As growth there continually slows
The ECB already knows
More policy ease
Will certainly please
The doves, though the hawks will oppose
If you manage to get past Brexit and the US-China trade talks, there are two other themes that are clearly dominating recent economic discussions. The first is the slowing of global growth based on what has been an increasingly long run of disappointing data around the world. Granted part of this is attributed to the ongoing uncertainty over the Brexit outcome, and part of this is attributed to the ongoing uncertainty over the trade talks. But there seems to be a growing likelihood that slowing growth is organic. By that I mean that even without either Brexit or the questions over trade, growth would be slowing. Virtually every day we either see weaker than expected data, or we hear from central bankers that they are closely watching the data to insure their policies are appropriate.
The recent change has been the plethora of those central bankers who are highlighting the weak data and the need to reevaluate what had been tightening impulses. In the past several days we have heard that message from SF Fed President Daly, ECB member Coeuré and ECB member Villeroy, all of whom have pointed out that raising rates no longer seems appropriate. What has been more surprising is that the more hawkish central bankers (Mester and George in the US, Weidmann and Nowotny at the ECB) have not pushed back at all, and instead have subtly nodded their heads in agreement. At this point, my gut tells me that the probability of another rate hike this year by any major central bank is near zero.
This observation leads to the other story which continues to gain ground, with yet another WSJ story on the subject this morning, MMT. Modern Monetary Theory, you may recall, is the post-hoc rationalization that limiting government spending because of silly things like debt and deficits is not merely unnecessary, but actually ‘immoral’ if that spending could be used for benefits like free college tuition or free healthcare for all or a minimum basic wage. It seems that MMT is set to overturn 250 years of economic analysis and upend simple things like supply and demand. The frightening thing about this discussion is that it is being taken very seriously at the highest political levels on both sides of the aisle, which implies to me that we are going to see some changes in the law within the next few years. After all, what politician doesn’t love the idea that they can spend on every harebrained idea and not have to worry about funding it through tax revenues. The guns and butter approach is every elected official’s dream. Borrowing ceilings? Bah, why bother. Deficits growing to 10% or more of GDP? No big deal! The Fed can simply print the money to pay for things and there is no consequence!
Granted, I don’t have 250 years of experience myself, but I do have over 35 years of market experience, and I disagree that there will be no consequences. This time is never different, only the rationales for bad actions change. Ultimately, the question of importance from an FX perspective is, how will currency markets be impacted by these policies? The answer is it will depend on the sequence of timing as different countries adopt them, but I would expect things to go something like this for every country:
Explicit MMT adoption will lead to currency strength as expectations of faster growth will lead to investment inflows. Currency strength will have two results, first MMT proponents will initially claim that the old way of thinking about the economy has been all wrong given that increased supply will lead to a higher priced currency. But the second outcome, which will take a little longer to become evident, will be an increase in inflation and destruction of corporate earnings, both of which will lead to a decided outflow of investment and a much weaker currency. At that point, the available options will be to raise interest rates (leading to recession) or raise taxes (leading to recession). Transitioning from massive fiscal and monetary stimulus, to neither will have a devastating impact on an economy. I only hope that the proponents of this lunacy are held to account during those dark days, but I doubt that will happen.
However, despite my fears that this will occur much sooner than anyone currently expects, it will not be policy this year. Alas, leading up to the 2020 presidential elections, it may look like a good call for Mr. Trump next year.
Let’s move back to today’s markets. After another strong session on Friday, the dollar has given back some of those gains this morning. Friday’s move was on the back of the Coeuré statements that the ECB will be considering rolling over the TLTRO’s, something that I mentioned several weeks ago as a given. But that more dovish rhetoric from the ECB was enough to drive it lower. This morning’s rebound (EUR, GBP and AUD +0.35% each) looks more like profit taking given there has been exactly zero new information in the markets. In fact, all eyes are on the central bank Minutes that will be released later this week as traders are looking for more clarity on just how dovish the central banks are turning. At this point, it feels like there is a pretty consistent view that rate hikes are over everywhere.
What about data this week? In truth, there is very little, with the FOMC Minutes the clear highlight:
|Existing Home Sales||5.00M|
However, we do have six Fed speeches this week from five different FOMC members (Williams speaks twice). Based on all we have heard, there is no reason to believe that the message will be anything other than a continuation of the recent dovishness. In fact, as most of the speeches are Friday, I wouldn’t be surprised to see the dovishness ramped up if Thursday’s data is softer than forecast. That is clearly the direction for now. We also hear from four more ECB speakers, including Signor Draghi on Friday. These, too, are likely to reflect the new dovish tone that is breaking out all over.
In the end, the dollar remains hostage to the Fed first, then other central banks. Right now, the narrative has changed quickly from Fed tightening to a Fed that is willing to wait much longer before getting concerned over potential inflation. Unless other central bankers are really dovish, I expect the market will see the current dialog as a dollar negative. Right up until the point where the ECB flinches and says further ease is necessary. But for today, modest further dollar depreciation seems to be about right.