blessing for PM Johnson’s Brexit strategy, because given the negative impact already in play, at the margin, Brexit is not likely to make a significant difference. Arguably, it is the growing realization that a hard Brexit is back on the table that has undermined the pound’s performance lately. Despite a marginal 0.1% gain this morning, the pound is the worst performing G10 currency this month, down about 4.0%. At this time, I see no reason for the pound to reverse these losses barring a change in the tone of the negotiations.

As to this morning’s session, the overall bullish tone to most markets has left the dollar on the sidelines. It is firmer against some currencies, weaker vs. others with no clear patterns, and in truth, most movement has been limited. The biggest gainer today has been RUB, which has rallied 1.0% on the strength of oil’s 8% rally. In fact, oil is back over $30/bbl for the first time in two months. Not surprisingly we are seeing strength in MXN (+0.75%) and ZAR (+0.65%) as well on the same commodity rally story. On the flipside, APAC currencies were the main losers with MYR (-0.5%) and INR (-0.45%) the worst of the bunch as Covid infections are making a comeback in the area. In the G10 bloc, NOK (+0.75%) and AUD (+0.7%) are the leaders as they, too, benefit most from commodity strength.

On the data front, last night saw Japanese GDP print at -3.4% annualized, confirming the technical recession that has begun there. (Remember, Q4 was a disaster, -7.3%, because of the imposition of the national sales tax increase.) Otherwise, there were no hard data points from Europe at all. Looking ahead to this week, it is a muted schedule focused on housing.

Tuesday Housing Starts 923K
  Building Permits 1000K
Wednesday FOMC Minutes  
Thursday Initial Claims 2.425M
  Continuing Claims 23.5M
  Philly Fed -40.0
  Leading Indicators -5.7%
  Existing Home Sales 4.30M

Source: Bloomberg

In truth, with the market still reacting to Powell’s recent comments, and his testimony on Tuesday, as well as comments from another six Fed members, I would argue that this week is all about them. For now, the V-shaped rebound narrative continues to be the driver. If the Fed speakers start to sound a bit less optimistic, that could bode ill for the bulls, but likely bode well for the dollar. If not, I imagine the dollar will remain under a bit of pressure for now.

Good luck and stay safe
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Trade is the Word

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Remember last year when Phase One
Was all that was needed to run
The stock market higher,
Light bears’ hair on fire
And help all the bulls to have fun?

Well, once again trade is the word
Investors are claiming has spurred
Their risk appetite
Both morning and night
While earnings and growth are deferred

Another day, another rally in equity markets as the bulls now point to revamped conversations between the US and China regarding trade as the critical feature to return the economy to a growth stance. Covid-19 was extremely effective at disrupting the phase one trade deal on two fronts. First, given a key part of the deal was the promise of substantial agricultural purchases by China, the closure of their economy in February and corresponding inability to import virtually anything, put paid to that part of the deal. Then there was the entire issue about the origin of Covid-19, and President Trump’s insistence on ascribing blame to the Chinese for its spread. Certainly, that did not help relations.

But yesterday, the White House described renewed discussions between senior officials to help ensure that the trade deal remains on track. Apparently, there was a phone conversation including Chinese Premier, Liu He, and both Treasury Secretary Mnuchin and Trade Rep Lighthizer last night. And this is the story on the lips of every buyer in the market. The thesis here is quite simple, US economic output will be goosed by a ramp up by the Chinese in buying products. Recall, they allegedly promised to purchase in excess of $50 billion worth of agricultural goods, as well as focus on the prevention of IP theft and open their economy further. Covid slowed their purchases significantly, so now, in order to meet their obligations, they need to dramatically increase their buying pace, thus supporting US growth. It’s almost as though last year’s news is driving this year’s market.

Nonetheless, that is the situation and yesterday’s US performance has carried over through Asia (Nikkei +2.6%, Hang Seng +1.0%, Shanghai + 0.8%) and on into Europe (DAX +0.9%, CAC + 0.8%). Not to worry, US futures are right in line, with all three indices currently higher by just over 1.0%.

Bond markets are rallying today as well, which after yesterday’s rally and the broader risk sentiment seems a bit out of place. But 10-year Treasury yields are down 10bps in the past two sessions, with this morning’s price action worth 3bps. Bunds have seen a similar, albeit not quite as large, move, with yields falling 5bps since Wednesday and down 1.5bps today. In the European market, though, today’s big story is Italy, where Moody’s is due to release its latest credit ratings update this afternoon. Moody’s currently has Italy rated Baa3, the lowest investment grade rating, and there is a risk that they cut Italy to junk status. However, we are seeing broad optimism in markets this morning. In fact, Italian BTP yields have fallen (bonds rallied) 8bps this morning and 14bps in the past two sessions. In other words, it doesn’t appear that there is great concern of a downgrade, at least not right now. Of course, that means any surprise by Moody’s will have that much larger of a negative impact.

Put it all together and you have the makings of yet another positive risk day. Not surprisingly, the dollar is under pressure during this move, with most G10 and EMG currencies in the black ahead of the payroll data this morning. And pretty much, the story for all the gainers is the positive vibe delivered by the trade news. That has helped oil prices to continue their recent rally and correspondingly supported CAD, RUB, MXN and NOK. And the story has helped renew hopes for a return to a pickup in international trade, which has fallen sharply during the past several months.

The data this morning is sure
To set records that will endure
For decades to come
As depths it will plumb
And question if hope’s premature

Here are the most recent median expectations according to Bloomberg:

Nonfarm Payrolls -22.0M
Private Payrolls -21.855M
Manufacturing Payrolls -2.5M
Unemployment Rate 16.0%
Average Hourly Earnings 0.5% (3.3% Y/Y)
Average Weekly Hours 33.5
Participation Rate 61.0%
Canadian Change in Employment -4.0M
Canadian Unemployment Rate 18.1%

Obviously, these are staggeringly large numbers in both the US and Canada. In fact, given the US economy is more than 12x the size of Canada, the situation north of the border looks more dire than here at home. Of course, the market has likely become somewhat inured to these numbers as we have seen Initial Claims numbers grow 30M in the past six weeks. But that does not detract from the absolute carnage that Covid-19 has caused to the economy. The question at hand, though, is whether the confirmation of economic destruction is enough to derail the idea that a V-shaped recovery is in the cards.

Once again, I look at the dichotomy of price action between the equity markets and the Treasury market in an effort to find an answer. The anticipated data this morning is unequivocal evidence of destruction of huge swathes of the US economy. We are looking at a decade’s worth of job growth disappearing in one month. In addition, it does appear likely that a significant proportion of these jobs will simply not return as they were. Instead, we are likely to see major transformations in the way business is carried out in the future. How long will it be before people are comfortable in large crowds? How long before they want to jostle each other in a bar to watch a football game? Or just go out on a Thursday night? The point is, equity markets don’t see the glass half full, they see it overflowing. However, 10-year Treasury yields at 0.60% are hardly an indication of strong economic demand. In fact, they are the opposite, an indication that future growth is going to be extremely subdued when it returns, and the fact that the entire term structure of rates is so low tells me that return is likely to take a long time. Much longer than a few quarters. To complete the analogy, the bond market sees that same glass as virtually emplty. So, stocks continue to point to a V and bonds to an L. Alas, history has shown the bond market tends to get these things right more often than the stock market.

The point is that the current robust risk appetite seems unlikely to have staying power, and that means that the current dollar weakness is likely to be fleeting. The bigger picture remains that the dollar, for the time being, will remain the ultimate haven currency. Look for its bid to return.

Good luck, good weekend and stay safe
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Somewhat More Bold

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The Old Lady left rates on hold
But Norway was somewhat more bold
They cut rates to nil
And won’t move them til
The virus is fin’lly controlled

Once again, central banks are sharing the headlines with Covid-19 as they attempt to address the havoc the virus is causing throughout the world. The latest moves come from the Bank of England, which while leaving policy unchanged, hinted at further stimulus to come next month, and the Norgesbank.

The base rate in the UK is currently at a record low level of 0.10%, and they have been adamant that there is no place for negative rates in the island nation. This means that QE is the only other serious tool available, and while they did not increase the amount of purchases at this meeting, it seems the current guidance, to reach a total of £465 billion, will be exhausted in July. Hence, two MPC members voted to increase QE today with the rest indicating that is a more appropriate step next month. In sum, expectations are now for a £100 billion increase at the June meeting. The other noteworthy thing from the meeting was the BOE’s economic forecast, which forecast a 14% decline in GDP in 2020 before a sharp rebound in 2021. This is by far the most dire forecast we have seen for the UK. Through it all, though, the pound has held its own, and is actually modestly higher this morning, although it remains lower by nearly 2% this month.

Meanwhile, the Norgesbank surprised almost every analyst by cutting its Deposit rate to 0.0%, a new record low for the country. With oil prices having rebounded so sharply over the past two weeks, one might have thought that prospects in Norway were improving. However, the commentary accompanying the cut indicated that the council members are trying to ensure that there will be no liquidity constraints when the economy starts to reopen post-virus, and so sought to stay ahead of the curve. They also indicated that there was virtually no chance that interest rates would move into negative territory, although we have heard that song before. The market is now expecting the Deposit Rate to remain at 0.0% for another two years. As to the krone, it is actually the strongest currency in the G10 (and the world) this morning, having risen by 1.6% vs. the dollar as I type, although it was even stronger prior to the Norgesbank action.

Today’s news simply reinforces that central banks remain the first line of defense for nearly every nation with regard to economic support during this period. As much as fiscal stimulus is critical for helping support any rebound going forward, central banks are still best positioned to adjust policies as necessary on a timely basis. Just remember how long and hard the process was for the US congress to write, debate, vote on and implement the CARES act. The same is true throughout the developed world, where legislative bodies don’t move at the speed of either the virus or markets. And so, for the foreseeable future, central banks will remain the primary tool for virtually every nation in seeking to mitigate the impact of Covid-19.

The biggest problem with this circumstance is that most central banks, and certainly the major ones, have nearly exhausted their ammunition in this fight. In the G10, the highest overnight rate currently is 0.25%, with the US, Canada, Australia and New Zealand all at that level. While QE was clearly a powerful tool when first widely introduced in 2010, it has lost some of its strength. At least with respect to aiding Main Street as opposed to Wall Street. That is why QE has evolved from government bond purchases to central bank purchases of pretty much any asset available. And yet, despite their collective efforts, monetary policy remains an extremely inefficient instrument with which to fight a viral outbreak. However, you can be sure that there will be many distortions to the economy for years to come as a result of all this activity. And that has much longer-term implications, likely slowing the pace of any recovery and future growth significantly.

Meanwhile, markets this morning are in fairly fine fettle, with equity indices in Europe all higher by something under 1%. And this is despite some pretty awful data releases showing French IP fell 16.2% in March and 17.3% Y/Y. Germany’s data, while better than that, was still awful (IP -9.2% in March and -11.6% Y/Y) and Italy regaled us with collapsing Retail Sales data (-21.3% in March). But no matter, investors are now looking into 2021 and the prospects of a strong recovery for their investment thesis. The only problem with this theory is that the potential for a non-V-shaped recovery is quite high. If this is the case, I would look for markets to reprice valuations at some point. Earlier, APAC equity markets were mixed, with the Nikkei edging higher by 0.3%, but Hang Seng (-0.6%) and Shanghai (-0.2%) both a bit softer. Finally, US futures are looking pretty good at this hour, higher by nearly 1.5% across the board.

Bond prices have edged a bit lower this morning, but movement has been modest to say the least. Yesterday saw Treasury yields rise from 10-years on out as the Treasury announced a surprisingly large 20-year auction of $20 billion. It seems that we are about to see more significant Treasury issuance going forward, and if the Fed does not continue to expand its balance sheet, we are likely to see the back end continue to sell off with correspondingly higher interest rates and a steeper yield curve. But that is a story for another day.

Elsewhere in the FX markets, Aussie (+0.9%) and Kiwi (+0.7%) have been the next best performers after NOK, as both are benefitting from the current narrative of reopening economies leading to the bottom of the economic peril. On the flip side, the yen (-0.4%) has given back some of its recent gains as risk appetite grows.

In the EMG space, the major loser is TRY, which has fallen 1.0% this morning, to a new historic low, after the central bank enacted rules to try to prevent further speculation against the currency. Alas, as long as it is freely traded, those rules will have a tough time stopping the rout. On the plus side, the three main movers have been RUB (+0.9%), ZAR (+0.8%) and MXN (+0.65%), all of which are benefitting from this morning’s positive risk attitude. One other thing to note is BRL, which while not yet open, fell another 2.5% yesterday and is back pushing its historic low levels vs. the dollar. The story there continues to be political in nature, with increasing pressure on President Bolsonaro as his most popular cabinet members exit and markets lose confidence in his presidency. My take is 6.00 is coming soon to a screen near you.

On the data front, yesterday’s ADP print of -20.236M was pretty much on the money and didn’t seem to have much impact. This morning we see Initial Claims (exp 3.0M), Continuing Claims (19.8M), Nonfarm Productivity (-5.5%) and Unit Labor Costs (4.5%). At this stage, we will have to see much worse than expected data to have a market impact, something which seems a bit unlikely, and beyond that, given tomorrow is the NFP report, I expect far more attention will be focused there than on this morning’s releases.

Overall, risk is in the ascendancy and so I would look for the dollar to generally remain under pressure for today, but I would not be surprised to see it recoup some of its early losses before the session ends.

Good luck and stay safe
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How Far Did It Sink?

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This morning the data we’ll see
Is highlighted by GDP
How far did it sink?
And is there a link
Twixt that and the FOMC?

Which later today will convene
And talk about Covid-19
What more can they do
To help us all through
The havoc that we all have seen

Market activity has been somewhat mixed amid light volumes as we await the next two important pieces of information to add to the puzzle. Starting us off this morning will be the first look at Q1 GDP in the US. Remember, the virus really didn’t have an impact on the US economy until the first week of March, although the speed of its impact, both on markets and the broad economy were unprecedented. A few weeks ago, I mentioned that I created a very rough model to forecast Q1 GDP and came up with a number of -13.6% +/- 2%. This was based on the idea that economic activity was cut in half for the last three weeks of the month and had been reduced by 25% during the first week. My model was extremely rough, did not take into account any specific factors and was entirely based on anecdotal evidence. After all, sheltering in home, it is exceedingly difficult to survey actual activity. As it turns out, my ‘forecast’ is much more bearish than the professional chattering classes which, according to the Bloomberg survey, shows the median expectation is for a reading of -4.0%, with forecasts ranging from 0.0% to -10.0%. Ultimately, a range of forecasts this wide tells us that nobody has any real idea what this number is going to look like.

Too, remember that while things have gotten worse throughout April, as much of the nation has been locked down, the latest headlines highlight how many places will be easing restrictions in the coming days and weeks. So, it appears that the worst of the impact will straddle March and April, an inconvenient time for quarterly reporting. In the end, the issue for markets is just how much devastation is already reflected in prices and perhaps more importantly, how quick of a recovery is now embedded in the price. It is this last point which gives me pause as to the current levels in equity markets, as well as the overall risk framework. The evidence points to a strong investor belief that the trillions of dollars of support by central banks and governments around the world is going to ensure that V-shaped rebound. If that does not materialize (and I, for one, am extremely skeptical it will), then a repricing of risk is sure to follow.

The other key feature today is the FOMC meeting, with the normal schedule of a 2:00 statement release and a 2:30 press conference. There are no updated forecasts due to be released, and the general consensus is that the Fed is unlikely to add any new programs to the remarkable array of programs already initiated. Arguably, the biggest question for today’s meeting is will they try to clarify their forward guidance regarding the future path of rates and policy or is it still too early to change the view that policy will remain accommodative until the economy weather’s the storm.

While hard money advocates bash the Fed and many complain that their array of actions has actually crossed into illegality, Chairman Powell and his crew are simply trying to alleviate the greatest disruption any economy has ever seen while staying within a loose interpretation of the previous guidelines. Powell did not create the virus, nor did he spend a decade as Fed chair allowing significant financial excesses to be built up. For all the grief he takes, he is simply trying to clean up a major mess that he inherited. But market pundits make their living on being ‘smarter’ than the officials about whom they write, so don’t expect the commentary to change any time soon.

With that as prelude, a survey of this morning’s activity shows that equity markets in Europe are generally slightly higher, although a few, France and Switzerland, are in the red. Interestingly, Italy’s FTSE MIB is higher by 0.4% despite the surprise move by Fitch to cut Italy’s credit rating to BBB-, the lowest investment grade rating and now the same as Moody’s rating. S&P seems to have succumbed to political pressure last week and left their rating one notch higher at BBB although with a negative outlook. Though Italian stocks are holding in, BTP’s (Italian government bonds) have fallen this morning with yields rising 4bps. In fact, a conundrum this morning is the fact that the bond market is clearly in risk-off mode, with Treasury and bund yields lower (2bp and 3bp respectively) while PIGS yields are all higher. Meanwhile, European equities are performing fairly well, US equity futures are all higher by between 0.5%-1.0%, and the dollar is softer virtually across the board. These latter signal a more risk-on scenario.

Speaking of the dollar, it is lower vs. all its G10 counterparts except the pound this morning although earlier gains of as much as 1.0% by AUD and NZD have been cut by more than half as NY walks in. This currency strength is despite weaker than expected Confidence data from the Eurozone, although with an ECB meeting tomorrow, market participants are beginning to bet on Madame Lagarde adding to the ECB’s PEPP. Meanwhile, CAD and NOK seem to be benefitting from a small rebound in the price of oil, although that seems tenuous at best given the fear of holding the front contract after last week’s dip into negative territory on the previous front contract.

EMG currencies are also uniformly stronger this morning, led by IDR (+1.0%) after a well-received government bond issuance increased confidence the country will be able to get through the worst of the virus’ impact. We are also seeing ZAR (+0.9%) firmer on the modestly increased risk appetite, and MXN (+0.7%) follow yesterday’s rally of nearly 1.7% as the worst fears over a collapse in LATAM activity dissipate. Yesterday also saw Brazil’s real rebound 2.75%, which is largely due to aggressive intervention by the central bank. The background story in the country continues to focus on the political situation with the resignation of Justice Minister Moro and yesterday’s Supreme Court ruling that an investigation into President Bolsonaro could continue regarding his firing of the police chief. However, BRL had fallen nearly 14% in the previous two weeks, so some rebound should not be surprising. In fact, on a technical basis, a move back to 5.40 seems quite viable. However, in the event the global risk appetite begins to wane again, look for BRL to once again underperform.

Overall, this mixed session seems to be more likely to evolve toward a bit of risk aversion than risk embrasure unless the Fed brings us something new and unexpected. Remember, any positive sign from the GDP data just means that Q2 will be that much worse, not that things are better overall.

Good luck and stay safe
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Yields Are Appalling

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Though prices for oil keep falling
And Treasury yields are appalling
The stock market’s view
Is skies will be blue
If Covid’s spread’s finally stalling

The ongoing dichotomy between equity market performance, traditionally a harbinger of future economic activity, and commodity market performance, also a harbinger of future economic activity, remains glaring. The commodity markets are clearly signaling significant demand destruction amid the economic devastation that has followed the spread of Covid-19. At the same time, equity markets around the world continue to recover from the lows seen in March, telling a completely different tale; that the future is bright.

When two key leading indicators offer such different portents, we need to look elsewhere to build our case of likely future outcomes. Clearly, government bond markets are the next best indicator, but their signal has been clouded by the more than $15 trillion that central banks around the world have spent buying those bonds since the financial crisis in 2008-09. Absent those purchases, would 10-year Treasury yields really be 0.65% like they are this morning? Would 10-year German bund yields really be at -0.44%, their 356th consecutive day yielding less than zero? Consider how much new debt has been issued and how that debt would have been absorbed absent central bank intervention. My point is that perhaps, using bond yields now as a proxy for future economic activity may no longer be quite as useful.

Which leaves us with the FX markets as our last signal for future activity. What does the dollar’s value tell us about expectations for the future? The problem with the dollar as an indicator is, its track record is extremely unclear. Throughout history, the US economy has been strong with both a strong dollar and a weak dollar. If anything, the dollar is a far better coincident indicator than anything else. After all, what is the risk-off/risk-on characteristic other than a signal of investors’ current views of the market. Thus, when fear is rampant, which was evident last month, the dollar performed extremely well. A quick look at currency returns during the month of March showed the dollar rising against 9 of its G10 Brethren, from 0.2% vs. the Swiss franc, to 10.7% vs. the oil-linked Norwegian krone. Only the yen, which managed a 0.75% rise, was able to outperform the dollar.

Not surprisingly, the EMG space saw some much more significant declines led by the Mexican peso (-18.1%) and Russian ruble (-15.3%). The broad theme in this bloc was that the best performers, those that fell the least, were APAC currencies with closer links to China, while LATAM and EEMEA were generally devastated. But, again, this was a real-time response to coincident activities, not a harbinger of the future.

The lesson to learn from this brief look at recent history is that there is no consensus view as to how things are going to evolve from here. Both sides make their respective cases strongly, and both sides can point to a substantial amount of data that supports their argument. However, the only universal truth is that economic disruptions that have been caused by the response to Covid-19 are unprecedented in both size and speed, and econometric models built for a different environment are unlikely to be very effective. Modeling of complex systems, whether the economy, the climate or the spread of a pathogen is an extremely fraught undertaking. More often than not, models will produce useless results. Their benefits generally come from the need to define conditions and factors, thus helping to better think and understand a particular situation, not from spurious calculations that produce a result. And this is why hedging is an important part of risk management, because regardless of what certain harbingers indicate, the reality is nobody knows what the future will bring.

But back to today’s activity. As we have seen for the past several sessions, the prospect of the reopening of economies is being seen by the equity markets as a clear positive. Despite abysmal earnings results across most industries, once again equity markets are firmer this morning, with most of Europe higher by 1.5%-2.0% and US futures pointing to gains of more than 1.0% on the open. Countries throughout Europe are starting to announce their plans to reopen with May 11 seeming to be the date where things will really start. And of course, the same process is ongoing in the US, with Georgia dipping its toe into the water yesterday, and other states lining up to do the same. Of course, the end of the lockdown does not mean that that things will return to the pre-virus situation. Incalculable damage has been done to every nation’s economy as regardless of government attempts, thousands upon thousands of small businesses will never return. Arguably, the one thing we know about the future is that it is going to be different than what was envisioned on January 1st.

Bond markets are behaving consistently with a modest risk-on view as Treasury and bund yields edge higher, while yields for the PIGS continue to slide. And finally, the dollar remains under pressure this morning, sliding against most of its counterparts as short-term fears abate. The best performers today in the G10 bloc are SEK and NOK, with the former rallying on what was perceived as a more hawkish than expected message from the Riksbank, when they didn’t cut rates back below zero at today’s meeting, and merely promised to continue to buy more bonds. NOK is a bit more difficult to explain given that oil prices (WTI -7.7%) continue to suffer from either significant excess supply or a complete lack of demand, depending on your point of view. However, given that NOK has been the worst performing G10 currency this year, it is probably due for some recovery given the positive sentiment seen today.

EMG currencies are also generally firmer, with MXN (+1.5%) atop the charts, as it, too, is ignoring the declining price of oil and instead finding demand after a precipitous fall this year. but we are also seeing strength in ZAR (+1.2%) and most EEMEA currencies, as some of last month’s excesses seem to be unwinding as we approach the end of April.

On the data front this morning are two minor releases, Case Shiller Home Prices (exp 3.19%) and Consumer Confidence (87.0). Rather, with the FOMC’s two-day meeting beginning this morning at 9:00, discussions will continue to focus on expectations for the Fed tomorrow, as well as the first look at Q1 GDP. But for today, I expect that we will continue to see this mildly positive risk attitude and the dollar to remain under modest pressure. My view remains that there are still significant issues ahead and the market is not pricing in the length of how bad things are going to be, but clearly for now, I am in the minority.

Good luck and stay safe
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