Later today, US President Trump will announce his plans for “reopening” the US economy, a process that has already started with baby steps here in Denmark where I sit (literally, as the first major step has been to reopen for the youngest children to attend kindergartens and primary schools). Today’s Saxo Market Call podcast includes a discussion of the likely very slow pace of activity resumption and the risk of fresh outbreaks of the virus from a lack of sufficient testing and protective equipment as countries open up. Observing the market, the difficulty here is in sorting through whether the recent rally is down to markets’ assumption that this process will prove relatively quick or whether the markets don’t care and only have their eyes on the central banks’ – and particularly the Fed’s – mandate to support asset prices at all costs.
I suspect the latter more than the former, but reaction to incoming data points won’t be interesting until much further down the road (the data after the opening up has thoroughly been established) as the market has already shown that it is willing to discount just about anything in the near term.
The brave new world of FX trading
Looking out over the horizon beyond these recent fits of risk-on and risk-off we need to consider how this crisis has changed the focus for exchange rate perspectives and what a post-Covid19 trading environment looks like for FX. After all, what are FX traders to use for fundamentals in a world where all policy rates in DM, for example, are pegged near the same levels and where one central bank after another is likely to slip into yield-curve-control mode to keep rates low all the way out the curve capped? (The YCC proves the most necessary and interesting as a policy once overt monetary stimulus becomes sufficiently massive to finally durably raise inflation fears and put longer term treasuries under pressure)
In markets, if you put your interventionist thumb down on one asset class – here sovereign bonds and policy rates for the entire curve – then another asset class will have to become the speculative vehicle to absorb the implications, for example, of what one might call the “relative financial repression game”. In this game, the key inputs for the FX trader are relative current accounts, which should loom larger in a world where capital markets are less dynamic and more manipulated than ever, and the severity of financial repression, i.e., to what degree the money printing in a given country is taking inflation beyond the policy rate – the relative ugliness of the negative real yield. In this game, FX could risk becoming the preferred instrument to trade and keep volatility quite high with every policy move and inflation release. At least, I would like to think so – imagine the depressing outlook for sovereign traders from here – stuck with capped yields and terminally manipulated markets. Even corporate bond fundamentalists must be throwing up their hands in disgust after recent interventions.
We continue to watch political signals out of Italy and among EU leaders as we await a meeting of EU finance and economy ministers today and next weeks. Yesterday’s session saw Italy-Germany spreads widening to as much as 240+ basis points versus 222 as of this writing and on the podcast and in the first slide of today’s slide deck for the podcast I pointed out the local divergence in the Italy CDS prices (insurance on Italian default) are somewhat divergent relative to the Germany-Italy yield spread, which the ECB can impact more directly. EURUSD saw a weak session yesterday, but the chart just continues to coil around in a shrinking range and doesn’t begin to break down unless we start to head south of 1.0800.
Given our discussion above of the local focus on risk-on and risk-off versus the possible longer term future focus on “relative financial repression”, Canada will need to mobilize massive stimulus to get ahead of the credit crunch unfolding in its private sector (especially housing) as well as the immediate emergency of a collapsing energy sector. At yesterday’s Bank of Canada meeting, the BoC expanded its menu of asset purchases to include provincial bonds and corporate bonds and presented scenarios in which Canada’s Q2 GDP falls between 15-and 30% annualized (Q1 estimates already at 10% annualized for Canada). Yesterday saw a fairly chunky rally in USDCAD that established the key line of support and gives heart to bulls looking for a retest of the top in the days and weeks ahead – while if the Fed’s and US treasuries combined efforts sufficiently succeed in forcing asset markets higher, the USD may yet fade here – the recent 1.3855 lows are the line in the sand.