Good Morning.. Pretty quiet overnight but early USD weakness was reversed as China data disappointed with imports falling steeply, which is not good news for an economy supposedly recovering quickly. AUD took a hit having regained .7000 briefly and the USD rallied generally but I think the USD has turned and may yet fall further. On that note I have added to the long EUR recommendation but I have moved some stops in AUDJPY and USDJPY up to entry points in case we stall and consolidate for a while with USDJPY testing 110.00. But I am watching bonds very closely, especially USTs and the curve. Rising yields maybe be part of the dumping of hedges or risk aversion trades but at some point rising US yields could hit asset prices. I will be interested to hear what the Fed has to say about this yield rise but they will be happy with the shape of the curve and the boost to the global economy from a weaker USD. He may have something to say about YCC as a few Fed speakers have flown that kite last week. I am not sure much has changed over the weekend and this current moves could extend.
Keep the Faith.
Details 08/06/20
What does the Fed do after THAT NFP data?
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We have an FOMC meeting this week and it will be interesting to hear how the Fed views what was an extremely interesting, if not shocking week last week. To say the US NFP data was something of a shock on Friday would be an understatement to say the least and it had academics and economists scratching their heads but there is a potential reason for this but even if we take that into account, the data was better than expected. (The BLS itself admitted that a “misclassification error” led to the unemployment rate being as much as 3% higher than reported.) One can only imagine what other “survey errors” were made but not fixed for the sake of “data integrity.” So, does that mean the Fed has done too much? Have they panicked and gone all-in just at the bottom? This is an interesting question if the data can be taken at face value. UST yields spiked yet again and there seems to be something of a rout in longer dated Treasuries and global bonds in general.
Not only did May payrolls not drop by the 7.5 million expected drop, but actually SOARED by 2.5 million, crushing expectations, and indicating that already in May when the country was under widespread lockdowns, jobs came soaring back. Not much of the NFP data makes sense; adding to the confusion is that ongoing Unemployment Claims surged after the April survey period and then they retreated by the end of the May survey period but even here the increase was 3M+ in ongoing claims. Something is wrong here.
This is an anomaly of those furloughed and receiving the bailouts but the long end of the curve is moving at pace and is seemingly heralding the all-clear for risk. The curve is steepening and to be honest just about every safe haven is being dumped.
The yield curve is starting to help the banks and I am not sure at all that this equity rally is just retail FOMO. All I will say here about that, is that the market is now throwing in the towel on hedging risk. It is getting long the market quickly. Gold is lower, oil is up, the JPY and CHF weaker and bonds are dumping! Could there be a broader signal of markets adjusting to risk on? Maybe the return to jobs is far quicker and stronger than expected but do we really think that all jobs will be safe? Not a chance as cost cutting is coming and some businesses are no longer around for those laid off to return to.
But again, does the US really need as much policy support as it is receiving and what side-effect could current policy be throwing up? It will be very interesting to hear what the FOMC and Powell have to say about this later this week but I still think we need to keep a clear focus on the consumer in all this and it appears that money received is going into saving or more importantly, to paying off debt and not spending.
This is healthy in one perspective but we have to acknowledge that the consumer has been using credit (debt to you and me) to finance a lifestyle it clearly cannot afford for some years now. If that is no longer the case, then growth in the US is in real trouble and so too earnings. US consumers repaid the most on their credit cards ever. I have mentioned the psychological state of the US consumer being important and this is the first evidence of some serious concern. Meanwhile the Fed continues to taper bond purchases to $4bln a day now which will undermine the already weakening bid in USTs. Are we about to hear more policy moves from the FOMC this week and possibly something on YCC as that kite has been flown by a few Fed speakers recently? I am not sure the “system” has come through the two hits from 2008 and 2020 yet unscathed let alone fixed; the central banks have bought time; that’s all.
I am keeping a watchful eye on global bond markets but especially the USTs at present, which, to be honest, seem to be suggesting the recovery has started. But we need to be careful with that assumption as while the market maybe starting to price an earlier recovery, are bonds also suggesting that all the Fed stimulus may come with a nasty side-effect? Surely, we can’t see inflation start to show up, can we? I would think not for now but 10yr and 30yr bonds seem to be suggesting some concern.
What will happen to global equities if global yields keep rising? I am sorry but they both cannot rise for long and I am wondering if vols start to spike in bond markets and become something of a pain trade as it would lead to substantially tighter financial conditions and thus, a hit to asset prices. 10yr USD real rates are up almost 25 bps on the quarter and this could start to pressure equity markets with something of a lag as shown below.
The start of the recovery may have happened for all I know and to be honest, the only real safe haven out there was the USD and that is looking very much like the move higher is over and done with. We know the central bank stimulus has been huge and unprecedented but coupled with the government’s fiscal dynamics as well, the boost globally is absolutely massive. The FOMC this week could be very interesting as a few speakers have been out flying kites regarding the use of YCC as Japan has done.
There is a lot of cash still residing in MM funds and the US equity market, according to recent data, is not burdened by massive longs yet. The US household savings rate is currently 33%; US mortgage loan applications/housing demand is surging; China service sector PMI highest in 3 years and the US labour data was a shock and there have, to date, been none of the expected credit events! Could equities keep rising with S&P hitting 3,300 or 3,600? Maybe so but that would see bonds collapse and that could change everything as higher US yields brings the debt issue into play. Right now, the bond move may suggest risk on but much more of this and the signal will shift from green to red. AUD fell last night after trading briefly above .7000 again as China data saw the trade balance explode higher with imports worryingly falling steeply. China May Exports came in at -3.3% y/y vs -7% consensus with May Imports -16.7% y/y vs -9.7% consensus. That is a steep fall in an economy that is supposedly recovering fast!
Meanwhile the USD is a top topic for discussion and where it may go from here. The USD was the “go to” currency in the height of the risk off phase but even before that, the USD had been in demand due to higher US rates and a leading economy and stock market. The position at the top of the world’s tech table saw foreign money flood into US tech firms and dollars were bought to pay for stocks. Plus there were fundamental flaws and weaknesses in many other currencies like the EU and GBP over the last few years and the AUD link to a faltering China kept the lid on that too. Countries were slashing rates and the differential played an important role but also Trump was way ahead with embracing MMT and spending. All of this worked into a very large long position in USD’s which may now be being unwound as we see a reversal in just about all of the above. This USD sell-off is good news for commodities and the EM space and can help global trade. Demand seems to be back for Iron Ore, Copper, oil and many others. The point here is that global capital, which was directed to the US as the only game in town, has been and can continue to be re-distributed. On that note I am adding to the long EUR recommendation here at 1.1285 and moving my stops up to entry levels in AUDJPY and USDJPY (see bottom of the piece below).
We have seen some potential game changing events in the EU with the ECB building a huge arsenal to fight market liquidity issues and keep rates down but the shift by Germany towards spending is a huge move for me. Plus they have offered up a deal to issue joint bonds with France, which if passed, would signify a greater potential for this union to develop and remove some doubts over its future. Both suggest bunds may lose its support as a safe haven against the existential threat within the EU structure. Positions in EUR were massively short and this may be unwound, especially so if the joint bond is ever passed but we may not get that decision for some time yet but it could be a huge step. EU equity markets like the DAX have outperformed as money is sucked into markets there supporting the EUR. The UK/EU trade issue is a still a cloud but many seem to think that they will fudge a deal as it is in both interests to do so but I am not sure about that. My long recommendation in EURGBP is not looking good again though as we rejected a move above .9000 again on Friday and the techs are turning against me. But I will leave the stop in place as I think Johnson is prepared to walk if the EU is as intransigent as ever over this trade deal.
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Strategy:
Macro:.
Long EURGBP @.8978 added @ .8940. Stop at .8825
Long USDJPY @ 108.58.. Stop at entry
Long AUDJPY 75.30.. Stop at entry
Long EUR @ 1.1360.. Stop at 1.1200ish. Added today at 1.1285.
Brought to you by Maurice Pomery, Strategic Alpha Limited.
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