Good Morning.. Back from a long weekend and again it seems that stocks don’t care about shocking data still, especially when, in their eyes, it comes in better than expected. But one thing that did catch my eye on Friday morning was the fall in FF rates to negative 7. This saw gold shoot up as if the Fed ever does go negative then gold yielding nothing will be in huge demand. But that move in FFs saw Powell hurriedly schedule a press conference for tomorrow and I think he may try and walk that move back (it has already moved back on the announcement). US yields may then start to rally and I am not sure stocks will like that but how hawkish can he be?.. The UK enters more Brexit talks and this may cap GBP for a bit and I am close to getting stopped in AUDJPY as stocks keep rising and we have heard little China baiting from the WH. I am waiting until we hear what Powell has to say tomorrow but I still think there are vast issues facing the EU still. How long can they finance the unemployed and there seems to be uncertainty about the abilities of European Commission President Ursula von der Leyen. Meanwhile the USD rotates around 100 in the DXY. All rather dull in FX at present but S. Korean data for the first 10 days of May were dreadful and the reality is we are facing a huge supply AND demand shock. I can’t see a V-shaped recovery at all and firms like Apple are moving supply chains from China to India. The outlook for China seems rather worse than expected post virus.

Keep the Faith..

Details 11/05/20

Markets price negative US rates so Powell schedules a statement: Can stocks hold? EU still a concern:

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As far as equity investors were concerned, the US data Friday was better than expected, which generated another 1.6% rally on top of an already incredible bounce off the lows. But bond markets are nowhere near as convinced about the health of the economy and early on Friday, at one point, Fed Funds traded -7bps! While the Fed has suggested that it was against negative rates, the bond markets do not believe them and this view was boosted by WH advisor Hasset saying that he would support negative rates but we are yet to hear Fed speakers suggest the same. The issue is an important one and I note that Powell has scheduled a statement for Tuesday, at which he is likely to push back on this; if he doesn’t then prepare for negative rates. 2Y yields hit record lows after Fed Funds futures accelerated their move to suggest increasingly more negative rates with the first negative implied rates expected to hit as soon as November. I guess the Powell hastily arranged statement titled “Current Economic Issues” means he will have to get these markets back where he wants them. But how hawkish can he be as he has already said that they were not considering negative rates. However the statement scheduling did see markets walk back some of the negative pricing.

If the Fed does go negative then gold will explode as even a zero yield will attract and gold pulled back from the highs after the Fed scheduling of a press conference tomorrow.

Whichever way you slice it the NFP data was shocking to say the least even if it was expected and there is a much bigger story behind this economic headline. The Atlanta Fed Q2 GDPNOW is currently sitting at -34.9% vs -17.6% previous, while the Fed is “slowing” UST buying to $7bln a day.

US yields rallied into the US afternoon after this announcement but US equity investors kept building longs. (Nasdaq was up almost 6% last week and Small Caps ripped higher.) This abandoning of UST buying is actually quite fast. From an initial $75 billion per day when the Fed announced the launch of Unlimited QE in mid-March, the US central bank first reduced its daily buying to $60 billion per day, then announced another ‘taper’ in its bond-buying program to $50 billion per day, which was followed by a reduction to 30 billion per day, which three weeks ago was again cut in half to $15 billion per day. Then, two weeks ago the Fed again slashed its daily POMO by another 33%, to $10BN per day, before cutting it to $8 billion last week. Fast forward to Friday when, in its latest just published schedule, the Fed unveiled that in the coming week it would purchase “only” $7BN per day.

That is a big support taken out of USTs.

While stocks continue to surge back towards 3000, the volumes are rather low.

The chart above seems to be a warning to me but again, a lot depends on how the top 5 stocks do in coming weeks and the concentration in these is a huge concern. But unless we see the FAANGs start to wobble then investors seem happy to keep calm and carry on buying. Just a reminder here or spoiler alert; the stock market is not the driver of the economy. There is quite clearly a “Great Divide” happening between the near “depression” economy versus a surging bull market in equities. Given the relationship between the two, they both can’t be right; can they?

We have two question that need answering with regard to the US economy now. Firstly, just how bad are things? Given the BEA will revise Q1-GDP towards -8%, and Q2 is estimated at nearly -20%, the unemployment rate of 14.7% will likely rise towards 20% in May’s report. These are numbers not seen since the “Great Depression,” and never seen in the official BEA data going back to 1948. Secondly, how long will the recovery take? On the second point; no one knows and this is why I am struggling with this low volume equity euphoria. The participation in the labour force has dropped to levels not seen since 1973 and is a key measure to watch. Since the “Financial Crisis,” the participation in the “Labour Force” never significantly rose despite record low unemployment rates. The reason being that the labour force was shrinking sharply over the last decade as more and more participants were simply no longer counted. This way of reading US unemployment is flawed.

Do you really believe that nearly 56% of the working-age population are no longer looking for work? This is garbage and the reality is much worse than reported in my view and there is a human tragedy taking place here that will make a deep and lasting impact on the US economy in my view.

The ripple effect from this is going to hit many associated industries as well as consumer confidence and spending habits and it is worth remembering that the US economy is 70%+ reliant on the consumer. There is a negative feedback loop between employment and consumption including confidence in keeping a job and the psychological impact of seeing others losing theirs. It isn’t just the economic data that is going to be horrid over the next few months, as earnings will likely be just as bad, as businesses rush to cut costs and remember that at some point, earnings do matter. I have mentioned debt quite a bit recently, but we need to focus on consumer debt now as the consumer takes a big hit through job losses and confidence. Proportionately, how heavy is the burden of this $4.15 trillion in consumer debt? When measured against the size of the US economy, it amounted to 19.3% of nominal GDP in Q1 and in Q4 last year, the highest ever in the data. It is a certainty that there will be big casualties in this regard and remember that a lot of the rescue packages are for the short-term only.

There are many people in the US that have maxed-out credit cards that cost them 25% in interest a year, and they have subprime auto loans that cost them 19% in interest, and they have student loans from years ago, and no savings. In this group are also people with fairly high incomes that have taken on too much debt, including credit card debt, and they need every last penny of their high incomes to make ends meet. But the national data puts all Americans into one bucket – the group that will be just fine no matter what the economy does, and the group that is strung out, plus everyone in between. Credit problems arise among those who scramble to make ends meet. Many of these consumer defaults, like corporate defaults, are yet to hit but they are coming unless the government decides to cancel some debt, which would ignite a very dangerous fuse to moral hazard.

Also, a lot of these data are just through the end of March, with only two weeks of the shutdown accounted for. I am sorry but there will be no V-shaped recovery and it is just a matter of time until equity investors realise this. Corporate debt is rising to new records due to the collapse in operating revenues. As such, companies will likely take all possible measures to conserve cash flow, reduce expenditure and be prudent about hiring decisions. This will lead to slower job creation and investment even once the economy opens. But if this huge rally has been based on the reality of ballooning Treasury issuance which has steepened the curve and the spectre of negative policy rates in 2021, then we may have a problem looming as close as Wednesday when Powell is likely to walk back any idea of negative rates which will see the curve step up in yields. May13th could be something of a game changer as to date the Fed and the hope of negative rates have been the driver but remove that idea then the reality is laid bare for all to see and that is the fact that the economy does matter. In S. Korea we got a glimpse of the future as they reported the first 10 days of May stats. One thing to consider as we pass peak virus and re-open is what happens to demand. It seems many expect a huge bounce. Take a look at these data from S. Korea; only 1st 10 days but pretty shocking for South Korea: Exports -46.3% & imports -37.2%!!! Note that this is the country that reports trade 1st in Asia & this is the best data we have so far for May. Apple has announced it is shifting about a 5th of its production form China to India. Is this the start of a large shift away from China?

What impact is this going to have on prices? I do wonder if we are looking at some low growth and rising prices as we come out of all this and that is going to be hard for central banks to deal with and may force many to keep short term policies a lot longer than wanted. Will businesses pass on higher costs, or can they? Margins could collapse and we could be talking about stagflation in 2021. The biggest threat comes from companies shifting supply chains permanently away from cheaper China imports to more reliable, but expensive, suppliers. As BB noted; companies like Disney, airlines and restaurants will likely have to raise prices to meet costs as social distancing rules will still apply. Fees for cable services will jump due to rising costs to carry sports broadcasts to compensate for a lack of fan revenue. Crude futures will likely rise as demand kicks in but suppliers stay firm in order to replenish revenues lost to the virus. Vehicles could see price increases too as automakers attempt to recoup 1st half of 2020 revenue. Oil is rising as people shun public transport and take to their cars. While prices will be rising, job growth will be slower to return to normal as social distancing will prevent us from reaching full employment. The combination of rising prices without rising wages will place enormous pressure on the economy, no doubt causing a real economic recession in 2021 and not one that’s the result of a pandemic. This stagflation scenario, not seen since the 1970s, is the worst case for markets, particularly risk assets like stocks and bonds.

Meanwhile, I still have some real concerns with the EU. The eurozone has made a very aggressive experiment trying to hide soaring unemployment under government-financed temporary lay-off schemes. This may prove a short-term success because official unemployment data will not seem as negative even when almost 30% of the labour force will be under some form of unemployment scheme by end of May 2020. However, this is also an enormous risk for economies with already elevated levels of debt and government spending. With public spending to GDP at 40% before the crisis, governments are likely to increase their expenditure by at least 10 points of GDP. This will likely lead the eurozone into a debt crisis like the 2011 one and with similar ramifications. Also there seems to be uncertainty about the abilities of European Commission President Ursula von der Leyen. Also there is talk that the EU could sue Germany over the court case. “The final word on EU law is always spoken” by the European court, she said. “Nowhere else.” So, basically you can take your local laws and stick em. I am glad we left.

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Strategy:

Macro:.

Short AUDJPY @ 69.25 added at 68.25 and Stop at 70.25 recent high.

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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