Incessant Whining

Can someone help me understand
Why euros remain in demand?
Theira growth rate’s declining
While incessant whining
Is constant from Rome to Rhineland

Another day, another failure in Eurozone data. This morning’s culprits were German and Spanish IP, both of which fell sharply. The German outcome was a fourth consecutive monthly decline, with a surprise fall of 0.4%, as compared to expectations for a 0.7% rise. Not only that, November’s release was revised lower to -1.3%. It seems pretty clear that positive growth momentum in Germany has faded. At the same time, Spain, which had been the best growth story in the entire Eurozone, also released surprisingly weak IP data, -6.2%, its largest decline in seven years, and significantly lower than the -2.3% expected. This marks two consecutive months of decline, and three of the past four. It appears that the Spanish growth story is also ebbing.

It should be no surprise that the euro has fallen further, down another 0.3% this morning and back to its lowest levels in two weeks. As I have consistently maintained, FX movements rely on two stories, with the relative strength of one currency’s economy and monetary policy stance compared to the other’s. And while the Fed’s U-turn at the end of January, marked an important point in the market’s collective eyes, thus helping to undermine the dollar strength story, the fact that the European growth story seems to be diminishing so rapidly is now having that same impact on the euro. The EU has reduced, yet again, its growth forecasts for the EU and virtually every one of its member nations. Italy’s forecast was cut to just 0.2% GDP growth in 2019. Germany’s has been cut to 1.1% from a previous forecast of 1.9% in 2019. As I have written repeatedly, the idea that the ECB can tighten policy any further given the economic outlook is fantasy. Look for a reversal by June and either a reinstatement of QE, or forward guidance eliminating any chance of a rate hike before 2021! Rolling over TLTRO’s is a given.

But the euro is not the only currency under pressure this morning, in fact, the dollar, once again, is on the move. The pound, for example, is also down by 0.3% as the market awaits the BOE’s rate decision. There is no expectation for a rate move, but there is a great deal of interest in Governor Carney’s comments regarding the future. Given the ongoing uncertainty with Brexit (which shows no signs of becoming clearer anytime soon), it remains difficult to believe that the BOE can raise rates. This is especially true because the economic indicators of late have all shown signs of a substantial slowdown of UK growth. The PMI data was awful, and growth forecasts by both private and government bodies continue to be reduced. However, despite the fact that the measured inflation rate has been falling back to the 2.0% target more quickly than expected, there is a great deal of discussion amongst BOE members that wages are growing quite quickly and thus are set to push up overall inflation. This continues to be the default mindset of central bankers around the world, as it is built into their models, despite the fact that there is scant evidence in the past ten years that rising wages has fed into measured price inflation. And while it is entirely possible that inflation is coming soon to a store near you, the recent evidence has pointed in the opposite direction. Inflation data around the world continues to decline. Despite Carney’s claims that Brexit may force the BOE to raise rates after a sudden spike higher in inflation, I think that is an extremely low probability event.

In the meantime, the Brexit saga continues with no obvious answers, increasing frustration on both sides, and just fifty days until the UK is slated to exit the EU. Parliament is due to vote on PM May’s Plan B next week, although it now appears that might be delayed until the end of the month. But in the end, Plan B is just Plan A, which was already soundly rejected. At this point, it is delay or crash, and as the pound’s recent decline implies, there are more and more folks thinking it is crash.

Other currency news saw the RBI cut rates 25bps last night in what was a mild surprise. If you recall I mentioned the possibility yesterday, although the majority of analysts were looking for no movement. Interestingly, the rupee actually rallied on the news (+0.2%), apparently on the belief that the new RBI Governor, Shaktikanta Das, has a more dovish outlook which is going to support both growth and the current market friendly government of PM Modi. However, beyond that, the dollar is broadly higher this morning. This is of a piece with the fact that equity markets are generally under pressure after a lackluster decline yesterday in the US; commodity prices have continued their recent slide, and government bonds are firming up with yields in the havens, like Treasuries and Bunds, declining. In addition, the one other currency performing well this morning is the yen. In other words, it appears we are seeing a mild risk-off session

Turning to the data, yesterday’s Trade deficit was significantly smaller than expected at ‘just’ -$49.7B with lower imports the driving force there. Arguably, we would rather see that number shrink on higher exports, but I guess tariffs are having their intended effect. This morning, the only scheduled data is Initial Claims (exp 221K), which jumped sharply last week, but have been averaging about 225K for the past several months. However, given what might be a turn in the Unemployment Rate trend, it is entirely possible that this number starts trending slightly higher. We will need to keep watch.

At this point, the dollar has continued to perform well for the past several sessions and there is no reason to believe that will change. The initial dollar weakness in the wake of the Fed’s more dovish commentary is now being offset by what appears to be ongoing weakness elsewhere in the world. I admit I expected to see the dollar remain under pressure for a longer period than a week, but so far, that’s been the case, one week of softening followed by a rebound with no obvious reason to see it stop. If equity markets continue to underperform, then it seems likely the dollar will remain bid.

Good luck
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