June Monthly

The investment climate in June will be shaped by forces that emerged in May.  Many countries began relaxing lockdowns and various activity-based alternative data, like traffic pattern, Open Table Reservations showed improvement on the margins.  Sentiment surveys, while mostly still depressed, were better than April readings.  The long slog back has begun.  There was also optimism over several different vaccines that had been initiated or soon will begin human tests.  The hope is that with regulatory forbearance, a vaccine may be ready by year-end.

At the same time, the US-China rivalry escalated.  The novel coronavirus added a new dimension to the older problems.  Restrictions on Huawei were tightened.  Nearly three dozen Chinese entities were sanctioned for human rights violations.  The US may tighten rules on foreign company listings on the US exchanges that may force the delisting of some Chinese-based companies.  The Trump Administration is urging that the government pension fund does allow investments in Chinese stocks or bonds.

China continues to press hard.  It has struck out at Australia for seeking an independent investigation into the origins of the coronavirus.  It successfully blocked Taiwan from being granted observer status at the World Health Organization. Border tensions with India have seen troop movements on both sides.  Beijing also signaled that it would insist on changes to Hong Kong’s Basic Law to give local officials greater authority to repress dissent spurring fresh concern.  The US announced intentions to curb Hong Kong’s special trade privileges after the State Department questioned its autonomy.

March was when
the markets froze up.  Governments and central banks around the world
began responding in earnest to the pandemic. The MSCI All Country World Index
(ACWI) bottomed on March 23. So did the S&P 500, while Europe’s Dow Jones
Stoxx 600 bottomed a week earlier (March 16), and the MSCI Asia Pacific Index
recorded its low a couple of days later (March 19).

April was about
further policy response. Efforts were increased in terms of size, scope,
and/or time. Officials were successful in removing the far left-hand tail risk.
Punishing volatility in the markets eased. Stress in the funding markets
relaxed.  The compression of demand, supply chain disruptions, the
contagion in the US meat processing industry, and some peculiarities with the
settlement of the deliverable futures light sweet crude oil contract, distorted
the commodity prices. The negative oil prices were quickly reversed and were
near $20 a barrel by the end of the month.

May was when the
high-income economies likely hit a trough as many countries begin relaxing
their lockdowns. Part of the rise in the price of some industrial commodities, including gasoline and iron ore, reflects a marginal improvement in demand. Of
course, the difference between relaxing lockdowns and economic recovery may be
quite stark, but the first thing that happens is that contractions slow and stop.

The lack of a strong EU response and a German Constitutional
Court ruling made it more difficult for the ECB to keep the peripheral premium
from widening over Germany and throwing a spanner into its transmission
mechanism.  However, the ECB is likely to expand its Pandemic Emergency Purchase Program of bond-buying and is undeterred by the controversial court decision.  The European Commission incorporated the German-French proposal for a 500 bln euro grant facility funded by EU bonds and the desire to appease several Northern European creditor nations, with a 250 bln euro loan facility.  Several countries in eastern and central Europe already had strained relations with Brussels, and they were put-off by all three camps without having been consulted.  A unanimous decision is required and this may be difficult to reach next month and investors can be expected to punish Europe by withdrawing savings on disappointment (i.e., selling the euro, equities, and peripheral bonds)

Some countries, central banks that have not adopted negative rates, are explicitly
considering them. The Bank of England
and the Reserve Bank of New Zealand are the leading contender but will likely
explore other policy options first. The Bank of England is likely to expand its bond-buying program in June.  Several facilities that the Federal Reserve
announced are beginning to be formally launched, and this will continue into
June. The Federal Reserve has pushed back against speculation that it would adopt negative rates.  Targeting a longer maturity than overnight fed funds is under consideration.  In the market’s vernacular, this is called yield curve control.  

Several political decisions will be made in June as well that could have a meaningful impact in the months ahead.  These include whether UK Prime Minister makes
good on this threat to leave the free-trade talks with the EU if there was no substantive
progress by June, or will OPEC+ extend its deepest output cuts or begin
relaxing them? In the United States, emergency unemployment benefits expire
at the end of July.  Will they be

The early survey
data for May showed a definite improvement over April.  While it is commonly recognized that the US
economy will contract sharply in Q2, data needs set the stage for a recovery in
Q3 to validate expectations. The capital markets have continued to stabilize,
and this has seen the Federal Reserve taper its Treasury purchases to $5 bln a
day down from $75 bln a day at its peak in late March and early April.  Fed officials have made it clear that there
is little interest in adopting a negative target rate.  Besides scaling its programs, a yield curve
control strategy, which would entail targeting a longer-dated maturity in addition to the overnight fund’s rate, could be the next innovation.  The Bank of Japan,
for example, targets the 10-year bond, while the Reserve Bank of Australia
targets the 3-year yield.  We suspect
that if the recovery disappointed for any reason, it could be adopted by late Q3.  There is some risk that the US trade relations
Hong Kong is adversely impacted, and exposed businesses should test contingency

Euro:  The euro has remained rangebound against
the dollar in May, and volatility has eased. 
Europe moves to center stage in June. 
First, the ECB meets on June 4 and is widely expected to increase its
Pandemic Emergency Purchase Plan by 250-500 bln euros.  The modest usage of the Pandemic Emergency
Long-Term Refinancing Operation (less than one billion euros), some observers
see the terms (-0.25 bp below the zero repo rate) could be made more
attractive.  Second, and not entirely unrelated,
the ECB’s Targeted Long-Term Refinancing Operation, with a rate that could be
as low as negative 100 bp if specific lending targets are met, could see strong
demand of a billion euros or more.  The
amount is likely to be inflated, but the rolling into the new facility some past
operations that were made on less favorable terms.  Third, the EU heads of state are expected to
decide on the joint effort to promote economic recovery among competing
proposals. A compromise between conflicting interests could prevent a unanimous decision and precipitate a crisis.    Even if successful, a joint bond may not be the prelude to a fiscal union as partisans argue.  The European Stabilization Mechanism and the
European Investment Bank issue bonds that are collective obligations.  Still, if Europe is the sum of its responses to the crisis, its collective action now is critical. 

(end of March indicative prices, previous
in parentheses)

Spot: $1.1100   ($1.0955) 

Median Bloomberg One-month Forecast $1.1075 ($1.0925) 

One-month forward  $1.1110 ($1.0960)    One-month
implied vol  6.4%  

Yen:   The dollar-yen exchange rate was
stable in May between JPY106 and JPY108. 
Violations were rare and shallow.  Public
support for Prime Minister Abe has fallen drop, and this may be invigorating plans
for a JPY100 trillion (~$926 bln) economic relief package.  The decline in energy prices, which Japan does
not exclude from its core measure that the central bank targets, drove the core
CPI back below zero in April.  The BOJ
expanded its corporate bond and commercial support efforts,  but the gradual rise in equities allowed it
to slow its ETF purchases in May. Interest rate differentials are also low and
stable, leaving the broad risk appetites to be the main driver of the exchange

Spot: JPY107.85 (JPY107.20)      

Median Bloomberg One-month Forecast JPY107.60  (JPY107.10)     

One-month forward JPY107.80  (JPY107.15)    One-month
implied vol  5.4% 

Sterling:  Nothing seemed to go in the UK’s favor in May, and sterling
was dragged lower.  Although sterling
recouped some of its earlier losses that carried it to six-week lows in the
middle of May (~$1.2075), it was still the weakest of the majors, depreciating nearly
2.75% against the dollar.  The virus has hit
the UK hard, and it is slower than many other countries to re-open.  Several Bank of England officials have played
up the possibility of adopting a negative target rate.  It seems neither imminent nor
inevitable.  At the June 18 meeting, the
BOE is more likely to increases is the bond-buying program by GBP100-GBP200 bln. Trade
talks with the EU do not appear to be going particularly well, and this may also
weigh on sterling. 

Spot: $1.2345  ($1.2590)   

Median Bloomberg One-month Forecast $1.2355 ($1.2375) 

One-month forward $1.2345 ($1.2590)   One-month implied
vol 8.9% 


Canadian Dollar:  The combination of the risk-on
attitude, reflected in the continued recovery of equities and the better supply/demand
factor that lifted oil prices by 60% in May, underpinned the Canadian dollar.  The US dollar fell to two-month lows in
late-May near CAD1.3725.   The Bank of Canada meets on June 3.  There seems to be no urgency to adjust policy
at Governor Poloz’s last meeting.  Macklem
will succeed him, but there is a strong sense of continuity.  Headline CPI fell below zero in April for the
first time since 2009, but this was driven by the drop in oil prices and
exaggerates the deflationary pressure. 
Underlying measures remain steady.  There appears potential toward CAD1.3500-CAD1.3600
if risk appetites remain strong. 

Spot: CAD1.3780  (CAD 1.3945) 

Median Bloomberg One-month Forecast  CAD1.3810 (CAD1.4140)

One-month forward  CAD1.3800  (CAD1.3945)    One-month
implied vol  6.9%  

Australian Dollar:  Since the end of March, the Australian
dollar has been the best performing major currency, appreciating about 8.5% against
the US dollar.  Australian equities were
also a significant beneficiary of the reflation-trade with the main benchmark
up nearly 5% in May.  The Federal Reserve
had greater scope to approach the zero-bound than the Reserve Bank of Australia
and this has resulted in the return of a normal relationship, where Australia
offers an interest rate premium over the US. 
Meanwhile, Australia’s push for an independent investigation of the
origins of the coronavirus have earned it the ire of Beijing, with a high tariff
(80%) levied on Australia’s barley exports to China and a ban on some
beef.  While China can find alternative supplies,
the same cannot be said Australian’s iron ore (at least in the short-run), which
may limit the fallout. 

Spot:  $0.6665 ($0.6510)       

Median Bloomberg One-Month Forecast $.0.6575  ($0.6460)  

One-month forward  $0.6665  ($0.6510)   
 One-month implied vol 10.8%  (11.6%)   

Mexican Peso:  The Mexican peso was the world’s strongest
currency in May, gaining nearly 9% against the US dollar.  It still is off almost 15% year-to-date, making
it the third-weakest behind the Brazilian real (~ -24.5%) and the South African
rand (~- 19.5%).  The shift in the peso’s
fortunes is more the result of the broader risk environment than an improvement
in Mexico’s economic or political outlook. 
The calmer markets and the global liquidity encourages asset managers to
re-establish positions to benefit from Mexico’s high real and nominal rates
that they were forced to cut in the dark days in March.  The peso also serves a proxy for many less
liquid or accessible emerging markets currencies.  The JP Morgan Emerging Market Currency Index
rose about 3.7% in May, the best monthly performance in more than four
years.  The dollar has surrendered around
half of this year’s gains against the peso. The momentum could carry toward
MXN21.00-MXN21.50, depending on the broader environment.

Spot: MXN22.18 (MXN24.15)  

Median Bloomberg One-Month Forecast  MXN22.38 (MXN 24.10)  

One-month forward  MXN22.28 (MXN24.20)     One-month
implied vol 18.5% 

Chinese Yuan:   At the risk of taking Chinese macroeconomic data at face value, it does appear the economy is recovering.  Nevertheless, more fiscal and monetary stimulus has been signaled.  The year-over-year decline in producer prices warns that a profit squeeze is still materializing.  As US-China tensions escalated, the dollar trended higher against the yuan.  The dollar appreciated against the yuan for four consecutive weeks through the end of May.  It is difficult to see how the tensions will ease in the coming months, especially given the US political cycle.  In late 2019, the dollar rose to nearly CNY7.1850 and stopped just shy in late May.  However, given the tensions, the risk is for additional dollar gains, though tempered by China’s other objectives, such as deter capital flight and spur import substitution.  In April, the Hong Kong Monetary Authority was intervening to stop the Hong Kong dollar from appreciating, which appeared to be in demand, given the interest rate pick-up.  However, by the end of May, investors had become more concerned about the future of the peg that the forward points widened to the most in two decades.  

Spot: CNY7.1365  (CNY7.0630)

Median Bloomberg One-month Forecast  CNY7.1150(CNY7.0620) 

One-month forward CNY7.1350  (CNY7.0760)    One-month
implied vol  4.7% 


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