Perhaps, Has Been Quelled

In Europe the powers that be
At last got around to agree
On policy specs
That are quite complex
But take pressure off Italy

So immigrants now will be held
Off shore, and some will be expelled
Frau Merkel survived
The euro? It thrived
This problem, perhaps, has been quelled

The dollar is under pressure this morning, largely led by the gains in the euro, which has rebounded 0.75%. The proximate cause of this rise was news from the EU summit that they agreed on a new immigration plan designed to reduce the pressure on Italy, a key staging point for African immigrants to the EU, as well as create a series of camps in North Africa to detain asylum seekers and refugees while they are processed. This has been a huge issue in Europe, with significant divisions amongst the various players, and has been a key driver of the rise of right wing populism on the continent. While it remains to be seen if the agreement actually comes in to force, and if it is effective in its stated goals, at least for now the market is giving it the benefit of the doubt. One critical feature is the belief that German Chancellor Merkel has now removed the threat of her governing coalition partner, the Christian Social Union, leaving the government and thus CDU/CSU/SPD coalition will continue with Merkel at the helm. Given Germany’s preeminent role in Europe, there has been significant concern that if Merkel is pushed out, ensuing EU leadership will be unable to maintain the growth momentum that currently exists. And remember, data continues to show that growth momentum in Europe is slowing anyway.

There was one bright spot on the data front, though, as Eurozone headline CPI printed at 2.0%, exactly as expected, but a positive nonetheless. Of course, the rise was entirely attributed to oil prices, as core CPI actually disappointed, falling to 1.0%, still very far from the target of “just below 2.0%”. It is by no means obvious that a more genuine inflation impulse is brewing on the Continent just yet, and so I continue to believe that the ECB, while it seems likely to end QE in December, will still not be raising interest rates for quite a long time in the future. In fact, my sense now is that Eurozone rates remain at -0.4% until Q1 2020 at the earliest.

Speaking of rates, we did hear from two Fed speakers yesterday, with both commenting on the brewing trade war situation. Bostic and Bullard remain on the dovish side of the spectrum, with each of them explaining that they were quite concerned over the possibility of a yield curve inversion occurring, and both of them remarking that their conversations with businesses in their respective regions highlighted those businesses’ concerns over the trade situation and the impacts it could have going forward. Bullard, in fact, continues to maintain that the Fed needn’t hike rates any further this year, while Bostic seems in the one more time camp.

I think it is time to have a brief discussion on the yield curve inversion situation. To be clear, I am looking at the yield spread between 2-year Treasuries and 10-year Treasuries, which in more normal times, has traded in a range of 75bps-125bps. This means that the 10-year Treasury’s yield was that much higher than the 2-year Treasury’s yield. This morning, however, that spread is just 32bps, and has been trending lower ever since the Fed started tightening policy. When the spread turns negative, it is called an inverted yield curve, and the concern arises from the fact that every time we have seen an inverted yield curve in the past fifty years, a recession has followed within a fairly short period of time.

Now I greatly respect this historical indicator and it makes sense economically that an inverted curve would lead to a slowdown in economic growth, but I think it is critical that we remember one thing that is truly different this time. In the past, the Fed’s balance sheet represented a much smaller proportion of the economy, generally less than 10%, and so any bonds they owned had only a minor impact on market pricing. Therefore it was reasonable to believe that the 10-year yield was an accurate reflection of what the market demanded for that risk. However, that is not today’s situation. Even though the Fed has begun to reduce the size of its balance sheet ever so slowly, it still remains as ~22% of the economy. And if you recall what QE was all about, it was a price insensitive bid for Treasury bonds that was designed to drive long-term rates lower, and it succeeded in doing so.

My concern is that those long-term rates are still a reflection of the Fed’s buying activity during QE, rather than an accurate reflection of investor demands regarding the risk of holding 10-year debt. In other words, they are likely much lower than they otherwise would be, in the absence of QE ever happening, and thus despite the fact that short term rates have been rising and a curve inversion seems possible soon, it may not be giving us the same type of signal. Given the strength of the US economy, and the current US inflation rate, it would not be hard to make the case that 10-year Treasury yields should be 4.5%-5.0%. After all, that would equate to real rates of just 1.7%-2.2% based on the current CPI readings of 2.8%. And real rates of 2% + or – have been the long run historical average. So if the Fed buying has resulted in 10-year Treasury yields being 170bps lower than the historical record for the economy, perhaps the angst over an inverted yield curve is misplaced at current levels. This could well be the first time that the curve inverts and no recession follows. Food for thought.

Anyway, back to the markets. As I mentioned above, the dollar is broadly weaker, which is not only the result of the European situation, but also seems a simple price correction heading into the weekend. Japanese data showed Unemployment falling sharply, as well as the BOJ able to reduce the amount of JGB purchases necessary to maintain stability in rates in that market. Indonesia surprised the punditry by raising overnight rates by 50bps, to 5.25%, which helped support the rupiyah. And in general, the dollar is on its back foot today.

I have been expecting a correction, so this price action is no surprise. Meanwhile, this morning we get the latest Core PCE number, the critical inflation data point that the Fed uses in their sorcery modeling (exp 0.2%, 1.9% Y/Y). We also see Personal Income (0.4%), Personal Spending (0.4%), Chicago PMI (60.0) and Michigan Confidence (99.1) as the month and quarter come to a close. In the end, while the dollar is under pressure today, I continue to look for the Fed to maintain its tightening cycle and the rest of the world to lag, thus the dollar remains more likely to rise going forward.

Good luck and good weekend

Badly Misled

There once was a theory that said
QE would prevent further dread
Of financial mayhem
From p.m. to a.m.
Alas we’ve been badly misled

Reality has now showcased
That faith here was somewhat misplaced
Thus markets worldwide
Are starting to slide
While Janet and Ben are disgraced

The human brain is a funny thing. One of its key features is its propensity to search for patterns in potentially random data. But even keeping that in mind, I cannot help but notice a pattern of market jitters across an increasing number of markets.

When the Argentine peso started falling sharply earlier this year (-47% YTD), it was seen as an idiosyncratic response to locally grown problems. After all, the financial situation in that country has been dire for years. When the Turkish lira started falling sharply a few months later (-22% YTD), it was attributed to concerns over the central bank’s diminishing independence in the face of pressure from Turkish President Erdogan. Again, this was seen as country specific and not part of a trend. Traders then noticed that the Brazilian real was seriously underperforming (-18.8% YTD), and it was chalked up to concerns over the upcoming election and ongoing economic malaise. But then the Mexican peso, which had rallied sharply at the beginning of the year, turned tail in April and has fallen more than 11% since then. Of course, this was chalked up to NAFTA and trade issues as well as the seeming certainty that AMLO, a left-wing populist firebrand, will be the next president of the country.

Pivoting to Asia we have started to see sharper declines in the Indian rupee, historically a much less volatile currency than those mentioned above, but now down -6.3% YTD and trading at a new historically low level. Indonesia? The rupiyah is down 8% YTD having fallen 4% in just the past three weeks. Thailand? Similar to Mexico, after a solid Q1 performance, it has fallen 6.2% in Q2 and is now lower by 3% on the year. And of course there is the Chinese yuan, which fell a further 0.3% overnight taking its YTD loss to 1.7%, but its Q2 performance to -6.0%.
This laundry list of currencies that have been under pressure is hardly exhaustive, but merely shown to demonstrate that this is not random data, but an actual pattern. And what is the common denominator for all these countries? Each one of them saw massive investment inflows over the past ten years as the Fed, ECB, BOJ, BOE, BOC and SNB, to name but a few, all massively expanded their balance sheets while driving longer term interest rates lower in an effort to help support their respective economies. In other words, they were all proponents of QE.

QE was always suspect as during the actual asset purchase stages, the central banks explained that the flow of purchases was the key feature of the process that would help improve economic outcomes. However, when they stopped buying assets (although not all of them have) they explained that it was still good because it was the stock of assets they had already purchased that was the important feature helping to improve economic outcomes. And then, when the Fed could no longer countenance the idea that QE was critical, given the US economy’s strong performance, they told us that reducing the balance sheet was merely background noise, “like paint drying” according to then Fed Chair Yellen, and would have no impact at all on markets or the economy. Now I don’t know about you, but this messaging never really made sense. How is it possible that expanding the Fed’s balance sheet >$3 trillion of assets would help the economy, but that contracting the balance sheet would have no impact?

Well, folks, we are witnessing that impact every day now. Whether it’s the Shanghai stock market, down more than 20% since January, or all of the currencies listed above, or rising bond yields across the entire emerging market space, the market somnolence calm that had prevailed for much of the past decade seems well and truly over. And not only that, this process is really just beginning. Market turbulence is going to be the new normal. And I assure you, this is entirely the result of QE, an emergency measure that morphed into central bankers’ favorite and most widely used tool for all occasions.

The point of all this is to remind you that volatility is neither unprecedented nor unusual when it comes to currency markets. In fact, prior to the financial crisis in 2008-9, it was the norm. And so those of you charged with hedging FX exposures need to keep on top of your programs, they are going to be crucial in mitigating earnings volatility going forward.

Please excuse my rant, but every once in a while things just pile up and need to be vented! Turning to the overnight markets, the dollar has actually had a mixed session, e.g. gaining vs. the pound but falling vs. the euro. However, this session follows yesterday’s NY trading which saw the dollar rally across the board. Ultimately, the central banks continue to maintain an outsized impact on the currency markets, and none of them are about to change their current policy trajectories. So a tighter Fed moving much faster than every other central bank means that the dollar will remain supported as we go forward. The question is more how far it will rally rather than if it will rally.

As to today’s data, we see the third reading of Q1 GDP (exp 2.2%) as well as Initial Claims (220K). Two Fed speakers, Bostic and Bullard, add to the mix, but given that the data has remained consistently upbeat in the US, it seems unlikely that they are going to change their tune very much. Instead, the big picture remains the same, broad dollar strength amid more volatile markets, but given recent price action and dollar strength, a mild dollar correction today doesn’t seem a bad bet.

Good luck

Not So Benign

The worries in China have spread
From stocks to renminbi instead
Its recent decline
Seems not so benign
And could drive more market bloodshed

Well, if President Xi’s goal is to make China the most talked about nation in financial markets, he is clearly on the right track. Of course, he may not like the tone of the conversation!

Once again, Chinese markets are dominating the global discussion with continued declines overnight in equity markets there (Shanghai -1.1%, Shenzhen -1.3%) alongside the recent weakness in the renminbi. This morning, CNY has fallen a further 0.4%, with the dollar now trading above 6.60 for the first time since last December. It is becoming abundantly clear that the PBOC is quite willing to allow further weakness in what appears to be a reaction to the ongoing trade dispute with the US. In the past two weeks, USDCNY has risen every day with the total movement clocking in at more than 3%, and quite frankly, there doesn’t seem to be any reason for it to stop. Last night the PBOC was seen intervening heavily in the market in an effort to moderate the decline, but it seems highly unlikely that the government there wants to stop it completely. As I mentioned yesterday, their key concern is that a more rapid decline in the yuan will result in significant capital outflows, or at the very least a sharp drop in capital inflows, and that has the potential to destabilize markets in China, and eventually, elsewhere in the world. And for a country that has been trying to burnish its image as a responsible global financial citizen, causing global market destabilization is clearly not the desired outcome. At any rate, given the ongoing standoff regarding the US-China trade situation, it seems highly unlikely that CNY will stop falling soon. Look for a gradual decline with a year-end target of 7.00 still quite viable in my mind.

Away from China, however, FX market activity has been less exciting. While the dollar continues its broad trend higher, the pace remains muted. For example, this morning, amongst the G10 currencies only NZD has moved more than 0.2%, with kiwi falling 0.6% as the market prepares for the RBNZ meeting this afternoon. Expectations are for no change in policy, but the suspicion is that the bank is becoming more dovish due to escalating trade rhetoric between the US and China.

Important economic data from the G10 is more notable by its absence than by what it is telling us about the economy. Last night brought us UK Home Price data, showing the slowest rate of price increases in five years, with prices in London actually falling by 1.9%. Combining this with testimony by Jonathan Haskel, who will take his seat on the MPC come September 1st, which showed him to be somewhat more dovish than Ian McCafferty, the member he is replacing, has clearly weighed on the pound. Otherwise, we saw a bit of mixed confidence data from Italy, soft confidence data from France and weak Irish Retail sales. None of this was very inspiring as evidenced by the euro’s 0.2% decline.

Meanwhile, the emerging market space remains under pressure as concerns over trade weigh heavily on the sector. It is important to remember that virtually every EMG country is dependent on its export sector for economic growth, and as the global free-trade framework that has existed for the past 70 years starts to come undone, these economies are going to suffer. The only potential exception right now is for the oil producers as President Trump’s recent call for a complete boycott of Iranian crude products has helped drive oil prices up by nearly 4% this week. So RUB, MXN and MYR have been able to outperform their EMG peers, although this morning all three are down vs. the dollar. In fact, the dollar has demonstrated strength throughout the market today, just as it has been doing for the past several months.

As to this morning, we see Durable Goods data (exp -1.0%, +0.5% ex transport) and we hear from two Fed speakers, Randy Quarles and Eric Rosengren. However, it seems unlikely that any of this will have a major market impact. Rather, I expect that the broad equity weakness that has been evident of late will continue (currently futures are pointing to a -0.5% opening in the US) and the risk-off tone that has engendered will help the dollar to remain underpinned. And of course, there is the ever present risk of some new commentary from President Trump that has the chance to upset markets. So volatility remains a good bet, as does modest continued dollar strength. This story is not even close to ending.

Good luck


In re Trade

Investors are growing afraid
That things will get worse in re trade
In Shanghai they’re shaken
With stocks there forsaken
At home, market bulls are dismayed

For the time being, there is only one story that seems to matter, the brewing trade war. Rhetoric is heating up on both sides of the Pacific and concerns are growing that what initially seemed to be a negotiating position by the US is morphing into a firm stance. It is becoming increasingly clear that President Trump believes that he can ‘win’ a trade war, and that China will suffer much greater harm in a much shorter time period than will the US. And despite yesterday’s equity market decline at home, the story in China remains significantly worse as evidenced by the Shanghai Index, which has now fallen more than 20% since January. At the same time, we continue to see the Chinese yuan suffer on a daily basis, with last night’s decline of a further 0.6% taking the movement over the past week alone to nearly 2.0%.

It can be no surprise that the CNY continues to weaken, as the currency remains the main safety valve for the Chinese economy. China is still mercantilist at heart, and the competitiveness of its exchange rate is a crucial factor in economic growth. As I mentioned yesterday, the PBOC’s key concern is that excessive weakness in the yuan will result in significantly more capital outflow than desired, which will in turn weaken the yuan further and potentially cause a more negative stock market reaction. We saw this occur in August 2015, and then to a somewhat lesser extent in January 2016, and both times the government’s response was to tighten rules restricting capital flows. While those tighter rules remain in effect now, if we see a more accelerated decline in the currency, look for yet another wave of regulation there to prevent further damage. It is, of course, somewhat ironic that as President Xi tries to appear as an internationalist in certain forums, his immediate response to a market hiccup is to close off access to investors, both domestic and foreign.

But CNY is not the only currency impacted by the current narrative. In fact, the entire emerging market space is under pressure with month-to-date declines in KRW (-4.5%), THB (-3.1%), MXN (-2.1%) and CAD (-2.6%). Well, even if Canada is not actually an emerging market, it has clearly been hampered by the trade story and NAFTA. And arguably, that is the driving force across all currencies right now.

Which nations will suffer the most if the global trading framework that has been developed over the past 70 years comes undone? It will be those nations where trade represents the largest share of the economy. A quick look at World Bank data from 2016 on the subject shows that Luxembourg is atop the list, with trade representing >400% of GDP followed closely by Hong Kong (373%) and Singapore (318%). While those are extremely high numbers, heading down the list shows that almost every EU country comes in above 100%, with even mighty Germany at 84%. Meanwhile, the US sits at just 27%. If you wonder why President Trump believes the US can win this ‘war’, it is because of data like this. The US retains the ability to be self-sufficient in almost everything, something that no other nation on the planet can boast. And while it would be inefficient and drive inflation higher, it seems pretty clear that the administration is going to push this envelope as far as it can. So be prepared for the trade story to dominate the headlines for the next several months, especially if US economic data doesn’t falter. And ironically, despite the fact that a weaker dollar would be more beneficial to the US in this case, look for the dollar to continue to outperform.

As to the rest of the FX market, the dollar has stopped its recent corrective decline and has rebounded this morning across the board. There has been vanishingly little data to absorb, and so my sense is that we are merely watching the trade story rhetoric play out. Yesterday’s New Home Sales data was quite strong, but that remains a relatively small sector of the entire housing market, and so is not the best descriptor of the economy. This morning’s data includes Case-Shiller Home Prices (exp 6.8%) and Consumer Confidence (128), neither of which should be too impactful. Rather, market players in every market will continue to watch the tape for the latest trade news and try to determine whether things are still heating up or whether the rhetoric has peaked. If pressed, I would say we are not close to a peak, and that this story has real legs. As such, I think the dollar will continue to be the main beneficiary for the time being.

Good luck

Growth There, To Defend

The Chinese want banks there to lend
In order to get folks to spend
So now banks need hold
Less cash, we are told
As Xi tries, growth there, to defend

Chinese banks are feeling a bit sprightlier this morning after the PBOC announced yesterday that they were cutting the required reserve ratio (RRR) by 50bps. This will release roughly $100 billion into the Chinese economy over time and should certainly act as a stimulant. As is typical, though, the PBOC has instructed the banks there on just how to use these funds. It seems that large banks are going to be required to increase debt/equity swaps with large, mostly state-owned, borrowers in order to prevent those firms from deteriorating further. (None of these banks are happy about this.) Meanwhile, small banks have been instructed to increase lending to the private sector SME’s.

The recent data from China has consistently disappointed and the escalating trade rhetoric between the US and China clearly has President Xi somewhat spooked. The last thing he can afford is for Chinese growth to slow significantly, especially if he is seen as part of the cause based on the trade dispute. It should be no surprise, then, that CNY has fallen a bit further this morning (-0.6%) in the wake of this activity, and it is actually now lower on a YTD basis. The currency remains one of the key safety valves for the Chinese economy, and especially given the broader global growth slowdown that appears to be occurring, I expect its weakness to continue. While the PBOC needs to be wary of allowing it to decline too rapidly, for fear that it will encourage significant capital outflows, a gradually weaker yuan is a very likely outcome as the year progresses.

The other noteworthy news from the weekend was the Turkish election, where President Recep Erdogan claimed victory with ~52.5% of the vote. In addition, his AKP party also won a majority in parliament, which means that he will be able to continue to strengthen his grip on power. The market’s initial reaction was for a TRY rally of as much as 3.0%, but it has already ceded all of those gains and is now lower by 0.2% as I type. Remember, Erdogan’s view is that high interest rates are the “mother and father of all evil” and he has promised to take a more active role in monetary policy now that he has won the election. Look for the lira to continue to decline, with 5.00 soon to be breached and 6.00 probably not that far behind.

But away from those stories, there is not much to discuss. German Ifo data printed at 101.8, which was 0.1 higher than expected, but still represents the sixth decline in the past seven months and is now at a more than one year low. In other words, nothing has changed with regards to the idea that the Eurozone economy is slowing down further, diverging from the ongoing growth story in the US. However, the euro is barely softer this morning, just 0.1%, as it continues to consolidate its gains from late last week. At the same time, the pound has fallen 0.25% despite a lack of economic news. It appears that the lack of positive movement on the Brexit talks is beginning to weigh more forcefully on the currency. The pound is down more than 5% this quarter, and by all indications, there is no solution in the offing for the more intractable Brexit issues, notably the Irish border and the transition arrangements. There are but nine months left before the UK is going to exit the EU and it increasingly looks like there will be no deal in place when it occurs. Despite the fact that the market is currently pricing in a 65% probability of an August rate hike, I remain of the view that the BOE is going to be on hold for quite a while yet.

Turning to the US, we see a bit of important data this week as follows:

Today New Home Sales 667K
Tuesday Case-Shiller Home Prices 6.8%
  Consumer Confidence 128
Wednesday Durable Goods -0.6%
  -ex transport 0.4%
Thursday Initial Claims 220K
  Q1 GDP (3rd look) 2.2%
Friday Personal Income 0.4%
  Personal Spending 0.4%
  Core PCE 0.2% (1.9% Y/Y)
  Chicago PMI 60.0
  Michigan Confidence 99

Durable Goods is likely to be the most carefully scrutinized, although the PCE data on Friday can clearly have an impact, especially if it is weaker than expected. We also hear from five more Fed speakers, mostly hewing from the center or dovish side of the spectrum. In the end, unless we see a major trade breakthrough, I expect that the US story is going to continue to be one of economic outperformance for now, tighter monetary policy and continued gradual strength in the dollar.

Good luck

A New Tune

The Old Lady sang a new tune
Implying two months after June
That rates there may rise
Which was a surprise
To pundits Thursday afternoon

Meanwhile further south it seems Greece
May finally get its release
Though still in arrears
Its tough overseers
Seem ready to settle for peace

The dollar is under pressure this morning, falling against most of its counterparts as it continues the decline begun yesterday. Arguably, the key catalyst yesterday was a more hawkish BOE, where though rates were left unchanged, Chief Economist Andy Haldane surprised the market by voting to increase rates, which took the tally to 6-3 in favor of remaining on hold, rather than the 7-2 expected. In addition, they indicated that they might begin to reduce the balance sheet when interest rates reached just 1.50%, rather than the 2.00% previously indicated. This means that the timeline for asset sales has clearly been shortened, a definitively hawkish sentiment. The pound’s response has been to rally 1.4% since the news, with the last 0.3% coming in this morning’s session. In addition, futures markets are now pricing in a 65% probability of a rate hike in August, up from 43% before the meeting. I continue to believe that Brexit will weigh too heavily on their minds to raise rates, but that is now a minority view.

This further isolates the BOJ, which left rates on hold last week and continues to make no headway regarding its efforts to push up inflation as evidenced by last night’s release that showed CPI continues to creep along at just 0.7% and just 0.3% -ex food & energy. In the end, the fact that the yen has weakened by 0.2% this morning ought not be a great surprise. There seems to be no scenario in which the BOJ is going to adjust its monetary policy anytime soon. In fact, if they do anything, I would argue it would result in additional easing.

But the pound was not the only currency that saw good news, the euro, too, has had a nice run this morning, rising 0.3%, after Flash PMI data showed a rebound in France, Germany and the Eurozone as a whole. The rise came within the service sector as manufacturing in all three readings disappointed further, but given that services is a much larger part of the relevant economies, the overall data still looked quite good. Adding to the good cheer was the announcement that Greece had reached a resolution with its creditors regarding debt relief. Essentially, official European creditors (the EU, Germany, France, etc.) have agreed to extend the maturity on Greek debt by 10 years, reduced interest rates further and offered a 10-year holiday before payments needed to be made. In addition, Greece will be getting one final dollop from the bailout program, totaling €15 billion, which will leave them flush for now and should encourage bond buying from investors other than the ECB. Net, it was a good day in Europe.

But emerging markets, too, have had a pretty good day, with some modest gains recorded across all three regions. For example, while there are still market jitters regarding Mexico’s presidential election slated for next week, the peso has managed to recoup about 0.4% this morning, which makes 3.3% since Monday. While that is certainly an impressive rally, and has largely been in sync with the rebound in oil prices, it is in the context of a currency that has fallen by 12.5% in the past two months. Ongoing NAFTA concerns, as well as investor fears that a victory by AMLO next week will jeopardize many investor friendly policies enacted by the current government, have clearly weighed on the peso.

Elsewhere in this bloc, traders and investors remain quite concerned over the outcome of this weekend’s Turkish election, where a big win for President Erdogan may result in even more unorthodox monetary policies and a much weaker lira.

Other key news is the OPEC meeting in Vienna that is ongoing right now, and where it remains unclear just how much more oil the group will be willing to pump. There is internal dissent because some members (Mexico, Venezuela) do not have the ability to increase output despite increased quotas, and so they are keen to see prices continue to rise. In fact, while oil touched its lowest level in more than two months on Monday, it has already rebounded about 5% since then. I’ve already mentioned the Mexican peso’s rebound in conjunction with that rise, and it is not surprising to see the Russian ruble behave in a similar manner.

However, in the end, the entire EMG bloc remains under pressure from the ongoing adjustments in monetary policy by the Fed, ECB and now the BOE. As developed market riskless returns rise, EMG currencies are going to continue to fall.

There is no US data this morning, and no Fed speakers on the calendar. In fact, today is likely to be a very quiet session as summer Fridays are wont to be. Unless we hear something new from the White House regarding trade, I expect that a modest further drift lower in the dollar is the most likely outcome.

Good luck and good weekend

At Best, Second Rate

The firm that defined what was great
Has run into trouble of late
GE used to be
A great company
But now it’s, at best, second rate

Maybe the biggest headline overnight was the fact that GE, an original member of the Dow Jones Industrial Average in 1907, is being dropped in favor of Walgreens at the end of the quarter. Oh how the might have fallen! This is stunning in that in 2000, it was the most valuable company in the world with a market cap of $548 billion. And while this is not likely to have a broader impact on anything, I think it is indicative of the changes that the global economy has undergone, especially recently.

The other story that really jumped out was the agreement between German Chancellor Merkel and French President Macron that the EU ought to have a common budget, a huge change for Merkel, as the two of them seek ways to prevent the entire bloc from falling apart. This has been a key sticking point for the Germans as they are concerned that they will be forced to fund the profligate habits of Italy, Greece, Spain, Portugal and even France. However, given the unraveling of the post WWII order that seems to be under way, and Merkel’s intense desire to maintain that order given how much it has benefitted Germany, I guess the time was right to concede a major point. If the entire EU ratifies this, then I see it as a significant long-term positive for the single currency. And while there is a long way to go before that happens, it is at least a first step.

Given the dearth of news, it ought not be surprising that markets overnight have been quiet. The dollar is little changed overall with gainers and losers about equally split. Treasury yields are higher by a single basis point and equity markets have rebounded very modestly from a run of negative days.

Looking at specific news, the UK leads with a better than expected CBI Industrial Trends report printing at 13, well above expectations of just 1 and a large jump from last month’s -1. It seems that the recent weakness in the pound has once again encouraged UK manufacturing. Speaking of the pound, it continues to be undermined by the declining probability of a rate hike in August, now estimated at just 43%, and by the ongoing Brexit bill debate in the House of Commons, where a loss for PM May might well bring down her government.

The euro has not had any data released of note, but ECB President Draghi, speaking at the Sintra conference, made a surprising statement indicating that the ECB could restart QE if the economy reversed course and weakened again. This is a far cry from last week’s discussion of the end of QE by December, and speaks to the fact that the doves on the ECB are still a voice to be reckoned with. The euro dipped when the statement hit the tape, but given how much it has fallen lately, and the positive possibilities from the Merkel-Macron announcement, it is only down 0.15% this morning.

However, beyond that, there is precious little to discuss today. Existing Home Sales from the US (exp 5.52M) is the only data point and rarely a market mover. Chairman Powell will be speaking in Sintra in a few hours, so the market will be very focused on his speech. However, there has been no data to suggest that he is going to change his view on the US economy nor his attitude about normalizing monetary policy. It appears that policy divergence will remain the driving force in currency markets for a little while yet.

Taking everything into account, while today doesn’t augur any significant movement, continued gradual strengthening of the dollar seems to still be the best bet. Manage your risks accordingly.

Good luck


Ten More Percent!

Said Trump in his latest lament
That his tariffs, he soon would augment
If China reacted
So they then enacted
Their own. Trump said ‘ten more percent!’

Clearly the biggest story overnight was the announcement by the Trump administration that they would seek to enact a 10% tariff on a further $200 billion of Chinese goods. The president remains adamant that China does not play by the rules and that the US is bearing the brunt of their mercantilist policies. This is not the venue for that discussion, but certainly the numbers show that US companies have been unable to expand their market share in any meaningful way on the mainland, hence the $376 billion trade deficit in 2017.

Market reaction to the announcement was immediate. Asian markets saw equities fall sharply (Nikkei -1.9%, Shanghai -3.8%), Treasuries rally (US 10yr yields -6bps to 2.87%) and the dollar move higher (EUR -0.65%, CNY – 0.4%) against virtually all currencies except the yen (+0.6%), which benefitted from safe haven flows. US equity futures are pointing lower as both Dow and S&P futures are down more than 1.2%. Commodity prices have also suffered, with energy and base metals lower and only gold holding its own this morning. If you didn’t remember what a risk-off scenario looked like, this is it. My observation is that the market reaction appears to be in the right direction, but I wonder just how much further things can move at this time. It strikes me that we have seen quite an exaggerated move thus a retracement seems more likely in the short run than an extension. Granted, if the latest set of tariffs are actually enacted markets are likely to suffer more, but for now, I kind of think we have seen the worst.

The Lords said a “meaningful vote”
Is a must as they seek to promote
A Brexit that’s gentle
And not detrimental
To constituent interests of note

The other story that has impacted markets was a successful vote in the House of Lords requiring that Parliament have a “meaningful vote” in any Brexit outcome. The intent is to prevent the UK from exiting the EU with no deal, but the May government claims it will hinder their negotiating leverage. The bill in question now heads back to the House of Commons where the vote is expected to be extremely close. In the meantime, the pound has taken it on the chin, down 0.5% and now trading at its lowest level since November. Interest rate futures in the UK have now reduced the probability of an August rate hike by the BOE to less than 50%, which given the increased uncertainty over the Brexit situation makes a great deal of sense. I have maintained that the BOE would not be raising rates because of Brexit, and now that the UK data seems to be showing a slowdown in the economy, and reduced inflationary pressures, I expect to be proven correct. There is just no way that Governor Carney can raise rates with Brexit hovering over the UK economy like the Sword of Damocles. The pound has further to fall, count on it.

Beyond that, I need to catch up on one thing, USDBRL, which fell sharply during last Friday’s session after the central bank, once again, aggressively intervened in the market adding dollar liquidity. Yesterday saw limited movement, but ultimately, the issue remains that the combination of underlying economic weakness and the uncertainty caused by the upcoming presidential election is encouraging international investors to withdraw funds. At some point, the central bank will realize that wasting reserves to protect the currency is a bad idea, but for now, they are clearly keen to prevent too much further weakness. If I had BRL receivables or assets to hedge, I think I would take advantage of the current levels as I expect that a move in spot to 4.00 and beyond is inevitable.

Also, I would be remiss if I didn’t mention a speech by Mario Draghi at the Sintra conference, explaining that the ECB would be patient as they determine the timing of the first rate hikes. That was an even more dovish spin to his press conference last week, and traders did sell the euro further when the comment hit the tape. But really, those are the key stories. Other than the yen, the dollar is stronger vs. all its major counterparts. And while some have seen larger moves than others, there was very little other news of note. So oil-linked currencies (RUB, MXN) have fallen more than those with less exposure to that sector, but really, that is all part of the same story.

This morning brings US housing data with Housing Starts (exp 1.31M) and Building Permits (1.35M) both released at 8:30. But that’s really it. St Louis Fed president Bullard speaks early and there are a few ECB speakers, but with Draghi out of the way and Powell not until tomorrow, I actually expect that today’s price action will be consolidative.

Good luck


Trying To End Doublespeak

A recap of actions last week
Shows Draghi maintains his mystique
While Powell, Jerome
Seems much more at home
In trying to end doublespeak

It is a remarkably dull session this morning, with both the dollar and most major government bond markets little changed. Market participants are still coming to grips with last week’s three central bank actions, and their ramifications going forward.

In essence, we learned that the Fed will not be deterred in its efforts to normalize monetary policy as the US growth story remains quite robust, and more importantly, both inflation and unemployment, the Fed’s two key metrics, are now at levels that represent an economy with the potential to overheat soon. And while there are a growing number of voices that are concerned that the Fed’s ongoing balance sheet reduction is having a particularly severe impact on certain emerging market economies, the Fed, thus far, remains unconcerned.

We also learned that the ECB is still highly uncertain over the future, but is dealing with a great deal of internal turmoil due to the two-speed economy they oversee. Northern Europe continues to significantly outperform the southern periphery and has seen its economic metrics improve to the point where a more normal monetary policy stance is appropriate. However, the PIGS are still wallowing in their domestic-led problems, with slower growth, much higher unemployment and almost no inflationary pulse. Ongoing easy money is critical in keeping any growth momentum alive there. Thus Draghi continues to walk a fine line to keep both sides happy. Many lauded his efforts Thursday, but the biggest concern remains that the ECB is going to find itself with no ammunition to fight the next broad economic downturn if they don’t get policy normalized soon. And Draghi just promised to keep interest rates negative at least until 2020. Even optimists feel that a recession is likely by then.

Finally, Kuroda-san has no choice but to continue QE and keep targeting a 0.0% yield on 10-year JGB yields. While unemployment remains quite low there, Q1’s sharp decline in GDP growth and the continued lack of inflation argue that there is no reason to look for a change in policy here anytime soon.

Keeping all that in mind, here’s what we can expect looking ahead. This week, perhaps the biggest story is the BOE meeting on Thursday, although it seems highly unlikely that they will change policy. Earlier expectations for a rate hike have been all but eliminated, and the probability for an August move continues to fall as well. The Brexit story remains the dominant theme there, and nothing has occurred on that front which implies a solution is any nearer. I continue to believe that the BOE will not adjust rates again before Brexit has occurred, and that the next move will be taken by Governor Carney’s successor.

Trade discussions will continue to be an important part of the market narrative, especially given that we have seen the imposition of the first round of tariffs by both the US and China. Equity markets are clearly unhappy with this, and there is no question that the chance for escalating trade issues has put a cloud over the global economy. We have already seen both MXN and CAD underperform pretty significantly as the NAFTA negotiations drag on, with trade issues the unambiguous driver there. Interestingly, this morning CNY is weaker by 0.3% and is actually back to its weakest level since mid-January. I have maintained all year that I expected a weaker yuan as the currency remains one of the most likely release valves for pressures in the Chinese economy. As the PBOC continues to squeeze over-leverage out of the market while supporting slowing economic growth, a weaker currency is an important tool in the process. Look for this trend to continue.

The data calendar this week is sparse:

Tuesday Housing Starts 1.31M
  Building Permits 1.35M
Wednesday Existing Home Sales 5.50M
Thursday Initial Claims 220K
  Philly Fed 20.0

Quite frankly, none of these seem likely to change opinions much. However, we do hear from six Fed speakers, including Chairman Powell on Wednesday. Now, given that we just heard from them, it seems unlikely that there will be much new news, but it is possible that there will be an attempt to fine-tune some of the thoughts. Thursday, as well as the BOE, is also the ECB’s answer to Jackson Hole with their Sintra, Portugal conference. Last year, Signor Draghi shook up the markets with what was a quite hawkish view, and the euro did rally in the wake of the comments. However, this year, given what we have just heard from all the major central banks, my sense is that there will be much less impact on markets. In fact, I expect the whole week to be pretty dull, with modest movement anywhere.

Good luck

Not Yet Done For

Continued patience
With the current policy
Sets Japan apart

Meanwhile from the Latvian shore
The ECB told us some more
By year end QE
Will definitely
Be gone, but NIRP’s not yet done for

As promised, this week has been eventful, but my sense is that despite a bit more data this morning, we have seen the bulk of the movement we are going to see. A quick recap may be in order. First, on Tuesday US CPI printed at 2.8% headline, 2.2% core, demonstrating that the inflation story in the US continues to grind higher and keeping pressure on the Fed to do something about it. And they did, increasing rates 25bps on Wednesday and explaining that the median FOMC member forecast has risen to four rate hikes this year from three at previous meetings. Then Wednesday night, Chinese data managed to disappoint across the board, which explains why the PBOC didn’t raise rates in sync with the Fed; too many domestic problems to worry about keeping up with the Joneses. Which brought us to yesterday’s ECB activity where they told us that QE was going to be reduced to €15 billion per month for Q4 of this year, and then end. But they also told us that the current negative rate structure would be in place “at least through [my emphasis] the summer of 2019.” This was taken as a very dovish stance by the ECB and when combined with yesterday’s blowout Retail Sales number in the US (+0.8%, +0.9% ex autos) set the stage for the dollar to rally sharply. In fact, the euro fell 1.9% yesterday, its largest decline since the Brexit vote almost exactly two years ago.

Finally, the overnight session had the BOJ leaving policy on hold, as expected, with no indication that they are going to change things until they start to see inflation. Given that headline inflation in Japan is running at 0.7%, my sense is the BOJ is going to be targeting a 0% interest rate on 10-year JGB’s for quite a while yet. And that means that monetary policy divergence between the BOJ and the rest of the world is going to continue to expand.

But that’s not all! We also now have to deal with the trade situation again, as the US is set to impose tariffs on $50 billion worth of Chinese goods starting as soon as next week, and the Chinese have vowed to respond immediately in kind. While there seemed to be a period where the trade situation may not spiral out of control, unfortunately that no longer seems to be the default option. It is not clear who is going to blink first, but until one side does, I expect that we are going to see increased concern by investors and some pressure on equity markets.

And I didn’t even mention emerging markets here, where ARS fell an impressive 6.5% yesterday, while BRL fell 2.25%. The former was afflicted by the onset of a truckers strike along with changes at the central bank that were seen as unhelpful to the government’s quest to stabilize the economy. Meanwhile, BRL had been the beneficiary of a massive intervention by the BCB, but as is always the case, the impact of something like that wanes over time. USDBRL is still very likely to trade to 4.00 and beyond before long. Meanwhile, after a 1.8% decline of its own yesterday, MXN is actually rebounding a bit this morning, up 0.5%. However, as trade tensions continue to flare, I expect that the peso, along with its LATAM counterparts, has further to fall.

Looking across the rest of the market, after yesterday’s substantial dollar rally (the dollar index rose 1.3%) it is no surprise to see many currencies consolidating those losses and the dollar is slightly softer this morning. So the euro has regained 0.2%, the pound 0.15% and the rest of EEMEA is up by similar amounts. APAC currencies generally fell overnight following yesterday’s US session, but I expect that when those markets open again Sunday evening, we will see a modest retracement there as well.

As to today, the last data of this eventful week brings us IP (exp 0.1%); Capacity Utilization (78.0%); Empire Manufacturing (19.1) and Michigan Sentiment (98.5). In truth, this data should be important as an indicator of how the economy is doing, but given both the remarkable week that we have already had, and the fact that eyes remain focused on the central banks directly, and not so much the underlying data, I expect that it will have only a limited impact at best. Rather, I expect that more consolidation is in order, and that the dollar could drift a touch lower to close the week.

Good luck and good weekend