Fifty Long Years

That broken old city, Detroit
The bankruptcy laws did exploit
For fifty long years
They’ve suffered with tears
From leadership quite maladroit

As an indication of just how dull the overnight session was in the FX market, the Detroit bankruptcy story is probably the biggest thing going right now, and it is having no impact in the global markets. We continue to feel the angst from the political problems in Portugal, and it seems Italy is closer to its government collapsing, but neither of these issues is having any impact on the euro. In fact, the euro continues to perform far better than can reasonably be explained by the data and news that has been released over the past week or so. Support for the single currency is remarkably robust despite its myriad problems, and I attribute that to continued reserve diversification from the Asian and Middle Eastern central banks. I understand that Bernanke has continued to walk back the tapering discussion, but it feels like that is old news at this point. The euro’s performance feels much more like a single, or small group, of buyers sitting on the bid rather than a broad group of buyers actively acquiring euros. It just seems to me that the price action and the information stream are out of synch. We shall see, but I find it hard to believe that an imminent no-confidence vote on the Italian government can be helping the single currency. However, for now, it appears that the support remains strong. None of this has changed my medium and long term views, and I continue to advocate receivables hedgers taking advantage of the current levels.

This weekend we get two events of note starting with the G20 meeting in Moscow this afternoon and tomorrow, followed by the Japanese Upper House election on Sunday. The G20 appears to be focused on tax issues, trying to close the loopholes amid the treaties that allow corporations to reduce their taxes so dramatically. Ultimately, if they can create an efficient way to do that, it can only be a net positive for the entire global economy. Alas, the key is the efficiency, and nothing the G20 has ever done could be considered efficient. Overall, I see no reason to expect the G20 to impact FX markets.  As to the Japanese election, the polls point to PM Abe’s LDP winning a majority, and it could be a strong one. I continue to believe this will be a catalyst for the next leg of yen weakness as once Abe consolidates his power he will be able to enact more legislation to implement his ‘third arrow’ and with luck, address some of the long term underlying issues in Japan.

The data overnight was completely uninspiring with the UK borrowing data likely the most interesting and it had no impact. We do see Canadian CPI this morning, but Canada has been an afterthought to the FX markets for the past several months, tracking the general USD movements but showing no leadership at all. I don’t imagine this data is going to change things there.

In the Emerging Market space, the dollar is generally weaker ahead of the LATAM opening, but most of the movement has been quite modest. There has been very little in the way of news here either, as markets seem to be taking a summer vacation. It is hard to get excited about much in this space right now as most of the movement here is predicated on the Fed’s actions. If the Fed is going to maintain QE3 for much longer then these currencies are going to regain their favor given the large yield advantage that still exists. However, if the taper does begin, I expect that this entire bloc will suffer dramatically, as it did last month when that was the general expectation.

It is a summer weekend and the Open Championship is on every trading room TV. My guess is we see very little activity today overall.

Good luck and good weekend
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QE’s Future Course

The course for QE’s not preset
It’s possible we’ll buy more debt
Of course it may be
A taper, we’ll see
We haven’t decided quite yet!

Chairman Ben was in the spotlight again yesterday, testifying before the House Financial Services Committee, and he continued to walk back any signs of imminent tapering of QE. His comments were underscored by the much weaker than expected housing data where Housing Starts fell 10%, to 836K (exp 960K), and Building Permits fell 7.5%, to 911K (exp 1000K). This was especially damaging because the US recovery, such as it is, has been highly dependent on a rebound in housing. If this data is not aberrational, we could be seeing much weaker GDP numbers going forward. Of course, that would be a boon for the stock market as it would imply no end to QE. In fact, once again we were treated to the spectacle of poor economic data and mixed/weak corporate earnings data driving an equity market rally. All markets continue to be completely beholden to US monetary policy, and that situation will obtain for a long time to come. Of course, at some point QE will come to an end as it becomes clear that the risks of inflating the Fed balance sheet further outweigh any possible benefit from modestly lower long term interest rates, and when that starts to happen, we will pine for the simple volatility we saw last month at the first mention of the word ‘taper’.

Amid the G3 currencies, the yen and Aussie dollar were the biggest losers overnight. Looking at the yen, it seems that the market is preparing for an LDP win this weekend in the Upper House elections, and a boost to PM Abe and his fiscal plans. As I have been writing, I believe this will be a catalyst for Abe to take the next step in Abe-nomics and as a result it will weaken the yen further. I expect that a test of the levels reached in late May, at 103.74, will occur. Overnight we saw Japanese Nationwide Department Store Sales rise 7.2%, its second highest increase in the last 10 years (second only to March 2012), and continuing its recent uptrend. It is this type of economic result that will encourage both Abe and Kuroda to keep pushing their easy money policies. And that is why the yen will continue to decline.

As to AUD, the story here continues to be intimately entwined with the Chinese growth story. However, as we continue to see more and more concern over just how slowly China is going to grow in the future, Aussie continues to suffer. Recent IMF comments, noting the risk for slower growth in China, seem to be the latest catalyst for Aussie weakness. And remember, the RBA is the only major central bank that doesn’t have to resort to QE to ease policy. They still have plenty of room to cut interest rates and have indicated a willingness to do so if they deem it necessary. We are still two weeks away from the next RBA meeting, but if we see weaker Chinese (and US) growth data in the interim, I expect that the RBA will be far more inclined to move, and the Aussie will suffer accordingly.

The euro is slightly lower this morning after the Greek Parliament passed legislation putting 25,000 Greek public sector employees on notice that they may be dismissed. So 6 years into the financial crisis and after a 27% decline in GDP and a default on their debt, the Greeks have finally gotten around to dismissing public sector workers. One wonders what their severance packages will be. I’m betting on 3 years at 90% pay. Nothing the Greeks have done has been sufficient to prepare the country to remain effectively within the euro. If it stays, it will be a basket case forever…literally forever. Meanwhile, the Portuguese continue to try to address their domestic problems with a weakened coalition government and a president who insists on a ‘unity’ government to fix things. Talks have been ongoing for 5 days between parties and still no agreement. This, too, is a nation that would benefit from the flexibility of its own currency. Alas its leadership is committed to eurocide (suicide by remaining in the euro).

The pound has had a mildly disappointing day as much better than expected Retail Sales data in the UK did not lead to any strength. It seems that the dollar’s modest general strength has been sufficient to offset the data, and traders are focused elsewhere for now.

This morning we see Initial Claims (exp 345K), Philly Fed (8.0) and Leading Indicators (0.3%), and Chairman Ben testifies to the Senate, so there should be some Q&A around 10:30. However, things are not shaping up to be too interesting, and I remain confident that Bernanke will not say anything that smacks of a taper for now. With no data tomorrow, my guess is the next big thing will be the Japanese elections Saturday night and any potential market moves on Sunday.

Good luck
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All Bernanke, All the Time

It’s Wednesday and Benny the Beard
Does desperately want to be cheered
By all the bond players
As well as soothsayers
But fears that instead he’ll be jeered

“Policy makers have been very careful in the U.S. to point out the distinction between monetary policy and bond-buying,” said Anshu Jain, co-CEO of Deutsche Bank AG. Once again I claim that this is a distinction without difference. The Fed initiated its QE policy only because it had run out of room to cut interest rates further, its traditional (and preferred) monetary policy channel. If it felt that negative short-term rates were viable, it would have continued down that road and not expanded its balance sheet as dramatically as it has. However, to claim that bond-buying by the Fed is not monetary policy is either willfully ignorant or a blatant lie. I am pretty sure that Anshu Jain understands this, but as with so many public figures, he is unwilling to allow the plain meaning of the words to stand for themselves because of the uncomfortable truth behind them. Thus all the market spin. As Chairman Ben heads to Capitol Hill today to testify to Congress, all eyes will be on what he has to say (which will be available at 8:30 this morning) and on his responses in the Q&A. He has a tough job trying to explain why his monetary policy actions are not monetary policy. Of course, the reason we care is because he is the single biggest influence on markets right now, so depending on the tone of the testimony, we will get different market responses.

“Bernanke today may also renew calls on lawmakers to avoid sharp short-term spending cuts, which he has said could harm the economy in the near term, while adopting a plan to lower long-term fiscal deficits,” according to Bloomberg News. This statement in a Bloomberg article this morning highlights one of the key problems the US has faced. For economists it is quite simple, promise to cut spending in the future but don’t do it now because it will have negative ramifications for the economy. Ultimately, the issue with this is that those long-term promises are never fulfilled, hence the ever expanding debt ratios. All the deficit hawks (myself included) are tired of the empty promises and are willing to suffer somewhat slower growth now in order to address the long-term problems. But most politicians are simple, self-serving hacks who care only about being reelected and they believe that if they stop giving away other people’s money to their constituents, they won’t be reelected. Hence, they will never, willingly, cut spending. This is the crux of the fiscal problem in the US (and elsewhere) and it is unlikely to be addressed by the current Senate or Administration. The House, to its credit, has tried to do so.  This also helps define the underlying fiscal condition in the US, which is a key part of market fundamentals.

So the question is, how will all this impact the FX markets? My sense is that the market has begun to embrace the idea that a reduction in bond buying is not a tightening of policy. I’m not sure why, but I guess if Bernanke says it frequently enough, people will eventually believe it. This has moved into the realm of propaganda, a dangerous outcome in my view. However, he may well be successful at convincing the masses that ending QE is not tighter policy and if so, I would expect the dollar to suffer. Remember, the dollar’s performance against most currencies of late has been largely predicated on the idea that the Fed had moved closer to the end of easing policy while the ECB, BOE and BOJ were all just getting started. However, if Bernanke is successful, we probably have some further dollar weakness ahead. This is especially true in both the euro and the pound, but I think the yen story has another feature, this weekend’s election for the Upper House of the Diet.

In the Eurozone, despite an increase in the visibility of problems in Greece, Portugal, Spain, Italy and France, buyers continue to appear. Draghi has been successful in virtually eliminating the existential threat to the single currency through his verbal intervention, and it seems reserve buyers are very willing to continue diversifying their USD holdings into EUR. Despite an ongoing recession across the entire continent, that shows no signs of ending, and promises of a long period of extremely low interest rates, the euro has held its own. If Bernanke convinces the market that he is not tightening policy, then the euro will test 1.35. It doesn’t make sense to me, but that seems to be the reality.

In the UK, today’s minutes of the July 4 MPC meeting showed a surprising 9-0 vote in favor of leaving the British QE amount unchanged as new Governor Carney was able to convince his colleagues that verbal intervention would be more effective, with less actual financial consequences. Today’s labor data from the UK underscored that unlike the Eurozone, the UK economy has brighter near term prospects. While the Unemployment Rate was unchanged at 7.8% (Europe’s is 12.4%), the Claimant Count fell a much greater than expected 21.2K, meaning that many fewer Brits were unemployed. This is analogous to our Initial Claims data. The pound has benefitted from the combination of both the MPC minutes and the data and has rallied here to its highest level in 2 weeks and looks very much like it has bottomed for now. I thought that the pound was headed toward 1.40, or at least 1.45, but if we do get there, it will take quite a while. At this point, I expect it to range trade between 1.50 and 1.55 for the next several weeks at least, and depending on what happens in the US, maybe longer.

In Japan, things are a bit different as there has been no indication of any policy change on the monetary side, but more importantly, the election this weekend will define exactly what kind of mandate PM Abe has to exploit. If he carries the Upper House, as currently expected, then the LDP will control all the policy levers and I believe will be more aggressive on the Fiscal/Regulatory side of things. I also believe that a big victory this weekend will result in a much weaker yen, perhaps a test of the 103 level, as traders anticipate the next leg of success in Abe-nomics.

Finally, emerging market currencies may be dramatically impacted by Bernanke as their recent weakness has been directly attributable to the idea of the US slowly tightening policy. If that idea is changed by today’s testimony, I expect that we will see these currencies, on the whole, recoup some of their recent losses. Slowing global growth remains a problem for them, especially the situation in China, but if there is a limited prospect for higher US rates, yield hounds will be back buying these currencies.

On the data front, yesterday’s CPI showed a greater than expected increase and may start to open the eyes of the FOMC, but we will need more of the same for it to have any real impact. Today we get Housing Starts (exp 960K) and Building Permits (1.0M) which will indicate if the recent rise in mortgage rates has had any substantive impact on the housing market, which has been a key driver in the US’s recent positive economic performance. But in the end, its all Bernanke all the time.

Good luck
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Bernanke Returns

Tomorrow Bernanke returns
To Congress to air his concerns
‘Bout growth that’s still slow
Though rates remain low
But Congress, it just never learns

The dollar is softer this morning against most currencies as a combination of diminishing expectations for the US taper and further actions by emerging market countries to protect their weakening currencies has led to more dollar selling. I find it instructive that despite a weak global growth profile, with most emerging markets underperforming their previous expectations, we are seeing them raise rates to protect their currencies. This points to two facts: first, the Fed remains the unquestioned driver of global monetary policy; and second, the “animal spirits” that are necessary to rekindle economic growth remain trapped under a global blanket of excess debt and regulation.

As to the first point, that is why the market remains on tenterhooks ahead of tomorrow’s Bernanke testimony to the House Financial Services Committee. Given the surprising comments about tapering from last month, and the extraordinary effort to walk back those comments since then, market participants are not sure what to expect. It is clear that the FOMC is pretty well divided on the QE process, with loud voices discussing both ending it and expanding it. Given the equity market’s extreme valuations, which are based almost entirely on the fact that there is so much liquidity in the system, the consequences of Bernanke’s words can be great. But it is not just equity markets that have been impacted. Emerging market assets had outperformed for many months as the excess liquidity searched for a home with higher returns than Treasuries. It was not that long ago that Brazil’s FinMin Mantega used the term ‘currency war’ to describe the Fed’s activities as he was trying to prevent excess BRL strength. Twelve months later he is trying to prevent excess BRL weakness as the change in market sentiment has resulted in the wholesale disposal of many EM currencies. Last night it was India’s turn to raise rates, by 200bps, in order to drain liquidity and bolster the currency, which had fallen to a record low last week. This, despite Indian growth near 5%, its lowest in more than a decade and far below its target of 7.5%-8.0%. Brazil has already raised rates 3 times in the past months and of course, China has been forcing the overnight on-shore interest rates higher via liquidity draining activities.  All of this is simply a result of the discussion of the idea that the Fed may change its policy which led to a virtual stampede out of these currencies and back to more liquid instruments.

With regard to the second point, it remains evident in the overall slow growth globally, with the IMF having reduced its global GDP forecasts for 2013 and 2014 four times already this year, and global data showing no signs of a strong rebound anywhere around the world. The one constant globally has been the increase in sovereign debt as slow growth reduces national tax receipts and adds pressure to the fiscal situations in countries around the world. The G8 countries average 98% of GDP as their debt ratios! Having read the Reinhart and Rogoff book, “This Time is Different”, which pointed out that GDP growth slows once the debt/GDP ratio reaches 90%, it is hard not to accept their observation. The fact that the average level of debt amongst this group of nations is above that level bodes ill for the timing of any substantive global recovery.

So what does all this mean for the FX markets? Well, we remain in a situation where comments by Bernanke remain the market’s dominant force, followed by the words of Draghi, Kuroda and Carney (not necessarily in that order). Data plays a secondary impact and then other influences like war and global unrest are only minor players in the game of FX. For instance, UK CPI rose a less than expected to 2.9% but the pound didn’t really respond. This seems to be related to the fact that tomorrow the minutes of the last MPC meeting will be released and traders are waiting to see what transpired under Carney’s first meeting. Verbal guidance has become the final tool in central bankers’ toolkits, and it appears that all the major central bankers are using it aggressively. So with new information due tomorrow, traders won’t risk positions today. German ZEW numbers were released at a worse than expected 36.3, down from last month, and yet the euro rallied. We also saw the weakest auto sales numbers in 20 years in Europe this morning. So here it was clearly not the data driving things, but arguably a continuation of position adjustments ahead of tomorrow’s Bernanke testimony. After all, traders are still net long dollars, according to the CFTC data, in response to the first tapering talk. Fear is increasing that Bernanke will be even more aggressive in dispelling any notion of a taper any time soon, which would put the dollar back on its heels. So bad EU data will not have the same impact. However, weak US data will encourage a further USD sell-off. So keep an eye on this morning’s CPI (exp 0.3%, 0.2% core), IP (0.2%) and Capacity utilization (77.7%). If these point to less robust US growth, look for the euro to rally further and a general dollar decline. However, if the data is strong, I would not expect dollar strength, just a lack of weakness.

It is always difficult to manage risk in market situations where comments are the key drivers rather than macro data. Alas, that is where we find ourselves for now. Longer term, I don’t think there have been any significant changes, but in the immediate future, market response will be all about Bernanke (and Draghi et al.).

Good luck
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Who Will Be Fleeced

The latest news from the Far East
Shows China has slowly decreased
The pace that it grows
Which just might expose
Investors who’re sure to get fleeced

As we head into the dog days of summer, market activity continues to show periodic bursts of excitement. Given the constant refrain from the world’s Central Banks that they are focused on the data, it only makes sense that market participants follow suit. So the latest data we saw was Chinese GDP last night, which showed Q2 at 7.5%, in line with the (reduced) expectations and down from Q1’s 7.7%. Perhaps more importantly, we continue to see economists around the world cutting their forecasts for Chinese growth with the 2013 number approaching 7.0%, the slowest in more than 2 decades, and 2014 showing only a modest rebound. Given the recent comments from Chinese Premier Li Keqiang about numbers as low as 6.5% being acceptable, my sense is we are going to see a continued reduction in the pace of Chinese growth. Especially because the PBoC is showing no signs of loosening monetary policy in response to the cash crunch that continues to manifest itself there. And on top of this, Chinese home prices remain robust, so the housing market continues to approach bubble territory while the rest of the economy suffers. In other words, the Chinese have some difficult policy issues to address, and it seems that slowing GDP is one of their preferred solutions. This doesn’t bode well for either commodities or countries that export them; notably Australia, Brazil and South Africa; as well as for the Asian nations that export components to China like Korea and Taiwan. While Aussie is a tiny bit higher this morning, the trend remains firmly lower with a breech of 0.90 likely as soon as this week in my view. Calling all receivables hedgers in AUD, the 1yr forward is barely more than 2 cents, so all-in sales are near 0.88. That will look good in one year’s time with spot near 0.80!

Looking elsewhere, the ongoing saga in Europe continues to garner headlines as the periphery struggles to figure out how to break the cycle of despair while the Germans remain reluctant to advance any action that smacks of financing the PIGS ahead of the election in September. On that note, I couldn’t help but laugh at the following comment from the folks at the IMF: “The Greek program may still achieve its ultimate goal of keeping Greece in the euro area and of making it able to recover and grow,” the report said. The IMF and the EU “have had to commit many more resources and for a much longer period than initially envisaged and results remain deeply disappointing and the ultimate outcome uncertain.” So after 6 years and a 27% decline in economic activity, those in charge of the Greek “rescue” program are disappointed and uncertain as to how things will wind up. I can tell them, Greece will ultimately fall out of the euro because at some point, the internal politics will shift sufficiently to toss out the grand coalition led by PM Samaras, and the opposition platform of euro exit will be enacted. It is the only viable long-term solution. Freed from the shackles of German prudence, Greece will be able to revert to its former position; modestly corrupt, somewhat inflationary but sovereign in its decisions. I guess the greatest conundrum continues to be the fact that despite the ongoing problems in the Eurozone and the currency’s inherent failings, the euro remains near 1.30. While I continue to see further depreciation, it seems that we will need something much more dramatic to change the broad valuation matrix. If the Fed does begin to taper, I expect the euro to suffer somewhat, but I guess that buyers remain in place who will prevent any collapse for now. As Lord Keynes famously said, “Markets can remain wrong far longer than you or I can remain solvent.”

The data for this week could be of real interest to the FX markets, even though there is no employment data (save the weekly Initial Claims number). Here is what is coming:

Today Empire Mfg 5.0
Retail Sales 0.8%
– ex Autos 0.5%
Business Inventories 0.0%
Tuesday CPI 0.3%
-ex Food & Energy 0.2%
TIC Flows -$40.0B
IP 0.3%
Capacity Utilization 77.7%
Wednesday Housing Starts 960K
Building Permits 974K
Beige Book
Thursday Initial Claims 341K
Continuing Claims 2959K
Philly Fed 7.8
Leading Indicators 0.3%

So first thing this morning we start to get a better idea of how things are going in the US and, more importantly, whether we think that Bernanke will start to consider that taper more seriously. Keep an eye on the CPI tomorrow, for any surprise on the high side will likely see bonds suffer and the dollar rise.

Good luck
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China’s World View

Said Chinese FinMinister Lou
Our growth this year might not get to
Seven percent
While we reinvent
Our ‘conomy’s latest world view

If ever there was proof positive that the equity market rally has been based entirely on the Fed’s policy actions, yesterday was it. Wednesday afternoon, Chairman Ben essentially promised not to raise rates anytime soon, and voila, equities rally with a vengeance. Of course, this also impacted Treasuries, which have rallied 20bps by this morning from their worst levels, and the dollar, which has fallen against most currencies in the past 2 days. As I have written before, the biggest impact on markets are the comments by various officials, not the data releases that show what is actually going on in the global economy. And the number one voice remains Bernanke, with Draghi, Carney and Kuroda-san far behind in influence. With this new promise by the Fed, in conjunction with last week’s comments by Carney and Draghi regarding extended periods of monetary ease, it is time to reevaluate the current market situation.

So what do we know? Discussion at the FOMC is active with a large contingent of members believing it is time to think about moderating the QE program, but a slight majority, including BerDudLen, willing to expand the balance sheet for many months to come. As such, I expect we will hear more dissent over the coming months, but we will not see a policy adjustment unless the employment data starts to really improve dramatically. But even though there is not likely to be a change at the Fed soon, it remains clear that of the four major central banks, the Fed is closest to withdrawing its easy money. And so, the dollar should remain underpinned by this idea. The importance of the monthly payroll data has probably increased now, if that is possible, so the first Friday of every month will offer that much more excitement. We know that both the BOE and the ECB are committed to easy money for at least another year, and probably more. This is especially true for the BOE, where Governor Carney seems to be pushing very hard to expand QE there or create some other policy to imply further monetary ease. And we know that the BOJ is going to continue its QE program until the money supply in Japan has doubled from its level of 4 months ago. So the liquidity game that has been driving markets around the world is still afoot.

Looking to the next most important central bank, the PBoC, and the Chinese situation, we learned late yesterday that growth of 6.5% in 2013 seems to be acceptable now. As I have written before, the extraordinary growth story in China is slowly coming to an end. This is due more to the law of large numbers than any real failings in policy there. It is just very hard for a $10 trillion economy to expand 10% a year. However, there have been some policy failings there, notably the recent cash squeeze that drove interbank lending rates up 10% overnight. Also, some portion of the past growth was arguably of a synthetic variety. I am sure you have heard of the phantom cities, where the Chinese have built an entire city in the hinterlands but nobody lives there. So the building activity added to growth, but the investment has been wasted thus far. At any rate, the current Administration seems ready to make adjustments in the historic growth mix in China, with more domestic consumption focus and less export orientation. And according to FinMin Lou Jiwei, they seem prepared to grow at 6.5% this year and going forward. Well, that is a big difference than the current average forecast of 7.5%, and will weigh heavily on commodity prices. It is no surprise that despite the dollar’s relatively poor performance during the past two sessions, AUD has performed even worse. A growth rate of 6.5% implies that demand for Australia’s commodities is going to be much lower. This will have a double effect of reducing the GDP numbers in Australia and encouraging the RBA to use some of its current scope to cut interest rates further. Neither of these related outcomes is going to support the AUD and so I would look for further underperformance there. In the past 3 months, Aussie has fallen almost 15%. While it seems to have stabilized over the past weeks, I think this news will be the catalyst for the next leg lower. I see 0.85 in the Aussie’s future.

With only PPI (exp 0.5%, 0.1% core) and Michigan Confidence (84.7) to be released today, I think the market is likely to continue to focus on the Fed story and the dollar will tend lower. Emerging market currencies, which have rallied nicely during the past two sessions are likely to see a little profit taking into the weekend though, so a modest decline in most of those should be expected.

Overall, while I have not adjusted my long-term views, it seems clear that the timing of those moves may be extended somewhat as the Fed tries to deal with its unprecedented dilemma. Just how will they unwind the most massive stimulus program ever initiated, and how much market volatility will they tolerate. Remember too the law of diminishing returns. While recent verbal intervention has seemed successful, the next round will be less so, and the following even less. They will have to conjure new methods to prod markets in their preferred direction at some point. While today is not shaping up as too exciting, there remains a great deal of excitement built into the world and that excitement will play out as more volatility going forward.

Good luck and good weekend
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We’re Not Gonna Stop With QE

Bernanke said, “Listen to me
We’re not gonna stop with QE”
I don’t understand
Why traders demand
More proof than they already see

While I grant that I am paraphrasing the Chairman’s words, I think that is the message he is trying to get across. Of course, once again I ask, how is it that tapering QE is not considered tightening, when increasing QE was considered easing of policy? If anyone can answer that question for me I would be most appreciative.

At any rate, as has been the case for the past many months, markets have responded aggressively to the latest words from Bernanke, this time accepting that there is no tightening of policy coming and so QE∞ remains infinite. The predictable results were for the Treasury market to rally, equities to rally and the dollar to fall. Perhaps surprisingly, the dollar seems to have been the biggest mover of the bunch, falling more than 1% vs. most of its major counterparts. So the euro is back above 1.30, the pound above 1.51 and USDJPY back below 100.

The euro is an interesting test case because at the same time that we have Chairman Ben saying the Fed is not about to start easing, we have Signor Draghi saying that ECB policy will be accommodative for “an extended period of time” (haven’t we heard that language before from the Fed?). So, who’s easy money is more important? Yesterday it was the Fed, the day before it was the ECB. And this, my friends, is why markets are so volatile. Central bankers around the world are going through a period of one-upmanship, and each time they speak, the market reacts to the latest comments. What we do know is that economic growth in the Eurozone continues to flounder amid an ongoing recession that shows no signs of ending. We also know that the picture in the US, while uneven, is much more encouraging. This is especially true in the Housing sector and in the recent employment data. So based on the old-fashioned idea of economic fundamentals driving things over time, I maintain my view that the dollar will outperform as the Fed will be tightening policy in some form far before the ECB. Does that mean the euro will tumble soon? Clearly not. But I maintain my view of 1.20 within a year.

Looking at the pound, we have a slightly different situation. BOE Governor Carney is clearly anxious to show that he can be creative and flexible when it comes to supporting the economy, and sounds almost anxious to ease policy further. But the improvement in UK data, which has been much better than expected, is preventing him from acting without tossing away any credibility he may have coming into the role. Over the course of the past month, all the PMI data was better than expected, Retail Sales were higher than expected as was IP. The employment data is improving and home prices are rising. Perhaps the only serious negative is that wage growth has been stagnant. Inflation remains above target but Carney has already indicated he is unconcerned with that for now. All of this leads me to believe that the BOE will not be easing policy further, but what Carney did say last week was that he was not going to tighten anytime soon, similarly to Draghi. So despite a more positive fundamental outlook, we have an essential promise from the BOE that they will not be tightening policy for a long time. Again, this contrasts with the Fed, which while not seeming to tighten immediately, is clearly past the inflection point from easing to tightening. Ultimately, the pound will continue its decline, perhaps slowly, but a move toward 1.45 seems reasonable over the next months, with an outside chance of going even lower.

Finally lets look at the yen. My gut about further action last night was wrong (although I ascribed only a 25% probability) and in fact comments were indicative that they BOJ is likely to stand pat at current policy settings for a while. They seem happy with the results so far as inflation expectations are picking up and their economic assessment has improved. It can be no surprise that USDJPY fell back below 100 after the meeting since there was no immediate impetus for either a stronger USD (based on Bernanke) nor a weaker JPY (based on Kuroda). As such, long USDJPY positions were unwound. Once again, lets look into the future and see what fundamentals indicate. On the US side, as already discussed, monetary policy is heading toward tighter not looser. On the Japanese side, while economic growth has been showing signs of picking up, the inflation expectations remain below their target of 2.0%, and the question is will they be able to achieve their aims in the stated timeframe of 2 years (probably about 21 months left). If anything, I expect that the BOJ will be forced to be more aggressive than they have already been as inflation continues to lag their target. So the long-term view remains for a weaker yen. I still like the election next week as the starting point for the next leg in yen weakness, but in any case, the yen has further to decline.

What I think we can look forward to over the coming months is more volatility as every central bank, both major and minor, tries to get across a nuanced message that they are in control. The problem will remain that they are not, and that the evidence over time will prove that, be it in rising inflation or non-existent growth.

Good luck
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