The Tempo of Growth

The President keeps on complaining
That higher Fed rates are constraining
The tempo of growth
But Powell is loath
To change things til prices are waning

Over the weekend, the President registered his dismay over recent Fed policy moves, apparently calling out Chairman Powell for raising rates too swiftly. His complaints centered on the fact that the Fed’s gradual removal of policy accommodation is helping to support the dollar and has been responsible for its recent strength. Recall that since the middle of April the dollar had rallied more than 8% before its recent modest pullback. So even with a 2% decline in the past week, the dollar remains far stronger than earlier this year. And that is what has the President upset. He sees the dollar’s strength through the lens of his trade policy and it is effectively undermining the tariff process.

Now, this is not the first time that the President has complained about the strong dollar (that occurred shortly after his election in 2016), but for some reason, the market has become far more concerned this time that it may impact the Fed’s actions. Perhaps adding to that sentiment was a speech yesterday by Atlanta Fed President, Rafael Bostic, where he explicitly stated that he would not knowingly vote for rate hike that would invert the yield curve. He is now the fourth Fed President to discuss that issue, although he is the only member of that group with voting privileges this year. The point is that there has been an increase in the discussion of whether the Fed will continue on its current rate hiking path which still seems slated for a hike in both September and December of this year and three more next year. Interestingly, though the dollar responded to the discussion, Fed funds futures remain unmoved and are still pricing in the same probabilities as last week, 90% for September and 60% for December.

So the question has become, will Powell ignore the President and act as he sees fit, or will he bow to political pressure? My money, at this point, remains on Powell. There has been no indication, as yet, that the US economy is doing anything but expanding at a solid clip. And more importantly, when looking at the Fed’s dual mandate, the current issue is clearly on the stable prices side rather than the unemployment side. While the Fed has decreed PCE is the key policy data point, there can be no mistake that Powell, an experienced pragmatist, is abundantly aware that CPI is running at its hottest level in more than a decade. The point is that inflation pressures continue to build and the Fed is not likely to ignore that situation. In fact, that is why Powell’s speech on Friday in Jackson Hole is arguably the most important news for the week. Everyone is waiting to hear if he has changed his tone, let alone his tune, about the economy and the proper Fed policy going forward.

Until then, though we will have to make do with tomorrow’s FOMC Minutes, where analysts will be looking for how much the trade story impacted their deliberations, and housing data tomorrow and Thursday.

Turning to the overnight session, the dollar has continued yesterday’s weakness and is lower by a further 0.35% this morning. The movement has been fairly uniform through the G10, with all of those currencies rallying between 0.2%-0.5%. And this has been a dollar story as there has been virtually no data of note from any one of those nations. In truth, the only G10 news of any sort came from Australia, where the Minutes from the last RBA meeting highlighted that increasing trade tensions could have a negative impact on the economy and currency, and that interest rates Down Under were unlikely to move at all during the next year.

Turning to the EMG bloc, we also see generic dollar weakness with just a few outliers. The Turkish lira continues to suffer, falling just under 1% this morning despite the dollar’s overall weakness, and we saw the Korean won slide 0.5% as well. But the rule has been a softer dollar today.

Given there is no US data to be released this morning, and there are no scheduled Fed speakers, it seems that the day is likely to follow the overnight pattern of mild further dollar weakness. Of course, given the apparent catalyst for this move, and the President’s penchant for doubling down, it would not be surprising to hear more from him if he felt it could push the dollar lower. However, history has shown that political wishes are just that, and the market will respond to policy changes, not talk. So even though further commentary by President Trump could lead to modest extra dollar weakness, as long as Chairman Powell maintains his current stance, this dollar move should be faded. Hedgers, take advantage of the opportunity to add to hedges at current levels, as my sense is that nothing at the Mariner Eccles building has changed. Higher US rates are on the way.

Good luck


There is a small nation called Greece
Which eight years ago had to cease
Expending their cash
Which led to a crash
And caused GDP to decrease

Today is important due to
The fact that austerity’s through
The bailout is finished
Though Greece is diminished
While people there barely make do

Even though all eyes are on emerging markets these days, and rightly so in many cases, I thought it was worthwhile to note that the Greek sovereign debt crisis is ‘officially’ over as of today. While the situation in Greece doesn’t seem to have improved that much overall, today is the day that the bailouts officially end and Greece returns to the group of nations that are fully independent-ish. In fact, the Troika still controls much of what Greece is allowed to do with respect to spending priorities and budget discipline, and the nation remains a basket case in most ways. But reality on the ground could never dissuade the Troika from touting that their programs were a huge success and that everybody will live happily ever after. At any rate, it is probably a good thing that this chapter in Europe’s history has finally closed, but I would wager that if you surveyed the Greek people, not many would find good things to say about the future, let alone the past. In the end, though, Greece remains a tiny nation within the Eurozone, and what happens there impacts markets through sentiment changes, not through financial ones.

At the same time, there is a much bigger problem brewing in Italy, with many of the same issues surfacing there as occurred in Greece, and fears that the recently elected, anti-establishment government may make decisions inconsistent with the EU’s wishes. But Italy is not a small country. It is the third largest in the Eurozone and carries the largest amount of debt, €2.3 trillion worth. The one thing of which I am confident is that we have not seen the last problems to emanate from the Eurozone, and correspondingly, with the euro itself.

Reverting to emerging markets, while everyone recognizes the wreck that is Venezuela, on Friday night they made some major adjustments to their currency regime, devaluing the official bolivar by 95% (now approaching the black market rate) and redenominating the currency by removing 5 zeroes from its value. But in the end, the currency is just a symptom of their problems, not the cause, and it will remain the basket case that it has become over the past twenty years until there is a new government in place.

Moving on to more frequently discussed EMG currencies, like TRY (-2.2%), INR (+0.3%) and RUB (-0.2%), things are far less interesting. Remarkably, a 2% decline in the Turkish lira seems like a good day after recent gyrations, and the rest of the FX world seems to be on vacation, with very little substantive movement overnight. As we are coming to the end of August, it should be no real surprise that markets are getting quiet as there are more and more traders on holiday, and unless there is a specific story on which to trade, those that are manning the desks seem likely to play things close to the vest.

Meanwhile, there was virtually no data of note released overnight, and no commentary from any officials. The US-China trade situation seems like it might be moving toward a better place, with ongoing negotiations designed to arrive at an outcome in November, but there is still a long time to go before anything truly positive arrives. And in the meantime, Thursday we are due to see new tariffs imposed on $16 billion more of Chinese goods. Otherwise, there’s just not that much happening.

And the calendar this week is underwhelming as well, although the KC Fed’s Jackson Hole Symposium does kick off on Friday with Chairman Powell starting the festivities Friday morning.

Wednesday Existing Home Sales 5.4M
  FOMC Minutes  
Thursday Initial Claims 215K
  New Home Sales 645K
Friday Durable Goods -0.5%
  -ex Transport 0.5%

So the reality is that Wednesday’s FOMC Minutes will be carefully scrutinized for any sign that there is growing concern over the trade issue, and then Friday’s Powell speech is the next thing that will really matter. My sense is that we are looking forward to a very quiet week, with modest gyrations in the dollar, but no trend extension likely.

Good luck

Decidedly Bleak

The view turned decidedly bleak
For EMG nations this week
Though Turkey was worst
Some others were cursed
As well, since more funding they seek

The Argies are feeling put out
The rand had an actual rout
In LATAM they all
Enjoyed (?) quite a fall
But China, more weakness, did flout!

In truth, this morning things are rather dull in the FX markets, although I’m pretty sure that most traders are relieved. It has been an extremely difficult week for emerging market currencies and volatility remains pretty high. As an example, this week saw the South African rand fall nearly 6%, with 1% coming overnight. In LATAM, while the Argentine peso fell nearly 6% that was not the only casualty. Brazil felt the sting with the real falling 2.75%; Chile saw its peso down 3.5% while the Colombian version fell 2.7%. In fact, the best performing peso was Mexico’s, falling only 1% this week.

Of course, given that the Turkish lira was where all this started; we cannot ignore its movement. If you recall, last week it collapsed, falling nearly 40% at its weakest. Then, in response to several moves by the central bank restricting liquidity and stealthily hiking interest rates, it recouped nearly half that loss. However, this morning, the lira is once again falling, down about 5% as I type. The only thing we know for sure is that this volatility is unlikely to end soon as the market will continue to test the central bank, as well as President Erdogan’s ability to continue his policies of folly.

Finally, a quick look at APAC currencies shows INR as the only one with significant movement, falling 2% and breeching the 70.00 level for the first time ever. But the rest of this space, though it definitely saw volatility, wound up little changed on the week. And despite a great deal of anxiety about the renminbi, it is essentially exactly where it started on Monday.

The message that can be gleaned from this movement is that there are a great many countries which have fiscal imbalances, and whose prospects for future growth are being impacted by a combination of two US policies. First, as the Fed continues to raise rates and withdraw liquidity from markets via shrinking its balance sheet, those nations that relied on cheap dollar funding for their recent growth are finding themselves under pressure. And, of course, the second US policy impacting these nations is the reintroduction of tariffs on trade. Most emerging markets are heavily reliant on exports, with the US as a major destination. Slowing trade growth is also going to negatively impact these economies, and force a re-evaluation of the level of their currencies. As long as these two policies continue, and there is absolutely no sign they are going to change any time soon, every emerging market currency will be living under its own Sword of Damocles.

Meanwhile, in the G10 space, things are decidedly less interesting. While the euro did manage to trade to new lows for the move earlier this week, it has been able to reverse those losses and is now essentially flat since last Friday. The same can be said for most of the space, with the early week panic having dissipated, and very little information to drive currency movement otherwise. The weekly data was very much as expected, showing that the Eurozone and the UK are both rebounding from a very weak Q1, but hardly exploding higher. Rather, both continue to lag US growth numbers, and while the BOE did hike rates two weeks ago, and the ECB continues to slowly wind down QE, neither seems likely to increase the pace of their policy tightening, and so change the near term outlook for their respective currencies. And remember that Brexit continues to hang over the pound (its very own Sword of Damocles), with a distinct lack of movement on that front, other than the calendar which now shows just over seven months to come to a deal.

As to the US, data this week was somewhat mixed with some quite positive results (Retail Sales and Productivity) and some weaker data (Housing Starts and Philly Fed). All told, the weakness was not nearly enough to change the Fed’s trajectory, of that I am certain. And so, in the end, there is no reason to change any views with regard to the dollar; as the Fed continues to tighten policy, the dollar will continue to rise, albeit slowly.

Good luck

More Concerned

More pressure has lately been felt
In China, despite Road and Belt
As growth there is slowing
And Xi Jinping’s knowing
He must change the cards he’s been dealt

So last night, the news that we learned
Was both sides have grown more concerned
Thus trade talks would start
While traders took heart
And short-sellers of yuan got burned

While the Turkey situation has not disappeared completely, the central bank there appears to be regaining some control over the lira through surreptitious rate hikes. Cagily, they have stopped offering one-week liquidity, which theoretically could be had for ‘just’ 17.75% and instead are forcing banks to fund at the more expensive overnight window. This amounts to an effective 300bp rate rise and has been a key reason, along with yesterday’s announced moves regarding short positions, as to why the Turkish lira has rebounded so sharply from its worst levels. This hasn’t changed the macroeconomic picture, nor can it address the ongoing political row between the US and Turkey, but it has been effective in cooling the ardor of traders to short the lira. We will continue to monitor the situation, but it appears, that for now, TRY will no longer be the primary topic in FX markets.

Which allows us to turn our attention to China, where last night it was announced that low level trade talks between the US and China would start later this month in Washington. That is clearly the best news we have heard on the trade front in months, and although the process for further tariffs continues apace in the US, and it seems highly likely that next weeks imposition of tariffs on $16 billion of Chinese goods would go ahead, traders took the news very positively. The FX response was to reverse the renminbi’s recent decline, which prior to the news had seen it trade above 6.95 and perilously close to the 7.00 level many analysts have targeted as critical in PBOC deliberations. But this morning, USDCNY has fallen 0.75%, quite a large move for the currency pair, as fears of further escalation in the trade war seem to have abated slightly. There is certainly no guarantee that these talks will amount to anything or bring about further discussions, let alone a solution, but for now, they have been extremely well received by markets. Not only did the yuan rally, but also the Shanghai Composite reversed its early weakness, having fallen 1.8% at the open, and closed lower by only 0.65%. Hong Kong shares, too, rebounded from early weakness to close only marginally lower. It is important to remember that one of the drivers of the Shanghai market had been much weaker than expected earnings from Tencent, the Chinese internet firm that owns WeChat, China’s answer to Facebook. But there is no question that the news about trade talks was a critical factor in the rebound.

With these two stories as the lead, it is not surprising that the dollar has ceded some of its recent gains and is a touch softer overall this morning. Other EMG currencies that had seen significant pressure like ZAR (+0.1%), MXN (+0.5%), and RUB (+0.3%) have at least stabilized, if not reversed course. Fear of contagion remains rampant amongst emerging market investors and I expect that they will only return to markets slowly. And of course, it is entirely possible that the measures taken by the various authorities will turn out to be insufficient to address what in many cases are structural problems, and the currency rout will resume. But for now, it feels like a modicum of calm has been restored.

Meanwhile, G10 currencies are also mildly firmer this morning, although the dollar remains near its recent highs. For example, while the euro is higher by 0.3%, it is still trading with a 1.13 handle. There has been very little Eurozone data to drive markets, but there have been several articles discussing the ongoing trauma in Italy and how concerns over the new government’s fiscal policies may still turn disastrous.

Looking toward the UK, Retail Sales data there was quite strong, rising 0.7% in July, well above expectations for a 0.2% rise. However, the benefit to the pound has been minimal, with it rising just 0.1% on the news. Brexit remains a huge cloud over the currency (and the economy) and every day there is no positive news means that there is that much less time to create a solution. You all know I foresee a hard Brexit, not so much on principle as much as because I fear the May government simply cannot decide how to proceed and is not strong enough to impose a decision.

The last noteworthy piece of news in this space comes from Oslo, where the Norgesbank left rates on hold, as expected, but also essentially cemented the idea that they will be raising rates in September, joining the growing list of countries that are beginning to remove the excess accommodation put in place as a response to the financial crisis. After all, the tenth anniversary of the Lehman bankruptcy, the time many hold as the starting point to the crisis, is coming up in less than a month!

This morning’s US data brings Housing Starts (exp 1.2M), Building Permits (1.28M), Initial Claims (217K) and Philly Fed (22). Yesterday’s data was pretty strong, with the Empire Mfg print higher than expected and productivity growth showing its highest outcome since Q1 2015. In all, there is nothing in the data that suggests the Fed is going to change its tune, and if the trade situation eases, it is even more likely the Fed remains steady. All in all, despite modest softness this morning, the dollar remains the best bet going forward.

Good luck


Myriad Flaws

The Turkish are starting to act
As dollars they try to attract
Restrictions imposed
Effectively closed
The method short-sellers had backed

But problems in Turkey remain
And although we’ve seen lira gain
The myriad flaws
In Turkey still cause
A major league capital drain

Much to my chagrin, I am forced to continue the discussion on the Turkish lira as it remains the driving force in FX conversations. Despite the fact that Turkey is a bit player on the world stage economically, the fear engendered by its recent policy actions and subsequent market gyrations continues to have spillover effects elsewhere around the world. The latest example is that the Indonesian central bank surprised most analysts last night and raised their policy rate by 25bps to 5.50% specifically to help fight further IDR weakness. The rupiah finds itself weaker by 1.2% this week, despite the rate hike, and nearly 5% since late June, which has included two rate hikes. Clearly, the market has evaluated the macroeconomic situation in Indonesia and sees too many similarities to Turkey, notably the significant amount of USD debt outstanding there. As long as the Fed continues to tighten policy, and there is no hint that they will be slowing down anytime soon, every emerging market with significant USD debt outstanding (besides Turkey and Indonesia, Malaysia, South Africa and Argentina come to mind) will continue to see their currency under pressure.

The question of whether the Turkey situation is a harbinger of others remains the hottest topic in FX markets. Last night, the Bank of Turkey took a page from China’s activity book and attacked the forward FX market by reducing the limit on banks’ swap transactions to 25% of shareholder equity, down from the previous level of 50%. This had the effect of driving up short-term lira rates substantially, with the overnight rate touching 34.5%. It should be no surprise that the lira has continued yesterday’s rebound, rising a further 3% this morning, but that is well off the highs for the session, when it traded back below 6.00 briefly. The point is that despite not raising the base rate, the central bank there does have some tools to help address the situation, at least in the short term. However, there is very limited confidence that President Erdogan will allow the central bank the leeway deemed necessary to address the lira’s problems in the long run. This story is nowhere near over, although several days into it, the story is starting to get a little tired.

Turning away from Turkey, the dollar is having quite a good session. Versus its G10 counterparts, we have seen consistent strength to the tune of 0.2%-0.3%. Data has not been the driver as the only notable release has been UK inflation, where the headline came out at 2.5%, 0.1% higher than last month, but right on analysts forecasts. There has been a modest amount of Brexit conversation, but none of it has been positive, and at this point, every day without positive news is likely to weigh further on the pound. Meanwhile the euro is making a run at 1.1300, a level not traded since late June 2017, and unless we see some policy adjustments, it is hard to believe that the data is going to turn things in the near future.

Regarding the rest of the emerging markets, there has been some substantial weakness in ZAR (-3.3%), MXN (-1.2%), KRW (-1.3%) and RUB (-1.4%), none of which have released any economic data of note. This feels much more like contagion as traders seek proxies to short while the Turkish authorities use up their ammunition. But of more interest to me is CNY, which has fallen 0.4% this morning to 6.9250 or so. Many analysts have been confident that the PBOC would not allow the renminbi to weaken past the 6.90 level, as they are concerned over potential capital outflows. However, I have maintained that the renminbi has much further to fall. I believe the PBOC will continue to see the renminbi as the most effective release valve for the pressures that continue to build in the economy there. Remember, too, that the government imposed much stricter capital controls earlier this year and so they are feeling more and more confident that they will not have a repeat of the 2015-6 situation. In fact, the most recent data showed that FX reserves in China actually rose last month, surprising every analyst. The upshot is that there is further room for CNY to decline, and a move past 7.00 is merely a matter of time. In fact, it would not surprise me if it occurred before the end of August.

Turning to today’s data releases, we actually receive a great deal of new information as follows: Empire State Manufacturing (exp 20); Retail Sales (0.1%, 0.3% ex autos); Nonfarm Productivity (2.3%); Unit Labor Costs (0.3%); IP (0.3%); Capacity Utilization (78.2%); and finally Business Inventories (0.1%). While Retail Sales will garner the most attention, I will be watching ULC carefully as wage growth remains the watchword at the Fed. If that number surprises on the high side, that will serve to reinforce the idea that Chairman Powell is going to ignore the screams of the emerging markets for quite a while yet. In the end, nothing has changed with regard to the broad macroeconomic picture and the dollar ought to continue to see support across the board. Don’t say I didn’t warn you.

Good luck


Somewhat Misguided

The story in Turkey remains
One loaded with stresses and strains
While Erdogan dithers
The lira, it withers
And everything points to more pains

It seems, though, most traders decided
Their fears turned out somewhat misguided
So havens they’ve sold
From Swiss francs to gold
As safety’s now soundly derided.

The crisis in Turkey is, literally, yesterday’s news! This morning, while there have been no policy changes announced by the Turkish government, it seems that markets are feeling a bit less stressed. In fact, the Turkish lira has rebounded 5.5% as I type, although it is still lower by 25% in the past week. There has been no indication that President Erdogan is going to allow interest rates to rise nor has there been any hint that the Turkish government is going to heed calls to address its fundamental economic problems. Rather, it appears that in the manner of autocrats everywhere facing economic stress, Erdogan is blaming foreign influences for his domestic problems. It makes no sense to me that this crisis in Turkey has ended, but it is not that surprising that after a market move of the magnitude we have just seen in TRY, it should pause. Remember, too,
a key stressor has been the US-Turkish dustup over the detention of an American pastor and the tariffs imposed by President Trump in an effort to force Erdogan to comply with the US request to release him. And that shows no signs of ending either. The point is that while things today have calmed down, my sense is this is a temporary lull.

Moving on from Turkey, we see that China released a passel of data last night, none of which impressed. Fixed Asset Investment fell to 5.5%, the smallest gain in this series since it began in 1996. Retail Sales fell to 8.8%, below expectations and continuing the downward trend that has been evident for the past two years, while Industrial Production rose 6.0%, also below expectations, and continuing the gradual decline in the pace of this statistic. Taking it all together demonstrates that China’s efforts to reel in excessive debt growth earlier this year is starting to pay dividends. The problem for President Xi is that combining that effort with a trade fight with the US is starting to have a bigger nationwide impact than he would like to see. This is why we will continue to see the PBOC ease policy further this year, and why I continue to expect further pressure on the renminbi going forward. There have been many analysts who claim that the PBOC will prevent the currency from weakening beyond 6.90 or 7.00 as they fear the potential effects on capital flows. I disagree with that assessment and expect we can see a further decline in CNY as long as the dollar continues its broad based rally.

As to other emerging markets that had been severely impacted yesterday, we have seen most of those currencies rebound this morning. For instance, ZAR has rallied 2.5%, RUB is +1.5% and MXN is +0.9%. The point is that with TRY taking a breather, the same has been true elsewhere in this space.

Turning to the G10, we received a significant amount of data this morning with most of it better than expected. For example, UK Unemployment fell to 4.0% while Eurozone GDP grew at a 0.4% rate in Q2, a tick higher than expected. We also saw the German ZEW Sentiment Index rise to -13.7, up significantly from last month and a full 7 points better than expected. There were myriad individual national prints regarding GDP, employment and inflation, most of which showed that Q2 growth in the Eurozone was better than Q1. However, none of that has had much of an impact on the euro, which continues to hover unchanged on the day around 1.1400. While this level is a few pips better than the lows seen yesterday, there is no indication that traders have changed their collective minds regarding the euro’s eventual strength. The pound, meanwhile, has rebounded a touch this morning, +0.15%, but that seems more to do with the fact that Brexit has been off the front page than with any specific data releases. Ultimately, unless the Brits figure out a fudge and can get the Europeans to go along, I fear the pound will test the post Brexit vote lows seen two years ago.

As to today’s session, the only data point in the US is NFIB Small Business confidence (exp 106.9). This could actually be quite important in telling us how the trade saga is playing out amongst small companies. Thus far, corporate America seems to have weathered the storm, although if the President does go through with his threatened 25% tariffs on $200 billion of Chinese goods, I expect that will have a larger negative impact on the economy. But for now, it remains full speed ahead in the US, and that includes for the Fed, which is almost certainly going to raise rates in September and again in December. In fact, I think the real risk is that they hike more than three times in 2019, and they do it sooner than the market is expecting. And that, my friends, will continue to support the dollar.

Good luck

Quite Foreboding

In this, the eighth month of the year
The market’s succumbing to fear
With Turkey imploding
It feels quite foreboding
And folks, it can get more severe!

On Friday I discussed the Turkey situation as one beginning to spiral out of control. Well, this morning it has lived up to that billing with the lira falling an additional 7.5% as I type, although that includes a substantial recovery from its worst levels today. Now, the central bank there has finally reacted by loosening reserve requirements and offering foreign currency loans to local banks in unlimited size, but those moves have had only a limited positive impact on the currency. And since President Erdogan refuses to countenance higher interest rates, it seems that the next move is going to be capital controls, and it is likely to come pretty soon. In fact, if the recent pace of the lira’s decline continues unchecked, and I see no reason for it to stop yet, I expect that we will see capital controls before the week is out, and maybe as soon as tomorrow.

Here’s the thing. Turkey’s growth over the past decade has largely been debt driven (after all, who’s hasn’t?) but the Turks have been one of the most aggressive in using USD funding such that dollar debt represents >50% of the total debt in the economy. When the Fed turned from ultra easy monetary policy to begin tightening, it really began to hurt them. And as Chairman Powell has not only continued the process begun under Yellen, but increased the pace, the pain has become unbearable for Turkey’s economy. So it is fair to say that Turkey’s problems are self-inflicted (had they taken a more local and gradual path toward growth they arguably wouldn’t be in this bind), but those problems are not unique within the emerging markets, and at a certain point to investors, it doesn’t matter.

As I mentioned Friday, herd behavior amongst investors is the rule, not the exception. And as liquidity in Turkish asset markets dries up, and it has, investment managers will be looking to sell other risky assets in order to manage their overall portfolios. That is a key reason why ZAR has fallen by 2.5% this morning. Too, the Mexican peso has fallen 2% and even the Korean won, which is nobody’s idea of an emerging market (per capita GDP ranks ahead of Spain, Italy and New Zealand according to the CIA) has fallen 1.0%. The point is, if an asset manager cannot sell what he wants to sell to reduce risk, then he will sell what he can sell in order to limit portfolio damage. And this is how contagion starts!

So does Turkey really matter? In the FX markets, prior to the recent situation, the Turkish lira was a favored carry trade component, with investors seeking to earn what had been very high yields with a relatively stable currency. But that trade is over, and by all appearances, Turkey is going to be facing a recession pretty soon, which means that real trade flows are likely to diminish as well. In that sense, Turkey doesn’t matter too much.

But when you put this situation in the context of what else is happening in the world, this could well be the proverbial last straw. We have already been dealing with escalating trade tensions that show no sign of ebbing; a seeming stalemate in the Brexit talks opening the door to the UK crashing out of the EU with no deal; a populist government in Italy threatening to challenge Eurozone fiscal rules; and not least, a Federal Reserve that, despite everything else going on, is hell-bent and determined to continue raising interest rates. It should be no surprise that a number of equity markets around the world have struggled so far this year, but there is still a lot more green than red on screens. However, market sentiment can only take so much stress before investors decide that the risk is no longer worth the reward. I fear that we may be approaching that point. Market sentiment can be fleeting, and right now, we seem to be watching it flee!

With that in mind, a look at the G10 currency space confirms everything we have seen for the past several sessions. The dollar is broadly higher, with the euro -0.3% and the pound -0.2% although the yen, as is its wont in a crisis, has rallied 0.5%. Equity markets around the world are bathed in red, with the Nikkei falling 2% overnight and European shares, on average, down about 0.5%. US equity futures are pointing to a -0.3% opening in New York as well. Treasuries and Bunds have continued their modest rally, with yields falling another 1-2bps, and commodity prices are under pressure again. In other words, this is a classic risk off performance.

What can stop this? Historically, it has been the IMF that would step in and help support a country and its currency when stressed in this manner (remember Argentina a few months ago getting a $50 billion line of credit), but I am skeptical of that happening this time around. There are two things likely to prevent the IMF from getting involved: first, President Erdogan has been extremely vocal in his disdain for orthodox economic policies like raising interest rates in to help combat rising inflation, but the IMF will demand tighter monetary and tighter fiscal policy, neither of which Erdogan is likely to embrace; and second, for the IMF to act, the US has to be on sides, and the current situation has been partly aggravated by the diplomatic row between the US and Turkey. It seems hard to believe that President Trump will give the IMF the leeway to extend help. Unfortunately, I fear that there is more turmoil in our future.

Turning to the data review this week, there is a modest uptick in the volume of data, but it is not clear any of it will be critical to the Fed’s view of the world.

Tuesday NFIB Small Business 106.9
Wednesday Nonfarm Productivity 2.3%
  Unit Labor Costs 0.3%
  Empire State Mfg 20
  Retail Sales 0.1%
  -ex Autos 0.3%
  IP 0.3%
  Capacity Utilization 78.2%
Thursday Housing Starts 1.26M
  Building Permits 1.31M
  Initial Claims 215K
  Philly Fed 22
Friday Michigan Sentiment 98

Arguably, Retail Sales will be the most watched number, but everything we have heard from Fed speakers of late has been full speed ahead, so we will need to see much weaker data to change that perspective. Either that or a total collapse in the emerging market space, with the latter situation seemingly far more likely than the former. In the end, I see no reason to change my views on the dollar’s broad trajectory, which remains higher for the foreseeable future.

Good luck