December Rate Hike Probabilities:
USD 83.6% + (Still in the cards)
EUR 2.2% – (Think December 2019)
GBP 83.6% + (Done deal, probably in November)
CAD 38.8% – (NAFTA uncertainty impact)
Fed Rhetoric 25bps
Abe-san in a landslide
Prepare for more yen
The dollar is firmer this morning, rising against all its G10 counterparts as well as most of the EMG bloc. The weekend brought us the Japanese general election where PM Abe cemented his grip on power with his LDP party winning more than 60% of the votes in yesterday’s election and his coalition claiming more than two-thirds of the seats. This result may open the way for the first amendments to the Japanese constitution since US General Douglas MacArthur imposed it some seventy years ago. At the top of the list for Abe-san is to allow Japan’s Self-Defense Force to be upgraded to armed forces with the ability to project power and participate in peacekeeping missions outside of Japan. This is clearly an area where Japan’s neighbors are somewhat concerned given the history from the first half of the twentieth century. But it is also in keeping with what we have seen all over the world during the past two years, wherein homogenous groups of people want to have more authority over their lives and nations. It is this urge that drove the Brexit vote, that seems to be fueling the Spanish crisis in Catalonia, and underpinned the less well-known votes in Lombardy and Veneto that occurred this weekend where both Italian provinces voted, in non-binding referenda, for more independence.
So why does this matter, you may ask. Generically, I would say that the currencies of nations feeling these internal pressures are likely to weaken over time as the very nation’s existence may be called into question. But for today, specifically, it is all about the increased probability that Abe will reappoint Haruhiko Kuroda as BOJ Governor and that means that QQE is alive and well in Japan. Kuroda-san is a one trick pony who’s strong belief is that if he prints enough yen and buys enough assets the Japanese economy will power ahead and create inflation. In fairness, Japan has seen six consecutive quarters of GDP growth, its best performance since the late 1990’s. His problem is that the BOJ’s mandate is to generate 2.0% inflation, something that has not been achieved since the early 1990’s. But a long track record of failure is no reason for a government to change its approach, and I fully expect that the BOJ will continue to expand its balance sheet until at least the end of Abe-san’s time as PM. After all, if purchasing $2.5 trillion of assets hasn’t had an impact, the reason must be they simply haven’t done enough yet!
In the end, we have seen the yen trade back above 114 this morning, back to its weakest (strongest dollar) point since July and I would contend that there is more room to run. The high for USDJPY this year has been 118.60 and I expect that we are heading back to that direction, and potentially beyond. If you consider the simple fact that the BOJ are going to continue to run an easy money policy while the Fed remains on track to tighten further this year and next, a higher dollar should be the result.
As to the rest of the G10 this morning, the Swedish krona is the worst performer, falling 0.65%, although the euro (-0.4%) and Swiss franc (-0.3%) are all leaning in the same direction. In fact, the pound is holding its own (-0.2%) after PM May seems to have garnered some support after last week’s EU summit in Brussels. While infighting by the Tories remains rampant, at least there seems some possibility that the UK will move forward in Brexit negotiations.
In the emerging markets, TRY is the laggard, falling 0.8%, after a story in a local newspaper there raised the possibility that the US would impose sanctions against Turkish banks because of Iranian sanction violations. While the Turkish government denied the story, it has clearly impacted the lira. But the dollar is generally firmer, with the all of the CE4 falling between 0.2% and 0.4%, ZAR down 0.4% and even CNY falling 0.3%. This has been all about broad-based USD strength this morning, although there are a number of stories with modest individual impacts around.
Shifting to the data front, while the volume this week is limited, we do get the first look at Q3 GDP here in the US, which will certainly have the market’s interest piqued.
Wednesday Durable Goods 1.0%
-ex transport 0.5%
New Home Sales 554K
Bank of Canada Rate Decision 1.00% (unchanged)
Thursday ECB Rate Decision -0.40% (unchanged)
Initial Claims 235K
Wholesale Inventories 0.4%
Friday Q3 GDP 2.5%
Q3 Price Index 1.8%
Michigan Sentiment 100.8
Aside from the US GDP data, the most widely anticipated feature of the week is the ECB meeting, where while no changes are expected for actual policy, Signor Draghi promised to outline the next steps beyond the current QE program. Expectations are for the current €60 billion/month of purchases to be reduced to between €30 billion and €40 billion and promised for another six to nine months (or longer if necessary). The smaller the promised total amount (monthly x minimum number of months promised) the better the euro should perform. After all, that will be seen as confirmation by the narrative that the ECB is tightening policy more rapidly. But I continue to take issue with the entire narrative and expect that Fed actions will continue to dominate expectations, meaning tighter policy here will lead to a higher dollar. That’s just the way it works.