Monthly Archives: February 2019

The Market’s Malaise

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Said Trump we might wait sixty days
Before, Chinese tariffs, we raise
Since talks have gone well
There’s no need to sell
Thus ended the market’s malaise

The US-China trade talks continue to dominate the news cycle with the latest news being President Trump’s comments that a sixty-day delay before imposing further tariffs is being considered. While this had been mooted by many analysts, including me, it still was sufficient to help boost the equity market in the US yesterday afternoon. Interestingly, it also seemed to boost the dollar, which rallied throughout yesterday’s session. Clearly, if the Chinese trade situation gets settled, which I continue to believe is quite difficult, it is a net positive for the global economy. But don’t forget that the President is also looking at tariffs on the European auto sector, as well as is maintaining tariffs on imported aluminum and steel, so all is not clear yet. But certainly, the China story has received top billing of late.

The other big story, Brexit, has had less press lately (at least outside the UK) as the ongoing machinations of the British Parliamentary process remain obscure to almost everyone else. The current argument seems to be that a bloc of EU skeptics wants to ensure that the option of a no-deal Brexit remains on the table as a negotiating tactic. You can’t really blame the EU for getting frustrated as the UK has not yet provided a united front as to their demands. But with that said, ultimately it will come down to the Irish backstop and how that can be tweaked to get enough support by the UK. It’s still a game of chicken. Elsewhere in the UK, MPC member Gertjan Vlieghe, one of the more dovish by reputation, commented that a hard Brexit was unlikely to require higher rates as Governor Carney had mentioned previously. That has been my stance all along, and I continue to see the UK leaning toward cutting rates as growth continues to ebb there.

Speaking of ebbing growth, German GDP in Q4 printed at 0.0%, no growth at all. If you recall, Q3 growth there was -0.2%, so they barely avoided a technical recession. While many analysts continue to point to a series of one-off circumstances that drove the poor performance, it remains pretty clear that the underlying growth impulse is under downward pressure. We saw this when the IMF and the European Commission both significantly reduced their forecasts for 2019 GDP growth in Germany, as well as throughout the Eurozone. Today’s data did nothing to change any views on that issue. Regarding the impact on the euro, while it is unchanged today, that is after a 0.5% decline yesterday and a more than 2% decline this month. In the end, the relative situation continues to favor the dollar over the euro in my view.

Japan released GDP data last night as well, with Q4 growth rebounding to a 1.4% annual rate after a sharp decline in Q3. Here, too, Q3 was blamed on idiosyncratic features, but the underlying features of this report show slowing consumption and softening external demand. The yen has been moving in lock-step with the euro, having fallen pretty steadily all month and is down a bit more than 2.0% as well. The difference between the euro and the yen, however is that the yen retains its haven status, and if the deterioration of economic growth continues and we start pushing toward recession, I see the yen outperforming going forward.

Stepping back and looking at the broad picture of the dollar this morning, it is modestly higher, with gains against some EMG currencies (INR, RUB, BRL), but weakness against both Aussie and Kiwi. In the end, the major currencies have done little although it seems the dollar continues to have legs, even in the short term.

On the data front, yesterday’s CPI data came in just a touch firmer than expected, with the core number unchanged at 2.2% rather than the expected 0.1% decline. This morning brings PPI, which nobody is really going to care about given we already got CPI, and Retail Sales, which have been delayed by the shutdown. Expectations there are for a 0.2% rise with a 0.1% rise ex autos. Yesterday we also heard from three Fed speakers, all of whom expressed confidence the economy was solid, and today we hear from one more. As I have recently written, the Fed message has been very consistent lately, growth is solid, inflation pressures remain tame and there is no reason to raise rates further. As long as that remains the case, it will support asset markets, and likely the dollar.

Good luck
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Great Apprehensions

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In England the rate of inflation
Has fallen despite expectation
By Carney and friends
That recent price trends
Would offer rate hike validation

But markets have turned their attentions
To news of two likely extensions
The deadline on trade
And Brexit charade
Have tempered some great apprehensions

Two key data points lead the morning news with UK inflation falling below the BOE’s 2.0% target for the first time since the Brexit vote while Eurozone IP fell far more sharply than expected. Headline CPI in the UK declined to 1.8% while core remained at 1.9%, with both printing lower than market expectations. Given the slowing economic picture in the UK (remember the slowest growth in six years was reported for Q4 and 2018 as a whole), this cannot be that much of a surprise. Except, perhaps, to Governor Carney and his BOE brethren. Carney continues to insist that the BOE may need to raise rates in the event of a hard Brexit given the possibility of an inflation spike. Certainly, there is no indication that is likely at the present time, but I guess anything is possible. Granted he has explained that nothing would be done until the “fog of Brexit” has lifted but given the overall global growth trajectory (lower) and the potential for disruption, it seems far more likely that the next BOE move is down, not up. The pound originally sold off on the news but has since reversed course and is higher by 0.3% as I type. Overriding the data seems to be a growing belief that both sides will blink in the Brexit negotiations resulting in a tentative agreement of a slightly modified deal with a few extra months made available to ratify everything. That’s probably not a bad bet, but it is by no means certain.

On the Continent, the data story was also lackluster, with Eurozone IP falling a much worse than expected -0.9% in December and -4.2% Y/Y. It is abundantly clear that Germany’s problems are not unique and that the probability of a Eurozone recession in 2019 is growing. After all, Italy is already there, and France has seen its survey data plummet in the wake of the ongoing Gilets Jaunes protests. However, despite this data, the euro has held onto yesterday’s modest gains and is little changed on the day. The thing is, I still cannot figure out a scenario where the ECB actually raises rates given the economic situation. Even ECB President Draghi has recognized that the risks are to the downside for the bloc’s economy, and yet he is fiercely holding onto the idea that the next move will be higher rates. It won’t be higher rates. The next move is to roll over the TLTRO’s and interest rates will remain negative for as far as the eye can see. There is a growing belief in the market that because the Fed has halted its policy tightening, the dollar will fall. But since every other central bank is in the same boat, the relative impact still seems to favor the US.

Away from those stories, the market continues to believe that a US-China trade deal is almost done. At least, that’s the way equity markets are trading. President Trump’s comment that he would consider extending the March 1 tariff deadline if there was sufficient progress and it looked like a deal was in the offing certainly helped sentiment. But as with the Brexit issue, where the Irish border situation does not offer a simple compromise, the US requests for ending forced technology transfer and IP theft as well as the reduction of non-tariff barriers strike at the heart of the Chinese economic model and will not be easily overcome. It seems that the most likely outcome will be a delay of some sort and then a deal that will have limited long-term impact but will get played up by both sides as win-win. In the meantime, the PBOC will continue to add stimulus to the economy, as will the fiscal authorities, as they seek to slow the rate of decline. And you can be sure that no matter how the economy actually performs, the GDP data will be firmly above expectations.

And those are the big stories. The dollar has had a mixed performance overnight with two currencies making substantial gains, NZD +1.25% and SEK +0.6%, both of which responded to surprises by their respective central banks. The RBNZ left rates on hold, as universally expected, but instead of offering signs of further rate cuts, simply explained that rates would remain on hold for two years before likely rising. This was taken as hawkish and the currency responded accordingly. Similarly, the Riksbank in Stockholm explained that they still see the need for rates to rise later this year despite the current slowing growth patterns throughout Europe. As I had written yesterday, expectations were growing that they would back away from any policy tightening, so the krone’s rally should be no real surprise. But beyond those two stories, movement has been much less substantial in both the G10 and EMG blocs.

This morning’s data brings CPI (exp 1.5% headline, 2.1% core) which will be closely watched by all markets. Any further weakness will likely see another leg higher in equity markets as it will cement the case for the Fed having reached the end of the tightening cycle. A surprise on the high side ought to have the opposite impact, as concerns the Fed might not yet be done will resurface. There are also three Fed speakers, but for now, that message of Fed on hold seems pretty unanimous across the FOMC.

Absent a surprise, my money is on a directionless day today. The dollar’s recent rally has stalled and without a new catalyst will have a hard time restarting. However, there is no good reason to think things have gotten worse for the buck either.

Good luck
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Progress Is Real

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In Beijing, talks focused on trade
Continue as both sides conveyed
That progress is real
With hopes for a deal
Increasing, or so it’s portrayed

Once again, the market is embracing the idea that a trade deal is coming and coming soon. Talks in Beijing have restarted and while yesterday President Trump indicated he would not be meeting Chinese President Xi by month’s end, as had been suggested last week, this morning, Mr Trump expressed a desire to meet with him “very soon”. Investors have taken this to mean that while a deal may not be completed by the initial March 1st deadline, there will be an extension of the truce and no tariff increases at that time. It should be no surprise that the equity market has taken this news well, with Asian stocks generally rallying (Nikkei +2.6%, Shanghai +0.7%), European stocks following suit (DAX + 1.3%, CAC + 1.1%) and US equity futures pointing higher (DJIA + 0.8%, S&P + 0.7%). Adding to the bullishness has been the news that there is a tentative deal in Congress to avoid a second government shutdown. So, all the stars have aligned for the bulls today.

And yet, the data continues to be lackluster with limited prospect to improve in the short run. A random sampling of recent releases shows that UK growth (as mentioned yesterday) was the weakest in six years and shows no signs of picking up ahead of Brexit. But also, Norwegian inflation is sinking along with Mexican IP and the Australian housing market. South African Unemployment remains near a record 27.5% and even the NFIB Survey here at home has fallen to its lowest level since November 2016 (Trump’s election), although it remains much closer to its historic highs than its lows. The point is that despite soothing words from central bank officials that recent weaker data is temporary, it is looking nothing of the sort. I’m not sure when temporary morphs into long-term, but we are now pushing into our fifth consecutive month of slowing global data and the trend shows no signs of abating.

So, what is an investor or a hedger to conclude from all this? Is the trade deal more important? Or is it the ongoing data story? While both of those may have short-term impacts, the reality remains that it is still the central banks that exert the most influence on markets. The Fed’s complete conversion from hawk to dove in six weeks has been THE dominant force in markets since December. Not only has that conversion helped the US markets, but it has dramatically reduced pressure on other nations to maintain their own hawkishness. This can be seen in the BOE, where earlier talk of needing to hike rates in the event of Brexit has abated. It can be seen in the ECB where the conversation has changed from raising rates in the autumn to what other measures of stimulus can they provide given the current negative rates and bloated balance sheet. (TLTRO’s will absolutely be rolled over.) In Scandinavia, both Norway and Sweden have seen inflation data decline and are now seen as far more likely to leave rates on hold rather than raising them as had been expected just a few months ago. And not to be outdone, the PBOC, which had been in the midst of a two-year program to reduce excess leverage in China, has handily turned far more dovish, injecting significant liquidity and ‘encouraging’ banks to make loans to SME’s there. So, in the end, while the trade story may garner headlines for a few more weeks, it remains a central bank controlled world.

As to today, the dollar is dipping slightly after a continued solid rally during yesterday’s session. This has been more evident in the EMG space than in G10. For example, MXN (+0.4%) and BRL (+0.95%) are leading the way in LATAM while INR (+0.7%) and CNY (+0.3%) have benefitted from the dollar’s lackluster performance. And of course, the dovish turn by the Fed has had an especially beneficial impact on EMG currencies since so many companies located there borrow in dollars. The idea that US rates have stopped rising has been one of the biggest changes we have seen.

However, it is important to remember that on a relative basis, US policy remains tighter than that anywhere else in the world, and as it becomes clearer that other central banks will turn more dovish, the dollar should retain its footing.

We have already seen the NFIB data print weaker than expected, and the only other data point today is the JOLT’s Jobs report (exp 6.90M), however, we do hear from Chairman Powell at 12:45 this afternoon, so all eyes will be on him. The thing is, given the data we have seen since the Fed changed course has continue to be weak, I would argue the only surprise can be dovish. In other words, comments hinting that the Fed will end the balance sheet roll-off, or a reevaluation of the neutral rate lower would be the type of thing to start a big rally. In the event that something like that were to occur, look for equities to rocket and the dollar to fall. But given the sudden increase in stories about prices rising in consumer products (yesterday’s WSJ talking about cat litter and detergent, today’s about Whole Foods raising prices), it seems hard to believe that a more dovish tone is likely.

In the end, the dollar has had a good run over the past two weeks. If that is ending, it is entirely reasonable, but don’t look for a collapse.

Good luck
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Brexit’s Impact

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From England and Scotland and Wales
The data is telling us tales
That Brexit’s impact
Is set to subtract
From growth and reduce Retail Sales

With less than seven weeks left before the UK is scheduled to leave the EU, the impact of two years of uncertainty is becoming clearer. This morning’s GDP data showed that growth declined -0.4% in December, dragging the Q4 number down to a below expected 0.2% and a full year number of just 1.4%, its weakest since 2009. As is always the case, uncertainty is the bane of economic activity. While the politics of brinksmanship may make sense in the long run, it is difficult to see the near-term benefits. And brinksmanship appears to be PM May’s last hope at putting in place the agreed deal by the UK Parliament. Despite her renewed efforts at getting the EU to offer some adjustments to the negotiated deal, there has been little willingness evident on the EU side to do so. However, the EU mandarins are not so ignorant as to believe that a hard Brexit will have no impact on their own nations’ economies, it is just that they believe that by holding firm the UK will blink first and Parliament will ratify the deal. I think PM May is of the same opinion. And perhaps they are correct, that is exactly what will happen. However, politics is not an exact science, and it appears there is still a very real probability that a hard Brexit is what we will get.

In the meantime, the market took no succor in this morning’s data, with the pound falling a further 0.35% on the day, increasing its month-to-date decline to 1.7% with the trend still firmly lower. While BOE Governor Carney has claimed repeatedly that he may need to raise rates in the event of a hard Brexit due to a price shock, I continue to believe there is virtually no probability that will occur. The initial negative impact on the economy will overwhelm any inflationary impulse, certainly from a political perspective, if not actually from an economic one. Despite the fact that the Fed appears to be on hold at this time, I would still bet on further policy ease rather than tightness from the BOE.

But the pound is not the only currency suffering this morning, in fact every G10 currency is weaker vs. the dollar as it becomes clearer with each passing day that the ability of central banks to remove policy accommodation from a weakening global economy is becoming more and more restricted. A good example is Norway, where growth has held up reasonably well (1.7% in Q4) but inflation has failed to meet expectations. This morning’s CPI data showed the headline rate fall a more than expected 0.4% to 3.1%. While that is clearly above their target, it is a product of the recent rise in oil prices. On a core basis, inflation is quickly falling back to its 2.0% target, and while the market is still pricing a rate hike for March, it is with less conviction. Another weak reading before the next Norgesbank meeting in March is likely to ice that expectation completely. Tightening into an environment of slowing global growth is extremely difficult for any country, let alone a peripheral oil exporter, to accomplish successfully. As it happens, NOK is lower by 0.55% as I type.

But it is not just G10 currencies under pressure this morning, it is the entire complex of dollar counterparts. EMG has seen broad based, albeit not extreme, weakness. The leading decliner is ZAR, with the rand falling 1.1% after the main electric utility, Eskom, disclosed further power cuts leading to concerns over slowdowns in production and mining. The utility is struggling under a massive debt burden and has been on the edge of bankruptcy for some time. But away from that country specific outcome, the dollar’s gains have averaged on the order of 0.2%-0.3% throughout all three EMG blocs.

Looking ahead to data this week we will see January inflation data as well as the delayed Retail Sales numbers amongst a full slate.

Tuesday NFIB Small Business 103.2
  JOLT’s Job Openings 6.9M
Wednesday CPI 0.1% (1.5% Y/Y)
  -ex food & energy 0.2% (2.1% Y/Y)
Thursday Initial Claims 225K
  PPI 0.1% (2.1% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
  Retail Sales 0.2%
  -ex autos 0.1%
Friday Empire Manufacturing 7.0
  IP 0.1%
  Capacity Utilization 78.7%
  Michigan Sentiment 94.5

We also have nine Fed speeches from six different FOMC members including Chairman Powell tomorrow afternoon. However, the Fed has lately been very consistent with the market clearly understanding that they are on hold for the time being. In fact, the market is beginning to price rate cuts into the curve by the end of this year, although the Fed itself has not indicated anything of the sort. One last Fed note; SF Fed President Mary Daly, in an interview on Friday, indicated that the FOMC was actively discussing the merits of using the balance sheet as part of the ‘regular’ toolkit, not simply keeping it for emergencies when interest rates were at the zero bound. That is a bit ironic given that prior to the financial crisis, the balance sheet was the main feature of how the Fed managed interest rates, increasing or reducing reserves in order to guide interest rates to their desired levels. But in this case, it sounds more like the first oblique embrasure of MMT, the idea that debt monetization is not only fine, but that it is immoral not to manage policy in that manner if there are still unemployed people out there. After all, the only risk is inflation, and they have that under control!!!

I am the first to admit that the dollar’s recent strength has surprised me. While I have maintained that it would eventually strengthen, I did not foresee the market embracing the idea that every other central bank would reverse the tightening bias so quickly. But it has. So for now, the US remains the tightest monetary policy out there, and the dollar is likely to continue to benefit accordingly.

Good luck
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Compromised

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The punditry seemed quite surprised
That trade talks have been compromised
If President’s Xi
And Trump can’t agree
To meet, forecasts need be revised

What then, ought the future might hold?
It’s likely that stocks will be sold
And Treasuries bought
As safety is sought
Plus rallies in dollars and gold

Risk appetites have definitely diminished this morning as evidenced by yesterday’s US equity decline alongside a very weak showing in Asia overnight. The proximate cause is the news that President’s Trump and Xi are not likely to meet ahead of the March 1 deadline regarding increased tariffs on Chinese goods. And while trade talks are ongoing, with Mnuchin and Lighthizer heading to Beijing next week, it seems pretty clear that the market was counting on a breakthrough between the presidents in a face-to-face meeting. However, not unlike the intractable Irish border situation in the Brexit discussions, the question of state subsidies and IP theft forced technology transfer are fundamental to the Chinese economy and therefore essentially intractable for Xi. I have consistently maintained that the market was far too sanguine about a positive outcome in the near-term for these talks, and yesterday’s news seems to support that view.

Of course, eventually a deal will be found, it is just not clear to me how long it will take and how much pain both sides can stand. Whether or not Fed Chair Powell believes he capitulated to Trump regarding interest rates, it is clear Trump sees it in that light. Similarly, it appears the president believes he has the upper hand in this negotiation as well and expects Xi to blink. That could make for a much rockier path forward for financial markets desperate to see some stability in global politics.

The trade news was clearly the key catalyst driving equities lower, but we continue to see weakening data as well, which calls into question just how strong global growth is going to be during 2019. The latest data points of concern are Italian IP (-0.8%, exp +0.4%) and the German trade surplus falling to €13.9B from €20.4B in November. Remember, Germany is the most export intensive nation in the EU, reliant on running a significant trade surplus as part of its macroeconomic policy structure. If that starts to shrink, it bodes ill for the future of the German economy, and by extension for the Eurozone as a whole. While it cannot be too surprising that the Italian data continues to weaken, it simply highlights that the recession there is not likely to end soon. In fact, it appears likely that the entire Eurozone will be mired in a recession before long. Despite the ongoing flow of weak data, the euro, this morning, is little changed. After a steady 1.25% decline during the past week, it appears to have found a little stability this morning and is unchanged on the day.

In fact, lack of movement is the defining feature of the currency markets this morning as the pound, yen, Loonie, kiwi, yuan, rupee and Mexican peso are all trading within a few bps of yesterday’s levels. The only currency to have moved at all has been Aussie, which has fallen 0.25% on continued concerns over the growth prospects both at home and in China, as well as the ongoing softness in many commodity prices.

The other noteworthy items from yesterday were comments from St Louis Fed president Bullard that he thought rates ought to remain on hold for the foreseeable future. Granted, he has been one of the two most dovish Fed members (Kashkari being the other) for a long time, but he was clearly gratified that the rest of the committee appears to have come around to his point of view. And finally, the Initial Claims data printed at a higher than expected 234K. While in the broad scheme of things, that is still a low number, it is higher than the recent four-week average, and when looking at a chart of claims, it looks more and more like the bottom for this number is likely behind us.

A great deal has been written recently about the reliability of the change in the Unemployment rate as a signal for a pending recession. History shows that once the Unemployment rate rises 0.4% from its trough, a recession has followed more than 80% of the time. Thus far, that rate has risen 0.3% from its nadir, and if claims data continues to rise, which given recent numbers seems quite possible, the implication is a recession is in our future. The one thing we know about recessions is that the Fed has never been able to forecast their onset. Given the fact that this recovery is quite long in the tooth, at 115 months of age, it cannot be surprising that a recession is on the horizon. My concern is that the horizon is beneath our feet, not in the distance.

There is no US data to be released today although next week brings both inflation and manufacturing data. But for now, all eyes are on the deteriorating view of the trade situation, which is likely to keep pressure on equity markets (futures are currently pointing lower by 0.5%) while helping support the dollar as risk is continuously reduced.

Good luck and good weekend
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Incessant Whining

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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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More Frustration

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In Europe, the dominant nation
Is starting to feel more frustration
As data implies
They’ll soon demonize
The Chinese US for their degradation

The story in Europe continues to be one of diminishing growth across the board. Early this morning, German Factory Order data was released showing orders unexpectedly fell -1.6% in December after a downwardly revised -0.2% decline in November. Weakness was seen in every sector as both domestic and foreign demand shrank. There is no way to paint this as anything other than a sign of ongoing economic malaise. Once again, I will point out that there is a vanishingly small probability that the ECB will consider raising interest rates later this year, with a far more likely scenario being that further policy ease is on the way. The immediate impact of this data was to see the euro continue its recent decline, having fallen a further 0.2% this morning and now trading back below the 1.14 level.

Speaking of potential further easing of ECB monetary policy, the discussion regarding TLTRO’s is starting to heat up. These (Targeted Long-Term Refinancing Operations) were one of the several ways the ECB expanded their balance sheet during the Eurobond crisis several years ago. The idea was that the ECB made cheap (or even negative rate) liquidity available to Eurozone banks that wanted to fund an increase in their loan books. If the loans qualified (based on the recipients) banks actually got paid to borrow the money from the ECB. So, it was a pretty sweet deal for them, getting paid on both sides of the transaction. Because these loans had initial terms of four and five years, they also counted toward banks’ capital ratios and thus helped reduce their overall cost of funding.

But starting in June, the first of these loans will fall under twelve months until repayment is due, and thus will no longer be able to be counted as long-term capital. As I have written before, there are two possible scenarios: this financing rolls off and banks are forced to fund their outstanding loans in the markets at a much higher price. The result of this will be either slimmer profit margins for the banks, undermining their balance sheets, or they will be forced to raise rates or call in those outstanding loans, neither of which will help the growth story in Europe. The other, far more likely, choice is for the ECB to roll the TLTRO’s over, allowing the banks to maintain their interest rate margins and insuring that there is no tightening of monetary policy in the Eurozone. Given the ongoing weakness in data, which do you think is going to happen? Exactly, they will be rolled over, despite the fact that the ECB is unwilling to commit to that right now. It would be shocking if that is not the outcome!

But the euro is not the only currency to decline this morning, in fact, dollar strength has been pretty widespread. For example, AUD has fallen -1.45% after RBA Governor Lowe explained that the balance of risks for the Australian economy had tilted lower. The market has understood that as a ‘promise’ that future rate hikes have been delayed indefinitely. Aussie’s fall helped drag Kiwi lower as well, with NZD down -0.65%. Meanwhile, the ongoing decline in oil prices, most recently on the back of rising US inventories, has undermined CAD (-0.6%), NOK (-0.4%), MXN (-0.5%) and RUB (-0.4%). Interestingly, the pound, which had been lower earlier, is the one G10 currency that has held its own this morning. Of course, it has been declining steadily for more than two weeks, ever since the last big Parliamentary vote. What appears to be happening is that traders grew to believe that with Parliament taking charge of the negotiations, a deal would be reached, and the risk of a hard Brexit diminished. But funnily enough, Parliament is learning that despite their distaste for the Irish border solution proposed by PM May, there is no obvious better way to address that intractable problem. Traders are starting to lose their confidence that the outcome will be a deal, as despite a universal claim that a hard Brexit should not and cannot happen, it just might happen.

Turning to emerging markets, we have seen weakness across the board there as well. One of the big changes that the Fed has wrought by changing its stance from ongoing hawkishness to apparent dovishness is that many APAC central banks, that had been raising rates steadily alongside the Fed last year, are now backing away from those policies. Last night Bank of Thailand left rates on hold and later this week we will hear from both the Philippines (no change expected) and India (possible 25bp rate cut). Both mark a change from recent policy direction. So, while the dollar suffered in the wake of the Fed’s change, as that sentiment propagates around the world, I expect that the dollar will find its footing. After all, if every central bank is easing policy, the forces driving the FX market will need to be non-monetary. And for now, the US remains the best economy around, despite recent signs of slowing here.

One other story I need to mention is an article in Bloomberg (https://www.bloomberg.com/news/articles/2019-02-06/imf-staff-floats-dual-money-to-allow-much-deeper-negative-rates?srnd=markets-vp) that talks about a paper written at the IMF suggesting the creation of e-money to be issued alongside current cash. E-money would have negative interest rates and an exchange rate with cash which would drive the value of cash lower over time (effectively creating a negative interest rate for holding cash). Given my current role as Chief Strategist at 9th Gear Technologies, I have a particular interest in the concept of e-money, as I do believe cash will become scarcer and scarcer over time. I have also been vocal in my concerns that e-money will result in permanent negative interest rates, and that was before the IMF weighed in with that exact view.

Turning to this morning’s data releases, US Trade data is due (exp -$54.0B) at 8:30, and then we hear from the Fed’s Randall Quarles this afternoon. However, his focus continues to be on regulation, so I don’t anticipate any new monetary policy information. If the news from Asia is the new trend, then expect to see talk of easier money from all around the world, with the Fed, once again becoming the tightest policy around, thus supporting the dollar. I don’t imagine it will happen all at once, as there are still those harping on the Fed’s U-turn, but eventually, the news will be other banks easing while the Fed stands pat.

Good luck
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A Bad Dream

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According to pundits’ new theme
December was just a bad dream
Though Europe’s a mess
And China feels stress
The fallout was way too extreme

The thing is, the data of late
Worldwide has not really been great
The only thing growing
Is debt which is sowing
The seeds of a troubled debate

The dollar has been edging higher over the past several sessions which actually seems a bit incongruous based on other market movements. Equity investors continue to see a glass not half full, but overflowing. Bond yields are edging higher in sync with those moves as risk is being acquired ‘before it’s too late’. But the dollar, despite the Fed’s virtual assurance that we have seen the last of the rate hikes, has been climbing against most counterparts for the past two sessions.

Some of this is clearly because we are getting consistently bad economic data from other countries. For example, last night saw Services PMI data from around the world. In France, the index fell to 47.8, its worst showing in five years. German data printed a slightly worse than expected 53.0, while the Eurozone as a whole remained unchanged at 51.2 It should be no surprise that Italy, which is currently in recession, saw its number fall below 50 as well, down to 49.7. Thus, while Brexit swirls on in the background, the Eurozone economy is showing every sign of sliding toward ever slower growth and inflation. As I have been repeating for months, the ECB will not be tightening policy further. And as the Brexit deadline approaches, you can be sure that the EU will begin to make more concessions given the growing domestic pressure that already exists due to the weakening economy. Net, the euro has decline 0.2% this morning, and is ebbing back to the level seen before the Fed capitulated.

Speaking of Brexit, the UK Services PMI data fell to 50.1, its worst showing in two- and one-half years, simply highlighting the issues extant there. PM May’s strategy continues to consist of trying to renegotiate based on Parliament’s direction, but the EU continues to insist it cannot be done. While very few seem to want a hard Brexit, there has been very little accomplished of late that seems likely to prevent it. And the pound? It has fallen a further 0.2% and is trading back just above 1.30, its lowest level in two weeks and indicative of the fact that the certainty about a deal getting done, or at the very least a delay in any decision, is starting to erode.

With the Lunar New Year continuing in Asia, there is no new news on the trade front, just the ongoing impact of the tariffs playing out in earnings releases and economic reports. But this story is likely to be static until the mooted meeting between the two presidents later this month. My observation is that the market has priced in a great deal of certainty that a deal will be agreed and that the tariff regime will end. Quite frankly, that seems very optimistic to me, and I think there is a very real chance that things deteriorate further, despite the incentives on both sides to solve the problem. The issue is that the US’s trade concerns strike at the very heart of the Chinese economic model, and those will not be easily changed.

Elsewhere, the yen has been falling modestly of late, which is not surprising given the recent risk-on sentiment in markets, but the Japanese economy has not shown any signs that the key concern over inflation, or lack thereof, has been addressed. During December’s equity meltdown, the yen rallied ~4.5%. Since then, it has rebound about half way, and in truth, since equity markets stabilized in the middle of January, the yen has been in a tight trading range. At this point, given the complete lack of ability by the BOJ to impact its value based on monetary policy settings, and given the strong belief that it represents a safe haven in times of trouble (which is certainly true for Japanese investors), the yen is completely beholden to the market risk narrative going forward. As long as risk is embraced, the yen is likely to edge lower. But on risk off days, look for it to rebound sharply.

And that’s really all we have for today. This evening’s State of the Union address by President Trump has the potential to move markets given the contentious nature of his current relationship with the House of Representatives. There is growing talk of another Federal government shutdown in two weeks’ time, although as far as the FX market was concerned, I would say the last one had little impact. Arguably, the dollar’s weakness during that period was directly a result of the change in Fed rhetoric, not a temporary interruption of government services.

At 10:00 this morning the ISM Non-Manufacturing data is released (exp 57.2), which while softer than last month remains considerably higher than its European and Chinese counterparts. Overall, as markets continue to reflect an optimistic attitude, I would expect that any further dollar strength is limited, but in the event that fear returns, the dollar should be in great demand. However, that doesn’t seem likely for today.

Good luck
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Hitting Home

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The current Fed Chairman, Jerome
Initially’d taken the tone
That interest rate hiking
Was to the Fed’s liking
Until hikes began hitting home

Then stock markets round the world crashed
And policymakers’ teeth gnashed
He then changed his mind
And now he’s outlined
His new plan where tightening’s trashed

It’s interesting that despite the fact that the employment report was seen as quite positive, the weekend discussion continued to focus on the Fed’s U-turn last Wednesday. And rightly so. Given how important the Fed has been to every part of the market narrative, equities, bonds and the dollar, if they changed their reaction function, which they clearly have, then it will be the focus of most serious commentary for a while.

But let’s deconstruct that employment report for a moment. While there is no doubt that the NFP number was great (304K, nearly twice expectations, although after a sharply reduced December number), something that has gotten a lot less press is the Unemployment Rate, which rose to 4.0%, still quite low but now 0.3% above the bottom seen most recently in November. The question at hand is, is this a new and concerning trend? If the unemployment rate continues to rise, then the Fed was likely right to stop tightening policy. Yet, most analysts, like politicians, want their cake and the ability to eat it as well. If the Fed has finished tightening because growth is slowing, is that really the outcome desired? It seems to me I would rather have faster growth and tighter policy, a much better mix all around. Now it is too early to say that Unemployment has definitely bottomed, but another month or two of rises will certainly force that to creep into the narrative. And you can bet that will include all the reasons that the Fed better start cutting rates again! Remember, too, if the Fed is turning from tightening to easing, I assure you that the idea the ECB might raise rates is absurd.

Now, with the Fed decision behind us, as well as widely applauded, and the payroll report past, what do we have to look forward to? After all, Brexit is still grinding forward to a denouement in late March, although we will certainly hear of more trials and tribulations before then. I was particularly amused by the idea that the British government has developed plans for the Queen to be evacuated in the event of a hard Brexit. WWII wasn’t enough to evacuate royalty, but Brexit will be? Not unlike Y2K (for those of you who remember that) while a hard Brexit will almost certainly be disruptive in the short run, I am highly confident that the UK will continue to function going forward. The fear-mongering that is ongoing by the British government is actually quite irresponsible.

And of course, there are the US-China trade talks. Except that this week is Chinese New Year and all of China (along with much of Asia) is on holiday. So, there are no current discussions ongoing. But markets have taken heart from the view that President’s Xi and Trump will be meeting in a few weeks, and that they will come to an agreement of some sort. The problem I see is that the big issues are not about restrictions as much as about protection of IP and forced technology transfer. And since the Chinese have consistently denied that both of those things occur, it is not clear to me how they can credibly agree to stop them. The market remains sanguine about the prospects for a trade reconciliation, but I fear the probability of a successful outcome is less than currently priced. While this will not dominate the discussion for another two weeks, be careful when it surfaces again.

Looking ahead to this week, while US data is in short supply, really just trade, we do see more central bank meetings led by the BOE (no change expected), Banxico (no change expected) and Banco do Brazil (no change expected). The biggest risk seems to be in Mexico where some analysts are calling for a 25bp rate cut to 8.00%. We also hear from six Fed speakers, including Chairman Powell again, although at this point, it seems the market has heard all it wants. After all, given Friday’s payroll report, it seems impossible to believe that any Fed member can discuss cutting rates. Not raising them is the best they’ve got for now.

Tuesday ISM Non-Manufacturing 57.1
Wednesday Trade Balance -$54.0B
  Unit Labor Costs 1.7%
  Nonfarm Productivity 1.7%
Thursday Initial Claims 220K
  Consumer Credit $17.0B

So, markets are in a holding pattern while they await the next important catalyst. The stories that have driven things lately, the Fed, Brexit and trade talks are all absent this week. That leads to the idea that the dollar will be impacted by equity and bond markets.

We all know that equity markets had a stellar January and the question is, can that continue? With bond markets also rallying, they seem to be telling us different stories. Equities are looking to continued strength in the economy, while bonds see the opposite. I have to admit, based on the data we continue to see around the world, it appears that the bond market may have it right. As such, despite my concerns over the dollar’s future given the Fed’s pivot, a reversal in equities leading to a risk off scenario would likely underpin the dollar. While it is very modestly higher this morning, it is fair to call it little changed. I think the bias will be for a softer dollar unless things turn ugly. If that does happen, make sure your exposures are hedged as the dollar will benefit.

Good luck
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Really Quite Splendid

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For traders, the month that just ended
Turned out to be really quite splendid
The stock market soared
As risks were ignored
Just like Chairman Powell intended

The problem is data last night
Showed growth’s in a terrible plight
Both Europe and China
Can lead to angina
If policymakers sit tight

Now that all is right with the world regarding the Fed, which has clearly capitulated in its efforts to normalize policy, the question is what will be the driving forces going forward. Will economic data matter again? Possibly, assuming it weakens further, as that could quickly prompt actual policy ease rather than simply remaining on hold. But reading between the lines of Powell’s comments, it appears that stronger than expected data will result in virtually zero impetus to consider reinstating policy tightening. We have seen the top in Fed funds for many years to come. Remember, you read it here first. So, we are now faced with an asymmetric reaction function: strong data = do nothing; weak data = ease.

Let’s, then, recap the most recent data. Last night the Caixin Manufacturing PMI data from China was released at a lower than expected 48.3, its lowest point in three years. That is simply further evidence that the Chinese economy remains under significant pressure and that President Xi is incented to agree to a trade deal with the US. Interestingly, the Chinee yuan fell 0.6% on the news, perhaps the first time in months that the currency responded in what would be considered an appropriate manner to the data. That said, the yuan remains nearly 2% stronger than it began the year. We also saw PMI data from Europe with Germany (49.7) and Italy (47.8) both underperforming expectations, as well as the 50.0 level deemed so crucial, while France (51.2) rebounded and Spain (52.4) continued to perform well. Overall, the Eurozone data slid to 50.5, down a full point and drifting dangerously close to contraction. And yet, Signor Draghi contends that this is all just temporary. He will soon be forced to change his tune, count on it. The euro, however, has held its own despite the data, edging higher by 0.2% so far this morning. Remember, though, with the Fed having changed its tune, for now, I expect the default movement in the dollar to be weakness.

In the UK, the PMI data fell to 52.8, well below expectations, as concerns over the Brexit situation continue to weigh on the economy there. The pound has fallen on the back of the news, down 0.3%, but remains within its recent trading range as there is far more attention being paid to each item of the Brexit saga than on the monthly data. Speaking of which, the latest story is that PM May is courting a number of Labour MP’s to see if they will break from the party direction and support the deal as written. It is quite clear that we have two more months of this process and stories, although I would estimate that the broad expectation is of a short delay in the process beyond March and then an acceptance of the deal. I think the Europeans are starting to realize that despite all their tough talk, they really don’t want a hard Brexit either, so look for some movement on the nature of the backstop before this is all done.

Finally, the trade talks wrapped up in Washington yesterday amid positive signs that progress was made, although no deal is imminent. Apparently, President’s Trump and Xi will be meeting sometime later this month to see if they can get to finality. However, it still seems the most likely outcome is a delay to raising tariffs as both sides continue the talks. The key issues of IP theft, forced technology transfer and ongoing state subsidies have been important pillars of Chinese growth over the past two decades and will not be easily changed. However, as long as there appears to be goodwill on both sides, then there are likely to be few negative market impacts.

Turning to this morning’s data, it is payroll day with the following expectations:

Nonfarm Payrolls 165K
Private Payrolls 170K
Manufacturing Payrolls 17K
Unemployment Rate 3.9%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.5
ISM Manufacturing 54.2
Michigan Sentiment 90.8

Clearly, the payroll data will dominate, especially after last month’s huge upside surprise (312K). Many analysts are looking for a reversion to the mean with much lower calls around 100K. Also, yesterday’s Initial Claims data was a surprisingly high 253K, well above expectations, although given seasonalities and the potential impacts from the Federal government shutdown, it is hard to make too big a deal over it. But as I highlighted in the beginning, the new bias is for easier monetary policy regardless of the data, so strong data will simply underpin a stock market rally, while weak data will underpin a stock market rally on the basis of easier money coming back. In either case, the dollar will remain under pressure.

Good luck and good weekend
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