Monthly Archives: January 2019

As Patient As Needed

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More rate hikes? The Fed said, ‘no way!’
With growth slowing elsewhere we’ll stay
As patient as needed
Since now we’ve conceded
Our hawkishness led us astray

If you needed proof that central bankers are highly political rather than strictly focused on the economics and financial issues, how about this:

Dateline January 24, 2019. ECB President Mario Draghi characterizes the Eurozone economy as slowing more than expected yet continues to support the idea that interest rates will be rising later this year as policy tightening needs to continue.

Dateline January 30, 2019. Federal Reserve Chairman Jay Powell characterizes the US economy as solid with strong employment yet explains that there is no need to consider raising rates further at this time, and that the ongoing balance sheet reduction program, which had been on “autopilot” is to be reevaluated and could well slow or end sooner than previously expected.

These are certainly confusing actions when compared to the comments attached. Why would Draghi insist that policy tightening is still in the cards if the Eurozone economy is clearly slowing? Ongoing pressure from the monetary hawks of northern Europe, notably Germany’s Bundesbank, continues to force Draghi to hew a more hawkish line than the data might indicate. As to the Fed, it is quite clear that despite the Fed’s description of a strong economy, Powell has succumbed to the pressure to support the equity market, with most of that pressure coming from the President. And yet central bankers consistently try to maintain that they are above politics and cherish their independence. There hasn’t been an independent central banker since Paul Volcker was Fed Chair from 1979-1987.

Nonetheless, this is where we are. The Fed’s dovishness was applauded by the markets with equities rallying briskly in the US (1.5%-2.2% across the indices) and following in Asia (Nikkei and Hang Seng both +1.1%) although Europe has shown less pluck. But Europe has, as described above, a slowing growth problem. This is best characterized by Italy, whose Q4 GDP release this morning (-0.2%) has shown the nation to be back in recession, their third in the past five years! It should be no surprise that Italy’s stock market is lower (-0.6%) nor that it is weighing on all the European indices.

Not surprisingly, government bond yields around the world are largely lower as well. This reaction is in a piece with market behavior in 2017 through the first three quarters of 2018, where both stocks and bonds rallied consistently on the back of monetary policy actions. I guess if easy money is coming back, and as long as there is no sign of inflation, there is no reason not to own them both. Certainly, the idea that 10-year Treasury yields are going to start to break higher seems to be fading into the background. The rally to 3.25% seen last November may well mark a long term high.

And what about the dollar? Well, if this is the new normal, then my views on the dollar are going to need to change as well. Consider this, given that the Fed has tightened more than any other central bank, the dollar has benefitted the most. We saw that last year as the dollar rallied some 7%-8% across the board. But now, the Fed has the most room to ease policy in comparison to every other G10 central bank, and so if the next direction is easy money, the dollar is certain to suffer the most. Certainly, that was the story yesterday afternoon in NY, where the dollar gave up ground across the board after the FOMC statement. Against the euro, the initial move saw the dollar sink 0.75% in minutes. Since then, it has traded back and forth but is little changed on the day, today, with the euro higher by just an additional 0.1%. We saw a similar move in the yen, rallying 0.7% immediately, although it has continued to strengthen and is higher by another 0.35% this morning. Even the pound, which continues to suffer from Brexit anxiety, rallied on the Fed news and has continued higher this morning as well, up another 0.2%. The point is, if the Fed is done tightening, the dollar is likely done rallying for now.

Other stories have not disappeared though, with the Brexit saga ongoing as it appears more and more likely to come down to a game of brinksmanship in late March. The EU is adamant they won’t budge, and the UK insists they must. I have a feeling that nothing is going to change until late March, just ahead of the deadline, as this game of chicken is going to play out until the end.

And what of the trade talks between the US and China? Well, so far there is no word of a breakthrough, and the only hints have been that the two sides remain far apart on some key issues. Do not be surprised to see another round of talks announced before the March 2 tariff deadline, or an agreement to postpone the raising of tariffs at that time as long as talks continue. Meanwhile, Chinese data released overnight showed Manufacturing PMI a better than expected (though still weak) 49.5 while Non-Manufacturing PMI actually rose to 54.7, its best reading since September, although still seeming to trend lower. However, the market there applauded, and the renminbi continues to perform well, maintaining its gains from the last week where it has rallied ~1.5%.

The US data picture continues to be confused from the government shutdown, but this morning we are due to receive Initial Claims (exp 215K and look for a revision higher from last week’s suspect 199K) as well as New Home Sales (569K). Yesterday’s ADP Employment number was much better than expected at 213K, and of course, tomorrow, we get the payroll report. Given the Fed’s hyper focus on data now, that could be scrutinized more closely than usual for guesstimates of how the Fed might react to a surprise.

In the end, the market tone has changed to mirror the Fed with a more dovish nature, and given that, the prospects for the dollar seem to have diminished. For now, it seems it has further to fall.

Good luck
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Will We Understand?

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The current Fed Chairman named Jay
Will speak to us later today
The question at hand
Will we understand
The message that he will relay?

Meanwhile, nearby trade talks resume
Midst fears that a failure spells doom
For Trump and for Xi
They need victory
To help both economies boom

Three main stories continue to dominate the headlines; Brexit, the Fed and US-China trade talks. Given that all three remain unsettled, it should not be surprising that markets have shown little direction of late. This is evidenced by the fact that, once again, the dollar is little changed this morning against the bulk of its counterparts while both Treasury yields and equity prices remain rangebound.

Starting with the Fed, this afternoon at 2:00 the policy statement is released and then at 2:30 Chairman Powell holds his first of eight press conferences this year. We all know about the change in tone from Fed speakers since the December meeting where the Fed funds rate was raised 25bps to 2.50%. Since then, we have seen every Fed speaker back away from the previous narrative of slow and steady rate hikes to the new watchword, ‘patience’. In other words, previous expectations of two or three rate hikes this year have been moderated and will only occur if the data supports them. At this point, it seems pretty clear that the Fed will not raise rates in March, and likely not in June either, unless the data between now and then brightens significantly. As to the second half of the year, based on the slowing trajectory of global growth, it is becoming harder to believe they will push rates higher at all this year.

This is a significant change of expectations and will certainly impact other markets, notably the dollar. Given the view that any dollar strength was predicated on tighter Fed policy, the absence of such tightening should negatively impact the buck. But as I frequently point out, the dollar is a two-sided coin, and if the Fed is tightening less than expected, you can be certain that so is every other central bank, with the possibility of easing elsewhere coming into play. On a relative basis, I continue to see the dollar being the beneficiary of the tightest monetary policy around.

Moving to the trade talks, while hopes remain high, it seems expectations need to be moderated. The US is seeking major structural changes from China, including the reduction of subsidies for SOE’s and changes in terms for partnerships between US and Chinese firms. China built its economic model on those terms and seems unlikely to give them up. And that doesn’t include the IP theft issue, which the Chinese deny while the US continues to maintain is the reality. I think the best case scenario is that the talks continue and that any tariff increases remain on hold for another 90 days to try to achieve a settlement. But I would not rule out the chance that the talks break down and that higher tariffs are put into place come March 2nd. If the former occurs, I expect equity markets to rally on hope, while the dollar comes under modest pressure. However, if they break down, equities will suffer around the world and I expect to see safe havens, including the dollar, rally.

Finally, to Brexit, where yesterday Parliament voted to have PM May go back and reopen negotiations but did not vote to prevent a no-deal Brexit. This is what May wanted, but it is not clear it will solve any problems. The EU has been adamant that they will not reopen negotiations on the deal, although they seem willing to discuss the ‘political’ issues like the nature and timing of the backstop deal regarding Ireland. At this point, it seems May is playing chicken with her own party, as well as Labour, and trying to force them to vote for the current deal as the best they can get. But with time running out and the requirement that a unanimous vote of the EU is needed in order to delay the timeline, the chance of a no-deal Brexit is certainly increasing. The pound suffered yesterday after the vote, falling about 1%, although this morning it has bounced 0.25% from those levels. It is very clear that the market has ascribed a diminishing probability to a no-deal Brexit, but hedgers need to be careful. That probability is definitely not zero! And if it does come about, the pound will fall very sharply very quickly. A 10% decline is not unreasonable under those circumstances.

Away from those stories, this morning brings us the ADP Employment report (exp 178K) and we cannot forget that NFP comes on Friday. Eurozone data was generally soft, as was Japanese data, but that has all become part of the new narrative of a temporary lull in the global economy before things pick up again when the big issues (trade and Brexit) are behind us. The risk is those issues don’t resolve in a positive manner, and the slowdown is not as temporary as hoped. If global growth keeps deteriorating, all ideas on monetary policy will need to be reconsidered, which will have a direct impact on views of the future of the dollar, equity markets and bonds. So far, things haven’t changed enough to bring that about, but beware a situation where economic data continues to slide.

Good luck
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If Things Go Very Wrong

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Last year he thought growth would be strong
This year, “if things go very wrong”
It seems Signor Draghi
Just might restart QE
And rate hikes? They’ll ne’er come along!

Markets continue to bide their time ahead of tomorrow’s FOMC statement and the press conference by Chairman Powell. In addition, the Brexit saga continues with a series of votes scheduled today in Parliament that may help determine the next steps in that messy process. And of course, the next round of US-Chinese trade talks are set to begin tomorrow. So, there is plenty of potential news on the near-term horizon. But before I touch on those subjects, I wanted to highlight comments from ECB President Draghi yesterday speaking to EU lawmakers in Brussels. From the Bloomberg article this morning:

        The president of the European Central Bank blamed “softer external demand and some country and sector-specific factors” for the slowdown, but indicated he still has some confidence in the underlying strength of the economy.
       “If things go very wrong, we can still resume other instruments in our toolbox. There is nothing objecting to that possibility,” he told lawmakers in Brussels in response to a question on whether net asset purchases could be restarted. “The only point is under what contingency are we going to do this. And at this point in time, we don’t see such contingency as likely to materialize, certainly this year.”

Basically, he opened the door to reinstate QE, something which just two months ago would never have been considered. And while he tried to downplay the problems, it is clear there is growing concern in Frankfurt about Eurozone growth. Surprisingly, to me, the euro barely budged on the report, as I would have anticipated a sell-off. However, given the Fed is due to make its comments tomorrow, it appears that traders are waiting to see where Powell comes out on the hawkish-dovish spectrum. Because to me, Draghi’s comments were quite dovish. But essentially, the euro has been unchanged since trading opened in Asia yesterday, so clearly the market doesn’t see these comments as newsworthy.

Now, looking at the other three stories, there has been virtually no new information released since last week. Regarding the Fed, yesterday’s WSJ had an article that looked like a Fed plant discussing how unimportant the balance sheet issue was, and how the Fed sees no evidence that shrinking the balance sheet is having any impact on markets. That assessment is quite controversial as many investors and pundits see the balance sheet as a key issue driving recent market volatility. I expect we will hear more on Wednesday from Powell, but I also expect that now that Powell has shown he cannot withstand pressure from a declining stock market, that the pace of balance sheet reduction is going to slow. I wouldn’t be surprised to see it cut in half with a corresponding rally in both stocks and bonds on the news. In this event, the dollar should come under pressure as well.

As to Brexit, there still seems to be this disconnect between the UK and the EU in that the UK continues to believe that if Parliament votes to renegotiate parts of the deal, the EU will do so. Thus far, the EU has been pretty consistent that they like the deal the way it is and that there is not enough time to make changes. But from what I have seen this morning, it seems the most likely outcome is the ‘Malthouse proposal’ which will essentially do just that. Get support from Parliament to go back and change the Irish backstop arrangement. While I know that there is no desire for a hard Brexit, it strikes me that one cannot yet be ruled out.

Finally, on to the trade talks, we continue to get conflicting information from the US side as to where things stand, but ultimately the key issue is much more likely to be enforcement of any deal, rather than the deal itself. There is a great wariness that the Chinese will agree to something, and then ignore the details and go back to business as usual. Or perhaps create new and different non-tariff barriers to maintain their advantages. While the equity market continues to be positive on the process, I don’t see things quite so rosily. I think a deal would be great, but I don’t ascribe more than a 50% chance to getting one. However, I do expect that any tariff increases will be postponed for another round of talks to be enabled.

Beyond those stories, not too much of note is happening, which is evident by the fact that there has been almost no movement in the FX market, or any market for that matter. The G10 currencies are within pips of yesterday’s closing levels, and even EMG currencies are generally little changed. One exception is BRL, which has fallen -0.6% as ongoing news regarding the mining disaster and its impact on CRDV, a huge Brazilian mining conglomerate, seems to be generating a little angst. But otherwise, even this bloc of currencies is little changed. Equity markets are close to flat, as are bond and commodity markets. In other words, investors and traders are looking to the horizon and waiting for the big stories to play out. First in line is the Brexit voting, so perhaps later this afternoon we will see some movement, but I suspect that the FOMC is actually THE story of note for most people right now.

Good luck
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A Market Doomsday

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Last week it was Mario’s turn
To tell us what gave him heartburn
The risk which is growing
That Europe is slowing
Thus, negative rates won’t adjourn

This week eyes are on Chairman Jay
Whose last comments tried to defray
The idea the rates
That he regulates
Will e’er cause a market doomsday

As we begin the new week, the biggest weekend event was the reopening of the US Federal government, although apparently it could shut down again in three weeks. Funnily enough, while economists have calculated that each week the government was closed, GDP would be reduced by 0.1%, nobody seemed to care that much. I think if traders can explain an anomaly, they will ignore it in pricing. And certainly, a government shutdown is a big picture anomaly.

But all the other stories remain the same. Brexit is still unresolved with the next series of votes to be held tomorrow. It remains unclear exactly how things will play out, but it seems pretty clear that neither side wants a no-deal outcome. However, whether that means a vote to delay things, or acceptance of the deal that was roundly rejected just two weeks ago is completely uncertain. Of course, the third option is that they simply opt not to leave the EU, which is within their power. At this point, it seems the most likely outcome is a delay, as nobody likes the deal, and PM May has consistently indicated she would follow the vote to leave.

With that as the background, the pound is lower by -0.4% this morning, actually one of the larger movers in FX overnight. This appears to be short term profit taking by traders who have been accumulating long positions over the past month. But keep in mind that the big, long-term positions remain short pounds. So as long as there is no hard Brexit, which seems highly unlikely given both sides’ stated opposition to that outcome, there is room for the pound to rebound in the next months. However, I continue to like the dollar far better than the pound given the potential for future growth in both places. And while the Fed may not be aggressively tightening policy anymore, I don’t think we are that close to easing. Meanwhile, the BOE is watching the UK economy slow perceptibly, and cannot be serious about raising rates in the near term.

But this week is really about two things, the FOMC meeting and the trade talks with China. Looking at the latter first, both sides have made encouraging noises, but the key issues for the US remain IP theft and SOE support, neither of which have been adequately addressed. I know the equity market has been euphoric over every hint that the trade war would end, and tariffs would be removed, but I think they are way ahead of themselves. I fear there is, at best, a 50:50 chance that talks are concluded successfully before the March deadline. However, I think it likely that as long as the dialog remains open, the US postpones implementation of new, larger tariffs. As to the FX impact, you can be sure that the PBOC is going to prevent CNY from weakening in any substantial way until the talks are concluded one way or the other. But given the ongoing weak data in China, I continue to expect to see the renminbi weaken over time.

And finally, the Fed. On Wednesday Chairman Powell will have a press conference after the statement is released at 2:00 EST. (There is zero expectation that policy will change.) There has been a great deal of carping by Street economists that because Powell is not a PhD economist himself, he cannot adequately deliver the message. But I disagree. Instead, I would argue the reason there has been difficulty in articulating the Fed’s stance is that they don’t really know what to do. The current situation is unprecedented historically, between the size of the balance sheet and the level of interest rates relative to the growth trajectory of the economy. They have already had to change the way they manage interest rates, no longer adjusting balances in the market and instead paying interest on excess reserves. The upshot of that change is that there is no history for them to examine regarding potential outcomes. At the same time, to a wo(man), every Fed member is adamant that because Treasuries have behaved well, the balance sheet rundown is not having any impact on markets at all. To which I ask, if it’s not having an impact, why did they do it in the first place? Clearly the Fed thought that QE was going to help support the economy by supporting the stock market (you remember, the Portfolio Balance Channel). So how can they seriously believe that if the implementation of QE was stimulative, its reduction would not reverse that stimulus? It is arguments like this that frustrate investors and help chip away at the Fed’s credibility.

As to the markets today, the dollar is pretty well behaved, having stabilized after pretty substantial weakness on Friday. Other than the pound mentioned above, not much significant movement has been observed. Equity markets are softer around the world and US futures are pointing in the same direction. Treasury yields have not moved from Friday, and oil prices are slipping slightly. It is hard to characterize the market as anything other than confused.

On the data front, although the government shutdown has ended, all the data has not been collected, let alone collated, so I expect that we will start to see things during the week. Of course, Friday brings the payroll report, and that seems set to be released. There is nothing of note scheduled today, so I will wait to list things until tomorrow when there is more certainty as to what is coming and when. So, for today, there seems little reason for the dollar to do much unless something really negative occurs in equities. That’s not my base case, but you never know, especially as there are key earnings releases later this week (Apple, Amazon, Microsoft, Alphabet) and any rumors could drive things. But overall, I expect a quiet session today.

Good luck
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Quite the Sensation

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Economists’ latest creation
Called MMT’s quite the sensation
It claims there’s no risk
To nation or fisc
From vast monetary dilation

So, here’s the deal…apparently it doesn’t matter if economic growth is slowing around the world. It doesn’t matter if politics has fractured on both sides of the Atlantic and it doesn’t matter if the US and China remain at loggerheads over how to continue to trade with each other. None of this matters because…MMT is the new savior! Modern Monetary Theory (MMT) is the newest output from our central banking saviors and their minions in the academic economic community. In a nutshell, it boils down to this; printing unlimited amounts of money and running massive budget deficits is just fine and will have no long-term negative consequences. This theory is based on the data from the past ten years, when central banks have done just that (printed enormous amounts of money) and governments have done just that (run huge deficits) and nothing bad happened. Therefore, these policymakers theorize, that nothing bad will happen if they keep it up.

Markets love this because hyper monetary and fiscal stimulus is perceived as an unambiguous positive for asset prices, especially equities, and so why would anybody argue to change things. After all, THIS TIME IS DIFFERENT he said with tongue firmly in cheek. This time is never different, and my greatest concern is that the continuing efforts to prevent any slowing of economic growth is going to lead to a situation that results in a massive correction at some point in the (probably) not too distant future. And the problem will be that central banks will have lost their ability to maintain stability as their policy tools will no longer be effective, while governments will have limited ability to add fiscal stimulus given their budget situations. But clearly, that day is not today as evidenced by the ongoing positivity evident from rising equity markets and an increasing risk appetite. Just something to keep in the back of your mind.

Said Mario after his meeting
‘This weakness should really be fleeting’
But traders believe
His view is naïve
Explains, which, why rates are retreating

It can be no surprise that the euro declined further yesterday (-0.8%), although this morning it has regained a small bit (+0.25% as I type). Not only did the PMI data disappoint completely, but Signor Draghi appears to be starting to recognize that things may not be as rosy as he had hoped. While he still held out hope that rates may rise later this year, that stance is becoming increasingly lonely. At this point, the earliest that any economist or analyst on the Street is willing to consider for that initial rate hike is December 2019 with the majority talking 2020. And of course, my view is that there will be no rate rise at all.

The problem they face is that that with rates already negative, when if the Eurozone slips into recession by the end of the year, what else can he do. Fortunately, Mario explained that the ECB still has many options in front of them, “We have lots of instruments and we stand ready to adjust them or use them according to the contingency that is produced.” The thing is, he was talking about forward guidance, more QE and TLTRO’s, all policies that are long in the tooth and appear to have lost a significant portion of their efficacy. As I have written before, Draghi will be happy to vacate his seat given the problems that are on the horizon. Though he certainly had to deal with a series of difficult issues (Eurozone debt crisis, Greek insolvency), at least he still had a full toolkit with which to work. His successor will have an empty cupboard. One last nail in the growth coffin was this morning’s Ifo data, which printed at its worst level in three years, 99.1, much lower than the expected 100.9. I would love to hear the euro bullish case, because I don’t see much there.

Away from that story, Brexit remains an ongoing market uncertainty, although it certainly appears, based on the pound’s recent trajectory, that more and more traders and investors have decided that there will be no Brexit at all. At least that’s the only thing I can figure based on what is happening in the market. On the one hand, I guess it is reasonable to assume that given all the tooth-gnashing and garment rending that we have seen, the belief is that Brexit will be so toxic as to be unthinkable. And we have begun to see some of the rest of the Eurozone members get nervous, notably Ireland which is adamant about preventing a hard border between themselves and Northern Ireland. Alas there is still no resolution as to how to police the border in the event the UK leaves. (And based on the ongoing US discussion, we know that any type of border barrier will be a waste of money!) It is not clear to me that it is viable to rule out a hard Brexit, but that is clearly what investors are beginning to do.

As to the US-China trade story, despite President Trump’s professed optimism that a deal will be done, Commerce Secretary Wilbur Ross, indicated that we are still “miles and miles” away from a deal. And though it certainly appears that both sides are incented to solve this problem, especially given the slowing growth trajectory in both nations, it is by no means clear that will be the outcome. At least not before there is another rise in tariffs. And yet, markets are generally sanguine about the prospects of the talks failing.

So, despite potential problems, risk is in the ascendancy this morning with equity markets rising, commodities and Treasuries stable and the dollar under pressure. It is almost as if there is fatigue over the myriad potential problems and given that none of them have actually created a difficulty of note yet, investors are willing to ignore them. At least that’s my best guess.

A tour around the FX markets shows the dollar softer against most of its G10 counterparts, with JPY the only exception, further adding to the risk-on narrative, while it remains mixed vs. EMG currencies. However, overall, the tone is definitely of the dollar on its back foot. Given the ongoing US government shutdown, there is no data scheduled to be released and the Fed remains in quiet mode ahead of next week’s meeting, so unless something happens regarding trade, my money is on continued dollar weakness in today’s session as more and more investors whistle that happy tune.

Good luck and good weekend
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Growth Had Decreased

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While Draghi and his ECB
Evaluate their policy
The data released
Showed growth had decreased
A fact they’re unhappy to see

With limited new information on the two key stories, Brexit and the trade war, the market has turned its attention to this morning’s Flash PMI data for Europe, which it turns out was not very good. French, German and Eurozone numbers (the only ones released) all printed much lower than expected with German Manufacturing dipping to 49.9, a concerning signal about future growth there. The euro responded as would be expected, falling 0.3% and helping to drag down many other currencies vs. the dollar.

This is the backdrop to today’s ECB meeting, further signs of slowing Eurozone growth, which cannot be helping the internal debate about slowly normalizing policy. The policy statement will be released at 7:45 this morning and is expected to show no changes in rates or the balance sheet. Remember, the most recent guidance has been that rates would remain on hold “at least through the end of summer” and that maturing securities would be reinvested. But today’s data has to weigh on that process. As I have argued in the past, there is, I believe, a vanishingly small probability that the ECB raises rates at all. And that is their big problem. If the current slowdown turns into a recession, exactly what else can the ECB do to support the economy there? Nothing! I’m sure they will restart QE, and it is a given that they will roll over the TLTRO’s this year, but will it be enough to change the trajectory? Mario will be pretty happy to turn over the reins to someone else this October as the next ECB President is likely to have a very unhappy time, with lots of problems and lots of blame and not many tools available to address things. This remains the key reason I like the euro to decline as 2019 progresses.

Away from that, though, the Brexit story is waiting for Parliamentary votes next week regarding the elimination of the no-deal choice, which has been seen as a distinct GBP positive. While it is a touch softer this morning, -0.2%, the pound is getting the benefit of every doubt right now. As I wrote yesterday, maintain a fully hedged positions as the risk of a sharp decline has not yet disappeared by any stretch.

There has been no discussion on trade, no US data and no Fed speakers, so traders and investors are running out of cues on which to deal, at least for now. Overall, the dollar is firmer this morning, but that is really just offsetting yesterday’s weakness. In fact, it is very difficult to look at the current situation and anticipate any substantive price action in the near term. While the ECB could surprise by easing policy, that seems highly unlikely for now. However, if we get an even gloomier outlook from Draghi at the 8:30 press conference, I could see the euro declining further. But absent that, it is shaping up to be quite a dull session.

Good luck
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Bred On Champagne

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In Davos, the global elite
Are gathering midst their conceit
That they know what’s best
For all of the rest
Though this year they’re feeling some heat

As growth ‘round the world starts to wane
This group, which was bred on champagne
Is starting to find
Their sway has declined
And people treat them with disdain

This is Davos week, when the World Economic Forum meets in Switzerland to discuss global issues regarding trade, finance, economics and social trends. Historically, this had been a critical stopping point for those trying to get their message across, notably politicians from around the world, as well as corporate leaders and celebrities. But this year, it has lost some of its luster. Not only are key politicians missing (the entire US entourage, PM May, President Xi, President Macron, AMLO from Mexico and others), but the broad-based rejection of globalist policies that have led to a significant increase in populism around the world has reduced the impact and influence of the attendees. Of course, this hasn’t prevented those who are attending from declaring their certitude of the future, it just puts a more jaundiced eye on the matter. As to the market impact of this soiree, the lack of keynote addresses by policymakers of note has resulted in quite a reduction of influence. But that doesn’t mean we won’t see more headlines, it just doesn’t seem like it will matter that much.

Inflation forecasts
In Japan have been reduced
Again. Is this news?

The BOJ met last night and left policy settings unchanged, as universally expected. This means that the BOJ is still purchasing assets at a rate of ¥80 trillion per year (ostensibly) and interest rates remain at -0.10%. Their problem is that despite the fact that they have been doing this for more than 6 years, as well as purchasing corporate bonds and equity ETF’s, they are actually getting worse results. Last night they downgraded their growth and inflation forecasts to 0.9% for both GDP and CPI as they continuously fail in their attempts to stoke price increases.

While the Fed has already begun normalizing policy and the ECB is trying to move in that direction (although I think they missed the boat on that), the BOJ is making no pretenses about the fact that QE is a fact of life for the foreseeable future. Policy failure at the central bank level has become the norm, not the exception, and the BOJ is Exhibit A. As such, the yen is very likely to see its value remain beholden to the market’s overall risk appetite. If we continue to see sessions like yesterday, where equities and commodities suffer while Treasuries are bid, you can be pretty sure the yen will strengthen. While this morning the currency is actually weaker by 0.3%, that seems more like a position adjustment rather than a commentary on risk. In fact, if equities continue to suffer, look for the yen to regain its lost ground and then some.

As to Brexit, the pound is trading back above 1.30 this morning for the first time since the first week of November, which was arguably more about the US elections than the UK. But the market is becoming increasingly convinced that a hard Brexit is off the table, and that some type of deal will get done, maybe not by March, but then after a several month delay. If this is your belief, then the pound clearly has further to rally, as the market remains net short, but my only advice is to be very careful as policy mistakes are well within the remit of all government organizations, not just central banks.

Beyond those stories, there has been no movement on the trade talks, although Larry Kudlow did highlight that some type of verification would be needed before anything is agreed. US data yesterday showed a much weaker than expected housing market with Existing Home Sales falling 10.0% since last year to just 4.99M in December. The Fed is silent as they prepare for next week’s meeting and the ECB is silent as they prepare for tomorrow’s meeting. In other words, it is not that exciting. Equity futures are pointing modestly higher, about 0.25%, although that is after a >1% decline in all markets yesterday. Treasury yields are higher by 2bps and oil prices are modestly higher (0.7%) after a sharper decline yesterday. Overall, the market remains unexciting and I expect that until we see a resolution of one of the key issues, notably trade or Brexit, things are likely to remain quiet. That said, it does appear that there are ample underlying concerns to warrant a fully hedged position for risk managers.

Good luck
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A Few Tweaks

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Ms May explained that her Plan B
Was really a wonder, you see
She’d get a few tweaks
And then in ten weeks
The UK would finally be free!

The way I see it, Plan B is essentially a game of chicken. To date, the EU has said that they are firm and will not cede any more ground than that already outlined in the deal on the table. However, with ten weeks to go, the reality that the UK could exit with no deal is starting to hit home. Regardless of what they have said to date, a hard Brexit is going to have real negative impacts on the EU, especially Germany, the Netherlands and France, as they are the biggest trading partners of the UK. So, PM May went back to Parliament and explained that she would go back to the EU and explain that there needed to be some changes or else it was no deal. The first cracks appeared on the EU side with Poland discussing a 5-year transition period as a possibility, although so far, no other EU nation has piped up.

But consider the situation for the ECB. Signor Draghi is desperate to move further down the road of reducing the extraordinary monetary ease that the ECB has implemented. Stopping QE was to be the beginning of the process with the next steps to be slow and steady rate increases. Now, it is already looking like a questionable call, and a hard Brexit will definitely result in even slower Eurozone growth, thus ratcheting up the pressure on Draghi to do something. Remember, this is the man who did ‘whatever it took’ to save the euro during the sovereign debt crisis in 2012. But interest rates are already negative, and they just ended QE last month. Will they really start it up again in a few months’ time? There is significant pressure building on the EU to blink, although whether or not they do is still unclear.

Yesterday I discussed the idea that Parliament would try to take matters into its own hands given its dissatisfaction with PM May’s deal, but that would be an extraordinary outcome, and is in no way certain to be achieved. This morning, the pound has edged higher (just 0.2%) after surprisingly good employment data with the Unemployment Rate falling to 4.0%. Sterling continues to trade well above the lows seen in December though well below most economist estimates of ‘fair value.’ The thing is, given the possibility that there is no Brexit, which would arguably result in a very sharp Sterling rally, as well as the possibility there is a hard Brexit, which would result in a very sharp decline, maybe the pound is in the right place after all. And for hedgers, 50/50 is the best I can offer. If pressed, I would say the odds of no Brexit have increased, but there is still no way to know at this point in time.

Other than this story, however, there is precious little new news of interest to the FX world. The trade situation continues to percolate, as does the US government shutdown, but neither one has seen any change of note overnight. In both cases, there doesn’t appear to be a deal in the near future.

Broadly speaking, risk is off today, with the dollar modestly higher against most counterparts, equity markets softening somewhat along with commodities and Treasury and Bund yields declining slightly. There are still many problems extant in the world, it’s just that none of them are acute right now. However, the odds of another significant disruption appear to be increasing, hence the risk reduction we are witnessing today.

This morning’s data is Existing Home Sales (exp 5.25M), which is unlikely to impact the dollar very much unless it misses by a lot. Otherwise, the market is likely to continue this modest risk aversion unless we hear something about either Trade or the shutdown. In other words, look for a quiet FX session today.

Good luck
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A Terrible Sight

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The data from China last night
Described their economy’s plight
With trade talks ongoing
Their growth is still slowing.
For Xi, it’s a terrible sight

While the Martin Luther King holiday in the US will close markets and keep things quiet here, the rest of the world continues to be active. Equity markets in Europe are weak on the back of disappointing data from China. In fact, that has been the story of the day. Chinese GDP in Q4 was reported at 6.4% higher than Q4 2018, its slowest pace of growth since the financial crisis in 2009. And when considered on an annual basis, the 6.6% growth in calendar 2018 was the slowest pace of growth since 1990. Retail Sales and Industrial Production also continued their long-term downtrends, with no sign that things are set to reverse anytime soon. While the trade situation with the US is clearly weighing on the Chinese economy, they are also reaping the ‘benefits’ of the decades of increased leverage needed to achieve previous growth targets. The telling statistic I’ve seen is that ten years ago, one dollar of leverage bought $0.80 worth of additional growth. Today that number is ~$0.15 of additional growth for each new dollar of leverage. That is not the recipe for long term success!

In the meantime, despite the comments on Friday about China proposing a path to reduce the US trade deficit to zero over six years, it seems that substantive talks on protecting IP and preventing its forced transfer to local Chinese partners have gone nowhere. (In addition, the idea that reducing that trade deficit to zero would be net beneficial is not actually clear. (This article by Mike Ashton, @inflation_guy (https://mikeashton.wordpress.com/author/mikeashton/)  does an excellent job of describing potential outcomes.) At any rate, Friday’s good vibes are not nearly as apparent this morning.

Of course, the other storyline that has been nonstop is Brexit, with today the deadline for PM May to put forth her Plan B. It remains unclear as to what she can actually change to get Parliament to agree, but she will try for something. An interesting analysis I saw this weekend actually made the case that the risk of a no-deal Brexit was actually vanishingly small. The idea is that Parliament will vote to make that outcome illegal, meaning the government cannot accept that as an outcome. (Remember, Parliament and the government are not the same institution, similar to our legislative and executive branches in the US.) The alternatives are to delay the deadline in order to get a new referendum put together, or to unilaterally decide not to leave. The problem I have with that idea is that it seems a bit like Parliament declaring that recessions are illegal. As much as they would like to avoid having them, it is not clear they control the situation. Certainly, the FX market is coming around to that view as the pound has been rallying for five weeks (although there was virtually no movement overnight), but it seems to me that there is still a significant risk of a no-deal outcome, which given the recent rally, will almost certainly result in a sharp fall in the pound.

Away from those two stories, things remain remarkably dull in the FX world. The ongoing government shutdown in the US has had limited impact (arguably just that some data has not been released), while within the Eurozone, data continues to ebb and the political will to make changes of substance remains absent. Japan remains in stasis and there is virtually no possibility, in my view, that either the ECB or the BOJ tightens policy at all in 2019. In fact, I continue to believe that they will both seek to ease further at the margins.

What about the emerging market you may ask? Again, the story remains one of limited new news, at least news that is sufficient to drive market movement. Overall, investors and traders are wedded to the big picture stories like trade and Brexit, and we continue to see broad based moves accordingly.

The data story this week is unimpressive (largely due to the shutdown) with just two data points coming, tomorrow’s Existing Home Sales (exp 5.24M) and Thursday’s Initial Claims (218K). With the Fed meeting next week, they are now in their quiet period so there are no speakers on the docket. Arguably, the ECB meeting on Thursday is the biggest FX news of the week, but there is no expectation for anything new. I imagine the press conference will focus on the previous comments about tightening later this year in the context of the ongoing economic slowdown there, but we have a few days before we have to worry about that. In the end, the dollar is modestly higher this morning, but I expect it to see very limited movement in the holiday market.

Good luck
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Ill at Ease

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The nation that once ruled the seas
Has lately been brought to its knees
The Minister, Prime
Has run out of time
And Parliament’s still ill at ease

In ten days, some votes will be held
As MP’s there all feel compelled
To take more control
Around the black hole
Of Brexit, so fears might be quelled

There continue to be two main stories driving markets, Brexit and the trade war between the US and China. Everything else has faded into the background amid moderating global growth and concerns of worse to come.

Starting with Brexit, in a week and a half (it’s actually 11 days, but that didn’t fit into the limerick), Parliament will be holding a series of votes to try to wrest control of the process from the government and to explain their demands on behalf of the ‘people’. Alas, what is clear is that there is no consensus on how to proceed, with a large number not wanting to go through with it at all, while others seek a hard Brexit. PM May has insisted that the vote was for leaving the EU, and that is exactly what the UK is going to do. Currently, the best idea that anybody seems to have is to seek to delay the official date for up to a year in order to come up with more support for any action at all. There is talk of holding a second referendum, talk of a snap election to help PM May win a mandate on how to proceed, and talk of a hard Brexit. The one thing that is clear is that the deal on the table will not be the roadmap, at least not as currently written.

With all that in mind, the FX market is starting to vote, and they are coming around to the idea that there will be no Brexit at all. At least that is my take on the fact that the pound has been rising steadily since the beginning of the year. While it is actually slightly softer this morning (-0.35%) on the back of weaker than expected Retail Sales figures (-0.9% in Dec), it is higher by 3.5% since January 2nd. My view that a hard Brexit will result in a much lower pound is universal, while a deal would clearly help the pound’s value. But no Brexit at all might open up a very significant rally. Remember, before the vote, the pound was trading around 1.45-1.50. Price action indicates to me that there are more and more traders and speculators who are betting on no Brexit and a sharp rebound. I will say that if there is a decision to hold a second referendum, look for the pound to rally very sharply, easily another 5%-8%, and to do so quickly. I just don’t think there will be another referendum.

As to the trade spat, the WSJ published an article of rumors and innuendo about the idea that the US is contemplating removing tariffs as a sign of good faith and a spur to help an agreement be reached. What was interesting was that at the very end of the article, it was mentioned that all of this talk was in the context of how to move the talks forward, and not an agreed plan of action. But equity markets around the world continue to look for positive catalysts and the end of the trade war would definitely fit that bill. Given the story was published late yesterday afternoon, it is no surprise that equity markets around the world have rallied, with Asia (Nikkei +1.3%, Shanghai +1.4%) and Europe (+1.0%-1.5% across the board) both performing quite well while US futures are pointing higher as well, albeit not quite as robustly (+0.4%). But the dollar has seen very little impact from this news as aside from the pound’s modest decline, it is doing very little overall.

Beyond those stories, much less of note is happening. Next week the ECB meets, and we are starting to see analysts discuss the prospects for the previously expected rate hikes later this year. Given the ongoing softness in Eurozone data, it remains hard to believe that the ECB is going to think that raising rates is the correct move. Rather, more likely will be an extension of the TLTRO’s and interest rates remaining right where they are for an extended period from here. All eyes will be on Signor Draghi’s characterization of the economy, as to whether risks are tilted to the downside or things are balanced, but even if he claims balance, the reality is the data is pointing lower. At some point, that will be acknowledged, and it will be clearer to all that policy will not tighten further in Europe for many years. In fact, it is much easier to believe that the next move will be for easier policy than tighter. And as I have continued to explain, I believe that will help the dollar overall.

As to this morning’s data, we see IP (exp 0.2%), Capacity Utilization (78.5%) and Michigan Sentiment (97.0). Canadian Inflation is also on the docket (1.7%), which hardly seems a reason to expect higher rates there. Looking ahead, there are no more Fed speakers until the meeting on the 30th as they have entered their quiet period. But the message we have received is quite clear, patience is a virtue and there will be no rate hike in either January or March. After that, if the data supports the idea that growth and inflation are picking up, I think they will move, but unfortunately, given the overall tone of data, that seems unlikely. As to the tone for today, it is hard to get too excited about the FX market without further specific news. It wouldn’t surprise to see the pound drift a bit lower as there will be some profit taking on the recent move, but for now, the dollar is likely to remain under very modest pressure overall. Especially if equities in the US perform like those elsewhere.

Good luck and good weekend
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