Where Riches Can Be Amassed

According to every newscast
The action in Syria’s past
So traders can focus
On finding the locus
Of where riches can be amassed

The limited military strike on Syrian chemical weapons facilities has quickly receded into the background from a markets perspective. The not surprising outcome has been a more than 1% decline in the price of oil, based on the idea that there will be no escalation of the fighting, and a decline in the Treasury market with yields rising about 4bps. If war is no longer imminent, safe havens are less necessary. In fact, the same is true with gold, which has edged slightly lower and the yen, which is little changed. The point is fear is not today’s market driver.

So what is driving markets? Well the equity space is going to be beholden to the Q1 earnings data that is starting to be released, and where expectations are very high based on the changes in the corporate tax rate. The FX market, however, seems to be looking more closely at the global growth theme. One of the points I have highlighted recently is that while the global economy is still growing, the data from Q1 has universally been softer than that of Q4 2017. The implication is that we may well have seen the peak in economic activity for this cycle and are starting to grow at a slower rate. After all, a quick look at leverage ratios shows that most of the world is already highly indebted and therefore the capacity to increase leverage, as well as its effectiveness at creating further growth, has been severely impinged. So the question becomes whether this situation will lead to a shift in the current narrative regarding central bank activities going forward. Because when push comes to shove, the FX market is still highly dependent on central bank policies for its direction.

One of the interesting features of the FOMC Minutes last week was the little watched description of deflationary concerns. For the first time since before the financial crisis, not a single Fed board member expressed any concern over the possibility of deflation in our future. Remember, this had been the driving force behind Ben Bernanke’s decision to embark on QE and has been part of the underlying mindset ever since. But with inflation clearly trending higher, and growth exceeding most estimates of its long-run potential in the US and Europe, it appears that the deflation boogey man is finally gone. And that implies that there will be much less concern that continuing on the current trajectory of Fed rate hikes will be a significant policy mistake. In other words, there is nothing on the horizon that is going to slow the Fed down, and if anything, I expect that they will tighten at a faster pace than currently forecast. This remains a key pillar underpinning my stronger dollar view.

What about the rest of the world? Well, ECB President Draghi continues to try to dispel the idea that the ECB is anxious to raise rates anytime soon. Measured inflation in the Eurozone continues to lag, and though there is a hawkish contingent in the ECB, led by the Germans and Dutch, they are by no means the majority at this stage. As such, I continue to think that the narrative is far too aggressive in its views of the timing of further ECB policy adjustments. We know that they will be buying €30 billion per month of assets through September but the question is what happens then. While there are some analysts who believe they will stop cold turkey, I disagree and look for them to reduce the purchase amount to either €10 billion or €15 billion per month for the rest of 2018, finally stopping at the end of the year. My confidence in this will increase if we continue to see the inflation data lag as it has been lately. In fact, last night’s German Wholesale Price release was a perfect example, printing at 0.0% rather than the 0.4% expected. There has been a consistency in the lack of measured inflation throughout the Eurozone, which, I believe, will continue to be cause for concern to the ECB.

In fact, the only nations that have actually embarked on tightening policy are Canada and the UK, both of which have raised rates far less than the US. While the market is pricing a 25bp hike by the UK next month, the Canadian story is less clear, especially as the NAFTA negotiations continue to hang over the country like a dark cloud. And, of course, the UK has its own dark cloud, the Brexit negotiations, where there remain several issues that seem intractable at this stage, notably the Irish border question. The point is there is still great uncertainty as to the UK economic situation going forward, and it seems to me that Governor Carney will not be able to become remotely aggressive unless we see inflation there suddenly jump significantly higher. Of course, while my medium term view remains the pound will fall, this morning it has been king of the G10 hill, rising 0.55%. As there has been no UK data released, my sense is that the release of a report by the Institute for Government, a UK think tank, that highlights all the things that the UK could do to moderate the impact of Brexit, including voting to rejoin the EU, may well be the driver.

In the end, the dollar is generally under pressure this morning, especially against its G10 counterparts, but we have also seen a sharp rebound in RUB after the Syrian situation failed to escalate. Of course, the sanctions story remains the key driver there, and I expect that the ruble will remain under pressure until something there changes. And lastly, HKD remains at the lower end of its band, with the HKMA selling another $1.3 billion in an effort to prevent it weakening further. It appears that capital flows out of Hong Kong are larger than initially anticipated. That said, there is no indication that the peg will be abandoned and the HKMA has significant firepower to prevent anything untoward from happening.

As to this week, we get a fair amount of data, led off with Retail Sales this morning.

Today Retail Sales 0.4%
  -ex autos 0.2%
  Empire Manufacturing 18.2
  Business Inventories 0.6%
Tuesday Housing Starts 1.264M
  Building Permits 1.315M
  IP 0.4%
  Capacity Utilization 78.0%
Wednesday Fed’s Beige Book  
Thursday Initial Claims 230K
  Philly Fed 20.1
  Leading Indicators 0.3%

Arguably the Retail Sales data is this week’s most important data point, as it may be seen as a key indicator of the pace of US growth.  At this point, the Fed still seems very committed to raising rates, so the data will have to really begin to pile up on the negative side for that attitude to change.  As it happens, we also hear from six Fed speakers, three of them, Dudley, Williams and Evans, twice.  At this stage, if any member of the FOMC is starting to see something that might give them pause, I expect we will begin to hear about it.  However, despite what is arguably a plateau in the data, there doesn’t appear to be a downturn in the near future, and so I see no reason to hear any dovish rhetoric, especially since none of the avowed doves are speaking.

In the background there are still a number of things that can have a large market impact, notably the trade situation and the politics in Washington, but on the surface, my take is the narrative is going to dominate this week, which means that today’s modest USD losses may extend a bit by Friday.  However, I do not foresee a breakout for any reason.


Good luck