From Europe, the data released
Showed growth there has clearly decreased
For Draghi this poses
(What everyone knows is)
A narrative challenge, at least

Once upon a time there was a group of nations that came together in an effort to reap the theoretical benefits of closely adhering to the same types of economic policies. They believed that by linking together, they would create a much larger ‘domestic’ market, and therefore would be able to compete more effectively on the global stage. They even threw away their own currencies and created a single currency on which to depend. Under the guidance of their largest and most successful member, this currency was managed by a completely independent central bank, so they could never be accused of printing money recklessly. And after a few initial hiccups, this group generally thrived.

But then one day, clouds arose on the horizon, where from across the great ocean, a storm (now known as the Great financial crisis) blew in from the west. At first it appeared that this group of nations would weather the storm pretty well. But quickly these nations found out that their own banks had substantial exposure to the key problem that precipitated the storm, real estate investment in the US. Suddenly they were dragged into the maelstrom and their economies all weakened dramatically. The after effects of this included questions about whether a number of these countries would be able to continue to repay their outstanding debt. This precipitated the next crisis, where the weakest members of the club, the PIIGS, all saw their financing costs skyrocket as investors no longer wanted to accept the risk of repayment. This had the added detriment of weakening those nations’ banks further, as they had allocated a significant portion of their own balance sheets to buying home country debt. (The very debt investors were loath to own because of the repayment risks.)

Just when things reached their nadir, and the very weakest piggy looked like it was about to leave the group, a knight in shining armor rode to the rescue, promising to do “whatever it takes” to prevent the system from collapsing and the currency from breaking up. Being a knight in good standing, he lived up to those words and used every monetary policy trick known to mankind in order to save the day. These included cutting interest rates not just to zero, but below; force-feeding interest-free loans to the banks so that that they could on lend that money to companies throughout the group; and finally buying up as much sovereign, and then corporate, debt as they could, regardless of the price.

Time passed (five years) and that shining knight was still doing all those same things which helped avoid the worst possible outcomes, but didn’t really get the group’s economy growing as much as hoped. In fact, it seems that last year was the best it was going to get, where growth reached 2.5%. But now there are new storm clouds brewing, both from the West as well as from within, and the growth narrative has changed. And it appears this new narrative may not have a happy ending.

Data released this morning showed that GDP growth in Italy was nil, matching Germany’s performance, and helping to drag Eurozone growth down to 0.2% for Q3, half the expected rate. French growth, while weaker than expected at 0.4%, was at least positive. In addition, a series of confidence and sentiment indicators all demonstrated weakness describing a situation where not only has the recent performance been slipping, but expectations for the future are weakening as well. It can be no surprise that the euro has slipped further on the news, down 0.2% this morning and continuing its recent trend. During the month of October, the single currency has fallen more than 2.2%, and quite frankly, there doesn’t appear to be any reason in the short run for that to change.

What may change, though, is Signor Draghi’s tune if Eurozone growth data continues to weaken. It will be increasingly difficult for Draghi to justify ending QE and eventually raising rates if the economy is truly slowing. Right now, most analysts are saying this is a temporary thing, and that growth will rebound in Q4, but with the ongoing trade fight between the US and China weakening the Chinese economy, as well as the Fed continuing to raise interest rates and reduce dollar liquidity in global markets, it is quite realistic to believe that there will be no reprieve. And none of that includes the still fragile Italian budget situation as well as the potential for a ‘hard’ Brexit, both of which are likely to negatively impact the euro. And don’t get me started about German politics and how the end of the Merkel era could be an even bigger problem.

The point is, there is still no good reason to believe the dollar’s rally has ended. Speaking of Brexit, the pound is under pressure this morning, down -0.35%, as the market absorbs the most recent UK budget, where austerity has ended while growth is slowing. Of course, everything in the UK is still subject to change depending on the Brexit outcome, but as yet, there has been no breakthrough on the Irish border issue.

As to the rest of the G10, Aussie and Kiwi both benefitted from a bounce in the Chinese stock market, at least that’s what people are talking about. However, it makes little sense to me that a tiny bounce there would have such a big impact. Rather, I expect that both currencies will cede at least some of those gains before the day is done. Meanwhile, the yen has softened, which has been attributed to a risk-on sentiment there, and in fairness, Treasury yields have risen as well, but the rest of the risk clues are far less clear.

Speaking of China, the PBOC fixed the renminbi at a new low for the move, 6.9724, which promptly saw it trade even closer to 7.00, although it is now essentially unchanged on the day. The market talk is that traders are waiting for the meeting between Presidents Trump and Xi, later this mornth, to see if a further trade war can be averted. If tensions ease in the wake of the meeting, look for USDCNY to slowly head lower, but if there is no breakthrough, a move through 7.00 would seem imminent.

And that’s really it for this morning. Yesterday’s US data showed PCE right at 2.0% for both headline and core, while Personal Spending rose 0.4%, as expected. Today’s data brings only the Case-Shiller Home Price Index (exp 5.8%) and Consumer Confidence (136.0), neither of which is likely to move markets. In addition, the Fed is now in its quiet period, so no more Fed speak until the meeting next week. Equity futures are pointing slightly higher, but that is no guarantee of how the day proceeds. In the end, it is hard to make a case for a weaker dollar quite yet.

Good luck
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