There once was a market in thrall
To central banks who overall
Had fueled the craze
For three thousand days
Preventing an equity fall

But recently views have matured
With traders somewhat less assured
The future will be
So calm and risk-free
Especially those unsecured

For the second day running, the dollar is broadly higher, although the movement has not been sufficient to come close to unwinding its early weakness this year. But what is more interesting to me is the fact that so many stories that I have been reading are focused on the idea that we may have seen a top, even a temporary one, to recent market moves.

Certainly, it would be fair to characterize some aspects of market behavior as mania-like (maniacal?), naturally starting with the cryptocurrency sphere, but also with the idea that changing the name of a company to include ‘blockchain’ is worth a 100% or 500% gain in the value of that company. The fact that stories continue to be told of people who gave up their day jobs to become Bitcoin traders or short volatility traders certainly reminds me of the run-up to the tech bubble, where equity day trading played a similar role. Or perhaps, of more recent vintage, was the house-flipping we saw in the run-up to the financial crisis nearly ten years ago, the very situation that started the new party on the back of central bank extraordinary monetary policy.

Most of you know that I have been somewhat skeptical that the extraordinary gains we have seen across markets will continue, recognizing that they cannot go on forever. And I have repeatedly said there doesn’t actually need to be a definitive catalyst to change views. Markets can be quite perverse, and there will be no announcement that the top has been achieved. But one thing of which I am pretty sure is that the more stories written about this particular subject, the more likely it will be a self-fulfilling prophecy. For the newer market entrant, the combination of an increase in warnings and the lack of new gains in your portfolio could easily be sufficient to cause a change of heart. Although, history shows that they will wait until they are much further under water before acting. At the very least, the idea of a more significant correction getting underway is quite viable, so be nimble.

But back to the FX market. Certainly part and parcel of the narrative of late has been the dollar’s weakness, which last year added up to a nearly 11% decline vs. its major counterparts. Almost every analyst call for 2018 has been for a continuation of that move, with some calling for another 15%-20%. I strongly disagree with that idea, and wouldn’t be surprised if we have already put in the bottom for the dollar this year. From a historic perspective, there have been numerous years (e.g. 2015) where the previous year’s trend reversed early on amid expectations of a continuation. And as I look at the fundamentals, notably monetary policy issues, I continue to see the Fed as the most likely to be more aggressive than expected and the dollar to benefit accordingly.

Early this morning the Eurozone data reconfirmed that there is no inflationary impulse yet on the Continent as the core CPI remained at 0.9%. Simultaneously, we got our first ‘dovish’ commentary from an ECB member in what seems like a year, when Vitor Constancio basically called into question the euro’s recent strength saying, “I am concerned about sudden movements which don’t reflect changes in the fundamentals. Looking at fundamentals, inflation declined slightly in December.” Of course, the market trades on the narrative, which anticipates the future fundamentals, but as I have said repeatedly, it would be very surprising if Signor Draghi turned hawkish at next week’s ECB meeting. Meanwhile, Dallas Fed President, Robert Kaplan, was out talking about the probability that we could see more than the three Fed hikes currently forecast for this year. Certainly that combination is worth a little dollar strength!

The point is, for the first two weeks of the year, we have seen an acceleration in the trends that held for last year, with equities exploding higher and the dollar falling broadly. If nothing else, my sense is things are overdone in the short run and that a correction, long overdue, may be coming soon. For all of you receivables hedgers, these are the best levels we have seen in three years and I would be keen to take advantage.

On the data front, IP (exp 0.5%) and Capacity Utilization (77.4%) are released this morning and then the Fed’s Beige Book comes out at 2:00pm. There has been nothing to suggest that the US economy is slowing down and I expect this data to reconfirm the recent trend. We also will hear more from Kaplan as well as Charles Evans and Loretta Mester, so watch the tape this afternoon. But from that crew, I expect a more hawkish bent, which means the dollar should behave well. While equity futures are pointing higher, that was yesterday’s story as well, right up until they tanked. All I’m saying is that change is coming, and it feels like we are beginning to see it more clearly.

Good luck
Adf

Two weeks of the year have now passed
With dollar bulls feeling downcast
The ECB hinted
The euros they’ve minted
Could be withdrawn awful darn fast!

While the dollar is a tad stronger this morning compared to Monday’s abbreviated trading, it remains well below the levels seen on Friday. In fact, year-to-date, the dollar has ceded almost 2.0% vs. its major counterparts. The FX narrative that is dominant right now goes as follows: the ECB, BOJ, BOE, etc. will begin to more aggressively reduce their QE policies amid increasing growth while the Fed has already executed the bulk of its policy adjustment. This was highlighted yesterday when Estonian ECB member, Ardo Hansson, said the following in an interview with the German newspaper, Boersen-Zeitung: “There are certainly good reasons to reduce the importance of the net
purchases in our communication soon — also with a view to a potential end to
these purchases. If growth and inflation continue to evolve broadly in line with the ECB’s latest projection, it would certainly be conceivable and also appropriate to end the purchases after September,” he said.
“The last step to zero is not a big deal anymore, you do not have to do a lot of fine-tuning. I think we can go to zero in one step without any problems.”

In other words, the ECB’s hawks are ready to roll immediately, but are willing to wait until March before announcing such. He even touched on the issue of the likely rise in the euro given such comments and said that an appreciating euro “is not a threat to the inflation outlook” and shouldn’t be overdramatized. So there you have it, another dyed in the wool ECB hawk out on the tape. It should be no surprise that the euro jumped after the release of these comments, and rightfully so. Basically, he is arguing for an immediate end to QE with no further transition past the current September date. We shall learn more next Thursday when the next council meeting is held, but I expect that Signor Draghi is unlikely to tip his hand. In fact, if anything, given how much press the hawks have received of late, I wouldn’t be surprised to hear him sing a particularly dovish tune in an effort to offset the other comments. Of course, before we hear from the ECB next week, we will see the latest Eurozone CPI numbers, released tomorrow and expected to show a reading of 1.4% with a core print of 0.9%. Let me just say that those are not numbers that will inspire a quickening in the pace of tightening by the ECB.

Away from the euro, we saw UK inflation data this morning and it printed a touch softer than anticipated, 3.0% and 2.5% core. Governor Carney will be thrilled he doesn’t have to write another letter to the Chancellor, and given the lagging increase in wages, it is good news for the UK population on the whole. But does it really signal a potential change in policy? If anything, the news that the EU continues to play hardball with the UK over Brexit terms strikes me as a further detriment to the currency. It remains difficult for me to foresee any interest rate adjustments by the BOE until the Brexit deadline has passed, while during that period, I could easily see the Fed raise rates five or six more times. The pound has no business above 1.37 in my view.

The other big mover over the past weekend has been the Chinese renminbi, which has rallied 0.8% since Friday and nearly 1.5% in the past week. I put very little credence in the idea that the Chinese comments about US Treasury bonds were meant as a threat of some sort as the reality is they have literally no other choices to maintain their reserves. Certainly they could diversify some portion of their reserves to other currencies, but the size and liquidity of the markets in Bunds or Gilts or JGB’s pales in comparison to Treasuries, as does the yield. And this is especially so because the ECB and BOJ continue to buy those bonds as well, further reducing liquidity and the availability of securities. Rather, to me what we are seeing is an ongoing tightening in Chinese policy as the country attempts to reduce the amount of leverage outstanding, and the corresponding uptick in the currency. Given the broad-based weakness in the dollar that we have witnessed since the beginning of the year, it should be no real surprise that CNY has gained in value as well. So for now, the dollar weaker narrative remains in place. However, I am not convinced it has that much staying power.

Looking ahead to this week’s data releases we see a more limited schedule as follows:

We also hear from Evans, Kaplan and Mester tomorrow, with the potential for some nuance, but my sense is that ahead of the FOMC meeting on the 31st, they are unlikely to break new ground, especially since the data hasn’t really changed much.

For now, the trend is your friend, and it is clear that the market is keen to push the dollar lower. But at some point, I continue to believe the rubber will meet the road and we will see higher inflation in the US leading to a quicker pace of Fed tightening and a stronger dollar. We shall see.

Good luck
Adf

The ECB said that it might,
According to their own foresight,
Be forced to increase
The pace that they cease
To buy bonds, thus making things tight

The euro responded with glee
Exploding past One and Twenty
If this is the plan
And not a straw man
The dollar, much lower, will be

And one other thing of real note
So many months after the vote
Seems Chancellor Merkel
Might have squared the circle
With new ministers to promote

Wow is all I can say this morning as the euro has virtually exploded higher during the past twenty-four hours. It started with the release of the ECB Minutes yesterday morning, which were read as quite hawkish. The belief that has gained widespread credence is that the time gap between the end of QE, now almost certainly to take place in September, and the first rate hike has been significantly shortened. Prior to the Minutes, the market was pricing in just a one-third chance of a 10bp rate hike by the end of this year. This morning that probability has jumped to almost two-thirds with a full hike priced in for March 2019 (it was December 2019 prior to the Minutes). It should be no surprise that the euro has rallied on the back of that change in sentiment. And in fairness, if the ECB is actually going to be more aggressive in their removal of monetary accommodation, it is the correct market response. Then, adding fuel to the fire was the announcement by Chancellor Merkel that after extensive negotiations between her CDU/CSP party and the center-left SPD, they have come to agreement for yet another ‘grand coalition’ government to lead Germany for the next four years. It has been over 100 days since the Germans went to the polls and concerns were growing that the much less palatable alternatives of either a minority government or a second vote were coming to fruition. But now, the market sees only blue skies ahead and the single currency has been the main beneficiary. In the past twenty-four hours, the euro has rallied 1.50% and is now trading at its highest level vs. the dollar since the beginning of 2015 (and at that point it was in the midst of a 25% decline!)

Of course, it remains to be seen if the ECB will follow through with the now mooted policy tightening, at least at the pace the market is expecting. Remember, while ECB policy is clearly still on emergency settings and almost certainly inappropriate for an economic area growing above trend, the Fed was in the same situation for several years before it finally started to get a bit more aggressive. Signor Draghi has not changed his stripes and remains a dove at heart, so while the pressure to tighten policy may well increase going forward, I continue to believe that he will do so only reluctantly and at a much slower pace than currently forecast. But for now, the euro bulls are in the ascendancy and I expect that the single currency has further room to run.

Meanwhile, on this side of the Atlantic, yesterday’s PPI data was shockingly weak, with both headline and core data printing at -0.1%, well below the +0.2% expectations and encouraging the narrative that the Fed was going to slow down its pace of tightening. This morning’s CPI data (exp 0.1%, 0.2% core) will be far more important, but it is certainly a disconcerting harbinger of today’s data. So adding it all up, the dollar has been under constant pressure since I wrote yesterday.

But there have been other things as well, notably Chinese Reserves data out overnight surprised everyone by showing a significant reduction in the pace of money growth and new loans. The government’s attempt to reign in leverage seems to be biting with expectations growing that Chinese interest rates are on course to rise soon. It can be no surprise that this data in combination with the largest Trade Surplus ($275B) ever recorded by the Chinese, and the softer US inflation data has resulted in a much stronger CNY. In fact, this morning the renminbi has gained 0.7% and is back at levels not seen since early 2016. But it’s not just CNY that has rallied in the emerging market bloc, virtually all of the space has outperformed. Not surprisingly, given the euro’s move, EEMEA has been the best performing region, but in truth we are seeing strength from all three regions.

So what are we to make of all this? In the constant ebb and flow of market activity, there is no question that things are pointing to a weaker dollar in the near term, at least before we see this morning’s CPI and Retail Sales data. If those numbers print as expected (Retail Sales exp 0.5%, 0.3% ex autos), then the dollar should remain under pressure for the rest of the day. Surprising strength in either of these data releases, especially CPI, however, could stop the dollar’s decline in its tracks. Given the narrative of increasing global growth, it seems hard to believe that suddenly the Fed will turn dovish. Rather, I would expect that we could see a hawkish turn from some of the centrists there, especially when they consider the situation elsewhere in the world. I continue to believe the Fed will lead the way in tighter monetary policy and the dollar will find support accordingly. But maybe not today.

Good luck
Adf

It now seems that yesterday’s story
‘Bout China was just transitory
Bond bears are frustrated
As fears have abated
Though any replay could be gory

This morning has seen a far less interesting array of stories with which to drive markets than we had been reading and hearing about earlier this week. Despite all the initial angst about China changing their tune on US Treasuries, the reality is that they have no choice but to remain invested, as there is no other market available where they can maintain their reserves safely. In addition, the fact is with the stability of the yuan lately, they are just not as likely to accumulate new reserves, and therefore not likely to increase their appetite. Remember, too, there is no possibility that they would discuss the idea of selling part of their holdings before they actually did so as it would work to their own disadvantage. It has been mooted that this was some type of signal from the Chinese to the Trump administration, although I doubt it had much impact. From the time I wrote yesterday morning, 10-year yields are lower by 5bps. However, this doesn’t change my view that we are going to continue to see those yields rise, but that is based on my view that measured inflation is going to return to the US.

Similar to the reversal in the Treasury market, the FX market has also returned to levels prevailing before that story made the rounds. While the dollar was under clear pressure yesterday morning, it too rebounded alongside the bond market and this morning sits little changed from Tuesday’s levels. In fact, the story today is there is no story. When looking at the FX markets broadly, compared to yesterday’s closing levels, in the G10 space, only AUD and NZD have moved more than 20bps, both rallying about 0.35% on the back of the continued strength in commodity prices. Meanwhile, in EMG world, though the movements have been slightly larger, there has been no discernible pattern. The biggest movement came from MYR, which rallied just 0.4% overnight on the back of the ongoing rise in oil prices (WTI is up to $64/BBL, its highest level since June 2015). Interestingly, the worst EMG performer overnight, though it fell just 0.25%, was MXN, despite the rise in oil prices. It seems there were some comments by the central bank governor regarding future peso weakness if NAFTA comes undone. That is a situation that I believe is entirely possible, and one about which I would be very cognizant if I had hedging activity in MXN.

FLASH – ECB MINUTES SEEN AS HAWKISH, EURO RALLIES

Moments ago the ECB released the Minutes from the December meeting and the upshot is that the hawkish commentary we have been hearing from some members seemed to be confirmed by the Minutes. The key statement was:

“The view was widely shared among members that the Governing Council’s
communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further toward the Governing Council’s aim. The language pertaining to various dimensions of the
monetary-policy stance and forward guidance could be revisited early [in 2018][my emphasis].”

It was the “revisited early” part that got the market going and the euro, although it had been virtually unchanged ahead of the release, jumped 50 pips and is now back near 1.20. The thought process seems to be that they are hinting at acting more quickly with regard to reduction in QE than previously stated, which if true is certainly bullish for the euro. However, I want to hear from Signor Draghi before I change my tune there. He has been consistently dovish and until that changes, I feel the euro will have difficulty.

While the Minutes added some excitement just now, overall it was a dull session. This morning brings US PPI data (exp 0.2% for both headline and core) although unless those numbers are significantly different, PPI generally has a limited impact on markets. Tomorrow’s CPI is a different story however. We also see Initial Claims (exp 245K) but that, too, doesn’t feel like it will matter much to markets. We hear from Bill Dudley this afternoon, and perhaps he will have something new to discuss, although I wouldn’t count on that either.

At this point, the euro is going to be the story for the day, and I wouldn’t be surprised to see it extend gains as the day progresses. But other currencies don’t appear to be all that interesting.

Good luck
Adf

Most traders apparently think
That Treasury prices will sink
If China stops buying
And so they are trying
Their profits, from this, to unlink

But strangely despite higher rates
The dollar, today, demonstrates
Low yields aren’t all
The buck needs to fall
Sometimes a new tale resonates

The biggest news overnight was the unsourced story out of Beijing that the Chinese had lost their appetite for US Treasuries. In fact, the rumor (or at least the concern) is that they may not simply stop buying them, but actively start to sell part of their holdings. This has been a key driver in the recent sharp rise in 10-year Treasury yields, which as I type are at new nine-month highs of 2.59%. (We need to go back to June 2014 for the last time yields were higher than this past March, and December of 2013, in the wake of the Taper Tantrum, for the last time they touched 3.0%.) Remember, the Chinese are the largest holder of US Treasuries which serve as the main vehicle to hold the bulk of their $3.1 Trillion of FX reserves. Last year, as the renminbi appreciated, their reserves continued to grow and alongside that, so did their demand for Treasuries. However, it is apparent they are no longer willing to tolerate further CNY strength, reducing the growth rate in their reserves, and correspondingly their demand for Treasuries. The multi-billion dollar question is, will they start to actively sell Treasuries, or simply stop buying them? A related question is will they seek to diversify their reserves away from dollars into other currencies?

It is the latter theory that seems to be driving the euro this morning, as despite the highest US yields in more than nine months, and the widest spreads between Bunds and Treasuries in nine years, the euro has rallied a solid 0.6% and is back above 1.20. The theory is that if the Chinese choose to diversify their reserves, they will be selling dollars and buying euros with the proceeds, thus driving the single currency higher. Also aiding the euro has been the non-stop rhetoric from the hawkish wing of the ECB, with Wiedmann et al hitting the tape regularly and discussing the end of QE while the doves remain silent. This has the market convinced that QE is ending in September with the most aggressive views calling for an early end. With regard to that thesis, tomorrow’s publication of the Minutes of the ECB’s December meeting might add some clarity. But in reality, we will need to hear more from Signor Draghi defending his view that QE is still necessary for the market to take heed. Ultimately, I continue to believe that the US inflation situation will play out more aggressively than that of Europe and that the Fed will continue to lead the way, dragging the dollar along for the ride. But that is not today’s theme!

But the G10 currency with the biggest move overnight was the yen, which has rallied a further 1.2% as I type. This seems to be a continuation from yesterday’s price action, which, if you recall, was driven by the news that the BOJ was going to be buying less JGB’s in their effort to control the yield curve. So now, in the course of just two days, the yen has rallied nearly 2%. This is proof positive that the central banks remain the key drivers of market activity. I would also argue that the combination of these two stories is a harbinger of what 2018 is going to look like, namely far more volatile markets than we experienced in 2017. As we continue to see the central banking community try to unwind their excessive extraordinary monetary policy experiments from the past eight years, the coma in which markets have found themselves is almost certainly going to end abruptly. And there is one other yen nugget to add, BOJ Governor Haruhiko Kuroda’s term is due to end in April. As of yet, PM Abe has not reappointed him, nor named a successor. This has led to concerns that a new BOJ Governor may have a different view of policy settings and therefore may adjust them more quickly than currently envisaged. That, too, would add to the volatility we are likely to see.

These stories have been enough to drive virtually the entire FX market with the result being the dollar is lower almost across the board. Of course, there is always an outlier, and today is no different. The ZAR continues to be the most volatile currency with a 1% decline after the ruling ANC declared that a discussion of removing President Zuma was NOT on their meeting agenda today. This implies that some decent portion of the rand’s recent strength has been due to a series of bets that they would get rid of Jacob Zuma, and more importantly, his destructive policy agenda. Meanwhile, TRY has also been under pressure seemingly on the back of position unwinding. In an example of a more classic market reaction, investors are responding to higher US yields by unwinding their carry trades in TRY and getting back into USD. If Treasury yields continue to rise, and I think they will, this trade has further to go, and will expand to numerous other EMG currencies. Remember, the carry trade is far more fraught when volatility increases, and that is something in which I have a great deal of confidence coming to pass. Hedgers, take note of the potential for higher volatility, it will have an impact!

There is no US data today, although tomorrow and, Friday especially, will bring us some important new information. In the meantime, we get three Fed speakers today, Evans, Kaplan and Bullard, all of whom hew closer to dovish than hawkish. So as I look ahead to today’s prospects, everything certainly points to further dollar weakness. This is supported by both the equity market weakness we are seeing overseas and in the US futures as well as the strength in commodities. Something that has not been getting much press, but which I think could be quite interesting, is that gold has rallied nearly 7% since the middle of December. The question here is whether this is a result of the broad based commodity rally, typically a harbinger of good economic times, or if this is a measure of fear increasing as it regains its status as a safe haven. I sense the latter may be closer to the truth. Look for more volatility, especially if we see Treasury yields pierce their March highs of 2.627%. That will open many more technical doors to further market shakeups.

Good luck
Adf

Did the BOJ
Change policy? Or are we
Jumping at shadows?

While the dollar continues to perform well overall, rallying against nine of its G10 counterparts, the story overnight was about the tenth, the Japanese yen. The BOJ announced that they were reducing the amount of long-dated JGB’s they were purchasing by ¥10 billion (~$90B) leading to a rise in yields and correspondingly a rise in the yen. When the news hit the tape, USDJPY fell 0.5% within minutes, and despite an attempt to recoup those losses early in the European session, remains lower by 0.4% as I type. The sharp response is due to the idea that this is a significant policy signal although most analysts in Tokyo don’t believe that to be the case. Rather, it appears to be a reaction by the BOJ markets group to the reality on the ground, namely they don’t need to purchase as many bonds to achieve their targets. And actually, that is a key part of the discussion. The likelihood that the financial markets department would announce a change in policy rather than the full board is extremely remote. But it does feel like a harbinger of the future with regard to the yen. At some point the BOJ is going to start to remove policy accommodation and when they do so, it seems reasonable to expect the yen could rally pretty sharply. Of course, Japanese inflation levels remain well below their targets and so actual policy change from the top seems likely to still be far in the future. Meanwhile, the yen is likely to come under further scrutiny by both speculators and investors, which implies to me that underlying volatility in the currency could rise. Hedgers beware!

But away from the yen, the dollar continues its recent rally, rising another 0.35% against the euro and 0.55% against the Swiss franc. Once again, this movement takes place against a backdrop of solid Eurozone data although the Swiss story is a bit less positive. From the latter, we saw Swiss Unemployment rise to a more than expected 3.2% in December, while Real Retail Sales continued their recent decline, falling 0.2%. I guess neither of those things would be considered a Swiss positive. On the other hand, from Europe we continue to see solid data, with German IP rising a more than expected 3.4% and its Trade Balance expanding more rapidly than forecast as well, up €23.7 billion in November. Meanwhile, the Eurozone Unemployment rate fell to its lowest level, 8.7%, since January 2009. And yet, the euro continues its recent decline. Cumulatively, the euro is now lower on the year by about 1.4%, and while market technicians are not yet likely to jump on this bandwagon, and the prevailing narrative remains that the dollar will fall all year long, it still feels to me like the dollar has further room to run in this rally. After all, 10-year yields on US Treasuries have traded back to 2.50% for the first time since last March, and I remain confident that they will continue higher. Interestingly, yesterday’s only US data print, Consumer Credit, blew away estimates and grew by $28B, far more than the $18B expected, as consumers attacked their holiday spending with credit cards and revolving debt. Confidence certainly remains high in the US, yet another reason I find it difficult to accept the narrative of a lower USD this year.

Pivoting to the Emerging markets, the big story was out of China, where the PBOC removed the fudge counter cyclical factor from the calculation of the daily fixing leading to a 0.4% rally. Last year, if you recall, the PBOC introduced this feature as they were fighting ongoing weakness in the yuan amid significant capital outflows. To their credit, the combination of cracking down on capital outflows and adding in a non-market factor to the fixing equation was successful in stemming the decline. In fact, the yuan rallied a solid 6.6% last year. And I guess that was enough because going forward, they claim that the market will be the driving force again. And while I am sure that will be true for the short term, it remains abundantly clear that they will do whatever they deem necessary to achieve the FX level they want. So if CNY starts to move more aggressively in either direction, you can be sure the PBOC will add some new policy to prevent ‘excessive’ movement. Once again, I would question how the IMF could consider the CNY a market driven currency and eligible to be part of the SDR. Talk about politics!

As to the rest of the EMG space, the dollar is today’s big winner virtually across the board, with only ZAR showing any strength. The story here was a market rumor that President Jacob Zuma had resigned, although there is no substantiation of that fact. However, there is no doubt in my mind that if he did do so, the rand would see significant gains.

The only data point this morning is the JOLTS Job Openings number (exp 6.025M), which seems unlikely to drive the FX market. We also hear from uber-dove Neel Kashkari, so look for more discussion on why interest rates should never be raised again. He will certainly be happy to have heard one of the newer members, Atlanta’s Raphael Bostic, say yesterday, “…I would caution that that [removal of policy accommodation] doesn’t necessarily mean as many as three or four moves per year.” So there is another dove on the board. The thing is, if inflation does continue to tick higher, and we will learn more on Friday, even the doves will come around. So far nothing we have seen this year has changed my view that higher inflation and higher interest rates in the US are on their way, and a higher dollar alongside. As to today, I see no reason for this modest dollar rally to end, so would look for the euro to test 1.1900 by the end of the day as a proxy for a tad more dollar strength.

Good luck
Adf

On Friday, I have to confess
The Jobs report didn’t impress
The dollar reacted
By getting compacted
But later, dispelled the distress

This morning the dollar is still
Increasing in value but will
Undoubtedly find
The rally will grind
To a halt, as it battles uphill

It has been a distinctly uninteresting session overnight despite somewhat better than expected Eurozone data being released. In fact, the dollar has continued its Friday afternoon price action and rallied vs. almost every currency. A recap of Friday’s US data showed a decent miss by the headline payroll number, just 148K rather than the 190K expected, and even with revisions the data was weak. But as I had suggested, there was more concern about the AHE data, which printed right on the number, continuing to point to earnings growth of 2.5% over the past year. While that is slower than the Fed clearly wants to see, at least it is not decelerating. The market’s initial reaction was for the dollar to sell off sharply, with the euro jumping 0.3% in the first minute of trading, but it spent the rest of the day ceding those gains and actually closed lower. The euro’s decline has continued here this morning and as I type, it is down by a further 0.35%. What makes this so surprising is the data showing Eurozone Economic Confidence is at its highest level in more than a decade, while the harder data, Retail Sales being today’s example, continues to improve as well. I would argue the consensus view on the dollar this year is distinctly negative, with the rationale being the ECB will be more aggressive than currently priced, while the Fed will simultaneously slow down their tightening policies in the absence of inflationary pressures. You also know that I disagree with that outlook and expect virtually the opposite central bank outcomes along with a dollar rally. One week into the year it is way too early to tell who will be correct, but I have not changed my view at all.

As to the rest of the G10, the dollar is firmer here as well. Alongside the euro, SEK has also fallen 0.35% as concerns increase over house prices there. After what had been non-stop rally in prices for ten years, they have fallen 7% in the past three months and are forecast to decline further. Of course, like all other assets, their prices have been a direct response to the extraordinary monetary policy from the world’s central banks. Is this the canary in the coalmine? It is not uncommon for secondary markets to exhibit the first signs of change when trends are under pressure. Keep a close eye here.

The other thing that is somewhat unusual is that commodity prices are continuing their rally despite the dollar’s strength. Generally the two move in opposite directions, but not today. Let me say that if we continue to see commodity prices rally as they have been, inflation expectations are going to need to rise. You are also aware that I am quite certain that we will see higher inflation readings this year, which will drive policy around the globe. So it seems that we have some anomalous price action this morning. But remember, one day is an anomaly, and perhaps even two days, but if it continues, it starts to become a trend.

A brief tour of the emerging markets shows that the dollar is king there as well this morning, with only one currency of the twenty-four I watch, THB, showing a gain vs. the dollar while the rest of the bloc is lower. And the baht is only higher by 0.1% after news showing foreign investors buying more Thai bonds for a ninth consecutive session. Otherwise, the key decliners have been ZAR, down 0.90% after a major analyst indicated he thought the rand’s 16% rally over the past two months was excessive. It seems some profits were taken this morning. But then the rest of this bloc, across all three geographic regions, is lower by varying amounts as well. Today is simply a day to buy dollars!

After last week’s data deluge, we have much less to digest this week, but Friday is important:

While the Fed doesn’t use CPI in its calculations, it is still the most widely followed inflation indicator and the market will immediately factor in any surprise. While these are December figures, and so I don’t expect much variance, anecdotally I have seen a number of places raise their prices in the new year already, so I expect that next month’s data is ripe for a higher print. In addition to the data, we hear from eight Fed speakers this week, although they mostly hew from the dovish side of the spectrum. As such, I expect to hear a lot about why the Fed needn’t be in a hurry to continue tightening policy. But in the end, even the doves will need to respond if the data shows prices rising. And that is this year’s big unknown; just how fast will prices rise in 2018.

As to the market today, it is hard to get excited about much further movement. My sense is that the dollar’s rally is likely to stall for now, although unless we hear something new and surprising from one of today’s Fed speakers, I see no reason for the dollar to give back its gains.

Good luck
Adf

Inflation in Europe remains
The data that never shows gains
For hawks it’s a worry
As they’re in a hurry
To raise rates ere Europe’s growth wanes

It should be no surprise that inflation remains the topic du jour in markets as it has risen to the top of every central bank’s agenda now that global growth appears in good shape on a synchronized basis. The problem, however, is that despite this uptick in growth, inflation continues to run well below targets. The latest data came from the Eurozone this morning, where headline CPI was released at 1.4%, 0.1% lower than last month but right on expectations, while the core reading, excluding food, energy & tobacco prices, remained stable at 0.9%. The ongoing absence of visible price pressures continues to split the ECB with a slowly growing hawkish wing arguing for a swift end to QE, while the more moderate and dovish members, including Signor Draghi, are perfectly happy to watch from the sidelines. After all, in the doves’ collective mindset, they have already acted by virtue of the reduction in QE purchases to be made starting this month and going forward at least until September. The upshot in the market has been modest weakness in the euro as traders become slightly less certain about the timing of the end of QE. After all, if, come September, Eurozone CPI is still running near current levels with core still around 1.0%, it will be extremely difficult for the ECB to make the case that it is time to end QE. And remember, the key driver in the euro’s ascent over the past nine months has been the idea that the ECB is going to become more aggressive than the Fed in its removal of policy accommodation.

As to the dollar’s overall performance this morning, it has shown broad based, if shallow, strength. In fact, it has rallied against all its G10 brethren, and against most of the emerging market bloc. However, movement overall has been quite limited and I believe that is due to the anticipation of today’s big data release, the payroll report.

Here are updated forecasts:

At this stage in a recovery cycle, one has to be impressed by the steady growth in employment. The impact from the hurricanes in September seems to have completely washed through the data, and there is no reason to think this report is going to underperform, especially since yesterday’s ADP number was a blowout on the high side at 250K. The point is that the employment situation in the US remains quite solid. Of more importance in my eyes, and likely in that of the FOMC, is how the AHE number evolves. Remember, the Fed remains ‘all-in’ on their Phillips curve models, and so will see an increase in this number as a critical input into their framework. Finally, keep an eye on the ISM data at 10:00, where further strength will add more pressure to the FOMC to potentially accelerate their policy tightening. Let me say that based on the start to the year in equity markets, there is a strong belief that the data will continue to be quite robust.

Aside from the data, we hear from two more Fed speakers, Philly’s Harker (centrist) and Cleveland’s Mester (hawk) later. Yesterday we heard from St Louis Fed President Bullard (dove) who made an interesting, if unproven point. He said that in countries that have established an explicit inflation target, the private sector has become more confident in central banks’ ability to deliver that target, and thus long-term inflation expectations have gravitated to the target. The impact is that it seems unlikely that inflation will run out of control in those countries. But it has also resulted in extremely sluggish movement in those indicators, meaning that the time line for inflation to regain its target has been extended. Of course, as he is a confirmed dove, he is simply talking his book. He remains keen to come up with a rationale for the Fed to slow down its policy trajectory. However, he is not a voter, and I don’t believe that this theory will gain widespread acceptance any time soon. In fact, I would argue that we have seen inflation run higher, and that the data is simply catching up. My gut tells me that the reaction function in the Fed, as currently constructed, is that strong data today, especially AHE, will lead to thoughts of even faster tightening, while any softness will be overlooked. Too much evidence is pointing to further economic strength, and higher prices by default. I still like the dollar overall on this basis, as I continue to believe the Fed will be more aggressive this year than the market expects.

Good luck
Adf

So what did we learn from the Fed?
They’re thinking that tax cuts instead
Of low unemployment
Could give them enjoyment
By driving price rises ahead

“We’ll have to be guided by the data as they come in, that’s what will dictate the path of our policy.” These words from Jerome Powell at his Senate confirmation hearing back on November 28th will be tested as we go forward. Yesterday’s FOMC Minutes showed that
the committee remains quite comfortable with the current economic growth prospects, highlighting strength in numerous sectors domestically as well as global growth. Recall that the December meeting occurred before the tax reform legislation became law. However, several committee members did discuss the prospects for said legislation and the impact it might have on the economy, and by extension the rate of inflation. It is clear that the Fed has completely turned its focus to the inflation story, and rightly so, given the current robust employment situation. So the question going forward, and one of the key drivers of markets and the dollar this year, is how will inflation behave in 2018?

The first data of the year have shown that economic growth continues apace, with PMI data from around the world beating expectations for both manufacturing and services. This morning’s readings from Europe and the UK are the latest, with the Service and Composite readings both pushing to the highest levels seen since the financial crisis. As well, from the US we saw ISM Manufacturing yesterday with a robust outcome of 59.7, also pushing back near its highest levels since the crisis. Of more importance, however, was the ISM Prices Paid index, printing at a much firmer than expected 69.0, and indicating further that inflation pressures are growing in the US.

The mystery of low inflation continues to be the theme on which the Fed hangs its hat. It is why two members dissented on raising rates in December, and what every dove will cite as they make the case for retaining extraordinary monetary policy. But inflation is real, it is quickening, and it is coming to a screen near you. Not only are we seeing price pressures at the factory gate as products are shipped, but we are seeing commodity prices staging a strong rally. In addition, the dollar’s weakness speaks directly to a rise in import prices, and after all, we run a very substantial trade deficit every month. The final hiding place has been in wages, but there remains a disconnect between the growth in wages (which according to the Atlanta Fed Wage Growth Tracker has been running at >3.2% for the past two years) and Average Hourly Earnings (AHE) which continues to run at a surprisingly low 2.5%. The thing is, there is no reason that Core PCE, the Fed’s designated measure of inflation, cannot rise despite the lagging of AHE. In fact, I expect that is exactly what we will see as 2018 progresses. Add to this the prospect for a further boost to US economic growth from the initial impacts of the tax changes and you have a recipe for higher inflation. This will force the Fed’s hand going forward. After all, if Chairman Powell is true to his word, higher inflation will guide the Fed toward higher rates. And that is not something the current market valuations have priced in. Rather I would argue what current valuations have prices in is permanent low interest rates and inflation, a highly unlikely outcome!

On to the dollar, which continues its recent performance and has fallen somewhat further this morning. Versus its G10 brethren, the dollar is down against all but the yen, which is basically flat on the session. Despite a strong performance by the US economy, it appears that traders continue to bet on an even stronger performance by other nations’ economies. Even the UK has shown resilience in the face of Brexit related uncertainty and has rallied further this morning. Last year the dollar remained under pressure all year as the narrative evolved toward the Fed slowing its pace of tightening while other nations started to increase theirs. I have seen nothing to indicate the Fed is going to slow down, and in fact, expect it is far more likely that they raise rates at least four times this year, more than they themselves penciled in back in December, and far more than futures markets currently have assessed. It is that change which will drive a change in dollar sentiment during 2018.

The story in emerging markets overnight was the same, with the dollar falling against virtually all its counterparts, led by TRY’s 0.7% gain followed closely by ZAR’s 0.6%. The latter is easy to understand as commodities, notably precious metals, have been rallying, while the former saw a response to a report by the central bank that the inflation story there was improving slightly. Remember, Turkish interest rates remain amongst the highest in the world. Elsewhere in this space, the story was similar if less dramatic, with currency strength a function of the dollar’s overall weakness rather than any specific stories per se.

This morning’s data brings the following: ADP Employment (exp 190K) and Initial Claims (242K), with the former having potential for instigating a move. Any reading that could imply further labor market tightening should impact US yields and by extension the dollar. However, I would argue that a weak number would not likely have a large negative impact given the market’s underlying premise is already that inflation will remain low forever! At any rate, the reality is that tomorrow’s data is far more important, so it is hard to get overlay excited this morning. The St Louis Fed’s Bullard speaks this afternoon, but I would be surprised if he starts to change the message, especially with the imminent arrival of a new Fed chair so soon. Adding it all up leads me to believe that the dollar is unlikely to fall much further instead staying quite near current levels. Tomorrow, however, could be a different story.

Good luck
Adf

For two weeks the dollar’s been hammered
As traders, for Krona have clamored
The narrative speaks
Of a dollar quite weak
A view with which I’m not enamored

But now that the New Year has started
With tax laws for earnings recharted
A new attitude
Ought soon be pursued
But this won’t be for the fainthearted

In the two plus weeks since I last wrote, the dollar has been sold off consistently, with the Swedish and Norwegian Krona(e) the biggest gainers in the G10 space, rallying between 3.5% and 4.0%. Pretty impressive movement in a short period of time! But across the entire G10, the dollar was the weakest currency as the narrative continues to focus on the idea that the Fed will be forced to slow down their current trajectory of interest rate increases while we will see a much quicker pace of tightening elsewhere in the world. For those of you who looked through my forecasts yesterday, it is clear I disagree with that story. However, as long as enough players in the market continue to believe the story, the dollar will remain under pressure.

So what can change that view? We will need to see the inflation story become much clearer for the US, meaning rising wages and prices, as well as ongoing dovishness from certain central bankers, notably Mario Draghi, in the face of an improving economic situation in Europe. And the improving economic situation in Europe continues apace. Yesterday saw the PMI data in Europe confirmed at its highest level since well before the financial crisis and this morning added record low German Unemployment to the mix. Certainly the story in Europe’s largest economy has been a success, but as yet, like elsewhere in the developed world, faster growth has not led to higher prices. And all of the commentary we have heard from Mario Draghi and his ECB brethren continues to focus on the lack of inflationary pressures as the root cause for the ECB’s need to continue to support the economy. In other words, while QE in Europe will be cut in half from last year’s levels starting this month, they are still adding assets to their balance sheet and continuing to cap Eurozone interest rates.

On the other side of that trade is the US, where the Fed has already embarked on its tightening campaign, both raising rates and allowing the balance sheet to start to shrink. In many ways I think the latter issue will be much greater, especially with the government’s growing need to issue significantly more debt to cover a growing budget deficit. The upshot is just as we are slated to get a big increase in supply this year, the biggest bid for Treasuries is going to shrink. To my knowledge, the laws of supply and demand have yet to be repealed, and that situation means that Treasury prices seem certain to decline as the year progresses. In my view, higher Treasury yields will be the key to underpinning the dollar’s surprising (to the market) strength this year.

It is important to remember that it was not just the G10 currencies that benefitted during the second half of December, but almost all emerging market currencies rallied as well. In fact the only two laggards there were the Argentine and Mexican pesos. As to the former, the story revolved around a relaxation in inflation targets for the next two years allowing easier monetary policy there to support growth. Of course, easier monetary policy (read lower interest rates) is anathema for an emerging market currency, hence the decline. Meanwhile, just south of our border it seems that the basic story driving the Mexican peso’s decline was concern over a growing campaign-finance corruption scandal, which was seen as a boost to AMLO and a more radical presidential outcome this summer. While both these currencies have rebounded somewhat from their worst levels of the period, it is important to remember that both have issues that can lead to further weakness. But elsewhere in EMG, it has been dollar bashing as well.

With the first week of the month upon us, we are due to be saturated with data as follows:

All eyes will be on today’s FOMC Minutes as traders and investors want to see more about the inflation discussion at the Fed. And then, of course, Friday’s payroll data will be key. Any hint that wages are rising more rapidly than forecast should be seen as an immediate dollar positive. Also, watch the Unemployment rate as if it were to decline further, it would also ratchet up pressure on the Fed.

As to today’s trading, the dollar seems to have stabilized after its recent declines. My sense is it will be responsive to the impressions from the Minutes, but that traders are really looking ahead to Friday.

Good luck
Adf