Good Morning.. A quiet session in Asia but again the USD holding decent gains and I think there are a couple of reasons for this now (see below). EURGBP is off the high and we still need to break and close above .9054 to see a new leg higher but I think it is coming as the UK economy, despite better data this morning (Retail sales) and overnight (GFK Confidence data), is going to recover slower than many of its piers and we still have a trade deal to negotiate in short time. Cable weakness was exacerbated by a stronger USD and the BoE which to be honest was less dovish than I expected but the market sent a clear signal that they do not agree with their optimistic assumptions. GBP and some of its crosses are starting to trend down again. Data everywhere is starting to improve after the unlocking and fully expected and now we wait to see who emerges first and strongest from all this. The US is talking of more fiscal support of $1trln and the EU may yet agree (not today) on the balance between grants and loans and get this Franco/German deal passed. I see the UK as coming third in that race. Also FX hedging costs have fallen to levels where buying US assets is a viable option again for those with negative rates like Japan or the EU. The USD remains bid. We have some huge US equity expiry’s today so beware around expiry time and it is also a Friday, so “Be careful out there”..

Keep the Faith..

Details 19/06/20

Markets less optimistic than the BoE and expected more. Negative rates push investors into USD and US assets.

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GBP got hit quite hard against most yesterday after, what on the surface seemed, if anything, a rather less dovish announcement. Short-term expectations were naturally weak but a quick recovery seen and they even suggested a slowing of the pace of Gilt purchases. They did vote for an additional £100bln for the QE programme and again, I think the market wanted more as it seems to me that they may be back in late summer having to justify why they are topping this up again and interestingly, the normally dovish Haldane (chief economist) voted against this increase. Either way GBP got hit quite hard with EURGBP back testing the recent highs near .9050.

The cross (daily above) could be about to start a new leg higher and a break of the recent highs could be significant as the bands start to diverge and I maintain the long recommendation (We need to break .9054 or we are in danger of a double top). The UK government is going to need the BoE to keep a cap on yields as they embark on a massive spending spree to help get the country through this crisis and the UK, in the middle of all this, is facing a tough trade deal to sort out with the EU in a short period of time. With Johnson now committed to no extension, he will need a deal early Autumn at the latest to prepare businesses for the outcome, which may yet be no deal. That Brexit clock is ticking loudly now and investors do NOT like uncertainty which the UK has in spades. UK consumer confidence data and retail sales data beat forecasts this morning but came off very low levels and GBP hardly budged.

Meanwhile the EUR leg of the cross could get a boost if and when the EU agrees to the Franco/German joint bond venture and I think it is just a matter of defining what percentage difference there will be between grants and loans for an agreement to be found. Today, European leaders will open negotiations over the proposed €750bln program to help their economies rebound from the Covid-19 lockdown, with Germany and France pushing for a deal to be wrapped up next month. This is part of the reason why I had suggested a long in EUR which unfortunately got taken out yesterday at 1.1200. But EUR crosses remain bid as a lot of the move yesterday was a dollar rally, which may extend but EUR strength against GBP remains firmly in place. IF this really is the EU’s moment, as Von der Leyen says it is, then this needs to get done or a lot of faith in the future of the EU will dissolve quickly.

At stake is a radical European Union plan to finance the recovery and tackle divergences in the region’s internal market that have widened as a result of the different national responses to the outbreak according to some but the inequalities in the Union have been an issue since inception. The program, which needs the backing of every nation does have its detractors. It would be funded by joint debt issuance which could be seen as a significant step toward closer economic integration. In my opinion, if they cannot get this done then the EU cannot really move on to a full union. This is indeed their moment but a deal is not expected at this meeting today; we may have to wait. No surprise there with the EU.

It was interesting yesterday after the BoE announcements, as GBP fell as yields moved higher. Some investors were rather surprised by the Bank saying it’ll slow its purchases because stress in financial markets has eased, while reserving the option to accelerate them up again if needed (they will in my opinion). Bonds fell, sending the yield on 30-year securities up 10 basis points, while the pound weakened more than 1%, which to me was a rather clear message to the BoE of a lack of confidence in their assumptions.

Cable is starting to trend lower again and is not helped by a return of USD strength. I have been discussing the USD strength here since the US retail sales data at the start of the week and it seems to have been something of a turning point with the DXY moving above 97.50 at one point yesterday and I think that has caught quite a few wrong footed.

The USD started rising just after the US retail sales data and didn’t stop even with a greater than expected rise in Jobless claims and if US Leading indicators are anything to go by, then the US economy is still in deep trouble. So why the USD strength?

I still think this is based on the fact that the US economy may recover more quickly than say the EU, Japan or UK. In addition, negative rates elsewhere are still playing a role. Japanese investors faced with negative domestic rates, are allegedly buying USD & risk assets; in April, Japan’s money managers bought the most US corporate debt in 8years and the second-highest amount of equities in 5years. It also looks like Trump is going to push hard for a further $1trln to throw at the problem and has fully embraced MMT as policy for getting the US restarted. He also seems happy to now put livelihoods over lives and get everyone back to work. The market has been waiting to see who in the developed world start to emerge first but the US is still suffering from rises in hospitalisations from the virus so the USD move may fade. But for now I can see why it is bid and in addition to this, FX hedges have collapsed again and so foreign countries like Japan and the EU may find US assets and Treasuries a viable investment again. I think this is important to understand when looking at the USD

Meanwhile the decoupling between the market and the economy has never been wider (below just another example).

S&P is mid-range here somewhere between 2930 and 3250 and we have some huge option expiry’s today and so with all that gamma floating around I think we may be quiet until expiry time barring left-field headlines. But US earnings dropped in the first quarter by 16%, the biggest decline since 2008, and are poised to fall again in the second quarter because of business disruptions tied to the coronavirus. Yet the S&P 500 has recovered most of its 34% plunge after setting a record in February. It seems that TINA is alive and well for now at least and history is littered with episodes like this that didn’t end well but we have never seen the amount of combined stimulus; ever.

So what can change all this? If we look around the world right now, we have some simmering risks; that’s a given. For a starter, we have Trump breaking down the global trade machine and pushing countries into a more protectionist stance while at home in the US we see a far more populist and nationalist government. This inward move will see a spike in geopolitical tensions and we are seeing this in many flashpoints around the globe, with Iran antagonising the US, N. Korea actively flexing its muscles on the Korean peninsular and Russian planes messing about in US airspace, let alone the China/India spat on their border. The danger of an accident turning into something bigger is extremely real. Wars can start on the smallest of instances. If Trump thinks he is losing the election, then he may lash out as Presidents have done in the past. Conflicts between Beijing and Hong Kong, and even Taiwan, are heating up again and the US sits in the middle selling arms to Taiwan and becoming actively involved in Chinese politics in HK. Relations between the two super-powers have never been worse and I haven’t even touched on the impact on global trade where globalisation is being broken down and we still have no vaccine for Covid.

We hear so much about how much the Fed is doing and how many new experiments it is trying but at the same time they are still pulling back on some strategies. Repos are being unwound along with USD liquidity swaps. I note with some interest that total assets on the Fed’s balance sheet for the week ended June 17, released yesterday actually shrank by $74 billion:

This $74 billion decline in total assets during the week was powered by a plunge in repo balances and foreign central bank liquidity swaps, while some alphabet-soup programs also unwound. And the junk-bond and ETF buying program stalled.

It seems to me there is a significant shift taking place at the Fed and I am not sure the broad market is aware of this. We all know the Fed props up markets and calls for the government to help with fiscal policies. But the Fed has started lending to entities, including states and banks, under programs that channel funds into spending by states, municipalities, and businesses, rather than into the financial markets. These types of programs are propping up consumption – not asset prices. That’s a new thing. I don’t think the hyper-inflated markets, which have soared only because the Fed poured $3 trillion into them, are ready for this shift. At the same time repo’s on the balance sheet are vanishing fast. The Fed is very aware that the velocity of money is as important as money supply. There are now three SPVs that route funds into consumption rather than asset purchases: The Paycheck Protection Program Liquidity Facility ($57 billion), the Main Street Lending Program ($32 billion), and the Municipal Liquidity Facility ($16 billion). This is not QE but more like paying businesses and municipalities, and ultimately workers/consumers, to consume. This money is circulating in the economy rather than inflating asset prices (money velocity). I am not sure many have spotted this as I read little on it. US equity markets are extremely sensitive to Fed balance sheet moves. The support they expect may be dwindling as the Fed may be focusing elsewhere.

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Strategy:

Macro:.

Long EURGBP @.8978 added @ .8940. Stop at .8900

Long EUR @ 1.1360.. Stop at 1.1200ish. Added at 1.1285. Stopped at 1.1200

Brought to you by Maurice Pomery, Strategic Alpha Limited.

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