Plan B

As PM May turns to ‘Plan B’
The choices are not one, but three
Will Brexit be hard?
Or will she discard
The vote so Bremainers feel glee

The third choice is seek a delay
From Europe so that the UK
Can head to the polls
To sort out their goals
And maybe this time choose to stay

Once again Brexit remains the topic du jour as the ongoing political maelstrom in the UK is both riveting and agonizing at the same time. The latest news is that PM May survived the no-confidence vote. Her next step was to reach out to all opposition parties to try to determine what they wanted to see in Brexit as a prelude to going back to the EU with more demands requests. But the market has dismissed that idea as a non-starter (which I think is correct) and instead is clearly expecting that the decision will be for the UK to seek an extension of several months so that the UK can organize a second referendum on the question. At that point, the result would be binary, either stay in the EU or accept a hard Brexit. At least, that seems to be the current thinking amongst market participants and pundits. The pound has continued its slow recovery from the December lows as investors and traders start to assume that there will be no Brexit after all, and that the only reason the pound trades at its current levels is because of the prospect of leaving the EU. I cannot handicap how a second referendum would turn out, but it does appear that any result would be extremely close in either direction. Like many of you, I am ready for this saga to end, but I fear we will be hearing about it for another six months. In the meantime, the pound will remain hostage to the latest thoughts on the outcome, with Brexit still resulting in a significant decline, while confidence in Bremain will result in sterling strength.

As an indication of just how remarkable the Brexit story has become, Fed activity has faded from the front pages. We continue to hear from Fed speakers and the consistent message is that the Fed is now in ‘wait-and-see’ mode, with no rate hikes likely in the near future unless economic data indicates that prices are rising sharply. It appears that the Fed is losing faith in its Phillips Curve models, and although there doesn’t seem to be a consensus on what should replace them, concerns over runaway inflation based on continued low Unemployment rates are diminishing.

Economic data from around the world continues to moderate, if not outright slow, and while recession remains in the future, it is arguably closer. The upshot is that no central banks are going to consider tightening policy further for quite a while, and the odds favor more policy ease from the big banks instead. As I have consistently written, the FX market remains entirely focused on the Fed without considering the fact that the ECB is in no position to think about raising interest rates later this year and is, in fact, more likely to have to reintroduce QE as the Eurozone economy slows. If the market is beginning to price in rate cuts by the Fed, which it is, then rate cuts by the ECB (or at least QE2) is a given. It is very difficult to see a path where the Fed eases and the ECB doesn’t follow suit, if not lead. This is not a positive outlook for the single currency.

Speaking of easing policy, the PBOC has been at it consistently as growth in China ebbs with no indication they will be reducing these efforts soon. While policy rates remain unchanged, the PBOC has continued to inject excess liquidity into the market there (so far this week they have injected CNY 1.169 Billion) in an effort to bring down short term financing costs for banks. The objective is to help the banks maintain their loan books, especially for those loans that are underperforming. As long as the renminbi remains relatively firm (and although weakening 0.3% overnight remains more than 3.0% from the 7.00 level that is seen as critical in preventing capital outflows), they will be able to continue this easing policy. However, at the point in time that the renminbi begins to weaken (and it will at some point), the PBOC will find its toolkit somewhat more restricted. Remember, despite the fact that so much has occurred in markets and policy circles recently, we are less than three weeks into 2019. There is plenty of time for trader and investor views to change if forecasted activities don’t materialize.

Once again, beyond those three stories, FX remains generally dull. Overall, the dollar is little changed this morning, rising against some currencies (CNY, NZD, RUB, MXN) and falling against others (JPY, EUR, GBP, BRL). The data releases were uninspiring with Eurozone inflation the most noteworthy release but coming in exactly as expected at 1.6% headline and 1.0% core. Those are not inflation rates that quicken the pulse. Yesterday’s Beige Book indicated an increase in uncertainty by a number of businesses but described ongoing decent economic activity. This morning we see Initial Claims (exp 220K) and Philly Fed (10.0), with the latter more likely to be interesting than the former. But for now, FX market attention continues to focus on Brexit first and then the Fed. And today that is not a recipe for excitement! I see little reason, at this point, for the dollar to do much of anything today.

Good luck
Adf

 

Disgraced

Prime Minister May was disgraced
As Parliament calmly laid waste
To hopes that her deal
With Europe could heal
The schism that Brexit emplaced

Yesterday’s Parliamentary vote on the Brexit deal negotiated between PM May’s government and the EU resulted in a resounding rejection. While the UK remains fairly evenly divided on the absolute concept of Brexit, what was made clear was that the terms proposed were unacceptable to all sides. As I have maintained, the Irish border issue is an intractable one, where one side or the other simply must cede ground. There is no middle way. At this time, neither side is willing to do so, and quite frankly, unless Northern Ireland is willing to reunite with Ireland, (which seems highly unlikely any time soon), there can be no deal that will be acceptable to both sides. This leaves three potential outcomes; the UK could leave the EU with no deal in hand and go back to WTO tariff rules; the UK could opt not to leave at all (based on the European Court of Justice ruling from November); or there is a small possibility that the deadline could be delayed a number of months in order to reopen negotiations.

Let’s unpack those three choices.
1. In a no-deal Brexit, pretty much every published analysis by economists has forecast a nearly apocalyptic result for the UK economy, with a deep recession followed by much slower growth. Or course, every one of those economists likely voted to remain as the demographics of the vote showed professionals, especially financial industry professionals, overwhelmingly voted to remain. In other words, they are talking their book. Will the UK suffer? Almost certainly. Will the UK collapse into a depression? Absolutely not. The UK was a strong and viable nation before the EU came into existence and will certainly continue to be so going forward. The market impact of this outcome is likely to be quite negative in the short term, however, with both the pound and UK equity markets falling sharply if it becomes clear this will be the outcome. While both will recover eventually, the timing on that is unclear.

2. If the May government opted to remain in the EU, essentially repudiating the results of the referendum, I fear it would lead to riots in the streets, certainly in the Midlands which led the vote to leave. In fact, I could see an alliance between the French gilets jaune and the Brexiteers as both will be taking to the streets in an effort to change the government. A unilateral decision not to leave would have much deeper consequences with regard to the political system within the UK, as there would be whole swathes of the nation that would cease to trust the government entirely. I actually think this is the least likely scenario, although in the event it occurred, I would expect both the pound and the FTSE to rally sharply initially, but as the consequences of that act became clearer, I imagine both would suffer greatly.

3. Delaying the deadline seems like the best fudge available to both sides at this point, although the initial comments by EU officials followed the line that, given the depth of the defeat of the already negotiated deal, there seems little chance to make small changes and get a new result. This will also require unanimous approval by the remaining 27 members of the EU, which sounds daunting, although if there it was believed there was a serious chance of coming up with a better deal would get done. Here, too, the market response will be for a rally in the pound, and probably the FTSE, as investors would likely take the stance that the delay presages a deal.

However, for the time being, PM May’s first course of business is to fight off the no-confidence motion brought by Labour Leader Jeremy Corbyn in his attempt to bring down the government and force a general election. Pundits believe that while the deal was unacceptable, May will hold on. The problem is, she has no ideas as to how to move the process forward. Certainly, the probability of a no-deal Brexit has increased somewhat after the vote. Interestingly, the FX markets have not really priced for that outcome. In fact, since the original vote date, December 11, when May pulled the bill to try to garner more support, the pound has rallied pretty steadily and is nearly 3% higher over the past month. It would seem that FX traders believe a deal will be found.

The other story of note is that the Chinese government is now set to cut taxes in an effort to add fiscal stimulus to their ongoing monetary stimulus efforts. Remember, they have already cut bank reserve requirements by another 1% this year, adding to 2% cuts from last year, and they have created a loan targeting policy for SME’s. Now income tax cuts are to be included as well. This highlights just how poorly the Chinese economy is performing right now, and how critical President Xi believes it is to continue publishing GDP growth above 6%. While the FX market has shown little response to these actions, they have had a much more positive impact on equity markets, with yesterday’s rallies easily attributed to the announcement. The one thing that is certain is that Xi will continue to do whatever he things is necessary to support economic growth in the short run, regardless of the potential longer-term negative consequences. After all, despite being President for life, he is still a politician!

Pivoting to the data story, yesterday Germany reported 2018 GDP growth of just 1.5%, its weakest performance in 5 years, although there was no report on Q4 growth. Given the surprise decline in Q3, pundits were watching to see if Germany had entered a technical recession, although it appears not to be the case. However, it is clear that growth in the engine of Europe is continuing to slow which doesn’t bode well for the entire Eurozone. Nor does it bode well for the ECB’s nascent attempts to remove policy accommodation. In fact, their biggest fear has to be that growth slows further there and they have basically no monetary tools left to combat the situation. This morning’s data has shown that inflation continues to ebb in Europe (France 1.6%, Germany 1.7%, Spain 1.2%, Italy 1.1%), and the UK (2.1%) as well, which reduces pressure to tighten policy at all. While US inflation is also softening, it continues to puzzle me that there is any belief the ECB (or the BOE for that matter) will consider raising interest rates any time soon. So even if the Fed is more dovish (and given remarks from the always hawkish KC President Esther George yesterday, it is clear that there is no rate hike in the near future in the US), the idea that any other central bank is going to be tightening policy is absurd.

In fact, I would argue that the dollar’s recent weakness has been predicated solely on the idea that the Fed will back off on previously forecast rate hikes. But if the Fed is stopping, you can be 100% certain that any thoughts of tighter policy elsewhere are also out the window, and so relatively speaking, the US remains the tightest policy around. I still like the dollar for that reason.

Good luck
Adf

Trumped

A great nation in the Far East
Is seeing its growth rate decreased
Their trade has been ‘Trumped’
As exports have slumped
According to data released

There are two stories of note this morning as follows:

1. Chinese Trade data
2. Brexit vote tomorrow

While both of these stories have knock-on effects, they are the conversation drivers today.

Starting with China, last night’s data showed that both exports (-4.4%) and imports (-7.6%) fell much further than forecast with the resulting Trade balance expanding to a $57 billion surplus. Adding to the concerns was a -13% decline in vehicle sales there, so a trifecta of poor data. The short-term response has been for equity markets to sell off as concerns over slowing global growth mount. In Asia the Hang Seng fell -1.4% while Shanghai fell -0.7%. European equities are also suffering, with the Stoxx 600 down -0.8% amid universal weakness there, and US futures are pointing toward opening declines on the order of -0.8%.

Highlighting the risk sell off, Treasury yields have fallen 3bps, oil prices are down 1.5% and gold has climbed 0.6%. Finally, in the FX market, the yen is today’s leader, rising 0.45% as I type. However, while that describes today’s market movement, the narrative seems to be shifting slightly, toward the idea that a resolution of the trade conflict between the US and China is coming sooner than previously thought. Certainly, if growth in China is slowing more rapidly than expected, President Xi will be motivated to get a deal done, and with the ongoing tribulations in Washington, President Trump would love nothing more than to trumpet a victory on trade. So, it certainly makes sense that both sides will find a solution, but it must be remembered that there are a number of very difficult issues to address, notably the question of IP theft and forced technology transfer, which will not be easy to fudge. With that said, it is clear that a resolution to the trade fight will result in a significant risk-on atmosphere in global markets.

The other story is the imminent vote in the UK Parliament regarding PM May’s Brexit deal. As should be expected in any compromise, nobody is happy with the deal. However, in this case, given May’s weak underlying support (remember she is leading a minority government), it appears that the deal has extremely limited support, even from her own party. It is no longer a question of whether the vote will go against the government, (it will), but by how many votes will it lose. Apparently, anything on the order of 40-50 votes could be seen as close enough for PM May to go back to the EU and seek some minor tweaks in order to get the deal done. However, it is increasingly looking like the loss will be catastrophic, on the order of 100 votes, which will remove any possibility of a Brexit deal.

A ‘No’ vote will leave two possible outcomes, either a no-deal Brexit, something that is greatly feared by markets and politicians alike, or no Brexit at all! The second choice seems quite confusing, given the referendum results in 2016, but several months ago, the European Court of Justice ruled that the UK could unilaterally decide to remain in the EU. Of course, if that is the decision it seems likely to ignite an extraordinary political firestorm within the UK, given that a legal referendum called for Brexit. So, all eyes will be on London tomorrow, but for right now, traders seem to be falling into the no Brexit camp as the pound has rallied 0.3% this morning. I would argue, however, that a no Brexit outcome would see major government upheaval and have quite a negative impact on the UK economy and the pound in the short run.

Away from those stories, there is not much interesting discussion. Overall, the dollar is mixed this morning, with both AUD (-0.3%) and CNY (-0.15%) falling after the Chinese trade data, RUB (-0.45%) and CAD (-0.15%) softer on weakening oil prices and TRY (-1.10%) suffering the slings and arrows of US threats in the event the Turks attack the US-backed Kurds in Syria. On the plus side, it has mostly been the yen and the pound as described above. Net, the dollar is little changed on the day.

Turning to this week’s data, there is a decent amount highlighted by the Fed’s Beige Book on Wednesday.

Tuesday PPI -0.1% (2.5% Y/Y)
  -ex food & energy 0.2% (2.9% Y/Y)
  Empire Manufacturing 11.25
Wednesday Fed’s Beige Book  
Thursday Initial Claims 220K
  Philly Fed 10
Friday Capacity Utilization 78.5%
  IP 0.2%
  Michigan Sentiment 97.0

In addition, we hear from four more Fed speakers, including uber-dove Kashkari and NY Fed President Williams. However, the Fed speak is unlikely to have changed from the onslaught last week, meaning there will still be a dovish bias perceived by the market.

As for today, while risk has been reduced, it does not feel like a major rout, but rather a modest adjustment to positions. My sense is that the Brexit vote tomorrow will be the big story for the market, and we will likely bide our time for the rest of the day, at least in FX markets. As long as the narrative continues to focus on a dovish Fed, the dollar will remain under pressure, that is unless the focus turns to more disruptive possible outcomes, when fear really blossoms. However, I don’t see a good reason for that to occur in the short run, so the dollar is apt to stay soft for now.

Good luck
Adf

Animal Spirits Were Stirred

All week from the Fed we have heard
That patience is their new watchword
The market’s reaction
Implied satisfaction
And animal spirits were stirred!

While it may be a new day, nothing has really changed. Yesterday we heard from both Chairman Powell and vice-Chairman Clarida and both said essentially the same thing: the Fed is watching both the economy and markets closely, and given where policy rates currently stand, they can afford to be patient before acting next. On the subject of the Fed’s balance sheet, neither indicated there was cause for a policy change, but Powell, when asked, remarked that if they thought the shrinking balance sheet was becoming a problem, they would not hesitate to adjust policy. The market interpretation was: the Fed is not going to raise rates anytime soon so we better buy stocks as quickly as we can. The result was yet another rally in equities with all three US market indices rising about 0.5% on the day. At this point, even the Fed must recognize that they have gotten their message across.

The next key story that remains ongoing is the trade situation between the US and China. There was no specific news on the subject and no comments from either side. The market view is that there was clearly some progress made during the initial discussions earlier this week and many people are optimistic that the next round of talks, which will include more senior representatives from both sides, can lead to a permanent resolution. As long as that remains the collective mindset, it is one less pressure point for global equity markets. However, it must be remembered that the US is seeking significant changes in the structure of the Chinese economy, and so a complete resolution will not be easy to achieve, especially in the accelerated timeline currently extant. I expect an extension of the timeline as the first concrete result.

The third key story has been Brexit, which continues to be a complete mess. Next week’s Parliamentary vote looks destined to fail, and now there is a growing movement for the deadline to be extended three months to the end of June. While that requires a unanimous vote to do so, comments from European members seem to be heading in that direction. The pound has benefitted from the discussion, as traders believe that the extra three months will help alleviate the risk of a no-deal Brexit and the forecast consequences on both the economy and the currency in that event. However, the Irish border remains unchanged and there has been no indication that the UK will accept an effective walling off of Northern Ireland for the sake of the deal. We shall see.

Two other stories are also gaining in their importance, the rebound in oil prices and further weakness in the Eurozone economy. As to the first, the OPEC agreement to cut production by 1.2 million barrels/day has served to remove fears of an oil glut and recent inventory figures have backed that up. As well, while WTI has traded back above $50/bbl, there is a growing belief that the US fracking community is not going to be able to produce as much oil as previously thought, especially if prices slip back below that $50 level. Oil prices have rallied for nine consecutive days but remain far below levels seen just last October. Historically, rising commodity prices have gone hand in hand with a declining dollar, and for right now, that correlation has been holding.

Finally, we continue to see weak economic data from the Eurozone, with this morning’s Italian IP data (-1.6% in Nov) the latest in a string that has shown Europe’s manufacturing sector is under increasing pressure. This story is the one that has received shortest shrift from the market overall. In fact, I would argue it has been completely ignored, certainly by FX traders. While everyone focuses intently on the Fed and the recent change of heart regarding future rate hikes, there has been almost no discussion with regard to the ECB and how, as economic growth continues to slow in the Eurozone, the idea that they will be tightening policy further come September is laughable. At some point, the market will realize that the Eurozone is in no position to normalize policy further, and that instead, the question will arise as to when they will seek to add more stimulus. My gut tells me that a change in forward guidance will be the first step as they extend the concept of rate hikes from; “not until the end of summer” to something along the lines of “when we deem appropriate based on the economic data”. In other words, the current negative rate regime will be indefinite, and if (when) the next recession arrives, look for a reintroduction of QE there. My point is that the euro has no business rallying in any substantive way.

With all of this as background, a quick tour of markets shows that while the dollar actually performed fairly well during the US session yesterday, it is giving back some of those gains this morning. For example, the euro, despite weak data, is higher by 0.3%. The pound, on the back of the renewed Brexit deal hope is higher by 0.5%. Firmer commodity prices have helped AUD (+0.6%), NZD (+0.9%) and CAD (+0.3%). But the biggest consistent winner of late has been CNY, which has rallied a further 0.65% overnight and is now up 1.6% this week. This is a far cry from the situation just a few weeks ago, when there were concerns the yuan might break through the 7.00 level. Two things come to mind here as to the cause. The first possibility is that there has been an increase in investment flows into the Chinese bond market, where yields remain higher than in much of the developed world, and the Chinese bond market is slowly being added to global bond indices requiring fund managers to add positions there. The second, slightly more conspiratorial idea is that the Chinese government is pushing the yuan higher during the trade negotiations with the US to insure that its value is not seen as an impediment to reaching any deal. Whatever you think of President Trump’s tactics, there is no question that the Chinese economy has come under increased pressure since the imposition of US tariffs on their exports. It is not hard to believe that the stronger yuan is a direct response to help reach an agreement as quickly as possible.

And that’s pretty much everything to watch today. This morning we get CPI data with expectations for headline to print at -0.1% (1.9% Y/Y) and ex food & energy to print at +0.2% (2.2% Y/Y). Thankfully there are no more Fed speakers, but I would say given the near unanimity of the message from the nine speakers this week, we have a pretty good idea of what they are thinking. Equity futures are pointing slightly lower following European markets, which are softer today. However, given that equity markets around the world have rallied steadily all week, it can be no real surprise that a little profit taking is happening on a Friday. As to the dollar, in the short term I think it remains under pressure, but over time, I continue to see more reasons to own it than to short it.

Good luck and good weekend
Adf

 

Greater Clarity

Last year rate hikes had regularity
But now the Fed seeks greater clarity
‘Bout whether our nation
Is feeling inflation
Or some other source of disparity

Investors exhaled a great sigh
And quickly realized they must buy
Those assets with risk
To burnish their fisc
Else soon prices would be too high

The December FOMC Minutes were received quite positively by markets yesterday as it appears despite raising rates for the fourth time in 2018, it was becoming clearer to all involved that there was no hurry to continue at the same pace going forward. The lack of measured inflation and the financial market ructions were two key features that gave pause to the FOMC. While the statement in December didn’t seem to reflect that discussion, we have certainly heard that tune consistently since then. Just yesterday, two more Fed regional presidents described the need for greater clarity on the economic situation before seeing the necessity to raise rates again. And after all, given the Fed has raised rates 225bps since they began in December 2015, it is not unreasonable to pause and see the total impact.

However, regarding the continued shrinking of the balance sheet, the Fed showed no concern at this point that it was having any detrimental effect on either the economy or markets. Personally I think they are mistaken in this view when I look at the significant rise in LIBOR beyond the Fed funds rate over the past year, where Fed Funds has risen 125 bps while LIBOR is up 187bps. But the market, especially the equity market, remains focused on the Fed funds path, not on the balance sheet, and so breathed a collective sigh of relief yesterday.

Given this turn of events, it should also not be surprising that the dollar suffered pretty significantly in the wake of the Minutes’ release. In the moments following the release, the euro jumped 0.7% and continued subsequently to close the day nearly 1% stronger. One of the underpinnings of dollar strength has been the idea that the Fed was going to continue to tighten policy in 2019, but the combination of a continuous stream of comments from Fed speakers and recognition that even back in December the Fed was discussing a pause in rate hikes has served to alter that mindset. Now, not only is the market no longer pricing in rate hikes this year, but also analysts are backing away from calling for further rate hikes. In other words, the mood regarding the Fed has turned quite dovish, and the dollar is likely to remain under pressure as long as this is the case.

Of course, the other story of note has been the trade talks between the US and China which ended yesterday. During the talks, market participants had a generally upbeat view of the potential to reach a deal, however, this morning that optimism seems to be fading slightly. Equity markets around the world have given back some of their recent gains and US futures are also pointing lower. As I mentioned yesterday, while it is certainly good news that the talks seemed to address some key issues, there is still no clarity on whether a more far-reaching agreement can be finalized in any near term timeline. And while there has been no mention of tariffs by the President lately, a single random Tweet on the subject is likely enough to undo much of the positive sentiment recently built.

The overnight data, however, seems to tell a different story. It started off when Chinese inflation data surprised on the low side, rising just 1.9% in December, much lower than expected and another red flag regarding Chinese economic growth. It seems abundantly clear that growth there is slowing with the only real question just how much. Forecasts for 2019 GDP growth have fallen to 6.2%, but I wouldn’t be surprised to see them lowered going forward. On the other hand, the yuan has actually rallied sharply overnight, up 0.5%, despite the prospects for further monetary ease from Beijing. It seems that there is a significant inflow into Chinese bond markets from offshore which has been driving the currency higher despite (because of?) those economic prospects. In fact, the yuan is at its strongest level since last August and seemingly trending higher. However, I continue to see this as a short-term move, with the larger macroeconomic trends destined to weaken the currency over time.

As to the G10 currencies, they have stabilized after yesterday’s rally with the euro virtually unchanged and the pound ceding 0.25%. Two data points from the Eurozone were mixed, with French IP slipping to a worse than expected -1.3% while Italian Retail Sales surprised higher at +0.7% back in November. While there was no UK data, the Brexit story continues to be the key driver as PM May lost yet another Parliamentary procedural vote this morning and seems to be losing complete control of the process. The thing I don’t understand about Brexit is if Parliament votes against the current deal next week, which seems highly likely at this stage, what can they do to prevent a no-deal Brexit. Certainly the Europeans have not been willing to concede anything else, and with just 79 days left before the deadline, there is no time to renegotiate a new deal, so it seems a fait accompli that the UK will leave with nothing. I would welcome an explanation as to why that will not be the case.

Turning to this morning’s activity, the only data point is Initial Claims (exp 225K), but that is hardly a market moving number. However, we hear from three regional Fed presidents and at 12:45 Chairman Powell speaks again, so all eyes will be focused on any further nuance he may bring to the discussion. At this point, it seems hard to believe that there will be any change in the message, which if I had to summarize would be, ‘no rate changes until we see a strong reason to do so, either because inflation jumps sharply or other data is so compelling that it forces us to reconsider our current policy of wait and see.’ One thing to keep in mind, though, about the FX markets is that it requires two sets of policies to give a complete picture, and while right now all eyes are on the Fed, as ECB, BOJ, BOE and other central bank policies evolve, those will have an impact as well. If global growth is truly slowing, and the current evidence points in that direction, then those banks will start to sound more dovish and their currencies will likely see plenty of selling pressure accordingly. But probably not today.

Good luck
Adf

Little Trust

Investors and traders believe
The trade talks will shortly achieve
Solutions robust
Despite little trust
Since both sides are known to deceive

Risk is definitely back on this morning as equity markets around the world continue their recent rebound, Treasury and bund prices slide, and commodities climb higher. As to the dollar, it is modestly softer, except against the yen, which is the worst performer in the G10 today.

The primary driver of these moves remains the US-China trade talks, which seem to be going pretty well. If you recall, Monday, Chinese Vice-Premier Liu He made an appearance to demonstrate the importance of the talks to both sides’ negotiators, and the fact that they were extended an extra day, only ending today in Beijing, implies that positive momentum was building and neither side wanted to give that up. While the first reports are that there are still some areas of wide disagreement, there seems to be no doubt that progress has been made.

In addition to the trade story, the market continues to hear soothing words from various Fed speakers regarding the pace of further potential rate hikes. Yesterday, St. Louis Fed President Bullard was quite clear that he thought there was no reason to raise rates further at this time given the lack of measured inflation, although he remains comfortable with the continuing unwinding of the balance sheet. And Bullard is a voter this year, so market participants tend to give voters just a little more credence in their comments. Later this afternoon the Fed will release the Minutes of their December meeting, although I don’t expect them to be that useful. You may recall that it was that meeting’s statement and the ensuing press conference that kicked off the last leg of the equity market rout. Investors kept seeing signs of slowing growth while the Fed seemed oblivious, especially to activity elsewhere in the world. In fact, it was that meeting that convinced many (myself included) that the Fed was no longer in the put writing business.

How wrong we all were on that score. We have heard from a half dozen Fed speakers in the past two weeks, including some of the most hawkish (Mester), and to a (wo)man they all indicated that there was no urgency to raise rates, with some, like Bullard, questioning if there was even a need to do so at all. Clearly, the market has become far more comfortable that the Fed is not out to destroy the equity market, and recent price action is the result of that change of view. Given the change of tone since the meeting, it seems unlikely to me that the Minutes will teach us very much about the current state of Fed thinking. Instead, we still have another eight Fed speeches (including another Powell speech) between today and Friday, which will give us all much better information than three-week old data.

Other news of note includes the announcement overnight by the PBOC that they would be instituting a new bank lending program, the Medium Term Lending Facility (MTLF) which is designed to offer cheap bank funding for loans to SME’s without overly expanding the liquidity in the market. Remember, the Chinese are still trying to wring excess leverage out of some sectors of the economy, but are also feeling the effects of overall slowing economic growth so feel the need to address that. These loans appear quite similar to the ECB’s TLTRO’s, which were deemed a big success when they were being issued. Of course, the key concern there is now that those loans are coming up to maturity, banks need to replace that funding and that is not so easy in a market where global liquidity is drying up. Will the same thing happen in China? Quite possibly. My observation on extraordinary monetary policy is that it has proven much harder to remove than to implement.

At any rate, the market was cheered by that news, as well as the trade talks, and the renminbi continues to behave quite well, actually rallying a further 0.2% this morning. I still foresee a weaker currency over time, but thus far, the PBOC has prevented any substantive movement.

Brexit continues to fester in the background with PM May losing another vote in Parliament. This new bill now prevents Her Majesty’s Treasury from adjusting tax rates in the event of a no-deal Brexit. And yet, there is no indication that the deal on the table is going to pass, so it remains unclear just how that will work. Given the magnitude of the issue, waiting to the 11th hour to achieve agreement may be the only way to get it done. And so, I continue to expect a very late acceptance of the deal, although it is by no means clear that will be the case. One other noteworthy Brexit item is the potential impact it will have on Japanese companies, who have used the UK as their beachhead into the EU. PM Abe will be visiting PM May tomorrow to make sure she understands how important a trade deal is to those Japanese firms, and how important those Japanese firms are to the UK economy.

And otherwise, the currency market remains fairly dull for right now. Even EMG currencies are only showing modest movement overall, albeit generally stronger today. The thing is, market participants are so focused on the major issues, and by extension the major currencies, that there has been reduced activity elsewhere. As long as risk appetite remains robust, the dollar should remain under pressure along with the yen. And for today, that seems like the best bet.

Good luck
Adf

Fear’s Been Replaced

As talks with the Chinese progress
Investors are feeling less stress
Thus fear’s been replaced
By greed with great haste
Despite the Fed’s shrinking largesse

Following on Friday’s blowout jobs report in the US, the good news just keeps on coming. Yesterday and today, the market’s collective attention has been on the seeming positive vibes coming from the US-Chinese trade talks ongoing in Beijing. While there has been no announcement thus far, hints by US officials (Kudlow and Ross) point to genuine progress being made. One of the things that has been extensively covered by the press in this round of negotiations is the administration’s efforts to not merely agree to a deal, but to insure that the Chinese adhere to their promises. Historically, this has not always been the case, which has been a source of much of the friction between the two nations. However, it does appear that the Chinese economy is slowing more rapidly than President Xi would like to see, and that the pressure to get it growing again is increasing. Thus, it is not impossible to believe that a deal of some sort will be coming together over the next several months. If pressed, I would guess that March will not be enough time to agree everything, but that there will be an extension of the current tariff regime (rather than any further increases) based on the positive momentum.

If the market is correct in forecasting a successful round of trade negotiations, then that will certainly reinvigorate the global growth story to some extent. And based on recent data releases, the world needs some good news. In the latest example of weakening data, Eurozone Sentiment indicators all fell sharply across the board. This included Business Confidence, Consumer Confidence and Economic Sentiment amongst others. The weakness was prevalent across all the major Eurozone nations as the numbers fell to their lowest levels in roughly two years. Once again, this raises the question of how much policy tightening the ECB can impose in a softening economy. Euro bulls need more than Signor Draghi’s words to make the case for actual interest rate increases, but given recent economic data, that is all they have. With this in mind, it should be no surprise that the euro has ceded some of its recent gains, but in truth, its 0.2% decline this morning just doesn’t seem that impressive.

Looking elsewhere in the G10 space, the Brexit story continues to unfold as expectations grow for the Parliamentary vote on the deal to be held next Tuesday, January 15. As of this writing, those expectations remain for the deal to be voted down by Parliament, although there is a rearguard action that is trying to simultaneously prevent the UK from exiting the EU with no deal. It seems unlikely that if Parliament votes no on this deal that there will be any ability to change the deal in a substantive manner to garner the required approval. And the Irish border situation has not gotten any less intractable in the interim. At this point, I would estimate that the odds are 50:50 that Parliament eventually buckles amidst the fear of a no-deal Brexit. The thing is, for currency hedgers, given the likely asymmetry of the outcome on the pound’s value, with a no-deal resulting in a much larger decline than the rally resulting from a deal, expected value of the pound remains lower, and needs to be addressed with that in mind. In other words, make sure you are max hedged against long GBP positions.

And in truth, those are the only stories of note. With oil prices edging higher the past two sessions (although WTI remains below $50/bbl), both CAD and NOK have bucked the trend today and strengthened modestly. However, the rest of the G10 is softer vs. the dollar by about 0.15%-0.25%. In the EMG space, the dollar has shown a bit more bounce, rallying by 1.3% vs. TRY, 0.5% vs. BRL and 0.7% vs. both ZAR and KRW. But despite today’s gains, those currencies all remain much firmer on the week, as the dollar has been a key underperformer during the past several sessions’ risk-on sentiment. In fact, I would estimate that today’s movement is simply some profit taking rather than anything more fundamental.

With the government shutdown ongoing here, data releases are subject to delay, specifically Friday’s CPI numbers, though today’s JOLT’s Jobs report (exp 7.063M) is published by the Labor Department so it may be delayed as well. Given its relative unimportance, I don’t foresee that being an issue, but if the shutdown continues for a much longer time, certainly markets, if not the Fed, will have less timely information regarding economic performance, and that is likely to be a negative. In the meantime, a quick look at equity futures shows that hope springs eternal with both Dow and S&P futures pointing higher by 0.8%. At this point, it certainly seems like risk will continue to be embraced, which is likely to prevent any further dollar strength in the short run.

Good luck
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If Things Go Astray

The jobs report Friday was great
Which served to confuse the debate
Is growth on the rise?
Or will it downsize?
And how will the Fed acclimate?

The first indication from Jay
Is data continues to say
While growth seems robust
We’ll surely adjust
Our actions, if things go astray

In what can only be described as remarkable, despite the strongest jobs report in nearly a year, handily beating the most optimistic expectations for both job growth and wages, Fed Chairman Jay Powell told the market that the Fed could easily slow the pace of policy tightening if needed. While this may seem incongruous based on the data, it was really a response to several weeks of market gyrations that have been explicitly blamed on the Fed’s ongoing policy normalization procedure. A key concern over this sequence of events is that the data of ‘data dependence’ is actually market indices rather than economic ones. For every analyst and economist who had been looking for Powell to break the cycle of kowtowing to the stock market, Friday was a dark day. For the stock market, however, it was anything but, with the S&P 500 rising 3.4% and the NASDAQ an even more impressive 4.25%. The Fed ‘put’ seems alive and well after a three month hiatus.

So what can we expect going forward? The futures market has removed all pricing for the Fed to raise rates further in 2019, and in fact, has priced in a 50% probability of a 25bp rate cut before the year is over! Think about that. Two weeks ago, the market was priced for two 25bp rate hikes! This is a very large, and rapid, change of opinion. The upshot is that the dollar has come under significant pressure as both traders and investors abandon the view of continued cyclical dominance and start to focus on the US’ structural issues (growing twin deficits). In that scenario, the dollar has much further to fall, with a 10% decline this year well within reason. Equity markets around the world, however, have seen a short-term revival as not only did Powell blink, but also the Chinese continue to aggressively add to their monetary policy ease. And one final positive note was heard from the US-China trade talks in Beijing, where Chinese Vice-Premier, Liu He, President Xi’s top economic official, made a surprise visit to the talks. This was seen as a demonstration of just how much the Chinese want to get a deal done, and are likely willing to offer up more concessions than previously expected to do so. The ongoing weak data from China is clearly starting to have a real impact there.

It is situations like this that make forecasting such a fraught exercise. Based on the information we had available on December 31, none of these market movements seemed possible, let alone likely. But that’s the thing about predictions; they are especially hard when they focus on the future.

As to markets today, while Asian equity markets followed Friday’s US price action higher, the same has not been true in Europe, where the Stoxx 600 is lower by 0.4%. Weighing on the activity in Europe has been weaker than expected German Factory Order data (-1.0%) as well as the re-emergence of the gilets jaunes protests in France, where some 50,000 protestors, at least, made their presence felt over the weekend.

Turning to the dollar, it is down broadly, with every G10 currency stronger vs. the greenback and most EMG currencies as well. If the market is correct in its revised expectations regarding the Fed, then the dollar will remain under pressure in the short run. Of course, if the Fed stops tightening policy, and we continue to see Eurozone malaise, you can be certain that the ECB is going to be backing away from any rate rises this year. I have maintained that the ECB would not actually raise interest rates until 2020 at the earliest, and I see no reason to change that view. With oil prices hovering well below year ago levels, headline inflation has no reason to rise. At the same time, despite Signor Draghi’s false hope regarding eventual wage inflation, core CPI in the Eurozone seems pegged at 1.0%. As long as this remains the case, it will be extremely difficult for Draghi, or his successor, to consider raising rates there. As that becomes clearer to the market, the euro will likely begin to suffer. However, until then, I can see the euro grinding back toward 1.18 or so.

One last thing to remember is that despite the Christmas hiatus, the Brexit situation remains front and center in the UK, with Parliament scheduled to vote on the current deal early next week. At this time, there is no indication that PM May is going to find the votes to carry the day, although as the clock ticks down, it is entirely possible that some nays turn into yeas in order to prevent the economic catastrophe that is being predicted by so many. The pound remains beholden to this situation, but I believe the likely outcomes are quite asymmetric with a 2-3% rally all we will see if the deal passes, while an 8% decline is quite viable in the event the UK exits the EU with no deal.

As to data this week, it will not be nearly as exciting as last week, but we see both the FOMC Minutes on Wednesday and CPI on Friday. In addition, we hear from seven Fed speakers across nine speeches, including Chairman Powell again, as well as vice-Chairman Clarida.

Today ISM non-Manufacturing 59.0
Tomorrow NFIB Small Business Optimism 105.0
  JOLT’s Job Openings 7.063M
Wednesday FOMC Minutes  
Thursday Initial Claims 225K
Friday CPI -0.1% (1.9% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)

All in all, it seems that the current market narrative is focused solely on the Fed changing its tune while the rest of the central banking community is ignored. As long as this is the case, look for a rebound in equity markets and the dollar to remain under pressure. But you can be certain that if the Fed needs to hold rates going forward because of weakening economic data, the rest of the world will be in even more dire straits, and central banks elsewhere will be back to easing policy as well. In the end, while there may be short-term weakness, I continue to like the dollar’s chances throughout the year as the US continues to lead the global economy.

Good luck
Adf

If Job Numbers Swoon

For Powell, the data he’s viewing
Shows weakness is palpably brewing
Will he change his tune
If job numbers swoon?
If not, it could prove his undoing!

The admonition that markets will remain volatile in 2019 certainly has held true to form thus far. After a significant sell-off in global equity markets yesterday, two pieces of news have now helped a partial rebound. First was the story that vice-ministerial trade talks are now scheduled to be held between the US and China next Monday and Tuesday. The market has taken this as a sign that the trade conflict is abating and that there will be a deal forthcoming shortly. While that would certainly be great news, it seems a bit premature. Nonetheless, it was clearly seen as a market positive overnight.

The second bit of news comes from China, where the PBOC has announced a 1.0% cut in the RRR for all Chinese banks, half to be implemented next week and half two weeks later. As opposed to the very targeted efforts announced earlier in the week, this is a broad-based easing of monetary policy, the first since 2016, and appears to be a direct response to the fact that the Manufacturing PMI data is alluding to contraction in the Chinese economy. As I have written before, China will be forced to continue to ease monetary policy this year due to slowing growth, and it is for that reason that I expect the renminbi to gradually decline all year.

But the bad news is not restricted to China, we have also seen weaker data from both the US and Europe. Yesterday’s ISM Manufacturing data printed at 54.1, significantly lower than expectations and its weakest print November 2016, and while still in expansionary territory is indicative of slowing growth ahead. Meanwhile, inflation data from the Eurozone showed that price pressures continue to recede there on the back of sharply declining oil prices with the area wide CPI rising only 1.6% and the core reading remaining at 1.0%. It appears that the mooted inflation pressures Signor Draghi has been dreaming about remain only in his dreams.

Bond market reaction to this data was very much as would be expected, with 10-year Treasury yields falling to 2.57%, their lowest level since last January, while Bund yields have fallen back to 0.15%, levels not seen since April 2017. In fact, the futures market in the US is now beginning to bet on a rate cut by the Fed before the end of 2019. If you recall, at the December FOMC meeting, the dot plot indicated a median expectation of two more rate hikes this year.

What we can safely say is that there is a great deal of uncertainty in markets right now, and many disparate opinions as to how the economy will perform going forward, and to how the Fed and its central banking brethren will respond. And that uncertainty is not likely to dissipate any time soon. In fact, my fear is that when it does start to fade, it will be because the data is pointing to a much slower growth trajectory, or a recession on a widespread basis. At that point, uncertainty will diminish, but so will asset values!

And how, you may ask, is all this affecting the dollar? Well, yesterday’s price action was of the risk off variety, where the yen was the leader, but the dollar outperformed most emerging market currencies, as well as Aussie and Kiwi, but was slightly softer vs. the rest of its G10 counterparts. This morning, however, on the strength of the trade talk news and policy ease by China, risk is being tentatively embraced and so the yen has fallen a bit, -0.35%, and the dollar has ceded most of its recent gains vs. the EMG space. For example, ZAR (+1.3%), RUB (+1.0%), TRY (+1.1%), and IDR (+1.0%) have all managed to rally sharply alongside a rebound in commodity prices. As well, the market is still enamored of newly installed President Bolsonaro in Brazil with the real higher by a further 0.9% this morning, taking the YTD gain up to 3.0%.

As for the G10, AUD has benefitted from the Chinese news, rising 0.55%, while CAD and NOK are both higher by 0.5% on the back of the rebound in oil prices. This move was a reaction to OPEC output falling sharply. As to the euro, it is higher by just 0.2% although it has recouped about half its losses from Wednesday now. And finally, the pound has bounced as well after its PMI data was actually a positive surprise. That said, it remains within a few percent of its post Brexit vote lows, and until there is a resolution there, will be hard-pressed to gain much ground. Of course, if there is no deal, the pound is likely to move sharply lower. The UK Parliament is due to vote on the current deal next week, although recent news from PM May’s political allies, the Northern Irish DUP, indicates they are unhappy with the deal and cannot support it yet. With less than three months to go before Brexit is upon us, it is increasingly looking like there will be no deal beforehand, and that the pound has further to fall. For hedgers, I cannot exhort you enough to consider increasing your hedges there. I think the risks are highly asymmetric, with a deal resulting in a modest rally of perhaps 2-3%, while a no-deal outcome could easily see an 8% decline.

For today, the NFP report is on tap with expectations as follows:

Nonfarm Payrolls 177K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.5

We also hear from Chairman Powell at 10:15, where the market will be parsing every word to try to get a better understanding of the Fed’s data reaction function, and perhaps to see which data points they deem most important. At this point, strong NFP data ought lead to declining Treasury prices and rising stock prices although I expect the dollar would remain under pressure based on the risk-on feeling. If the data is weak, however, look for stock futures to reverse course (currently they are higher by ~1.0%) and Treasuries to find support. As to the dollar then, broadly stronger, although I expect the yen will be the best performer overall.

Good luck
Adf

A Statement, Acute

The company named for a fruit
Explained in a statement, acute
Though services grew
Its gross revenue
Was destined, not to follow suit

The impact ‘cross markets was vast
As traders, most havens, amassed
Thus Treasuries jumped
The dollar was dumped
While yen demand was unsurpassed

Happy New Year to all my readers. I hope it is a successful and prosperous 2019 for everyone.

But boy, has it gotten off to a rough start! Since I last wrote on December 14, volatility across markets has done nothing but increase as fear continues to pervade both the investor and trader communities. While some pundits point to the trade war and/or the US government shutdown, what has been apparent to me for the past several months is that central banking efforts around the world to normalize policy have begun to take their toll on economic activity and by extension on markets that have become completely dependent on that monetary buffer.

Ten years of extraordinary monetary support by central banks around the world has changed the way markets behave at a fundamental level. The dramatic increase in computer driven, algorithmic trading across markets, as well as passive investing and implicitly short volatility strategies has relegated fundamental analysis to the dust heap of history. Or so it seems. The problem with this situation is that when conditions change, meaning liquidity is no longer being continually added to markets, all those strategies suffer. It will be interesting to watch just how long the world’s central banks, who are desperately trying to normalize monetary policy before the next economic downturn, are able to continue on their present path before the pressure of slowing growth forces a reversion to ‘free’ money for all. (Despite all their claims of independence, I expect that before the summer comes, tighter monetary policy will be a historical footnote.)

In the meantime, last night’s volatility was triggered when a certain mega cap consumer electronics firm explained to investors that its sales in China would be much weaker than previously forecast. Blaming the outcome on a slowing Chinese economy, management tried to highlight growth elsewhere, but all for naught. The market response was immediate, with equity markets falling sharply, including futures in both Europe and the US, and the FX markets picking up where last year’s volatility left off. Notably, with Tokyo still on holiday, the yen exploded more 3.5% vs. the dollar during the twilight hours between New York’s close and Singapore’s open, trading to levels not seen since last March. While it has given back a large portion of those gains, it remains higher by 1.2% in the session, and is more than 5% stronger than when I last wrote. If ever there was a signal that fear continues to pervade markets, the yen’s performance over the past three weeks is surely that signal.

Speaking of slowing Chinese growth, the recent PMI data from China printed below that critical 50.0 level at a weaker than expected 49.4, simply confirming the fears of many. What has become quite clear is that thus far, the trade dispute is having a much more measurable negative impact on China’s economy than on the US economy. This has prompted the PBOC to ease policy further overnight, expanding the definition of a small company to encourage more lending to that sector. Banks there that increase their loans to SME’s will see their reserve requirements reduced by up to a full percentage point going forward. (One thing that is very clear is there is no pretense of independence by the PBOC, it is a wholly owned operation of the Chinese government and President Xi!) I guess China is the first central bank to back away from policy normalization as the PBOC’s previous efforts to wring excess leverage out of the system are now overwhelmed by trying to add back that leverage! Look for the ECB to crack soon, and the Fed not far behind.

And while the rest of the FX market saw some pretty fair activity, this was clearly the key story driving activity. The funny thing about the euro is that there are mixed views as to whether the euro or the dollar is a better safe haven, which means that in risk-off scenarios like we saw last night, EURUSD tends not to move very far. Arguably, its future will be determined by which of the two central banks capitulates to weaker data first. (My money continues to be on the ECB).

This week is a short one, but we still have much data to come, including the NFP report tomorrow. So here is a quick update of what to expect today and tomorrow:

Today ADP Employment 178K
  Initial Claims 220K
  ISM Manufacturing 57.9
  ISM Prices Paid 58.0
Friday Nonfarm Payrolls 177K
  Private Payrolls 175K
  Manufacturing Payrolls 20K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.5

Tomorrow we also hear from Fed Chair Powell, as well as two other speakers (Bullard and Barkin) and then Saturday, Philly Fed President Harker speaks. At this point, all eyes will be on the Chairman tomorrow as market participants are desperate to understand if the Fed’s reaction function to data is set to change, or if they remain committed to their current policy course. One thing that is certain is if the Fed slows or stops the balance sheet shrinkage, equity markets around the world will rally sharply, the dollar and the yen will fall and risky assets, in general, should all benefit with havens under pressure. At least initially. But don’t be surprised if the central banks have lost the ability to drive markets in their preferred long-term direction, even when explicitly trying to do so!

Good luck
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