Good morning.. Stocks yet again made solid gains in a quiet market and my stop was triggered as it seems potential risks are ignored. It will take something to slap them in the face to consider selling it seems. They clearly feel the central banks will not allow anything bad to happen; good luck with that. Interestingly with all the Fed has done with swap lines et al, the USD remains bid with the DXY still above 100. Within all this we have seen continued EUR weakness but not just against the USD but AUD, GBP and JPY and I think this may continue. With JPY demand possibly into Japan’s golden week, I can see EURJPY breaking lower and have recommended a short today. BUT FX may be quiet into the Fed tomorrow. I am not hearing any rapid commitment to delivering this EU package. If it does get agreed then all bets are off but for now, time is not on their side… I am not sure what we should take from US Treasury markets either and it worries me that these are turning Japanese (see below). Will central banks ever be strong enough to reverse all this? I hope so or we are all headed down the Japanese path and look where that got them.
Keep the Faith.
Details 28/04/20
Equity investors happy to ignore potential risks as we wait for the central bank meetings this week: Recommend short EURJPY.
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As I expected, I saw my stop in S&P hit yesterday as yet again, in a quiet market, stocks ran higher. The pricing of potential risk seems to have disappeared and it seems that most are prepared until we actually see a shocking headline, or something slaps them in the face before even thinking of selling. But it has to be said that the rally off the lows is impressive and technicals still look pretty constructive unless we break back below 2735 ish.
Again, it appears that investors are on the side of the central bank actions rather than the dire outlook for the economy and to be honest it is yet unknown how the balance between the massive hit to the global economy against the counter-balance of the largest set of stimuli the world has ever seen pans out. But my concern is that millions more seem likely to lose their jobs and many corporations will be forced out of business creating some stress in the credit space. Maybe equity investors are aware of this and believe central banks and government just will not allow it to happen; but can they stop the rise in unemployment and the impact that will have for possibly years; not months?
To date, as you well know, we have more than 26mln Americans claiming benefits and how long will the government support them? In the EU it is reported that more than 30m workers in Europe’s five biggest economies have applied to have their wages paid by the state via short-term leave schemes designed to stop unemployment skyrocketing in the coronavirus crisis. How long can furloughing be supported? Governments have stressed that these are short-term support measures. Again a lot of the asset market strength is based on governments supporting businesses and individuals through what is supposed to be a short-term crisis until this virus eases. And easing it is but we are some way off a vaccine still as we head into unlocking economies. But how quickly will the unemployed be re-hired? If companies start failing, they will not be hiring anyone back. This brings up the question of just how far government support is prepared to go. If printing more money is seen as no longer dangerous, then why don’t we abandon taxation and pay people to not work? This idea that there is now a bottomless pit of freshly printed money seems absurd. Take it to another level and why don’t we pay all the world’s fisherman to stop plundering the oceans for a year to replenish stocks or pay the loggers not to cut down the rain forests?
I think there is a time and cash limit that governments will stick too. I don’t know how deep they are prepared to go but the casualties will start to crop up if we are still here at the end of the summer. We may well be way past peak and on the way to beating this thing but the economic impact may last a lot longer if the unemployment rates soar. In the UK, companies in the airline, retail and hospitality sectors are worried about the end of the country’s new furlough scheme in June. I do not see the global economy back on its feet and hiring again in June. In Spain there are similar worries that the government may not extend the special version of its Erte short-term leave scheme, which is supporting about 4m workers and is set to expire when the national state of alert is lifted on May 9! Japan’s PM Abe said that “the economy is in a situation he has not experienced before; the psychological situation is worse than the Great depression”. This psychological impact is what worries me with regard to the global consumer on whom the majority of economies are so reliant. Support schemes are going to have to be extended but just how far will they go? I will be interested to hear if Powell still sees an H2 recovery; it seems unlikely to me.
This week, Moody’s estimated that the US government’s announced stimulus efforts “along with materially weaker revenues and growth” stand to propel the federal fiscal deficit from 4.6 per cent of gross domestic product last year to more than 15 per cent this year. Of course the big question here is; does it matter? This is a question impossible to answer and is just one of many unknowns related to this virus issue/crisis. Will financial markets ever be the same again after all this as there seems to be a growing concern about how central banks reverse out of policies they have put in place, supposedly for a short period of time? On a macro basis, it seems clear to me that global growth is going to struggle to recover and not just because of huge job losses but the damaging impact of peak globalisation. This transition from globalisation will keep the brakes on global growth for many years in my view.
With the lockdowns, we have seen a massive swathe of businesses see that many workers can work extremely efficiently from home and this may change the way many work, with “hot desking” and less office space. The digital office boom is upon us. But this is not the only change coming from this crisis; debt looms large for the global economies. It is all very well the US, who own the reserve currency to suggest they can always sell debt but not all can say that and the issuance coming down is simply staggering; is there really the demand out there for all this? With so much debt to cover, I think it is about time that governments go after the multi-nationals that dodge tax and a fight is coming. Those tech companies that are the darlings of equity investors may not look so great when they get the tax bills. Tax collecting from these companies is surely the correct thing to do, even for Trump. On top of all this, how will the rebuilding of supply chains develop as many seem to be suggesting bringing manufacturing home or moving it? Can they be restructured and efficient in a hurry; I doubt that. But one thing is clear; and that is the peak in globalisation may be the start of higher prices for consumer goods across the globe.
The balance sheets of the US Federal Reserve and the European Central Bank are currently north of $6tn and €5tn respectively. That is equivalent to about a 13 per cent share of the global economy. Staggering numbers which seem almost incomprehensible. But weirdly the USD remains bid with the DXY still above 100 after all the Fed has done with swap lines et al. This suggests there is still demand and the US are going to have to supply more and more US dollars to the global system. That balance sheet is likely to move higher. Oil suggests we are looking at a deflationary phase and rates look set to stay low for as far as the eye can see but so too does the growth outlook and higher unemployment may be a feature as the world embraces the new digital and tech era. Many of the job losses will be permanent in my view and one thing central banks and governments cannot fix is demographics; go ask the Japanese about that. Are we all on the same road as Japan in the developed world? Well, our central banks are following the failures of the BoJ, so possibly yes.
It is believed that the US government will also do more which means more debt and more issuance. On the whole, this would translate to between $3.8-$4 trillion in financing needs for 2020 according to GS, almost a trillion dollar increase to Goldman’s prior deficit estimate, and 300% more than the US sold in calendar 2019. Financing such a massive gap, amounting to 20% of GDP, will require a broad-based increase across maturities and product types. But now it seems the favoured space is the Bills end of the curve. Such an initial surge in bill issuance makes sense only when there’s reason to believe a sizable portion of the funding gap is temporary and likely to fade quickly (it would take a huge optimist to believe that’s the case now). If we have learnt anything from Japan, it is that these policies are never taken back. Auction sizes will have to be lifted fairly aggressively across the spectrum—a conservative estimates sees increases of $12-$15bn in monthly auction sizes across the front and belly, and a more conservative $5-$8bn in longer maturities. This is a tidal wave of issuance and guess who the biggest buyer will be; yup; the Fed. This is the monetization of debt and is something the Fed is NOT supposed to be doing. Someone needs to ask Powell about this tomorrow.
The trouble is that the US and a few others are following Japan’s template and the US bond market is rapidly losing its status as a barometer for future indications on the health of the US economy. It is in the early phases of becoming irrelevant!
What does this chart above tell you? Massive risk aversion; right? Well, the S&P traded at 2890 last night. The Fed is so dominant in the US markets that they are destroying some important mechanisms. The US bond market was one of the most reliable indicators and forward looking. Extraordinary monetary policy measures are now ordinary and bonds are the most distorted markets as a result and following the dangerous and damaging path of the JGB market. At some point, the Fed and many others are going to have to be strong and reverse out of this but how; without creating an asset run? Will stimulus solve the health crisis? Will financial market manipulation solve the real economic problems on Main Street? Does coronavirus infection provide you with subsequent immunity? When will a vaccine be widely available? Good luck working out the answers to these questions from anything 10-yr government bond yields tell you.
Meanwhile, the EUR continues to under-perform and I can see this extending and with some JPY demand into Japan’s Golden week I can see EURJPY lower from here. I think a break of 115.54 could start a new leg lower and so I am recommending a short here at 116.13.
The technical outlook has been bearish for a while but I think this breaks lower again now. Stop above 117.25 for me. I think the ECB may try and do more but to no avail and I am not hearing positive news on delivering the EU package either. If they do agree than all bets are off for anything EUR related but that could take a while yet and time is not on their side. The USD strength is also an interesting story. It should be lower but isn’t, as mentioned above but realistically, the alternatives all look awful. But it is not only bonds that are losing their directional value but JPY is also rarely moving against risk aversion as it did. With stocks soaring, USDJPY has fallen in the last few days. If risk on can’t take USDJPY up then it’s probably going lower. On a much more macro outlook, EURJPY could be resuming a bigger downtrend with the next downside target being 109.48 (2016 low). In any case, outlook will remain bearish as long as 122.87 resistance holds, in case of a rebound.
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Strategy:
Macro:.
Small short S&P @ 2773 added at 2809. Stopped at 2880.
Long USDCAD 1.4140. Stop 1.3850ish.
Short EURJPY @ 116.13.. Stop above 117.25
Brought to you by Maurice Pomery, Strategic Alpha Limited.
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