Congressional Sloth

The Chairman is set to appear
Near Mnuchin, and both will make clear
Congressional sloth
Is killing off growth
Thus, action’s required this year

The subtext, though, is that the Chair
Has realized his cupboard is bare
No ammo remains
To prop up the gains
That stocks have made ‘midst much fanfare

Yesterday’s risk-off session may well have set the tone for the week, as there has been precious little rebound yet seen.  In addition to the virus story, and the news of large bank misdeeds, the US election story remains a critical factor, although at this point, any impact remains difficult to discern.  The one thing that is quite clear is that there is a very stark choice between candidates.  Given the prevailing meme that it is going to be a very close election, and the outcome could be in doubt for weeks following November 3rd, and assuming that the market response will be quite different depending on who eventually wins, one cannot blame traders and investors for omitting the issue from their current calculations.  While eventually, there is likely to be a significant market response, at this point, it seems there is little to be gained by positioning early.

In the meantime, however, the current administration continues to seek to do what it thinks best for the economy, and today we will get to hear from Chairman Powell, as well as Treasury Secretary Mnuchin, in Congressional testimony.  As is always the case in these situations, the text of Powell’s speech has been pre-released and it continues to focus on the one (apparently only) thing that is out of his control, more fiscal stimulus.  In his opening remarks he will describe the economy as improving but with still many problems ongoing.  He will also explain that monetary stimulus needs the help of fiscal stimulus to be truly effective.  In other words, he will explain that the Fed is now ‘pushing on a string’ and if Congress doesn’t enact new stimulus measures, there is little the Fed will be able to do to achieve their statutory goals.  Of course, he won’t actually use those words, but that will be the meaning.  It is abundantly clear that the Fed’s ability to support the real economy, as opposed to financial markets, has reached its end.

However, it is not just the Fed that has reached its limit, essentially every G10 central bank has reached the limit of effective central banking.  It has been argued, and I agree with the sentiment, that the difference between ‘normal’ positive interest rates and the zero and negative rates we currently see around the world is similar to the difference between Newtonian and Quantum mechanics in Physics.  In the positive rate environment, things are exactly as they seem.  Investment decisions are based on estimated returns, and risk of repayment is factored into the rate charged. There is a concept called the time value of money, where one dollar today is worth more than that same dollar in the future.  It is the basis on which Economics, the subject, was formulated.  This is akin to Newton’s well-known laws like; Every action has an equal and opposite reaction, or a body in motion will stay in motion unless acted on by another force.  They are even, dare I say, intuitive.

But in the zero (or negative) interest rate world, investment decisions are completely different.  First, the time value of money doesn’t make sense as it becomes, a dollar today is worth less than a dollar in the future.  As well, the addition of forward guidance is self-defeating.  After all, if they know that interest rates are going to remain zero for the next three years, what is the hurry for a company to borrow money now? Especially given the extreme lack of demand for so many products.  Instead, managements have realized that there is no need to worry about increasing production, they will always be able to do that when demand increases.  Rather, their time can be better spent reconfiguring their capital structure to reduce equity (lever up) and show ever increasing EPS growth without risking a poor investment decision.  This is akin to the difficulty in understanding the quantum realm, where uncertainty reigns (thank you Heisenberg) and the accuracy of measuring the position (EPS) and momentum (growth) of a particle are inversely related.

The problem is that central bankers are all Newtonians (or Keynesians), and so simply plug zero and negative numbers into their models and expect the same reactions as when they plug in positive numbers. And the output is garbage, which is a key reason they have been unable to stimulate economic activity effectively.  Alas, as long as problems persist, central bankers will feel compelled to “do something” when doing nothing may be the best course of action.  In the end, look for more monetary stimulus as it is the only tool they have.  Unfortunately, its effectiveness has been diminished to near zero, like their interest rates.

In the meantime, a look around markets shows that risk is neither off nor on this morning, but mostly confused.  Asian equity markets followed yesterday’s US losses, with declines of around 1% in those markets open.  (The Nikkei remained closed).  But European bourses have turned modestly higher on the day as the results of some regional elections in Italy have been taken quite positively.  There, the League’s Matteo Salvini lost seats to the current government, thus reducing the probability of a toppling government and easing pressure on Italian assets.  In fact, the FTSE MIB is the leading gainer today, higher by 1.2%, but we also see the DAX (+1.0%) and CAC (+0.5%) shaking off early losses to turn up.  US futures are mixed at this time, although well off the lows seen during the Asia session.

In the bond market, yesterday saw Treasury yields decline about 3 basis points amidst the ongoing risk reduction, but this morning, prices are edging lower and the yield has backed up just about 1bp.  In Europe, things have been much more interesting as Italian BTP’s have rallied sharply during the day, with yields now down 3.5 basis points, after opening with a similar sized rise in yields.  Bunds, meanwhile, are selling off a bit, as fears of an eruption of Italian trouble recede.

And finally, the dollar, which had been firmer much of the evening, is now ceding much of those gains, and at this hour I would have to describe as mixed.  In the G10, NOK (-0.5%) remains under the most pressure as oil prices continue to soften and there is now a controversy brewing with respect to the investment strategy of the Norwegian oil fund.  But away from NOK, the G10 is +/- 0.15%, which means it is hard to describe the situation as significant.

In the emerging markets, ZAR (+1.1%) continues to be the most volatile currency around, with daily movements in excess of 1%.  It has become, perhaps, the best sentiment gauge out there.  When investors are feeling good, ZAR is in demand, and it is quick to be sold in the event that risk is under pressure.  CNY (+0.45%) is the next best performer.  This is at odds with what appears to be the PBOC’s intentions as they set the fix at a much weaker than expected 6.7872, or 0.4% weaker than yesterday.  It seems the PBOC may be getting concerned over the speed with which the renminbi has been rising, as in the end, they cannot afford for the currency to appreciate too far.  On the red side of the ledger, KRW and IDR both fell 0.6% last night as risk mitigation was the story at the time.

Aside from Chairman Powell speaking today, we also see Existing Home Sales (exp 6.0M), which if it reaches expectations would be the highest print since 2007.  If risk is back in vogue, then I would look for the dollar to continue to edge lower.  And you can be sure that Chairman Powell will not do anything to upset that apple cart.

Good luck and stay safe

Turning the Screws

There once was a great city state
That introduced rules and debate
However its heirs
Lead muddled affairs
Thus Roman woes proliferate

Meanwhile from the UK, the news
Gave Johnson’s opponents the blues
Improvements reported
In confidence thwarted
The Sterling bears, turning the screws

Italian politics has once again risen to the top of the list of concerns in the Eurozone. This morning, 5-Star leader, Luigi Di Maio, is on the cusp of resigning from the government, thus forcing yet another election later this year. The overriding concern from the rest of Europe is that the man leading the polls, Silvio Matteo, is a right-wing populist and will be quick to clash with the rest of the EU on issues ranging from fiscal spending to immigration policy. In other words, he will not be welcome by the current leading lights as his views, and by extension the views of the millions who vote for him, do not align with the rest of the EU leadership. Of course, there has been steady dissent from that leadership for many months, albeit barely reported on this side of the Atlantic. For example, the gilets jaunes continue to protest every week around the country, as they voice their disagreement with French President Macron’s attempts to change the rules on issues ranging from pensions to taxes to labor regulations. And they have been protesting for more than a year now, although the destructive impact has been greatly reduced from the early days. As well, there are ongoing protests in the Catalonia region of Spain with separatists continuing to try to make their case. The point is that things in Europe are not quite as hunky-dory as the leadership would have you believe.

However, for today, it is Italy and the potential for more dissent regarding how Europe should be managed going forward. The result has been the euro reversing its early 0.25% gains completely, actually trading slightly lower on the day right now. While there is no doubt the recent Eurozone data has been better than expected, it remains pretty awful on an absolute basis. But markets respond to movements at the margin, so absent non-market events, like Italian political ructions, it is fair to expect the euro to benefit on this data. In fact, there is an ongoing evolution in the analyst community as a number of them have begun to change their ECB views, with several implying that the ECB’s next move will be policy tightening, and some major Investment Banks now forecasting 10-year German bunds to trade back up to 0.0% or even higher by the end of the year. We shall see. Certainly, if Madame Lagarde hints at tighter policy tomorrow, the euro will benefit. But remember, the ECB is still all-in on QE, purchasing €20 billion per month, so trying to combine the need to continue QE alongside a discussion of tighter policy seems a pretty big ask. At this point, the euro remains under a great deal of pressure overall, but I do expect this pressure to ebb as the year progresses and see the dollar decline eventually.

As to the UK, the hits there just keep on coming. This morning, the Confederation of British Industry (CBI), which is essentially the British Chamber of Commerce, reported that both orders and price data improved modestly more than expected, but more importantly their Optimism Index jumped to +23 from last month’s -44, which is actually its highest level since April 2014, well before Brexit was even a gleam in then-PM David Cameron’s eye. Not surprisingly, the pound has rallied further on this positive jolt, jumping 0.5% this morning and is the leading performer against the dollar overall today. It should also be no surprise that the futures market has reduced its pricing for a BOE rate cut next week to a 47% probability, down from 62% yesterday and 70% on Friday. Ultimately, I think that Carney and company would rather not cut if at all possible, given how little room they have with the base rate at 0.75% currently. If we see solid PMI flash data on Friday, I would virtually rule out any chance for a cut next week, and expect to see the pound rally accordingly.

Away from those two stories though, market activity has been far less interesting. The rest of the G10, beyond the pound, is generally within 10bps of yesterday’s closing levels. As to the Emerging markets, the big winner has been ZAR, which has rallied 0.65% after CPI rose to 4.0%, although that remains well below the midpoint of the SARB’s target range of 3.0% – 6.0%. Expectations are for continued policy ease and continue investment inflows to help support the currency. But other than the rand, it has been far less interesting in the FX market.

The ongoing fears over the spread of the coronavirus seem to be abating as China has been aggressively working to arrest the situation, canceling flights out of Wuhan and being remarkably transparent with respect to every new case reported. In fact, equity markets around the world have collectively decided that this issue was a false alarm and we have seen stocks rally pretty much everywhere (Italy excepted) with US futures pointing higher as well.

And that really sums up the day. The ongoing impeachment remains outside of the framework of the market as nobody believes that President Trump will be removed from office. The WEF participants continue to demonstrate their collective ability to pontificate about everything, but do nothing. And so, we need to look ahead to today’s data, and probably more importantly to equity market performance for potential catalysts for movement. Alas, the only US data of note is Existing Home Sales (exp 5.43M), something that rarely moves markets. This leaves us reliant on equity market sentiment to drive the FX market, and with risk definitively on this morning, I expect to see EMG currencies benefit while the dollar suffers mildly.

Good luck


Centrists’ Dismay

In three weeks and some the UK
Will head to the polls and convey
To markets worldwide
If Brexit’s the side
They favor, to centrists’ dismay

In London today, and all week actually, the Confederation of British Industry is having their annual conference. As such, both Boris and Labour leader Jeremy Corbyn will be addressing the largest UK trade association to describe their views of the future based on an electoral victory on December 12. In brief, Boris is promising certainty with regard to Brexit as well as some tax cuts and spending on goodies. Meanwhile, Corbyn is promising to nationalize certain industries (British Telecom to give “free” high speed internet access to everyone in the country and the National Energy Grid to force more green activity and decisions) in order to achieve his party’s goal of poverty equality for all.

However, the weekend’s polls show that Boris is expanding his lead with the average result now showing the Tories with 42%, Labour with 30%, the LibDems at 14% and the rest of the assorted parties making up the balance. Arguably, the biggest weekend news was that every Tory running for a seat has signed a pledge to support the Brexit deal if elected. In essence, the Tories are leading and projected to get a majority, and they have pledged to complete Brexit. The market response has been pretty positive, at least the FX market, with the pound rallying a further 0.5% this morning after having rallied 1.0% last week. In fact, at 1.2950, we are pushing back to the highs seen in the immediate aftermath of the Brexit deal changes. As I have maintained since the election was called, I expect Boris to win and Brexit to go ahead shortly thereafter. At this point, it certainly seems like the UK will be out of the EU by the current January 31 deadline. As to the pound, I think we can see a move to 1.32-1.34, but probably not much more at this point. We will need to see significant progress on the ensuing trade agreement with the EU to see much further strength.

Other weekend news of note showed that the PBOC cut its seven-day repo rate by 5bps, to 2.50%, which despite the tiny movement cheered both traders and investors. Later this week, they will reveal the 1-year Loan Prime Rate, which is their new benchmark interest rate, and anticipation has grown they will be reducing that as well. The lesson here is that managing inflation, which has been rising rapidly due to the explosive growth in food, notably pork, prices, is a secondary concern. Instead, due to the fact that the economy is slowing even more rapidly, as evidenced by last week’s terrible Retail Sales and IP numbers, the PBOC’s marching orders are clearly to support GDP growth. Remember, despite the fact that President Xi is president for life, if GDP growth slows and unemployment rises, he will have some serious problems. In fact, it is this situation which has most pundits certain that a trade deal with the US will get signed. Both presidents need a win, and this is a relatively easy one for both.

Speaking of the trade deal, there was a high-level conversation over the weekend, between Liu He and the tag team of Mnuchin and Lighthizer, and both sides indicated progress continues to be made. That said, there is no indication that an agreement on where the presidents will meet to sign a deal has been reached, let alone an actual agreement on the deal. So, much remains to be done before this process is finished, but I am confident that we will read a string of positive tweets on a regular basis beforehand. Meanwhile, the PBOC’s modest rate cut had only a minor impact on the renminbi, which continues to trade just below (dollar above) the 7.00 level. Until a deal is finalized, it is hard to make a case for a large movement.

One last noteworthy item is from South Africa, where S&P has changed its outlook to negative from neutral. This is often a precursor for a ratings cut, and given S&P already has the country firmly in junk territory, at BB, Moody’s decision to maintain its investment grade rating last month seems more and more out of place. The rand is under pressure this morning, down 0.4%, although it remains closer to the top of its recent trading range than the bottom. What that means is there is ample opportunity for the rand to decline more sharply if there is any hint that Moody’s is going to move. The problem for South Africa is that if Moody’s changes them to junk, the nation’s debt will fall out of the MSCI global bond index and there could be as much as $15 billion of net sales. The rand would not receive that warmly, and a quick move back to the 15.50 level is to be expected in that case.

And those are the big stories this morning. Generally, I would characterize the markets as in a modest risk-on mode, with the dollar slightly softer, the yen and Swiss franc as well, while Treasury yields have edged higher and equity markets have edged higher as well. But, overall, it is pretty dull.

Looking ahead to the data releases this week, there is nothing of major consequence with Housing the focus:

Tuesday Housing Starts 1320K
  Building Permits 1381K
Wednesday FOMC Minutes  
Thursday Philly Fed 6.0
  Initial Claims 218K
  Leading Indicators -0.2%
  Existing Home Sales 5.49M
Friday Michigan Sentiment 95.7

While we do see the Minutes on Wednesday, given the onslaught of Fed speakers and consistency of message we have received since the last meeting, it seems hard to believe that we will learn anything new. One thing to watch closely is the Initial Claims data, which last week printed at 225K, higher than expected and where another higher than expected print could easily kick off a narrative of slowing employment, something that has much larger implications. There are a few Fed speakers, with uber-hawk Loretta Mester regaling us twice this week, although, again, it seems we have already heard everything there is to hear.

So today is shaping up to be quiet, with the modest risk-on behavior likely to continue to soften the dollar. We will need something bigger (e.g. a successful trade deal confirmed by both sides) in order to shake things up in my view.

Good luck

QE We’ll Bestow

The data continue to show
That growth is unhealthily slow
The pressure’s on Jay
To cut rates and say
No sweat, more QE we’ll bestow

The market narrative right now is about slowing growth everywhere around the world. Tuesday’s ISM data really spooked equity markets and then that was followed with yesterday’s weaker than expected ADP employment data (135K + a revision of -38K to last month) and pretty awful auto sales in the US which added to the equity gloom. This morning, Eurozone PMI data was putrid, with Germany’s Services and Composite data (51.4 and 48.5 respectively) both missing forecasts by a point, while French data was almost as bad and the Eurozone Composite reading falling to stagnation at 50.1. In other words, the data continues to point to a European recession on the immediate horizon.

The interesting thing about this is that the euro is holding up remarkably well. For example, yesterday in the NY session it actually rallied 0.45% as the market began to evaluate the situation and price in more FOMC rate cutting. Certainly it was not a response to positive news! And this morning, despite gloomy data as well as negative comments from ECB Vice-President Luis de Guindos (“level of economic activity in the euro area remains disappointingly low”), the euro has maintained yesterday’s gains and is unchanged on the session. At this point, the only thing supporting the euro is the threat (hope?) that the Fed will cut rates more aggressively going forward than had recently been priced into the market. Speaking of those probabilities, this morning there is a 75% probability of a Fed cut at the end of this month. That is up from 60% on Tuesday and just 40% on Monday, hence the euro’s modest strength.

Looking elsewhere, the pound has also been holding its own after yesterday’s 0.5% rally in the NY session. While I think the bulk of this movement must be attributed to the rate story, the ongoing Brexit situation seems to be coming to a head. In fact, I am surprised the pound is not higher this morning given the EU’s reasonably positive response to Boris’s proposal. Not only did the EU not dismiss the proposal out of hand, but they see it as a viable starting point for further negotiations. One need only look at the EU growth story to recognize that a hard Brexit will cause a significant downward shock to the EU economy and realize that Michel Barnier and Jean-Claude Juncker have painted themselves into a corner. Nothing has changed my view that the EU will blink, that a fudged deal will be announced and that the pound will rebound sharply, up towards 1.35.

Beyond those stories, the penumbra of economic gloom has cast its shadow on everything else as well. Government bond yields continue to decline with Treasury, Bund and JGB yields all having fallen 3bps overnight. In the equity markets, the Nikkei followed the US lead last night and closed lower by 2.0%. But in Europe, after two weak sessions, markets have taken a breather and are actually higher at the margin. It seems that this is a trade story as follows: the WTO ruled in the US favor regarding a long-standing suit that the EU gave $7.5 billion in illegal subsidies to Airbus and that the US could impose that amount of tariffs on EU goods. But the White House, quite surprisingly, opted to impose less than that so a number of European companies that were expected to be hit (luxury goods and spirits exporters) find themselves in a slightly better position this morning. However, with the ISM Non-Manufacturing data on tap this morning, there has to be concern that the overall global growth story could be even weaker than currently expected.

A quick survey of the rest of the FX market shows the only outlier movement coming from the South African rand, which is higher this morning by 0.9%. The story seems to be that after three consecutive weeks of declines, with the rand falling more than 6% in that run, there is a seed of hope that the government may actually implement some positive economic policies to help shore up growth in the economy. That was all that was needed to get short positions to cover, and here we are. But away from that story, nothing else moved more than 0.3%. One thing that has been consistent lately has been weakness in the Swiss franc as the market continues to price in yet more policy ease after their inflation data was so dismal. I think this story may have further legs and it would not surprise me to see the franc continue to decline vs. both the dollar and the euro for a while yet.

On the data front, this morning we see Initial Claims (exp 215K) and then the ISM Non-Manufacturing data (55.0) followed by Factory Orders (-0.2%) at 10:00. The ISM data will get all the press, and rightly so. Given how weak the European and UK data was, all eyes will be straining to see if the US continues to hold up, or if it, too, is starting to roll over.

From the Fed we hear from five more FOMC members (Evans, Quarles, Mester, Kaplan and Clarida), adding to the cacophony from earlier this week. We already know Mester is a hawk, so if she starts to hedge her hawkishness, look for bonds to rally further and the dollar to suffer. As to the rest of the crew, Evans spoke earlier this week and explained he had an open mind regarding whether or not another rate cut made sense. He also said that he saw the US avoiding a recession. And ultimately, that’s the big issue. If the US looks like a recession is imminent, you can be sure the Fed will become much more aggressive, but until then, I imagine few FOMC members will want to tip their hand. (Bullard and Kashkari already have.)

Until the data prints, I expect limited activity, but once it is released, look for a normal reaction, strong data = strong dollar and vice versa.

Good luck

So Distorted

Said Draghi, if things get much worse
Then more money, I will disburse
And negative rates
Which everyone hates
Will never go into reverse!

This morning, the Germans reported
That IP there’s lately been thwarted
Now markets are waiting
For payrolls, debating
Why everything seems so distorted

India. Malaysia. New Zealand. Philippines. Australia. India (again). Federal Reserve (?). ECB (?).

These are the major nations that have cut policy rates in the past two months, as well as, of course, the current forecasts for the two biggest central banks. Tuesday and Wednesday we heard from a number of Fed speakers, notably Chairman Powell, that if the economy starts to weaken, a rate cut is available and the Fed won’t hesitate to act. At this point, the futures market has a 25% probability priced in for them to cut rates in two weeks’ time, with virtual certainty they will cut by the late July meeting.

Then yesterday, Signor Draghi guided us further out the calendar indicating that interest rates in the ECB will not change until at least the middle of 2020. Remember, when this forward guidance started it talked about “through the summer” of 2019, then was extended to the end of 2019, and now it has been pushed a further six months forward. But of even more interest to the markets was that at his press conference, he mentioned how further rate cuts were discussed at the meeting as well as restarting QE. Meanwhile, the newest batch of TLTRO’s will be available at rates from -0.3% to 0.10%, slightly lower than had previously been expected, but certainly within the range anticipated. And yet, despite this seeming dovishness, the market had been looking for even more. In the end, the euro rallied yesterday, and has essentially maintained its recent gains despite Draghi’s best efforts. After all, when comparing the policy room available to the Fed and the ECB, the Fed has the ability to be far more accommodative in the near term, and markets seem to be responding to that. In the wake of the ECB meeting, the euro rallied a solid 0.5%, and has only ceded 0.1% of that since. But despite all the angst, the euro has not even gained 1.0% this week, although with the payroll report due shortly, that is certainly subject to change.

Which takes us to the payroll report. Wednesday’s ADP data was terrible, just 27K although the median forecast was for 180K, which has a number of analysts quite nervous.

Nonfarm Payrolls 185K
Private Payrolls 175K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Participation Rate 62.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5

Given the way this market is behaving, if NFP follows ADP, look for the dollar to fall sharply along with a big bond market rally, and arguably a stock market rally as well. This will all be based on the idea that the Fed will be forced to cut rates at the June meeting, something which they are unwilling to admit at this point. Interestingly, a strong print could well see stocks fall on the idea that the Fed will not cut rates further, at least in the near future, but it should help the dollar nicely.

Before I leave for the weekend, there are two other notable moves in the FX markets, CNY and ZAR. In China, an interview with PBoC Governor Yi Gang indicated that they have significant room to ease policy further if necessary, and that there is no red line when it comes to USDCNY trading through 7.00. Those comments were enough to weaken the renminbi by 0.3%, above 6.95, and back to its weakest level since November. Confirmation that 7.00 is not seen as a crucial level implies that we are going to see a weaker CNY going forward.

As to ZAR, it has fallen through 15.00 to the dollar, down 0.5% on the day and 3.4% on the week, as concerns grow over South Africa’s ability to manage their way through the current economic slump. Two key national companies, Eskom, the electric utility, and South African Airways are both struggling to stay afloat, with Eskom so large, the government probably can’t rescue them even if they want to. Slowing global growth is just adding fuel to the fire, and it appears there is further room for the rand to decline.

In sum, the global economic outlook continues to weaken (as evidenced by today’s German IP print at -1.9% and the Bundesbank’s reduction in GDP forecast for 2019 to just 0.6%) and so easier monetary policy appears the default projection. For now, that translates into a weaker dollar (more room to move than other countries) and stronger stocks (because, well lower rates are always good, regardless of the reason), while Treasuries and Bunds should continue to see significant inflows driving yields there lower.

Good luck and good weekend