Inflation Stagnation

December Rate Hike Probabilities:

USD   66.4%  (The hawks are winning)

EUR     0.3%   (Think December 2019)

GBP   80.6%   (Done deal, probably in November)

CAD   63.1%  (Not as confident as before)

Fed rhetoric       25bps


The data continues to show

That Europe continues to grow

However inflation

Keeps showing stagnation

So tight money’s not apropos

Foreign exchange seems to be an afterthought this morning with the dollar under modest pressure, but really just consolidating its recent gains. The ongoing releases of PMI data show that Europe continues to recover from its sclerotic past, although it does not appear to be accelerating further. GDP growth of the 2.0% variety seems to be in store for the continent going forward, which given its history since the European bond crisis, is really not too bad at all. But given that inflation remains quiescent there, I continue to believe that the ECB is extremely unlikely to become hawkish any time soon. This is not to say that they will not begin to taper their QE purchases, which is clearly set for the beginning of next year, but the idea that the ECB will quickly follow up with rate rises remains a fantasy for those long euros. To date, ECB speakers have been consistent in their comments about the sequencing of events, and have not changed their tune regarding the extended period of low rates following the end of QE. I maintain that the ECB will not even adjust the deposit rate there from its current -0.40% until the beginning of 2019 at the earliest, and it could take another year simply to get back to 0.0%! I would argue that the narrative continues to compress this timeline and the longer it drags on the more likely the euro is to give back some of this year’s gains. As such, I wouldn’t read very much into this morning’s 0.25% gain in the euro, which is arguably just trading noise and not representative of any new trends.

If we look elsewhere, we see a similar pattern of price action. For example, the pound has rallied 0.35% this morning, arguably on the strength of a modestly better than expected Services PMI report (53.6, exp 53.2), but then this follows the pound’s 1.65% decline during the past week. So the direction makes some sense in the short run, but it becomes increasingly difficult to remain bullish pounds in the medium and long term in my view. After all, the Brexit negotiations have not been conclusive, at least not the public commentary, and it is easy to argue that a ‘hard Brexit’ with no transitional deal will be a significant negative for the UK economy in the short run at least. In fact, if that grows to be the most likely outcome, I would expect that the pound to suffer quite substantially. But even in the case where some agreement is reached, it appears that the UK is likely to come away with lesser terms, and I would expect further pressure on the pound then too.

The commodity bloc, meanwhile, has also rallied softly this morning, with metals prices seeming to be the key sector today. There was a positive Bloomberg story about increases in iron ore shipments from Australia to China and that appears to have encouraged traders to bet on the Aussie. CAD has been a relative laggard, up just 0.1%, but given the gradual slide in oil prices we have seen over the past week, it is not that surprising that CAD has had trouble making gains. After all, the correlation between oil and CAD remains strong at 0.4%, albeit that is a bit lower than we have seen in the past.

In the emerging markets, the big winner has been INR, which rallied 0.8% after the RBI left rates on hold and a large order to sell dollars entered the market. Despite the Fed’s penchant toward tighter policy, the RBI has been moving in the opposite direction, having cut rates 7 times since the beginning of 2015, with expectations for further declines as inflation remains under control. But given today’s general dollar weakness, we have also seen solid gains from PLN (+0.7%) and ZAR (+0.6%), with the rest of the space firm, but to a much lesser extent. Regarding Poland, the NBP left rates unchanged at 1.50% again, which was widely expected for today, but has seemed to add pressure to the view that they will be forced to raise rates in the not too distant future amid a rising inflation environment. Interest rate markets have been increasing their bets on just such an outcome, and the zloty has benefitted accordingly. The rand, meanwhile, seems to have simply recouped yesterday’s losses, which were fanned by concerns over both the ongoing political turmoil there as well as weaker PMI data.

This morning we get back to data with ADP Employment (exp 135K) and ISM Non-Mfg. (55.5) on the docket. After Monday’s very strong ISM Manufacturing data, hopes are rising for a good print here as well. The ADP number, however, will be skewed by the recent hurricanes and so ought not be seen as indicative of the underlying situation. Friday’s payroll data is also likely to be far less informative than usual because of the hurricanes impacts last month. In fact, I would guess that next month’s numbers will still be somewhat skewed. Interestingly, I think the upshot of that is there will be very little data released between now and December to alter the Fed’s thinking on raising rates then. In other words, December is a done deal!

Chair Yellen does speak this afternoon, but it would be surprising, given the venue of a Community Banking Event, that she would focus on monetary policy. As such, my take is any positive data surprises will be seen as dollar positives, while negative ones can be waved away as hurricane related. All told, a consolidation day seems in the cards, but there has been no change to the story yet.

Good luck