Quite A Thrill

The central bank down in Brazil
Investors there, gave quite a thrill
The currency rallied
While traders all tallied
Their losses from months of ill will

For now, the Brazilian central bank has stopped the bleeding. Friday’s price action was quite impressive, with the real rising more than 5% after the central bank said they would significantly increase the amount of dollars they would add to the market via FX swaps, their preferred method of intervention. Rather than raising interest rates, as we saw in Argentina, Turkey, India and Indonesia, each of which failed to stem their currency’s respective declines, the Brazilians decided to add the USD liquidity by themselves. And it was effective as evidenced by the move in the currency. Alas, for equity investors, it did not solve the problem, with the Bovespa falling another 1.25%, taking it down more than 13% since the beginning of June.

There are now five major emerging market countries that find themselves under significant pressure in the financial markets. All of them run significant current account deficits and all of them have significant amounts of USD debt outstanding that must be repaid or refinanced this year. While the Brazilians managed to stop the problem for now, the future remains quite uncertain, and if I had to guess, I expect that we will see significant further weakness in these currencies as the year progresses.

In Canada there was a breach
As leaders there just could not reach
Consensus on how
That group can endow
The future that most of them preach

Meanwhile, the G7 meeting broke up amid accusations on all sides of bad faith in the discussions, and ultimately no consensus as to what comes next. This is arguably the worst possible outcome, and there is now greater concern that the trade situation is going to become worse. Most analysts and economists had decried the tariffs to date, but had pointed out that the amounts were relatively trivial compared to global commerce. But given the acrimony that has been ongoing since the end of the meeting (at least based on Twitter comments) and the fact that the next set of tariffs are slated to be bigger than the last, it might start to have a more significant impact. If nothing else, it will call into question the underlying positive sentiment that we have seen in most developed markets around the world lately. The market impact, interestingly, has been relatively muted with APAC equity markets generally higher on the session, and EMEA ones all trading in the black as well. In fact, the biggest losers seem to be CAD and MXN, each of which is down more than 0.5% over concerns that the NAFTA negotiations are going to crumble in the wake of the harsh rhetoric following the conference.

But despite all this, the big story this week is really the central banks, with the Fed, ECB and BOJ all meeting between Wednesday and Friday. Current expectations are as follows: the Fed will raise the Fed funds rate 25bps; the ECB will leave policy unchanged, but slightly more than half the analyst community believes they are going to define when and how QE is going to end; while the BOJ is likely to leave policy completely unchanged. As I wrote last week, we have heard from several emerging market central banks about how the Fed’s current trajectory of both interest rate hikes and QT (allowing the balance sheet to gradually shrink) is having a major impact on their own economies. Obviously, we have seen that in the market action over the past several months. So the question is, will Chairman Powell heed these pleas to change the Fed’s current plans and slow things down, or will he continue full speed ahead? My money is on full speed ahead based on two things; first, his speech at the IMF last month demonstrated pretty clearly that he doesn’t buy the story that the Fed’s actions are causing the EMG problems; and second, history shows that every central bank, when it comes to developing crises, is reactive not proactive. The Fed is very keen to get US interest rates back closer to neutral so they have some ammunition when the next downturn comes, in fact I believe this is their primary objective right now. In summary, I see only limited evidence that the Powell Fed is going to change its policy trajectory because of what is happening in a handful of emerging markets. Powell is no Yellen!

And to think, I didn’t even mention the historic summit between President Trump and North Korean leader, Kim Jong-Un, which takes place tomorrow. Of course, the market implications of this summit are much harder to divine. Arguably, a positive outcome should help KRW somewhat, but I just don’t see the clear market impact of any results.

Turning to the overnight markets, we did see some data that had an impact. UK data was quite weak overall with IP -0.8% in April, well below expectations, and the Trade deficit growing to -£5.2B, it’s largest decline since December 2016. While the BOE remains adamant that growth has been better than Q1 data implied, their argument is looking a bit more difficult to maintain this morning. The pound responded by falling 0.4% and the market is now awaiting this week’s employment and inflation data to determine if the BOE will be able to maintain their rhetoric about raising rates. Currently, the market is pricing in about a 60% probability of an August rate hike. We shall see.

The euro, meanwhile, has edged a bit higher, +0.15%, after the new Italian FinMin, Giovanni Tria, committed to the euro and indicated that his focus would be on domestic structural reforms rather than exiting the single currency. Those comments have alleviated the immediate fears and Italia equities have rallied more than 2% in their wake. In addition, Italian government bonds have also rallied, with yields across the curve falling sharply in what looks like a serious short squeeze. Remember though, regardless of these comments, the reality is that the new government looks set to blow up Eurozone fiscal constraints with their tax and spending plans, which means that further problems are sure to arise.

A listing of this week’s data shows that there is much important information due alongside the central bank activities.

Tuesday NFIB Small Biz Sentiment 105.3
  CPI 0.2% (2.8% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Wednesday PPI 0.3%
  -ex food & energy 0.2%
  FOMC Rate 1.75% – 2.00%
Thursday Initial Claims 224K
  Retail Sales 0.4%
  -ex autos 0.5%
  Business Inventories 0.3%
Friday Empire State Mfg 19.6
  IP 0.1%
  Capacity Utilization 78.0%
  Michigan Confidence 98.7

The Fed will get to see the rest of the world’s view as to what inflation is like tomorrow morning, and despite their utilization of PCE for their models, they cannot be blind to the continued increase in this metric. As well, Retail Sales data on Thursday will be another good indicator of how the economy is performing. Other things happening this week that will matter to markets include the ongoing Brexit story in the UK, where the Brexit bills head back to the lower house of Parliament for voting, and where PM May is hopeful of rebounding from the beating she has been taking from the House of Lords.

All told, there is a great deal on the calendar this week, much of which is likely to have an impact on financial markets. If I had to choose, though, I would contend that the FOMC actions, especially the tone of the statement and the press conference is going to be the single biggest event. Buckle up folks; this is going to be an active week.

Good luck
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