US Presidential debate farce, Compass points way to more lockdown worries

Morning Note

Staying up for the first Presidential debate would hardly have been worth it. Unedifying is the best word to describe. Biden held his own and the president missed his chance, mainly by talking over his rival at any opportunity; he did not allow Biden enough rope to hang himself.

Race featured prominently, but Trump only played to his base. This was the disruptive, abrasive Twitter Trump. We await to see whether the spectacle has had any impact on the up to one in ten voters yet to make up their minds. As grandpa Wilson would have said, I hae ma doots.

And as I keep saying, what matters in the US Presidential Election will be turnout in key battleground states and for this Trump needs it to be as rancorous as possible to energise his base. There is talk Biden won’t want to do more debates – that would be a mistake and make him look worse than he does after a relatively successful outing for the Democrat nominee, given the low expectations.

Equities down – will rebalancing give Wall Street a lift?

Stock markets fell yesterday, with European bourses down but off the lows. The FTSE 100 ended under 5,900. The S&P 500 butted its head against the 50-day moving average and came off to finish at 3,335.

US futures indicated further losses for Wall Street after the debate concluded. Asian markets were mixed. European stocks were mixed at the open but turned green after a weak start and the FTSE 100 rose above 5,900 with a weaker pound helping.

Month- and quarter-end rebalancing flows may make for volatility today. With US stock markets enduring a tough month there could be some reallocation back into equities that lifts Wall Street later.

Treasury yields ticked lower with bonds finding some bid, with the 10-year benchmark yield to 0.64%, its weakest since the start of September. I think last night gave the market a taste of the kind of election jitters to expect – the only thing the market wants is to get this election out of the way and draw a line under the whole charade.

Having kicked on from the 100-day line, gold firmed as TIPS moved more into negative territory but failed to clear $1,900.

Dollar slips lower, ADP in focus ahead of Friday’s NFP

The response in FX to the debate was a bit ‘meh’, but the dollar continued to ease back off the highs struck late last week and early this week, with DXY moving under 94, with bears eyeing the support at 93.70.

Later today is the ADP nonfarm report, which comes two days before the final NFP report ahead of the election. GBPUSD declined in early trade to test the 1.28 round number but the pair remains very much in its range of 1.27-30 that has bounded the price action for the last 3 weeks.

Britain’s economy contracted the most on record in the second quarter, albeit the 19.8% drop in GDP was less than the previously estimated 20.4%. Whilst this is backwards looking, just how optimistic can we be about the near future?

Compass Group uncertain about the future

Rising cases here threaten to mean further restrictions on our liberty that will act to further depress economic activity and consumer sentiment. Meanwhile unemployment will undoubtedly rise, harming the consumer sector even further.

Compass Group’s pre-close update contained some worrying signals for investors about this very problem, with management warning that the pace at which revenues and margins will recover remains unclear, especially given the possible increase in lockdown measures in the Northern Hemisphere through the winter months.

Group revenues fell about 19%, with Europe –25%, North America –19% and the Rest of World –9%. Sports and Leisure businesses in Europe and North America remain closed, but there has good recovery in Education and Healthcare.  Shares fell 4%.

Lockdowns and expected disruption to arrangements mean airline shareholders need to keep a close eye on forward booking trends. Flight searchers are down anything from 60-80% from a year before, according to Kayak. The chart below shows demand for the UK over the course of the year. The figures for the rest of Europe are comparable.

Talk of negative interest rates has been doing the rounds a lot on Threadneedle Street of late. But the Bank of England would be well advised to consider a Federal Reserve study that says the European Central Bank (ECB) made a big error when it opted for negative rates.

As repeatedly stressed in these columns, negative rates represent a monetary policy black hole from which it is very hard to escape and it harms banks, eroding their profits and capital ratios over time.

The study from the San Francisco Fed notes that “banks expand lending only temporarily under negative rates” and “as negative rates persist, they drag on bank profitability even more”.

It concludes: “While lending initially increases under negative rates, our analysis implies that gains are more than reversed as negative rates persist. Overall, our results suggest that caution is warranted when considering negative monetary policy rates to encourage additional bank lending. Under extended negative rate episodes, evidence shows that both bank profitability and bank lending activity decline. This calls into question one of the primary motivations for negative policy rates.”

Chart: Negative rates are meant to increase loan growth, not depress it

Elsewhere in commodities, oil was softer as the API weekly inventory data showed a small draw on crude stocks while there was a build in gasoline inventories. As noted yesterday, traders should be wary of global onshore inventories flipping from draws to builds

The American Petroleum Institute recorded a draw of 831k on oil inventories whilst gasoline inventories rose 1.6m vs expectations for a draw of 1.3m. Oil stocks at Cushing, Oklahoma rose by 1.61m. As data points to a slowdown in the velocity of people, demand for oil is already rolling over and stocks may well start to build without China hoovering up the excess.

EIA data on tap later today will provide further guidance for markets. WTI (Nov) retreated to a two-week low at $38.42 but recovered $39, which is forming the near-term support. September lows at $36 are in focus.

Risk appetite resurfaces, HSBC shares soar

Morning Note

Risk appetite has returned after last week’s turbulence. European bourses rose 1-2% in early trade on Monday after Wall Street’s rally on Friday lifted the boats. The S&P 500 was still down for the week, but with the broad market -10% from its all-time highs at the low, those looking for a correction after the hot summer rally may have found it already.

The market tested 3200, which is where it reached at the peak in June before the pullback and where it closed 2019. Bonds have not taken part in the drawdown – US 10-year Treasuries have barely budged this month and remain stuck around 0.66%. This might imply that the September sell-off is more about a repricing of risk assets based on valuations and profit-taking after the summer run-up, rather than deeper fears about a prolonged stagnation in the economy.

Volatility likely on US presidential debate, NFP this week

Nevertheless, with the first US presidential debate and the last jobs report before the election coming this week, there is ample scope for markets to remain volatile. Until we clear the highs from a fortnight ago – 3400 on SPX, around 3300 on Stoxx 50 and 6,000 on the FTSE, the downside bias remains.

Rising numbers of coronavirus cases imply a softer recovery, depressed consumer sentiment and the need for more fiscal support to generate upside. Markets don’t seem to be moving too much on vaccine news and rumours – there may be a realisation that a vaccine is not a silver bullet that will repair all the damage done in 2020, even if it makes 2021 look brighter.

Ping An adds to HSBC stake

HSBC shares rallied 10% after Ping An Asset Management increased its stake in the bank. HSBC’s largest shareholder only marginally bolstered its holding to 8% from 7.95%, but the vote of confidence translated into a very substantial rally for the shares both in Hong Kong and London.

HSBC had lately sunk to a 25-year low after being named in reports relating to money laundering, so maybe this was some simple averaging-in by Ping An. Shares are only back to where they were a fortnight ago – when stocks have been beaten down as much as HSBC they are often ripe for larger percentage swings as investors try to figure out what is the real value.

If you think Britain’s banks are fundamentally sound, shares are priced compellingly. Lloyds at 25p trades at 0.35 of book value.

BoE Tenreyro defends negative rates

Bank of England rate setter Silvana Tenreyro defended negative rates in an article over the weekend, in what we could construe as a careful piece of choreography to communicate the bank’s shift towards a state of outright financial repression.

She said there were ‘encouraging’ signs that there are no longer the same obstacles to cutting rates to below zero. But she’s been positive on negative rates for several months so we should probably not read too much into her comments.

Andrew Bailey remains the most important voice of the MPC and whilst he did not seek to quell speculation last week that the Bank is considering how to use negative rates, he did stress that it’s not in a hurry to pull them out the toolbox.

Brexit talks in focus for GBP

Brexit talks resume this week and despite all the noise, both sides want a deal. Whilst the UK threw a spanner in the works with the internal market bill, the real substance of the trade deal is what matters. On that front the EU and UK are about 90% there. The problem is the remaining elements and without these sorted there is no deal.

Nevertheless there is hope that they will enter the ‘tunnel’: the period of closed, detailed talks that would lead to a deal. If there is white smoke this week then sterling will rally strongly, but I would expect this to drag on for a while longer, for deadlines to be missed and for GBP crosses to remain exposed to negative headline risk.

The euro retained its downside bias after more jawboning from the ECB.  Ignazio Visco, Italy’s central bank governor, said the euro’s recent strengthening is “worrying us because it generates further downward pressures on prices at a time when inflation is already low”. A slate of ECB speakers this week are likely to lean hard on governments to deliver fiscal support.

Chart: GBPUSD tests near-term resistance at 1.28

Stocks attempt rally after selloff, sterling down on Bailey remarks, Kingfisher enjoys DIY boom

Morning Note

Stock markets firmed in early European trade but remain battered and bruised by yesterday’s sell-off as fears of a second wave of cases and new lockdown measures dealt a blow to risk sentiment. Selling pressure has been building for some time and the dam broke yesterday.

A recovery in the final hour of trade lifted the market off the lows so it wasn’t full capitulation, but there could yet be more downside as the S&P 500 approaches correction territory.

SPX, Dow tumble, tech strength stems Nasdaq losses

The S&P 500 declined by 1.2% and the Dow dropped 1.8% but tech stocks fared better with the Nasdaq flat for the day. Shares in Apple rose 3% and Microsoft was up 1% as some of the Covid winners showed more resilience to fears over second waves of the pandemic and fresh lockdown measures, which seemed to be the trigger.

Despite the heavy selling, bulls put in a strong finish – the Dow was down over 900 points at the low before ending –500pts. At its lows the S&P 500 plunged by as much as 2.7%. Nevertheless, the broad market is now already –6% for the month of September, has notched four straight daily declines for the first time since March, and is over 8% off its all-time high.

The FTSE 100 fell over 3%, breaching the 21-day simple moving average line. Despite the pressure the bulls just held the 5,800 round number and closed above the Sep 4th low of 5,799. The Stoxx 50 breached the July lows and is now close to its Jun bottom having sunk under its 200-day SMA. The move follows a clear period of congestion that was calling for a breakout, having been caught in an ever-narrower range.

The DAX fell almost 4.5% with heavy selling into the closing bell seen as bears tried but failed to crack the 12,500 round number as the 78.6% retracement of the Feb-Mar rout held. There were modest gains in early trade on Tuesday but the rally looks a little wobbly.

Fading hope for another round of stimulus in the US is another weight, with the death of Ruth Bader Ginsburg over the weekend seen as a decisive blow against a bipartisan deal being achieved before the election, since it materially magnifies the polarisation in Washington. A deal will need to wait until after November 3rd.

In addition, a heavy ramp up in August with far too much hot money chasing too few shares, increasingly stretched valuations, the lack of a vaccine on the horizon and the rising risk of volatility around the US Presidential Election – and uncertainty over whether we will get a clean result – seems to have caught up with the markets.

UK government set to introduce new Covid curbs, Kingfisher gets DIY boost in Q2

The UK government is set to introduce fresh measures to ‘control’ the virus – curfews and working from home if possible. What a difference a month makes – only a few weeks ago we were being implored to get out and about to help out. It’s almost like they don’t know what they are doing.

While pub shares fell on curfew news, several earnings reports today highlight the uneven nature of the recovery so far, and the uncertain path ahead.

Tui – uncertainty over the course of lockdowns and quarantine rules is leaving holidaymakers unsure about booking in the coming months. The winter 20/21 programme has been further reduced by 20% since the Q3 update, to around 40% adjusted capacity, reflecting ‘the current uncertainty relating to travel restrictions’. TUI says it is currently 30% sold for the adjusted winter capacity.

Compared to the normal levels of prior year, bookings are currently down 59%, in line with adjusted capacity. Consumers are much happier to assume things will be ‘back to normal’ by summer 2021. Tui says bookings are up 84% but at 80% adjusted capacity, however we should caution that much of this will be pushback demand from this summer as consumers changed travel dates to next year.

Cost-cutting has helped TUI weather the storm – that and some whopping bailouts from the German government, but it and the entire travel industry needs governments across Europe to give far greater clarity over restrictions and quarantines. Shares rose a touch but the rest of the travel sector was weaker with Carnival off another –4% and IAG down –3% after a drubbing yesterday.

Kingfisher enjoyed a strong recovery in Q2 as DIYers tackled their jobs lists. This recovery has continued into Q3 to date, management say, with growth across all banners and categories. Q3 20/21 group LFL sales to Sep 19th are up 16.6%.

DIYers are driving the recovery – sales at B&Q rose 28% in Q2 on a like-for-like basis. Trade less so – Screwfix LFL sales were up just 2.4%, though they are +9.9% in Q3 so far – as the construction industry struggles to get going again. Overall UK & Ireland sales rose 2.4% in the first half despite lockdown as people rediscovered their homes and their desire for improving them. French bounced back strongly, with Q2 sales +27% vs the –41.5% decline in Q1.

First half sales were –5.9% lower. Overall H1 sales were a tad lighter but cost reductions meant adjusted pre-tax profit rose 23% to £415m, with retail margins +140bps to 9%. Shares rose 6% in early trade and have more than doubled off the March low.

Dollar climbs on Fed jawboning, BoE’s Bailey to speak today

In FX, the rollover in risk sentiment and some interesting Fed jawboning played into the dollar bulls, with DXY sustaining a breach of the channel on the upside and clearing its 50–day SMA, which had been a key point of resistance last week. Gold retreated under $1,900 at one point with the stronger dollar weighing.

The Fed’s Bullard said the US has done enough on the fiscal front, whilst Dallas Fed president Kaplan stressed that the Fed should not keep its hands tied by committing to ZIRP forever even if the economy bounces back. Powell stressed that the Fed will use all its tools to do whatever it takes.

More Powell today plus Bank of England governor Andrew Bailey, who said in remarks this morning that the recovery in Q3 has been ahead of expectations but stressed that the hard yards are ahead.

All the market wants to know is whether negative rates are coming or not – he said the Bank has looked ‘very hard’ at the scope to cut rates further, including negative rates. So this was not the attempt to distance the MPC from the negative rate comments in last week’s release to give the central bank more flexibility. As the MPC indicated last week, Bailey wants to leave negative rates on the table.

GBPUSD was under fresh pressure under 1.28 and could be set up for a bear flag continuation with a possible dive back to 1.22. If this holds, bulls need to clear 1.30 to be encouraged. The key test is the 200-day EMA around 1.2760 which was tested last week and held, encouraging a rally back to 1.30. Cable shed this support in the early European session as Bailey got on the airwaves – one to watch today with the 100-day the last line of defence.

Flattening the curve? Equities pull back

Morning Note

The daily rate of global coronavirus has hit a new high of 106,000. Whilst the likes of Italy, Spain and Britain get things under some degree of control, elsewhere it’s not looking so good. Of course, the economic effects of the pandemic have very little correlation with the disease, but the response by governments to lock down. The worry is second and tertiary waves are coming, and developed nations fall back on their lock down playbook. It’s far from over.

Markets remain choppy as investors play the waiting game, whilst oil prices have risen again as inventory data painted a bullish picture. PMIs from Europe this morning show improvement but coming off an exceptionally low base in April. Germany’s services PMI jumped from 16.2 to 31.4. France’s rose from 10.2 to 29.4.

It’s a step in the right direction, but remember how these PMIs are calculated – respondents can only answer if the state of their industry is better, worse or the same as the month before. Contraction is still the state of play. Overnight data showed Japan’s exports down 21.9%, the worst decline since 2009; whilst South Korean exports also plunged.

Stocks rose yesterday but eased back today as Asian trade data worried investors. The S&P 500 hit its best intra-day level since March 6th at 2980 (2985 on March 6th was the high), closing at 2971 vs the close of 2972 on that day. The 200-day simple moving average sits just above but the 100-day line has provided the topside resistance for the last two sessions. Futures indicate a lower open.

The FTSE 100 rose 1% on Wednesday but handed back the gains at the open as European stocks faded. Equity indices are near or at the top of the ranges are still posting weekly gains. The US is creeping ahead of the pack with big tech driving things – Facebook soared yesterday after it announced a new e-commerce business that could take on Amazon. The Nasdaq rose 2%, ahead of the broad market, and is up for the year and not far away from its all-time highs.

Oil prices rose firmly after a bullish inventory report from the EIA. Crude stockpiles declined by 5m barrels in the week to May 15th, against an expected build of 1.2m barrels. But it was less bullish when you dig deeper into the report. Gasoline stocks rose 2.8 million barrels vs an expected 2.1m drop. Distillate stockpiles were up by 3.8 million barrels, which was more than expected.

WTI (Aug) pushed up above $34 and is looking to close the March 6th-9th gap. Oil is riding higher on great-than-expected loss of output in the US. After the EIA this week predicted a sharp decline in US output next month, the concern will be that higher prices sees the taps opened again.

Andrew Bailey, the governor of the Bank of England, chose his moment well: just as he told MPs that the Old Lady is prepared to consider negative rates, a UK gilt auction delivered a negative interest rate on three-year paper.

The fact that the government can get paid to borrow money shows just how much central banks have already become ‘the market’ for sovereign debt. The problem is, as discussed in a recent note, getting out of a negative rate cycle is tricky and the Eurozone and Japan are hardly poster children of monetary policy success.

Minutes from the Fed’s last meeting were also released yesterday and showed a willingness to look at yield curve control, and still indicated no desire to go down the negative rate path. Once you go down it, it’s exceptionally difficult to get out. Moreover, it’s bad for banks and the financial system and doesn’t make consumers more likely to get out and spend.

Chart: SPX tests 100-day resistance

Negative rates: not now Bernard

Morning Note

Not Now, Bernard is a children’s story about parents who don’t pay attention and don’t notice their son has been gobbled up by a monster, which they duly allow into the house. One could make parallels with central banks and the monstrosity of negative rates.

Last week a strange thing happened: Fed funds futures – the market’s best guess of where US interests will be in the future – implied negative rates were coming. The market priced in negative rates in Apr 2021. It doesn’t mean they will go negative, but the market can exert serious gravitational pull on Federal Reserve policy. Often, the tail wags the dog, and the market forces the Fed to catch up. Of course, given the vast deluge of QE, it’s not always easy to read the bond market these days – central bank intervention has destroyed any notion of price discovery.

Now this is a problem for the Fed. Japan and Europe, where negative rates are now embedded, are hardly poster children for monetary policy success. Nevertheless, the President eyes a freebie, tweeting:

As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the “GIFT”. Big numbers!

The Fed needs to come out very firmly against negative rates, or it could become self-fulfilling. Numerous Fed officials this week are trying their best to sound tough, but they are not brave enough to dare sound ‘hawkish’ in any way. Minneapolis Fed president Neel Kashkari said Fed policymakers have been ‘pretty unanimous’ in opposing negative interest rates, but he added that he did not want to say never with regards to negative interest rates.

It’s up to Fed chair Jay Powell today to set the record straight and make it clear the Fed will never go negative, or the US will go the way of Japan and Europe. Powell has to push very hard against this market mood. Too late says Scott Minerd, Guggenheim CIO, who believes the 10-year yield will eventually hit -0.5% in the coming years. Powell speaks today in a webinar organized by the Peterson Institute for International Economics. If he doesn’t lean hard on the negative rate talk it will cause a fair amount of mess on the short end.

UK 2yr yields turn negative, RBNZ doubles QE

Another strange thing happened this morning – UK interest rates also went negative. The 2yr gilt yield sank to an all-time low at -0.051% as markets assessed how much stimulus the UK economy is going to need (more on this below).

Inflation may or not be coming; deflation is the big worry right now as demand crumbles. The Covid-19 outbreak, or, more accurately, the response by governments, creates a profoundly deflationary shock for the global economy. Just look at oil prices. And yet, as central banks approach the precipice of debt monetization and Modern Monetary Theory, inflation could be coming in a big way.

So, we move neatly to the Reserve Bank of New Zealand (RBNZ), which last month said it was ‘open minded’ on direct monetisation of government debt. Today’s it has doubled the size of its bond buying programme but kept rates at 0.25%. The kiwi traded weaker.

German judge slams ECB

Sticking with central banks, and Peter Huber, the German judge who drafted the constitutional court’s controversial decision was reported making some pretty stunning remarks about the European Central Bank. Speaking to a German publication he warned the ECB is not the ‘Master of the Universe’, and, according to Bloomberg, said: ‘An institution like the ECB, which is only thinly legitimized democratically, is only acceptable if it strictly adheres to the responsibilities assigned to it’. These are pretty stunning and underline the extent to which this decision upends the assumption of ECJ oversight in the EU and over its institutions. Remarkable.

US stocks tumble on talk of lockdown extensions

US stocks had a dismal close, sliding sharply in the final hour of trading as Los Angeles County looked set to extend its stay at home order for another three months and Dr Fauci warned of reopening too early. The S&P 500 fell 2% and closed at the session low at 2870. The close could leave a mark as it broke support and we note the MACD crossover on the daily chart. European markets followed suit and drove 1-2% lower – this might be the time for the rollover I’ve been talking about for the last fortnight.

Pound off overnight lows after Q1 GDP decline softer-than-expected

Sterling is softer but off the overnight lows after less-bad-than-feared economic numbers. GBPUSD traded under 1.23 having tested the Apr 21st swing low support at 1.2250 ahead of the GDP print. The UK economy contracted by 5.8% in March. However, the –1.6% contraction in Q1 was less than the –2.2% expected, while quarter-on-quarter the economy contracted -2% vs –2.6% expected. GBPUSD bounced off its lows following the release, but upside remains constrained and the bearish MACD crossover on the daily chart still rules. We know it’s bad – the extension of the furlough scheme does not indicate things will be back to normal this year.

Oil markets are still looking quite bullish. A number of OPEC ‘sources’ yesterday suggested the cartel would stick to the 9.7m bpd cuts beyond June. API figures showed a build of 7.6m barrels, though there was a draw on stocks at Cushing, Oklahoma of 2.3m barrels. Gasoline inventories fell 1.9m barrels, but distillates continued to build by 4.7m barrels. EIA inventory data is later today is expected to show a build of 4.8m barrels.

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