Patience is Needed

Mnuchin said patience is needed
While Powell said growth must be seeded
As both testified
And each justified
Their views, which both said must be heeded

Two months into the response to Covid-19, differences in policy views between the Fed and the Administration are starting to appear. In Senate testimony yesterday, Treasury Secretary Mnuchin indicated the belief that sufficient fiscal support has been authorized and its implementation is all that is needed, alongside the relaxation of lockdown rules around the country, for the economy to rebound sharply. The Administration’s base case remains a V-shaped recovery, with Q3 and Q4 showing substantial growth after what everyone agrees will be a devastatingly awful Q2 result.

Meanwhile, the Fed, via Chairman Powell, took the view that we remain in a critical period and that further stimulus may well be necessary to prevent permanent long-term damage to the economy. He continued to focus on the idea that until people feel safe with personal interactions, any rebound in the economy will be substandard. Of course, to date, of the $454 billion that Congress authorized for the Treasury to use as seed money underlying Fed lending schemes, less than $75 billion has been utilized. It seems that if Chairman Powell was truly that concerned, he would be ramping up the use of those funds more quickly. While part of the problem is the normal bureaucratic delays that come with implementing any new program, it is also true that the Fed is not well suited to support small businesses and individuals. Programs of that nature tend to require more fiscal than monetary support, at least as currently defined and implemented in today’s world. Remember, the Fed is not able to take losses according to its charter, which is why all the corporate bond buying and main street lending programs are already on shaky legal grounds.

The interesting thing about the dueling testimonies was just how little of an impact they had on market behavior yesterday. In fact, the late day equity market sell-off was almost certainly driven by the concern that yesterday’s media darling, the biotech firm Moderna, Inc., may not actually have a viable vaccine ready this year. Remember, it was the prospect that a vaccine was imminent and so lockdowns could be lifted that was critical in investor minds yesterday. If the vaccine story is no longer on track, it is much harder to justify paying over the top for equities. At any rate, that late day move set the tone for a much more subdued session in both Asia and Europe overnight.

Looking at markets, last night saw a mixed equity picture in Asia (Nikkei +0.8%, Shanghai -0.5%) and a very modest positive light in Europe (DAX +0.6%, CAC 0.0%, FTSE 100 +0.2%). More positively, US futures are pointing higher as I type, with all three indices looking at a 1% gain on the open if things hold. Bond markets are similarly uninspired this morning, with Treasury yields higher by less than 1bp while German bund yields are down by the same. In fact, looking across the European market, half are slightly higher, and half are slightly lower. Again, nothing of interest here.

Commodity markets show that oil continues to rebound sharply, up another 1% this morning and now above $32/bbl for WTI. Remember, it was less than a month ago that the May futures contract settled at -$37/bbl as storage was nowhere to be found. Certainly, any look at commodity markets would indicate that economic growth was making a return. But it sure doesn’t feel like that yet.

Finally, FX markets continue to see the dollar cede some recent gains as fears over USD funding by global counterparts continue to ebb on the back of Fed lending programs. In fact, this is exactly where the Fed can do the most good, helping to ensure that central banks around the world have the ability to access USD liquidity for their local markets.

A tour of the G10 shows that today’s biggest winner is NZD (+0.65%) followed by AUD and CHF, both higher by about 0.4%. The Kiwi dollar was supported by central bank comments about NIRP remaining a distant prospect, at best, with many hurdles to be jumped before it would make sense. Aussie seems to have benefitted from Japanese investment flows into their government bond markets, which are now relatively attractive vs. US Treasuries. Finally, after a short-lived decline yesterday afternoon, apparently driven by some options activity, the Swiss franc is simply returning to its previous levels. The other seven currencies are within a few bps of yesterday’s closing levels with only the background story of the Franco-German détente on EU economic support even getting press in the group.

In the EMG space, ZAR is today’s runaway leader, currently higher by 1.75% as a combination of continued strength in the price of gold and a major technical break have helped the rand. It must be remembered that the rand, even after today’s sharp rally, has been the third worst performing currency over the past three months having fallen more than 16%. This morning, the technicians are all agog as the spot rate traded back through its 50-day moving average, a strong technical signal to buy the currency. While economic prospects continue to be dim overall there and there is no evidence that the rate of infection is slowing, technical algorithms will continue to support the currency for the time being.

Otherwise, it is RUB (+1.1%) and MXN (+0.9%) that are trailing only the rand higher this morning, with both clearly benefitting from the ongoing rebound in oil and, more importantly, in the broad sentiment in the future for oil. Last month it appeared that oil was never going to matter again. That is not so much the case anymore. On the downside today, KRW (-0.4%) is the leading, and only, decliner in the space as the BOK creates a 10 trillion won (~$8 billion) SPV to inaugurate a QE program.

On the data front, yesterday’s housing data was pretty much as expected, with both Starts and Permits falling sharply. Today the only news of note comes at 2:00 when the FOMC Minutes are released. But given how much we have heard from Powell and the rest of the committee, will this really have that big an impact? I would be surprised.

The dollar continues under pressure for the time being and will stay that way as long as USD funding pressures overseas remain in check. While there are no obvious drivers in the near term, I continue to look at the pending change of heart in Europe regarding fiscal support and see an opportunity for a more structural case for dollar weakness over time.

Good luck and stay safe
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Our Fears

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

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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