Splendid

The summit in Singapore ended
And President Trump called it splendid
More talks will ensue
To seek a breakthrough
On nukes while Korea’s defended

Despite all the headlines it made
Most markets, no movement displayed
For traders instead
What’s crucial’s the Fed
And how policy is portrayed

The major headlines this morning revolve around the historic summit meeting between President Trump and North Korean leader, Kim Jong-un. While the President portrayed the outcome as “fantastic”, it remains to be seen how much progress was actually made. Nonetheless, it is a promising first step on what is likely to be a long road. Market response was muted as there was very little information given, but one would expect that if things really do proceed toward a North Korean denuclearization, it would only be a positive for risk assets. However, this is certainly going to take time, and I expect that the market will largely ignore the process until something concrete occurs.

Turning to more immediate market concerns, this morning’s CPI report will garner all the attention. Expectations are for the headline number to rise 0.2% (2.8% Y/Y) with the core rate also expected at +0.2% (2.2% Y/Y). There is no question that inflation in the US is on an upward trajectory. The key question is how will the Fed respond? Based on the Minutes of the May FOMC meeting, where there was ample discussion on the symmetry of their 2.0% target, it seems clear that the Fed is not likely to panic in the near term. However, arguably the only thing that has changed is the level at which market uncertainty starts to enter the equation. It used to be that markets started tightening policy as inflation rose toward 2.0%. Now that level is arguably going to be something like 2.3% or 2.4%, but if inflation continues to rise, the market will respond eventually.

Pivoting to the Fed, tomorrow’s 25bp rate hike is already baked in. The questions here are will the statement imply one or two more interest rate hikes this year, and how high will estimates of the terminal rate rise. Chairman Powell will almost certainly face pointed questions at the press conference regarding the Fed’s impact on emerging markets as well as what levels of inflation will make the FOMC uncomfortable. However, I imagine he will dismiss EMG issues and give no concrete answers regarding inflation. Based on all that I have read so far, I think the Fed is very comfortable with their current interest rate path, and will need to see significant market upheaval to consider changing things. Remember, February brought some pretty decent market volatility and that did not dissuade the Fed from raising rates in March. Current market conditions are far more benign, so it seems unlikely that things are going to change in Washington any time soon.

Looking at the overnight activity, the dollar is little changed overall. The euro is essentially unchanged despite a much weaker than expected Gernan ZEW report (Economic Sentiment fell to -16.1). At the same time, despite somewhat better than expected employment data from the UK, the pound has barely benefitted. In fact, the only currency that has shown any movement of note in the G10 space is CAD, which continues its recent decline and is down a further 0.3% with the dollar trading back above 1.30 again. This level has proven to be pretty dollar formidable resistance over the past six months, but given the driver this time seems far more Canada specific (trade tensions with the US), I suspect we could see this move continue in the short run.

Meanwhile, in the emerging market space, far more currencies have fallen slightly vs. the dollar than risen, but the magnitude of the movement has been quite small. Notably, the Turkish lira, after a sharp rally late last week on the central bank’s moves, has given back all of those gains. Other problem children include MXN, which has fallen 1.5% since Friday, back to its recent lows and ARS, which has fallen another 2.7% and is making new historic lows. The point is that the underlying questions involving emerging markets have not been addressed, and the opportunities for further movement are manifest. But it doesn’t seem they will be answered today.

Given the proximity of the central bank meetings, once the inflation data is out of the way, it would be surprising if we saw too much movement ahead of the FOMC announcement. As things currently stand, nothing has changed my view regarding the fact that the cyclical factors for the dollar, namely short term interest rates and positive economic signals, continue to outweigh the structural factors, the growing twin deficits and ensuing growth in debt, and so the dollar ought to continue to benefit for a while yet.

Good luck
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