Signs of Dissension

In China they claim that firms grew
Their profits and gross revenue
Encouraged by this
The bulls added risk
While bears had to rethink their view

Quite frankly, it has been a fairly dull session overnight with virtually no data and only a handful of comments.  Risk appetite is in the ascension after the Chinese reported, Saturday night, that Industrial Profits rose 19.1% Y/Y.  What’s truly remarkable about that statistic, and perhaps what makes it difficult to accept, is that throughout most of 2019, those numbers were negative.  In other words, prior to the outbreak of Covid-19, Chinese firms were struggling mightily to make money.  But since the very sharp dip in March, the rebound there, at least in this statistic, has been substantial.  While it is certainly possible that organic growth is the reason for this sharp rebound, it seems far more likely that PBOC support has been a key factor.  Remember, while they don’t get as much press as the Fed or ECB, they are extremely involved in the economy as well as financial markets.  After all, there is no semblance of independence from the government.

According to those in the know
The ECB’s starting to show
Some signs of dissension
Amid apprehension
The rate of inflation’s too low

In one camp the PIGS all believe
More money they ought to receive
But further up north
The hawks have put forth
The view PEPP should end New Year’s Eve

Meanwhile, the other story that is building is the growing split in the ECB between the hawks and doves regarding how to react to the evolving situation.  The breakdown is exactly as expected, with Italian, Spanish and Portuguese members calling for more support, via an expansion of the PEPP by December, latest, in order to assure those economies still suffering the aftereffects of the Covid shutdowns, that the ECB will prevent borrowing costs from rising.  Meanwhile, the hawkish set, led by Yves Mersch, the Luxembourgish ECB governor, sees the glass half full and has explained there is no need for further action as the economy looks much better.  Naturally, German, Dutch and Austrian members are on board with the latter view.  Madame Lagarde, the consensus builder, certainly has her work cut out to get policy agreement by the next meeting at the end of October.

Adding to the difficulty for the ECB is the apparent strength of the second wave of the virus that is truly sweeping the Continent.  While France has been the worst hit, with more than 11,000 new cases reported yesterday, the Netherlands, Belgium, Italy and Germany are all seeing caseloads as high, or higher, than the initial wave back in March.  European governments are reluctant to force another shutdown as the economic consequences are too severe, but they feel the need to do something that will demonstrate they are in control of the situation.  Look for more rules, but no mandatory shutdowns.

And remarkably, those are the only economically focused stories of the session.  The ongoing US presidential campaigns, especially now that the first debate is nearly upon us, has captured the bulk of the US press’s attention, although the angst over the Supreme Court nomination of Judge Amy Coney Barrett has probably been the cause of more spilled digital ink in the past several days.

So, a turn toward markets shows that Asian markets generally performed well (Nikkei +1.3%, Hang Seng +1.0%) although interestingly, despite the Chinese profits data, Shanghai actually fell -0.1%.  Europe, on the other hand, is uniformly green, led by the DAX (+2.7%) and CAC (+2.0%), with the FTSE 100 higher by a mere 1.5%.  US futures have taken their cues from all this and are currently pointing to openings nearly 1.5% higher than Friday’s closing levels.

Bond markets continue to offer little in the way of price signals as central bank activity continues to be the dominant force.  I find it laughable that Fed members are explaining they don’t want to increase QE because they don’t want to have an impact on the bond market.  Really?  Between the Fed and the ECB, the one thing in which both have been successful is preventing virtually any movement, up or down, in yields.  This morning sees the risk-on characteristic of a rise in Treasury and Bund yields, but by just 1.5bps each, and both remain well within their recent trading ranges.  Yield curve control is here in all but name.

As to the dollar, it is softer vs. its G10 counterparts with the pound (+1.25%) rising sharply in the past few minutes as the tone leading up to the restart of Brexit negotiations tomorrow has suddenly become quite conciliatory on both sides.  But we have also seen solid gains in SEK (+0.7%), NOK (+0.6%) and AUD (+0.5%).  The Stocky story has to do with the fact that the Riksbank did not receive any bids for credit by the banking community, implying the situation in the economy is improving.  As to NOK and AUD, a reversal in oil and commodity prices has been seen as a positive in both these currencies.

In the emerging markets, the picture is a bit more mixed with ZAR (+0.3%) as the leading gainer, although given the relative movement in the G10 space, one would have expected something more exciting.  On the downside, TRY (-1.65%) and RUB (-0.85%) are outliers as the declaration of war between Armenia (Russian-backed) and Azerbaijan (Turkish-backed), has raised further concerns about both nations’ financial capabilities to wage a hot war at this time.

On the data front, while the week has started off slowly, we have a lot to absorb culminating in Friday’s NFP numbers.

Tuesday Case Shiller Home Prices 3.60%
Consumer Confidence 90.0
Wednesday ADP Employment 630K
Q2 GDP -31.7%
Chicago PMI 52.0
Thursday Initial Claims 850K
Continuing Claims 12.25M
Personal Income -2.5%
Personal Spending 0.8%
Core PCE 0.3% (1.4% Y/Y)
Construction Spending 0.7%
ISM Manufacturing 56.3
ISM Prices Paid 59.0
Friday Non Farm Payrolls 850K
Private Payrolls 850K
Manufacturing Payrolls 38K
Unemployment Rate 8.2%
Average Hourly Earnings 0.2% (4.8% Y/Y)
Average Weekly Hours 34.6
Participation Rate 61.9%
Michigan Sentiment 78.9
Factory Orders 1.0%

Source: Bloomberg

On top of the data, we have thirteen Fed speeches by eight different Fed speakers, although the Chairman is mute this week.  It seems unlikely that we will get a mixed message from this group, but it is not impossible.  After all, we have both the most hawkish (Mester today) and the most dovish (Kashkari on Wednesday) due, so the chance for some disagreement there.  As to the data, it would appear that the payroll data will be most important, but do not ignore the PCE data.  Remember, both PPI and CPI have been surprising on the high side the past two months, so a surprise here might get some tongues wagging, although I wouldn’t expect a policy change, that’s for sure.

Net, with a positive risk backdrop, it is no surprise to see the dollar under pressure.  However, I expect that we are more likely to see a modest reversal than a large extension of the move unless stocks can go up sharply from their already elevated levels.

Good luck and stay safe
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Dreams All Come True

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

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

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

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

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

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

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

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

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

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

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

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

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

Good luck and stay safe
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Unless Lowered Instead

All eyes have now turned to the Fed
As pundits expect Jay will spread
The message that rates,
Until future dates,
Are fixed, unless lowered instead

Most market activity is muted this morning as traders and investors await the latest words of wisdom from Chairman Jay and his compadres. The key questions in the air are:

1. What will the Fed’s new forecasts describe?
2. What will the dot plot (remember that?) look like?
3. Will there be any change in current forward guidance?
4. Will there be any mention of yield curve control (YCC)?

Let’s quickly try to unpack these and see what they mean.

1. The Fed ordinarily updates its economic forecasts quarterly, but wisely, in my view, skipped March’s update given the incredible uncertainty that existed due to the beginnings of the Covid-19 impact. Three months later, the breadth of economic destruction has become clearer, but it will be interesting to learn their current views on the topic. For comparison, last week the ECB forecast a central scenario of Eurozone GDP as follows: 2020 -8.7%, 2021 +5.2%, 2022 +3.3%. The OECD forecast global GDP at -6.0% this year and US GDP at -7.3% this year assuming no second wave of infections. Those numbers fall to -7.6% and -8.5% respectively if there is a second wave of Covid infections. No matter how you slice it, 2020 is set to report negative GDP growth, but the question is, will the Fed demonstrate relative optimism or not?

2. The dot plot, as you may recall, was the biggest issue for a long time, as it was the Fed’s non-verbal way of offering forward guidance. The idea was that each FOMC member would offer his/her own views of the future level of rates and the median forecast was seen as a proxy of the Fed’s views. While it is abundantly clear that the view for 2020 will remain 0.00%, the real question is what the timeline anticipated by the FOMC will be as to when rates can start to rise again. It strikes me that while there will be some divergence, as always, we are likely to see only very gradual increases expressed, with a real possibility that 2021’s median will also be 0.00% and rates only beginning to rise in 2022. This begs the question…

3. How will they proffer their forward guidance? Current language is as follows: “The Committee expects to maintain this target (0.00%-0.25%) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” Current thoughts are they could become more specific with respect to the timeline, (e.g. saying rates would remain at current levels until the end of 2022) or with respect to data (e.g. until Unemployment is at 5.0% and Inflation is back to 2.0%). Of course, the lesson from Chairman Bernanke is that if they go the latter route, they can easily change the level as they see fit. But for now, the longer the timeline, the more confidence that would seem to be imparted. At least, that’s the theory.

4. Finally, there has been a great deal of discussion regarding YCC and whether the Fed will announce a program akin to the BOJ (10-year) or RBA (3-year) where they target a rate on a specific maturity of the Treasury curve. Most analysts, as well as Cleveland Fed President Mester, believe it is too early to make a pronouncement on this subject, but there are those who believe that despite the equity market’s recent frothiness, they may want to step harder on the gas pedal to make sure they keep up what little momentum seems to have started. To me, this is the biggest story of the afternoon, and the one with the opportunity for the most market impact. It is not fully priced in, by any means, and so would likely see a huge rally in both bonds and stocks as the dollar fell sharply if they were to announce a program like this. I like gold on this move as well.

So, plenty to look forward to this afternoon, which explains why market activity has been so limited overall so far today. Equity markets in Asia were barely changed, although in the past few hours we have seen European bourses start to decline from early modest gains. At this point the DAX (-0.8% and CAC (-0.6%) are fully representative of the entire Eurozone space. At the same time, US futures have turned mixed from earlier modest gains with Dow e-minis down 0.3% although NASAAQ futures are actually higher by a similar amount.

Bond markets are generally anticipating something from the Fed as the 10-year has rallied and yields declined a further 3bps which now takes the decline since Friday’s close to 10bps. Bunds and Gilts are both firmer as well, with modestly lower yields while the PIGS are mixed as Greek yields have tumbled 9bps while Spain (+3bps) and Portugal (+4.5bps) see rising yields instead.

And finally, the dollar is definitely on its back foot this morning. In fact, it is lower vs. the entire G10 bloc with Aussie and Kiwi leading the way with 0.5% gains. Right now, the Aussie story looks more technical than fundamental, as it approaches, but cannot really hold 0.70, its highest point in almost a year. But overall, what is interesting about this movement is that despite yesterday’s desultory equity performance and this morning’s modest one as well, the dollar is behaving in a risk-on manner. Something else is afoot, but I have not yet been able to suss it out. I will though!

In the EMG space, the dollar is lower against virtually all its counterparts with IDR as the major exception. The rupiah fell 0.65% last night, actually recouping larger earlier losses at the end of the session, after the central bank explained they would be capping any strength in an effort to help Indonesian exporters. On the plus side is a range of currencies from all three blocs, which is evidence of pure dollar weakness rather than specific positive currency stories.

On the data front, overnight we learned that Chinese PPI was weaker than expected, reflecting weakness in its export markets and not boding well for that elusive V-shaped recovery. We also saw horrific April French IP data (-34.2% Y/Y), but that was pretty much as expected. This morning we get the latest CPI data from the US (exp 0.3%, 1.3% ex food & energy), but inflation remains a secondary concern to the Fed for now. Rather, there is far more focus on the employment data at the Mariner Eccles Building, so really, for now it is all about waiting for the Fed. If pressed, I think they will be more likely to offer some new, more dovish, guidance as it appears they will not want to lose any positive momentum. That means the dollar should remain under pressure for a little while longer.

Good luck and stay safe
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