Completely Dissolved

The last time the FOMC
Sat down to discuss policy
The trade talks were purring
While folks were concurring
A hard Brexit never could be

But since then the world has evolved
And good will completely dissolved
So what they discussed
They now must adjust
If problems are e’er to be solved

It wasn’t too long ago that the Fed was the single most important topic in markets. Everything they said or did had immediate ramifications on stocks, bonds and currencies. In some circles, the Fed, and their brethren central banks, were seen as omnipotent, able to maintain growth by simply willing it higher. A natural consequence of that narrative was that the FOMC Minutes especially, but generally those of all the major central banks, were always seen as crucial in helping to better understand the policy stance, as well as its potential future. But that time has passed, at least for now. Yesterday’s FOMC Minutes were, at best, the third most important story of the day mostly because they opened the window on views that are decidedly out of date. Way back then, three weeks ago, the backdrop was of a slowly resolving trade dispute between the US and China with a deal seeming imminent, growing confidence that a no-deal Brexit was out of the picture, and an equity market that was trading at all-time highs. My how quickly things can change!

To summarize, the Minutes expressed strong belief amongst most members that patience remained the proper stance for now, although a few were concerned about too low inflation becoming more ingrained in the public mind. And then there was a technical discussion of how to manage the balance sheet regarding the tenors of Treasury securities to hold going forward, whether they should be focused in the front end, or spread across the curve. However, no decisions were close to being made. It should be no surprise that the release had limited impact on markets.

The thing is, over the past few sessions we have heard an evolution in some FOMC members’ stance on things, specifically with Bullard and Evans discussing the possibility of cutting rates, although as of now, they are the only two. However, we have heard even some of the more hawkish members willing to imply that rate cuts could be appropriate if the ‘temporary’ lull in the growth and inflation data proves more long-lasting. As has been said elsewhere, while the bar for cutting rates is high, the bar for raising rates is much, much higher. The next move is almost certainly lower.

And what has caused this evolution in thought since the last FOMC meeting? Well, the obvious answers are, first, the sharp escalation in the trade war, with the US raising tariffs on $200B of Chinese imports from 10% to 25% as well as threatening to impose that level of tariffs on the other $325B of Chinese imports. And second, the fact that the Brexit story has spiraled out of control, with further cabinet resignations (today Andrea Leadsom, erstwhile leader of the Tories in the House of Commons quit the Cabinet) adding to pressure on PM May to resign and opening up the potential for a hardline Boris Johnson to become the next PM and simply pull the UK out of the EU with no deal.

In fact, while I have written consistently on both topics over the past several months, the Fed remained the top driver previously. But now, these events are clearly completely outside the control of monetary officials and markets are going to respond to them as they unfold. In other words, look for more volatility, not less going forward.

With that as a backdrop, it can be no surprise that risk is being jettisoned across the board this morning. Equity markets are down around the world (Shanghai -1.4%, Nikkei -0.6%, DAX -1.75%, FTSE -1.4%, DJIA futures -0.9%, Nasdaq futures -1.25%); Treasuries (2.35%) and Bunds (-0.11%) are both in demand with yields falling; and the dollar is back on top of the world, with the yen along for the ride. A quick survey of G10 currencies shows the euro -0.15% and back to its lowest level since May 2017, the pound -0.2% extending its losing streak to 13 consecutive down days, while Aussie and Canada are both lower by 0.25%.

In the emerging markets, despite the fact that the PBOC continues to fix the renminbi stronger than expected, and still below 6.90, the market will have none of it and CNY is lower by a further 0.2% this morning and back above 6.94. Despite higher oil prices RUB and MXN are both softer by 0.6% and 0.4% respectively. CE4 currencies are under pressure with HUF leading the way, -0.4%, but the rest down a solid 0.25%-0.3%. In other words, there is no place to hide.

The hardest thing for risk managers to deal with is that these events are completely unpredictable as they are now driven by emotions rather than logical economic considerations. As such, the next several months are likely to see a lot of sharp movement on each new headline until there is some resolution on one of these issues. Traders and investors will be quite relieved when that happens, alas I fear it will be mid-summer at the earliest before anything concrete is decided. Until then, rumors and stories will drive prices.

Turning to today’s session we see a bit of US data; Initial Claims (exp 215K) and New Home Sales (675K). Tuesday’s Existing Home Sales disappointed and represented the 14th consecutive month of year-on-year declines. Of more interest, we have four Fed speakers (Kaplan, Barkin, Bostic and Daly) at an event and given what I detect is the beginnings of a change in view, these words will be finely parsed. So, at this point the question is will the fear factor outweigh the possible beginning of a more dovish Fed narrative. Unless all four talk about the possibility of cutting rates as insurance, I think fear still reigns. That means the dollar’s recent climb has not ended.

Good luck