The Next Year Or So

Said Williams, “the next year or so”
Should see rates reach neutral, you know
At that point we’ll see
If our GDP
Is humming or soon set to slow

The dollar is under very modest pressure this morning, although in reality it is simply continuing to consolidate its recent gains. While there have been individual currency stories, the big picture continues apace.

As I write, the IMF is holding its annual meeting in Indonesia and so we are hearing much commentary from key financial officials around the world. Yesterday, IMF Managing Director Lagarde told us that the ongoing trade tensions were set to slow global growth. Overnight, we heard from NY Fed President John Williams, who said that the US economy continued to be strong and that while there is no preset course, it seemed likely that the Fed would continue to adjust policy until rates reached ‘neutral’. Of course, as nobody knows exactly where neutral is, there was no way to determine just how high rates might go. However, there was no indication that the Fed was going to pause anytime soon. Dallas Fed President Robert Kaplan, who said that he foresaw three more rate hikes before any pause, corroborated this idea. According to the dot plot, 3.00% seems to be the current thinking of where the neutral rate lies as long as inflation doesn’t push significantly higher than currently expected. All this points to the idea that the Fed remains on course to continued policy tightening, with the risks seemingly that if inflation rises more than expected, they will respond accordingly.

The other truly noteworthy news was from the UK, where it appears that a compromise is in sight for the Brexit negotiations. As expected, there is some fudge involved, with semantic definitions of the difference between customs and regulatory checks, but in the end, this cannot be a great surprise. The impetus for change came from Germany, who has lately become more concerned that a no-deal Brexit would severely impact their export industries, and by extension their economy. The currency impact was just as would be expected with the pound jumping one penny on the report and having continued to drift higher from there. This seems an appropriate response as no deal is yet signed, but at least it appears things are moving in the right direction. In the meantime, UK data showed that Q3 GDP growth is on track for a slightly better than expected outcome of 0.7% for the quarter (not an annualized figure).

As to the other ongoing story, there has been no change in the tone of rhetoric from the Italian government regarding its budget, but there are still five days before they have to actually submit it to their EU masters. It remains to be seen how this plays out. As I type, the euro has edged up 0.15% from yesterday’s close, but taking a step back, it is essentially unchanged for the past week. If you recall, back in August there was a great deal of discussion about how the dollar had peaked and that its decline at that time portended a more significant fall going forward. At this point, after the dollar recouped all those losses, that line of discussion has been moved to the back pages.

Turning to the emerging markets, Brazil remains a hot topic with investors piling into the real in expectations (hopes?) of a Bolsonaro win in the runoff election. That reflected itself in yet another 1.5% rise in the currency, which is now higher by more than 10% over the past month. The China story remains one where the renminbi seems to be on the cusp of a dangerous level, but has not yet fallen below. Equity markets there took a breather from recent sharp declines, ending the session essentially flat, but there is still great concern that further weakness in the CNY could lead to a sharp rise in capital outflows, or correspondingly, more draconian measures by the PBOC to prevent capital movement.

But after those two stories, it is harder to find something that has had a significant impact on markets. While Pakistan just reached out to the IMF for a $12 billion loan, the Pakistani rupee is not a relevant currency unless you live there. However, this issue is emblematic of the problems faced by many emerging economies as the Fed continues to tighten policy. Excessive dollar borrowing when rates were low has come back to haunt many of these countries, and there is no reason to think this process will end soon. Continue to look for the dollar to strengthen vs. the EMG bloc as a whole.

This morning brings our first real data of the week, PPI (exp 2.8%, 2.5% ex food & energy). However, PPI is typically not a market mover. Tomorrow’s CPI data, on the other hand, will be closely watched for signs that inflation is starting to test the Fed’s patience. But for now, other than the Brexit news, which is the first truly positive non-dollar news we have seen in a while, my money is on a quiet session with limited FX movement. The only caveat is if we see significant equity market movement, whereby a dollar reaction would be normal. This is especially so if equities fall and so risk mitigation leads to further dollar buying.

Good luck
Adf