Wholly Absurd

The summit betwixt Trump and Kim
Was called off by Trump on a whim
Thus risk was disposed
And when markets closed
The future had looked mighty grim

But last night the news that we heard
Was Kim would still meet, undeterred
Thus buyers returned
And seemed unconcerned
The process was wholly absurd

Yesterday saw risk reduction in the form of softer equity prices and firmer Treasury prices as the ongoing saga of the proposed summit between President Trump and North Korean leader, Kim Jong-Un, was called off by Mr Trump due to the increasingly antagonistic rhetoric by the Koreans. It seems that many investors were basing their decisions on the idea that détente between the two nations would help alleviate one of the thorniest geopolitical issues currently percolating (arguably, Iran is the other right now). So calling off the talks was seen as a distinct negative for markets. But at this point, my take is this is all part of President Trump’s negotiating tactics, based on the fact that the North Koreans responded quite quickly that they were still willing to meet. And perhaps those tactics are working as it makes the Koreans seem more desperate to get a deal done. The upshot is that what had been a mild risk off session before the Korean response, turned around to a mild risk on session. The lesson to be learned here is that basing any financial market decisions on the twists and turns of the current geopolitical process is a hazardous way to act.

As I write this morning, equity markets around the world have edged up from yesterday’s declines, but remain largely within recent trading ranges. The bigger signal is from the Treasury market, where even this morning yields on the 10-year continue to decline, now down to 2.96%, and an indication that bond traders and stock traders see the world differently right now, with the bond boys and girls far more risk averse. Finally, pivoting to the FX universe, after a down and up day yesterday (falling early before rallying into the close), the dollar is extending its late day gains, albeit mildly. The thing is today’s dollar price action seems far less about the dollar per se, and more about the broad swath of negative news we’ve seen from elsewhere.

Data from the Eurozone showed that the German economy has yet to show any signs of a rebound from its much weaker than expected first quarter. The IFO survey printed at 102.2, unchanged, but still continuing its six-month declining trend. The euro edged lower by 0.2% upon the release and has basically remained there since, hovering right around 1.1700. Based on its recent price action, it certainly seems like the euro has further to decline.

The UK gave us the second reading of Q1 GDP, which reconfirmed that growth there was just 0.1%, a mild disappointment to those who have been trying to argue that the first print overstated the problems. The pound also suffered on the release and is down 0.3% on the session, falling to its lowest level in six months. From Japan, Tokyo CPI data, which is seen as a harbinger for the nation as a whole, fell to just 0.4%, weaker than expected and an indication that talk of the BOJ changing its policy anytime soon is foolish. In fact, I think it is more likely that they expand their QQE program than curtail it. The yen, which had benefitted from the recent risk aversion, has backed off slightly today, falling 0.2%.

But that is my point, none of these are dollar stories, rather today is a session of idiosyncratic market reactions. Another great example is SEK, where the Swedish debt office has decided to take a large long krone position, SEK 7 billion ($800M) as part of their management program. This is directly at odds with the Riksbank, who has been working hard to weaken the currency to stoke inflation. The result is that SEK is stronger by 0.3% against the dollar and 0.6% vs. the euro. But again, that is not a dollar situation.

The emerging markets offer the same tale, with Turkey, the current poster child for economic mismanagement, offering to allow banks to repay certain dollar borrowings from the central bank with Turkish lira. That will certainly have a short-term positive impact, but it does nothing to address the underlying fundamentals within the Turkish economy, and is likely to be a temporary benefit at best.

It is difficult to look around the markets today and come away with a consistent theme. Instead, it appears that investors and traders are looking ahead to the long weekend in both the US and the UK and have decided to moderate positions so they can enjoy the beach. Nothing has changed in the background stories, whether it is the Fed’s ongoing policy tightening, or the lack of a compelling case for the ECB to begin to tighten further. Inflation is not evident in Japan, Turkey, Argentina, Indonesia and Brazil are still under significant pressure and the dollar’s recent strength continues to undermine many previous investment memes. Now, none of this has addressed the US fiscal imbalances nor the idea that the dollar is likely to suffer in the long run. But as Lord Keynes reminded us, in the long run we are all dead. It could be a very long time between now and when the market starts to actually take those big structural issues into account. As such, my advice remains to manage your risk based on the current cyclicals and that still points to the dollar advancing for the foreseeable future.

Ahead of the holiday weekend we get one piece of data, Durable Goods (exp 2.6%, 0.0% ex transport) and we get to hear from Chairman Powell at 9:00. I’m confident that the market is far more interested in what he has to say than in the data print. However, it is inconceivable to me that he will change his tune at all. Look for him to continue to dismiss global volatility and to say policy is on the right path for now. In other words, US rates will continue to rise and the dollar along with them.

Good luck and good weekend