Good Morning.. Pretty quiet night for markets as we wait for the ECB meeting today where we may have a few variables and thus, a choppy EUR later. Talk is of €500bln more which will do absolutely nothing for the real economy. But Wall St secured further gains yesterday and will probably do so again today as it seems all that matters is the Fed talking of unlimited liquidity. US long end yields remain elevated and Aussie 10yr yields moved above 1% for the first time since March. I still think we may see further gains in some of these JPY crosses but we are approaching some chart levels in USDJPY at 109.38 (although I see this above 110.00 soon) and EURJPY at 122.87ish… EURGBP is starting to recover quietly as trade talks seem to be producing no thawing of the ice between the UK and EU. US weekly jobless claims will see more of the human tragedy unfold in the US and many will not have jobs to go back to. But data still has little impact as it is all about liquidity; for now.

Keep the Faith

Details 04/06/20

Much the same as yesterday: The ECB, how much and when? Have markets gone crazy?

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After a brief spell of consolidation and some profit taking, things returned to normal as stocks continued to rally, the USD fell and JPY crosses gained further. What may not have attracted so much attention was the continuing fall in US 30yr futures taking long-end US yields much higher and the curve steeper. This clearly helps financials.

Line chart of Difference between five-year and 30-year Treasury yields, basis points showing The US yield curve steepens after big move in the long bond

Its been a long time since the 5s-30s were this steep. I think this has, in part, something to do with the break higher in USDJPY but in addition to that, USDJPY is back tracking stocks. 109.38 is chart resistance in USDJPY but that looks highly vulnerable to me. But the weaker USD elsewhere has seen another surge in JPY crosses. Having said that, there was a brief concern as it became apparent that AUD was diverging from Aussie 3yr yields. This caused a brief dip in AUD and indeed AUDJPY but it seems our stop was in the right place.

I fear that maybe EURJPY would have been a better choice but with the ECB today (more on that below) maybe not and Aussie 10yr yields rallied over 1% for the first time since March. In the US 5s-30s widened to almost 118 basis points on Tuesday, the highest at any point since 2017 save for a brief intraday spike during the Treasury market disruption of mid-March. This is a concern but at present the market is focusing on other issues and AUD, AUDJPY and JPY crosses all bounced as US stocks rallied yet again. I still think the market is not that long of USDJPY or indeed many JPY crosses. I still think the function of a lower USD may still be with us as it is correlated to Fed policy, as discussed here yesterday and so these JPY crosses could still surprise.

The gap between two-year and 10-year Treasury yields has nudged slightly higher since mid-April, now sitting at 52 basis points. But the move in the 30yr is interesting as to my mind this is too far out for the Fed to take control if they do adopt YCC. We could see long end yields rise further. The recent steepening of the yield curve could also be attributed to the Fed pulling back as an active buyer of Treasuries as they continue to taper purchases. But a steeper yield curve and indeed a lower USD is good news for global markets and the EM space, however, gold is suffering as US yields rise. The Fed tells us how many UST’s they will buy every Friday for the following week and last Friday the Fed announced that this week it would purchase $22.5BN for the full week, on average $4.5BN per day (down from $5BN last week), as per the following daily breakdown.

But yesterday’s purchases were lower and I am not sure why. Was it because there was limited supply? I might just keep an eye on this.

What still worries me as we scramble around looking for a vaccine still, which needs to be kept in mind, is that economists and central bankers still seem unsure how long or what shape any recovery, if indeed one is coming, will take. This makes it very hard to invest; yes trading is still possible but are we investing or gambling with so many unknowns? Certainly some very clever fund managers and economists have been made to look rather stupid with this equity rally as well as idiots like me. It is hard to stand in front of and to be honest data suggests the market is not that long! We are also facing an unprecedented period as we have never seen a slowdown like this one.

No wonder there is so much head scratching going on and it sure is hard reaching up here and buying global equities if you are square. Maybe that is the point and stocks cannot fall until the market has been forced back long. Personally, I still have some macro issues regarding the consumer and their spending habits going forwards. PCE drives GDP and labour drives PCE. The vast majority of families in the U.S. work to consume. The wealthy may have assets but the large majority of citizens must consume its wages. Accordingly, PCE is mostly a function of employment and the size of our pay packets.

At present, probably because the numbers are so huge and unintelligible, the unemployment disaster is being ignored as many believe with unlocking, many will return to work. But not all in my view and maybe less will have jobs to go back to. The graph below shows the year over year change in the number of employed versus the year over year change in PCE. When averaged over two years, as the darker lines show, the correlation is clear.

I am not sure that there can or will be a bounce straight back to 3.5% or even 5% unemployment and nearer 10% may be with us for a while. That will do significant damage to consumer confidence AND spending.

I think many seem to forget that in the 2008/09 recession, the payrolls number troughed two years after the recession started, falling 6.3% from the prior peak. From that low point, it took over four years for the labour market to fully regain the losses. In total, the labour market required six years to recover the pre-recession peak. I am not sure anything has priced that. Interestingly, the Congressional Budget Office (CBO) agrees with a slower recovery in that the recovery will be much longer than most economists forecast. The CBO’s Nike swoosh forecast shows the economy will not fully recover for at least a decade. What will that do to earnings and can the Fed maintain current policies for 2, 3, 5 or 10years? The point is that every time we get another crisis, which in my view are related, we start dealing with it from a lower and weaker starting point. I just wonder if we may be running out of road to kick that can down.

Then of course, we move on to the ECB meeting today where an ECB doing nothing would be quite a shock. There are many variables of what they may announce and so some EUR volatility seems likely. Best guess is Lagarde and Co. go for an additional €500bln which I think is consensus and possibly fully priced after ECB speakers have given us some form of heads up for this meeting. But it could be 750 or 250 and when will it start; could there be a delay, as to be honest there is no great pressure on spreads right now. Some observers believe the policy could be extended past 2020 so there is a lot to consider and it is never easy to asses just what the market has priced with the EUR and peripheral bond strength recently. Alongside any policy decisions, I think investors will be keen to hear the new macroeconomic projections that this meeting brings as it will encapsulate the full virus impact.

Clearly growth and inflation will be revised lower with GDP expected to be estimated between -8% to -12% as Lagarde has suggested with a return to pre-crisis levels not before 2022. Again a central bank less convinced of a swift recovery, if indeed that is the case. I think investors may start to focus on recovery times as that seems really important to me. Yet again, I fully expect inflation to be revised down but surely a member of the press conference will ask; why do more when it is plain policies so far have not created any inflation at all and no growth; just as is the case still in Japan? I do not think there is any point in cutting rates either. I think the main issue here is IF the markets really feel that by doing more makes one iota of difference and whether there are any concerns over the fact that the ECB is turning Japanese. I think the Joint bond issue is helping EUR recover but that is yet to be passed. Germany is spending more though, which is positive and it is governments now that need to step up; the ECB has passed its effectiveness.

An extension for the policy may well be needed as little more than two months into the program, the ECB has burnt through almost a third of the money supposed to last through the end of the year, suggesting it’ll exhaust its buying space around October. While that leaves policy makers with some time to decide by how much they want to increase purchases, any delay would likely spark a market backlash — particularly in Italy, where the central bank has skewed purchases in recent weeks. I think the ECB will give the peripheral bond markets what they want but on a macro basis, I do not think it will help the EU economy much at all; if at all. QE does not create growth or inflation when starting from these levels. We all know that. Again this is policy for bond markets and NOT the economy. There is no demand for loans and so this printed money will most likely find itself parked in equity markets. Again. Regarding the proposed bailouts; with peripheral bond yields so low and the ECB scooping up all the required issuance of debt, do Italy and others actually need more bailouts. There is a danger that the richer nations, who have shown discontent with joint bonds, feel the same!

Away from all that, quite a few economists and analysts are asking the question of whether markets have gone crazy, considering that U.S. stocks are up 40% from a low in March, the dollar is close to losing its 2020 gains, and emerging-market assets are in demand for no good reason – unless you’re a yield hunter. Some market watchers point to the unlocking of economies but we all know that without a vaccine, we’re all at risk of a second wave of the virus, and the economic fallout of the lockdowns will probably reverberate for years to come. We all know the likelihood of a v-shaped recovery is diminishing and that many will not have a job to return to s businesses close and at best cut staff to reduce costs. Second-quarter earnings announcements are just around the corner, bankruptcies are on the rise, unemployment is astronomical, and banks are in for a world of pain (although a steeper curve is helping in the US). The weakest links in Europe are entering their biggest tourist season on a hope and a prayer that families would be comfortable enough to put their kids on a flight for a much-needed holiday (I probably won’t to be honest).

Safe havens like the USD and the JPY have been discarded for equities but the problem is the market is not that long of risk yet. Markets may seem crazy and may do for a while longer as all that consumes investors is that the Fed is prepared to do whatever it takes. This rally is about liquidity; not the economy, which at some pint may be tested as the market is NOT the economy. But markets need to be euphoric (which they now seem to be) and heavily long (which looking at all the cash in MM funds is not the case yet) to crash. The question now be how long can the Fed keep all this up?

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Strategy:

Macro:.

Long EURGBP @.8978 added @ .8940. Stop now at .8825

Long USDJPY @ 108.58.. Stop at 107.79

Long AUDJPY 75.30.. Stop 74.40

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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