Surely Displeasing

In Germany, GDP’s easing
An outcome that’s surely displeasing
A recent assessment
Of Chinese investment
Highlights global growth could be wheezing

The synchronous global growth story took a few more body blows today as both Chinese Retail Sales (actual 9.4%, exp 10.0%) and Fixed Investment (actual 7.0%, exp 7.4%) disappointed markets. In fairness, IP rose a more than expected 7.0%, but the net outcome was a depiction of an economy that is being slowed by the government’s efforts to reduce leverage. And while that is no bad thing, it still results in slowing economic activity. In fact, the slowdown in investment points to a continued future slowing in economic activity in China. A little while later, Germany reported that Q1 GDP actually rose only 0.3% (1.3% annualized), half the rate of Q4 and lower than the 0.4% expected. This has variously been attributed to extreme cold weather in March, a flu epidemic and a series of IG Metal strikes during their wage negotiations. These explanations are an effort to highlight that this was a temporary phenomenon, rather than the beginning of a trend. And perhaps they are correct, although the April data thus far have not borne out that case. And it was not only Germany that came up short, but also both the Netherlands and Portugal failed to meet expectations. The point here is that thus far in Q2, the data have not indicated that Q1 was a temporary blip. Now it may well be that things have improved significantly and that will start to show up in the data soon, but to date, the evidence is scant.

It can be no surprise that the dollar has held its own in the wake of these releases, with the euro edging lower on the day while the renminbi has fallen 0.25%. Yesterday’s price action was a bit more volatile as the euro made a run at 1.20 in NY’s morning session (remember the Villeroy comments), but then declined steadily all afternoon essentially closing unchanged on the day. One of the themes I have seen lately is that the dollar’s recent strength can be entirely attributed to a short squeeze in positioning. I agree that the large outstanding short positions played a role, in fact I wrote about it several times in the past month. But despite the fact that there are long-term structural issues affecting the dollar, my read is that the short-term cyclical factors remain the dominant driver for now. With 10-year yields trading back above 3.0% this morning, and the data stream continuing to point to ongoing US growth vs. slowing growth elsewhere in the world, it is hard for me to make the case that the cyclical story is over. It is why I continue to look for the dollar to perform well in the near term.

Adding to the dollar’s overall luster is the fact that the problematic emerging market currencies are just getting more problematic. Both Turkey and Argentina have fallen to new historic lows this morning as their local situations deteriorate. In Turkey, President Erdogan has explained to the market that after the election next month, he expects to take more direct control over the economy, which implies that he will be cutting interest rates there. That is certainly not the traditional policy for a nation with rising inflation and a weakening currency, but in this case, I expect he is a man of his word. TRY has further to fall. In Argentina, there are essentially no bids for the peso, which fell another 7.5% yesterday as the central bank has stopped wasting reserves in an effort to slow the decline. Right now, the only hope is that the IMF stand-by loan of $30-$40 billion is agreed soon and investors are willing to believe that it will stabilize the situation. We’ll see. But it is not just those two currencies that are suffering. BRL fell more than 2 big figures yesterday, (0.6%) and is steadily marching toward 4.00 as the presidential election process there heats up. A mixed data picture in Brazil shows the consumer still hanging in there, but production data slipping. Certainly not the best of circumstances. And India has also been suffering lately, falling another 0.5% overnight after inflation data highlighted that the RBI likely needs to be a bit more aggressive in raising rates. And while the rupee has not yet traded to new historic lows, it is a scant 1% from those levels.

My point is that it feels premature to dismiss the dollar rally at this stage. This is especially so in view of the fact that there is zero evidence that the Fed is going to change its strategy of tightening policy via both interest rate increases and a reduced balance sheet. And so I won’t do so. Rather I remain confident that the ongoing data situation will point to the dollar continuing its rally for now. With that said, all eyes will be on Mario Draghi tomorrow morning when he speaks, as if he has turned hawkish at all, that would signal that the ECB is ready to actually change policy, something I don’t believe will occur, but something that would clearly underpin a less bearish case for the euro.

This morning brings arguably the most important US data of the week in Retail Sales (exp 0.3%, -ex autos 0.5%). We also see Empire Manufacturing (15.5) at the same time, but the sales data should dominate.

One other thing, the politics of trade policy has almost certainly had a market impact, even beyond the potential for it to drive inflation higher. The recent turn on the Chinese phone company ZTE, where the administration is now working to reduce the draconian sanctions imposed earlier has been taken by some as a sign that the trade negotiations with China may be moving forward. As there were many who expected the dollar to weaken in the event that the US became significantly more protectionist, this is likely a mild benefit as well. In fact, it is hard to point to something that is a clear dollar negative right now. Granted, weak US data would help to turn the tide, but it would need to be quite consistent in order to do so. In the end, based on the current evidence, I see no reason to alter my views. And for today, I think all signs point to a bit more dollar strength.

Good luck

Pile On!

Said Mester the US is strong
And lest it goes terribly wrong
As I’ve been advising
Our rates will keep rising
That’s 2018’s theme song

Said Villeroy who spoke thereupon
When QE is finally gone
It’s quarters not years
Ere a rate hike appears
And the euro bulls called, “pile on!”

The dollar is broadly, but not universally, softer this morning as it continues to consolidate its strength of the past month. The latest driver was a series of comments by Banque de France governor, and ECB governing council member, Francois Villeroy de Galhau. Interviewed by Bloomberg TV before an event in Paris, he dismissed the slowdown in Q1 as temporary, but more importantly he said that once QE ends, which he confirmed would be in 2018, the “…extended period of time, well past the horizon of the net asset purchases” that the ECB has promised will follow before the first rate hike, will be measured in quarters not years. In other words, at its most aggressive interpretation, the ECB is looking to raise rates in the early summer of 2019. That is appreciably sooner than the market had been pricing, especially since the weak Q1 data was confirmed by weak April data. It should be no surprise that the euro rallied (+0.35%) in the wake of those comments, as part of its recent weakness has been attributed to the belief that the ECB would be forced to delay its policy changes. At the same event, Cleveland Fed President Loretta Mester, a current FOMC voter, reiterated her view that the Fed would continue raising rates and that eventually Fed Funds would rise above the neutral rate. However, given she is likely the most hawkish Fed member, there was no new information in her comments and so it did nothing to offset the Villeroy remarks.

If Villeroy is correct, and the Eurozone sees faster growth resume from Q2 forward, then we may well head back to the synchronous global growth narrative. This is likely to undermine the dollar somewhat going forward. But that remains to be seen, especially as the most recent data has not supported the idea that the Eurozone is rebounding. Until we see that data change, however, I see no reason to alter my view that the US is continuing to lead this economic cycle. In other words, last week’s mild dollar weakness seems far more likely to have been trading consolidation than the beginning of a new trend lower.

Away from those comments, the other Eurozone news was the agreement in Italy between 5 Star and the League to join forces and lead the country. This is by far the most radical antiestablishment outcome from recent European elections and their mooted programs, led by a Universal Basic Income and a low flat income tax, seem to be logically inconsistent and it is unclear how they will be able to implement them. It also seems that if they do, Italy’s fiscal problems are likely to grow with potential negative consequences for the euro. But it is early days, and talk is cheap. Let’s wait until we see something more concrete come from this new alliance.

The pound has also rallied this morning (+0.4%) as there seems to be a modestly more bullish take on the latest Brexit discussions within the British government, but that is not to say that anything has been agreed. Otherwise, within the G10, the dollar is only modestly softer with little in the way of news.

Emerging market currencies, however, have had a less successful session, with a number of them still struggling to find traction. We have discussed Turkey and Argentina, both of which have significant structural problems. Malaysia’s markets reopened last night for the first time since the surprising election results that brought Mahathir Mohamed back to power. With the nation’s markets closed on Thursday and Friday last week, today was the first time to see how things would respond to the results. MYR opened lower by more than 1%, as the equity market there fell sharply on the opening as well, but as the day progressed, it regained the bulk of those losses and, in fact, MYR is essentially unchanged from its pre-election levels at this time. As to the rest of APAC, the dollar was mixed, gaining vs. some and falling vs. others, but with no rhyme or reason and no large movers. EMEA currencies have generally fared better, with most stronger this morning, although TRY continues to suffer, and MXN, the only LATAM currency open as I type, has regained a bit of its recently lost luster. Watch BRL, where the presidential election is beginning to heat up, and its growing current account deficit combined with the political uncertainty has led to a steady decline all year, almost 9% so far. I fear it may have further to fall.

Data this week is far less interesting than last, but is as follows:

Tuesday Retail Sales 0.3%
  -ex autos 0.5%
  Control Group 0.4%
  Empire Manufacturing 15.5
  Business Inventories 0.3%
Wednesday Housing Starts 1.325M
  Building Permits 1.35M
  IP 0.6%
  Capacity Utilization 78.4%
Thursday Initial Claims 217K
  Philly Fed 22.0
  Leading Indicators 0.3%

Arguably, Retail Sales tomorrow will be the biggest draw, but given that inflation has been the watchword, not growth, it doesn’t feel like it will have that big an impact. We also hear from four more Fed speakers this week, and we get some important Chinese data on Retail Sales and Fixed Investment. In the end, though, it doesn’t feel like there is good reason to believe that FX is going to be that interesting this week. My sense is that the dollar will continue to consolidate as we await the next grouping of data. If we continue to see relative strength in the US data compared with the Eurozone and the UK, the dollar should resume its recent uptrend. However, watch Wednesday when Signor Draghi speaks, as if he confirms the Villeroy comments, it could have a big impact with the euro rallying more sharply.

Good luck

Quite Concerned

There once was a banker named Mark
Who four months ago sounded stark
In warning that rates
Might rise at more dates
As UK growth steepened its arc

But yesterday morning we learned
The BOE was quite concerned
The growth they expected
Could not be detected
And so any rate hike was spurned

There is a new narrative evolving, but as it remains early days the accuracy of this narrative is going to be called into question periodically. Yesterday was a perfect example. In the old narrative, synchronous global growth was the theme alongside dormant inflation pressures in the US with the two factors leading to the Goldilocks economy of strong growth, low inflation and no urgency to increase policy interest rates. But all of that started to sound less plausible once it became clear that, at least in Q1, synchronous global growth was actually strong US growth with many laggards, and Fed commentary hewed more hawkish than had previously been expected. The results have been evident over the past month with the dollar moving higher amid rising inflation, (and by extension interest rate) expectations, combined with weaker than expected foreign data. This has caused interest rate differentials to increase in the dollar’s favor.

One of the key reversals has been in the UK, where back in February, Governor Carney sounded extremely hawkish, explaining to the market that rates would likely rise more, and more frequently than had been expected at that time. The market promptly repriced and expectations for a hike yesterday rose as high as 90% at one point. Alas, the data never supported Carney’s thesis, showing the UK economy slowing sharply and the Brexit negotiations made no significant progress thus adding further uncertainty to the situation. As this unfolded, Carney walked back his earlier hawkishness and now the question is will the BOE still find it appropriate to raise rates this year at all? My gut tells me that they will not and that as the Fed continues on its merry way, the pound will continue to suffer. Yesterday’s market response to the MPC vote showed an initial dovish read with the pound falling sharply on the news (-0.7%), but then recovering most of that ground before the close and the rest of it this morning. So as I type, the pound is exactly where it was just before the MPC announcement.

Of course, the question is, why did the pound rebound yesterday? And that is down to the other part of the recent narrative that did not hold to form, US inflation. Yesterday’s CPI data was lower than expected with headline rising 0.2% (2.5% Y/Y) but core rising only 0.1% (2.1% Y/Y), a tick lower than expected. Now my good friend Mike Ashton, (@inflation_guy) whom you all should follow if you are interested/concerned about inflation, pointed out that the low print was driven by used car prices, which fell quite sharply. That is pretty aberrational and likely not indicative of the inflation story, which showed that things like medical expenses, housing and apparel all continued their trajectory higher. However, the market saw the headline, breathed a sigh of relief, and bought stocks and bonds while selling the dollar. That outcome is directly in opposition to what the new narrative is supposed to explain, and there were many who were quick to highlight how the old narrative was really still holding sway.

The thing is, as central banks, and thus market participants, focus more keenly on each data point, surprises in those data points are going to result in market responses. For what its worth, my take is that the new narrative remains a better description of the current market situation, and that it has further to evolve. In other words, I expect to see US growth outpace the rest of the world’s for a little while longer, US inflation to continue be felt and the Fed to continue its hawkish sentiment, all of which leads to the dollar continuing to climb. Adding to that is the oil picture, which because it seems to be rising on supply issues, rather than demand issues, is actually supporting the dollar through the inflation connection. In other words, its not that demand is so great it is driving oil prices higher thus leading to its own self-moderation of higher production, but the fact that concerns about Venezuela’s oil production continuing to slip and worries about the impact of the US withdrawing from the Iran nuclear pact on potential Iranian output that are driving prices higher, thus impacting inflation more directly.

So given that extremely messy backdrop, the dollar this morning is mildly extending the selloff that started in the wake of the CPI data. Looking across the G10, the pound is today’s biggest winner; rallying 0.4% to fully regain the BOE induced losses yesterday. As to the rest of the group, movement has been much smaller, on the order of 0.1%-0.2%. There has been very little data of note overnight to drive things, which is arguably one of the reasons that movement has been so muted. Switching to the EMG bloc, other than the Turkish lira, which continues its slow-motion collapse falling 1.1%, the dollar is modestly softer. However, while there are clearly a growing number of idiosyncratic stories regarding currencies in this bloc (TRY, ARS, IDR, MYR) each of which has led to sustained weakness, the bulk of the bloc continues to trade as per the dollar overall. So strong dollar days impact all of them similarly, and weak dollar days do the same thing. Today happens to be a weak dollar day. But not excessively so.

The only data of note this morning is the Michigan Confidence report (exp 99.0), but that is rarely a market mover. St Louis Fed President Bullard speaks at 8:30, which has potential to move things, but as he is already a known dove, it is unlikely that dovish comments from him regarding yesterday’s CPI will have much impact. If he were hawkish, however, that would be a different story. Looking it over, and with the weekend fast approaching, I would say we are far more likely to see the dollar continue to soften today as those traders who have jumped on the strong dollar bandwagon lately will be more likely to take profits ahead of the weekend and with the CPI data still ringing in their ears. But the medium term trend of a stronger dollar remains fully intact in my view.

Good luck and good weekend


Policy of Choice

Persistent easing
Remains policy of choice
But inflation still hides

As the market awaits the BOE’s rate decision this morning, the dollar has edged lower amid muted activity. Last night the Minutes of the BOJ’s April policy meeting were released and it should be no surprise that the commentary focused on the need to maintain their current monetary ease in order to achieve their inflation target. You may recall that at the April meeting, they discarded the timeline for achieving their goal, and now are simply trying to get there as quickly as they can. Of course, it has been more than five years since Kuroda-san was first appointed and expanded the BOJ’s asset purchase program in an effort to eliminate the deflationary spiral that had come to dominate the Japanese economy. And they haven’t come close to being successful yet.

I’m not sure how many of you remember the ‘Misery index’, a term coined by economist Arthur Okun in the 1970’s and effectively used by then presidential candidate Ronald Reagan in 1979, which was simply the sum of the inflation and unemployment rates. The idea was to show just how bad things were in the US economy back then, and in fact, that was the height of the stagflation era and the index was around 20%. In the US today that number is ~6.0% depending on which measure of inflation you use. In Japan, that number is 3.6%! My point is that things in Japan are hardly dire despite all the angst at the BOJ. I’m not saying that the debt situation there is sustainable, merely that the ongoing conversation regarding the horror over the lack of inflation seems to be misplaced. It remains extraordinary to me that central bankers the world over are so focused on driving inflation higher. Inflation is a problem in Argentina, running at 40%. Inflation running at 1% in Japan seems pretty manageable. (In fairness, higher inflation would reduce the real value of Japan’s massive debt load, so I do understand that rationale. But that doesn’t help the man on the street!) The yen did little in response to the Minutes, although it has definitely been under pressure for the past several sessions. However, that may well be more a result of general dollar strength than specific yen weakness.

Moving on there are two key stories for the rest of the day. First is the aforementioned BOE rate decision. A month ago, the market had been pricing upwards of a 90% chance of a 25bp rate hike today. Now that number stands below 10%. In the interim, we have seen both less hawkish commentary from several BOE members, notably Governor Carney when he reminded everyone that there was more than one opportunity for the BOE to raise rates this year if they had to. And shortly thereafter, Q1 GDP printed at just 0.1%, significantly lower than expected. Meanwhile, the most recent CPI data fell to 2.5%, below expectations and seeming to be trending lower. Add it all up, and there seems little reason for the BOE to get aggressive here. During the past month, the pound has fallen some 5% and the market is now awaiting the next BOE signals. Any further dovishness, which could be signaled by a unanimous vote to remain on hold, could easily lead to another 1%-2% decline, although if there are more than the 2 votes to raise rates we have seen the past several meetings, the market would likely interpret that as hawkish, and the pound should add to this morning’s rebound of 0.45%

The other data point of note this morning is CPI from the US. Current expectations are for CPI to rise 0.3% (2.5% Y/Y) with the ex food & energy number to be 0.2% (2.2% Y/Y). I continue to believe the risk is for a higher print and the reaction would be for the dollar to resume its rally. Whether or not you believe that the Fed is mistaken to be tightening so aggressively, it seems clear to me that Chairman Powell is on a mission and is going to keep going for the rest of the year at least. And while one of my concerns is that a recession in the US could be coming sooner than most pundits expect, there is no obvious sign that it is imminent, and so the Fed will keep going. Despite the fact that the Fed uses PCE in their models, they are not blind to the recent swift rise in CPI.

Other than that, and unless we get some new information from unexpected places (read the White House), it feels like the dollar, which has softened somewhat overnight, is likely to rebound a bit. Treasury yields continue to support the greenback, and interestingly, the rally in oil prices has had very little impact. One of the things people point to regarding oil is that there is a strong negative correlation between oil and the dollar. My question is which way is the causality? It is not clear to me that oil drives the dollar, nor that the dollar drives oil. And it is very possible that the causality changes over time, although the correlation has remained pretty consistent. In fact, the recent simultaneous strength of the two is the outlier. In the end, I’m not prepared to opine on whether continued oil price strength will weaken the dollar’s support. But my gut tells me that right now, the two are trading on different issues, and so are somewhat independent. If that is the case, then be prepared for the dollar to continue its ascent even if oil heads toward $80/bbl.

Good luck

It’s Just Not True

Chair Powell said it’s just not true
That all of the things that we do
Impact EMG
Instead what we see
Is our actions hardly pass through

Price volatility throughout the emerging markets continues to be one of the dominant discussions amongst traders and investors. But interestingly that discussion has now spread to central bankers as well. Early this morning Chair Powell, in a speech in Zurich, tried to explain that Fed policy is not a very big driver of market activity in the EMG space, although there have been instances in the past where that seemed to be the case, notably the Taper Tantrum in 2013. However, looking at his charts and listening to him, I was not really convinced. Certainly my observation from a long career in the markets is that Fed policy impacts every other country, just some more than others. Interestingly, yesterday the economists at the San Francisco Fed released a paper saying that FOMC policies clearly had an impact on other economies, with the biggest impact on those economies that run large current account deficits. Now that is research that I can appreciate as it coincides with my (and many other) observations over time. In fact, I wrote about this just yesterday and this has been a common theme amongst many analysts. In the end, the market didn’t seem to pay too much attention to Powell’s speech.

The President’s soon to decide
If sanctions will be reapplied
On oil from Iran
Imposing a ban
And impacting prices worldwide

The other key story in the market this morning is the imminent decision from the White House on whether the US will be exiting the Iran nuclear deal and potentially reimposing sanctions on Iranian companies. If the US does exit the deal, it is expected to result in a reduction of Iranian oil exports of approximately 500K bbl/day, a pretty significant amount, although not enough to cripple supply. Remember, oil prices have risen >10% in the past month as this process has evolved and it is a fair question to ask whether or not we have seen the worst already. However, the overall uncertainty has been a definite issue for the market, and while the oil price might have already adjusted, it is likely there will be knock-on effects in other markets, as well as on the prices of specific companies who benefitted from the reengagement with Iran. The point is that we have the opportunity for another volatility inducing event occurring in the near future which means that havens are likely to perform well today.

Which brings us to the dollar and its recent activity. One of the key features we have seen lately has been the dollar’s ongoing rebound after last year’s weakness. In fact, the euro is now trading below 1.1900 this morning, which is its lowest level this year. The pound, too, is back to its YTD lows, although hasn’t broken through those levels yet, and only the yen has not yet ceded all its gains for the year. Of course, given the yen’s status as a safe haven currency, it should be no surprise that it has outperformed the other two major currencies. The question really is can this dollar rally continue, and if so, how much farther can it go?

At this point you all know that I believe the dollar has further to rally. It has become abundantly clear that the US economy continues to lead the way forward as much of the rest of the developed world has seen a trend of slowing growth develop. Meanwhile, there is absolutely no indication that the FOMC is going to change its current plan, of at least two more rate hikes this year alongside the continued reduction in the size of its balance sheet. In fact, though a number of Fed speakers (most recently, Atlanta’s Bostic) have been clear that they are comfortable with some overshoot in inflation, that comfort is likely to have limits. It remains difficult for me to see the Fed passing off, say, 2.5% inflation as unconcerning, certainly not based on the more hawkish makeup of the current voters. Given that background, and the fact that the correlation between US interest rates and the dollar has reasserted itself of late, I continue to see higher rates in the US and a stronger dollar. We will need to see either a reversal of the slowing growth data elsewhere or a significant turn lower in the US data to change this trend. Right now, neither seems likely, but given the uncertainty created by the current administration’s policies, anything is possible.

So looking at the overnight activity, the dollar continues to rally. This morning it is higher by 0.4% vs. the euro, 0.3% vs. the pound and 0.8% vs. the Australian dollar. A quick look at the overnight data shows Japanese household spending to have been a disappointment in March, actually falling -0.1% rather than rising the expected 0.7%. Australian Retail Sales were disappointingly flat, undermining the Aussie. Halifax House prices in the UK fell -3.1% in April, much more than expected, which can be seen in the pound’s weakness, while from the Eurozone, German IP rose 1.0%, pretty much as expected, and not nearly enough to change the recent trend of weaker data from the continent.

Remember, too, that market positioning shows speculative dollar shorts are still quite large and while they have been reduced lately, still have much further to go. This means that there is going to be a natural bid for the dollar for a while yet unless the data turns abruptly. In fact, my take is that we will continue to see the dollar outperform almost all other currencies until at least the middle of summer, at which point the specs are likely to be square.

I understand the structural issues that are going to weigh on the dollar in the longer term, but there is no indication those are going to make themselves felt in the near future. Rather, the current trend is quite strong and growing stronger, and as such, barring something truly dramatic from the US (a collapse in data or an about face from the Fed) I see the dollar continuing along its merry way. Is my year-end forecast of 1.05 for the euro really out of court? Right now it doesn’t seem so!

Good luck


Sans Subpoena

A widely diverse group of nations
(The site of so many vacations)
Is finding of late
Their slowing growth rate
Has caused currency fluctuations

The EMG market arena
From Turkey down to Argentina
Has seen steep declines
Amid bad headlines
Now buyers won’t come sans subpoena

While the focus of this note has generally been on the major currencies, recent price action, where the dollar continues to power ahead overall, has started to really have an impact on emerging market currencies. In fact, the real question in this space is just how far can they fall? I have written before about the weakest links in the EMG space, those countries running significant current account deficits, and those are the countries that are leading the way lower on the currency front. Argentina, Russia, Brazil, India, Turkey and the Philippines are top (bottom?) of the list. In fact, they have fallen so much collectively over the past month, that it has become the most popular discussion topic of the morning. Well that, and how will the Fed react to Unemployment below 4.0%. But let’s look at the EMG laggards for now. Here’s how much these currencies have fallen this year:

ARS 17.4%
RUB 11.9%
BRL 6.5%
INR 5.2%
TRY 11.9%
PHP 4.1%

It is important to remember that at the beginning of the year, when the narrative had the dollar set to fall sharply and Goldilocks still alive and well, these were among the favored trades for investors. Each of these have higher interest rates than in the US, and there were many who felt it was a no-brainer to establish the carry trade, borrowing dollars to short against owning this diverse group of currencies. Well, that trade has come a cropper, now showing negative returns for the year and with the dollar’s latest move higher, looking like it can only get worse. In fact, given the continued positive economic news from the US, as well as the prospects for ongoing rises in US interest rates, my sense is that these currencies have further to fall. With yields in the US back to approaching some sense of value, or at least having finally turned positive on a real basis, the appetite for this bloc, in general, is likely to remain more limited. Hedgers beware of further declines here. While it may be expensive to hedge assets in these nations, it feels like it will be a lot more expensive not to!

Now back to the G10 world. As I’m sure everyone is already aware, Friday’s Unemployment Rate print of 3.9% was the lowest since December 2000. While the headline NFP number was a little light, the revisions to the past months made up the slack. In fact, the only data point that was somewhat disappointing was AHE, which at 2.6% was a bit softer than expected. In the end, though, there is no question that the labor market in the US remains quite strong. In fact, as the Unemployment rate continues to decline, the doves’ argument that there is still substantial slack in the labor market is becoming harder to make. The point is that the evidence continues to grow that the Fed is going to raise rates at least four times in total this year, and depending on how the data evolves, one cannot rule out a fifth hike toward the end of the year.

Meanwhile, the evidence of slowing growth elsewhere in the world continues to mount with the latest data point Germany’s Factory Orders, which declined -0.9%, well below expectations and the third consecutive monthly decline. And it’s not just Germany, but the Eurozone as a whole, which showed Retail PMI falling below 50 last month (48.6), a seventeen-month low. In other words, the idea that the US continues to grow solidly while the rest of the world slips back remains the prevalent theme. And there is no reason to think that the dollar will suffer any time in the near future accordingly.

Looking ahead, this week brings some important new information as follows:

Today Consumer Credit $16.0B
Tuesday NFIB Small Biz Optimism 105.0
  JOLTS Jobs 6.1M
Wednesday PPI 0.3%
  -ex food & energy 0.2%
Thursday BOE Rate Decision 0.5% (unchanged)
  Initial Claims 220K
  CPI 0.3% (2.5% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Friday Consumer Sentiment 99.0

At this stage, the idea that the BOE will raise rates has completely been priced out of the market. Rather, there will be a great deal of interest to see how they update their economic and inflation forecasts, which arguably should be lower than before. And here in the US, all eyes will be on Thursday’s CPI print, where anything above expectations will simply add to the idea that the Fed will be even more aggressive than currently priced. In the end, there is nothing that would have me change my view that the dollar will continue to be the top performer going forward. Look for continued gradual dollar appreciation as the week progresses.

Good luck

Did NFP Jump?

The question for traders today
Is what will the jobs report say
Did NFP jump?
And was there a bump
In prospects for increasing pay?

As is common on Payroll days, market activity ahead of the release has been muted. While we did see weakness in Asian equity markets, European shares have been much less exciting and US futures are pointing to a very minor downtick on the open. The dollar continues to show broad strength, resuming its recent march higher against the euro and the yen, while commodity prices are mixed. Finally, Treasury yields continue to trade between 2.92%-3.00% as investors seek the next clues as to the Fed’s likely path. Of course, we know they will be raising rates, the question is just how fast.

So here is a quick recap of market expectations this morning:

Nonfarm Payrolls 191K
Private Payrolls 190K
Manufacturing Payrolls 15K
Unemployment Rate 4.0%
Participation Rate 62.9%
Average Hourly Earnings (AHE) 0.2% (2.7% Y/Y)
Average Weekly Hours 34.5

If you recall, last month’s NFP number was a much weaker than expected 103K, but the month before that showed 321K. There may be some seasonal adjustment issues, but in the end, the economy continues to find room for roughly 200K new workers each month and has done so for the past five years or so. But as we have seen lately, there is likely to be a great deal more attention paid to the AHE number, as it is the direct inflation data point from the report. Yesterday’s data showed that productivity growth was even slower than expected at 0.7% while Unit Labor Costs rose a robust 2.7%. It is data of this nature that has the Fed concerned that inflationary pressures are building more rapidly than they are currently forecasting. Weak productivity growth is just not going to help the case for either economic growth improving or inflation moderating. However, until the release, there is nothing else to discuss on the subject.

Turning elsewhere, Eurozone PMI numbers were released and showed that the trend in growth there and in the UK continues lower. This is especially disappointing to the many confirmed euro bulls as the weakness in Q1 was being attributed to bad weather throughout much of the continent. However, this is now the second month of Q2 and the trend lower continues to point to a slowing growth trajectory. For the ECB this is a problem as they have been chomping at the bit to end QE. But how can they justify removing policy accommodation if the growth picture continues to slow and inflation alongside it? My argument is they cannot, and that the much-discussed ending of QE in September is likely to be delayed further. The current market expectation is for the ECB to discuss its future plans at the July meeting. There had best be an upturn in the data if they expect to change the current policy settings.

At this point, it may be fair to say that the synchronous global growth story is dead and buried. While the US has been hanging on quite well, arguably on the back of significantly increased fiscal stimulus, we are not seeing that elsewhere. And this could be an even bigger problem for emerging markets than for the rest of the G10. EMG currencies have been under significant pressure for the past month as the combination of higher US rates and a stronger dollar are a heavy weight. In fact, we are starting to see some cracks in the weakest members with TRY and ARS both falling to new historic lows; the latter despite an emergency 300bp rate hike yesterday. As I have written before, those countries that run significant current account deficits and fund in dollars are likely to see their currencies fare quite poorly. So Brazil, the Philippines and India are amongst the potential biggest losers on this basis. This is something to keep in mind for hedging decisions going forward.

And really that’s all there is ahead of the data. With the FOMC meeting behind us, we get five Fed speakers today although four of them are after the markets close. However, this will be the first we get to hear about what the tenor of the discussions were at the meeting. My guess is we are going to get some calibration on just how much inflation above 2.0% these speakers are willing to allow before getting nervous. It seems a foregone conclusion that the economy will be running ‘hot’ for a while. My concerns lie in the fact that inflation trends are very long lasting, and with the trend clearly higher, the idea it will suddenly stabilize seems unlikely. In addition, given the ongoing trade tensions, and continued strength in energy prices, the risk of a surprisingly high inflation print seems far greater than the risk of a surprisingly low one. I continue to believe that the Fed is behind the curve, and that as the year progresses, it will become obvious even to them. At that point, the trajectory of interest rate increases will steepen further, and the dollar will benefit on the back of that. But for now, I think this slow USD appreciation is the most likely outcome going forward.

Good luck and good weekend

Don’t Worry or Fret

The FOMC when they met
Explained that there’s no problem yet
Regarding inflation
Or acceleration
Of wages, don’t worry or fret

In fact, what they seemed to imply
Was prices must rise really high
Before they will worry
As they’re in no hurry
To wave the recov’ry bye-bye.

The FOMC left rates on hold, as was universally expected, but the statement changes were a bit harder to parse. On the one hand they recognized that inflation was moving higher, although they were nonplussed about inflation expectations despite those seeming to rise as well. On the other hand, they had a mixed view of economic growth, highlighting strength in investment but recognizing that consumption has ebbed slightly. Arguably, the biggest deal was that they mentioned, not once but twice, that their inflation goal is symmetric, which was read to mean that they are perfectly comfortable with inflation running above 2.0% for some time. Of course, the question is just how far above 2.0% inflation will have to go before they become uncomfortable. The market response was actually quite interesting as the initial move in equity markets was higher but then stocks gave back those gains and then some and were lower overall on the day. The dollar, meanwhile, initially sold off on the report, but then rebounded sharply to trade to its highest point this year. While it has not been able to maintain those gains thus far this morning, the trend remains clearly in the dollar’s favor for the time being.

With this meeting out of the way, the market is now 100% convinced that they will raise rates in June, and the punditry, if not the markets, are pretty certain that they will not act again before September. This idea of only adjusting policy at press conference meetings has become deeply ingrained in analyst thinking. And I guess as long as the Fed forecasts of the trajectory of growth and inflation are correct, that is a reasonable expectation. The problem with this theory is that the Fed is notoriously awful at forecasting growth and inflation. It is with that in mind that I cannot help but look at the trend in inflation, which remains sharply higher, and think that by September they are going to figure out that they are falling behind the curve and will need to step up the pace of policy tightening. If the trend is your friend, which remains a longstanding markets mantra, then current trends are pointing to higher inflation, higher interest rates and a higher dollar as we go forward. We will need to see some pretty dramatic changes in the underlying economics in order to break these trends.

Turning our attention to the rest of the world, this morning the ECB was met with weaker than expected CPI data, exactly what they don’t want to see if they are keen to end their QE program. The April reading of 1.2% continues the trend seen since January 2017, when it briefly touched 2.0%. And remember, this is ongoing despite rising oil prices, which has one of the biggest impacts on inflation and inflation expectations. The point is the hawks are watching their case disintegrate in front of their eyes and are going to be hard-pressed to convince the rest of the council that ending QE is urgent. As I have watched the Eurozone data unfold, it is becoming clearer every day that not only is QE not going to end in September, but it is not even going to be reduced. For all the euro bulls out there, this is another nail in the coffin.

Meanwhile, the UK is feeling the pressure as well as the Services PMI data was released at a weaker than expected 52.8, with the trend since Q4 clearly heading down. It is no surprise that the idea of a BOE hike next week has been priced out of the market. Adding to the pressure on the UK economy is the ongoing political wrangling over how to deal with Brexit. It appears that PM May is slowly losing her grip on power with the hardliners in her cabinet unwilling to accept a kluge solution for the Irish border issue and very clearly willing to leave the Customs Union accordingly. While the pound is down more than 5% from its recent peak in mid-April, it remains 13% above the lows seen in the wake of the initial Brexit vote. I would contend that the market has become far too accepting that a good deal will result from the negotiations, and thus have not discounted a more dramatic outcome. Combining the ever tightening US policy action with a more negative Brexit outcome leads me to believe that a move back toward 1.25 is quite viable before the year ends.

In the EMG space, the dollar, though slightly softer this morning, is broadly higher this year. There have been numerous articles describing the key issues for these currencies which essentially boil down to rising US rates reduce the attractiveness of emerging markets as an investment opportunity and so result in position adjustments. This pressures EMG currencies lower, which simply adds to the vicious cycle of negativity. The resulting weaker currency pressures EMG companies, who have borrowed in USD (apparently to the tune of ~$3 trillion) because it takes more local currency to repay those loans, thus negatively impacting their profits and driving a further exodus from those securities. You can see how this might get out of control if some exogenous factor arose, but even in its current form, it is very difficult to make the case that this cycle will end soon. That is even truer if the Fed is forced to increase the pace of rate hikes. In the end, it is difficult to look at this bloc of currencies and see anything other than downside for the summer at least.

As for today, we have another rush of data as follows: Initial Claims (exp 224K); Trade Balance (-$49.9B); Nonfarm Productivity (0.9%) and Unit Labor Costs (3.0%) all at 8:30. Then at 10:00 we see Factory Orders (1.3%) and ISM Non-Manufacturing (58.4). To me, the productivity data will be the most interesting. There has been much discussion of the mysterious weakness in productivity data in the US over the past decade, and it is clear that weakness has been one of the drivers of the much weak recovery that has occurred during that time. Former Fed Chair Yellen recently highlighted that as long as wage growth increased at a pace of productivity plus 2%, there would be limited pressure for higher inflation. However, given the dearth of productivity growth, which has averaged below 1% for quite a long time, and given that wages are growing at least at 2.8% as measured, it seems that we are on the cusp of a potential breakout on the inflation side. This is just another indicator to watch in order to follow the inflation trend.

I know I have been harping on inflation a lot lately, but that is only because I see it is the great unknown in market behavior. Given how long it has been since high inflation has plagued the US, there are many traders and investors who have never seen markets respond to this situation. What I want to reiterate is that it is a very real risk to market behavior, and especially to the FX market. There has been nothing in the data that indicates inflation is just going to reach 2.0% and stabilize there. Rather, history shows that it is far more likely to continue higher and force the Fed’s hand. And that is likely to happen sooner than most people expect. It is just another reason that I like the dollar to continue to outperform as the Fed responds while other central banks have a very different economic picture to evaluate.

Good luck

Seventeen Voices

A gentleman Fed Chair named Jay
Is leading a meeting today
Where policy choices
‘Mongst seventeen voices
Is likely, on markets, to weigh

It seems most investors agree
The statement today will be free
Of hawkish content
And that’s why they’ve spent
Their cash on a stock-buying spree

The dollar, this morning, has taken a breather from what has turned into quite a nice run higher over the past two weeks. If you recall, a week ago I suggested that the euro would break below 1.20 by the end of April. Well, I was wrong by one day, as yesterday we breeched that level for the first time since January 11, and as I type, we remain slightly below. What is quite interesting to me is that the bulk of what I have been reading over the past several days has been a confirmation of everything I have written over the past several months.

To wit, the synchronous global growth story is falling apart as data from the Eurozone, the UK, Japan and China all slows down. Meanwhile, US data continues to perform well thus taking us back to the US economic leadership story. A key part of this message is that the inflationary impulse in the Eurozone, the UK, Japan and China is still lagging, if not missing completely, despite the rise in oil prices while in the US, every price indicator points to rising inflation. This combination of events has led to very different commentary from the respective central banks. The ECB has been at pains to highlight patience is a virtue and that they didn’t even discuss monetary policy at their meeting last week because they were too busy focusing on what was happening in the economy. Expectations for the BOE next week have turned around 180 degrees as the previous idea of a 25bp rate hike has been completely eliminated due to the weakening data and ongoing Brexit concerns. The BOJ has given up its timeline for reaching its inflation target, having missed it for the past five years, and is seen now as likely to continue QQE indefinitely. And finally, the PBOC has actually eased policy, cutting the Reserve requirement by 100bps two weeks ago, so any idea of tighter monetary policy there has been thrown out the window.

Which leads us to the Fed today. There is no question that the consensus view is that there will be no policy changes and that the Fed statement today will offer little new information. The market has become quite accustomed to the Yellen approach of only adjusting policy at meetings with press conferences, and so the strong belief is that they won’t do anything. But it is important to remember that until 2012, under Bernanke, there were no Fed press conferences at all and they acted when they thought it was appropriate. In fact, for many years, they didn’t even announce rate moves, they simply acted in the money markets to adjust the supply/demand situation to drive rates. Now given the impact of QE and the resultant excess reserves that exist, they can no longer manipulate rates in that manner. But they certainly have the ability to change policy without a press conference. And after all, they could call for one after the statement and I assure you that every news agency would be there at the appointed time. All I’m saying is it is a mistake to believe that the lack of a scheduled press conference precludes the Fed from adjusting policy.

Now with that in mind, I don’t think they are going to raise rates, but what I think is quite possible is that based on the data we have seen since the last meeting, particularly the ongoing rise in inflationary data, I expect the language in the statement to recognize the evolving economic landscape and sound more hawkish. I mean it is hard to consider the inflation situation balanced. Rather inflation is clearly trending higher. And why they should continue to believe that it will stabilize at 2.0% after having risen rapidly in the past few months is beyond me. I think the bigger question is will they mention something about allowing inflation to run hot for a while before getting concerned.

With the correlation between 10-year Treasury yields and the dollar having returned to its historically positive condition, and the 10-year back at 3.00% as I type this morning, I think a hawkish tone from the FOMC is quite possible and will help to generate the next leg higher in the dollar. And this is true against all currencies, both G10 and EMG as this story is completely US-centric.

There’s really little else to discuss this morning. The overnight data simply confirmed the slowing growth trajectory elsewhere in the world. The only data point in the US today is ADP Employment (exp 190K), which may alter some views about Friday’s NFP report if it is sufficiently different from expectations. However, it’s really all about the Fed today. So I would look for limited movement until the release at 2:00pm. If I am correct about a more hawkish lean, look for the dollar to extend its rally. And quite frankly, if they come across as dovish, then the dollar could easily retrace 1% or more. However, I think the evidence points to the hawks continuing to rule the roost there.

Good luck



The Fed must be thrilled while they’re meeting
‘Cause price rises aren’t just fleeting
Inflation is higher
As they all desire
But will it soon be overheating?

They must be dancing at the Mariner Eccles building this morning, as PCE inflation finally achieved the Fed’s target of 2.0%! Hooray!! I know I’m glad to see prices rising more rapidly for the things I buy every day, aren’t you?

But seriously, this probably represents a significant change in the mindset at the FOMC. For the past nine years they have been doing everything they could think of in order to drive inflation higher. In fact, deflation was their greatest concern for a number of years, although I would argue that threat passed shortly after the original bout of QE helped unfreeze markets in 2009. Regardless, we have seen inflation rise consistently for the past year, and now that the cell phone anomaly has passed out of the annual data, we are getting a truer reading of what prices are doing in real life. And as I’m sure you are all aware, they are rising. But potentially more important to the Fed than the fact that the price of a gallon of gas or milk is higher is the fact that wages are growing more rapidly. Friday’s ECI data highlighted that and is consistent with the ongoing wage and price sub-indices we have seen from ISM and PMI data for the past several months. The Beige Book highlighted the issue and there must be four stories in the WSJ alone today about labor shortages and the higher wages being offered. The upshot is that the Fed would have to be willfully blind to not recognize that both wages and prices are rising pretty robustly at this point.

So what will they do about it? Well, this is what the conversation is all about. The narrative that has driven markets for the past year has been focused on the idea that synchronous global growth would force the EU, UK, Japan and China to all tighten policy more aggressively than had previously been thought while at the same time the market had already priced in all the US activity. The problem for the narrative is that the data is not cooperating as evidenced most recently by this morning’s weaker than expected UK PMI data, down to 53.9 from a downwardly revised 54.7 and much worse than expected. Or by yesterday’s German CPI data, which fell to 1.4%, rather than holding at 1.5%. And these are just the latest two data points that are undermining the narrative adding to virtually everything that was released during Q1. The point is that the narrative is losing its luster, and instead, what we are beginning to see is a change in expectations. It is no longer an extreme outlying view to expect US rates to rise more than the market had been pricing, or to expect that the ECB backs away from ending QE this year. In fact, futures markets have been making those changes lately with the probability of a fourth Fed hike this year now up to 50% (personally, I think it is 100%) and the probability of the BOE raising rates next week essentially 0% with not even one full hike priced in for 2018 now.

The impact on the dollar has been dramatic, as it has rallied more than 3% in the past two weeks and all of those trading ranges having been broken toward a higher dollar. While this is no surprise to me, there are clearly many in the market that have been caught offside by the move as evidenced by the still massive short positions in the dollar that are recorded on the futures exchanges. As I wrote earlier, it is getting quite expensive to hold a short dollar position given the high and rising US rate situation compared to rates elsewhere in the world. I expect that we will continue to see position covering and the dollar will continue to rally going forward, at least for a while.

Not surprisingly, the pound is the worst performer overnight (-0.7%) as the PMI data has simply added to its recent woes. Yesterday it was a political question, this morning an economic one. Quite frankly, it is very difficult to look at the UK economy and consider that higher rates are the proper prescription to enhance growth there. The key will be the next inflation reading in three weeks’ time. If that continues the recent trend of softening, the market should completely discount any rate hikes by the BOE this year and the pound is likely to fall further. Of course next week we will hear from the BOE directly, and while they will be laying out their latest forecasts, I feel like the market will remain focused on the data.

But both the euro and the yen have been under pressure as well, as data in both places has done nothing to encourage the idea that either the ECB or the BOJ will actually be in a position to reduce accommodation soon. In both cases, there has been no consistent inflationary impulse to date and the question now starting to be asked is whether the ECB, in particular, will ever be able to end QE. I mean, if growth is heading back down to trend of around 1.0%-1.5% with QE, what does that say about prospects without QE. Meanwhile, Japan has been expanding its asset purchases for two decades with no obvious benefit. The question for both these central banks is what will they do if a recession arrives and they are already at negative interest rates? It won’t be pretty, and I’m pretty sure the dollar will be the beneficiary at that time. But that is not going to happen very soon, so no need to worry about that right now.

Pivoting to the emerging markets, the dollar is higher against virtually the entire bloc. Even Mexico, which had a blowout Q1 GDP reading of 1.1% (4.6% annualized) that was much better than expected, is softer this morning by 0.35%. Clearly the ongoing trade ructions are having a significant impact on this bloc of currencies, but so are higher US rates and broad-based USD strength. There is some irony in the fact that many of the things that the Trump administration has done (tax cuts, increased spending, regulatory reduction) have helped underpin the dollar despite a seeming desire to have a weaker currency. But for now, the dollar is king and is likely to remain so for a bit longer.

This morning’s data brings ISM Manufacturing (exp 58.6) and Construction Spending (0.5%). The FOMC meeting also begins this morning, but the statement isn’t released until tomorrow afternoon. There is no expectation for the Fed to change policy here, but I remain of the opinion that the statement could be somewhat more hawkish than benign. In fact, there is little that the Fed has seen of late that would imply dovishness is the appropriate stance. Look for the dollar to continue to benefit this week with the euro finally breaking back below 1.20 for the first time since early January.

Good luck