Monthly Archives: July 2018

Waiting For Jay

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The markets are waiting for Jay
To testify later today
The hawks are excited
As they feel united
More hawkishness he will convey

Yesterday’s Retail Sales data was the latest data point highlighting the US economy’s continued robust expansion. The 0.5% headline gain matched expectations, but it was the revision higher of last month’s 0.8% reading (which if you recall was much higher than expectations then) to 1.3% that really got tongues wagging. Several analysts raised their expectations for Q2 GDP to above 5.0% in the wake of the report, although the market response seems somewhat puzzling. Both equity and bond markets yesterday were essentially flat, oil prices tumbled more than 4% and the dollar was slightly softer. Arguably, after robust data, one would have expected higher stocks, higher bond yields (lower prices) and a stronger dollar. This should serve to remind everyone that while trends remain in place, there is rarely a one-for-one reaction from data to market prices.

However, what the data does accomplish is paint a picture of a still quite strong economy as a backdrop to Chairman Powell’s testimony to the Senate Banking Committee later this morning. If we have learned one thing about Powell, it is that he is willing to use plain English to describe his views, rather than couch those views in the obfuscation of economic jargon. But perhaps far more importantly, he consistently reminds his audience that there are many important concepts (e.g. the neutral interest rate or the natural rate of unemployment, NAIRU) that are not observable and where the Fed relies on estimates from its models. And while these variables are seen as critical to the PhD set, Chairman Powell recognizes that they cannot be used to fine tune the economy. It is this trait that sets Powell apart from his recent predecessors, and I personally believe, in a good way. At any rate, while the prepared remarks are fairly neutral in tone, there is a growing belief that the Q&A is likely to lean hawkish when it comes to monetary policy questions. However, I imagine that there will also be a significant amount of preening by certain Senators when they lambaste the Fed’s actions regarding banks and the recent stress tests. In fact, my sense is that he will not get to speak too much about the economy, and as such, I don’t expect his testimony to have much market impact at all.

With that said, there is certainly nothing from the recent data that would indicate the Fed is about to slow down its tightening, and the market is now pricing a 62% probability of two more rate hikes this year. In the end, this remains dollar supportive in my view.

Moving on to another economy that seems to be getting ready to tighten policy, UK employment data was released this morning and it was quite strong yet again. The Unemployment Rate remained at its 42-year lows of 4.2%, as 137K more jobs were created in the past three months. Not only that, but Average Earnings at 2.7% continue to print above recent inflation, resulting in real wage gains and a further clue that the UK economy, despite the ongoing Brexit drama and uncertainty, remains fairly solid. Certainly the market expects Governor Carney to raise rates next month, with futures pricing in a greater than 80% probability at this time, and so we will have to see some much weaker data on Q2 GDP or inflation later this week to change that view. The pound has benefitted this morning, edging up a further 0.1%, which makes about 0.5% of gains over the past four sessions. Not that inspiring, but at least logical today.

Overall, the dollar is marginally lower this morning, although it is a mixed picture vs. individual currencies. For example, MXN is weaker by 0.7% on the back of the decline in oil prices with RUB similarly lower by 0.4%. However, other currencies have shown modest strength vs. the dollar, notably CHF, INR and NZD, each with their own idiosyncratic story. The point is there is no overriding theme in the FX market this morning.

One thing I think worth pointing out is that the yen has recently lost some of its safe haven luster. Ever since the financial crisis, the yen had become seen as a haven in the face of market turmoil, rallying when nervousness was evident. I have always thought that characterization misplaced. Prior to the crisis, being short yen to fund other assets was a hugely prevalent position, known as the carry trade. When those assets started to decline sharply during the crisis, all that we saw was those carry trades unwind, which, by definition, included yen purchases. Investors weren’t indicating they preferred yen to other assets; they were closing outstanding positions. But the haven narrative stuck and so we have lived with it for a decade now. Perhaps we are finally coming round to a period where that narrative will diminish, and old havens, notably the dollar and gold, will make a comeback. Certainly the dollar is holding up its end of the bargain overall, so my sense is that gold may not be too far behind if we see another market disruption. In the meantime, the yen has fallen 0.2% this morning and is actually trading back at its lowest level since early January. It would not be surprising to see further yen weakness over the coming months, especially if my thesis on the haven issue is true.

Before we hear from the Chairman, Capacity Utilization (exp 78.3%) and IP (0.6%) are to be released. However, unless something extraordinary prints there, I expect that markets will remain quiet until Powell starts. At that point, it is all up to him.

Good luck
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The Beast of the East

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This weekend the data released
By China showed growth had decreased
Investment has slowed
And that doesn’t bode
Too well for the Beast of the East

It has been a fairly quiet session overnight, as the weekend news cycle seems to have reverted back toward the summer doldrums of the past. While traders and investors remain on edge over the brewing trade conflict between the US and China, and how that may impact the rest of the world, the only actual news was Chinese data out last night.

It can be no surprise that the GDP figure, at 6.7%, was exactly as forecast [Woe betide the statistician in China who releases a GDP number less than President Xi declares], but it was somewhat surprising that both IP (6.0%) and Fixed Asset Investment (6.0%) were both released at levels softer than expected, and more importantly, at the softest levels in 15-20 years. Given that it is too early for the trade situation to have impacted the Chinese data, the most likely situation is that even the Chinese are beginning to recognize that growth on the mainland is set to slow further. In fairness, China has made a big deal about their pivot away from mercantilist policies to a more domestically focused economy, and given that Retail Sales (9.0%) were actually slightly firmer than expected, perhaps they are moving in that direction. However, unlike most developed countries, China’s domestic consumption is only around 50% of the economy (it is between 70% and 80% for OECD nations), and so that modestly better performance is not likely to be enough to maintain the growth trajectory that Xi wants over time.

In the end, though, there was only limited market reaction to the news, with Chinese equity markets slightly softer (Shanghai -0.25%) and the renminbi, though initially falling slightly, has since rebounded and is firmer by 0.3% as I type. Of course, in context, the dollar is softer across the board this morning with most major currencies appreciating by a similar amount.

Aside from the Chinese news, there was precious little of interest to drive trading. Oil prices have been sliding as Saudi Arabia has agreed to pump more oil and the US and other nations are considering tapping their strategic reserves in an effort to lower prices. Earnings season is underway with continued high hopes for US companies and less robust ones for the rest of the world. However, US equity futures are barely higher at this time, <0.1%, indicating a wait-and-see attitude has developed. And rounding things out, Treasury yields have edged higher by about 1bp although they remain well below levels seen back in May.

Pivoting to the data for the week, it is a mixed bag, with arguably the most important events Chairman Powell’s testimony to the Senate on Tuesday and House on Wednesday.

Today Empire Manufacturing 22
  Retail Sales 0.5%
  -ex autos 0.4%
  Business Inventories 0.4%
Tuesday Capacity Utilization 78.3%
  IP 0.6%
  Powell Testimony  
  TIC Flows $34.3B
Wednesday Housing Starts 1.32M
  Building Permits 1.333M
  Powell Testimony  
  Fed Beige Book  
Thursday Initial Claims 220K
  Philly Fed 22

However, we cannot ignore Retail Sales this morning, which is seen as a descriptor of the current economic situation. This has been one of the highlights of the economic story in the US, especially in the wake of the tax cuts and stimulus spending bills at the beginning of the year.

As long as growth in the US continues above its estimated long term trend (which is often pegged just below 2.0%), the Fed is going to continue to tighten policy via both rate hikes and a shrinking balance sheet, and the dollar should remain relatively well bid. While there is a case to be made that added fiscal stimulus at this stage in the economic cycle is a mistake (classical economics indicates tighter fiscal policy is warranted), there is no mistaking that the US economy remains the key engine of growth for the world, and that as the Fed tightens policy further, the dollar is set to benefit more.

Good luck
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Dashing Hopes

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Said Trump when he landed in London
Your Brexit deal needs to be undone
Because as it stands
We’ll never shake hands
On trade, dashing hopes ere they’ve begun

On Thursday, PM Theresa May has had yet another trying day. President Trump came to town and wasted no time skewering her recently outlined Brexit framework indicating that if the UK heads down her preferred road (you remember, trade in goods to remain within the EU umbrella, but services to be wide open) that the US would not be able to sign a free trade deal. Trump’s point, albeit indelicately made, is that a comprehensive trade deal with the UK will be impossible because the EU will be involved. And, as you may remember, Trump has several issues with the way the EU approaches trade. This was a terrible blow to May because she has clearly been counting on a deal with the US to help offset the changed status with the EU.

It should be no surprise that the pound did not take the news well and as I type, it is lower by 0.6% today and 1.7% this week. And this is despite the fact that Governor Carney virtually promised to raise rates at next month’s BOE meeting. We are still a long way from any resolution on the Brexit situation, and I continue to believe that uncertainty over the outcome will weigh on Pound Sterling. The pound remains some 12.5% below its levels prior to the Brexit vote two years ago. While it is still well clear of the lows seen at the beginning of last year (1.2000 or so) given my belief that there will be no Brexit deal signed, I expect that the market will return to those lows over time. Higher rates or not, confidence in the UK right now is somewhat lacking.

The other big news overnight was the Chinese data releases that showed that the trade surplus rose sharply to $41.6 billion with the US portion rising to a record $29 billion. This may be a timing issue with many companies anxiously shipping product ahead of the imposition of tariffs. But it also could simply reflect that the Chinese economy is slowing down, thus import growth is ebbing, while the US economy continues to power ahead and lead the global economy. In the end, I am certain that the Trump administration will look at these numbers and feel further justification in their stance on trade.

But on top of the trade data, Chinese Money Supply growth continues to ebb, a sign that economic activity on the mainland is slowing. Other indications of a Chinese slowdown are that the government’s campaign to reduce excess leverage seems to have gone into reverse. There have been several stories about how Beijing is now looking for local governments to insure they spend allocated money rather than worry about cutting back on new allocations. It seems that there is a growing fear that real GDP growth (not necessarily what is reported) is slipping more quickly than President Xi is prepared to accept. With this in mind, it is no surprise that the renminbi is under further pressure this morning, down 0.45%, and is now trading back at levels not seen since last August. And it has further to fall. I expect that we will be testing 7.00 before the year is over.

One last noteworthy item was yesterday’s CPI release, where headline CPI printed at 2.9%, its highest since 2012, and the ex food & energy number printed at 2.3%. What this tells us is that wage gains are barely keeping up with inflation, and so consumers are not really benefitting from the recent modest uptick we have seen there. We heard from both Chairman Powell and Philly President Harker yesterday and both indicated they were comfortable with the Fed’s current trajectory. Both also indicated that while the trade situation has not yet impacted the economy in any meaningful way, they could foresee how that might come about and cause the Fed to rethink their strategy. As of now, I remain in the four hikes this year camp, and will need to see a substantial change to the economic data to change that view.

Turning to the overnight FX performance, the dollar has continued its recent uptrend, rising against almost all its counterparts in both the G10 and the EMG. In fact, the dollar has risen every day this week, completely unwinding last week’s decline. There was a modest amount of data from the Eurozone, all pointing to the ongoing lack of inflation in the region, which continues to undermine the ECB’s case to normalize policy quickly. We also continue to see issues throughout emerging markets with TRY, for example, plummeting 6% this week as the market responds to President Erdogan’s cabinet moves. Remember, he installed his son-in-law as FinMin and ousted all the market friendly ministers in the cabinet. As I have written before, this currency has much further to fall.

Meanwhile, US equity markets continue to power ahead, well at least the big tech names continue to do so and that has been sufficient to drive the averages higher overall. However, market breadth continues to narrow which is always an ominous trend. Treasury yields have been stable in the 10-year space, but the 2-year continues to march higher and that spread is down to 26bps, edging ever closer to inversion. While I believe that the signaling effect this time is not quite the same due to the massive distortions in bond markets brought about by QE, I am in a minority view there.

In the end, the big trends remain intact, which means to me that the dollar is going to continue its march higher. Hedgers keep that in mind as you start to think about your 2019 hedging needs.

Today’s only data is Michigan Sentiment (exp 98.2) and then we hear from Atlanta Fed President Rafael Bostic. But given what we just heard from Harker and Powell (and Brainerd and Williams earlier in the week), there is no indication that the Fed is going to change its tune in the near future. The trend is your friend, and right now that trend is for the dollar to continue to rally.

Good luck and good weekend
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The Fed’s Fallen Short

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This morning’s inflation report
Ought show that the Fed’s fallen short
In holding down prices
And so my advice is
It’s time, those short dollars, abort

Yesterday’s session was dominated by two key themes; the suddenly increased trade tensions after the announcement of a new list of $200 billion of Chinese tariff targets, and the sharp decline in oil prices (WTI – 5.0%) after Libya declared the end of force majeure with respect to shipments from its eastern port. The oil price decline, which occurred despite a surprisingly large drawdown of US inventories, was in sync with other commodity prices, notably copper which fell 2.5% and is now down more than 16% in the past month. Copper is generally seen as an important harbinger of future economic growth given its widespread use throughout different industries, and so falling demand for copper often leads to slower economic growth. And yet, despite the declining commodity price environment, yesterday’s PPI data (3.4% Y/Y) was the strongest in more than six years while expectations for today’s CPI are similarly elevated with consensus views looking for 0.2% monthly increases in both headline and core data which translates into 2.8% headline and 2.3% core on a Y/Y basis.

If those expectations are met, the Fed will certainly continue its hiking cycle, which ought to continue to support the dollar going forward. The other key dollar support has been risk aversion, which is where the trade story comes into play. As long as trade tensions remain front-page news, investors are likely to remain skittish which means they will be reducing risk and looking for safe places to invest. US Treasuries remain the global safe haven of choice, and so both Treasuries and the dollar should continue to benefit from this situation.

Yesterday I mentioned that there had been no indication that there were background talks ongoing between the US and China regarding trade, something I found surprising given the situation. However, this morning there is a story that such talks are, in fact, proceeding which implies to me that there will be some type of solution that arrives before the next round of tariffs are in place. Look for concessions on both sides as well as comments highlighting the strength of the Sino-US relationship, especially with regard to North Korea. At least that’s my view. But it will be several months before anything comes to fruition, and so we are likely to be subject to further volatility on the subject.

One of the impacts of the China trade story was yesterday’s very sharp decline in the renminbi (-1.1%), which resulted in the currency falling to its weakest level since last August. Some pundits see this as an attempt to adjust for the recent tariff impositions by the US, but a case can be made that since the dollar was so strong overall yesterday, (USDX +0.65%), the CNY move was not really out of character. And this morning, the renminbi has already retraced half of that movement, so I am inclined to give the Chinese the benefit of the doubt here and accept the broad dollar strength thesis. In fact, one of the things that continues to haunt the PBOC is their mini devaluation in 2015, which triggered significant capital outflows and forced the imposition of very strict capital controls in China. Regardless of the trade situation, I assure you the Chinese will do all they can to prevent a repeat of that outcome. However, steady depreciation of the renminbi going forward remains my base case.

Otherwise, in G10 space the Bank of Canada raised rates by 25bps, as expected, which helped the Loonie temporarily, but in the end, it seems that weaker oil prices overwhelmed the rate hike and CAD fell 0.75% on the day. However, the BOC continues to sound upbeat on the economy for now and is positioned to continue to track the Fed’s policy for the next year or two.

From the UK, this morning, we received PM May’s latest Brexit position paper which is seeking to have the UK track EU goods regulations, but simultaneously looking for the UK to go completely its own way regarding services and seek trade agreements around the world on that basis. While it is an interesting idea, and one with merit given that services represent ~80% of the UK economy, with less than nine months before the Brexit date, it feels like they may not be able to complete much of the process in time. However, the BOE appears completely ready to raise rates next month with the market pricing an 80% probability of the event and Governor Carney commenting that growth in the UK continues to perform as the BOE expected in its rebound from Q1. The pound, however, has added a small 0.1% decline this morning to yesterday’s 0.5% slide.

Beyond these stories, nothing of note to the FX markets has really been evident. Given the strength of yesterday’s dollar move, it would be no real surprise if there was a small retracement, but in fact, I have a feeling that we are going to see high side surprises in the CPI data which will only serve to increase Fed expectations and support the dollar. So my money is on the dollar continuing its strengthening trend of the week and closing yet higher today.

Good luck
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Both Sides Will Lose

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The trade story’s back in the news
With stock markets singing the blues
Two hundred bill more
Confirms the Trade War
Will happen, and both sides will lose

The Trump administration’s announcement last evening that they are targeting another $200 billion of Chinese imports for tariffs, this time 10% across the board, has interrupted the markets recent sense of calm. In fact, the immediate response was for equity markets around the world to fall sharply and the dollar to regain its footing. Investors had come to believe that the initial salvo of tariffs on $34 billion by each nation would be the extent of things, and that negotiations would soon begin. However, assuming things with this administration is a fraught activity as unpredictability has been Trump’s hallmark since his election.

It is interesting to consider the market ramifications of this growing trade war between the US and China. For instance, since March 22, the day the first tariffs were announced, the Shanghai Index is down more than 15% while the S&P 500 is higher by a bit more than 3.0%. While economists have ridiculed Trump’s statement that “trade wars are easy to win”, it certainly seems that the US has so far come out ahead, at least on this measure. At the same time, the Chinese renminbi has fallen ~5.6% over the same period, which could mean that investors are more confident that the US will come out ahead…or it could mean that the PBOC has simply forced guided the currency lower in an effort to offset the impact of the tariffs.

However, the one thing that I take away from this process is that neither side is going to back down anytime soon. As Trump is leading the charge, he is unlikely to back off without having won some major concessions from the Chinese. At the same time, Chinese President Xi, who has spent the past five years consolidating his power, cannot afford to look weak to the home crowd. So my advice is to prepare for higher prices on lots of things that you buy, because this is likely to drag on for a long time.

As an aside, while the politics may favor Xi, I think given the nature of the imbalance, where the Chinese not only have far more items that can be taxed, but that they remain a largely mercantilist economy depending on exports for growth, it means that China’s economic situation is likely to deteriorate far more than that of the US. However, it is not clear to me that I would call that ‘winning’!

At any rate, the one thing that seems almost certain is that the dollar is going to be a major beneficiary of this process. Not only are other currencies going to suffer as their nations’ exports are reduced and growth impaired, but the ensuing inflationary impact of tariffs on the US is going to encourage the Fed to be more aggressive. Given the dollar’s positive response to the tightening of Fed policy already, as well as the growing divergence between the US economy and the rest of the world, the brewing trade war has simply increased my dollar bullishness.

Pivoting to the overnight markets, the dollar has rallied for a second straight day, showing strength against all its G10 counterparts and most EMG currencies. There continues to be a dearth of data on which to base trading outcomes and it seems most likely that the dollar’s recent strength, while receiving a catalyst from the trade situation, is a continuation of its rebound from last week’s decline. In the end, the dollar is still largely range bound and has been so since its rally ended in mid May. I continue to believe we will need new data of note to encourage a breakout, with the next real opportunity tomorrow’s CPI print. A surprisingly high print will get tongues wagging over the Fed picking up the pace, and likely support the dollar. However, I don’t believe the opposite is true. A weaker than expected print will simply confirm that the Fed will stay on its current trajectory, which may not help the dollar much, but should not undermine it.

The other potential driver is going to be the general risk tone in markets. It is very clear that the dollar has regained its status as a safe haven, and with every escalation in the trade war, risk aversion will lead to further dollar strength. This is especially true given that the other potential havens, JPY and CHF, continue to offer negative interest rates and so are far less attractive to investors looking for a short-term home for their assets. To me, all the evidence still points to the dollar’s next leg being a move up potentially testing the levels seen back in the beginning of 2017 over time.

On the data front, this morning brings PPI (exp 0.2% for both headline and core) but all eyes will be on tomorrow’s CPI, not today’s number. We also hear from NY Fed President Williams late this afternoon. Given both the timing, some four weeks since the last FOMC meeting, and his elevated role, it is possible that he could create some volatility by adding new information to the mix. However, my read is that the data trajectory has remained quite steady, and although he will almost certainly mention the trade situation and its potential to upend the economy, I doubt there will be new information forthcoming. So in the end, I like the dollar to continue to grind higher as the day progresses.

Good luck
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Now In Disarray

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The saga of Minister May
Improved not one whit yesterday
When Boris resigned
Pound Sterling declined
And her party’s now in disarray

The news from the UK continues to dominate market headlines as less than twenty-four hours after the resignation of the Brexit Minister David Davis, Boris Johnson, a Brexit hardliner and Foreign Minister also resigned from PM May’s cabinet. While PM May replaced both men quickly, the problem is one of appearances in that she seems to be losing control over her government. The market’s immediate reaction was to sell the pound (it fell 0.7% yesterday after the news and has maintained those losses) as concerns over a leadership challenge and potentially a new election were brought to the fore. However, since then, it seems things have quieted down a bit and there is even talk that this could be a Sterling positive as it may result in a softer Brexit with less economic impact. In the meantime, this morning’s data showed that GDP has been rebounding from Q1’s flat reading, with the monthly May reading rising 0.3% and although IP data was soft (-0.4% in May), Construction was strong (+1.6%) and it appears that Governor Carney will still have enough ammunition to justify a rate increase next month. The risk to that outlook is if a leadership challenge emerges in Parliament and PM May is deposed. In that event, market participants may take a dimmer view of the near future depending on who replaces her.

Away from the British Isles, however, there is less excitement in the G10 economies. The big US news remains political with President Trump naming Brett Kavanaugh to replace retiring Supreme Court Justice Anthony Kennedy. However, on the economic front, there has been precious little news or commentary. In fact, until Thursday’s CPI reading, I expect the US story to be benign unless something surprising happens in the Treasury auctions beginning today, where the US is raising $69 billion via 3yr, 10yr and 30yr auctions.

From Germany we saw the ZEW surveys disappoint with the Sentiment Index falling to -24.7, its lowest print since December 2011 during the European bond crisis. This has encouraged a reversal in the euro, which is down 0.3% this morning after a week of gains. As well, the other, admittedly minor, Eurozone data also pointed to modest Eurozone weakness, thus giving the overall impression that the recent stabilization on the continent may be giving way to another bout of weakness. However, we will need to see more important data weaken to confirm that outcome. Certainly, Signor Draghi is convinced that the worst is behind them, but he has always been an optimist.

In the emerging markets, Turkey has once again stolen the headlines as President Erdogan named his son-in-law as Minister of Finance and Economics, thus following through on his threat promise to take firmer control over monetary policy. In the cabinet reshuffle he also removed the last vestiges of central banking experience so I would look for inflation in Turkey to start to really take off soon, and the currency to fall sharply. And that is despite the fact that it fell 3% yesterday after the announcement. In fact, I would look for more moves of that nature and a print above 5.00 in the not too distant future.

But other than that, while the dollar is stronger this morning, it is not running away. The broad theme today seems to be modest profit taking by traders who had been running short dollar positions, and so a bit of further strength would be no surprise. On the data front, the NFIB Small Business Optimism Index was released earlier at 107.2, stronger than expected and still showing that small businesses remain confident in the economic situation for now. The JOLTs jobs report comes at 10:00 and should simply confirm that the employment situation in the US remains robust. My gut tells me that modest further dollar strength is on tap for today, but really, barring a political bombshell, I expect that things will be very quiet overall. It is the middle of summer after all.

Good luck
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The Winsome Ms. May

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The lady who leads the UK
Last night had a terrible day
Dave Davis resigned
And strongly maligned
The PM, the winsome Ms. May

Arguably the biggest news over the weekend was the sudden resignation last night of the UK Brexit Minister, David Davis, who decided he couldn’t countenance the outcome of Friday’s Cabinet meeting. The crux of that agreement was that the UK would continue to abide by EU food and manufacturing regulations after Brexit becomes final in March. Davis, who had campaigned for Brexit and was always seen as more of a hard-liner, thought this was too much of a concession, and heeded PM May’s general call to leave if he couldn’t get on board. While Dominic Raab, another pro-Brexit voice, quickly replaced him, the resignation has simply highlighted the ongoing uncertainties within the UK on the subject.

Markets, however, have remained surprisingly subdued on the news. It appears that traders are far more focused on how the BOE responds to the Brexit story than on the Brexit story’s daily twists and turns. And as of now, there has been no change in the view that the Old Lady is going to raise rates next month come hell or high water. Futures markets continue to price a more than 80% probability of that occurring. So in the end, despite a key political shakeup, the pound has actually rallied 0.45% and is now more than 2.2% clear of the nadir reached at the end of June. Perhaps the mindset is that PM May now has greater control over the cabinet and so is in a stronger position going forward which means that a soft Brexit will be the outcome. At least, that’s the best I can come up with for now.

Otherwise, the weekend has been extremely quiet. With that in mind I think a recap of Friday’s events is in order. The employment report was probably as good as it gets, at least from the Fed’s perspective. NFP increased a better than expected 213K and last month’s number was revised higher to 244K. The Unemployment Rate actually ticked higher to 4.0%, but that was because the Participation Rate rose as well, up to 62.9%, which while better than last month remains well below the longer-term historical trend. But for now, it demonstrates to the Fed that there is still some slack in the labor market, which means there is less concern that wage increases are going to spur much higher inflation. And the AHE data proved that out, rising 2.7% Y/Y, in line with both expectations and recent history. It seems the Fed is going to continue to focus on the shape of the yield curve rather than rising inflation, at least for now. If, however, we start to see some sharply higher inflation data (CPI is released this Thursday), that may begin to change some thinking there.

The other data Friday showed that the Trade deficit shrank to -$43.1B, it’s smallest gap since October 2016. This is somewhat ironic given that Friday was also the day that the US imposed tariffs on $34 billion of Chinese goods. It is too early to determine exactly how the trade situation will play out, although virtually every economist has forecast it will be a disaster for the US, and if it expands potentially for the world. That said, the equity markets have clearly spoken as Chinese stocks have fallen more than 20% in the past months, while US stocks have edged slightly higher. This story, however, has much further to go with there likely being many new twists and turns going forward.

Here in the middle of the summer, it is a light data week, with Thursday’s CPI clearly the highlight.

Today Consumer Credit $12.7B
Tuesday NFIB Small Biz Optimism 105.6
  JOLT’s Job Openings 6.583M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
Thursday CPI 0.2% (2.9% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Michigan Sentiment 98.2

We also hear from four Fed speakers and we are at the point between meetings where there has been enough data for some views to have changed. However, my sense is there will be more discussion of the yield curve than of the economy as that has once again become a hot topic amongst a number of the regional Presidents.

Broadly the dollar has been under pressure overnight, continuing last week’s corrective price action. There has been some indication that data elsewhere in the world, especially in the Eurozone, has started to pick up again. If that trend continues, then I expect that the dollar will remain on its back foot. After all, its recent strength had been predicated on the idea that the US was continuing to show economic strength, diverging from the rest of the world’s near-term prospects. A change in that narrative will clearly change the FX story. However, it is not a foregone conclusion that is the outcome. I remain convinced that the dollar is likely to be the leader for quite a while yet.

Good luck
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Lighthearted

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At this point one must be impressed
Investors have not become stressed
A trade war has started
Yet they are lighthearted
With willingness still to invest

On top of that word from the Fed
Is they will keep pushing ahead
With rate hikes until
Our growth starts to chill
Or when markets start to bleed red

There has certainly been a lot to digest in the past twenty-four hours. Arguably the biggest story is the imposition of tariffs by the US on $34 billion worth of Chinese goods, which began at midnight last night. China is responding in kind and the Trump administration is determining whether they want to up the ante by an additional $200 billion. Now that the trade war is ‘officially’ underway, the key questions are just how far it will go and how long it will last. While there has been nothing in the press indicating that background negotiations are ongoing and that things can be resolved soon, based on the US equity market’s insouciance, it certainly seems that many investors feel that is the case. I hope they are correct, and soon, because otherwise I expect that we will see a more substantial correction in stocks. As to the dollar in this case, I expect that it will continue to benefit from its safe haven status in a time of market turmoil.

A second fear for equity investors has to be the Fed, which explained in yesterday’s release of the June meeting minutes, that while the trade situation could well become a concern in the future, for now they are much more focused on the potential for the US economy to overheat. The upshot is that the Fed is bound and determined to continue normalizing policy by gradually raising rates and by allowing the balance sheet to continue to gradually shrink. Speaking of the balance sheet, starting this month, they are going to allow $40 billion per month to roll off, and then beginning in October, it will be $50 billion per month until they reach whatever size they determine is appropriate. That means that $270 billion of bids for Treasury’s are going missing for the rest of the year. As the Fed continues to drain liquidity from the economy, I expect that the dollar will continue to benefit across the board, and that the US equity market will face additional headwinds. After all, QE was effective in its goal of forcing investors further out the risk curve and driving equity prices around the world higher as central banks everywhere hoovered up government bonds. Well, with yields rising and central banks backing away from the market (all while equity prices remain robustly valued) it seems there is ample opportunity for a substantial correction in stocks.

You may have noticed I said exactly the same thing when discussing the trade war situation. My point is that we are starting to see multiple catalysts align for a potential change in tone. A higher dollar and lower US (and likely global) equity prices seem like an increasingly possible outcome. Be prepared.

This leaves us at our third big story for the day, the payroll report this morning. Yesterday’s ADP Employment number was a mild disappointment, rising 177K rather than the 190K expected, but the reason appeared to be a lack of available workers rather than a lack of demand for hiring. In other words, the labor market in the US remains extremely strong. Or so it seems. Here are this morning’s expectations:

Nonfarm Payrolls 195K
Private Payrolls 190K
Manufacturing Payrolls 18K
Unemployment Rate 3.8%
Average Hourly Earnings 0.3% (2.8% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$43.7B

It strikes me that this is a potential third catalyst that will line up with the trade war and Fed story in that a strong print today will encourage the Fed to continue or even accelerate their activities; it will encourage the administration that they can outlast the Chinese in this war of attrition, and so the dollar is likely to firm up while equity markets suffer. In the event payrolls disappoint, I think we could see the dollar’s modest correction lower continue and I expect that equity markets will be fine, at least in the US.

Remarkably, I don’t have space to more fully discuss what appears to be a euro positive, where Chancellor Merkel has averted disaster in Germany by getting the third coalition partner, the SPD, to agree to her immigration reforms thus keeping her government intact. As long as this internal truce lasts, there should be no further impact on the euro, but if the problem arises again (and I’m pretty sure it will soon) the euro is likely to suffer. At the same time, the pound is on tenterhooks as PM May is meeting with her cabinet today to finalize a negotiating stance regarding Brexit. If she cannot get the cabinet to agree, I expect the pound will feel the heat as concern over the fall of the May government will rise and an election campaign just nine months before the deadline for leaving the EU cannot be seen as a positive, especially with the chance that Jeremy Corbyn, the far-left Labour Party leader could become the next PM. Investors will not appreciate him in that seat, at least not at first.

As to the overnight session, the dollar is slightly softer and equity markets are under modest pressure, including US futures, as the market awaits the labor situation report. Remember, too, that many trading desks remain lightly staffed because of the holiday, and so liquidity is going to be a bit less robust than normal. If pressed my thought is that NFP will print near consensus, around 200K. I just wonder if the Unemployment Rate doesn’t tick even lower. And keep an eye on AHE, where my gut tells me it will be 0.4% enough to get Fed tongues wagging again. Net, I like the dollar to end the week on a strong note.

Good luck and good weekend
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Lack of Dismay

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The deadline for tariffs is nigh
And Friday they’ll start to apply
But so far today
The lack of dismay
Has forced pundits all to ask why

Tomorrow is tariff day, as the US is set to impose 25% tariffs on $34 billion of Chinese goods beginning at midnight tonight. The Chinese are prepared to respond in kind, and it seems that the second battle of the emerging trade war (steel and aluminum were the first) is about to begin. Interestingly, financial markets remain extremely calm at the prospect of escalation with equity prices rebounding from Tuesday’s late losses and the dollar ceding some of its recent gains. I question how long this can continue, especially if we move on to stage three of the battle, where President Trump has promised tariffs on an additional $200 billion of Chinese goods. That poses a bigger problem for China as they only import about $135 billion in goods from the US each year (hence the deficit!)

The question at hand, though, is what type of impact this will have on markets going forward. Economic theory tells us that consumers will seek substitutes for those goods but that prices will rise somewhat to offset the effects of either paying the tariffs or accounting for the higher cost of the substitutes. In other words, inflation, which has been steadily moving higher in the US, is destined to continue that trend, if not accelerate somewhat. From there, it is a short hop to higher US interest rates and a stronger dollar. However, if this process continues long enough, it is likely to undermine the US growth story. If that were to happen, weakening data would likely cause the Fed to grow more cautious in their policy normalization drive. In that event, we are likely to see the dollar’s current strengthening trend stall. As is so often the case, one set of stimuli with a particular response leads to another set of stimuli with the opposite impact. The thing is, it will probably be 2019 before there is any indication that US growth is really slowing due to the trade story, and so I see only a limited chance that the Fed adjusts its policy trajectory this year. In other words, I think despite the tariffs, the Fed will still raise rates twice more in 2018.

Perhaps we will get a better idea of the Fed thinking on the subject when the Minutes of June’s FOMC meeting are released this afternoon. And while we have heard from several FOMC members that they are beginning to become concerned about the impact of the trade war, at this point, the data continues to favor policy continuation.

In the meantime, the dollar is a bit softer this morning as Germany finally printed some good data. For the first time this year, Factory Orders rose (+2.6%). While that is encouraging, it still begs the question as to whether this is the outlier number, or whether the previous five months of data were the aberration. But the euro is higher by 0.35% and pushing back toward 1.1700. That said, it has largely been range bound, between 1.1550 and 1.1750, for the past month. It doesn’t strike me that today’s data point is going to change that.

From the UK, Governor Carney was on the tape explaining that the growth picture there has been good enough to warrant higher rates if it continues. Yesterday saw the Services PMI in the UK rise to 55.1, well above expectations of 54.0, and its highest level in 9 months. The futures market has now increased its probability of an August rate hike to 82%, which barring any disastrous announcement on Brexit, seems sufficient to allow the BOE to act. However, nothing I have read has indicated that the UK is going to come up with a workable solution for the current Brexit issues, and I continue to believe that next March, the UK will be leaving the EU with no deal in hand. If that is the case, whatever the BOE was planning will come under renewed scrutiny, and it seems unlikely that rates there will go any higher. In addition, just like in the wake of the actual vote, I would expect the pound to suffer significantly at that time. All of this tells me that GBP receivables hedgers need to be very proactive in managing those risks, especially when we get a bounce in cable.

In the emerging markets, there has been one major move since I last wrote; MXN is higher by nearly 2.5%. While the move was just beginning Tuesday morning, the market has become enamored of the idea that President Trump and President-elect Obrador are going to be great friends and solve many of the problems that exist between the two nations. I don’t mean to be negative, but I find it hard to believe that will be the case. In fact, I expect that based on campaign rhetoric, the US and Mexico will see increased tension, which I am certain will lead to the peso suffering more than the dollar. In the end, Mexico is far more reliant on the US than the other way around, so stress in that relationship will hurt the peso first.

But otherwise, amid a smattering of data and news, the dollar is mildly softer this morning. After the Minutes are released and digested, all eyes will turn toward tomorrow’s payroll report. And in fact, we get a preview this morning with the ADP employment print (exp 190K) and Initial Claims (225K). We also see ISM Non-Manufacturing (58.3), which is likely to continue to show the current strength of the US economy. In the end, we are range bound, but as of now I still see a better case for dollar strength than weakness going forward.

Good luck
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A New Complication

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Last Friday it seemed immigration
Had ceased as a cause of vexation
In Europe, but then
On Monday again
It suffered a new complication

The euro first rose, then declined
But now there’s a new deal designed
To finally forestall
For once and for all
The chance Merkel might have resigned

Remarkably, the immigration debate in Germany continues to dominate the news. Last night, German Interior Minister Horst Seehofer agreed to a new deal regarding the immigration situation and withdrew his threatened resignation. This led to a major sigh of relief in the markets as the fear of Frau Merkel’s coalition falling apart has once again receded. While Merkel clearly remains in a weakened state, if this deal can be signed by all the parties involved (a big if), the market may be able to move on to its next concerns. It should be no surprise that the euro has rebounded on the news, after all it has tracked the announcements extremely closely, but the rebound this morning, just 0.1%, has been somewhat lackluster after yesterday’s rout. Perhaps that has as much to do with the release of Eurozone Retail Sales data, which disappointed by printing at 0.0% in May, less than expected and yet another indication that growth in the Eurozone is on a slowing trajectory.

As an aside, if I were Mario Draghi, I might be starting to get a little more nervous given that the Eurozone economy is almost certainly trending toward slower growth and the ECB has very little ammunition available to counter that trend. Rates remain negative and QE is set to run its course by the end of the year. It is not clear what else the ECB can do to combat a more severe slowdown in the economy there.

But away from the daily immigration saga in Germany, the dollar has had a mostly softer session. This is primarily due to the fact that it had a particularly strong rally yesterday and we are seeing short-term profit taking.

China remains a key theme of the market as well, with the renminbi having fallen for twelve of the past thirteen sessions with a total decline of nearly 5.0%. While it has rebounded somewhat this morning (+0.35%), that is small beer relative to its recent movement. Last night, PBOC Governor Yi Gang was on the tape explaining that the bank would “keep the yuan exchange rate basically stable at a reasonable and balanced level.” That was sufficient for traders to stop their recent selling spree and begin to take profits. While there are some pundits who believe that the Chinese will allow the renminbi to decline more sharply, I believe there is still too much fear that a sharper decline will lead to more severe capital outflows and potential economic destabilization at home. As such, I expect to see the CNY decline managed in a steady and unthreatening manner going forward. But I remain pretty sure that it will continue to decline.

Other than those two stories, here’s what’s happening today. SEK has been the biggest winner in the G10, rising 1.25% after the Riksbank, although leaving rates on hold at -0.5%, virtually promised they would begin raising them by the end of the year. That is a faster pace than expected and so the currency reaction should be no surprise. However, keep in mind that Sweden is highly dependent on trade, and as trade rhetoric increases, they could well be collateral damage in that conflict. Aussie is the next biggest winner, having risen 0.7% after the RBA also left rates on hold, as expected, but the statement was seen as having a mildly hawkish tinge to it. But remember, AUD had fallen more than 4.5% in the past month, so on a day when the dollar is under pressure, it can be no surprise that the rebound is relatively large.

In the EMG space, MXN is today’s big winner, rallying 1.3% as the new story is that there are now more areas between the US and Mexico where President Trump and President-elect Obrador will be able to find common ground. Certainly both presidents are of the populist stripe, and so perhaps this is true. But my gut tells me that once AMLO and his Congress are sworn in (it doesn’t happen until December 1!) the market will recognize that the investment environment in Mexico is set to deteriorate, and so the currency will follow.

On the data front, yesterday’s ISM data was quite strong at 60.2, well above expectations and a further indication that the economic divergence theme remains alive and well. This morning we await only Factory Orders (exp -0.1%) and Vehicle Sales (17.0M), with the latter likely to be more interesting to market players than the former. Of course, tomorrow is July 4th, and so trading desks are on skeleton staff already. That means that liquidity is probably a bit sparse, and that interest in taking positions is extremely limited. Look for a lackluster session with the dollar probably edging a bit lower, but things to wind up early as everybody makes their escape.

Good luck
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