They Lack Fortitude

December Rate Hike Probabilities:

USD   83.6% + (Still in the cards)

EUR     3.1% + (Think December 2019)

GBP   84.9% (Done deal, probably in November)

CAD   44.2% (NAFTA uncertainty impact)

Fed Rhetoric               25bps


As government’s try to conclude

The series of talks they’ve pursued

Enhancing relations

On trade betwixt nations

They’re finding they lack fortitude


Thus most trade agreements in place

Have lately been labeled disgrace

While market reactions

Have caused more distractions

And made outcomes hard to embrace


It couldn’t have been ten minutes after I finished writing yesterday about how the pound was outperforming its peers on the back of the high inflation readings in the UK that BOE Governor Mark Carney disappointed markets in his testimony to Parliament by saying policy adjustments would likely be made in the coming months rather than pinpointing November. This was seen as far less hawkish than anticipated and the pound suffered immediately, falling 50 pips in minutes and ultimately nearly a big figure. It simply goes to show that there are myriad potential catalysts for movement and many come out of the blue. This morning’s UK Labor market data was largely in line with expectations as the Unemployment Rate remained at cycle lows of 4.3% while wages grew slightly faster than expected at 2.1%. The problem is that Inflation is still running near 3.0%, so real wages continue to shrink. Adding to this is the ongoing impasse in Brexit negotiations, where the EU’s chief negotiator, Michel Barnier, claimed that no progress would be made at this week’s summit thus making December the earliest point for a substantive breakthrough. As I type, the pound is little changed on the day, although it did trade lower by as much as 50 pips earlier this morning. And as I have consistently written, the pound is going to suffer further during the Brexit process and I continue to look for it to fall well below 1.30 and test even the 1.20 level over time. Receivables hedgers need to take note.

But Brexit is not the only trade pact in the news these days, NAFTA is still front and center as well. The renegotiation of that pact is going through its own ups and downs, which has been evidenced by the peso’s underperformance during the past month, having fallen 5.5%. And that decline has been flattered by yesterday’s 1.4% rally on the news that despite tough going, the original December deadline that had been mooted by the US has been extended into next year. NAFTA is also having a direct impact on the Canadian dollar, which has seen its own gyrations based on headlines on the subject. There is a secondary impact as well, on the BOC’s reaction function. Recent comments from BOC Governor Poloz have cast doubt on how rapidly he will tighten policy because of the uncertainty of any potential outcome in those trade talks. Thus, as the rate probabilities at the top of the note point out, what had seemed a sure thing for one more rate hike this year has now fallen to less than a 50/50 chance. Let me say that if the BOC is going to react to NAFTA, I am not going to try to opine on the likelihood of any action there. However, given the fact that the Fed still seems slated to raise rates in December, I believe USDCAD probably has some short term upside potential.

Away from these specific stories, the dollar continues to perform relatively well, rising against all its G10 counterparts and most EMG counterparts today, as the Fed has shown no signs of backing off their December move. Adding to that is the belief that President Trump may appoint a more hawkish Fed Chair, with three of the five on the short list (Warsh, Taylor and Powell) seen as hawks. The other two are arguably just one, reappointing Chair Yellen, as I believe that Gary Cohen has virtually no chance. So if I am correct about Cohen, and you consider that Yellen is the one currently advocating further rate hikes, despite her history of dovishness, it seems to me that US policy is going to continue to tighten, narrative be damned. And that is going to support the dollar against all comers going forward. We will need to see other central banks start to become far more hawkish to change that dynamic, and I continue to believe we are just not close to that situation. No matter what the narrative says about the ECB on the cusp of tightening, the reduction in QE is likely more a technical problem than a statement of intent (they are running out of bonds to buy) and they are not going to actually raise rates for at least another 18 months, if not longer. Look for the dollar to continue to gain.

This morning brings Housing Starts (exp 1175K) and Building Permits (1245K), with both those expectations modestly lower than last month’s outcomes. After a long slow rebound in housing, it seems that this sector may be leveling off. We also get the Beige Book this afternoon, which ought to provide some insights into the ongoing economic situation. Of late, it has pointed to continued moderate growth with only small signs of wage price pressures. We shall see.

As I wrote earlier this week, my sense is the dollar is gathering itself for the next leg higher as the Fed remains resolute while other central banks falter.

Good luck