Monthly Archives: July 2019

A Rate Cut’s Assumed

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In Washington DC today
We’ll get to hear from Chairman Jay
A rate cut’s assumed
So, equities boomed
While dollar strength seems here to stay

Markets are on tenterhooks as the release of the FOMC statement approaches. That actually may be overstating the case. The market is highly confident that the Fed is going to cut the funds rate by 25 bps this afternoon as there has not been nearly enough change in the trajectory of the economic data over the past ten days to change any views. During this ‘quiet period’ we have seen solid, if unspectacular economic indicators. Certainly nothing indicating a severe slowdown, but also nothing indicating that the economy is overheating. As well, we have heard from several other central banks, notably the ECB and BOJ, that further policy ease is on the way and they are ready to move imminently. Finally, the whipped cream on this particular decision was released yesterday morning when core PCE data printed at 1.6%, a lower than expected outcome, and sufficient proof that inflation remains too quiescent for the Fed’s liking. At this point, it all seems anticlimactic.

Perhaps of more interest will be the press conference to be held at 2:30, when Chairman Powell will be able to explain more fully the rationale behind cutting rates with an economy running at potential, historically low unemployment and the easiest financial conditions seen in a decade. But hey, inflation is a few ticks low, so that is clearly justification. (As an aside, I find it remarkable that any central bank is so wedded, with precision, to a specific target inflation rate, and that not achieving that target is grounds for policy change. Let’s face it, monetary policy tools are blunt instruments and work with a significant lag. In fact, when a target is achieved, that seems to be more luck than skill. There are a number of central banks that aim for inflation to be within a range, and that seems to make far more sense than setting a 2.0% target and complaining when the rate is at 1.6%.)

In the meantime, there are still a few other things that are impacting markets today, notably the US-China trade talks and the ongoing Brexit story. Regarding the trade talks, the delegations met for two days in Shanghai and made approximately zero headway. The word is they are further apart now than when talks broke down three months ago. Suddenly it is dawning on a lot of people that these trade talks may not be concluded on a politically convenient schedule (meaning in time for the US election). The market impact was a decline in Asian equity indices with the Nikkei falling 0.9%, both Shanghai and Korea falling 0.7%, and the Hang Seng in Hong Kong down 1.3%. However, European indices have barely moved on the day and US futures are pointing higher after Apple beat earnings estimates following the close yesterday. The implication here is that US markets have moved on from the trade story while Asian ones are still beholden to every word. Quite frankly, that seems to be a realistic outcome given the fact that trade represents such a small part of the US economy as opposed to every Asian nation, where it is a major driver of economic activity.

Turning to the Brexit story, the pound plumbed new depths yesterday, trading close to 1.21 before a modest bounce this morning (+0.15%) as Boris continues to hold a hard line on talks. He is pushing very hard for the EU to reopen the existing, unratified deal and will not meet face-to-face with any EU counterparts until they do so. Thus far, the EU has been adamant that the deal is done, and they refuse to change it.

But here’s the first clue that things are going to change; the Bank of Ireland said that a hard Brexit will reduce GDP growth in 2020 to 0.7% from the currently expected 4.1% growth. As I mentioned before, Ireland is on the front lines and will feel the brunt of the early impacts. At some point, probably pretty soon, Taoiseach Leo Varadkar is going to prevail on the rest of the EU to reopen talks before Ireland is crushed. And remember, too, that a no-deal Brexit leaves the EU with a £39 billion hole in their budget as that was to be the UK’s parting alimony payment.

While the EU tries to convince one and all that they hold the upper hand, it is not clear to me that is the case. Working in Boris’s favor was today’s Q2 GDP data from the Eurozone showing growth falling to 0.2% in the quarter with Italy at 0.0%, Spain dipping to 0.5% and France having reported 0.2% yesterday. Germany doesn’t actually report until next month, but indications are 0.0% is the best they can expect. The euro remains under pressure, trading at the bottom of its recent 1.11-1.14 trading range and shows no signs of rebounding. And of course, the fact that the ECB is getting set to ease policy further is not helping the single currency at all. I maintain that despite the Fed’s actions today, unless Powell promises three more cuts soon, the dollar will remain bid.

And those are really today’s stories. Overall, the FX market is pretty benign today, with the largest mover being TRY, which rallied 0.45% as optimism is growing that the economy is stabilizing which means that the current high rates are quite attractive to investors. But away from that, movement has been on the order of 0.10%-0.20% in either direction. In other words, nothing is happening.

On the data front, remember this is payroll week as well, and today we see ADP Employment (exp 150K) and then Chicago PMI (50.6) before the FOMC this afternoon. As earnings season is still underway, I expect equities to respond to that data, but the dollar will likely bide its time until the Fed. After that, nothing has changed my broadly bullish view, although an uber-dovish Powell could clearly do so.

Good luck
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Boris is Fumbling

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The British pound Sterling is tumbling
As traders think Boris is fumbling
His chance to succeed
By forcing, at speed
Hard Brexit with some Tories grumbling

It’s official, the only story of note in the FX markets today is Brexit. Despite central bank meetings and key data, the number one discussion is about how far the pound will fall in the event of a hard Brexit and how high the likelihood of a hard Brexit has become. Since Friday morning, the pound is down by 2.5% and there doesn’t appear to be a floor in the near term. It seems that traders have finally decided that BoJo was being serious when he said the UK would leave the EU with or without a deal come October 31. As such, today’s favorite analyst pastime is to guess how low the pound can fall with a hard Brexit. So far, there has been one estimate of parity with the dollar, although most estimates talk about 1.10 or so. The thing is, while Brexit will clearly be economically disruptive, it seems to me that the warnings of economic activity halting are vastly overstated for political reasons. After all, if you voted Remain, and you are in the media (which was largely the case) then painting as ugly a picture as possible suits your cause, whether or not it is based on factual analysis or fantasy.

But let’s discuss something else regarding the potential effects of a hard Brexit; the fears of a weaker currency and higher inflation. Are these really problems? Is not every developed country (and plenty of emerging ones) in the world seeking to weaken their currency through easier monetary policy in order to gain a competitive advantage in trade? Is not every developed country in the world complaining that inflation is too low and that lowered inflation expectations will hinder central bank capabilities? Obviously, the answer to both these questions is a resounding ‘YES’. And yet, the prospects of a weaker pound and higher inflation are seen as devastatingly bad for the UK.

Is that just jealousy? Or is that a demonstration of central bank concern when things happen beyond their control. After all, for the past decade, central banks have basically controlled the global economy. Methinks they have gotten a bit too comfortable with all that power. At any rate, apocalyptic scenarios rarely come to pass, and in fact, my sense is that while the pound can certainly fall further in the short run, we are far more likely to see the EU figure out that they don’t want a hard Brexit after all, and come back to the table. While a final agreement will never be finished in time, there will be real movement and Brexit in name only as the final details are hashed out over the ensuing months. And the pound will rebound sharply. But that move is still a few months away.

Away from Brexit, there has been other news. For example, the BOJ met last night and left policy rates on hold, as universally expected, but lowered their inflation forecast for 2019 to 1.0%, which is a stretch given it’s currently running at 0.5%. And their 2.0% target is increasingly distant as even through 2022 they see inflation only at 1.6%. At the same time, they indicated they will move quickly to ease further if necessary. The problem is they really don’t have much left to do. After all, they already own half the JGB market, and have bought both corporate bonds and equities. Certainly, they could cut rates further, but as we have learned over the past ten years, ZIRP and NIRP have not been all that effective. With all that said, the yen’s response was to rise modestly, 0.15%, but basically, the yen has traded between 107-109 for the past two months and shows no signs of breaking out.

We also saw some Eurozone data with French GDP disappointing in Q2, down to 0.2% vs. 0.3% expected, and Eurozone Confidence indicators were all weaker than expected, noticeably Business Confidence which fell to -0.12 from last month’s +0.17 and well below the +0.08 expected. This was the weakest reading in six years and simply highlights the spreading weakness on the continent. Once again I ask, do you really think the EU is willing to accept a hard Brexit with all the disruption that will entail? As to the euro, it is essentially unchanged on the day. Longer term, however, the euro remains in a very clear downtrend and I see nothing that will stop that in the near term. If anything, if Draghi and friends manage to be uber-uber dovish in September, it could accelerate the weakness.

Away from the big three, we are seeing weakness in the Scandies, down about 0.5%, as well as Aussie and Kiwi, both lower by about 0.25%. Interestingly, the EMG bloc has been much less active with almost no significant movement anywhere. It appears that traders are unwilling to do anything ahead of tomorrow’s FOMC statement and Powell’s press conference.

On the data front this morning we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (0.2%, 1.7% Y/Y), Case-Shiller Home Prices (2.4%) and Consumer Confidence (125.0). Arguably, the PCE data is most important as that is what the Fed watches. Also, given that recent CPI data came in a tick higher than expected, if the same thing happens here, what will that do to the insurance cut narrative? The point is that the data of late has not warranted talk of a rate cut, at least not the US data. But will that stop Powell and company? The controlling narrative has become the Fed must cut to help the rest of the world. But that narrative will not depreciate the dollar very much. As such, I remain generally bullish the dollar for the foreseeable future.

Good luck
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More Clear

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The contrast could not be more clear
Twixt growth over there and right here
While Europe is slowing
The US is growing
So how come a rate cut is near?

It seems likely that by the time markets close Friday afternoon, investors and traders will have changed some of their opinions on the future given the extraordinary amount of data and the number of policy statements that will be released this week. Three major central banks meet, starting with the BOJ tonight, the Fed tomorrow and Wednesday and then the BOE on Thursday. And then there’s the data download, which includes Eurozone growth and inflation, Chinese PMI and concludes with US payrolls on Friday morning. And those are just the highlights. The point is that this week offers the opportunity for some significant changes of view if things don’t happen as currently forecast.

But before we talk about what is upcoming, perhaps the question at hand is what is driving the Fed to cut rates Wednesday despite a run of better than expected US economic data? The last that we heard from Fed members was a combination of slowing global growth and business uncertainty due to trade friction has been seen as a negative for future US activity. Granted, US GDP grew more slowly in Q2 at 2.1%, than Q1’s 3.1%, but Friday’s data was still better than expected. The reduction was caused by a combination of inventory reduction and a widening trade gap, with consumption maintaining its Q1 pace and even speeding up a bit. The point is that things in the US are hardly collapsing. But there is no doubt that growth elsewhere in the world is slowing down and that prospects for a quick rebound seem limited. And apparently, that is now the driving force. The Fed, which had been described as the world’s central bank in the past, seems to have officially taken on that mantle now.

One fear of this action is that it will essentially synchronize all major economies’ growth cycles, which means that the amplitude of those cycles will increase. In other words, look for higher highs and lower lows over time. Alas, it appears that the first step of that cycle is lower which means that the depths of the next recession will be wider and worse than currently expected. (And likely worse than the last one, which as we all remember was pretty bad.) And it is this prognosis that is driving global rates to zero and below. Phenomenally, more than 25% of all developed market government bonds outstanding now have negative yields, something over $13.4 Trillion worth. And that number is going to continue to grow, especially given the fact that we are about to enter an entirely new rate cutting cycle despite not having finished the last one! It is a strange world indeed!

Looking at markets this morning, ahead of the data onslaught, shows that the dollar continues its winning ways, with the pound the worst performer as more and more traders and investors begin bracing for a no-deal Brexit. As I type, Sterling is lower by 0.55%, taking it near 1.23 and its lowest point since January 2017. As long as PM BoJo continues to approach the EU with a hard-line stance, I expect the pound to remain under pressure. However, I think that at some point the Irish are going to start to scream much louder about just how negative things will be in Ireland if there is no deal, and the EU will buckle. At that point, look for the pound to turn around, but until then, it feels like it can easily breech the 1.20 level before summer’s out.

But the dollar is generally performing well everywhere, albeit not quite to the same extent. Rather we are seeing continued modest strength, on the order of 0.1%-0.2% against most other currencies. This has been the pattern for the past several weeks and it is starting to add up to real movement overall. It is no wonder that the White House has been complaining about currency manipulation elsewhere, but I have to say that doesn’t appear to be the case. Rather, I think despite the international community’s general dislike of President Trump, at least according to the press, investors continue to see the US as the destination with the most profit opportunity and best prospects overall. And that will continue to drive dollar based investment and strengthen the buck.

Away from the FX markets, we have seen pretty inconsequential movement in most equity markets with two exceptions (FTSE +1.50% on the weak pound and KOSPI -1.8% on increasing trade issues and correspondingly weaker growth in South Korea). As to US futures markets, they are pointing to essentially flat openings here this morning, although the earnings data will continue to drive things. And bond markets have seen similarly modest movement with most yields within a basis point or two of Friday’s levels. Consider two bonds in Europe in particular; Italian 10-year BTP’s yield 1.54%, more than 50bps less than Treasuries, and this despite the fact that the government coalition is on the rocks and the country’s fiscal situation continues to deteriorate amid a recession with no ability to cut rates directly; and Greek 10-year yields are 2.05% vs. 2.08% for US Treasuries! Yes, Greek yields are lower than those in the US, despite having defaulted on their debt just 7 years ago! It is a strange world indeed.

A look at the data this week shows a huge amount of information is coming our way as follows:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.3%
  Core PCE 1.7%
  Case-Shiller Home Prices 2.4%
  Consumer Confidence 125.0
Wednesday ADP Employment 150K
  Chicago PMI 50.5
  FOMC Rate Decision 2.25% (-25bps)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 214K
  ISM Manufacturing 52.0
  ISM Prices Paid 49.6
  Construction Spending 0.3%
Friday Trade Balance -$54.6B
  Nonfarm Payrolls 165K
  Private Payrolls 160K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.2% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Factory Orders 0.8%
  Michigan Sentiment 98.5

And on top of that we see Chinese PMI data Tuesday night, Eurozone GDP and Inflation on Wednesday and a host of other Eurozone and Asian data releases. The point is it is quite possible that the current view of the world changes if the data shows a trend, especially if that trend is faster growth. Right now, the default view is global growth is slowing with the question just how quickly. However, a series of strong prints could well stop that narrative in its tracks. And ironically, that is likely the best opportunity for the dollar to stop what has been an inexorable, if slow, climb higher. However, the prospects of weak data elsewhere are likely to see an acceleration of central bank easing around the world with the dollar benefitting accordingly.

In sum, there is an awful lot happening this week, so be prepared for potentially sharp moves on missed expectations. But unless the data all points to faster growth away from the US while the US is slowing, the dollar’s path of least resistance remains higher.

Good luck
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Rates Will Be Hewn

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Inflation remains far too low
In Europe, and so Mario
Has promised that soon
Their rates will be hewn
And, too, will their balance sheet grow

The ECB did not act yesterday, leaving all policy unchanged, but Signor Draghi was quite clear that a rate cut, at the very least, would be coming in September. He hinted at a restart of QE, although he indicated that not everyone was on board with that idea. And he pleaded with Eurozone governments to implement more fiscal stimulus.

That plea, however, is a perfect example of why the Eurozone is dysfunctional. While the ECB, one of the key Eurozone institutions, is virtually begging governments to spend more money, another one of those institutions, the European Commission, is prepared to sanction, and even fine, Italy because they want to spend more money! You can’t make this stuff up. As another example, consider that Germany is running a 1.7% fiscal surplus this year, yet claims it cannot afford to increase its defense spending.

It is this type of contradiction that exemplifies the problem with the Eurozone, and more specifically with the euro. Every nation is keen to accept the benefits of being a member, but none want to assume the responsibilities that come along with those benefits. In other words, they all want the free option. The euro is a political construct and always has been. Initially, countries were willing to cede their monetary sovereignty in order to receive the benefits of a more stable currency. But twenty years later, it is becoming clear that the requirements for stability are greater than initially expected. In a way, the ECB’s policy response of even more NIRP and QE, which should further serve to undermine the value of the single currency, is the only possible outcome. If you were looking for a reason to be long term bearish on the euro, this is the most powerful argument.

Speaking of the euro’s value, in the wake of the ECB statement yesterday morning, it fell 0.3% to 1.1100, its lowest level since mid-May 2017, however, Draghi’s unwillingness to commit to even more QE at the press conference disappointed traders and the euro recouped those early losses. This morning, it is basically right at the same level as before the statement, with traders now turning their focus to Wednesday’s FOMC meeting.

So, let’s consider that story. At this point it seems pretty clear that the Fed is going to cut rates by 25bps. Talk of 50bps has faded as the last several data points have proven much stronger than expected. Yesterday saw a blowout Durable Goods number (+2.0%, +1.2% ex transport) with both being well above expectations. This follows stronger than expected Retail Sales, CPI and payroll data this month, and even a rebound in some of the manufacturing surveys like Philly and Empire State. While the Housing Market remains on its heels, that doesn’t appear to be enough to entice a 50 bp move. In addition, we get our first look at Q2 GDP this morning (exp 1.8%) and the Fed’s favorite inflation data of PCE next week before the FOMC meeting concludes. Strength in any of this will simply cement that any cut will be limited to 25bps. Of course, there are several voting members, George and Rosengren top the list, who may well dissent on cutting rates, at least based on their last comments before the quiet period. Regardless, it seems a tall order for Chairman Powell to come across as excessively dovish given the data, and I would contend that the euro has further to fall as a result. In fact, I expect the dollar has further to climb across the board.

The other big story, of course, is the leadership change in the UK, where PM Boris had his first discussion with EU leaders regarding Brexit. Ostensibly, Boris demanded to discard the Irish backstop and the EU said absolutely not. At this point the EU is counting on a sufficient majority in the UK Parliament to prevent a no-deal Brexit, but there are still three months to go. This game is going to continue for a while yet, but at some point, it is going to be a question of whether Ireland blinks as they have the most to lose. Their economy is the most closely tied to the UK, and given they are small in their own right, don’t have any real power outside the EU. My money is on the EU changing their stance come autumn. In the meantime, the pound is going to remain under pressure as the odds of a no-deal Brexit remain high. This morning it is lower by a further 0.2%, and I see no reason for this trend to end anytime soon.

In other news, Turkey slashed rates 425bps yesterday as the new central bank head, Murat Uysal, wasted no time in the chair responding to President Erdogan’s calls for lower rates. The market’s initial response was a 1.5% decline in the lira, but it was extremely short-lived. In fact, as I type, TRY is firmer by nearly 1.0% from its levels prior to the announcement. Despite the cut, interest rates there remain excessively high, and in a world desperately seeking yield, TRY assets are near the top of the list on both a nominal and real basis.

Beyond that, it is hard to get excited about too much heading into the weekend. While equity markets suffered yesterday after some weak earnings data, futures are pointing to a better opening this morning. Treasuries are virtually unchanged as are gold and oil. So all eyes will be on the GDP data, where strength should reflect in a stronger dollar, but probably weaker equities, as the chance for more than a 25bp cut dissipates.

Good luck
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Thus Far They’ve Failed

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The ECB meeting today
Is forcing its members to weigh
The costs if they wait
To cut the base rate
Vs. benefits if they delay

Their problem is as things now stand
Recovery should be at hand
But thus far they’ve failed
As growth’s been curtailed
From Sicily to the Rhineland

Today brings the first of three major central bank meetings in the next six days as the ECB is currently meeting and the market awaits the outcome. Next week we will hear from both the BOJ and then the Fed, but for now all eyes are turned toward Frankfurt.

Expectations, as measured by the futures market, have moved to a 48% probability of a 10bp rate cut by the ECB this morning, although most of the punditry believe that Signor Draghi will simply lay the groundwork for a cut in September at the next meeting. The arguments for waiting are as follows: given the expectations of a Fed rate cut, with some still holding out hope for 50bps, the market benefits of cutting today would be quickly offset, and one of the few arrows the ECB still has left in its quiver would be wasted. The key benefit they are seeking is a weaker euro, and the concern is that any weakness will be short-lived, especially in the event of a 50bp cut by Powell. Of course, one need only look at the chart to see that the euro has been trending steadily lower for the past year, falling nearly 5% since last July, although as we await the meeting outcome it remains unchanged on the day. It’s not clear to me why else they would wait. After all, the data continues to point to ongoing Eurozone weakness every day. This morning’s example was the German Ifo Business Climate Index, which fell to 95.7, its lowest point since April 2013. It is becoming abundantly clear that Germany is heading into a recession and given Germany’s status as the largest economy in the Eurozone, representing nearly one-third of the total, that bodes ill for the entire bloc.

I maintain that it makes no sense to wait if they know that they will cut next month. They are far better off cutting now, maybe even by 20bps, and using September to restart QE, which is also a foregone conclusion. The funny thing about appointing Madame Lagarde, the uber dove, as the next ECB president, is that she won’t have anything to do once she sits down given the fact that all the easing tools will have been used already. Well, perhaps that is not strictly correct. Lagarde will be able to expand QE to cover, first, bank bonds and then, eventually equities.

(As an aside, for all you capitalists out there, the practice of central banks buying equities should cause great discomfort. After all, they can print as much money as they need to effectively buy ownership in all the public companies in an economy. And isn’t the definition of Socialism merely when the government owns the means of production? It seems to me that central bank equity purchases are a great leap down that slippery slope!)

At any rate, FX markets have largely been holding their breath awaiting the ECB outcome this morning. The same cannot be said of equity markets, where we continue to see records in the US, and markets in both Asia and Europe continue to rally on the idea that lower rates will continue to support stocks. At the same time, bond markets are also still on the march, with Bunds trading to yet another new low, touching -0.46% yesterday, and currently at -0.41%. Treasuries, too, remain bid, with the 10-year yield ticking slightly lower to 2.03%. And in the commodity space, oil prices are firmer after both a surprisingly large inventory draw and the ongoing issues in the Persian Gulf as the UK and Iran duke it out over captured tankers.

With the Brexit story now waiting for its next headlines, which will likely take at least a few days to arrive, and the US-China trade story awaiting next week’s meetings in Beijing, it is central banks all the way as the key market drivers for now. This morning’s Initial Claims (exp 219K) and Durable Goods (0.7%, 0.2% -ex transport) seem unlikely to be key movers.

So Mario, it’s all up to you today. How dovish Draghi sounds will be the key event for today, and likely the impetus behind movement until next Wednesday when Chairman Powell takes the spotlight. Personally, I think he will be far more dovish than the market is currently pricing and we will see the dollar rally further.

Good luck
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The Die Has Been Cast

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So now that the die has been cast
And Boris is PM at last
The window is closing
To set forth composing
A Brexit deal that can be passed

Meanwhile throughout Europe the tale
Shows Draghi is likely to fail
In rekindling growth
While he and Jay both
Find prices their great big White Whale

By the end of the day, Queen Elizabeth II will install Alexander Boris de Pfeffel Johnson as Prime Minister of the United Kingdom. After naming a new cabinet, he will make his first speech and will certainly reiterate that, regardless of the status of negotiations with the EU, the UK will be leaving on October 31. While all of these things had been widely anticipated, their reality sets in motion a potentially turbulent three months. Given the overall weakening growth impulse in the UK economy and the ongoing political intrigue, there is not much to recommend owning the pound right now. Interestingly, however, it is firmer by 0.3% this morning on a combination of a slight uptick in Mortgage Approvals, demonstrating that perhaps the UK housing market is not completely dead, as well as some ‘buy the news’ activity after a prolonged decline in the currency.

Looking ahead, it appears that the only thing that will help rally the pound in any significant manner would be a clear change of heart by the EU regarding reopening negotiations on Brexit. And while, to date, the EU has been adamant that will not occur, one need only look at the continuing slide in the Eurozone economy to recognize that the EU cannot afford a major shock, like a no-deal Brexit, to occur without falling into a continent wide recession.

Which leads to the other key story of the day, the absolutely abysmal Eurozone PMI data that was released earlier this morning. While these are all flash numbers, they paint a very dark picture. For example, German manufacturing PMI fell to 43.1, well below last month’s 45.0 as well as consensus expectations of 45.1. In fact, this was the lowest point since seven years ago during the Eurozone crisis just before Signor Draghi’s famous “whatever it takes” comments. And while the Services number fell only slightly, to 55.4, the Composite result was much worse than expected at 51.4 and pointing toward a real possibility of a technical recession in Germany. French data was similarly downbeat, with Manufacturing falling to 50.0 and the composite weak, with the same being true for the Eurozone data overall.

Given the data, it is no surprise that the euro has edged even lower, down a further 0.1% this morning after a 0.5% decline in yesterday’s session. Interestingly, there are still a large number of pundits who believe that the ECB will stay on the sidelines tomorrow at their meeting, merely laying the groundwork for action in September. However, that continues to be a baffling stance to me, especially when considering that Mario Draghi is still in charge. This is a man who has proven willing, time and again (see: whatever it takes”), to respond quickly to perceived threats to economic stability in the Eurozone. There is no good reason for the ECB to wait in my view. Whether or not the Fed cuts 50 next week (they won’t) is hardly a reason to fiddle while Europe burns. Look for a 10bp cut tomorrow, and perhaps another 10 bps in September along with the announcement for more QE. And don’t be surprised if QE evolves into bank bonds or even equities. Frankly, I think they would be better off writing everyone in the Eurozone a check for €3000 and print €1 trillion that way. At least it would boost consumption to some extent! However, central bankers continue to work with their blinders on and can only see one way to do things, despite the fact that method has proven wholly insufficient.

As to the rest of the market, Aussie PMI data continued to decline, dragging the Aussie dollar down with it. This morning, AUD is lower by 0.35% and back below 0.70 again. With more rate cuts in the offing, I expect it will remain under pressure. Japan, on the other hand saw PMI data stabilize and actually tick higher on the Services front. This is quite a surprise given the ongoing trade ructions between the US and China, themselves and the US and themselves and South Korea. But despite all that, the data proved resilient and, not surprisingly, so did the yen, rallying 0.15% overnight. The thing about the yen is that since the beginning of June it has merely chopped back and forth between 107 and 109. The BOJ’s big concern is that given the relative lack of policy leeway they have as compared to the Fed, that the yen might restart a significant rally, further impairing the BOJ’s efforts at driving inflation in Japan higher. One other thing to remember is that despite the ongoing equity market rally, we have also seen a consistent bid in haven assets. While this dichotomy is highly unusual, it nonetheless implies that there is further room for the yen to appreciate. A move to 105 in the near-term is not out of the question.

But in truth, today’s general theme is lack of movement. The pound is by far the biggest mover, with most other currencies continuing to chop back and forth within 0.1% of yesterday’s closes. It appears that FX traders are awaiting the news from the ECB, the BOJ and the Fed in the next week before deciding what to do. The same is not as true in other markets, where equity bulls continue to rule the roost (corral?) as despite ongoing tepid earnings data, stocks remain bid overall. Bonds, too, are still in demand with Treasury yields hovering just above 2.0%, but more interestingly, Eurozone bonds really rallying. Bunds have fallen to -0.38%, which has helped drag France to -0.11%, but more amazingly, Italy to 1.53% and Greece to 1.97%! That’s right, Greek 10-year yields are lower than US 10-year yields, go figure.

Turning to the data story, yesterday saw the 16th consecutive decline in Existing Home Sales, another -1.7% with New Home Sales (exp 660K) the only data point on today’s docket. The Fed remains in quiet mode which means markets will be all about earnings again today. Some of the bellwether names due to report are AT&T, Boeing and Bank of America. But in the end, FX remains all about monetary policy, and so tomorrow is likely to be far more interesting than the rest of today.

Good luck
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Sans Details

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In England and Scotland and Wales
A new PM finally hails
With Boris the man
We know the game plan
Is Brexit, as yet sans details

As of 7:05 this morning, it was finally official that Boris Johnson was elected as the new leader of the UK’s Conservative and Unionist Party (aka the Tories) by a substantial margin. By all rights, as of tomorrow, he will be the new Prime Minister of the UK. Congratulations Boris!

And so, the Brexit story now takes a new turn as Boris was instrumental in campaigning for the vote three years ago, and has been a vocal supporter ever since, unlike his predecessor, Theresa May. He has been abundantly clear that if the EU does not reopen the negotiations, he will take the UK out of the EU without a deal. Yet to date, the EU has been adamant that the only deal available is the one they have already tabled. Since the beginning, I have maintained that while the UK will certainly be negatively impacted by a no-deal Brexit, the EU will also feel significant pain. This is especially true in northern Europe, with Germany, France and the Netherlands amongst the biggest exporters to the UK. Thus, we are now involved in the biggest game of chicken seen in the global economy in a very long time. (While the politicians describe this as brinksmanship, I think chicken is a better label.) At this point, it is anybody’s guess how things will turn out, but what we do know is that if there really is a no-deal Brexit, the pound will fall much further, the euro will decline, and global growth will slow further.

As it happens, we are already seeing the UK economy slip, with the latest evidence being this morning’s CBI report which printed at a much worse than expected -34, its lowest since the immediate wake of the Brexit vote in 2016. And not surprisingly, the pound remains under pressure, down 0.1% as I type, which makes 2.1% during the past month. In addition, we heard from BOE member Saunders, who confirmed that the BOE default assumption of a smooth Brexit may not be the outcome, and that monetary policy will need to adjust to the new realities in that case. While he continues to fear a stagflationary outcome, there remains little case for the BOE to raise rates anytime soon. The evidence is abundantly clear that in a global rates environment that is declining, there is virtually no chance the UK would tighten policy in any way. Despite the fact that the US has far more room to cut rates than the UK, the problems attendant to Brexit, at least initially, are going to continue to weigh on the pound going forward.

Away from the Brexit story, all eyes are turning toward the ECB meeting to be held in two days’ time in Frankfurt. While most analysts around the world are convinced that Signor Draghi is going to use this meeting to set the table for more action in September, the market is moving toward my view that a rate cut is coming Thursday. OIS markets are pricing in a 40% probability of a 10bp cut, and there are a few outlier analysts who are even calling for 20 bps right away. After all, if you consider what NY Fed president Williams said last week about how, when rates are low, acting aggressively right away is a better strategy than a slow decline in rates, that would argue for 20 bps on Thursday. The other question is whether they will introduce some sort of tiering into the program to allow the European banks, which have been getting killed by the negative rate charges, to exempt some portion of their excess reserves from the penalty rates. That is actually a huge deal, and one where there is very little clarity. In the meantime, despite the fact that the market is certain the Fed is going to cut rates by 25 bps next week, I think the euro has room to fall further in the interim. It is lower by 0.25% this morning, and I expect a move toward 1.10, especially as I believe they will cut Thursday.

As to the rest of the G10, the dollar is broadly stronger, but the magnitude of change remains very modest, on the order of 0.10%-0.20%. In the EMG space, the dollar has also seen broad strength, although here, too, the size of the movement remains muted, with the biggest losers falling just 0.3% (PLN, HUF, IDR). It should be no surprise that markets continue to bide their time as we await the official news from the ECB as well as Friday’s US GDP data, which will clearly play into the FOMC decision next week.

And that’s pretty much today’s story. Equity earnings continue to be released, and it seems that most are beating the lowered expectations that are out there. This has been enough to prevent further equity market damage but has not led to significant gains. On the rate front, Treasuries have been stagnant for the past few sessions with 10-year yields standing at 2.03%, well off the highs seen two weeks ago in a technical sell-off, but certainly with plenty of room to decline from here, especially in the event the Fed does cut 50. We get one piece of data, Existing Home Sales (exp 5.33M), but that seems unlikely to change many views regardless of the outcome. So, my view remains that the dollar’s slow drift higher is still the most likely outcome for now.

Good luck
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The Doldrums

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In summer, the doldrums at sea
Describe lack of activity
The same can be said
As markets stop dead
Awaiting some new policy

Markets remain generally dull this morning as despite what appear to be a number of catalysts to drive things, (tension in the Persian Gulf, increased tension in HK, debt ceiling concerns in the US, etc.) all eyes remain focused on the FOMC meeting next week, and to a somewhat lesser extent, the ECB meeting this Thursday. The Fed is now in their quiet period, meaning we won’t hear anything from any FOMC members until they release the statement on July 31. And remember, the last thing we heard was NY Fed President John Williams explaining that when rates are already low (like they are now) that history shows it is better if a central bank acts preemptively and aggressively when cutting rates. Yes, it’s true that the NY Fed issued a statement afterward explaining that was an academic speech and had nothing to do with current monetary policy discussion, but that doesn’t really matter. The market reaction last week was to ramp up expectations for a 50bp cut next week, and the disclaimer only had a marginal impact.

Meanwhile, virtually every analyst believes that the ECB is merely going to set the table for cutting rates in September, with a number looking for confirmation that they are going to restart QE next January. It seems to me that if they already know they are going to cut rates in September, and they know that the incoming ECB president, Madame Lagarde, is going to be in favor of the move, that there is a pretty good chance they cut rates this week. Markets are not priced for that outcome which means that it would likely have a pretty significant impact on the euro, pushing it lower right away. And consider the situation if the Fed only cuts 25bps, which I continue to believe is the most likely outcome, whereby you would have a more dovish than expected ECB and more hawkish than expected Fed. That will not help the euro, trust me. In addition, on Wednesday, we will see the Flash PMI data from Europe and Thursday, just before the ECB meeting ends, German Ifo data as well. Weakness there could easily be used as a justification for an earlier rate cut. All I’m saying is that the idea that the Fed is starting out on an easing path does not necessarily imply the dollar is going to tumble, despite the President’s wishes.

However, ahead of those meetings, traders are reluctant to maintain large positions, and we have seen trading activity ebb. At least in the FX markets. Looking at current levels, the euro, which is down a marginal 0.10% this morning, is back within pips of the lows seen just before Chairman Powell, in June, explained that the Fed would be cutting rates again soon. So, if the ECB does cut, that could easily help take the euro down to levels last seen in mid 2017. Meanwhile, the pound is today’s worst performing G10 currency, falling a further 1/3 of 1% as the market awaits tomorrow’s announcement as to the results of the Tory leadership contest, the winner of which will become the next UK PM. All signs still point to Boris Johnson, and the market interpretation of that is a greater likelihood of a hard Brexit. Remember, too, that despite all the machinations in Parliament there, Brexit remains the law of the land in the UK, so the efforts to prevent or mollify it actually have an uphill battle.

Away from those two currencies, the dollar is marginally stronger, but the performance is somewhat mixed. For instance, the yen is weaker by 0.2%, but Aussie is stronger by 0.1%, and perhaps that is the message. While there is no broad theme, movement has been limited overall. The same situation exists within the EMG bloc, where there are both gainers and decliners, but none of them have moved very far, certainly not enough to describe a trend.

Looking ahead to the data this week, we see the following:

Tuesday Existing Home Sales 5.33M
Wednesday New Home Sales 660K
Thursday ECB Meeting -0.40%
  Initial Claims 219K
  Durable Goods 0.7%
  -ex transport 0.2%
Friday Q2 GDP 1.8%

Arguably, after the ECB meeting, where a surprise cannot be ruled out, Friday’s first look at Q2 GDP is going to be the most interesting thing we see. There is a pretty wide range of expectations for this number, as there are more and more analysts falling into one of two camps, either recession is coming, or everything is full steam ahead. But more importantly, if the GDP data is weak, look for expectations of a 50bp rate cut next week to be cemented in, while a strong print is likely to see just the opposite; stocks decline, the dollar rise and expectations of a 25bp rate cut only. But until then, the housing data is likely not that interesting, after all that has been a consistently weak sector of the economy, and Durable Goods will be superseded by GDP. So with no speakers on the docket, it should be a pretty dull week until we get to Thursday.

One caveat is that if Jeremy Hunt surprises and wins the Tory contest in the UK, look for the pound to rally a few cents initially. However, there is still little to recommend a sharp rally unless Brexit is canceled, and he has promised to leave as well.

Good luck
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A Half Point’s Preferred

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Said Williams, the Fed must be swift
When acting if growth is adrift
The market inferred
A half point’s preferred
Which gave all stock markets a lift

If there was any doubt that markets are still entirely beholden to the Fed, they should have been removed after yesterday’s price action. First, recall that a number of emerging market central banks cut interest rates, some in a complete market surprise (South Korea), while others were anticipated (Indonesia, South Africa, Ukraine) and yet all of those currencies strengthened on the day. It is always curious to me when a situation like that occurs, as it forces a deeper investigation as to the market drivers. But this investigation was pretty short as all the evidence pointed in one direction; the Fed. Yesterday afternoon, NY Fed President John Williams gave an, ostensibly, academic speech about how central banks should respond to economic weakness and highlighted that they should act quickly and aggressively in such cases. Notably, he said, “take swift action when faced with adverse economic conditions” and “keep interest rates lower for longer.” The market interpretation of those comments was an increased expectation for a 50bp rate cut by the Fed at the end of the month. Stocks reversed early losses, bonds rallied, with yields falling 4bps and the dollar fell as much as 0.5%. While a spokesperson for the NY Fed made a statement later trying to explain that Williams’ speech was not about policy, just academic research, the market remained convinced that 50bps is coming to a screen near you on July 31! We shall see.

The problem with the 50bp theme is that the economic data of late has actually been generally, although not universally, better than expected. Consider that last week, both core CPI (2.1%) and PPI (2.3%) printed a tick higher than expectations; Retail Sales were substantially stronger at 0.4% vs. the 0.1% expected; and both the Empire State and Philly Fed indices printed stronger than expected at 4.3 and 21.8 respectively. Also, the jobs report at the beginning of the month was much stronger than expected. Of course, there have been negatives as well, with IP (0.0%), Housing Starts (-0.9%) and Building Permits (-6.1%) all underperforming. In addition, we cannot forget the situation elsewhere in the world, where China printed Q2 GDP at 6.2%, its lowest print in the 27 years they have been releasing quarterly data, while Eurozone data continues to suffer as well. The implication is that if you assume there is a case for a rate cut at all, the case for a 50bp rate cut relies on much thinner gruel.

At this point, even if we continue to see stronger than expected US data, I believe that Powell and company are locked into a rate cut. Given that futures markets have fully priced that in, as well as the fact that the equity markets are unquestionably counting on that cut, disappointment would serve to truly disrupt markets, potentially impinging on financial conditions and certainly draw the ire of the White House. None of these consequences seem worthwhile for the potential benefit of leaving 25bps of dry powder in the magazine. Add to this the fact that we have heard from several Fed members; Bostic, Kaplan and George, none of whom are enthused about a rate cut at all. Now, of those three, only Esther George is a current voter, but one dissenting vote will not be enough to sway a clearly dovish FOMC. Add it all up and I think we see 25bps when the dust settles. Of course, if that’s the case, it is entirely realistic to see equity prices ‘sell the news’ unless Powell is hyper dovish in the press conference.

And in truth, that is the entire story today. Virtually every story in the financial press focuses on rate cuts, whether the question about the Fed, or the discussion of all the other central banks that have already acted. There is an ongoing argument about whether the ECB actually cuts rates next week, or if they simply prepare the market for a cut in September and the reinstitution of QE in January. Most analysts are opting for the latter, believing that Signor Draghi will wait and see, but if they know they are going to cut, why wait? I think there is a much better chance of immediate action than is being priced into the market.

On the Brexit front, the voting by Tory members continues, and by all accounts, Boris is still in the lead and due to be the next PM. That will continue to pressure the pound, as unless there is further movement by the EU, the chances of a no-deal Brexit will continue to rise. In fact, next week will be quite momentous as we hear from the ECB and get the UK voting results on Thursday.

Away from these stories, most things fall into the background. For example, China Minsheng Group, a major Chinese conglomerate, is defaulting on a $500 million bond repayment due in August. Clearly, this is not a positive event, but more importantly speaks to two specific issues, the lack of US dollar liquidity available in emerging markets as well as the true nature of the slowdown in the Chinese economy. This will be used as further ammunition for the camp that believes the Chinese significantly overstate their economic data.

Turning to this morning’s activity, the only data point is the Michigan Sentiment data (exp 98.5) and we get one more Fed speech, from uber-dove James Bullard. The dollar is stronger today, after yesterday’s afternoon selloff, having risen 0.35% vs. the euro and with gains also against the yen (0.3%), Aussie (0.25%) and most emerging market currencies (MXN 0.3%, ZAR 0.6%, CNY 0.1%). My sense is that yesterday afternoon’s price action was a bit overdone on the dollar, and so we will see more of that unwound ahead of the weekend. Look for modest further USD strength.

Good luck and good weekend
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Could Not Be Severer

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For two years the EU played rough
On Brexit and called every bluff
They forced the UK
To see it their way
And every pushback they’d rebuff

But now that the date’s drawing nearer
And Johnson can’t be any clearer
He’ll walk with no deal
It’s now become real
That Brexit could not be severer

So Barnier finally blinked
Agreeing the Irish were linked
And in a surprise
He talked compromise
Though as yet, no new deal’s been inked

The pound is higher this morning as news that the EU is willing to discuss a compromise for the Irish border has clearly changed the discussion. If you recall, the EU has been adamant that the only deal available is the one that erstwhile PM May negotiated, which includes a section on the Irish border that could easily keep the UK beholden to the EU in perpetuity. Naturally, the Brexiteers were not happy with that outcome and it eventually led to May’s resignation.

The problem for the EU is that Boris Johnson, who is the most likely candidate to become the new PM when results are announced next week, has been abundantly clear that if the EU doesn’t fix the parts of the deal that are controversial, he will take the UK out on October 31 without a deal. And there is no indication he is bluffing. So suddenly the EU has figured out that a no-deal Brexit is a real possibility and that they may no longer have the upper hand. Consider that the UK has already suffered economically during the run-up to the actual exit, while the EU’s suffering has been self-inflicted and not related to Brexit at all. Given the EU’s economy is broadly slowing already, the last thing they need is something like Brexit, which would likely tip the EU into recession if there is no deal. And voila, the EU has finally figured out that they have much to lose in this negotiation.

It should be no surprise that the pound has rallied on the news, although the 0.5% rally is not that impressive. But it’s a start, and if the two sides can come to an agreement on the Irish situation, then there is a real opportunity for the pound to rebound sharply. After all, a smooth Brexit has always been likely to drive the pound back toward 1.40. While it is still way too early to assume that outcome, at least it is back on the table.

The other theme of the overnight session has been central bank rate cuts, with South Korea surprising analysts with a 25bp cut to 1.50% while they lowered forecasts for both growth and inflation for 2019 and 2020. The ongoing trade situation between the US and China is a major headache for the Koreans, and don’t forget they have their own direct trade issue with Japan regarding the Japanese export of key materials for Korean manufacturing. We also saw Indonesia cut rates 25bps, beginning the reversal of the 175bps of rate hikes they implemented in 2018. While growth there remains solid, with inflation falling and forecasts for slowing growth in its key export markets, this was not a great surprise. Analysts are looking for two more cuts this year as well. Interestingly, neither the won nor rupiah weakened on the news, with both currencies firmer by 0.15% when the market closed in Asia time.

And perhaps that is the theme for today, mild dollar weakness despite other nation’s activities. But the operative word is mild. In fact, the pound’s rally, which was also helped by surprisingly robust Retail Sales data, is by far the largest move of the session. Otherwise, in both G10 and EMG spaces, we are seeing some back and forth on the order of 0.10%-0.20%, hardly enough to get excited about.

Clearly, there is much more market discussion on the earnings season as it unfolds in the US. Yesterday’s big news was Netflix, which missed estimates on subscriber growth in Q2 and has seen its stock fall sharply in the aftermarket. But Eurozone equities are under pressure as well after weak results from SAP and Nordea Bank presage further struggles on the continent.

Now here’s something to consider. Right now, the market is fully priced for a Fed cut at the end of the month, and there is a strong expectation that the ECB meeting next week is going to outline its future policy ease. Those have been key drivers in the broad equity market rally we have seen since June, and if either Powell or Draghi disappoints, equity markets are certainly going to suffer. But what if earnings data comes in broadly worse than expected, a la Netflix last night, and equity prices fall regardless of the rate story. After all, by almost every measure, valuations in the US equity space are quite high so a decline may well be due on its own, rate cuts or not. The question is how those same central banks will respond. Will they ease more aggressively to prevent a further decline, or will they ignore the outcome? In the past, this wasn’t really a consideration as central banks were focused only on inflation and employment or growth. But these days I’m not so sure that is the case. Just beware if earnings data start to stumble.

Turning to this morning’s session, there are only two US data points, Initial Claims (exp 216K) and Leading Indicators (0.1%). We also hear from two Fed speakers, Bostic and Williams, although both have already explained their views earlier this week. On that subject, we heard from FOMC voter Esther George yesterday and she has been the first Fed speaker to be clear that there is no reason for a rate cut anytime soon. Now she has always been one of the more hawkish Fed members and it would not shock me if she dissented at the next vote assuming a rate cut is the outcome. Wouldn’t it be interesting if the first dissent under Powell’s tenure was looking for a cut and the second, in the following meeting, was looking to stay on hold? It certainly indicates there is a diversity of opinion at the Fed, at least with regard to the proper policy implementation if not with regard to Keynesianism.

And that’s all there is for today. Earnings data are likely to be the main drivers as neither data point is seen as a market mover. With the dollar on its back foot this morning, I see no reason for it to turn around at this time. Look for a further slow decline.

Good luck
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