Hold the Line – a

Said Trump about Russia and China
While we raise rates they hold the line – a
So rubles and yuan
Both fall further down
Thus new trade rules we will enshrine – a

The dollar fell pretty sharply during yesterday’s session (-0.4%) as President Trump weighed in on the currency markets with an early morning tweet calling out both Russia and China for devaluing their currencies. It is, of course, ironic since the reason the ruble has fallen so far is because of the latest US sanctions that were imposed on specific Russian individuals and companies, as well as the threat of imposing additional sanctions on Russian government bonds. The upshot is that the ruble’s recent trauma was directly caused by US actions. It seems pretty harsh to call them out for weakening their own currency when we did the dirty work.

At the same time, the yuan has not really been weakening at all lately; in fact it is within spitting distance of multi-year highs. The last time the yuan was this strong was the day before China devalued it by 2% back in August 2015. If you remember that scenario it led to a mini crisis in markets with equities falling sharply around the world and the Chinese ultimately being forced to impose capital controls as locals sought to get their money out as rapidly as possible into a safer setting. So with this as a backdrop, the dollar fell pretty sharply on the tweet and maintained those losses all day long. Arguably, the market’s broader concern is that the US is going to start to use the dollar as a negotiating tool in the ongoing trade fight. After all, we have already heard Trump himself mention the negatives of a strong dollar, and remember, Treasury Secretary Mnuchin was clear in some comments at Davos in February that a weak dollar was beneficial for US trade. So the market was already on edge before the latest comments from the President.

Adding to the dollar’s malaise was the ongoing mediocre US data with Empire Manufacturing slipping further than expected to 15.8, clearly coming off the boil from Q4’s activity. We also saw continued lackluster Retail Sales data, which rose just 0.2% ex autos, hardly the stuff of a robust economy and finally the NAHB housing index fell to 69, its fifth consecutive decline and seemingly indicating that the top of the housing market is behind us. Given the trajectory of interest rates in the US, that cannot be a real surprise. In summary, ongoing soft data along with an administration that seems to be talking the dollar down are more than enough to offset the growing interest rate differential in the dollar’s favor.

As to the overnight session, very little has occurred since the NY close. The dollar is virtually unchanged overnight, with the entire G10 space trading within pips of their closing prices. But it was not only quiet in the G10 bloc; EMG currencies have also been extremely sluggish in their price action. It appears that traders are waiting for the next big piece of news and quite frankly, all eyes are turned toward Washington as that seems to be the source of most market moving information these days. Given the unpredictability of that source, it is fruitless to try to anticipate anything in particular.

So heading down more traditional lines of inquiry, the overnight data showed that China’s GDP continues to grow strongly, with Q1 coming in at 6.8%, above analysts expectations. However, some of the underlying data, like IP and Fixed Asset Investment were both a bit softer than expected, perhaps pointing to a somewhat moderating future there. And while this data includes the solar panel and washing machine tariffs, those were small potatoes in the grand scheme of things, so almost certainly had no impact on the broad data. Staying in Asia, Japanese IP also disappointed, printing at 0.0% rather than the 4.1% monthly expansion expected. This is of a piece with the data that we have been seeing for the past three months, where the vaunted synchronized global expansion is feeling a great deal of pressure.

Turning to the Eurozone, there were two pieces of noteworthy data, Italian inflation, which disappointed at 0.9% Y/Y, well below the 1.1% forecast, and the German ZEW index, which fell to -8.2, its first negative reading since the immediate aftermath of the Brexit vote in 2016 and its lowest level since the Eurozone bond crisis in 2013. Once again I will point out that it is very clear the global economy has lost some zest. From the UK, however, we saw labor data that showed wages rising at their fastest pace, 2.8%, since 2015 and continuing to trend higher. At the same time the Unemployment rate fell to 4.0% for the month taking the three-monthly average rate to 4.2%, its lowest reading since the mid-1970’s! Obviously that is good news, but it seems the FX market presaged the data with yesterday’s rally, as this morning the pound is actually a touch softer. In the end it is important to remember that Unemployment is a lagging economic indicator, meaning it takes a backward looking picture. This actually becomes clear when looking at the ongoing dichotomy between softening production and consumption data we have seen alongside the still robust employment and inflation data that is being released. To my eye, as I have repeatedly said, economic growth for the cycle peaked back in Q4 and we are going to see a steady erosion in the data going forward.

Looking ahead, we have our most active data day of the week with both Housing Starts (exp 1.264M) and Building Permits (1.315M) to be released at 8:30 and then our own IP (0.4%) and Capacity Utilization (78.0%) data coming at 9:15. We also hear from five Fed speakers, Williams, Quarles, Harker, Evans and Bostic, so there will be plenty of opportunity for some new views. In fairness, Quarles is testifying before Congress on banking regulation so is unlikely to touch on policy, but the other four are clearly available for additional nuance and information.

I actually find it quite interesting that the dollar stopped declining after yesterday’s fall. I think what we are witnessing is the level at which the continued widening of interest rate differentials offsets perceptions of future extra-monetary policy action (things like tariffs and jawboning). And in the end, despite all of the angst about the falling dollar, the reality is it remains well within its recent trading range, and in fact, has not even threatened the bottom of that range. All my years of experience lead me to believe that the interest rate differentials remain the most critical factor in currency values, and to my eye, especially given the apparent easing of the global growth trajectory while the Fed is clearly on track to continue tightening, the dollar will be the beneficiary. Maybe not today, but certainly by the end of the year.

Good luck