A QE Encore

The data from Europe once more
Showed slowing one cannot ignore
I’m starting to think
That Draghi will blink
And promote a QE encore

It is always interesting to watch the evolution of a narrative. For the longest time it was absolutely obvious to one and all that the dollar was going to decline sharply this year just like it did last year. The structural case was clear, but more importantly, it was also widely assumed that every other G10 central bank was going to begin to normalize its own monetary policy and narrow the gap with the Fed. Another key point was that the market had already priced in the Fed tightening while the best was yet to come from the ECB, BOJ, BOE et al. Well, let’s be clear here. There is only one central bank that is actually normalizing monetary policy at this point, the Federal Reserve. To date there has been no ambiguity from the Powell Fed, rates are going to rise consistently this year unless something shocking occurs. Even the futures market is starting to buy the story with a 48% probability of four rate hikes now priced in for this year.

Meanwhile, the data last night simply highlighted the reasons why the Fed is the only bank normalizing policy, because the spurt of growth seen elsewhere around the world in 2017 has clearly been ebbing ever since New Year’s Day. The latest examples showed the German IFO survey falling to 102.1, its lowest level since March 2017 and extending a pattern that has clearly rolled over and is now trending lower. Adding to the mix were declines in both French and Italian Business Confidence, with both of them heading back to one-year lows. In fact, the pattern in all three nations is identical, December marked the top and the deceleration is picking up speed. Given this apparent slowing in Eurozone growth, it remains a mystery to me why so many market pundits expect the ECB to end QE in September. While I understand that there are hawks on the Governing Council, they are not even close to the majority, and we have heard nothing from Signor Draghi except cautionary words about patience and prudence in their actions going forward. The ECB meets on Thursday and there are limited expectations of any action. However, the prevailing wisdom is that come the June meeting, they will announce their plans for policy after September. Given the current trajectory of growth in the Eurozone, it appears to me that QE will continue beyond September, perhaps at a reduced rate, but that it will not end. And raising rates? That is still eighteen months away at the earliest and a case for 2020 cannot be ruled out.

Meanwhile, the story in Japan is quite similar, with economic growth there showing signs of faltering compared to 2017 as survey data continue to disappoint on a regular basis. Adding to the mix is the fact that the Goods and Services Tax (VAT) is going to be raised by two percentage points, to 10%, come next April 1st. This has been part of the Japanese fiscal plan for the past five years, but it has been postponed twice already because in each of the first two stages, the economy slowed sharply in the immediate aftermath of the tax hike. Of course, PM Abe, who is currently dogged by some domestic scandals, is desperate to prevent an economic downswing, as that would further undermine his political strength. And so, the idea that the BOJ is going to begin to normalize monetary policy is actually laughable at this stage. They are not going to do anything of the sort. Rather a much more interesting story has been the increased interest of Japanese insurers to buy US Treasuries on an unhedged basis with the 10-year yield now nearing 3.00%. It is flows of this nature that are going to help underpin the dollar (and the Treasury market) for the time being.

Concomitant with the slowing growth is the lack of inflationary pressure elsewhere around the world, with Australia the latest data point. Inflation there remained at 1.9%, failing to rise as expected and still well below the midpoint of the RBA’s target of 2.0%-3.0%. The implication is that the RBA will remain on the sidelines of policy for a considerable while yet. Slowing growth and low inflation are not the backdrop for tighter monetary policy. Folks, the dollar is not about to collapse. And while it remains in the relatively narrow trading range of the past three months, I am becoming more confident that we will break that range with a stronger dollar rather than a weaker one!

With that rant out of the way, let’s take a look at the markets this morning. Actually, the dollar is essentially unchanged today, holding onto its gains of the past week. In fact, in the G10 only Kiwi has moved more than a few pips, and its 0.3% decline is hardly significant. At the same time, something that we are continuing to see is weakness in the EMG currency bloc. And while it is not universal this morning, with the rebound in oil prices this morning underpinning both the RUB and MXN somewhat, those nations that are running current account deficits (Indonesia, India, Philippines, Brazil, etc.) have seen their currencies continue to fall amid rising USD rates. Many nations borrow in dollars and the combination of increased debt and higher rates usually reflects itself in a weaker currency. As an example, BRL has fallen 10% during the past three months. It is very hard to make the case that any of this class of currency will rebound unless US rates begin to decline, and given the Powell Fed, that doesn’t seem very likely. So hedgers, as expensive as it may be to manage these asset risks, I believe that hedging will be the least expensive way to keep things in check.

There is one last thing to note in the EMG bloc, and that is China. Despite an almost mythical acceptance that President Xi can create any outcome he wants, economic reality often intrudes on those dreams. While there is no question that Xi is keen to reduce overall leverage in the economy and deflate the housing bubbles that exist around the country, apparently he is not willing to do so if it results in slowing growth. So we have been getting simultaneous policy adjustments that both tighten and ease conditions, with things like the surprise RRR cut from last week a clear easing, but a crackdown on WMP’s and local government debt a clear tightening. At the end of the day it appears (to me at least) that with the rest of the world seeing a slowdown in the growth trajectory, China will see the same thing. After all, they remain a highly mercantilist economy reliant on international trade, so if growth is slowing elsewhere, it will have an immediate impact. The point is that easier monetary policy seems like one of the few tools they have available to help manage things, and part of that will be a slowly depreciating renminbi, at least to my mind. Food for thought.

As for today, we follow up yesterday’s solid Existing Home Sales report of 5.6M with a look at New Home Sales (exp 630K) along with Consumer Confidence (126.1), however neither of these is typically a market-moving event. Instead, I expect that the trends that we have seen for the past week are likely to remain in motion, although at a moderated pace. The bottom of the trading range in the euro has been 1.2155; so don’t be surprised if we make a run at it, although I believe we will need new information in order to break through. Friday’s GDP maybe? Or next week’s FOMC or payroll report all come to mind as potential catalysts. But nothing today.

Good luck