Good Morning.. Stocks still like a dovish Fed and that was what we got and the USD made new recent lows with Cable above 1.3000 at some point. There is a real shift in sentiment towards the USD now and while we may need to take a breather, the charts still suggest the USD heads lower. I have recommended a short in USDJPY this morning (I know; late to the party) but I think the Fed wants a lower USD and is why they have extended the swap lines to keep the USD demand off the FX markets. Sentiment can play a huge role in currencies that are backed by nothing but good faith!!! German GDP and Unemployment data today along with EU consumer confidence but US weekly claims the main event for me as these data will be part of NFPs. I think the equity markets need to start pricing in what a deep and long impact of unemployment will have on the economy, which is not being helped by an inward looking president who seems determined to break from the globalised world that has served us so well. The USD may be the reserve currency (for now) but it seems to me that some are looking for an alternative. Maybe the world needs a lower USD now.
Keep the Faith..
Details 30/07/20
The Fed says nothing to undermine USD weakness: Going short USDJPY and does the Fed want a lower USD?
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No policy shifts were expected and so it was down to just how dovish Powell would be and it became clear early on that he sees troubled waters ahead. Highlighting the on-going issues associated with ever-increasing virus cases, he warned the economy would “depend significantly on the course of the virus” after the Fed had extended measures to deal with the risk of an international shortage of dollars. He cited “non-standard, high-frequency data” on credit card spending, employment, hotel occupancy, restaurant bookings and consumer surveys as heavily impacted by the ongoing virus and to be honest, most of this was expected. “The pace of the recovery looks like it has slowed since the cases began that spike in June,” Powell said at the press conference following the meeting. “It’s too early to tell both how large that is and how sustained it will be. We just don’t know yet,” he added. With a direct message to Congress, he said “Even if the reopening goes well — and many, many people go back to work — it is still going to take a fairly long time for parts of the economy that involve lots of people getting together in close proximity” to recover, he said. “Those people are going to need support.” In other words; get on with it!
The USD was weak into this and weakened further with Cable breaching 1.3000 briefly and charts on many currency pairs suggest further gains. Cable daily below.
The question now is if this dollar move has legs or are we about to see a bout of profit taking. Below is the Bloomberg USD Index.
So far, price action has indicated little fear of that but the move has extended quite a bit now. USDJPY seems reluctant to push much lower but charts still suggest it could. Below is the weekly USDJPY chart.
Break the lows seen last night around 104.75 and we may resume the fall to test recent lows. I think these lows get taken out and I am prepared to short USDJPY here at 105.25 with a tight stop above 106.75. But that is the technical picture; what about the fundamentals? Well, to my mind, the Fed changed little last night and the equity markets rallying through the session helped keep the USD under pressure. The interesting thing to watch for now is if equities do ever decide to fall, whether the inverse correlation with that move still sees USD demand. But over and above that, what the Fed is continuing to do and threaten, and the weakness of the high frequency US data, suggests the USD may still struggle as other nations emerge stronger than the US which has a huge unemployment issue hanging over it and growth may still suffer.
U.S. GDP likely plunged a record 34.8% in the second quarter amid shutdown
On balance it looks like the data “are pointing to a slowing in the pace of the recovery,” Powell said, though it was too soon to say how large — or sustained — this pause would last. If he doesn’t know then we all have to assume we still have a lot of uncertainty ahead. US stocks however, due to the belief the Fed may have to do more, climbed 1.25% but Asian markets were a little more mixed (Nikkei marginally lower) and the US drifted back up off the lows. Stocks continue to stride way ahead of fundamentals but at some point, when it becomes clear that global growth is sliding again, that may change but for now Fed actions and dovishness still dominates.
Not much on that chart above to suggest any fear of a setback yet but I do wonder about the earnings potential in a global slowdown. Senate Leader Mitch McConnell said: Hoping to reach a deal on unemployment benefits by Friday and I guess investors believe a compromise just has to be found and investors seem to like markets where governments spend like crazy. The world has turned upside down and I fail to see how investors define risk in these markets now.
Central bank interventions, coupled with the massive fiscal inputs from governments, have distorted reality to such an extent that bad news has somehow morphed into being good news! How can that be and how long can this unreal situation last? The issue here is that these interventions have created an atmosphere where zero rates somehow remove any risk associated with debt. But debt does matter and at all levels and many weak corporates are about to find that out as more bankruptcies and closures hit home. Unemployment certainly matters and at some point, so will earnings; or the lack of them. This disconnect from reality is an amazing phenomenon but there remains a belief that we can all get out in timely fashion if something does break. Maybe so but history is full of moves like this and few ended well. Returns on equity have collapsed and the hunt for yield has seen high risk sectors priced as AAA. There is an accident in there somewhere. Risk is not just about the VIX or vol in general as that is reactive; it has to be about permanent loss of capital, which is the real threat investors face.
Even the most traditional Bellwethers for risk are being clouded by central banks and we get less information from our bond markets now about future risk and this maybe blinkering investors. US Treasuries and government bonds from other highly rated countries are widely considered to be risk-free assets, as they are fully backed by the sovereign. This is true in a sense, as governments with top-quality ratings have always tended to pay back their debts in nominal terms. Fed purchases also obscure investor perspective of the most important price in any global market, the price of money. Bonds now, set at historic low yields tell us nothing. Treasury yields were historically a good barometer for expected inflation/deflation. Falling yields tend to paint a slow growth, disinflationary picture. Higher yields reflect investor desire for compensation to protect against rising inflation concerns. That ship has sailed. But it must not be overlooked that the purchasing power of those bonds is not guaranteed, due to inflation. It is inflation that is a real danger now and while that seems a long way off, the massive government stimulus (about to grow again in many economies) may actually spark a recovery and I can almost guarantee that populist governments and central banks, will be slow to reverse these stimulus measures.
Recent Fed-speak threatens even more aggressive policy actions, including yield curve control and higher inflation targets. They appear to want to do an even more expanded version of QE. Already warped by Fed influence over interest rates, those actions will further deform inflation indicators and asset prices. As a net importer, a weaker dollar is inflationary and a stronger dollar deflationary. Therefore, a continuance of dollar weakness warns of inflationary pressures ahead. A weaker dollar may also result from colossal deficits and destructive monetary policy. While some argue other countries’ governments and central banks are doing the same thing, they are not as aggressive. Additionally, unlike the U.S. dollar, currencies of other countries are not the global reserve currency. Does the Fed want a lower USD? The Fed recently conducted nearly $500 billion in FX dollar swaps with foreign central banks. The publicly stated purpose of the exchanges is to provide foreign nations with dollars. The real purpose is to keep the currency transactions off of the FX markets. Ergo, the intent is to reduce upward pressure on the dollar as foreign countries seek dollars to satisfy dollar debt obligations.
But inflation, it is said, is for the future but what about now? WH Officials have said that the Trump administration is working to use financial initiatives to move production facilities out of Asia and into the US/Latin America/Caribbean; focus will be in areas like infrastructure/energy/ transport & the project could bring back $30-50b in investments to the US. This underlines the WH objective of breaking off from the globalisation that has created the low-cost goods we all crave. This is a very significant time for global trade and it looks threatened. This and the further impacts from phase2 of the trade war are not priced and this war is intensifying. But Trump is not only building walls with China but even close allies. He said: Germany pays Russia billions of dollars a year for Energy, and we are supposed to protect Germany from Russia. What’s that all about? Also, Germany is very delinquent in their 2% fee to NATO. We are therefore moving some troops out of Germany! America is turning inwards and becoming protectionist and for the biggest economy on the planet; that matters.
Investors also need to bear in mind that Governments are playing a bigger role in economies in response to the pandemic. They are taking a firmer grip on companies by providing the capital necessary for them to continue functioning. Already, we are starting to see certain conditions that could affect companies’ operations over the long term, such as the requirement that loan recipients forgo stock buybacks or cut dividends, particularly in industries such as utilities, automobiles and airlines. Banks are setting aside massive bad loan provisions and all the central banks are warning that things are not getting any better. Banks are facing some uphill battles going forwards and flat yield curves and bad loans are not going to help. Santander, Spain’s largest lender and one of the Eurozone’s eight global systemically important banks (G-SIBs), has posted its first ever loss in 163 years of operations and it was huge! It is not only US banks setting aside billions for the Tsunami of defaults that are coming.
The losses were the result of a €2.5 billion charge related to the recoverability of tax deferred assets as well a €10.1 billion write-down on assets across a number of key overseas markets. In Europe, the banks are once again gearing up for their earnings calls. Like Santander, many will report losses and some of them already have. Big banks have capital to absorb the losses that are coming but some have less than others. According to the European Banking Authority, many of the worst capitalized institutions in Europe are in Spain. Almost at the very bottom of the pile is none other than Banco Santander, placing 123rd out of 127. Too big to fail? I guess so. But the risks out there should not be ignored and this virus is far from going away and a vaccine still months away. The damage being done is clear and we may even see more lockdowns. The US is at the centre of this and is, in part, why we have seen this negative shift towards the USD but with the on-going trade wars and the US pushing towards more isolation from the global stage, this shift may be more permanent and investors seem to be looking for alternatives to the USD. The Fed is seemingly helping the USD lower with the extended swap lines too. Be careful with this, as sentiment can play a huge role in currencies that are backed by nothing more than good faith!
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Strategy:
Macro:.
Short USDJPY @ 105.25.. Stop at 106.75
Long EURAUD @ 1.6250 stop at 1.6080
Long EURGBP @ .9020 Stop at .9020
Brought to you by Maurice Pomery, Strategic Alpha Limited.
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