Overview: Oil prices have collapsed to start the new week. The May contract, which expires now, is off over 20% to a little more than $14 and the June contact is off nearly 7% near $23.30. Falling demand and limited storage space continue to overwhelm output cuts from OPEC+ that are to start next month. Equities are struggling to extend the first back-to-back weekly gain in two months. The Nikkei fell by over 1%, and Australia’s benchmark was off early 2.5% (liquified natural gas is priced off oil). Europe’s bourses are mixed, leaving the Dow Jones Stoxx 600 treading water, while the US shares are clearly lower, and the S&P 500 is off almost 1%. Core bond yields are a little softer, but what stands out is the jump in peripheral yields, led by a 10 bp jump in Italy. Spain and Portuguese yields are 3-4 bp higher. The US benchmark is sporting a softer yield near 62 bp. The US dollar is mixed. The oil sensitive currencies, like the Norwegian krone and Canadian dollar, are the weakest of the majors (~-0.40%), while among emerging markets, the Mexican peso (~-1.5%) and Russian rouble (~-0.80%) are bearing the brunt. Gold is extending last week’s decline below $1700 and found a bid near $1672.
China appeared to double down on its failed strategy in Hong Kong by allowing officials to arrest many leaders of the recent protest movement. There is concern that if this renews demonstrations that officials could seize the opportunity to cancel the September legislative council election. The clampdown in Hong Kong seems a dangerous move for Xi. As we argued before, the undercurrents suggest that his ambition to be a lifetime leader may be slipping through Xi’s grasp. The Hong Kong strategy has failed. The inroads Huawei may have been making into Europe are being reversed. Of note, the UK appears to have signaled that it will drop the company from its mobile network. There also is a pushback against the efforts of Chinese businesses to target European companies for acquisition. The World Health Organization is facing criticism for not working with Taiwan, ostensibly as a condition for Beijing’s support. There seems to be greater interest in recognizing Taiwan in more ways than before the pandemic. Trump’s allusion to the virus being possibly a deliberate Chinese action, despite denials by his adviser Dr. Fauci, keeps the pot agitated, like tactics used about Obama’s birth certificate and religion.
It has gone largely unnoticed that since November 2018, a 12-month moving average of Japan’s seasonally-adjusted trade balance has been in deficit. The seasonally-adjusted shortfall was JPY190 bln in March, somewhat larger than expected. Exports were off 11.7% year-over-year. Exports to the US and Europe were notably weak. Of note, auto exports were off more than 13%. Imports fell 5%, which less than expected. The weakness of Japan’s trade sector will weigh on Q1 GDP estimates. The preliminary official estimate not due for another month. It will be the second consecutive quarterly contraction.
The dollar has been confined to a narrow half yen range below JPY108.00 and inside the pre-weekend range. It was unable to settle above JPY108 last week at all. It found support a little below JPY107 last week. Despite losses in its equities, the Australian dollar is firm. Coming into today’s session, it has strengthened in nine of the past 10 sessions. It is testing the $0.6400 area. Last week’s high was near $0.6450. The technical indicators appear to be warning that a high is near. The Chinese yuan traded quietly within the range seen in the last session (~CNY7.0650-CNY7.0820). As widely expected, the new benchmark, the 1-year Loan Prime Rate, fell by 20 bp to 3.85%. It was widely telegraphed by recent money market operations.
Fitch lowered Portugal’s credit outlook to stable from positive and retained the BBB rating. It is not that surprising given the circumstances. Fitch expects the economy to contract by almost 4% this year, dragged down by hit to the tourist industry that accounts for a sixth of GDP and nearly a fifth of employment. The ECB has unveiled a substantial and flexible bond-buying program, and a majority of the external financing needs are sovereign. About half of the private sector’s liabilities are intra-company loans.
The European heads of state teleconference on April 23 is key. The ECB’s 750 bln euro flexible bond-buying program is a modest downpayment of what is seen as needed. The Eurogroup of finance ministers compromised on a 540 bln euro package, which is also seen to be insufficient to get ahead of the curve of expectations and need. Reports indicate that the ECB is pushing for the establishment of a “bad bank” that could absorb the non-performing loans, both the legacy (from the earlier Great Financial Crisis and the sovereign crisis), as well as those spurred by the current crisis). Recall that previously Spain, Ireland, and Germany done so, but that was before rules were established (Recovery and Resolution Directive) that required a process that imposes losses owners (equity) and creditors (bonds) before using public funds. Thos rules hampered, though did not wholly prevent, Italy, for example, from disposing of some of its bad loans.
While creditor nations are still reluctant to embrace corona bonds, there is still a sense that there is room to compromise. The creditors, wanting to avoid a political or economic replay of the earlier crisis, appear to be looking for some compromise. Is it anything or everything but mutualization? This is the kind of situation in which Merkel often has risen in the past to find some compromise that does not fully resolve the underlying conflict but still extends the field of play. The threat of denomination risk appears to be rising, and one sign is the rise in the price of insuring Italian sovereign risk. The credit-default swap is near 250 bp, which is about 100 bp higher the late March low.
The euro is confined to about 30 ticks on either side of $1.0870. It turned better bid in Europe, but nearby resistance in the $1.0900-$1.0920 area looks like a sufficient cap today. The euro appears to be forging a base against sterling just below GBP0.8700. A 2.4 bln euro option at GBP0.8700 expires today. Sterling is trading well within the pre-weekend range of roughly $1.2410-$1.2520. Consolidation is the most likely near-term scenario.
Ahead of the weekend, the Federal Reserve announced it would continue to taper its purchases of Treasuries and Agency bonds. It will buy $15 bln of Treasuries or $75 bln over the course of the week. In those frantic days in mid-March, it was buying $75 bln a day. Agency purchases will be reduced to $10 bln a day. The Fed’s balance sheet grew by about $300 bln last week to $6.4 trillion.
Often President Trump has been understood to be talking the dollar lower, though, from time-to-time, other senior officials have played it down. Market participants and observers were caught off-guard by his recent comment that “The dollar is very strong…and dollars–strong dollars are overall very good.” Of all the factors that drive the $6.6 trillion a day foreign exchange market, the desires of officials are rarely salient. Separately, Trump agreed to postpone some tariffs for the next 90 days, except for antidumping or countervailing duties, which means that the waiver does not apply to China, steel, or actions associated with the retaliation for illegal aid to Airbus. This could offer some relief for US importers.
A new compromise by granting new funds for the Payroll Protection Program and more funds for hospitals appears in the works. The cost could be another $500 bln. The Senate could vote today and the House tomorrow. A unanimous vote would allow it to pass without the House having to come back into sessions. Over the weekend, a roughly $18 bln aid package for farmers was announced. It includes about $16 bln of direct aid and $2 bln purchase program of agriculture goods.
Moody’s downgraded Mexico’s sovereign rating to A3 (equivalent to A- at S&P and Fitch) with a negative outlook. S&P and Fitch have also cut Mexico rating recently to BBB and BBB- respectively. It cited the weakened growth prospects, but there is little new here. It still sees Mexico as a better credit risk than the other two main rating agencies. Fitch sees it nearly losing its investment-grade status. Moody’s took a stronger stance against Pemex, cutting its rating two notches to Ba2 (BB equivalent).
The US dollar reached a high near CAD1.4120 before the weekend, and a move above there now would likely signal a test on last week’s high near CAD1.4180. Above there, the next target is near CAD1.4260. Falling oil and falling equities provide a poor backdrop for the Loonie. The IMF estimates that Mexico has had among the weakest policy responses to the crisis in the region and estimates it to be less than 1%. The dollar reached a high last week near MXN24.43. A move above MXN24.50 would target the MXN24.80 area initially.