A Sour Note

Markets ended last week on a sour note as a few underlying themes continue to afflict investor sentiment.  The latest concern was the decision by US Treasury Secretary Mnuchin to pull back the Fed’s Main Street Lending Program despite Fed objections. The timing is clearly not ideal given the worsening in the US economy likely in the next few weeks amid a spike in Covid-19 cases, and lack of fiscal stimulus.  That said, these facilities have hardly been used, due in part to stringent terms on many of these lending facilities.  Also pulling the funds back from the Fed could give Congress room to move towards a fiscal deal.  The decision may also not get in President-elect Biden’s way; if he needs the funds for the Fed to ramp up lending the Treasury can quickly extend funding without Congressional approval when he becomes President.  However, no new credit will be available in these programs during the interim period before he takes office, which could present risks to the economy.

Equity markets will continue to struggle in the near term amid a continued surge in Covid cases.  The latest data revealed that the US registered a one-day record of 192,000 cases.  More and more states are implementing stricter social distancing measures, but its worth noting that restrictions are less severe than in March-April.   There are also growing concerns that the upcoming Thanksgiving holiday will result in an even more rapid spread of the virus, with the US centre for Disease Control and Prevention recommending Americans not travel over this period.  The battle playing on investor sentiment between rising Covid cases and the arrival of several vaccines, is being won by Covid worries at present, a factor that will likely continue to restrain investor sentiment for equities and other risk assets over the short term at a time when major US equity indices are running up against strong technical resistance levels. 

This week attention will turn to the Federal Reserve FOMC minutes (Wednesday) for the 5th November meeting.  While there were no new actions at this meeting the minutes may shed light on the Fed’s options to change “parameters” of quantitative easing (QE) and how close the Fed is to lengthening the maturity of its asset purchases.  Separately October US Personal Income and Spending data (Wednesday) will likely show some softening as fiscal stimulus fades.  Elsewhere, Eurozone and UK service purchasing managers indices (PMIs) (Monday) will likely reveal continued weakness in contraction territory as lockdown restrictions bite into activity.  Brexit discussions will be under scrutiny, with speculation growing that we could see a deal early in the week.  On the monetary policy front, decisions in Sweden and Korea (both on Thursday) will focus on unconventional policy, with potential for the Riksbank in Sweden to extend its quantitative easing program and Bank of Korea likely to focus on its lending programs and liquidity measures, rather than cut its policy rate.  Finally, expect another strong increase in Chinese industrial profits for October (Friday).

In Asia, official worries about currency appreciation are becoming increasingly vocal.  As the region continues to outperform both on the Covid control and growth recovery front, foreign inflows are increasingly being attracted to Asia.  This is coming at a time when balance of payments positions are strengthening, with the net result of considerable upward pressure on Asian currencies at a time of broad downward USD pressure.  Central banks across the region are sounding the alarm; Bank of Korea highlighted that its “monitoring” the FX market amid Korean won appreciation while Bank of Thailand announced fresh measures to encourage domestic capital outflows, thus attempting to limit Thai baht appreciation.  In India the Reserve Bank appears to be continuing its large-scale USD buying.  In Taiwan the central bank is reportedly making it easier for investors to access life insurance policies denominated in foreign currencies. Such measures are likely to ramp up, but this will slow rather than stem further gains in Asian currencies in the weeks and months ahead in my view.

Lingering Disappointment

Another soft close to US stock markets at the end of last week sets up for a nervous start to the week ahead.  The S&P 500 has now declined for a third straight week, with tech stocks leading the way lower as more froth is blown way from the multi-month run up in these stocks.  Lingering disappointment in the wake of the Federal Reserve FOMC meeting is one factor that has weighed on risk assets.  More details on how the Fed plans to implement its new policy on average inflation targeting will be sought. Markets will also look to see whether the Fed is pondering any changes to its Quantitative Easing program. This week Fed officials will get the opportunity to elaborate on their views, with several Fed speeches in the pipeline including three appearances by Fed Chair Powell. 

Disappointment on monetary policy can be matched with a lack of progress on the fiscal front, with hopes of an agreement on Phase 4 fiscal stimulus ahead of US elections fading rapidly.  A loss of momentum in US economic activity as reflected in the NY Fed’s weekly economic index and declining positive data surprises as reflected in the Citi Economic Surprise Index, are beginning to show that the need for fresh stimulus is growing.  On the political front, the situation has become even more tense ahead of elections; following the death of Supreme Court justice Ruth Bader Ginsburg attention this week will focus on President Trump’s pick to replace her, adding another twist to the battle between Democrats and Republicans ahead of the election.    

Another major focal point ahead of elections is US-China tensions, which continue to simmer away. China’s economy and currency continue to outperform even as tensions mount.  August’s slate of Chinese data were upbeat and China’s currency (CNY) is increasingly reflecting positive economic momentum, with the CNY CFETS trade weighted index rising to multi week highs.  There is every chance that tensions will only get worse ahead of US elections, likely as the US maintains a tough approach in the weeks ahead but so far Chinese and Asian markets in general are not reacting too much.  This may change if as is likely, tensions worsen further. 

After last week’s heavy slate of central bank meetings, this week is also going to see many central banks deliberate on monetary policy.  The week kicks off with China’s Loan Prime Rate announcement (Mon), followed by policy decisions in Hungary and Sweden (both Tue), New Zealand, Thailand, Norway (all on Wed), and Turkey (Thu).  Markets expect all of the central banks above to keep policy unchanged as was the case with the many central banks announcing policy decisions last week.  The lack of central bank action adds further evidence that 1) growth is starting to improve in many countries and 2) the limits of conventional policy are being reached.  While renewed rounds of virus infections threaten the recovery process much of the onus on policy action is now on the fiscal front. 

Central Banks and Governments Act To Combat COVID-19. Will It Be Enough?

In just a few weeks the world has changed dramatically.  What was initially seen as a virus localised in Asia has spread throughout the world with frightening speed.  The shocking destruction that COVID-19 has wrought globally in both health and economic terms will not fade quickly.  The virus is destroying complacency in all areas.  Total and complete lock down is becoming key to arrest the virus’ ascent, but many have yet to change their ways, believing that they will be ok.  How naïve is that!

Governments and central banks are finally coming to grips with the economic and health costs, but also the realisation that even in many developed countries, they are woefully unequipped to deal with the health crisis that is unfolding.  Global policy makers and the public at large has gone from a phase of denial, to outright panic and increasingly into fear, which then brings forth the most aggressive responses.

Unfortunately, the lack of global cohesion amongst policy makers has meant that responses have largely been piecemeal and uncoordinated.  Two of the biggest super powers, the US and China, have despite a now forgotten about Phase 1 trade deal, become increasingly acrimonious in their dealings with each other.  This, at a time when the world is looking for leadership, is proving to be major impediment to dealing with the effects of the virus.

It is not all bad news in term of co-ordination.  Central banks globally appear to be acting in unison, even if accidently, in terms of slashing interest rates, aggressively increasing quantitative easing, flushing the financial system with US dollar liquidity and easing some of the regulatory burden on banks.  This has helped to improve market functioning, which increasingly appeared to be breaking down over recent weeks.  It may not however, prevent further pressure on asset markets given the destruction in economic  activity globally.

Unprecedented times call for unprecedented measures.  Governments are now stepping up to the plate.  Massive fiscal stimulus plans are being ramped up around the world.  G7 economies have pledged to do “whatever is necessary” and to co-ordinate actions though much has been un coordinated.  US lawmakers are currently deliberating on a stimulus package worth over a $1tn though this could rise significantly in the weeks ahead, Germany is planning to create a EUR 500bn bailout fund, and the UK has announced an “unprecedented” multi billion pound package of measures.  These are but a few of the various stimulus measures being undertaken globally.

China has yet to announce a major stimulus package, but has instead opted for more incremental measures as its economy begins to recover following a major lockdown.  However, just as China’s supply constraints are easing, demand is weakening sharply as economies globally shut down.  The implication is that China’s recovery will not be a quick one either.  More stimulus is likely.  Recent reports suggest China will step up special bond issuance for infrastructure spending, but more is likely.

Overall, the economic shock is just beginning as the health shock is intensifying.  We will need to brace for more pain in the weeks and months ahead.  We can only hope that the measures announced so far and yet to be announced alongside with strict adherence to health recommendations will be sufficient to prevent deeper and longer lasting damage.  The jury is still out.

US dollar surges through key levels

Demand for risky assets continues to strengthen as reflected in various indicators including my Risk Aversion Barometer which has moved deeper into risk loving territory while equities remain on an upward trajectory. Central banks are providing the main source of support for investor risk appetite, with a combination of lower policy rates and quantitative easing providing a major fillip.

Additionally various central banks appear to be talking down their currencies and/or intervening (note RBNZ and Riksbank) adding to the downward pressure versus USD. In Japan’s case the G7 appeared to give its blessing to Japanese policy over the weekend, aiding in the decline in the JPY.

Usually the USD would not benefit in times of improving risk appetite but it is finding plenty of support from the fact that Fed policy is set to diverge with other central banks, with the currency breaking key levels against major currencies including EUR (below 1.30), JPY (above 100) and AUD (below 1.00). The surge in US Treasury yields is underpinning the USD helped by firmer US economic data in particular on the jobs front.

According to a Wall Street Journal article over the weekend the Fed is already formulating an exit strategy from QE although the timing is still being debated, another factor supporting the USD at the beginning of this week. Various Fed speeches over coming days will likely provide more clues on any timing or plans for an exit policy. Meanwhile, higher US yields and a firmer USD continue to pile on the pressure on gold prices.

There may be a little caution in pushing the USD higher this week as US data releases are likely to look softer, with retail sales, industrial production and housing starts set to record declines. Nonetheless, any pull back in the USD or yields may simply provide better levels for investors to go long the USD and short Treasuries especially as data elsewhere will not look much better. Indeed, while in Europe there will be a likely bounce in the German ZEW investor confidence index in May, Q1 Eurozone GDP will record a contraction for the sixth consecutive quarter.

Euro slipping ahead of Eurogroup meeting

The US September jobs report released last Friday will provide some encouraging news for markets to digest this week but holidays in the US and Japan today will keep trading relatively subdued. The jobs report itself was in any case somewhat mixed, and while the unemployment rate dropped to 7.8%, the actual increase in payrolls was relatively soft at 114k although there were revisions higher to past months.

The US jobs report does not necessarily change the picture regarding US quantitative easing. The Fed and subsequently markets will not change their expectations based on one month’s data. In this respect, any benefit to the USD will be limited although the increase in US 2-year bond yields has already exhibited itself in a firmer USD/JPY exchange rate. Nonetheless, this week’s US data will help maintain the assessment of gradual US recovery, with the Beige Book, trade data and Michigan confidence in the spotlight. US data will continue to look relatively better than in Europe.

Most attention will remain on Europe and the Eurogroup meeting beginning today. The reluctance of Spain to request a formal bailout will be a negative factor for European markets, although Portuguese austerity measures likely to be approved today, negotiations between Greece and the Troika (EU, IMF and ECB) on the next tranche of loan disbursements for the country, as well as potential for Cyprus and Slovenia to request a bailout will also come under scrutiny at the meeting.

Currencies are generally range bound, although EUR/USD is verging on another drop below 1.3000. Spain’s refusal to request for a formal bailout holds risks to the EUR especially if peripheral including Spanish bond yields move higher again. While ECB President Draghi’s commitment to OMT (Outright Monetary Purchases) reinforced last week, will provide some solace to the EUR, it will prove meaningless unless moves ahead with a bailout.

Two of the biggest FX losers so far into October have been the NZD and AUD. The AUD in particular has been struck by the surprise RBA rate cut and faltering commodity prices. AUD/USD looks set for a test of 1.0100 technical support, but direction this week business and consumer confidence data over the next couple of days ands the September jobs report on Thursday.

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