The Dollar and Equities are Finishing the Week on Firm Footing

Overview: A 9.8% contraction of the Chinese economy in Q1 did not derail investor optimism today, which saw Asia Pacific stocks rally strongly after Gilead reported very preliminary positive testing of its drug to fight the coronavirus and plans to re-open are developing. Japan's Nikkei and South Korea's Kospi surged more than 3%. The MSCI Asia Pacific Index, Europe's Dow Jones Stoxx 600, and the S&P 500 are posting their first back-to-back weekly gains since the first half of February. European bourses are recouping the losses from early in the week, and the S&P 500 looks poised to gap higher at the open. Benchmark yields rose in the Asia Pacific region, and the central banks in Australia and New Zealand indicated they would buy few bonds next week. European core bond yields are little changed, while in the periphery, led by Italy, yields are softer. Despite this risk-on mood, the dollar is firm against all the majors, but the yen and New Zealand dollar, and only the yen are higher on the week. Emerging market currencies are mixed today, but the JP Morgan Emerging Market Currency Index is off about 1.5% this week. May WTI has fallen to $18 a barrel after settling in the US below $20.  Gold is a little more than 1% lower and is now nearly flat on the week, a little below $1700.  

Asia Pacific

China's reported contraction was not far off from what economists expected. The nearly 10% quarterly contraction translates to a 6.8% year-over-year decline in output. The bright spot appears to be that March data showed some improvement, especially industrial production (-1.1% in March). The slide in investment also moderated in March. However, retail sales were dismal (-15.8% vs. Bloomberg survey median forecast of -10%). This warns that supply may be returning before demand. We expect China to shortly announce new infrastructure measures to help stimulate the economy and absorb production internally.

The Japanese government was forced by political wrangling within the coalition to pullback from the JPY300k payout to those households hit hard by the virus and instead give all households JPY100k. In contrast, the US program is means-tested. The shift by Japan's Prime Minister Abe could triple the cost of the program, as the state of emergency is extended to cover the entire country, not just a few prefectures. The broadening of the cash payout would ostensibly not only raise the amount of stimulus but is thought to expedite the payout.  

The dollar is trading just inside yesterday's range as the recovery ran out of steam just north of JPY108.00. It finished last week near JPY108.50. Support is seen near JPY107.60. The Australian dollar recovered from about $0.6245 yesterday to reach almost $0.6385 in early turnover today before running out of steam. Look for the $0.6300-$0.6400 range ahead of the weekend. After falling for the past two weeks, the dollar rose about 0.5% against the Chinese yuan at CNY7.0740. 

Europe

The weak coordination marks the official response to the pandemic. Just like the absence of strong leadership from Washington has left the states to compete (e.g., PPE and ventilators) and to cooperate where they can (e.g., regional coordination of easing shutdowns), so too with European countries. Five European countries (France, Spain, Austria, Belgium, and Greece) imposed bans on short sales. The prohibitions were imposed in the middle of March when officials could not strike broader participation, and efforts to shut the markets in mid-March were rebuffed. French regulators extended their ban until May 18. Spain, Austria, Belgium, and Greece's blockage of short sales was to end today and next week (Greece) and have also been extended. Italy's ban runs until mid-June. 

Bank of England Governor Bailey reportedly had advocated a coordinated market closure and verbally admonished against aggressively shorting stock in mid-March because it was not good for the economy. Looking at the equity market performance both year-to-date and over the past month, it is hard to make the argument that short-selling bans resulted in better returns relative to the regional benchmark (e.g., Dow Jones Stoxx 600) or Germany's DAX. To say that there were other sellers is an understatement. A more granular investigation is needed to see if bid-offer spreads widened. At the same time, if the absence of short-selling did not alter the "price discovery process" then the social value of allowing pools of capital to sell what they do not own (which requires an elaborate network of share providers, risk managers, compliance officers, back-office, etc.) may not be so obvious outside of the industry.    

To varying degrees, central banks have three levers of power. The first is monetary policy proper, involving the price and quantity of money. Second, are the purchases of other assets. The third is the regulatory authority. The ECB took moved this third lever yesterday.  It reduced the amount of capital needed to support trading activity for six months. Ironically, the ECB explained the reduction in funds put aside as part of its response to the "extraordinary levels of volatility." Investors know volatility as risk, so at the moment that trading has become riskier, the ECB (and other central banks) permit greater risk-taking by the banks. It is important in the transmission of monetary policy to ensure markets run smoothly. Market-making functions and the liquidity they provide is essential. These are activities require scale, which means banks with large trading operations, will be the largest direct beneficiaries of the reduced capital requirement. Officials are subject to criticism when they take measures that limit market activity, as in the ban on short selling, and they are chastised for favoring large entities over small. 

The euro is pinned near the week's lows, just above $1.08. Around 1.3 bln euros in expiring options are struck between $1.0835 and $1.0850. It finished last week near $1.0935. The month's low (so far) was set by $1.0770. A recovery back above $1.09, where a 1.3 bln euro option is struck that will also be cut today,  is needed to take the pressure off it at the start of next week. Earlier in the week, sterling approached its 200-day moving average near $1.2650, but met a wall of sellers and backed off to almost $1.24 yesterday. It tried again to poke above $1.25 and found sellers waiting. A break of $1.24 could spur a quick more toward $1.2350 and would weaken the near-term technical outlook.  

America

Even though NY and NJ have extended their shutdowns to the middle of May, some other states may relax a bit earlier, and Gilead Science's preliminary results for its Remdesivir drug treatment of Covid-19 helped lift spirits. The results look better than other tests of it, though many questions remain unanswered (no control group), and there are other tests being conducted. Still, it seems to give insight into sentiment and the psychological importance of hope. The equity market reaction from late yesterday through now also seems to suggest that many investors remain cautious and are not prepared for higher equities. A Pew poll may explain why. Roughly 2/3 of Americans are more concerned that the social restrictions are eased too early rather than too late. 

The Bank of Canada announced it would buy 40% of the government T-bill sales, up from 25% now for an unspecified period. In the US, the flood of Treasury bill issuance has kept the bill-OIS spread wide and reflecting ongoing stress. Three-month dollar LIBOR rose yesterday for the first time in nearly two weeks. Mexico's President AMLO requested an advance from Banxico of its profits that are due next year. The central bank refused. The request does not appear to be far from what others are doing, like the UK Treasury took unlimited overdraft privileges at the BOE. Still, emerging market economies have less latitude when it comes to central bank independence.  

The US dollar reached almost CAD1.4185 yesterday, a nine-day high,  before reversing lower to settle a big figure lower. Follow-through selling saw it reach almost CAD1.40 in Asia before bouncing back through CAD1.41. There is a $1.9 bln option at CAD1.40 that will be cut today. A $580 mln expiring option is struck at CAD1.4045. Over the past 30 and 60 sessions, the percent change in the Canadian dollar is better correlated with the percent change in the S&P 500 than with oil prices (WTI). The greenback's low for the week against the Mexican peso was set on Monday near MXN23.2460. The high for the week was set yesterday around MXN24.43. It had fallen to MXN23.70 in Asia before rebounding and has held above MXN24.00 in the European morning. The dollar had fallen every day last week against the peso, but a higher close today would be the fourth advance this week.     

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