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