Good Morning.. I thought I would be walking into lower equity markets and lower JPY crosses after the fall into the Wall St close last night as the WH steps up the negative rhetoric on China. But China export data beat expectations and AUD, AUDJPY and stocks jumped back up. But I am still of the view that the WH is going to step up against China over this virus issue and Caixin-Markit services PMI showed the second-sharpest fall in export orders and the fastest rate of job shedding on record for China’s services industry and the authorities are keen to shift to a more services-based economy. Global growth is and will be on its knees for some time yet. The EUR failed to rise and is struggling to find friends at present and for good reason. For some unknown ridiculous reason the new BoE governor has decided to announce the rate decisions at 07:00 London time before SSTg opens and at a time of minimal liquidity which says a lot about his understanding of markets. But we also have a crisis building in the EM space and TRY hit a record low today. There is shock coming soon and that may see the USD rise further. Oil and JPY crosses suggest there is danger out there but equities don’t. Jobless Claims from the US today again; just another 3mln expected so who cares; Right?
Keep the Faith
Details 07/05/20
US administration keeps China in their sights while China exports rise:
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It is becoming clear that the US administration is targeting China in a blame game for the virus as the US lurches towards a recession which could erode the chances of Trump getting a second term. Trump sent Pompeo out this time with a long list of grievances and speculation about how China handled the early days of the virus. According to Pompeo and Trump, the coronavirus that has killed more than a quarter million people worldwide likely escaped from the Wuhan Institute of Virology, a laboratory that studies some of the world’s most dangerous pathogens and yet they fail to provide us with any definitive proof. This is like suggesting Saddam had WMD; they didn’t but it suited the administration for us to believe it. This is clearly deflecting any blame and allowing Trump, who is now clearly electioneering, to suggest the forthcoming battering the US economy is about to take is nothing to do with him. That is now pretty clear but inside the halls of the U.S. intelligence community, the evidence is less definitive, while intelligence agencies around the world are also casting doubt on that theory but that would never stand in his way.
Whatever the facts are, this escalation is likely to bring the trade war back into focus and both the WH and investors need to be wary of this as equities are fragile enough without the return of trade war headlines. We saw US equities fall into the close last night, AUD and AUDJPY fell on the back of all this and my fear is that US/China relations may be becoming irreparable.
I expected to walk in this morning to a much lower AUDJPY which made a low of 67.63 overnight (well below the 68.25 break lower) but China data surprised last night and the CNH strengthened. This was due to the Chinese export data which was due to come in at -15.7% yoy but smashed those expectations with a rise of 3.5%. (However, Imports fell 14.2% after -11.2% expected). Aussie exports also grew more than expected. Also according to an article in the FT regarding China; “The public confidence has now rebounded to a reasonable level as Chinese nationals see the government’s ability to bring the outbreak under control.” Having said all that, the “independent” Caixin-Markit services PMI showed the second-sharpest fall in export orders and the fastest rate of job shedding on record for China’s services industry and the authorities are keen to shift to a more services-based economy. Bloomberg suggests Chinese leaders are contemplating “the option of not setting a numerical target for economic growth this year given the uncertainty caused by the global coronavirus pandemic.” That would not surprise me to be honest but they have been very “creative” with that data anyway.
Chinese people may now be moving around outside more but the economy has a very long way to go and so with that and the fact that the US has China in its sights, I am staying short AUDJPY for now.
The USD held onto some decent gains and I think a few decent levels are being broken in EUR, GBP, AUD and a few crosses. GBP looks rather weak and a look down at support in Cable at 1.2247 looks likely to me and EUR just cannot rally and for good reason. The EM space looks dreadful and the risks there are not being fully prices in developed markets in my view. The USD could quite easily pop quite a bit higher now but the pop higher in GBP this morning has stalled the USD rise for now.
Meanwhile, as all that was going on we heard that the US Treasury has a $2.7 trillion funding need (to pay for all those bailouts) this quarter which will lead to a record $3 trillion in debt sales just this quarter and while it has seen its issuance of Bills and CMBs explode to over $2.6trillion since March 30, it can’t rely on short-term debt which has to be rolled every few weeks and so we saw longer end disruption as yields rose.
Interestingly TBAC released its minutes yesterday and in it suggested that “the current challenge for Treasury is to increase issuance to finance the policy response while avoiding a decline in market functioning. The Committee noted that, while interest rates have reached historic lows, there are inherent risks based on the expected Treasury supply in the coming months.” I guess there are; but will the Fed not just scoop up all the leftovers and monetize the debt anyway? But it seems to me a lot of officials within the Treasury are concerned. One member of the TBAC committee concluded that the current challenge for Treasury is to increase issuance to finance the policy response while avoiding a decline in market functioning. The last thing we need now is a dysfunctional US bond market but I fear that is what we already have as the massive Fed interventions/manipulation of the bond markets is destroying the forecasting ability of bonds. Is there the foreign demand for US Bills or USTs now? Who cares; the Fed is there? But Moody’s recently expanded its “B3 Negative and lower list” which soared to its highest tally ever — 311 companies. A record number of investment grade names have been or are about to be cut to junk, unleashing the long-awaited flood of fallen angels. The default Tsunami has not hit yet be the sea has disappeared from the beach.
It is very fashionable to ignore shocking data as we all know things are bad but what we don’t know (and no one does) is how long it will last. We are expecting to see another 3mln US Jobless claims today and unemployment tomorrow is expected to hit 15%! The collapse in services PMI data and the massive jump in unemployment are notable exceptions as I am not convinced that either can rebound quickly and right there you have the core of the global economic engine. Business activity and production at US non-manufacturing industries in April collapsed to the lowest level since inception of the ISM Non-Manufacturing Index in 1997, from already weak levels in March and that with employment is the very core of the US economy. But still equity markets do not respond but oil has. Oil seems the best barometer out there at present as bonds lose their usefulness as they are so manipulated by central banks now and that includes the Fed and USTs.
The Fed is actively removing price discovery in US bond markets and it is noteworthy that stocks are getting sensitive to oil moves. How can things recover quickly when new orders have collapsed to almost zero; it will take a long time to repair that damage and supply may also be an issue with the disruption of supply chains as many pull businesses and manufacturing back home? It is quite clear that we still see issues for some time on the horizon for the supply chain, operational capacity, human resources and finances, as well as the uncertain timelines for the resumption of business and a return to normality; whatever that looks like now. Oil exporters are facing a $1.2 trillion cut in annual income, and institutional property owners are facing steep declines as tenants stop paying rent and structural declines in employment will pressure rents lower in housing and commercial properties.
Consumers are struggling to pay auto loans, mortgages, student loans and all sorts of household bills and many are going hungry. A lot of the unemployed will not be heading back to jobs as some companies won’t exist and others will be cost cutting for months. So we have corporate debt escalating along with household debt to unprecedented levels and investors expect everything to snap right back? I don’t think so. How long can bailouts last as bailouts are not a permanent substitute for income. In the short-term, bailouts are a necessary substitute for lost income but longer term, subsidising income with borrowed money weakens the currency and the economy, as productivity stagnates.
The other issue is the bashing the EM space is still getting and I am amazed I am not hearing more concerns over this. There is a real danger that the USD rises again and with that there could be real stress in the EM space and TRY, RUB, ZAR and a host of others look extremely fragile right now. In Turkey, the country’s finance minister had to jump on a call to investors to reassure them that they could get through this which is a clear sign that they probably can’t. Albayrak said that Turkey was not targeting a specific level for its currency (because that is a fight they cannot win) but stepped in only when necessary to ensure financial stability. TRY hit a record low this morning against the USD. BRL has been downgraded and the REAL pounded in recent times and I really think this is a huge risk area. I think there is a potential shock headline coming soon from the EM space as I suggested yesterday and that will see the USD pop.
But it is not just the EM space as it seems to me that a potential seismic shift is taking place in the EU and sides are being taken and lines drawn in the sand. QE programmes have completely distorted market prices across all asset classes, grossly inflated the price of financial assets and have created dire future consequences for the European economy in terms of unemployment and disincentives to growth and investment – but these aren’t issues the ECB is ever likely to admit, with its limited monetary stability mandate. They are very aware of these consequences, but to admit them would be a self-fulfilling disaster. Maybe the fact that the UK is leaving has finally done more damage to the EU’s future than that of the UK’s. I have long had a theory that with no Euro bond or banking union, there can be no EU over time and we may just be at that time of discovery now. The Germans are not going to allow all the hard-working Germans and the responsible government to do all that hard work and give it all away to Italy and Spain and right there lies a problem that is not going away. The Italians and Spanish may threaten to leave but Germany and the others know the real cost of that to Italy and Spain. So an impasse again and some form of compromise or fudge I guess is coming but they take an age to agree to. In the meantime, the EUR could quite easily keep falling.
Very briefly the BoE left rates unchanged with a 9-0 vote but voted 7-2 to keep QE unchanged with two wanting more. With liquidity so low at 07:00 in London, why on earth does the new governor think this is a good time to have a rate announcement? Clearly, he has no idea about markets which is something of a concern in itself! I still think the USD pops higher soon and so this shallow rally in Cable may well be an opportunity.
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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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