Feet to the Fire

December Rate Hike Probabilities:

USD   80.2% + (Still in the cards)

EUR     2.0% (Think December 2019)

GBP   86.6% + (Done deal, probably in November)

CAD   45.8% (Actually falling pretty sharply)

Fed Rhetoric               25bps


Inflation in England’s attained

A level that must be restrained

Another tick higher

And feet to the fire

For Carney, by law its ordained


It’s always difficult to figure out exactly what drives the dollar (or any market) during a particular session. Ultimately, I always revert to the economic fundamentals, as they ought to exhibit the most influence over time. But in any given session, there are any number of things that can do the job. The dollar is generally stronger this morning as pundits point to a meeting President Trump had with Stanford economist John Taylor regarding chairmanship of the Fed. Ostensibly, Trump was quite impressed. Taylor is best known for his eponymous Taylor Rule, which derives the proper rate for Fed Funds based on specific economic and financial criteria. And that rule, right now, signals that Fed Funds should be near 3.75%, not 1.25%. So the idea that the next Fed chair will be more hawkish gained a great deal of credence overnight and the dollar benefitted directly.

One minor exception, however, is the pound, which had rallied a bit after September’s CPI data printed at 3.0% as expected (It has actually started to give back some of this gain but continues to outperform other G10 currencies). UK legislation requires the BOE Governor to write an open letter of explanation if the headline inflation rate moves more than 1% in either direction from the statutory target of 2.0%. So despite the fact that market participants were anticipating this outcome, the reality was still enough to move the market. Essentially, this has made it clear that the UK will be raising rates at their November meeting, removing the emergency 25bp rate cut they implemented immediately in the wake of the Brexit vote in June of last year. What makes this surprising is that given the otherwise desultory UK data, it seems hard to believe that they would go down this path, but it does seem to be highly probable at this time. What is truly interesting, though, is the fact that the market isn’t looking for another move by the BOE for more than a year after this. The point is that a hike in three weeks’ time is not the beginning of a tightening cycle as much as it is a knee-jerk response to recent inflation readings. And of course, the weak pound has dramatically impacted those inflation readings, which despite its recent performance is still lower by 10% since the Brexit referendum.

Speaking of Brexit, I have not seen any news that indicates the current stalemate between sides has changed and so the odds of ‘no deal’ seem to be climbing every day. As I read about the ongoing talks, it almost seems to me that neither side really wants a deal. The EU is terrified that if they give anything away in a deal, other members are going to raise their hands for the same benefits. At the same time, the UK has made it clear that while a financial settlement is possible, they are not going to pay a lot of money without getting something in return. I have suspected for a while that a transitional deal would be highly problematic, and nothing I have heard or read lately has changed that view. We will know for sure when the UK Treasury starts allocating funds for contingency issues in the event of a ‘no deal’ outcome. I think that will be a very negative signal for the pound as the rest of the market will come around to the idea that the UK is about to exit the EU with no contingency plans. I maintain that receivables hedgers need to be taking advantage of this short-term rally.

Away from the UK, the euro has been one of the worst performers overnight as the ongoing Spain/Catalonia saga continues to sap good will from the currency. Spain reduced its own growth outlook for 2018 (2.3% down from 2.6%) due to the repercussions from the secessionist impulse in Catalonia. Since Spain has been an important bright spot for the Eurozone, especially from the southern portion, as long as this crisis remains unresolved I expect further pressure on the euro. At the same time, this morning’s data reconfirmed that inflation is nowhere near the ECB’s target of ‘just below 2.0%’ with core CPI printing at 1.1%. We even saw some softness in the German ZEW figures (17.6 vs. exp 20.0). None of this bodes well for the narrative of an early end to QE or tighter policy and it has resulted in a 0.4% decline in the euro this morning.

In the Emerging markets, we have seen some more significant movement this morning, led by ZAR (-0.65%), whose political machinations rarely seem to be a positive for either the economy or the currency. Today’s story has revolved around Cabinet changes made by President Zuma there as he tries to consolidate whatever power he has remaining. We have also seen a sharp decline in KRW (-0.4%) after North Korea rejected diplomatic talks and said a nuclear war “…may break out any moment.” Finally, CNY has fallen by 0.45% overnight as the Communist Party congress opens in Beijing. Surveying the situation there over the past months shows that President Xi, far from being embracing markets to help the economy, has decided that centralized control is the best way forward. It is an open question, in my mind, whether they will be able to control both the currency and economy in the manner they like, and when push comes to shove, I expect them to let the currency correct, not the economy. So while I am pretty bearish the renminbi in the long term, for now I suspect it will not be allowed to move very far. In fact, last night’s decline is quite surprising to me.

This morning’s data brings IP (exp 0.3%) and Capacity Utilization (76.2%). These generally don’t move the market. Yesterday morning we saw a much stronger than expected Empire Manufacturing print (30.2 vs. exp 20.4) indicating that US industrial growth remains on track. My sense is it is time for the dollar’s uptrend from early September to begin to reassert itself as the combination of ongoing strong data, a potentially hawkish new Fed chair and problems elsewhere in the world all point to strength. Hedgers beware!


Good luck