Good morning.. A mixed session at best in Asian markets with China helped by more stimulus but Nikkei down more than 1%. Oil keeps falling and this has repercussions way past the oil markets. The USD (DXY) was back above 100 briefly again this morning but the direction is unclear still but we have to say that with all the Fed is doing, the USD seems remarkably resilient. This suggests there may still be stress out there and I am sure the risks remain in the credit space as NPL’s are going to hit hard, especially in the energy and retail sectors. Again I do not see things returning to “normal” anytime soon. The EU is still suffering and I think this continues and the political fall-out is a potential concern on top of everything else. This oil fall, if it holds, is going to hit many companies and is hugely deflationary. I am not sure any of this justifies this extended rally in stocks but it is hard standing in the way. We have also gone from a US Bill shortage to a flood and the danger here is that bill yields now rise. That may keep the USD bid. Barring left field headlines, we could have a quiet one today..

Keep the Faith..

Details 20/04/20

Is the EU doing enough? Oil keeps falling and the Fed still has some issues.

–

After the fudge compromise package, agreed by EU leaders recently, there seems to be a growing feeling that it is not enough. European Stability Mechanism Managing Director Klaus Regling said “Europe will need at least another 500 billion euros from European Union institutions to finance its economic recovery after the coronavirus pandemic, on top of the agreed half-a-trillion package” already agreed upon. He clearly sees a second phase of spending necessary in an effort to prop up an ailing economic union. He even suggested that may not be enough. Just how weak is the EU now? Very is the only word I would use and Spain and Italy are still really struggling in the fight against this virus. But the damage goes right across the Union. The question is whether this union can start acting like one but that seems unlikely still. EU leaders are to discuss that at a videoconference on April 23 but I am not sure how much appetitive there is to pre-commit. Cracks are still there in the EU and bond markets, despite the huge interventions are still showing fault-lines appearing.

BTP/Bund spreads are wider despite all the efforts of the ECB. This as it seems Italy can issue almost what it likes this year but the cracks are there for all to see. As of the end of last year, Italy’s public sector debt was 136% of GDP but is looking now that it will hit nearer 180% if the IMF GDP forecast is anywhere near correct (which looks likely at 10% lower than 2019). Can the ECB fix Italian problems or can even the EU leaders? Maybe the ECB can bridge some of the issues while Italy gets through this virus peak but what about dealing with all the knock-on effects which will likely take years to clear up? Italy does not back using anything connected to the ESM and Draghi’s “do whatever it takes” OMT programme has never been used. Of course, another course open to Italy is to default or seek a debt restructure and is that what BTPs are so fearful of? The problem with a default is that Italy would rather shoot itself in the foot as the local banks are some of the biggest holders which is nuts. Irish economist Karl Whelan suggests that Italy could “haircut” its bonds and win enough savings to nationalise and save them. Investors would be wiped out but deposits saved. Hmm; allowing investors to suffer; that would be different.

Of course, the other danger is a shift in politics to a less EU friendly government driven by populist demand to fight the EU. A threat to leave, close to all the Brexit news, could give the EU a very necessary wake-up call with regards to helping the weak. Politicians are finding willing ears when blaming the EU for all Italy’s woes. This is akin to what pushed the UK to vote and eventually agree to leave. Politics are now very important and there is nothing the ECB can do about that. I am sure peripheral parties will see this as an opportunity to grow and while this may take time to build, if it gets momentum, as the UK found out, it may be unstoppable and will certainly not disappear when the lockdown ends or the virus is defeated. EU politicians outside of Italy are starting to even talk about this publicly as Macron takes the stage suggesting the EU could fall apart if unity is not shown. He is right of course but I am surprised he made the comments public as it may have a negative impact on the Italian psyche. Maybe Germany and the Netherlands, so keen to hold onto their wealth, should consider what an Italian default or a move to vote on remaining would do to that wealth.

Meanwhile Oil keeps falling and traded below a $16 handle at one point last night and there are some serious concerns now over where and how to store all the supply. This is a big deflationary issue looming in the short term but comes with other implications. Oil markets have not seen the likes since the late ‘90s. It still seems that the demand shock is greater than the agreed cuts in production. The expiry of the front month weighed heavily in the market but June was down too.

Oil companies are taking some action where they can and Baker Hughes data on Friday showed that the number of oil rigs in the US has dropped by more than a third over the past month. The US shale market is in for a very tough time and it looks like some may not survive leaving some pretty awful non-performing loans to be sorted out by lenders. Brent crude was down 1.1 per cent at $27.78 a barrel on Monday in Asia. We also see a second rating agency has downgraded Mexico’s debt-laden state oil company Pemex to junk, which will trigger forced bond sales and raise future financing costs. Rating agencies are going to be busy and that includes the US.

The ongoing crash in oil, which OPEC+’s agreement to cut 9.7mmb/d in output last weekend has failed to halt, takes place as Crude prices in the US oil capital are getting dangerously close to zero. According to Bloomberg, buyers bidding for crude in landlocked sections of Texas, ground zero of the shale revolution, are offering as little as $2 a barrel for some oil streams, a precipitous markdown from a month ago. It is cheaper than some bottles of water here in the UK. Meanwhile we have seen US banks take over $20 billion in reserves in anticipation of a looming default wave (a five-fold increase is not nearly enough based on historical precedent) and Moody’s predicting that as many as 30% of Americans with home loans – about 15 million households – could stop paying their mortgages if the U.S. economy remains closed through the summer or beyond. The default risks are rising.

Surely loan defaults are about to happen when 22mln Americans lose their jobs. The credit space, despite all the Fed is doing, is still at risk and may explain why the USD is not falling. According to Moody’s its list of distressed credit names, those rated B3 Negative and lower, soared to its highest tally ever – 311 companies – with Services, Oil & Gas, Gaming, and Restaurant sectors the largest contributors. This is not going away and it is quite clear that the Fed’s expanded policy actions will not translate into material fundamental improvement for the weak HY balance sheets.

Bank of America echoes this and writes that the Fed’s “bold, surprising” announcements “do nothing to address the ultimate credit risk – non-payment, downgrades, and fallen angels, nor should they, and we thus remain comfortable with our existing views on expected default rates, which we estimate at 9% over the next 12mo.” For your guide the IMF see those rates at 14%. Can the Fed ride this out? It seems many feel the answer may be no. The Fed has done so much and has probably capped some of the USD demand issues but not all it seems; the USD just will not go down. The Treasury had unleashed an unprecedented flood of T-Bill issuance, which in the past 12 trading days has amounted to a record $1.5 trillion in gross new debt sold between T-Bills and Cash Management Bills, as shown below.

Just a month ago there was a shortage of bills and we had the Repo squeeze but now we have bills pouring into the bond markets which could start seeing yields rise.

The Treasury is using bills to pre-fund the multi-trillion fiscal stimulus (and will have to be rolled every few weeks), Bill supply last week pushed Treasury bill yields from below OIS to 20 bps above OIS. To the guys at CS (Pozsar) this spike is ominous and suggests that the market may be nearing a tipping point on the front-end. A push higher in bill yields will undo a lot of the good work the Fed has done. The consequence of sharply higher yields is that it would offset much of the Fed’s actions and serve as a liquidity drain: according to Pozsar (the expert on this), “higher bill yields could pull funds away from the FX swap market as foreign central banks put their dollars into bills, not FX swaps, and as bill-OIS spreads grind more positive, they will push FX swap implied yields higher, OIS-OIS cross-currency bases more negative and that will limit how much more U.S. dollar Libor-OIS spreads can tighten from here.” The last thing we want to see is the Fed going all-out and using YCC which would be a nail in the coffin for free markets and risk pricing. I hope we don’t get to that as the bond markets are forward looking and warn of risks in the future. The BoJ has taken this road and they have a broken bond market with few participants; it is pointless.

I saw an interesting article over the weekend; it was Charlie Munger, vice chairman of Berkshire Hathaway, who was talking with The Wall Street Journal about the current situation and how he and Warren Buffett are looking at it. Spoiler alert for equity investors; they’re not buying. Remember they bought everything in 2008; not this time. “Nobody in America has ever seen anything else like this,” Munger said. “This thing is different. Everybody talks as if they know what’s going to happen, and nobody knows what’s going to happen.” My sentiments entirely. And in terms of the stock market, he said, “I don’t have the faintest idea whether the stock market is going to go lower than the old lows or whether it’s not.” Hmm. I still am of the opinion that there is too much euphoria in equity markets and risks clearly remain, even with all the Fed and governments are doing. Whether we hit the lows, I also have no idea but I think some pain is still possible. That may see the USD surprise higher again.

—————————————————————————————————————-

Strategy:

Macro:.

Short EURGBP @ 8901.. Stop @ entry now (took substantial profits at.8760)

Brought to you by Maurice Pomery, Strategic Alpha Limited.

—————————————————————————————————————-

Strategic Alpha Report Disclaimer

Doo Prime endeavor to ensure the reality, adequacy, reliability and accuracy of all the information provided, but do not guarantee its accuracy and reliability. All the information, analyses, comments, statements, and/or data provided in this report is for information purposes only. Client’s use of any contents of the report as the basis for the transaction, the client shall fully aware of the risks and agreed to bear all the risks. Client shall cautiously judge the accuracy of the information. Doo Prime has no liability for any loss caused by any inaccuracy or omissions of the contents and subjective reasons of Client.