Things Could Come To Grief

Said Harker, the Philly Fed chief
Two more hikes this year’s my belief
The issue I fear
Is inflation’s near
At which point things could come to grief

As equity markets around the world remain roiled on the back of concerns over the changing political and regulatory landscape for the tech sector, it is refreshing to have a Fed member ignore the issue in comments. This is all the more surprising since virtually everybody else who gets in front of a camera gives us his or her “insights” into what is causing the increase in volatility. But the reason this is refreshing to me is that it implies the new Fed leadership is far less concerned with equity price movement than the old. Rather, they are focused on their actual mandate of price stability and full employment. So in an interview yesterday, Philly Fed President Patrick Harker indicated he had increasing concerns that inflation was picking up and that he was now fully on board with two more rate hikes this year. Granted, according to the dot plots from last week’s FOMC meeting, it still appears that the core of the Fed is expecting three more hikes, but the fact that every Fed comment we have heard since the meeting has touched on the inflation risk is indicative of the fact that the hawks remain in command. And remember, Harker is not a voter this year, so while his opinion matters, he can’t vote against a fourth hike. In a nutshell, this is further proof that the Fed put is fading and that most Fed member’s individual economic models are pointing to higher inflation going forward. The real question seems to be the pace of rising inflation they expect, not whether it will come about.

This is all with a piece of another big market story, the rise in short term interest rates beyond what the Fed has actually done. This morning, the 2yr-10-yr spread in Treasuries is down to 50bps, it’s flattest since before the financial crisis, and after a two-month respite, seems set to continue flattening. Remember, an inverted yield curve remains one of the most well-known signals of a future recession. In fact, the argument in pundit circles is whether the Fed is about to make a key policy error, raising rates too far or too fast and thus driving the economy into recession. The way I view the issue is that despite the Fed having raised rates six times in this cycle, rates continue to be near historically low levels. If a few more hikes, such that Fed Funds was at 2.25% or 2.50% is sufficient to tip the US into recession then the long term damage that QE inflicted on the economy is even a bigger issue to be addressed. Apparently, a decade without actual price signals is a bad thing! Who’d have thunk it? It is still premature to say that things are going downhill, and after all, Q4 GDP grew by a more than expected 2.9% according to yesterday’s data, but I am very concerned over the timing of the next recession. My first concern is that we are already in the second longest growth period in the post-war years and so are likely coming close to the end. My second concern is that virtually every pundit and economist out there is so sanguine on the subject with forecasts that a recession won’t happen until late 2019 or early 2020. My experience with consensus forecasts is that if everybody agrees something will happen but is confident it will take a long time to occur, it will happen much sooner than expected. As such, my fear is that by the end of this year the picture will be much worse and recession either upon us or imminent.

And what will this do to the dollar? Well, that is a tougher question. My gut tells me that as the synchronized global growth story begins to unravel, as it will if I am correct, then expectations for the ECB and BOJ to halt their QE programs will rapidly diminish, and correspondingly, both the euro and the yen will suffer. In addition, our key trading partners, Mexico and Canada, would almost certainly see their own economies suffer and their currencies alongside them. Of course, the flip side to that argument is that the Fed would need to reverse its policy tightening and so perhaps undermine the appeal of the dollar. Much of this will depend on the exact timing of when it becomes clear that the global economic cycle has turned. However, I fear that the turn is much sooner than currently expected.

As to the overnight session, markets are clearly getting tired from the increased volatility that we have seen around the world, and so movement has been much less impressive heading into the long Easter holiday weekend. In fact, broad-based dollar indices are essentially unchanged, which given that both the euro and the yen are essentially unchanged makes sense. But in truth, looking across all currencies, I think the largest movement I saw was just 0.3%, not nearly enough to need an explanation. We continue to see European data point to the idea that Q4 2017 was the peak in growth there, with last night’s Swiss KOF index falling to 106 and extending its trend lower from last year. UK housing prices were also soft, although German employment remains quite robust. The one thing to remember about employment data though, is it is a lagging indicator and so will be the last thing to fall in the downturn. But on the whole, it has been a dull session.

This morning, however, holds the promise of some activity as we get a series of key data points. Personal Income (exp 0.4%), Personal Spending (0.2%), and Initial Claims (228K) will all pale compared to the PCE (1.7%, 1.5% core) which are the Fed’s key inflation inputs in their models. Any higher print in that series should have an immediate impact on markets, with an increased concern that the Fed will get even more hawkish driving equities lower and the dollar higher. Similarly, a soft number is likely to see equities rally and the dollar fall as relief spreads. Then at 9:45 Chicago PMI is released (62.8) and finally at 10:00 we get Michigan Sentiment (102.0) to finish the data for the week. In the end, I continue to look for the dollar to benefit from the data but do not see any large movement in the near future, especially with the holiday tomorrow and with much of Europe closed on Monday.

Good luck and good weekend


A New Paradigm

There once was a long stretch of time
When markets were truly sublime
But six weeks ago
A sudden outflow
Of funds caused a new paradigm

Volatility continues to be the watchword in markets these days, especially in the equity space. The last three sessions have seen a rout, a boom and then another rout with each move pushing 2% or more. This is proof positive, if it wasn’t already obvious, that the days of somnolence and steady gains that we experienced in 2017 are well and truly over. It is actually quite difficult to keep up with all the stories that are whipsawing sentiment as they come fast and furious each day. Trade wars, a renewal of the cold war, increased regulatory scrutiny on the tech sector, higher inflation, softening economic data and political turmoil are just some of the factors that have been blamed for the recent price action. And while I am sure that each one of those factors had some impact at some point in time, I would ultimately point to a single overriding issue that has changed things, the removal of central bank support from markets continues apace.

For nearly ten years the major central banks around the world printed and injected $21 Trillion (with a T) into global markets in their efforts to support economic growth. This was a hyper-Keynesian play that all their models told them would prevent further damage. But this was essentially an enormous experiment in monetary policy with no certain outcome. And while it seems that the central banks may have stopped a sharp decline in economic activity back then, the unintended consequences of their actions are starting to be felt. Now as the Fed leads the way in removing that support, markets are having a difficult time coping with the change. Remember, even though the Fed is reducing its balance sheet, the ECB and BOJ continue to add to theirs, so right now, it seems there as a fragile equilibrium in total central bank balance sheet size. But there is every indication that the latter two are preparing to reduce theirs as well which, as I have written time and again, is part and parcel of the current market narrative and a key rationale behind expectations of a weaker dollar going forward.

But something else occurred during this period as well; we saw a significant increase in computer-led, automated trading including AI processes. And all of those models were built based on the most recent market data, which happened to include the unprecedented stimulus of the world’s central banks. However, it is becoming abundantly clear that this fact was not seen as a variable, rather simply as part of the initial conditions. The upshot is not only do we have an entire generation of traders who have never seen a down market, but we have an entire industry segment of computer trading models that never assumed it was part of the equation. Having been involved in markets for a pretty long time, I can tell you that volatility is the norm, not the exception. And while there may be a specific catalyst to any given move, the underlying market paradigm has very clearly shifted to one where price movement going forward is going to be fast and uncertain rather than last year’s remarkable slow and steady in one direction.

While equity markets get the most press, this phenomenon has been the reality across every market and that means each one is going to seem increasingly unstable compared to what we got used to seeing last year. So be prepared, this is going to be the state of play for quite a while.

Now, with all that said, the overnight session was actually pretty tame. While yesterday’s US equity market rout saw some follow through in Asia, with both Chinese and Japanese markets falling sharply, as well as a significant Treasury rally taking the 10-year yield down to 2.76%, breaking both the bottom of its trading range and the 50-day moving average (a key technical indicator), European markets have been soft but not excessively so, and the FX market has shown a muted response. In fact, surprisingly, the dollar is slightly stronger against most currencies, with the biggest surprises being the yen and Swiss franc, the two best-known havens. In a market like this I would have expected both those currencies to rally, and yet both are lower as I type, with the CHF (-0.4%) actually the weakest of the G10 bloc. As there was no data released in either nation, these moves are clearly not data related but rather seem to be of a piece with the broad dollar trend today.

And what, you may ask, is driving the dollar higher? That is the $64,000 question, but one with no obvious answer. Scanning the broad markets, my sense is one thing supporting the dollar these days is the ongoing rise in short dated US rates, notably LIBOR, which continues to power ahead and has reached its highest point since 2008 at 2.30%. While most analysts continue to highlight the technical reasons driving the rise, the rate has clearly become an attractive carry target. In addition, given the last time that the LIBOR-OIS spread had widened this much the market was in the midst of the Eurozone bond crisis, and this spread has historically been a harbinger of systemic credit concerns, there are clearly some investors who are simply more comfortable in dollars than other currencies. Consider that prior to QE, the dollar was the ultimate safe haven currency. If the central banks are heading back toward that status again, doesn’t it make sense for the dollar to reacquire that mantle of the safest currency around? Once again I will point out that as the paradigm shifts in central banks and monetary policy, the impacts are going to be felt throughout markets in some unexpected ways.

With all that in mind, let’s discuss what to expect today. Yesterday’s data showed us that Housing prices are still rising and consumer confidence may well have peaked. This morning we await the final look at Q4 US GDP (exp 2.7%) along with an advanced Trade report (goods only expected at -$74.0B). Since the former is so backward looking, it would take quite a revision to move markets. However, given the current focus on trade, it is very possible that a larger than expected number in the trade report could have some knock-on effects, especially if we hear commentary from the White House, as it could reignite trade war fears. Yesterday we also heard from the Atlanta Fed’s Rafael Bostic who said he is comfortable with the current rate path at this time although he and his fellow FOMC members were closely watching the data to see if things change. He speaks again today and it would be remarkable if he changed his tune.

Speaking of the Fed, one thing that I believe has already changed under Chair Powell is that the idea the Fed will step in to allay concerns if equity markets tumble, the so-called Fed put, has been significantly devalued in the new Fed. If it still exists, I would at the very least that the strike price has been moved far out of the money. In other words, a stock market decline would need to be so large and so fast that the Fed believes it would destabilize the economy itself, and that is a much higher bar than markets had gotten used to from the previous three Fed Chairs. This, too, is part of the new paradigm. Taking everything into account, my sense is that the dollar will continue to hold onto its modest gains today, but that large movements will need to await further data. Remember, tomorrow we have PCE data released, and any surprise to the high side will simply reinforce the idea that the Fed is not going to be deterred in raising rates. But that is not today’s concern.

Good luck


No More Are Afraid

On Friday the story was trade
That caused folks to be so dismayed
But Monday’s returns
Allayed those concerns
Thus buyers, no more, are afraid

But what of the data released
From Europe, that showed growth decreased
That story remains
Their ‘conomy’s gains
Are fragile at the very least

Wow! What more can one say regarding the breathtaking rally in the equity markets yesterday, which has essentially extended around the world this morning. Does this mean that all our problems are behind us? I kind of doubt it, but you would never know that from the way things have traded in the past twenty-four hours. Ultimately, my sense is that we are going to continue to see market volatility increase and that it is going to seem worse than it actually is because of the extended period, right up until the end of January 2018, where market volatility had been unnaturally suppressed by central bank actions. Given the human tendency toward recency bias, many investors are watching the past few weeks of more historically normal price volatility and thinking that the world has come unglued. However, volatility is barely back to its long run average and arguably we can see it go much higher. In fact, if central banks actually continue to remove the excess liquidity they have been injecting into markets for the past ten years, it is very likely to do so. In other words, this is the new ‘new’ normal.

But this isn’t a note about equities, rather one about FX, and that story continues to unfold as well. This morning, the dollar has recouped some of yesterday’s losses after Eurozone economic data disappointed yet again. First up was Spanish inflation printing at a softer than expected 1.3% and showing no signs of heading back toward the ECB’s target of “just below 2.0%.” Then came the Eurozone sentiment indicators with Business Confidence falling to 1.34 (exp 1.39) and Economic Sentiment falling more than expected to 112.6 from last month’s 114.2 reading. While it is important to remember that these numbers are still strong historically, the recent trend indicates that the Eurozone economy likely peaked in Q4 2017. If this trend continues it is going to be much more difficult for Signor Draghi to completely kill QE at the end of September. Rather, it is more likely that he will wind up extending it, at a lower rate of perhaps €10 billion or €15 billion per month at least through the end of the year. This will also have the effect of delaying any movement on the interest rate front, maybe even until 2020. My point is that expectations that the ECB is going to tighten policy sooner rather than later seem to be misplaced, and any strength the euro has shown on that basis should be unwound. In fact, this morning we heard from Erkki Liikanen, the Finish representative on the ECB, who explained that ongoing low price pressures mean there is no hurry to tighten policy.

But it’s not just the euro under pressure this morning; the dollar is performing well across the board. The pound is down more than a penny on what largely seems to be a correction to the past two days impressive rally. Given the dearth of news regarding the UK this morning, this is likely to have been driven by a large order, especially as the pound was trading near its highest levels since the Brexit vote in 2016. The market continues to price in a high probability that the BOE is going to raise rates in May, and that has underpinned a great deal of the bullishness on the currency. The thing is, UK data, too, has started to miss the mark. And while the economy has definitely performed far better than had been forecast two years ago in the event of a Brexit vote, the numbers still show slow growth, something on the order of 1.5%, with inflation well above their 2.0% target (most recently at 2.7%). I continue to believe the hawkish case is overstated, but clearly much will depend on how the Brexit negotiations evolve.

As to the rest of the G10, the dollar is pretty consistently firmer on the order of 0.2%-0.3%, which is clearly all about the dollar rather than any currency per se. EMG currencies are also generally under some pressure this morning, although here, too, the movements have not been that large. I have not seen any significant stories other than the news that the US and South Korea have agreed details of a revised trade pact which has helped the won rally about 1.5% in the past two sessions. In LATAM, while MXN is little changed this morning, it has been strutting its stuff all year having rallied nearly 6.0% and is the best performing currency against the dollar this year. As we continue to hear of positive results from the NAFTA talks, it seems clear that the peso will gain further. The biggest risk here is in this summer’s election, where Antonio Manuel Lopez Obrador (better known as AMLO) continues to lead the polls and could well be the next president. The thing is he makes Bernie Sanders seem conservative, and markets are quite fearful of some major shifts in policy if he is elected. But right now, that is not on traders’ collective minds.

This morning brings two minor pieces of data, Case Shiller House Prices (exp 6.2%) and Consumer Confidence (131.0), neither of which seems likely to impact markets. Atlanta Fed President Bostic speaks this morning as well, although based on the complete lack of coverage of the three Fed speakers yesterday; it seems unlikely that he will break new ground in the narrative. In other words, the FX market will continue to look elsewhere for catalysts, with the equity market the most likely driver. Futures there are pointing to further gains as I type, which based on recent correlations are probably a dollar negative. However, this year, given the increase in equity market volatility, I am reluctant to say that a higher opening will lead to a higher close. If anything, yesterday’s rally seemed a bit overdone, and I wouldn’t be surprised to see a modest decline in stocks by the end of the day alongside a little bit more USD strength.

Good luck

Just Splendid

While last week the world almost ended
This morning all things seem just splendid
It seems a trade war
May not be in store
Here’s hoping the rally’s extended!

I guess the world is actually not going to end this morning. I know that if you watched the price action Friday afternoon, it certainly seemed like it was the beginning of the end. Between the imminent trade war with China and the ongoing reputational destruction of US mega cap tech companies, the leaders of the equity market rally, there was no place to hide. Treasuries, which did rally sharply last week on their haven status, find themselves subject to the largest weekly supply surge in history this week, with the Treasury looking to sell $294 billion worth, so it is reasonable to expect some pressure there. And the dollar? Well everybody continues to hate the buck with a vengeance and keeps calling for an imminent collapse. So what’s a risk manager to do?

Well first off, it now appears as if the trade talk was not quite as dangerous as previously thought. This morning’s storyline is that the US and China have been engaged in an active trade dialog behind the scenes covering autos, steel and financial services, and that real headway has been made. In addition, it turns out that the US and South Korea have reached an updated trade agreement covering autos and steel and that the Koreans will not be subject to any steel tariffs. So one of the biggest concerns from Friday has been ameliorated.

Second, and in a related fashion, the background threat of the Chinese stepping away from the US Treasury market as a weapon against the US also seems to have abated. To begin with, that threat has always been oversold in my view, as the Chinese have virtually no alternatives when it comes to investing their reserves. The fact is that US Treasuries are the only market that can handle the flow while simultaneously offering liquidity and safety. Ask yourself this, if they sold their Treasury holdings, ignoring the fact that it would destroy hundreds of billions of dollars of value by simply doing it, where would they put the money they got? No other market is capable of receiving that type of investment without severe distortion. But on top of that, given the new story about the ongoing trade dialog, it seems clear that there will be no perceived need for the Chinese to do so. As such, I think we can expect that they will continue to participate in US Treasury auctions and that the bond market is not going to collapse. That said, I still do believe that Treasury yields rise throughout the year, just not that rapidly.

In fact, of the big concerns last week, the only one that has not seemingly been addressed is the tech stock story, with news this morning that Europe is now seeking to break up Google hitting the tape. This story, which is truthfully outside the purview of this note, probably still has legs, and in many ways is likely more impactful on equity markets, and by extension the global market situation. The one thing I will say is that from all that I have read, it has become abundantly clear that there are going to be changes forced on this sector through either legislation or regulation, and that the business models are going to be forced to change to the detriment of shareholders.

With all this in mind, let’s now look at the dollar. This morning, the trade has been one-way, with the dollar under pressure against both G10 and EMG currencies. It seems that the underlying FX narrative, that the Fed will behave less hawkishly than their own rhetoric while the ECB and BOJ will be more hawkish continues to drive the debate. There is also a growing expectation that central bank reserve managers, who have been increasing their share of USD reserves over the past several years, may start to reverse that trend. Historically, the dollar has represented between 60%-64% of international reserves with the euro next at between 20%-24%, and then a smattering of other currencies like the yen, pound, Canadian and Australian dollars, and ever since the renminbi was named part of the SDR, a small portion of renminbis. However, based on the idea that the global trade situation is going to change given the potential for increased tariffs and quotas, it seems the idea is that other nations won’t need as many dollars to manage their affairs. At least that was clearly the thought before the news that the imminent US-Chinese trade war may not actually be imminent. Certainly, as reserve managers adjust their ratios it impacts the FX markets. But history has shown that those adjustments tend to come after large movements in the dollar have already taken place, they don’t precede them. And while the dollar did fall between 8%-10% last year, that simply doesn’t qualify as a large move historically. In addition, that comes after the dollar had rallied more than 25% in the prior two years, so I would contend that reserve managers are not quite ready to act. However, the story is getting play.

As to the movers overnight, there was very little data released to drive things. In the G10, the pound has been the best performer, rising 0.7%, after news that the Labour Party has tabled a bill that would seek to prevent a hard Brexit in the event an agreement isn’t reached on time. What I find interesting about that is the idea that if the UK and EU fail to agree on a timely basis, who’s to say the EU will be willing to extend the interim package, regardless of whether the UK is willing. But the market saw this as a positive. However, we have seen strength in the euro as well, and Aussie has performed well on the abatement of trade tensions. Interestingly, the yen is virtually unchanged this morning.

In the EMG bloc, it should be no surprise that CNY is stronger, up 0.65%, on the lessened trade tensions. But also we have seen RUB rally 0.5% on continued strength in the oil price and ZAR rally after Moody’s left their Baa3 rating intact and moved them up to a stable outlook. This prevents many international bond funds from being forced to liquidate their positions and has relieved some pressure on the currency. Overall, the APAC and EEMEA blocs have performed quite well, with the reduced trade tensions the obvious catalyst.

Data this week is limited but important and as follows:

Tuesday Case Shiller Home Prices 6.2%
  Consumer Confidence 131.0
Wednesday Q4 GDP (Final) 2.7%
Thursday Initial Claims 228K
  Personal Income 0.4%
  Personal Spending 0.2%
  PCE 0.2% (1.7% Y/Y)
  Core PCE 0.2% (1.5% Y/Y)
  Chicago PMI 63.2
  Michigan Sentiment 102

My take is all eyes will be on the PCE data given the Fed continues to focus on that. With the FOMC meeting out of the way, we also get a decent number of Fed speakers starting with Mester, Quarles and Dudley today, then Bostic tomorrow and Wednesday and finally Harker on Thursday. Given the fact that the important data this week doesn’t appear until Thursday, it seems unlikely that any of these speakers will be giving us new information. Rather they are far more likely to discuss how their view fits with the prevailing Fed narrative.

In the end, it feels like the dollar will have a hard time making much headway this week, unless there is a more definitive outcome on trade, one which satisfies all parties. My sense on that is it will take a bit longer to come about, so look for the dollar to remain under pressure.

Good luck

Values Revised

Can anyone be that surprised
That markets, their values revised?
With trade wars prevailing
Investors are wailing
Meanwhile now the buck’s pulverized

Risk, my friends, is on the run. What a difference a week makes! Just last week, we had seen equity markets regain most of their early February losses and inflows into equity funds exploding. The Treasury market was quiescent, trading in a narrow range and the dollar had edged slightly higher amidst dull market activity. Goldilocks had risen Phoenix-like from the ashes of the early February inflation scare. That was so last week. This morning, the world is a completely different place. Clearly, the biggest issue has become global trade after President Trump imposed tariffs on ~$50 billion worth of Chinese imports and the Chinese retaliated, thus far in a measured fashion, with their own tariffs on ~$3 billion of US goods. And remember, this follows in the wake of the US steel and aluminum tariffs that were imposed late last week. (As an aside, the metals tariffs have been reduced to basically China, Russia and Japan with the Canada, Mexico and Europe being left off the list. Japan is a curious inclusion as I thought the Japanese were an ally as well, but that’s the situation.) However, the latest round is completely different, specifically targeting one nation and of much greater scale. It should be no surprise that investors are reducing positions in their riskiest assets and fleeing to the safe havens of the world, at least as currently considered.

First the yen, which is trading back below 105.00 for the first time since Mr Trump’s election in 2016, looks like it has further to run. We continue to see futility in the BOJ’s efforts to create inflation in the economy. Japan continues to run a massive current account surplus, thus drawing more funds into the country, and the expectations that there would be investment outflows given the growing interest rate gap with the US have been short-circuited, not least by the fact that the 10-year yield in the US has fallen nearly 15bps from its recent peak in the rush to safety. Highlighting the problems that Kuroda-san has was last night’s Japanese CPI data, printing at a lower than expected 1.5% with the core, the rate they target, remaining at just 1.0%. Funnily enough, the one thing that will clearly occur if a trade war begins to expand is that inflation will pick up everywhere. Somehow, though, I don’t think Kuroda, or any central banker for that matter, will be pleased with that outcome. In the end, as long as trade is the lead headline, look for the yen to continue to gain, albeit slowly.

Treasuries, as mentioned above, are also still perceived as a haven and yesterday saw a sharp rally with yields there falling to their lowest level since late January. Despite the increased issuance required, and despite the fact that the Fed will be bidding for fewer Treasuries over time, right now investors are responding to the increase in anxiety due to the trade story and its impact on equity prices. One of the things that has been so interesting during the past 18 months has been the positive correlation between bonds and stocks, a direct result of the Goldilocks narrative. Solid growth underpinning higher stock prices but low inflation keeping interest rates in check. Historically, these two asset classes have a negative correlation, and that historic relationship is reasserting itself. The issue here is that countless portfolio strategies were built on the idea that
Goldilocks would go on indefinitely. As it becomes clearer that will not be the case, all of those strategies will find themselves in increasing difficulty and likely see further unwinding. And this points to further equity market adjustments. The real question is the speed with which these occur, and the trade story has simply accelerated the movement.

The other thing that is back in the news is the increase in volatility. Back in February, it was the unwinding of the short volatility ETF’s that drove the equity market correction. But it seems that was merely the first hit to Goldilocks. One of the points I have maintained for a long time is the fact that market volatility, across asset classes, was likely to come back more quickly than generally anticipated. And I have a feeling that is what we are beginning to see now. The VIX index is back near 25, a level seen in February during the rout, and prior to that last seen after the Brexit vote in June 2016. In other words, options are back in vogue. The real question is how long it can retain this elevated level. Volatility is a mean-reverting characteristic, with mildly trending markets typically punctuated by spikes, like we are seeing now. The thing is, given the extraordinary length of time that volatility was depressed by global QE; it is conceivable that it will take a fairly extended period of high volatility to offset the previous condition. As those Goldilocks based strategies are unwound, odds are that market activity will continue to be quite choppy.

So what does this mean for the FX market? Well, I expect that we are going to see some significant divergence in different currencies. For example, the yen and Swiss franc should likely be strong performers during this period. Both remain safe havens, as does gold, which is up more than 1% this morning, and neither is likely to lose that status. As to the euro, my take is it will wind up doing very little at all. While the Eurozone runs a C/A surplus, which is a clear positive for the currency, there is still little indication that the ECB is going to step up the pace of policy tightening. This is going to continue to undermine the euro bullish position of an accelerated pace, and when contrasted to a Fed that has clearly turned more hawkish, will weigh on the euro.

Meanwhile, the pound has been feeling its oats as traders anticipate that the BOE is set on a path of tighter policy with a 25bp hike almost baked in for the May meeting. I continue to question just how much the BOE will be able to do given the overhang of Brexit, but at this point, based on their recent meeting outcome with two voters looking to raise rates immediately, unless we see a serious equity market correction around the world before they meet again, it certainly appears they will raise rates. And arguably, the pound should hold its own accordingly.

The real action will happen elsewhere in the world, with many emerging market currencies likely to see significant pressure. For example, last night KRW fell 1% as South Korea is right in the crosshairs of further trade tensions. We are also seeing stress in other currencies in this bloc as USD funding costs increase due to technical factors in the US. I’m sure you have heard about the widening of the LIBOR-OIS spread, which in the past has been a harbinger of credit stress (it widened sharply during the financial crisis and the European bond crisis) although this time it seems to have a more benign explanation driving it. But in the end, higher LIBOR means higher funding costs for all those emerging market companies and countries that have used the dollar market to manage their finances. The point is that there will be continued stress in this area and that many emerging market currencies are likely to underperform while this market anxiety persists. This is especially true in LATAM and APAC although less so in EEMEA as many of those companies/countries fund in euros. In the end, I have a feeling a broad dollar index will exhibit limited movement, but that we will see some fairly large activity in the crosses.

As to today’s session, there are two data points, Durable Goods (exp 1.7%, 0.6% ex transport) and New Home Sales (620K). We also hear from four Fed speakers, Bostic, Kashkari, Kaplan and Rosengren, however given that we just heard from the Fed on Wednesday, it would be surprising if the message changed at all. And so, with equity markets around the world under continuing pressure and US equity futures pointing lower, my take is we will continue to see risk be removed. Look for further yen strength and emerging market currencies to remain under pressure.

Good luck and good weekend



It turns out the market misread
How strong are the hawks at the Fed
Though rates they did raise
They saw some delays
Ere rates rise much higher ahead

Meanwhile from the Old World we learned
The path of growth, lower has turned
So Draghi and friends
May need to extend
QE when June’s meeting’s adjourned

The upshot of yesterday’s FOMC meeting and press conference was that the Fed raised rates by 25bps, as expected, but the changes in the dot plot were further out in time than many had forecast, coming in 2019 rather than a fourth hike this year. What this did accomplish was to raise the terminal rate in this cycle to 3.40%, up from the previous rate of 3.10%, although the long-term view remains much lower than historical levels and is still anchored below 3.0%. And so this was declared to be a dovish tightening by pundits everywhere. We also learned that Chairman Powell is not as beholden to his own models, as arguably he hasn’t built any himself, and therefore seems far more willing to listen to others and observe the economy instead of assuming his own model is reality. That is certainly a healthy change! He continues to speak more forthrightly and in another blessing, cut things short at the press conference in less than forty-five minutes as compared to former Chair Yellen’s penchant to ramble on for well more than an hour. So perhaps reality and brevity will come to define Powell’s Fed, and if so, we are all better off.

The market response was less optimistic as equity markets, which had traded higher all day prior to the meeting, fell in its wake and closed lower. The dollar, which had edged lower ahead of the meeting added steam to that movement and fell quite sharply. Meanwhile, Treasury yields, which had been treading water, rose about 3bps. In other words, no market’s expectations were fulfilled. Again, I think that is a positive outcome. I believe the financial markets are far healthier when there are clearly different opinions around instead of the situation we have seen for most of the post financial crisis period, which is everybody has to be in the same trade. A little more daily volatility is likely to result in significantly less drama when there is a major change.

Before I look at today I need to correct something from yesterday’s note, the reasoning behind the strength in MXN and CAD that we saw yesterday. It turns out that the movement was directly related to unconfirmed news that the US was climbing down on a NAFTA demand about US content in automobiles. That had been a major sticking point, especially given the way supply chains for the Big Three had developed over the past twenty years, but now seems to bring the process one step closer to a successful renegotiation. It is not surprise that both currencies rallied on the news.

As to this morning, the noteworthy outcome has been the Eurozone Flash PMI data, which came in softer than expected for the second month running. While the numbers are still strong, the trajectory is less positive than it had been all last year and is starting to call into question just how much faster and for how much longer the Eurozone economy is going to be able to grow above trend. In fact, the euro has traded lower on the news, (-0.2%) although that is only a small portion of yesterday’s gains. Certainly, if the growth trend slows further, Signor Draghi will have a hard time claiming that QE must end abruptly in September and we are likely to see it extended even further. At the same time, the pound has added to yesterday’s gains after UK Retail Sales data showed a surprising improvement, with the headline number rising 0.8% in February compared to expectations of just a 0.4% increase. So for two days running we have seen UK data show resilience despite the ongoing uncertainty over Brexit. One other noteworthy mover in the G10 space has been AUD, which is down 0.35% this morning after Australian labor market data disappointed. The Unemployment Rate rose unexpectedly to 5.6% and the number of employed grew less than expected. This will certainly not encourage the RBA to raise rates sooner, and if it continues, could well see talk of yet another cut eventually. It should be no surprise Aussie is soft this morning.

Meanwhile, in the emerging markets, there has been far less drama and currency movement. Obviously, the big question remains over the tariff announcement the Trump administration is due to make today regarding China. The word is they are seeking to impose tariffs on $50 billion of Chinese imports while the Chinese are readying retaliation. No good can come from this process, but I expect that we will start to go down the road before either side blinks. Interestingly, the renminbi has fallen 0.2% ahead of the news, which for that currency is a pretty good-sized move. But away from that, the EMG bloc is a mixed bag of gainers and losers with nothing showing an outsized reaction to anything.

This morning brings the usual Initial Claims data (exp 225K) and then Leading Indicators at 10:00 (exp 0.3%), although neither seems likely to have a major impact on markets. There are no Fed speakers today, although we hear from three tomorrow morning, so the FX market will be looking for other cues. Equity futures are pointing lower at this point, but the bond market has rallied slightly, generally giving opposite signals to the dollar. My sense is that with the Fed out of the way, the broad based dollar weakening narrative is likely to return, and so further softness is on the cards today. But over the medium term, I continue to look for the dollar to rebound.

Good luck


Not Quite Concluded

The question on lips that we see
Is four hikes more likely than three?
Could well be alluded
If not quite concluded
When next speaks the FOMC

Well, the big day is finally here and at 2:00 this afternoon the FOMC will release its latest monetary policy statement. Shortly thereafter, Chairman Powell will face the cameras in his first press conference as Fed chair. Here’s a recap of the situation as we await the news: at the December policy meeting the Fed raised rates 25bps, their fifth such rate hike since the process began two plus years ago, and penciled in three more rate hikes for 2018. However, in the intervening three months, US fiscal policy has been given a significant boost from both tax cuts and reform and a large increase in deficit spending. We have also seen US data perk up, specifically inflation data on wages, which has been a key lagging indicator for the Fed. Finally, we heard from Chairman Powell in his congressional testimony that in his personal view, things were definitely better in the economy. This series of events has led a large contingent of analysts to now expect the Fed to raise rates four times this year and perhaps again next year. Meanwhile, futures markets are pricing in a 39% probability of a fourth hike in 2018 and not even three hikes in 2019. This is where the rubber meets the road on my views for the dollar going forward. I continue to come down on the side that the Fed will be more hawkish than the market is pricing, and that as the market adjusts US rates higher, the dollar will benefit. But right now, it’s all speculation. We will find out this afternoon, and we can evaluate the situation tomorrow morning.

In the meantime, a look at the FX markets shows that after a very strong performance yesterday by the dollar, it is under pressure this morning. Yesterday’s movement seems to have been the result of positioning, or more accurately the unwinding of some of the massive short dollar positions that are extant. This morning, the most notable story has come from the UK, where the pound has rebounded sharply (+0.5%) after much better than expected UK employment data. The Unemployment rate in the UK fell to a lower than anticipated 4.3%, and the 3-month employment change rose by a much greater than expected 168K. The implication here is that the UK economy is going to weather Brexit far better than might be expected and that Governor Carney and the BOE are right to raise rates soon and begin addressing above target inflation. While I remain skeptical on the issue, if the data continues to show the UK economy improving, then I will have to change my view.

Elsewhere in the G10, the dollar is also lower, but there has been very little in the way of specific data or news to drive the movement. As I said before, this appears to be position adjustments ahead of the FOMC this afternoon.

In the EMG bloc, however, we are seeing some very substantial movement, notably MXN which has rallied more than 1% this morning on the back of the ongoing rebound in oil prices. Oil has reacted to heightening tensions between Saudi Arabia and Iran, collapsing Venezuelan production and increasing demand as evidenced by the surprising inventory drawdown in yesterday’s US data. This movement has helped not only the peso, but also RUB and CAD. The rest of EEMEA is generally firmer this morning as well, as this group continues to mirror the euro’s movements, but APAC currencies had a more mixed session, with both gainers and losers there. It seems that the dollar’s softness really started at the end of the Asian session, so is more developed in Europe. In the end, though, all of these currencies will be beholden to the FOMC’s actions this afternoon, so I wouldn’t get too caught up in the movement thus far.

And that’s really it for the day. At 10:00 we see Existing Home Sales (exp 5.42M) but it is hard to believe that the market will truly respond to that number today. Equity markets are little changed this morning after a bit of a whipsaw earlier this week with sharp declines Monday followed by a modest rebound yesterday. The 10-year yield continues to hover in its 2.85%-2.95% range, showing no signs of wanting to break out in either direction yet. However, one thing of note is the ongoing increase in 3mo LIBOR, which has hit 2.25%, its highest level since 2008. It seems that the increase in borrowing by the Treasury, which has largely been effected through short term Treasury Bills, and the conversion of much corporate cash to even shorter maturities as it is soon to be deployed (remember the repatriation story) has driven this market far more than had been anticipated. The knock-on effects here are that foreign USD borrowers are finding it more expensive to refinance their outstanding debt and thus we are seeing short-term rates rise in other countries around the world, notably those whose currencies are linked to the USD like Saudi Arabia and Hong Kong. Ultimately, this is all of a piece with the rising US rate story and I believe will continue to be supportive of the dollar going forward.

Until the Fed announcement, I find it hard to believe we will see much movement, but afterwards, be prepared for some fireworks. Funnily enough, I think the big risk to the market is that the statement and Powell’s comments are more dovish than expected. The hawkish view has clearly grown in stature lately, so I would guess the pain trade is a more dovish outcome (no indication of four rate hikes this year, no rise in the terminal rate), which would have an immediate negative effect on the dollar. I guess we’ll see in a few hours!

Good luck