The French Need More Time to Succeed

Both Merkel and Hollande agreed
The French need more time to succeed
By Twenty Fifteen
Their budget they’ll wean
From deficits its been decreed

The FX markets are still trying to come to grips with all the confusion in other markets as well as the flow of new data that comes on a daily basis.  What we have seen of late is many of the previous relationships between markets breaking down as investors and traders try to understand the potential outcome from changes in monetary policy that seem to be inevitable.  Will the Fed taper their bond purchases?  And if they do, what impact will that have on equity prices and the dollar?  Will Japan stretch into purchases of more equities or foreign bonds?  Will the ECB initiate a true QE program or will they extend more LTRO’s?  There are a lot of possibilities with very little certainty attached to any of them, at least with regards to their timing.  And all of these will result in some pretty significant market gyrations if/when they come.

I would argue the Fed remains the key driver of most market activity as the debate about QE3 continues.  Once the idea that the Fed may reduce the level of bond purchases hit the markets, the dollar started an immediate rebound against most currencies.  While the euro traded back above 1.30 yesterday, which is pretty much its highs for the past 2+ weeks, it is easy to forget that on May 1, the euro was above 1.32.  We have seen a similar pattern across the other G3 currencies, with both the pound and yen rebounding off recent lows, but still weaker than at the beginning of May.  So the Fed story remains the primary market mover.  However, underlying that are the idiosyncratic issues in each currency.  For example, the EU data last night showed Unemployment at a new record rate of 12.2%, confirming the ongoing policy problems on the Continent.  The European Commission officially sanctioned a longer time-line for France, Spain and Portugal to achieve their budget deficit targets of 3%, although with or without sanctioning, it was going to take longer.  And these things helped undermine the euro’s recent rally.

In Japan, data showed better than expected IP in April, +1.7%, but CPI at -0.4% Y/Y in April, indicating that the BOJ still has much work to do to successfully defeat deflation.  And still, in Japan, there is more discussion of the technical aspects of their policy and how to implement it smoothly rather than any further changes in policy.  While it seems we have been above 100 for quite a while, in fact, we did not break that level until May 9.  The fact that we have retraced a small percentage of the movement is neither surprising nor damaging to the long term trend.  A popular theme in the market right now is that the yen has moved as much as it can based on Japanese activity and the next bout of weakness will be driven by the Fed’s activity.  Certainly if the Fed does taper bond purchases, USDJPY should rally sharply, but I still believe that Kuroda has a few more things to do if the inflation data does not start to move toward positive numbers, notably purchasing riskier assets and foreign bonds.  While neither of these is likely soon, don’t rule them out by the end of the year.

Market response to the Fed story has been quite notable in the emerging markets, where currencies across the board have fallen quite substantially this month.  In fact a quick look at some of the main EMG currencies this month show the following declines:

ZAR                   12.5%
MXN                   5.8%
INR                   5.1%
BRL                  4.9%
KRW                   2.5%

Clearly there are other things beyond the Fed impacting the ZAR, with local labor strife and weak gold prices in the mix, but looking at BRL, MXN and INR, I would say that is largely the change in sentiment with regards to the Fed.  Will these declines continue?  My gut tells me that despite momentum increasing and capital flows reversing (EMG bond funds saw outflows of $2.94 Billion last week), this has the feeling of selling the rumor, rather than the news.  Certainly another percent or two seems viable, but not much more than that.  What does this mean for hedgers?  Payables hedgers should be layering in again as current levels represent close to the best that we have seen in the past 12 months.

Good luck and good weekend
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No Guarantees

The ECB and BOJ
Told markets (their fears to allay)
Our policy ease
Has no guarantees
But promised that its here to stay

Strong US data yesterday, with both House Prices and Consumer Confidence printing at multi-year highs was enough to get the equity markets rallying and the dollar following suit.  Simultaneously, the bond market behaved as it should, falling, with US 10 year yields rising to their highest level in more than a year.  But that was yesterday.  The overnight story has been a bit less clear, with the dollar giving back some of yesterday’s gains, although bond prices continue to decline, and equity markets around the world having a mixed performance. The OECD concluded a number of reviews of world economies and the results have not been that encouraging.  In a nutshell, they cut their 2013 forecast for growth in China to 7.75% from 8.0%; they cut their forecast for France, Greece, Italy and Portugal and they called out the ECB to do more to help the Eurozone.  They largely left the US expectations unchanged and commended the Fed for its aggressive policy and had encouraging words for Japan.

With regard to central bank policy, however, there seems to be a different tone in the markets.  Yesterday we heard from both BOJ and ECB members that the current policy stance was to remain in place as long as necessary.  This is quite a contrast to market concerns that the Fed is getting ready to taper its $85 billion monthly bond buying spree.  While I don’t believe the Fed is that close to stopping, it has been called the rationale for both recent USD strength and any equity market weakness that we see anywhere in the world.   And there is no doubt in my mind that as soon as they do indicate even a slower pace of purchases, bond prices will fall sharply and the dollar will rally.  So it is truly crucial data for the FX market.  Next Friday we will see the US employment situation for May and that will give us a great deal of information as to how things are likely to proceed.  A strong report should cause a great deal of angst amongst the easy money set, and could well see both bonds and stocks decline.  But we will address that more fully next week.

For today, there is no US data to drive things, but tomorrow we will see the usual Initial Claims data as well as the first revision of Q1 GDP.  Friday could be a bit more interesting with Personal Income, Spending and Chicago PMI all to be released.

Today’s USD weakness seems excessive at this point, and I expect that some of it will reverse before the day ends.  Ultimately, we remain on a very slow dollar trend higher as the problems elsewhere in the world seem to dwarf those in the US.  That pace is highly dependent on the relative monetary policy stances of the key central banks.  So to me, since the Japanese have been quite clear that they are just beginning their aggressive tactics, little is likely to change there.  But both the Fed and the ECB are now the prime movers of markets, with any hint of policy changes from either one almost certain to have an outsized impact.  Watch for clues of further ECB ease or initial Fed tightening.  While neither is on the cards for today, they could be sooner than you, or I, think.

Good luck
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Draghi’s Legerdemain

In Italy, Portugal, Spain
Small business is feeling the strain
The ECB moans
They still can’t get loans
Despite Draghi’s legerdemain

It has been a relatively quiet Memorial Day weekend in the FX markets, with last week’s activities mostly being consolidated.  There seems to be a sense of calm overtaking the markets and I can’t tell if it is simply the start of summer, with less interest exhibited by players, or if it is a genuine sense of relief that things may be getting better.  My gut tells me it has more to do with summer than with the progress that has been made recently by governments around the world.

Looking at Europe first, there was another weak piece of data with French Consumer Confidence falling to 79, exp 85, although the euro had only a modest reaction to that news.  In fact, ultimately it is slightly higher on the day.  The newspapers have all been focused on the change in tone amongst the EU leadership as there seems to be less discussion of further austerity and more discussion of how to encourage growth.  The problem is all the ideas to encourage growth revolve around the government doing something, rather than simply allowing businesses to perform their best.  More mandates and regulations are not going to increase the GDP of Europe.  There has been much written on the inability of small and medium sized businesses in Southern Europe to get credit to expand, with Germany going so far as initiating a program to have its own development bank, KfW, make favorable loans directly to SPANISH companies!  FinMins throughout Europe decry a broken transmission system, but I think it is simply banks evaluating the credit risk of these companies and charging accordingly.  After all, the banks remain in the cross-hairs of the ECB as well, with capital requirements constantly increasing.  However, it is difficult to imagine the Eurozone growing strongly without those smaller companies growing.  Will this help the situation?  Perhaps at the margin, but ultimately, the peripheral nations remain vastly uncompetitive by virtue of years of bloated costs and benefits, and until that is corrected, which will be a long painful process, Europe will suffer.  As will the euro, which will have difficulty rallying from current levels.

In Japan, 10 year JGB yields reached above 0.90% again overnight as an auction of new bonds was not that well received.  There is a certain irony in the idea that the BOJ is seeking to increase inflation significantly but simultaneously reduce yields on JGB’s.  Those two actions are diametrically opposed, and ultimately, given the massive expansion in money supply that is on the cards, JGB yields will rise.  Last night we heard from a BOJ member, Miyao, who reiterated that the massive expansion was still on track despite last week’s comments from Economy Minister Amari, and that seemed to be sufficient to help USDJPY to rally about 1%.   The yen still has much further to fall, but it feels like we are going to spend much of the summer range trading.  As USDJPY has rallied so much in the past 9 months, a period of consolidation seems inevitable.  While I continue to look for 110 or beyond by year’s end, it is very likely that the next several month’s will see a 100.50/103.50 range.  In fact, that would be healthy for the move, and prepare the market for the next leg higher in the dollar.

Overall, the dollar has been mixed this morning, with market players looking at specific stories rather than broad themes.  If I am correct about the summer doldrums arriving, then this should be the pattern more frequently than not.  It is my view that currency markets will not be the prime drivers of the financial system this summer, rather they will be the tail of what happens.  So keep an eye on equities and commodities as well as US Treasuries.  Especially if Treasury yields begin to rally, then we could see some FX fireworks, but if the Fed is successful at containing those rate rises, the summer should be dull in the FX world.

Good Luck
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Is the Fed in a Pickle?

The Fed finds itself in a pickle
As governors sound somewhat fickle
Is QE to end?
Or will they extend
Bond buying much more than a trickle?

Markets remain unhappy this morning with volatility the main theme.  After yesterday’s dramatic sell-off in the Nikkei, overnight we saw a further 3% decline before it recovered and finished up about 1% on the day.  The yen is following in the Nikkei’s footsteps, strengthening when the Nikkei falls and reversing alongside any rally.  Will this type of price action continue?  I doubt it.  Market participants have too much trouble keeping up with this type of movement profitably, and so they will step away from the market when losses start to mount.  Has the long-term situation changed?  I think not.  If anything, what we learned is that the Fed discussion about ending QE seems to be the only one they are having.

To recap what we have learned this week; the Fed may or may not taper off bond purchases depending on what happens to inflation and the employment situation.  SF President Williams made sure to tell us that just because the Fed starts down the tapering road it doesn’t mean they won’t reverse course.   St Louis President Bullard is more focused on inflation, saying he would like to see that number rise before considering ending QE.  Bernanke was able to confuse everyone on Wednesday by saying the Fed had no intention of ending QE right before he answered a question by saying QE could end within the next several months.   It is this clarity of thought that has given the market fits, and will probably prevent any further equity rally until things are more settled.  In a similar vein, BOJ Governor Kuroda has been confusing things by saying his plan is to lower interest rates but that as the economy improves, rates could go higher.  So which is it?

Equity futures this morning are pointing lower once again, somewhere between 0.5% and 0.75%, but remember yesterday things opened terribly and wound up virtually unchanged.  The data still matters, and not only did we see better IFO data from Germany this morning, but we have Durable Goods to look forward to this morning in NY with expectations for a rebound from last month’s terrible print of -6.9%, to +1.5%, +0.5% ex transport.

No market moves in a straight line, but underlying trends are powerful drivers of market activity.  I continue to believe that the Fed will purchase their $85 billion of bonds each month for the rest of the year.  I continue to believe that the BOJ will push the envelope on even more stimulus if the Japanese inflation data does not start to improve shortly.  I continue to believe that the ECB is going to be forced into further policy ease as the Eurozone fails to show economic improvement and the devastating employment situation across the continent forces them to look beyond their inflation mandate.  And so, I see no reason to expect anything other than a weaker yen on the basis of continued policy ease, a weaker euro, on the basis of an increase in policy ease, and an overall stronger dollar on the basis of improved economic growth and the eventual end of QE.  But right now, the market is confused and concerned.

For hedgers, this means that orders remain the best tool for managing risk.  Choose a level and wait for it to be achieved.  Given the current volatility, if it is within 2-3%, it has a real chance to be done over the course of the next week.

Good luck and have a great holiday weekend
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QE or Not QE

QE, or not QE, that is the question:
Whether Bernanke will see fit to continue
Buying all the Treasury has to offer,
Or whether the Fed will not merely stop
But actually sell that which they already own
And by so doing, change the fortunes of both men and nations.

William Shakespeare could not have written a story with more drama than what is currently ongoing in the markets.

There once was a bearded old man
Of whom I was never a fan
In Congress today
What he seemed to say
Was QE has been a great plan

But then what he told every nation
Was QE might soon need cessation
Equities stumbled
The bond market tumbled
The dollar was given salvation

It has been a hectic twenty-four hours in the FX markets, and in markets in general, ever since Chairman Ben started his testimony before Congress.  Leading up to that, the equity rally continued, the dollar was strong and bond’s had found stability.  But the contrast between his written testimony, that it would be a while before there were any changes to Fed policy, and the Q&A responses that the FOMC has considered reducing the amount of QE within the next several meetings was too much for the market.  Equities reversed course in the US, closing lower on the day, and bonds sold off pretty extensively as the prospect for a less aggressive Fed meant that investors would have to absorb all the Treasury issuance.  The dollar rallied on this activity, especially against the yen, as the prospect of higher Treasury yields attracted Japanese investors.

And then Tokyo walked in.  Things started quietly in Asia, right up until the release of the HSBC PMI numbers for Chinese Manufacturing, which at 49.6 were lower than expected and below the critical 50 boom-bust line.  Signs of unexpected weakness in China were too much for the Asian markets to accept, and the Nikkei wound up falling 7.3% last night; USDJPY declined 1.6% and US 10yr yields fell about 10bps.  Fear was suddenly back in vogue and with positions overextended, a sharp reversal in markets was the outcome.   But remember this, in the broad scheme of things, Japanese equities have rallied 48% over the past 6 months and the yen has declined 22%, so this correction is just that, and likely nothing more.  Is it painful?  Clearly, for short term traders it has been difficult.  But does it signal the end of the current trends?  I firmly believe that the longer term trends remain intact, and that a weaker yen and stronger overall dollar will continue to be the way of the future.

Did anything else of note go on in the markets?  Well, the EU leadership had a meeting yesterday in Brussels where they discussed the state of their Union.  The outcome was that the austerity measures that have driven policy for the past 3 years seem to have lost favor almost universally, and now policymakers are looking for ways to get the economy growing again.  Currently, the European Commission is forecasting a continuation of the current recession for 2013, with area growth to decline 0.4% on the year.  The EU leadership seems to be shifting its collective focus on the rising unemployment situation, especially amongst the youth in Europe, and are now tasked with developing plans to help mitigate this problem.  I have an idea, scale back employee union strength and allow companies to hire and fire as they need rather than have the government dictate the terms of all employment.  I bet that would help solve some of their problems!  But of course, that is not the European way, and so I expect we will see more government funded schemes to encourage the hiring of youth a la the Italian job sharing idea that was proffered yesterday.  It is this type of regulatory nightmare that feeds the idea the euro cannot be successful as a currency in the long run.  This morning, it has rallied marginally, but given the dollar’s general strength elsewhere (JPY excepted), I feel this gain will be forfeited soon enough.  A lower euro is in our future.

The Swiss franc is weaker this morning as SNB President Jordan remains committed to weakening it further, and a growing number of market players believe that they will soon move the EURCHF floor up to 1.25 from its current level of 1.20.  If I were the SNB, I would look to raise that floor to 1.30 since the market is clearly in the mood for a weaker CHF.  But right now all remains speculation.  I expect that the CHF will remain weak for now.

Finally, AUD suffered last night as well, at least initially, which should be no surprise given the weak Chinese data.  However, in the intervening hours, we have seen the Aussie rally back to 0.97 and it is actually marginally higher than yesterday’s close.  This has the feel of position unwinding rather than confidence in the Australian dollar, and I expect that AUD will continue its recent declining trend going forward.  After all, if China is slowing to 7.0% growth, rather than the 7.5-8.0% that had been expected, will they continue to import quite as much coal and iron ore?

The thing to remember in markets as volatile as we are currently seeing is that this price action will stabilize again, probably pretty soon.  So orders at your levels are better than trying to pick a top or bottom, as they are less stressful and easier to work with.  I expect that today will remain pretty volatile, but that as we head into the Memorial Day holiday weekend, things will be much calmer by tomorrow.

Good Luck
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Our Favorite Fed Chairman

Our favorite Fed Chairman, old Ben
Will speak before Congress’ wise men
We’ll hopefully learn
If QE they’ll spurn
Or if they’ll start printing again

The dollar is firmer against most currencies this morning, although the euro is holding its own right now.  It has been a central bank focused day, starting with the BOJ overnight upgrading their economic assessment for the fifth consecutive month, even describing inflation expectations as having started to increase.  Certainly that is their goal, but it remains to be seen if this is mere wishful thinking, or if the data will support these comments.  As it is, they left policy unchanged amid an indication they are comfortable with the current mix.  If the data continues to disappoint, (i.e. inflation remains negative) then look for another boost.  But in the meantime, they will continue to buy 70% of JGB issuance, and the yen will remain under pressure.

In the UK, we saw the minutes of the most recent MPC meeting with no change in the voting status and the general tone of the minutes seeming to be one of hope rather than fear.  The recent pick up in data has been well received by some members, but others are still quite concerned that the recovery is so fragile.  As to the pound, it seems that they are comfortable with the pound falling further, just not in an extreme manner.  Are they going to increase QE?  I still don’t believe so as the data has not indicated the need of late.  But, with new Governor Carney at the helm, he may decide to put his imprimatur on policy at the next meeting.  At the same time as the minutes were released, Retail Sales data came out and the data was horrible, with headline at -1.3% and core at -1.4% month/month.  The pound instantly fell about 0.5 cents and has maintained those losses since.  I guess, the MPC has to be happy with the pound, if not with the Retail Sales data!

Europe has been the least interesting of the spaces overnight, with the euro edging higher on cross driven activity, specifically EURCHF movement.  Comments from SNB President Jordan in an interview indicated that the idea of raising the current EURCHF floor to 1.25, or implementing negative interest rates have both been under discussion.  When the market saw this hit the tape, the CHF fell against both the euro and the dollar, and that seems to be the catalyst for the modest EUR strength.

In the US, we had comments from Bill Dudley overnight, saying that the Fed would need to see the data for at least another 3 to 4 months before deciding if the economy has been able to weather the sequestration spending cuts and the Fed can reconsider monetary policy.  There was certainly no indication that he was ready to stop the QE party at this point.  And later today Chairman Bernanke testifies before Congress on monetary policy, so it will be a perfect opportunity to clarify the Fed’s current thinking on the timing of any exit from QE.  I maintain that they will buy $85 billion/month for the rest of the year, but if we do see better US data, I may need to rethink that process.

We also get Existing Home Sales in the US this morning, with the market looking for 4.99M as the print, up about 1.4% from last month.  However, I don’t believe the dollar will react to this number unless it is a big outlier.

The most notable emerging market of late has been South Africa, where the ZAR has traded to its weakest point in more than 4 years, above 9.60.  A combination of labor unrest and falling prices for gold and platinum seem to be the catalysts.  The ratings agencies have put the country on negative watch, although with a current rating of Baa1, it remains well into investment grade territory.  The reason the Rand hasn’t fallen further is because 10yr yields are about 6.40%, which are awfully attractive in the current bond universe.  So while there is fear over further ZAR weakness, there are still yield hungry investors willing to take the risk in order to earn that yield.  Interestingly, as we open this morning, more emerging currencies are stronger vs. the dollar than weaker, although the movements remain quite small.  Given the dollar’s strength against the majors, this is a bit surprising.  But given the vagaries of daily fluctuations, it is certainly not unprecedented.

Overall, unless the Chairman says something about adding to QE or otherwise quite dovish, I expect the dollar to hold its own all day.

Good luck
Adf

Just Kidding

Has yen weakness gone
Far enough?  Says Amari
I was just kidding!

Remember yesterday, when Japanese Economy Minister Akira Amari said that the yen’s weakness had gone far enough and that there were people who would be hurt by a further decline?  Apparently, he was just kidding.  I guess after those comments hit the tape, he was called into a room and it was explained that the Japanese government doesn’t focus on the currency exchange rate, only on its growth policies and efforts to achieve 2% annual inflation in 2 years time.  When Amari recanted his comments, USDJPY immediately rallied and this morning we are back to just below 103.  As I have maintained consistently, there is more to this story with the yen having much further to go.  The next big resistance is at 103.30-50, but that too will be breached and 110 remains my target for year-end.

The other story of note overnight was the UK inflation data, which was released early this morning much lower than expected.  CPI fell to 2.4%, expected 2.6%; and core CPI fell to 2.0%, exp 2.3%.  (Do you think the Japanese are jealous?) Seriously, though, the pound immediately fell after the release, down 0.6% and back to its lowest level in about 6 weeks.  The key is that with inflation falling and with Mark Carney starting his term on June 1, the idea of an increase in QE has gained much traction in the market.  And remember this, the US story has been more discussion of how and when the Fed is going to withdraw stimulus, so the idea of another wave of QE in the UK is a clear negative for the pound.  If it is to happen, I would expect it will need to wait for the second MPC meeting run by Carney, as he will need to introduce himself at this one.   But the recent UK growth story has seemed to improve, so this is no slam dunk.

The euro is little changed overall, as German PPI data was largely ignored as was a mild upgrade of the German economy by the Bundesbank.  There was no other data released in the Eurozone and I think all eyes are on the next EU meeting this week, although it doesn’t seem likely to have a market impact given its focus on energy and tax policies.

Today has seen broad based, albeit modest, USD strength, with the emerging market currencies fading almost universally, the dollar stronger against the commodity currencies, and commodity prices in general having fallen a bit.  With no US data to look forward to, market players seem content buying dollars on any dips for now.   The broad outlines of market activity are little changed of late, and although we will hear from St Louis Fed president Bullard today, tomorrow Chairman Ben speaks to Congress and that has the potential for a much bigger impact.   So I expect another generally quiet session, with perhaps a bit further USD strength by the end of the day.

Good luck
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