Tag Archives: #volatility

A Rough Week

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Investors have had a rough week
As both stocks and bonds sprung a leak
The hope is, today
The data will say
Inflation is well past its peak

The thing is, Q3’s GDP
Described a robust ‘conomy
Will that push the Fed
When looking ahead
To restart their tightening spree?

I imagine most of us are a little tired of the negativity in markets on a daily basis of late.  Yesterday was just another in a series of negative equity market sessions with the US indices declining between -0.75% (DJIA) and -1.75% (NASDAQ).  And this happened despite (because of?) a significantly higher GDP report than most analysts had forecast.  The print, 4.9%, was truly impressive and it was accompanied by stronger than expected Durable Goods orders (4.7%) and continuing solid Initial Claims data (210K).  In other words, the data points to a robust US economy which, one might conclude, would be a positive for risk assets.  One would be wrong.

It seems there are many possible explanations for this seeming conundrum although I favor the following: ongoing elevated interest rates are putting pressure on earnings multiples and driving them lower.  The fact that GDP growth remains robust implies the Fed will be in no hurry to cut rates thus maintaining its higher for longer attitude for even longer.  In this situation, the discount cash flow model, which underlies much, if not most, stock market analysis, tells us that companies growing at 10% cannot be valued at 50x earnings, the math just doesn’t work.  Hence, despite solid performance, investors are rerating the value of these companies lower.  The bigger problem is that the current market multiple remains well above its long-term average so there is further, potentially, to fall.

One other thing to note regarding the economy is that it is quite common for there to be very strong quarterly GDP prints just before a recession begins.  Clearly yesterday’s number was quite strong, in fact the strongest (excluding the post-covid rebound) since Q1 2014.  However, that does not preclude the fact that we may still be headed toward a recession.  Now, arguably, a recession, or at least if the data starts to look like a recession is upon us, would get the Fed to change their tune and consider relaxing their current policy stance.  However, recessions tend to come with much lower earnings and historically are not that good for risk assets either.  It is this concern that has so many praying calling for a soft landing.  Alas, I would not wager on that outcome.

I think it is important to remember that market movements do not have to be driven by outside catalysts but can happen of their own volition.  In fact, that is my point on the rerating of market multiples.  This can occur regardless of any data, whether good or bad.  If the investor community is becoming nervous, and if there is an alternative like we have today with short-dated Treasuries yielding 5% or more, equity prices can decline much further around the world, whatever their current valuations are.  While we all try to rationalize movements in the markets after the fact, on any given day, no specific catalyst is needed from outside the market itself.

With this in mind, though, the rest of the world has not followed yesterday’s US market lead and instead we have seen a rebound in Asian shares with the Hang Seng (+2.1%) leading the way but the rest of the space mostly higher by at least 1%.  European bourses are more mixed with a combination of mostly small gains and losses although the CAC in Paris is an outlier (-1.0%).  US futures, though, are mostly in the green with the NASDAQ the leader (+0.6%) at this hour (7:45).

The bond story, though, is quite interesting as there has been a great deal of volatility in this space of late.  You may recall that I mentioned the abysmal 5-yr auction on Wednesday.  Well, yesterday the Treasury auctioned 7-year paper and the results were outstanding with the best bid-to-cover ratio since March 2020.  This led to a major rally in the bond market with yields continuing their yoyo movement and falling 14bps although this morning they are bouncing from those levels and are higher by 3bps.  European sovereigns did not come along for the Treasury ride yesterday showing much less movement and this morning they are edging lower by between 1bp and 3bps. This is in the wake of yesterday’s ECB meeting where Madame Lagarde left policy on hold for the first time after eleven consecutive rate hikes, and tried to explain that they would be completely data dependent for the time being.  Not for nothing but the recent data from Europe looks pretty awful, so if that is the case, I would expect to see cuts on the horizon there.

Volatility continues apace in the oil market as well with yesterday’s decline followed by 1.5% rally this morning.  It seems that yesterday’s story about a potential de-escalation of the Israeli-Palestinian crisis was trumped by news that the US had bombed several sites in Syria in response to attacks on US bases in Iraq last week.  Ostensibly these sites are controlled by Iranian proxies indicating the possibility of a widening conflict in the Middle East.  I suspect that we are going to continue to see volatility here, but net, the structural issues remain beneficial for oil in my view.  As to gold, it is little changed this morning and simply maintaining its recent gains as fear continues to be a market driver right now.  Base metals were clearly cheered by the strong US data as both copper (+1.1%) and aluminum (+0.25%) are firmer this morning.

Looking at the dollar, it should be no surprise that it continues to perform well overall.  Between the risk issues and the strong economic data, the US certainly seems a better place to put your money than most others right now.  USDJPY continues to trade above 150 but is not running away and there is no indication the BOJ has been involved at all.  The euro keeps pushing toward 1.05 and the pound looks like it is headed down to 1.20 soon.  USDCNY is back near its recent highs as the perceived benefits of Chinese fiscal stimulus are not seen as yuan positives at this point, especially given the divergence between US and Chinese monetary policy.  It is very difficult, at this time, to come up with a reason for the dollar to decline in any substantial way.

On the data front, this morning brings Personal Income, (exp 0.4%), Personal Spending (0.5%), and the all-important Core PCE (0.3%, 3.7% Y/Y) with Michigan Sentiment (63.0) coming later at 10:00.  At this point, all eyes remain on the FOMC meeting next week where there is essentially no expectation of a rate move.  We would need to see a REALLY hot PCE number this morning to change that.  As such, I expect that a consolidation in risk markets is quite possible with little movement in the dollar overall.  Beware, however, if stocks sell off later today as that could be a tell that there is more pressure to come.  I clearly recall that the Friday before Black Monday in October 1987, stocks sold off aggressively, just not as aggressively as they did on the Monday!.

Good luck and good weekend

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To ZIRP They’ll Adhere

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The sides of the battle are set
Will shortfalls, inflation, beget
Or is it the call
That prices will fall
Because of those trillions in debt

In circles, official, it’s clear
That no one believes past this year
Inflation will heighten
And so, they won’t tighten
But rather, to ZIRP they’ll adhere

It appears that the market is arriving at an inflection point of some type as the question of inflation continues to dominate most macroeconomic discussions.  For those in the deflation camp, rising prices are not nearly enough to declare that inflation is either upon us or coming soon, while inflationistas are quite comfortable highlighting the steady drumbeat of rising prices across both commodities and finished products as evidence of the new paradigm.  Both sides of this discussion recognize that the CPI data released last week was juiced by the base effects of the economic impact of last year’s government lockdowns and the ensuing price declines we saw in March, April and May of last year.  Which means that the entire argument is based on dueling forecasts of the future beyond that.  In other words, until we see the CPI print covering June but released in the middle of July, we will only have speculation as to the future impact.

What is transitory?  Ultimately, that becomes the biggest question in markets as the Fed has been harping on that word for months now.  According to Merriam-Webster, it describes something of brief duration or temporary.  Which begs the question, what is brief?  Is 3 months brief?  6 months?  Longer?  Arguably, brief depends on the context involved.  For instance, 3 months is an eternity when considering a spot FX trading position, while it is but a blink of an eye when considering a pension fund’s time horizon for investments.

There continue to be strong arguments in favor of both sides of the argument.  On the deflationist side the main points are; debt, demographics, technology and globalization, all of which have been instrumental in essentially killing inflation over the past 40 years.  No one can argue with the fact that the massive amount of debt outstanding will lead to an increasing utilization of resources to service that debt and prevent spending elsewhere driving up prices.  As nations around the world age, the strong belief is that individuals consume less (except perhaps healthcare) and thus reduce demand for everyday items.  Technology essentially exists to reinvent old processes in a more efficient form, thus reducing the cost of providing them, while globalization has been the underlying cause for the excess supply of labor, capping wages and any wage/price spiral.  In addition, they argue that inflation is not a one-off price rise, but a constant series of rising prices that feeds through to every item over time.

Inflationists see the world in a different manner post-Covid, as they highlight the breakdown of globalization with regulations preventing international travel and efforts to reduce the length of supply chains.  In addition, they point to the extraordinary growth in the money supply, with the added fact that unlike in the wake of the GFC, this time there is significant fiscal spending which is pushing that money beyond the confines of financial markets and manifesting itself as rising prices.  We continue to see company after company announce price hikes of 7%-15% for everyday staples which is exactly they type of situation that gets people talking about inflation.  Inflationists highlight the fact that there are shortages of commodity products worldwide and that because of the dramatic shutdowns last year from Covid, capex in mining and energy exploration was decimated thus delaying any opportunity for supply to catch up to current demand, which, by the way, is growing rapidly amidst the fiscal support.  As they are wont to say, the Fed can’t print copper or corn.  The point is, if there are basic product shortages for more than a year and prices continue to rise, is that still transitory?

Right now, there is no clear answer, which is what makes the discussion both entertaining and crucial to the future direction of financial markets.  By now, you are all aware I remain in the inflationist camp and have been for a while.  I cannot ignore the rising prices I see every time I go into a store.  But the deflationists make excellent points.  This argument discussion will rage for at least another two months and the July CPI release.  Until then, the one thing that seems clear is that market volatility is likely to remain significant.

As to markets today, while Asia had a mixed equity session (Nikkei -0.9%, Hang Seng +0.6%, Shanghai +0.8%), Europe has come under pressure as the morning has progressed.  At this time, we are seeing all red numbers led by the FTSE 100 (-0.7%), with the CAC (-0.4%) and DAX (-0.3%) both slipping as well.  US futures, which had been essentially unchanged all night are starting to slip as well, with all three major indices currently lower by 0.3%.

Interestingly, bond yields are edging higher this morning, at least edging describes Treasury yields (+0.2bps) while in Europe, sovereign markets are selling off pretty aggressively.  Bunds (+2.2bps), OATs (+3.1bps) and Gilts (+2.1bps) are all lower, while Italian BTPs (+5.5bps) continue to see their spread vs. bunds widen rapidly, up more than 20bps in the past 3 months.

Commodity prices are having a more complicated session with oil essentially unchanged, gold (+0.3%) and silver (+0.75%) both firmer along with base metals (Cu +0.5%, Al +0.9%, Sn +0.6%) while agricultural products are more mixed (Soybeans +0.4%, Wheat -0.8%, Corn +0.75%).

Finally, the dollar is mixed with gainers and losers across both G10 and EMG blocs.  Even though commodity prices are holding up reasonably well, the commodity bloc in the G10 is weak this morning, led by NZD (-0.7%), NOK (-0.6%) and AUD (-0.3%).  Much of this movement seems to be on the back of positioning rather than fundamental news.  On the plus side, JPY (+0.2%), and EUR (+0.2%) are the leading gainers, but it is hard to get excited about such small movements.

EMG currencies have seen a bit more variance with APAC currencies under pressure (IDR -0.6%, KRW -0.5%, SGD (-0.3%) as concerns grow over another wave of Covid inspired lockdowns slowing recovery efforts in the economies throughout the region.  CNY is little changed after overnight data showed Retail Sales (17.7%) much weaker than the expected 25.0% gain although the other key data points, Fixed Asset Investment (19.9%) and IP (9.8%) were both pretty much in line.  On the positive side we see TRY (+1.0%) on the back of easing Covid restrictions alongside a healthy C/A surplus in April, and HUF (+0.7%) after a central banker intimated that they could be raising interest rates to fight inflation as soon as next month.

Not a ton of data this week, but here is what we see:

Today Empire Manufacturing 23.9
Tuesday Housing Starts 1705K
Building Permits 1770K
Wednesday FOMC Minutes
Thursday Initial Claims 455K
Continuing Claims 3.64M
Philly Fed 41.9
Friday Existing Home Sales 6.08M

Source: Bloomberg

The Fed speaking calendar is a bit less full this week with only four different speakers although they will speak seven times in total.  Vice-Chair Clarida is the most important voice, but we already know that he is going to simply defend the current policy regardless of data.

With all that in mind, it appears that the dollar remains beholden to the Treasury market, so today’s limited movement, so far, in the 10-year has seen mixed and limited movement in the buck.  This goes back to the opening discussion; if you think inflation is coming, and expect Treasury yields to continue to rise, look for the dollar to follow along.  If you are in the deflationist camp, it’s the opposite.  But remember, at a point in time, inflation will undermine the dollar’s value.  Just not right away.

Good luck and stay safe
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More Terrified

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The narrative starting to form
Is bond market vol’s the new norm
But Jay and Christine
Explain they’re serene
Regarding this new firestorm

However, the impact worldwide
Is some nations must set aside
Their plans for more spending
As yields are ascending
And FinMins grow more terrified

Confusion is the new watchword as investors are torn between the old normal of central bank omnipotence and the emerging new normal of unfettered chaos.  Now, perhaps unfettered chaos overstates the new normal, but price action, especially in the Treasury and other major government bond markets, has been significantly more volatile than what we had become used to since the first months of the Covid crisis passed last year.  And remember, prior to Covid’s appearance on the world stage, it was widely ‘known’ that the Fed and its central bank brethren had committed to insuring yields would remain low to support the economy.  Of course, there was the odd hiccup (the taper tantrum of 2013, the repo crisis of 2018) but generally speaking, the bond market was not a very exciting place to be.  Yields were relatively low on a long-term historical basis and tended to grind slowly lower as debt deflation central bank action guided inflation to a low and stable rate.

But lately, that story seems to be changing.  Perhaps it is the ~$10 trillion of pandemic support that has been (or will soon be) added to the global economy, with the US at $5 trillion, including the upcoming $1.9 trillion bill working its way through Congress, the leading proponent.  Or perhaps it is the fact that the novel coronavirus was novel in how it impacted economies, with not only a significant demand shock, but also a significant supply shock.  This is important because supply shocks are what tend to drive inflation with the OPEC oil embargos of 1973 and 1979 as exhibits A and B.

And this matters a lot.  Last week’s bond market price action was quite disruptive, and the terrible results of the US 7-year Treasury auction got tongues wagging even more about how yields could really explode higher.  Now, so far this year we have heard from numerous Fed speakers that higher yields were a good sign as they foretold a strong economic recovery.  However, we all know that the US government cannot really afford for yields to head that much higher as the ensuing rise in debt service costs would become quite problematic.  But when Chairman Powell spoke last week, he changed nothing regarding his view that the Fed was committed to the current level of support for a substantially longer time.

Yesterday, however, we heard the first inkling that the Fed may not be so happy about recent bond market volatility as Governor Brainerd explained that the sharp moves “caught her eye”, and that movement like that was not appropriate.  This is more in sync with what we have consistently heard from ECB members regarding the sharp rise in yields there.  At this point, I count at least five ECB speakers trying to talk down yields by explaining they have plenty of flexibility in their current toolkit (they can buy more bonds more quickly) if they deem it necessary.

But this is where it gets confusing.  Apparently, at least according to a top story in Bloomberg this morning which explains that ECB policymakers see no need for drastic action to address the rapidly rising yields of European government bonds, everything is fine.  But if everything is fine, why the onslaught of commentary from so many senior ECB members?  After all, the last thing the ECB wants is for higher yields to drive the euro higher, which would have the triple negative impact of containing any inflationary impulses, hurting export industries and ultimately slowing growth.  To me, the outlier is this morning’s story rather than the commentary we have been hearing.  Now, last week, because of a large maturity of French debt, the ECB’s PEPP actually net reduced purchases, an odd response to concerns over rising yields.  Watch carefully for this week’s action when it is released next Monday, but my sense is that number will have risen quite a bit.

And yet, this morning, bond yields throughout Europe and the US are strongly higher with Treasuries (+5.3bps) leading the way, but Gilts (+3.6bps), OATs (+2.7bps) and Bunds (+2.4bps) all starting to show a near-term bottom in yields.  The one absolute is that bond volatility continues to be much higher than it has been in the past, and I assure you, that is not the outcome that any central bank wants to see.

And there are knock-on effects to this price action as well, where less liquid emerging and other markets are finding fewer buyers for their paper.  Recent auctions in Australia, Thailand, Indonesia, New Zealand, Italy and Germany all saw much lower than normal bid-to-cover ratios with higher yields and less debt sold.  Make no mistake, this is the key issue going forward.  If bond investors are unwilling to finance the ongoing spending sprees by governments at ultra-low yields, that is going to have significant ramifications for economies, and markets, everywhere.  This is especially so if higher Treasury yields help the dollar higher which will have a twofold effect on emerging market economies and really slow things down.  We are not out of the woods yet with respect to the impact of Covid and the responses by governments.

However, while these are medium term issues, the story today is of pure risk acquisition.  After yesterday’s poor performance by US equity markets, Asia turned things around (Nikkei +0.5%, Hang Seng +2.7%, Shanghai +1.9%) and Europe has followed along (DAX +0.9%, CAC +0.6%, FTSE 100 +0.8%).  US futures are right there with Europe, with all three indices higher by ~0.6%.

As mentioned above, yields everywhere are higher, as are oil prices (+1.5%).  However, metals prices are soft on both the precious and base sides, and agricultural prices are mixed, at best.

And lastly, the dollar, which had been softer all morning, is starting to find it footing and rebound.  CHF (-0.3%) and JPY (-0.25%) are the leading decliners, but the entire G10 bloc is lower except for CAD (+0.1%), which has arguably benefitted from oil’s rally as well as higher yields in its government bond market.  In what cannot be a great surprise, comments from the ECB’s Pablo Hernandez de Cos (Spanish central bank president) expressed the view that they must avoid a premature rise in nominal interest rates, i.e. they will not allow yields to rise unopposed.  And it was these comments that undermined the euro, and the bulk of the G10 currencies.

On the EMG front, overnight saw some strength in Asian currencies led by INR (+0.9%) and IDR (+0.55%) as both were recipients of foreign inflows to take advantage of the higher yield structure available there.  On the downside, BRL (-0.7%) and MXN (-0.5%) are the laggards as concerns grow over both governments’ ongoing response to the economic disruption caused by Covid.  We have seen the Central Bank of Brazil intervening in markets consistently for the past week or so, but that has not prevented the real from declining 5% during that time.  I fear it has further to fall.

On the data front, ADP Employment (exp 205K) leads the day and ISM Services (58.7) comes a bit later.  Then, this afternoon we see the Fed’s Beige Book.  We also hear from three more Fed speakers, but it would be shocking to hear any message other than they will keep the pedal to the metal for now.

Given all the focus on the Treasury market these days, it can be no surprise that the correlation between 10-year yields and the euro has turned negative (higher yields leads to lower euro price) and I see no reason for that to change.  The story about the ECB being unconcerned with yields seems highly unlikely.  Rather, I believe they have demonstrated they are extremely concerned with European government bond yields and will do all they can to prevent them from moving much higher.  While things will be volatile, I have a sense the dollar is going to continue to outperform expectations of its decline for a while longer.

Good luck and stay safe
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Overrun

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Our planet, third rock from the sun
Has clearly now been overrun
By Covid-19
Whose spread is unseen
And cannot be fought with a gun

It is certainly difficult, these days, to keep up with the latest narrative about how quickly the virus will continue to spread and when we will either flatten the infection curve or will get past its peak. Every day brings a combination of optimistic views, that within a few weeks’ things will settle down, as well as pessimistic views, that millions will die from the virus and it will be many months before life can return to any semblance of normal. And the thing is, both sets of opinions can come from reasonably well-respected sources. Adding to the confusion is the fact that there is still a huge political divide in the US, and that many comments are politically tinged in order to gain advantage. After all, while it has not been the recent focus, there is still a presidential election scheduled for November, a scant seven plus months from now.

With this as the baseline, it cannot be that surprising that we have seen the extraordinary volatility present throughout markets in recent weeks. And while volatility may have peaked, it is not about to fall back to the levels present two months ago. In fact, the one thing of which I am certain is it will take a long time for markets to settle back into the rhythms that had seemed so pleasing and normal for so many years.

Something else to note is that while central banks seem to have been able to positively impact market behavior in recent days, the cost of doing so has gone up dramatically. For example, during the financial crisis, the widely hated TARP bill had a price tag of $700 billion, clearly a large number. And yet that is one-third of what the present stimulus bill will cost. And the Fed? Well it took them three months in 2008 to expand their balance sheet by $1 trillion. This time it took less than three weeks. And they are not even close to done!

It is the latter point that brings the greatest risk to markets, the fact that the cost of addressing market failures has grown far faster than the global economy. This is a result of the serial bubble blowing that we have seen since October 1987, when the Maestro himself, then Fed Chair Alan Greenspan, promised the Fed would support markets and not allow things to collapse. That inaugurated a pattern of central bank behavior that prevented markets of any kind from clearing excesses because the political fallout would have been too great. But as we have seen, each bubble blown since has had a larger and larger price tag to overcome. The question now is, have we reached the limits of what policymakers can do to prevent markets from clearing? Certainly, they will never admit that is the case, but much smarter people than me have made the case that their capabilities have been stretched to the limit.

It is with this as background that I think it makes sense to discuss what we have seen this week alone! Using the S&P 500 as our proxy, we saw a sharp decline on Monday, over 4%, and then a three-day rebound of nearly 18%! In fact, from its lows on Monday, the rebound has been more than 20%. Many in the financial press have been saying this is now a bull market. My view is that is bull***t. A bull market needs to be defined as a market where prices are rising on the back of strong underlying fundamentals and where long-term prospects are strong. The recent fixation on 20% movements as defining a bull or bear market are completely outdated. Instead, I think the case is far easier to make that we are ensconced in the beginning of a bear market, where the long-term, or at least medium-term, fundamentals are quite weak and prospects are uncertain, at best, and realistically quite negative for the coming quarters. Declaring a bull market on the same day that Initial Unemployment Claims printed at nearly 3.3 million, far and away the highest in history, is ridiculous! I fear that the movement this week in stocks and the dollar, is not the beginning of a new trend, but a reactive bounce to previous price action.

Turning to the dollar, after a remarkable rally in the buck throughout the month of March, it too has fallen sharply during the past several sessions. The proximate cause was the Fed, which when it announced its laundry list of new programs on Monday evening was able to calm immediate fears over a lack of USD liquidity. It appears that the dollar’s two week run of strength was driven by global fears over a shortage of dollar liquidity available coming into quarter end next week. We saw this in the movement of basis swap spreads, which blew out in favor of dollars, and we saw this in the FX forward market, where every price that encompassed the turn was no longer linearly interpolated. But the Fed has thrown $5 trillion at the problem and for now, that seems like it is enough, at least for this quarter. Markets have settled, and the fear over coming up short of dollars has abated for the time being.

But this is not over, not by a longshot. Navigating the next few months will be quite difficult as we are sure to see more negative news regarding the virus, followed by policy attempts to address that news. Until a solid case is made that globally, the peak of the infection curve is behind us, we are going to remain in a tenuous market state with significant volatility.

Finishing with a brief look at the dollar this morning, it is actually having a mixed session. In the G10, NOK continues to be the most volatile currency by far, down 1.3% this morning after an intervention led 14% rally in the past week. Of course, that was after it fell nearly 29% in the previous two weeks! And you thought only EMG currencies were volatile! But the rest of the G10 space shows JPY strength, +0.9%, as repatriation flows help the currency, and then much lesser movements in both directions from the rest of the bloc.

In the emerging markets, the story is similar, with KRW the biggest gainer, +1.8% overnight, as the BOK confirmed its recent activity qualifies as QE, and more importantly, that they will continue to do everything necessary to support the economy. Meanwhile, on the opposite end of the spectrum is the Mexican peso, which has fallen 1.5% this morning after Standard & Poor’s downgraded the country’s credit rating by a notch to BBB and left them on negative watch. The peso, too has had a wild ride this month, declining nearly 6 full pesos at its worst level, or 30%, before rallying back sharply this week by 10% at its peak, now more like 8.2%. Again, the point is that we can expect ongoing sharp movements in both directions for now.

With spot today being month-end, I realize many companies will be active in their balance sheet rolling programs. Forward bid-ask spreads continue to be wider than normal but have definitely moderated from what we saw in the past two weeks. This is the new normal though, so for the next several months, be prepared for wider pricing than we all learned to love.

Good luck, good weekend and stay safe
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No Easy Fix

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As fears ‘bout the virus increased
Supply and demand growth have ceased
There’s no easy fix
Or policy mix
But funding soon will be released

Words fail to describe the price action across all markets recently as volatile seems too tame a description. Turbulent? Tumultuous? I’m not sure which implies larger moves. But that is certainly what we have seen for the past two weeks and is likely to be what we see for a while longer. The confluence of events that is ongoing is so far outside what most market participants had become accustomed to over the past decade, that it seems many are simply giving up.

Consider; signing of phase one of the trade deal between the US and China was hailed as a milestone that would allow trading to return to its prior environment which consisted of ongoing monetary support by central banks helping to underpin economic growth with low inflation. As such, we saw equity markets worldwide benefit, we saw haven assets come under some pressure as havens were seen as unnecessary, and we saw the dollar rally as the US equity market led the way and investors everywhere wanted to get in on the party.

But that is basically ancient history now, as the combination of the discovery, evolution and spread of the coronavirus along with a pickup in US electoral excitement essentially destroyed that story. The past two weeks has been the markets’ collective effort to write a new narrative, and so far, they have not agreed on a theme.

The interesting point about Covid-19 economically is that it has created both a supply and a demand shock. The supply shock was the first thing really observed as China shut down throughout February and companies worldwide that relied on China as part of their supply chain realized that their own production would be impaired. So, we had a period where the focus was almost entirely on which multinational companies would be reducing Q1 earnings estimates due to the supply problems. This also encouraged the economics set to assume a “V” shaped recovery which had most investors looking through Q1 earnings warnings and remaining fully invested.

Unfortunately, as Covid-19 spread though, and I think it is now on every continent and spreading more rapidly, governments worldwide have imposed travel restrictions to the hardest hit countries (China, South Korea, Italy). But an even bigger problem is that many companies around the world are imposing their own travel and hiring restrictions, with Ford, famously, halting all business travel alongside a number of major banks (JPM, HSBC, Credit Suisse). In fact, yesterday, I was visiting a client who explained that our meeting would be their last as they are not allowing other companies to visit their headquarters starting today. The point is this is a demand shock. Travel and leisure companies will continue to suffer until an all clear is sounded. Talk of postponing or canceling the Olympics in Tokyo this summer is making the rounds. Talk of sporting events being played in empty arenas has increased. (March Madness with no crowds!) And there are the requisite stories about store shelves being emptied of things like toilet paper, paper towels and hand sanitizer.

The problem for policy makers is that the response to a supply shock and the response to a demand shock are very different. A demand shock is what policymakers have been assuming since the Great Depression, as easing monetary and fiscal policy is designed to increase demand through several different channels. But a supply shock requires a different emphasis. Neither monetary nor fiscal policy can address Covid-19 directly, curing the ill or protecting those still uninfected. The closure of manufacturing capacity as a response to trying to avoid the spread of a disease is going to have a massive negative impact on corporate finances. After all, interest is still due even if a company doesn’t make any sales. To address this, central banks will need to show forbearance on banks’ non-performing loan ratios, as well as incent banks to continue to lend to companies so impacted. It needs to be more finely targeted, something at which central banks have not shown themselves particularly adept.

And of course, after a decade of central bankers teaching markets that if there is a decline of any magnitude, the central bank will step in, policy space is already quite limited. In sum, the next market narrative remains unwritten because we have never seen this confluence of circumstances before and there are millions of different ideas as to what is the right way to behave. Volatility will be with us for a while.

So with that long preamble, turning to the markets sees that after yesterday’s remarkable risk-on rally in the US, arguably catalyzed by the fact that Senator Sanders fared more poorly than expected in Super Tuesday voting, (thus reducing the chance of his eventual election), Asia picked up the baton and rallied. But Europe has not been able to follow along with virtually every European equity market down at least 1.5%. US futures are also suffering, currently lower by 1.75% or so across all three indices. Meanwhile, 10-year yields, which yesterday managed to trade back above 1.0%, are down nearly 10bps this morning as risk is being jettisoned left and right. The yen is rocking, up by 0.6%, with the dollar trading below 107.00 for the first time since October. In fact, the dollar is generally on its back foot this morning, as the market continues to price in further significant rate activity by the Fed, something which essentially none of its counterparty central banks can implement. At this point, the market is pricing in almost 50bps more at the March meeting in two weeks, and a total of 75bps by July. The ECB doesn’t have 75 to cut, neither does the BOJ or the BOE or the RBA. So, for now, the dollar is likely to remain soft. But as the market has priced these cuts in, I would have anticipated the dollar to fall even further. This hints that the dollar’s decline is likely near its end.

On the data front, remarkably, yesterday’s ISM Non-Manufacturing print was stellar at 57.3, but nobody is certain how to interpret that and what impact Covid-19 may have had on the data. Today we see a bit more data here with Initial Claims (exp 215K), Nonfarm Productivity (1.3%), Unit Labor Costs (1.4%) and Factory Orders (-0.1%). My sense is that Initial Claims is the one to watch. Any uptick there could well be interpreted as the beginning of layoffs due to Covid-19, but also as a prelude to weaker overall growth and perhaps a recession. It is still early days, but arguably, Initial Claims data, which is weekly, will be our first look into the evolution of the economy during the virus.

For now, the dollar remains soft, and I doubt any data will change that, but the dollar will not fall forever. Layering in receivables hedges seems like a pretty good plan at this point.

Good luck
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Under Stress

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The week that just passed was a mess
With both bulls and bears under stress
As equities fell
Most bonds performed well
And dollars? A roaring success

Pundits have been searching for adjectives to describe the week that is ending today. Tumultuous strikes me as an accurate reflection, but then stormy, tempestuous and volatile all work as well. In the end though, the broad trends have not changed at all. Equities continue to retreat from their mid-summer highs, bonds continue to rally sharply while yield curves around the world flatten and the dollar continues to march higher.

So what is driving all this volatility? It seems the bulk of the blame is laid at the feet of President Trump as his flipping and flopping on trade policy have left investors and traders completely confused. After all, late last week he declared tariffs would be imposed on the rest of Chinese imports not already subject to them, then after market declines he decided that a portion of those tariffs would be delayed from September until December. But then the Chinese struck back saying they would retaliate and now the President has highlighted he will be speaking directly with President Xi quite soon. On the one hand, it is easy to see given the numerous changes in stance, why markets have been so volatile. However, it beggars belief that a complex negotiation like this could possibly be completed on any short timeline, and almost by definition will take many more months, if not years. There is certainly no indication that either side is ready to capitulate on any of the outstanding issues. So the real question is, why are markets responding to every single tweet or comment? To quote William Shakespeare, “It is a tale told by an idiot, full of sound and fury signifying nothing.” Alas, there is every indication that this investor and trader behavior is going to continue for a while yet.

This morning we are back in happy mode, with the idea that the Presidents, Trump and Xi, are going to speak soon deemed a market positive. Equity markets around the world are higher (DAX +1.0%, CAC +1.0%, Nikkei +0.5%); bond markets have been a bit more mixed with Treasuries (+2bps) and Gilts (+4.5bps) selling off a bit but we continue to see Bunds (-1.5bps) rally. In fact we are at new all-time lows for Bund yields with the 10-year now yielding -0.73%!

As to the dollar, it is still in favor, with only the pound showing any real life in the G10 space, having rallied 0.65% this morning with the market continuing to be impressed with yesterday’s Retail Sales data there. In fact, if we look over the past week, the pound is the only G10 currency to outperform the dollar, having rallied more than 1.0%. On the flip side, the Skandies are this week’s biggest losers with both SEK and NOK down by 1.35% closely followed by the euro’s 1.1% decline, of which 0.3% has happened overnight.

The FX market continues to track the newest thoughts regarding relative central bank policy changes and that is clearly driving the euro. For example, yesterday, St Louis Fed President Bullard, likely the most dovish FOMC member (although Kashkari gives him a run), sounded almost reticent to continue cutting rates, and ruled out the idea that an intermeeting cut was necessary. While he supported the July cut, and will likely vote for September, he again ruled out 50bps and didn’t sound like more made sense. At the same time, Finnish central bank president Ollie Rehn, a key ECB member, explained that come September, the ECB would act very aggressively in order to get the most bang for the buck (euro?). The indication was not only will they cut rates, and possibly more than the 10bps expected, but QE would be restarted and expanded, and he did not rule out movement into other products (equities anyone?) as well. In the end, the market sees that the ECB is going to basically do everything else they can right away as they watch the Eurozone economy sink into recession. Meanwhile, most US data continues to point to a much more robust growth situation.

Let’s look at yesterday’s US data where Retail Sales were very strong (0.7%, 1.0% ex autos) and Productivity, Empire Manufacturing and Philly Fed all beat expectations. Of course, confusingly, IP was a weaker than expected -0.2% and Capacity Utilization fell to 77.5%. Adding to the overall confusion is this morning’s Housing data where Starts fell to 1191K although Permits rose to 1336K. In the end, there is more data that is better than worse which helps explain the 2.1% growth trajectory in the US, which compares quite favorably with the 0.8% GDP trajectory on the continent. As long as this remains the case, look for the dollar to continue to outperform.

Oh and one more thing, given the problems in the Eurozone, do you really believe the EU will sit by and watch the UK exit without changing their tune? Me either!

Next week brings the Fed’s Jackson Hole symposium and key speeches, notably by Chairman Powell. As to today, there is no reason to expect the dollar to do anything but continue its gradual appreciation.

Good luck and good weekend
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Fears Have Been Slaked

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For several days markets have quaked
As muck about trade has been raked
But Wednesday’s retracement
And China’s emplacement
Of yuan means some fears have been slaked

Yesterday was a session for those with strong stomachs. Equities plummeted (DJIA -589) early as did bond yields (10-year Treasury yields fell to 1.59%) with both markets pointing to an imminent recession. But then, as sometimes happens, things turned around inexplicably. There was no data to drive the change, as there was really no data yesterday. The only Fed comments were from Chicago’s Evans, a known dove, who said that the recent escalation in trade tensions could well warrant further rate cuts. But we already knew that and had heard it on Tuesday from two other Fed speakers.

However, the fear that was rampant at the opening (gold exploded through $1500/oz, USDJPY traded below 105.50) just as quickly dissipated and through the rest of the session, equities rallied back to flat, Treasury prices fell such that yields actually closed the day higher than the day before, and both the dollar and yen reversed early gains and settled slightly lower on the day. Gold, however, maintained most of its gains.

Price action like that, which can be quite unsettling, tends to be indicative of a great deal of uncertainty in markets. In fact, that is what markets do best, with bulls and bears fighting it out for supremacy. But the ultimate conclusion has to be that recent market trends are being questioned. As I wrote yesterday, and has been widely mentioned elsewhere as well, there is a fundamental difference of opinion between the stock and bond markets, where bonds investors see a much gloomier economic future than stock investors. In fact, it is fair to say, that stock investors are so fixated on the potential benefits of lower interest rates that they seem to be forgetting why those lower rates are being contemplated, slowing growth. At some point, this conundrum will be resolved, either as Treasury yields rebound amid stronger growth indications, or with lower stock prices as the economic data defines a worse economic situation than currently expected. While my view, alas, remains the latter is more likely, it is still an open question as to how things play out.

The end result, however, is that as I have written frequently in the past, volatility in markets is going to be with us for some time to come. Today, though, it is not as evident as it was yesterday. Equity markets around the world have shown modest gains, generally on the order of 0.5%, while bond prices have been fairly stable along with the dollar. In fact, the dollar has done very little overall.

There has been much made of the fact that the PBOC fixed USDCNY at 7.0039, above the 7.00 level and its weakest fix since 2008. However, market expectations were for a fix at an even higher level, ~7.0130, so despite the optics on the surface, this was seen as an attempt to mitigate the recent anxiety. Ultimately, the PBOC is likely to allow a very gradual depreciation of the yuan going forward as they find themselves caught between competing problems. On the one hand, slowing growth indicates the need for a weaker yuan to help support exporters. However, the flip side is that the huge increase in USD borrowings by Chinese companies, especially in the local property sector, means that a weaker yuan will crimp their ability to service and repay that debt, potentially leading to larger systemic issues. Clearly the PBOC wants to avoid anything like that, so slow and steady seems the most likely outcome.

And in fact, that is probably what we are going to see in a number of currencies as the impacts of the growing trade conflict widens around the world. The dollar will continue to be a key destination for investment as long as the US economy, even if it is slowing somewhat, remains stronger than economies elsewhere. Yesterday we saw the aggressive actions of three Asian central banks, and last night the Philippines cut rates by 25bps as well. Markets are pricing in cuts pretty much everywhere in the world so the fact that the Fed is likely to produce at least two more cuts is hardly a reason to avoid the dollar. In fact, US rates continue to trade above every other developed market rate and, as such, remain attractive to foreign investors. There is no evidence that situation will change in the near-term, and so support for the dollar is likely to remain firm.

A quick look at today’s price action shows what I would describe as consolidation of recent moves. Looking across the board, the dollar has had a strong week against most currencies. The two exceptions have been the yen, which has rallied 1.25% on increased market fears, and the euro, which surprisingly has rallied about 1.0% this week. But otherwise, the dollar has been ascendant vs. virtually everything else. As long as economic uncertainty remains the driving force in markets, and that seems like a pretty good bet, the dollar should continue to perform well.

On the data front, the only thing to be released is Initial Claims (exp 215K) and there are no Fed speakers on the calendar. That implies that the FX market will take its cues from elsewhere, with equities the leading candidate. In the current framework, stronger equities means less risk and less reason to hold dollars, so given Europe’s modest rebound and US futures pointing higher, that seems like a reasonable expectation for today, a modestly softer buck.

Good luck
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Shocked and Surprised

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Delivering just twenty-five
Did not satisfy Donald’s drive
To boost US growth
So he made an oath
That tariffs he’d quickly revive

Investors were shocked and surprised
As trade talks had seemed civilized
Thus stocks quickly fell
And yields did as well
Seems risk assets are now despised

Just when you thought it was safe to go back in the water…

Obviously, the big news yesterday was President Trump’s decision to impose a 10% tariff on the remaining $300 billion of Chinese imports starting September 1st. Arguably, this was driven by two things; first was the fact that he has been increasingly frustrated with the Chinese slow-walking the trade discussions and wants to push that along faster. Second is he realizes that if he escalates the trade threats, the Fed may be forced to cut rates further and more quickly. After all, one of their stated reasons for cutting rates Wednesday was the uncertainty over global growth and trade. That situation just got more uncertain. So in President Trump’s calculation, he addresses two key issues with one action.

Not surprisingly, given the shocking nature of the move, something that not a single analyst had been forecasting, there was a significant market reaction. Risk was quickly jettisoned as US equity markets turned around and fell 1% on the day after having been higher by a similar amount in the morning. Asian equity markets saw falls of between 1.5% and 2.0% and Europe is being hit even harder, with a number of markets (DAX, CAC) down more than 2.5%. But even more impressive was the decline in Treasury yields, which saw a 12bp fall in the 10-year and a 14bp fall in the 2-year. Those are the largest single day declines since May 2018, and the 10-year is now at its lowest level since October 2016. Of course, it wasn’t just Treasuries that rallied. Bund yields fell to a new record low of -0.498%, and we have seen similar declines throughout the developed markets. For example, Swiss 10-year yields are now -0.90%, having fallen 9bps and are the lowest in the world by far! In fact, the entire Swiss government yield curve is negative!

And in the FX market, haven number one, JPY rallied sharply. After weakening early in the session, it rebounded 1.7% yesterday and is stronger by a further 0.5% this morning. This has taken the yen back to its strongest level since April last year. Not surprisingly the Swiss franc saw similar price action and is now more than 1.0% stronger than yesterday. However, those are not the only currencies that saw movement, not by a long shot. For example, CNY has fallen 0.9% since the announcement and is now within spitting distance of the key 7.00 level. Significant concern remains in the market about that level as the last time the renminbi was that weak, it led to significant capital outflows and forced the PBOC to adjust policy and impose restrictions. However, there are many analysts who believe it is seen as less of a concern right now, and of course, a weaker renminbi will help offset the impact of US tariffs.

Commodity prices were also jolted, with oil tumbling 7% and oil related currencies feeling the brunt of that move. For example, RUB is lower by 1.2% this morning after a 0.5% fall yesterday. MXN is lower by a further 0.3% this morning after a 0.6% decline yesterday and even NOK, despite its G10 status, is lower by 1.0% since the tariff story hit the tape. In fact, looking at the broad dollar, it is actually little changed as there has been significant movement in both directions as traders and investors adjust their risk profiles.

With that as a prelude, we get one more key piece of data this morning, the payroll report. Current expectations are as follows:

Nonfarm Payrolls 164K
Private Payrolls 160K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Average Hourly Earnings 0.2% (3.1% Y/Y)
Average Weekly Hours 34.4
Trade Balance -$54.6B
Michigan Sentiment 90.3

You can see the bind in which the Fed finds itself. The employment situation remains quite robust, with the Unemployment Rate expected to tick back to 50-year lows and steady growth in employment. This is hardly a classic set of statistics to drive a rate cut. But with the escalation of the trade situation, something they specifically highlighted on Wednesday, they are going to need to address that or lose even more credibility (although it’s not clear how much they have left to lose!) In a funny way, I would wager that Chairman Powell is secretly rooting for a weak number this morning which would allow further justification for rate cuts and correspondingly allow him to save some face.

In the end, the key to remember is that markets are beholden to many different forces with the data merely one of those, and increasingly a less and less important one. While historically, the US has generally allowed most market activity without interference, there has clearly been a change of heart since President Trump’s election. His increased focus on both the stock market and the dollar are something new, and we still don’t know the extent of the impact this will have over time. While volatility overall has been relatively low, it appears that is set to change with this increased focus. Hedgers keep that in mind as programs are implemented. All of this untested monetary policy is almost certainly building up problems for the future, and those problems will not be easily addressed by the central banks. So, my sense is that we could see a lot more volatility ahead.

In the meantime, today has the sense of a ‘bad news is good’ for stocks and vice versa as equity investors will be looking for confirmation that more rate cuts are on the way. As to the dollar, bad news will be bad!

Good luck and good weekend
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10%’s Not Enough

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Said Trump, 10%’s not enough
It’s time that we really get tough
So starting next week
A quarter we’ll seek
Believe me, this ain’t just a bluff

If there was any question as to whether or not markets had fully priced in a successful conclusion of the US-China trade talks, last night’s price action should have answered it in full. President Trump is clearly feeling his oats, as his approval rating rises alongside the stock market and the economy, and so he changed the landscape once again. With Chinese Vice-premier Liu He, the chief negotiator in the trade talks, scheduled to arrive in the US later this week to continue, and in the market’s view conclude, those discussions, the President, last night, threatened to increase tariffs on $200 billion of goods to 25% from the current 10%, and to impose 25% tariffs on another $325 billion of goods, which is essentially everything else the US imports from China. In a heartbeat, views changed from rainbows and unicorns to Armageddon. Equity markets around the world plunged, commodity prices tumbled and the dollar and yen both rallied. Interestingly, Treasury prices have not moved much yet, although with the UK and Japan on holiday, overseas Treasury markets are extremely thin, so it could be there just hasn’t been any trading. Of course, it also could be that Treasury prices had already incorporated a less rosy future than equity markets, and so have less need to adjust.

One of the most common themes espoused lately has been the remarkable decline in asset price volatility this year, with measures in equities, bonds and currencies all pushing to cyclical lows. While there is a contingent of analysts (present company included) who believes that this is the calm before the storm, it is also true that market activity has been unidirectional since January, with that direction higher.

With respect to volatility, nothing has yet changed regarding the view that volatility increases when prices fall in both equity and bond markets although the relationship between volatility and the dollar is far less structured. In fact, there has been a significant increase in the amount of short volatility bets being made in the market, similar to the situation we saw at the beginning of 2018. Of course, I’m sure we all remember the disintegration of the XIV ETF (really it was an ETN), when a spike in volatility reduced its value by more than 85% in two days. Well, currently, records show that there is an even larger short volatility position now than there was last February when things went pear-shaped. The point is it is worthwhile to be careful in the current environment.

As to the dollar, historically volatility has increased in both rising and declining dollar environments depending on the circumstances. Given the dollar’s overall strength lately has been accompanies by a decline in volatility, it seems a fair bet to assume that if the dollar were to reverse lower, it would do so in a volatile manner rather than as a steady adjustment. Remember, too, currencies tend to overshoot when large moves occur. However, at this point, I would expect that fear in other markets will continue to support the dollar, and hence keep volatility at bay.

A recap of price movement overnight shows that the Shanghai Composite fell 5.5% and the Hang Seng fell 2.9% (the Nikkei was closed). Europe is currently trading with both the DAX and CAC falling 2.0% (FTSE is also closed) and US futures are pointing to nearly 2.0% losses on the open as well.

Meanwhile, the dollar is broadly higher. It has rallied 0.5% vs. the pound, offsetting a large part of Friday’s GBP rally that was based on the rumor PM May and Labour leader Corbyn were soon going to announce agreement on a Brexit deal. While nothing has come of it yet, that does explain the pound’s sharp Friday movement. AUD and NZD are both lower by 0.5% as the market looks to this evening’s RBA meeting with a 50% probability of a rate cut priced and the belief that the RBNZ will need to match that tomorrow if it occurs. Aussie is back below 0.70, and my sense is it has further to fall, especially if the trade situation deteriorates. Elsewhere in the G10, the euro is little changed after slightly better than expected PMI data seems to have been enough to offset trade concerns. And finally, the yen, as would be expected of a haven asset, is higher by 0.25%.

Versus emerging market currencies, the dollar has had an even stronger performance. It should be no surprise that CNY has fallen sharply (-0.75%) especially since the PBOC cut the RRR for small and medium sized banks by another 1.0% in an effort to stabilize markets. Elsewhere in Asia both INR and KRW fell 0.65% with other currencies having a slightly less negative result. EEMEA has seen ZAR fall 1.0% and TRY -1.20% although the latter has more to do with the possibility that the recent election in Istanbul, where President Erdogan’s party lost, would be overturned and a new one held thus undermining the concept of democracy in Turkey even further. Finally, LATAM markets are waking up under modest pressure, but have not yet fallen sharply.

Turning to this week’s data, there is not much overall, but we do see CPI data Friday.

Tuesday JOLTs Job Openings 7.24M
Thursday Initial Claims 220K
  Trade Balance -$50.2B
  PPI 0.2% (2.3% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Friday CPI 0.4% (2.1% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)

We also will hear a lot of Fed speaking, with eleven speeches from eight different FOMC members including Chairman Powell on Thursday. This week’s talks could well be market moving as last week’s press conference was not as smooth as it might have been. Look for lots of nuance as to what the Fed is looking at and why they think it is appropriate to be patient. As of now, it doesn’t seem that there is any leaning toward an “insurance” rate cut in the near term, but, especially if Friday’s CPI data is softer than expected, that theme could well change. As such, for now, I don’t see a good policy reason for the dollar to retreat, and if the trade situation deteriorates, it should help the buck, but given the mercurial dynamics of the President’s negotiating tactics, I wouldn’t rule out a complete reversal of things before long.

Good luck
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