Certainty’s Shrinking

The data from yesterday showed
That Services growth hadn’t slowed
But ADP’s number
Showed job growth aslumber
An outcome that doesn’t, well, bode

This morning it’s Mario’s turn
To placate the market’s concern
His toolkit keeps shrinking
And certainty’s sinking
That he can prevent a downturn

The glass is always half-full if you are an equity trader, that much is clear. Not only did they interpret Chairman Jay’s words on Tuesday as a rate cut was coming soon (although he said no such thing), but yesterday they managed to see the combination of strong ISM Non-Manufacturing data (56.9 vs exp 55.5) and weak ADP Employment data (27K vs exp 180K) as the perfect storm. I guess they see booming profits from Services companies alongside rate cuts from the Fed as job growth slows. At any rate, by the end of the day, equity markets had continued the rally that started Tuesday with any concerns over tariffs on Mexican imports relegated to the dustbin of last week.

Meanwhile the Treasury market continues to have a different spin on things with 10-year yields still plumbing multi-year depths (2.10%) while the 5yr-30yr spread blows out to its steepest (88bps) since late 2017. The interpretation here is that the bond market is essentially forecasting a number of Fed rate cuts as the economy heads into recession shortly. It isn’t often that markets have such diametrically opposed views of the future, but history has shown that, unfortunately in this case, the bond market has a better track record than the stock market. And there is one other little tidbit of market data worth sharing, the opposing moves of gold and oil. Last week was only the third time since at least the early 1980’s that gold prices rallied at least 5.2% while oil fell at least 8.7%, an odd outcome. The other two times? Right before the Tech Bubble burst and right before the Global Financial Crisis. Granted this is not a long track record, but boy, it’s an interesting outcome!

The point is, signs that economic growth is slowing in the US are increasing. One thing of which we can be sure is that while slowing growth elsewhere may not lead to a US recession, a US recession will absolutely lead to much slower growth everywhere else in the world. Remember, the IMF just this week reduced their GDP growth forecasts yet again for 2019, and their key concern, the deteriorating trade situation between the US and the rest of the world, is showing no signs of dissipating.

Into this mix steps Mario Draghi as the ECB meets today in Vilnius, Lithuania (part of their annual roadshow). At this point, it is clear the ECB will define the terms of the new TLTRO’s with most analysts’ views looking for very generous terms (borrowing at -0.4%) although the ECB has tried to insist that these will only last two years rather than the four years of the last program. There is also talk of the ECB investigating further rate cuts, with perhaps a tiered structure on which reserves will be subject to the new, lower rate. And there is even one bank analyst forecasting that the ECB will restart QE come January 2020. Futures markets are pricing in a rate cut by Q1 2020, which is certainly not the direction the ECB intended when they changed their forward guidance to ‘rates will remain where they are through at least the end of the year.’ At that time, they were thinking of rate hikes, but that seems highly unlikely now.

With all of this in mind, let us now consider how this might impact the FX market. As I consistently point out, FX is a relative game. This means that expectations for both currencies matter, not just for one. So, the idea that the Fed has turned dovish, ceteris paribus, would certainly imply the dollar has room to fall. But ceteris is never paribus in this world, and as we are likely to hear later today at Draghi’s press conference, the ECB is going to be seen as far more dovish than just recently supposed. (What if the TLTRO’s are for three years instead of two? That would be seen as quite dovish I think.) The point is that while the signs of a weaker US economy continue to grow, those same signs point to weakness elsewhere. In the end, while the dollar may still soften further, as expectations about the Fed race ahead of those about the ECB or elsewhere, that is a short-term result. As I wrote earlier this week, 2% or so further weakness seems quite viable, but not much more than that before it is clear the rest of the world is in the same boat and policy eases everywhere.

FX market activity overnight has shown the dollar to be under modest pressure, with the euro up 0.3% while the pound and most of the rest of the G10 are up lesser amounts (0.1%-0.2%). However, many EMG currencies remain under pressure with MXN -0.75% after Fitch downgraded its credit rating to BBB-, the lowest investment grade, and weakness in ZAR and TRY helping to support the broad dollar indices. But in the big picture, the dollar remains in a trading range as we will need to see real policy changes before there is significant movement.

Turning to this morning’s data, aside from the Draghi presser at 8:30, we also see Initial Claims (exp 215K), the Trade Balance (-$50.7B), Nonfarm Productivity (3.5%) and Unit Labor Costs (-0.8%). But the reality is that, especially after yesterday’s ADP number, all eyes will be on tomorrow’s NFP print. In the event that ADP was prescient, and we see a terrible number, watch for a huge bond market rally and a weaker dollar. But if it is more benign, around the 185K expected, then I don’t see any reason for markets to change their recent tune. Expectations of future Fed rate cuts as ‘insurance’ will help keep the dollar on its back foot while supporting equities round the world.

Good luck