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:
|Average Hourly Earnings||0.5% (3.3% Y/Y)|
|Average Weekly Hours||33.5|
|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