Monthly Archives: July 2019

Appetite’s Whet

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Both Powell and Kaplan agreed
That lower rates are what we need
The table’s now set
And appetite’s whet
For more cuts to soon be decreed

If there was any uncertainty, prior to yesterday, about a rate cut by the Fed at the end of this month, it should be completely eliminated now. Not only did Chairman Jay reiterate that the Fed was “carefully monitoring” the situation (shouldn’t that always be the case?) and that the Fed would use all its available tools to maintain the expansion, but we heard from Dallas Fed President Robert Kaplan that he was turning in favor of a ‘risk management’ cut in order to be sure that things don’t start to turn down soon. Given the integration in the global economy over the past years and given the fact that the US still represents 24% of global GDP, it should be no surprise that things occurring elsewhere in the world have an impact on the US and vice versa. As such, it is not unreasonable for the Fed to try to take the global economic situation into account when determining US monetary policy. And one thing that is clear is that global GDP growth is falling. So folks, we have seen the top in interest rates around the world and the only question is just how quickly they will fall in different jurisdictions.

In a nutshell, that is the FX story. Historically, relative monetary policy has been one of the prime drivers of FX rates, with currencies attached to tight policy appreciating vs. those attached to loose policy. This has been the basis of the carry trade, and arguably, nothing about this process has changed. It’s just that for the first time in memory, pretty much every nation is driving policy in the same direction, in this case looser. This leads to a probable outcome where currency values remain largely stable. After all, if everybody cuts by 25bps, aren’t we all still in the same place?

The irony is that, as discussed by RBA Governor Lowe several weeks ago, if every central bank is cutting rates at the same time, the effectiveness of those rate cuts will be severely diminished. Remember, one of the key transmission mechanisms of rate cuts is to reduce the currency’s value in order to help support trade, and eventually growth. But if everybody cuts, that mechanism will be severely impaired, and so the central banks will be forced to find new tools. And while they are actively looking for new ways to ease policy, in the end, monetary policy is simply some combination of interest rates and money supply. Until now, central banks have focused on managing interest rates. But this is why MMT, or something like it, is a growing possibility. When thoughts turn to money supply as the only other thing to adjust, and as ‘new’ thinking permeates the political class, MMT is going to become increasingly attractive. I’m not sure which nation will be the first to publicly embrace the idea of debt monetization (my money’s on Japan though), but you can be sure that whichever it is will see its currency depreciate sharply, at least until other nations follow their lead. Only time will tell, but that is not a positive future.

With that as a somewhat depressing backdrop, let’s look at market activity. Generally speaking, the dollar has done little this morning after yesterday’s rally. Or perhaps yesterday’s rally was more a function of other currency weakness. Remember, the pound’s decline was all about Brexit, not the US. The euro’s decline was all about weakening economic sentiment in the Eurozone and the idea that the ECB would be acting sooner rather than later. Yesterday also saw the Mexican peso fall sharply, more than 1%, after President Trump tweeted about reimposing tariffs on China. It seems that traders are still nervous over more tariffs, and with the ongoing border situation between the US and Mexico, see any tariff threats as potentially applying to Mexico as well.

But this morning, the biggest movers are RUB and TRY, both recouping about 0.4% of yesterday’s losses. The G10 currencies are within 0.10% of yesterday’s levels and show no sign of breaking out in the near term. Of course, that is subject to another Brexit announcement or comments from central bankers, however, nothing is scheduled on those fronts. Equity markets, too, have had little direction as investors await the next shoe to drop. Interest rate markets remain fully priced for a 25bp rate cut by the Fed in two weeks, while there remains some uncertainty as to just what Signor Draghi will announce next week. I will say that if he did announce a 10bp rate cut, it would have a pretty big impact on the single currency, and not in a positive manner.

As to bonds, both Treasuries and Bunds remain 10-15bps from their recent lows but show no signs of selling off further (higher yields). Rather, those markets are demonstrating all the behavior of a consolidation after a large unwinding move. Given the strong trend lower in central bank policy rates, it seems highly unlikely that yields in the government space, and by extension elsewhere, have anywhere to go but down.

Turning to today’s data, we see Housing Starts (exp 1.261M), Building Permits (1.3M) and then at 2:00 the Fed releases its Beige Book. But we have no more Fed speakers and it seems highly unlikely that any of that will be enough to change any views. One other thing happening this afternoon is the G7 FinMins are meeting in France, but those talks are highly focused on taxation of tech companies with monetary policy a sidelight. After all, everybody is already cutting rates, so what else can they say?

Alas, it appears to be another day with limited cause for FX movement, which for hedgers is great, but for traders, not so much.

Good luck
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Be Prepare for Mayhem

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Next week when the former PM
Steps down be prepared for mayhem
Both Johnson and Hunt
Are willing to punt
May’s deal, which they’re quick to condemn

Remember, back in the day, when I suggested that the probability of a hard Brexit was much higher than the market was assuming? In fact, I have been highlighting this fact pretty consistently since, at least, January heading up to the original deadline. Well, now, it appears that the market is figuring out that the probability of a hard Brexit is higher than they previously assumed. Last night, in a debate between the two candidates for PM, front-runner Boris Johnson and Jeremy Hunt, both were clear that the Irish backstop was dead in the water, and both were clear that they would be willing to walk away with no deal. Ongoing negotiations have become more difficult as the UK is making more demands and the EU is now complaining that the UK is trying to “bully” them! This is the funniest statement that I have ever seen. For two years, the EU essentially bullied PM May into agreeing to things that were unpalatable, including the Irish backstop. Now all of a sudden, the EU’s tender feelings have been hurt by the UK pushing back!

Since the original vote, pundits around the world have assumed that the UK would bear the brunt of the fallout from Brexit. After all, the rest of the EU is the UK’s largest trading partner, and the UK only represents something like 10% of EU exports. But as the EU dips back into recession with monetary policy already stretched, it is becoming clearer that the EU will suffer greatly in a no-deal Brexit. Just ask Germany how its auto manufacturers will be impacted when suddenly there are tariffs on BMW’s in the UK. The point is that both sides are likely to feel pain, although it seems the UK has already absorbed part of it, while the rest of the EU has been laboring under the assumption that the UK would cave in eventually. My view is there is no chance of a deal at this point and there are only two possible outcomes; no-deal Brexit or no Brexit. However, there seems to be limited willingness to hold a second referendum to try to overturn the first one, with major splits within both main parties there. And that leads to a no-deal Brexit. Be prepared.

It should be no surprise that this has had a pretty big impact on the pound this morning, which has fallen by 0.75% to its lowest level since January 2017. And this is despite better than expected employment data where wages grew a stronger than expected 3.6% in May, while the Unemployment rate remained at 45-year lows of 3.8%. While the UK economy seems to be holding up reasonably well, I continue to look for the BOE to cut rates in November after the hard Brexit occurs, if only as a precaution for a quick slowdown. Meanwhile, the pound is likely to continue to decline between now and then, testing 1.20 before long. However, vs. the euro, where the pound has also been sliding, I expect that trend to stabilize and even reverse. This is due to the fact that the Eurozone is going to suffer far more than currently anticipated from a hard Brexit. Right now, the cross is trading at 0.9030. I would look for a move in the euro to 1.05-1.06 and the cross to head down to 0.88.

Away from the Brexit story, things are a bit less exciting on the currency front. Broadly the dollar is strong today, as weaker Eurozone data (German ZEW Sentiment fell more than expected to -24.5) has pundits discussing a recession in Germany and confirming a more aggressive policy ease from the ECB. As such, the euro is lower by 0.3% this morning, as all the dovishness from the Fed is being offset by all the dovishness from ECB members.

Down Under, the RBA Minutes continue to highlight the need to keep policy accommodative as they, too, recognize that their old models need tweaking and that lower rates will not lead directly to further inflation. Aussie, which has actually performed pretty well overall since Powell’s first testimony last week, is lower by 0.2%. While the RBA is likely to remain on hold for now, look for more cuts as soon as the Fed starts to cut.

And those have really been the key drivers in the market today. Looking at the CE4, all of them have fallen roughly the same 0.3% as the euro meaning there is no new information to be gleaned. LATAM currencies are barely budged and APAC has also seen very limited movement overnight. The same can be said of global equity markets, which have seen very limited movement, on the order of 0.2% as investors await the next big story. Arguably, that story will start to be told next week by the ECB, with the punchline added by the FOMC at the end of the month. In the meantime, earnings season is beginning, so individual equity prices are likely to see movement, but it is hard to get excited about a macro move in the near term. And bonds? Well, they have stopped falling as the overly aggressive long positions seem to have been unwound. I expect they will start to rally again, albeit at a slower pace than we saw at the beginning of the month.

This morning brings the most interesting data of the week, Retail Sales (exp 0.1%, 0.1% ex autos), as well as a spate of Fed speakers including Chairman Powell at 1:00 this afternoon. If Retail Sales disappoint already low expectations, look for bonds to rally along with stocks as the dollar falls. If they are quite strong, I think the market is far less prone to react as the July rate cut is still a done deal. It just will have a much smaller probability of being a 50bp cut.

Good luck
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Akin to Caffeine

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There once was a time in the past
Where weakness in growth, if forecast
Resulted in prices
That forewarned a crisis
And traders sold what they’d amassed

But nowadays weakness is seen
As something akin to caffeine
‘Cause central bank measures
Will add to their treasures
It’s like a brand new cash machine

Chinese growth data was weak last night, falling to its lowest quarterly rate in the twenty-seven years that China has measured growth on a quarterly basis. The outcome of 6.2%, while expected, confirms that the ongoing trade situation with the US is having an increasingly negative impact on GDP worldwide. Naturally, not unlike Pavlov’s dogs, the market response was to rally on the theory that the PBOC would be adding more stimulus soon. After all, every other central bank in the world (save Norway’s) is preparing to ease policy further as growth worldwide continues to slow down. And so far, the Pavlovian response of buying stocks on bad news continues to be working as evidenced by the fact that equity markets throughout Asia rose. However, the magnitude of that rise has been quite limited, with gains of between 0.2% and 0.4% the norm. in fact, that market response is actually a bad sign for the central banks, because it demonstrates that the effectiveness of their policies is expected to be much less than in the past. Diminishing returns is a normal outcome for the repeated use of anything, and monetary policy is no different. The implication of this outcome is that despite the growing certainty that the Fed, ECB, BOJ, PBOC, BOE and more are going to ease policy further, equity markets seem unlikely to benefit as much as they have in the past. And if when a recession finally arrives, look for a change of heart in the equity community. But in the meantime, party hearty!

Speaking of further policy ease, it seems the market is chomping at the bit for next week’s ECB meeting, where there are two schools of thought. The conservative view is that Signor Draghi will sound quite dovish and indicate a 10bp cut is coming in September. But that is not nearly as exciting a view as the more aggressive analysts are discussing, which is a 20bp cut next week and the introduction of QE2 in September. Interestingly, despite all this certitude about ECB rate cuts, the euro is actually slightly higher this morning (albeit just 0.1%). It appears that traders are betting on the fact that if Draghi is aggressive, the Fed will have the opportunity the following week to match and outperform the ECB. Remember, the Fed has 250bps of rate cuts before it reaches ZIRP while the ECB is already negative. Despite the recent academic work explaining that negative rates are just fine and helping the situation, it still seems unlikely that we are going to see -2.0% anywhere in the world anytime soon. Ergo, the relative policy stance implies the Fed will ease more and the dollar will suffer accordingly. Just not today. Rather, today, the dollar is little changed overall, with some gains and some losses, but few large moves.

And those have been the real stories of note over what was a very quiet weekend. This week we see a fair amount of data, including Retail Sales, but more importantly, we hear from five more Fed speakers, including Chairman Powell tomorrow, in a total of nine speeches.

 

Today Empire Manufacturing 2.0
Tuesday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.2%
  Capacity Utilization 78.2%
  Business Inventories 0.3%
Wednesday Housing Starts 1.262M
  Building Permits 1.30M
  Fed’s Beige Book  
Thursday Initial Claims 216K
  Philly Fed 5.0
  Leading Indicators 0.1%
Friday Michigan Sentiment 98.5

Given the importance of the consumer to the US economy, the Retail Sales data is probably the most important data point. Certainly, a weak outcome will result in rate cut euphoria, but it will be interesting to see what happens if there is a strong print. But otherwise, this seems more like a week where Fed speakers will dominate, as we hear from NY’s John Williams twice, as well as a mix of other governors and regional presidents. In the end, though, Powell’s comments are key, as I expect he will be looking to fine tune his message from last week’s congressional testimony.

It remains clear that the Fed has the most room to ease policy, and as long as that is the case, the dollar should remain under pressure. However, given the fact that the US economy continues to outperform the rest of the developed world, I don’t anticipate the dollar’s decline to be extreme, a few percent at most.

For today, there is precious little else to really drive things, so look for more of the recent choppiness that we have observed in markets, with no real directional bias.

Good luck
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Soon On the Way

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Said Brainerd and Williams and Jay
A rate cut is soon on the way
Inflation’s quiescent
And growth’s convalescent
So easing will help save the day

We have learned a great deal this week about central bank sentiment from the Fed, the ECB, the BOE, Sweden’s Riksbank as well as several emerging market central banks like Mexico and Serbia. And the tone of all the commentary is one way; easier policy is coming soon to a central bank near you.

Let’s take a look at the Fed scorecard to start. Here is a list of the FOMC membership, voting members first:

Chairman Jerome Powell                – cut
Vice-Chair Richard Clarida             – cut
Lael Brainerd                                    – cut
Randal Quarles                                 – cut
Michelle Bowman                            – ?
NY – John Williams                           -cut
St Louis James Bullard                    – cut
Chicago – Charles Evans                  – cut
KC – Esther George                           – stay
Boston – Eric Rosengren                 – cut

Non-voting members
Philadelphia – Patrick Harker       – cut
Dallas – Robert Kaplan                    – ?
Minneapolis – Neel Kashkari         – cut 50!
Cleveland – Loretta Mester            – stay
Atlanta – Rafael Bostic                    – stay
Richmond – Thomas Barkin          – stay

While we have not yet heard from the newest Governor, Michelle Bowman, it would be unprecedented for a new governor to dissent so early in their tenure. In the end, based on what we have heard publicly from voting members, only Esther George might dissent to call for rates to remain on hold, but it is clear that at least a 25bp cut is coming at the end of the month. The futures market has priced it in fully, and now the question is will they cut 50. At this point, it doesn’t seem that likely to me, but there are still two weeks before the meeting, so plenty can happen in the interim.

But it’s not just the Fed. The ECB Minutes were released yesterday, and the telling line was there was “broad agreement” that the ECB should “be ready and prepared to ease the monetary policy stance further by adjusting all of its instruments.” It seems pretty clear to me (and arguably the entire market) that they are about to ease policy. There are many analysts who believe the ECB will wait until their September meeting, when they produce new growth and inflation forecasts, but a growing number of analysts who believe that they will cut later this month. After all, if the Fed is about to cut based on weakening global growth, why would the ECB wait?

And there were the Minutes from Sweden’s Riksbank, which were released this morning and showed that their plans for raising rates as early as September have now been called into question by a number of the members, as slowing global growth and ongoing trade uncertainties weigh on sentiment. While Sweden’s economy has performed better than the Eurozone at large, it will be extremely difficult for the Riksbank to tighten policy while the ECB is easing without a significant adjustment to the krona. And given Sweden’s status as an open economy with significant trade flows, they cannot afford for the krona to strengthen too much.

Meanwhile, Banco de Mexico Minutes showed a split in the vote to maintain rates on hold at 8.25% last month, with two voters now looking for a cut. While inflation remains higher than target, again, the issue is how long can they maintain current policy rates in the face of cuts by the Fed. Look for rate cuts there by autumn. And finally, little Serbia didn’t wait, cutting 25bp this morning as growth there is beginning to slow, and recognizing that imminent action by the ECB would need to be addressed anyway.

In fairness, the macroeconomic backdrop for all this activity is not all that marvelous. For example, just like South Korea reported last week, Singapore reported Q2 GDP growth as negative, -3.4% annualized, a much worse than expected outcome and a potential harbinger of the future for larger economies. Singapore’s economy is hugely dependent on trade flows, so given the ongoing US-China trade issues, this ought not be a surprise, but the magnitude of the decline was significant. Speaking of China, their trade data, released last night, showed slowing exports (-1.3%) and imports (-7.3%), with the result a much larger than expected trade surplus of $51B. Additionally, we saw weaker than expected Loan growth and slowing M2 Money Supply growth, both of which point to slower economic activity going forward. Yesterday’s other important economic data point was US CPI, where core surprised at 2.1%, a tick higher than expected. However, the overwhelming evidence that the Fed is going to cut rates has rendered that point moot for now. We will need to see that number move much higher, and much faster, to change any opinions there.

The market impact of all this has generally been as expected. Equity prices, at least in the US, continue to climb as investors cling tightly to the idea that lower interest rates equal higher stock prices. All three indices closed at new records and futures are pointing higher across the board. The dollar, too, has been under pressure, as would be expected given the view that the Fed is going to enter an easing cycle. Of course, while the recent trend for the dollar has been down, the slope of the line is not very steep. Consider that the euro is only about 1% above its recent cyclical lows from late April, and still well below the levels seen at the end of June. So while the dollar has weakened a bit, it is quite easy to make the case it remains within a trading range. In fact, as I mentioned yesterday, if all central banks are cutting rates simultaneously, the impact on the currency market should be quite limited, as the relative rate stance won’t change.

Finally, a quick word about Treasury bonds as well as German bunds. Both of these markets were hugely overbought by the end of last week, as investors and speculators jumped on the idea of lower rates coming soon. And so, it should be no surprise that both of these markets have seen yields back up a decent amount as those trades are unwound. This morning we see 10-year yields at 2.13% in the US and -0.21% in Germany, well off the lows of last week. However, this trade is entirely technical and at some point, when these positions are gone, look for yields on both securities to head lower again.

This morning brings just PPI (exp 1.6%, 2.2% core) which is unlikely to have much impact on anything. With no more Fed speakers to add to the mix, I expect that we will continue to see equities rally, and that the dollar, while it may remain soft, is unlikely to move too far in any direction.

Good luck and good weekend
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Half Has Allure

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The Fed Reserve Chairman named Jay
Is tasked, market fears, to allay
He did it in spades
Explaining that trade
And Brexit, could possibly weigh

On growth in the US this year
And so he implied cuts were near
A quarter seems sure
But half has allure
Since price rises never appear

Every market story today is the same story; the Fed is going to cut rates at the end of the month. In fact, the only mystery at this point is whether it will be the 25bps that is currently fully priced in by the futures market, or if the Fed will jump in with a 50bp cut. Every market around the world has felt the impact of this story and will continue to do so until the actual cut arrives.

The knock-on effects have been largely what would be expected from a lower rate environment. For example, equity prices have risen almost everywhere, closing at new record highs in the US yesterday and trading in the green throughout Asia overnight and Europe today. The dollar has fallen back, much to President Trump’s delight I’m sure, giving up some of its recent gains with declines of 0.5% vs. the euro, 0.6% vs. the pound and 0.7% vs. the yen. Emerging market currencies have also rallied a bit with, for example, BRL rising 1.3%, ZAR 1.8% and KRW up 0.8%. Even CNY has rallied slightly, +0.25%, although as we already know, its volatility is managed to a much lower level than other currencies.

Bond markets, on the other hand, have not demonstrated the same exuberance as stocks, commodities (gold +2.0%) or currencies today as they had clearly anticipated the news last week. If you recall, Bunds had traded to new record lows last week, touching -0.41% before reversing course, and are now “up” to a yield of -0.31%. And 10-year Treasuries, after trading to 1.935% a week ago, have since reversed course, picking up nearly 12bps at one point, although have given back a tick this morning. In fact, many traders have been looking at the market technicals and see room for bond yields to trade higher in the short-term, although the long-term trend remains for lower yields.

But those are simply the market oriented knock-on effects. There will be other effects as well. For example, it is now patently clear that a new central bank easing cycle is unfolding. We already knew the ECB was preparing to cut, and you can be sure they will both cut rates and indicate a restarting of QE at their next meeting on July 25. Meanwhile, by that date, Boris Johnson is likely to be the new UK PM which means that the BOE is going to need to prepare for a hard Brexit in a few months’ time. Part of that preparation is going to be lower interest rates and possibly the restarting of QE there as well. In fact, this morning, Governor Carney was on the tape discussing the issues that will impact the UK in the event of a hard Brexit, including slowing growth, lower confidence and weakness in markets. Japan? Well, they never stopped easing, but are likely to feel a renewed sense of urgency to push harder on that string, especially if USDJPY starts to fall more substantially. And finally, of the major economies, China will also certainly be looking to ease monetary policy further as growth there continues to lag desired levels and the trade situation continues to weigh on sentiment. The biggest problem the PBOC has is they have no sure-fire way to cut rates without quickly reinflating the leverage bubble they have been working to reduce for the past three years.

And of course, away from the major central banks, you can be sure that we are going to see easier monetary policy pretty much everywhere else in the world. This is especially true throughout the emerging markets, the countries that have suffered the most from the combination of higher US rates and a stronger dollar.

The irony of all this is that, as RBA Governor Lowe pointed out two weeks ago when they cut rates, if everybody cuts rates at the same time, one of the key transmission mechanisms, a weaker currency, is likely to have far less impact because the relative rate structure will remain the same. This is the reason that the dollar is likely to come under pressure in the short-run, because the Fed has more room to cut rates than most other central banks. But in the end, if everybody reaches ZIRP, currency valuations will need to be decided on other criteria with macroeconomic performance likely to be a key driver. And in the end, the dollar still comes up looking like the best bet.

And that’s really it. Every story is about the Fed cutting rates and how it will impact some other country, market, company, policy, etc.. Brexit is hanging out there, but until the new PM is named, nothing is going to change. The trade talks have restarted, but there is no conclusion in sight. Granted, several individual currencies have suffered of their own accord lately, notably MXN which fell more than 2.0% on Monday after the FinMin resigned due to philosophical differences with President AMLO, and TRY, which fell a similar amount at the end of last Friday after President Erdogan fired the central bank president and replaced him with someone more likely to cut rates. But those are special situations, and in truth, a good deal of those losses have been mitigated by the Fed story. As I said, it is all one story today.

Looking ahead to today’s market, we see our only important data point of the week, CPI (exp 1.6%, 2.0% core) and we also get Initial Claims (223K). But Chairman Powell testifies in front of the Senate today, and we hear from Williams, Bostic, Barkin, Kashkari and Quarles before the day is through as well. Given the Minutes released yesterday indicated a majority of FOMC members were ready to cut this month, it will be interesting to see how dovish this particular group sounds today, especially in the wake of the Chairman’s comments yesterday. Overall, I think the bias will be more dovish, and that the dollar probably has a bit further to fall before it is all over.

Good luck
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Beggar Thy Neighbor

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A story that’s making the rounds
Although, it, so far, lacks real grounds
Is that the US
Might try to depress
The dollar ‘gainst euros and pounds

If so, that’s incredible news
And dollar bulls need change their views
But beggar thy neighbor
Does naught but belabor
The trade war, instead, it, defuse

The most interesting story that has started to gain traction is the idea that the Trump administration is considering direct intervention in the FX markets. While most pundits and investors focus on the Fed and how its monetary policy impacts the value of the dollar (which is completely appropriate), the legal framework in the US is that the Treasury is the department that has oversight of the currency. This means that dollar policy, such as it is beyond benign neglect, is formulated by the Secretary of the Treasury, not the FOMC. This is why the Treasury produces the report about other countries and currency manipulation every six months. Also, this is not a new situation, it has been the case since the abandonment of the Bretton Woods Agreement in 1971.

Since the Clinton Administration, the US policy has been a ‘strong dollar is in the US best interest’. This was made clear by then Treasury Secretary Robert Rubin and has been an accepted part of the monetary framework ever since. The issue with a strong dollar, of course, is that it can be an impediment for US exporters as their goods and services may become uncompetitively priced. Now, during the time when the US’s large trade deficits were not seen as problematic, the strong dollar was not seen as an issue. Clearly, earnings results from multinational corporations were impacted, but the government was not running policy with that as a priority. However, the current administration is far more mercantilist than the previous three or four, and as we have seen from the President’s Twitter feed, dollar strength has moved up the list of priorities.

It is this set of circumstances that has analysts and economists pondering the idea that the Treasury may direct the Fed to intervene directly in the FX market, selling dollars. History has shown that when a country intervenes by itself in the FX market, whether to prevent strength or weakness, it has generally been a failure. The only times when intervention has worked has been when there has been a general agreement amongst a large group of nations that a currency is either too strong or too weak and that intervention is appropriate. The best known examples are the Plaza Accord and the Louvre Accord from the mid-1980’s, where the G7 first agreed that the dollar was overvalued, then that it had reached an appropriate level. The initial announcement alone was able to drive the dollar lower by upwards of 10%, and the active intervention was worth another 5%. The result was a longer term weakening of nearly 40% before it was halted by the Louvre Accord. But other than those situations, for the large freely floating currencies, intervention has been effective at slowing a trend, but not reversing one. And the current dollar trend remains higher.

If the US does decide to intervene directly, this will have an enormous short-term impact on the FX market (and probably all markets) as it represents a significant policy reversal. However, in the end, macroeconomic fundamentals and relative monetary policy stances are still going to drive the value of every currency. With that in mind, it could be a long time before those influences become dominant again. Of course, the other thing is that the history of beggar-thy-neighbor FX policy is one of abject failure, with all nations seeking the same advantage, and none receiving any. Certainly, this is something to keep on your radar.

Away from that story, the dollar is actually stronger this morning, with the euro having breached 1.12, the pound tumbling toward 1.24 and most currencies, both G10 and EMG on the back foot. In fact, this is the problem for the Trump administration on this front, the growth situation elsewhere in the world continues to deteriorate more rapidly than in the US. Not only did Friday’s employment data help support the dollar, but this morning we saw very weak UK and Italian Retail Sales data to add to the economic malaise in those areas. In fact, economists are now forecasting negative GDP growth in the UK for Q2, and markets are pricing in a 25bp rate cut by the BOE before the end of the year. Meanwhile, in the Eurozone, all the talk is about how quickly the ECB is going to restart QE, with new estimates it could happen as soon as September with amounts up to €40 billion per month. While that seems to be a remarkably quick reversal (remember, they just ended QE six months ago), with the prospect of an ECB President Lagarde, who has lauded QE as an excellent policy tool, it cannot be ruled out.

Pivoting to the trade story, the latest news is that senior officials will be speaking by phone this week and the chances of a meeting, probably in Beijing in the next few weeks are rising. The problem is that there are still fundamental differences in world views and unless one side caves, which seems unlikely right now, I don’t see a short-term resolution. What is more remarkable is the fact that the lack of any discernible progress on trade is no longer seen as an issue by any markets. Or at least not a major one. While equity markets have softened over the past two sessions, the declines have been muted and, at least in the US, indices remain near record highs. Bond yields have risen a bit, implying the worst of the fear has passed, although in fairness, they remain incredibly low. But most importantly, the dialog has moved on, with trade no longer seen as the key fundamental factor it appeared to be just two months ago.

Turning to this morning’s news, there is only one data point, JOLT’s Job Openings (exp 7.47M) but of much more importance we hear from Chairman Powell at 8:45 this morning, followed by Bullard, Bostic and Quarles later in the day. Powell begins his testimony to Congress tomorrow morning, but everyone will be listening carefully to see if he is going to try to walk back expectations for the July rate cut that is fully priced into the market. My money is on confirming the cut on the basis of continued low inflation readings. However, given that is the market expectation, there is no reason to believe the dollar will suffer on the news, unless he is hyper dovish. So, the current strong stance of the buck seems likely to continue for the rest of the day.

Good luck
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Some Real Fed Appeasing

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The jobs report Friday suggested
That everyone who has requested
Employment has found
That jobs still abound
And companies are still invested

The market response was less pleasing
At least for the bulls who seek easing
With equities falling
And yields, higher, crawling
Look, now, for some real Fed appeasing

We are clearly amidst a period of ‘good news is bad’ and ‘bad news is good’ within the market context these days. Friday was the latest evidence of this fact as the much better than expected Nonfarm Payroll report (224K vs. 160K expected) resulted in an immediate sell-off in equity and bond markets, with the dollar rallying sharply. The underlying thesis remains that weakness in the US (and global) economy will be sufficient to ensure easier monetary policy, but that the problems will not get so bad as to cause a recession. That’s a pretty fine line to toe for the central banks, and one where history shows they have a lousy record.

However, whether it is good or bad is irrelevant. What is abundantly clear is that this is the current situation. So, Friday saw all three major US indices fall from record highs; it saw 2-year Treasury yields back up 11bps and 10-year yields back up 8pbs; and it saw the dollar rally roughly 0.75%.

The question is, why were markets in those positions to begin with? On the equity side of the ledger, prices have been exclusively driven by expectations of Fed policy. Until the NFP report, not only was a 25bp rate cut priced into Fed funds for the FOMC meeting at the end of the month, but there was a growing probability of a 50bp rate cut. This situation is fraught with danger for equity investors although to date, the bulls have been rewarded. At least the bond story made more sense from a macroeconomic perspective, as broadly weaker economic data (Friday’s numbers excepted) had indicated that both the US and global economies were slowing with the obvious prescription being easier monetary policy. This had resulted in German bunds inverting relative to the -0.40% deposit rate at the ECB as well as US 10-year yields falling below 2.00% for the first time in several years. Therefore, stronger data would be expected to call that thesis into question, and a sell-off in bonds made sense.

And finally, for the dollar, the rally was also in sync with fundamentals as higher US yields, and more importantly, the prospect of less policy ease in the future, forced the dollar bears to re-evaluate their positions and unwind at least some portion. As I have been writing, under the assumption that the Fed does indeed ease policy, it makes sense that the dollar should decline somewhat. However, it is also very clear that the Fed will not be easing policy in a vacuum, but rather be leading a renewed bout of policy ease worldwide. And as the relative interest rate structure equalizes after all the central banks have finished their easing, the US will still likely be the most attractive investment destination, supporting the dollar, but also, dollar funding will still need to be found by non-US businesses and countries, adding to demand for the buck.

With this as a backdrop, the week ahead does not bring much in the way of data, really just CPI on Thursday, but it does bring us a great deal of Fed speak, including a Powell speech tomorrow and then his House and Senate testimony on Wednesday and Thursday. And don’t forget the ECB meeting on Thursday!

Today Consumer Credit $17.0B
Tuesday NFIB Small Biz 105
  JOLT’s Jobs Report 7.47M
Wednesday FOMC Minutes  
Thursday ECB Meeting -0.4%
  Initial Claims 222K
  CPI 0.0% (1.6% Y/Y)
  -ex food & energy 0.2% (2.0% Y/Y)
Friday PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Remember, that on top of the FOMC Minutes to be released Wednesday afternoon, we will hear from seven different Fed speakers a total of thirteen times this week, including Powell’s testimony on Capitol Hill. Amongst this crowd will be the two most dovish members of the FOMC, Bullard and Kashkari, as well as key members Williams and Quarles. It will be extremely interesting to see how these speakers spin the jobs data relative to their seemingly growing bias toward easing. Much has been made of the idea of an ‘insurance’ rate cut, in order to prevent anything from getting out of hand. But Powell will also need to deal with the allegations that he is capitulating to President Trump’s constant demands for lower interest rates and more QE if he comes across as dovish. I don’t envy him the task.

Regarding the ECB meeting, despite continuing weakness in most of the Eurozone data, it feels like it is a bit too soon for them to ease policy quite yet. First off, they have the issue of what type of impact pushing rates even further negative will have on the banking system there. With the weekend news about Deutsche bank retrenching across numerous products, with no end of red ink in sight, the last thing Signor Draghi wants is to have to address a failing major bank. But it is also becoming clearer, based on comments from other ECB members (Coeure and Villeroy being the latest) that a cut is coming soon. And don’t rule out further QE. The ECB is fast becoming desperate, with no good options in sight. Ultimately, this also plays into my belief that despite strong rationales for the dollar to decline, it is the euro that will suffer most.

However, the fun doesn’t really start until tomorrow, when Chairman Powell speaks at 8:45am. So for today, it appears that markets will consolidate Friday’s moves with limited volatility, but depending on just how dovish Powell sounds, we are in for a more active week overall.

Good luck
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More Concern

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Most data of late have been weak
Thus central banks are set to tweak
Their policy rates
As they have mandates
Designed to keep growth at a peak

Now later this morning we’ll learn
If payrolls are starting to turn
Last month’s poor display
And weakness today
Would certainly cause more concern

It’s payroll day in the US and markets have been extremely quiet overnight. In fact, given yesterday’s July 4th holiday here in the US, they have been quiet for two days. However, don’t let the lack of market activity distract you from the fact that there are still a lot of things ongoing in the global economy.

For example, a key question on analysts’ minds has been whether or not a recession is in the offing. Data continues to generally disappoint, with this morning’s sharply lower German Factory Orders (-2.2%) and UK Labor Productivity (-0.5%) as the latest in a long line of crummy results. And given last month’s disappointment on the US payroll front (recall the outcome was 75K vs. the 185K expected) today’s numbers are being closely watched. Here are the current median expectations based on economist surveys:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 0K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.4

A couple of things to note are the fact that the NFP number, even if it comes in at the median expectation, still represents a declining rate of job growth compared to what the US experienced in 2018. This is likely based on two factors; first that this historically long expansion is starting to slow down, and second, that there are less available workers to fill jobs as population growth remains restrained. The other thing to remember is that the Unemployment Report has always been a lagging indicator, looking backwards at how things were, rather than giving direction about the future. The point is that worsening of this data implies that things are already slowing. As I wrote Wednesday, don’t be surprised if when the inevitable recession finally gets determined, that it started in June 2019. I failed to mention the ADP report on Wednesday as a data release, but it, too, disappointed, printing at 102K, some 40K below expectations.

With that as our cheerful backdrop, let’s consider what to expect ahead of the release:

Weaker than expected results – If the NFP number prints at 90K or less, look for equity markets to rejoice as they perceive the Fed will become even more aggressive in their attempts to head off a recession, and the idea of a 50bp rate cut at the end of the month takes hold. Bond markets, too, will soar on the same expectations, while the dollar is likely to give up its overnight gains (granted they were only about 0.2%) as a more aggressive Fed will be seen as a signal to sell the buck. The key conundrum in this scenario remains equities, which continue to rally into weaker economic conditions. At some point, if the economy continues to weaken, the negative impact on earnings is going to outweigh the kneejerk reaction of buying when the Fed cuts, but as John Maynard Keynes reminded us all, ‘markets can stay irrational far longer than you can stay solvent.’

Results on or near expectations – If we see a print in the 120K-180K range, I would expect traders to be mildly disappointed as the call for a more aggressive Fed policy would diminish. Thus equities might suffer slightly, especially given they are sitting at record highs, while bonds are likely to see yields head back toward 2.0%. The dollar, meanwhile, is likely to maintain its overnight gains, and could well see a modest uptick as the idea of more aggressive Fed easing starts to ebb, at least for now.

Stronger than expected results – Any print above 180K will almost certainly, perversely, see a stock market selloff. It is abundantly clear that equity buyers are simply counting on Fed largesse to keep the party going. The market has nothing to do with the fundamentals of the economy or individual company situations. With this in mind, strong data means that the Fed will have no call to cut rates. The result is that the futures market will likely reprice the odds of a rate cut in July lower, perhaps to a 50% probability, while equity traders will take the news as a profit-taking opportunity given the lack of reason for a follow through higher in stocks. Bonds will get tossed overboard as well, as concerns about slowing growth will quickly abate, and a sharp move higher in 10-year yields is entirely realistic. As a point of information, the last time the payroll report was released on July 5th, in 2013, 10-year yields rallied 25bps on a surprising payroll outcome. And remember, technical indicators show that the bond market is massively overbought, so there is ample opportunity for a sharp move. And finally, because of the holiday yesterday, trading desks will have skeleton staffs, further reducing liquidity. Oh yeah, and the dollar will probably see significant gains as well.

The point is that there are two possible outcomes that could see some real fireworks (pun intended) today, so stay on your toes. While one number is just that, a single data point, given the recent trend in place, today’s data seem to have a lot of importance. If pressed, my sense is that the trend of weaker data that has been evident worldwide is going to manifest itself with something like a 50K print, and an uptick in the Unemployment Rate to 3.7% or 3.8%.

We will know shortly.

Good luck and good weekend
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Laden With Fears

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When lending, a term of ten years
At one time was laden with fears
But not anymore
As bond prices soar
And bond bulls regale us with cheers

Another day, another record low for German bund yields, this time -0.396%, and there is no indication that this trend is going to stop anytime soon. While this morning’s PMI Composite data was released as expected (Germany 52.6, France 52.7, Eurozone 52.2), it continues at levels that show subdued growth. And given the ongoing weakness in the manufacturing sector, the major fear of both economists and investors is that we are heading into a global recession. Alas, I fear they are right about that, and when the dust settles, and the NBER looks back to determine when the recession began, don’t be surprised if June 2019 is the start date. At any rate, it’s not just bund yields that are falling, it is a universal reaction. Treasuries are now firmly below 2.00% (last at 1.95%), but also UK Gilts (0.69%), French OATs (-0.06%) and JGB’s (-0.15%). Even Italy, where the ongoing fight over their budget situation is getting nastier, has seen its yields fall 13bps today down to 1.71%. In other words, bond markets continue to forecast slowing growth and low inflation for some time to come. And of course, that implies further policy ease by the world’s central bankers.

Speaking of which:

In what was a mini bombshell
Said Mester, it’s too soon to tell
If rates should be lowered
Since, as I look forward
My models say things are just swell

Yesterday, Cleveland Fed president Loretta Mester, perhaps the most hawkish member of the Fed, commented that, “I believe it is too soon to make that determination, and I prefer to gather more information before considering a change in our monetary-policy stance.” In addition, she questioned whether lowering rates would even help address the current situation of too-low inflation. Needless to say, the equity markets did not appreciate her comments, and sold off when they hit the tape. But it was a minor reaction, and, in the end, the prevailing wisdom remains that the Fed is going to cut rates at the end of this month, and at least two more times this year. In truth, we will learn a great deal on Friday, when the payroll report is released, because another miss like last month, where the NFP number was just 75K, is likely to bring calls for an immediate cut, and also likely to see a knee-jerk reaction higher in stocks on the premise that lower rates are always good.

The IMF leader Lagarde
(Whom Greeks would like feathered and tarred)
Come later this year
The euro will steer
As ECB prez (and blowhard)

The other big news this morning concerns the changing of the guard at the ECB and the other EU institutions that have scheduled leadership changes. In a bit of a surprise, IMF Managing Director, Christine Lagarde, is to become the new ECB president, following Mario Draghi. Lagarde is a lawyer, not a central banker, and has no technocratic or central banking experience at all. Granted, she is head of a major supranational organization, and was French FinMin at the beginning of the decade. But all that reinforces is that she is a political hack animal, not that she is qualified to run the second most important policymaking institution in the world. Remember, the IMF, though impressive sounding, makes no policies, it simply hectors others to do what the IMF feels is correct. If you recall, when Chairman Powell was nominated, his lack of economics PhD was seen as a big issue. For some reason, that is not the case with Lagarde. I cannot tell if it’s because Powell has proven to be fine in the role, or if it would be seen as politically incorrect to complain about something like that since she ticks several other boxes deemed important. At any rate, now that politicians are running the two largest central banks (or at least will be as of November 1), perhaps we can dispel the fiction that central banks are independent of politics!

Away from the bond market, which we have seen rally, the market impact of this news has arguably been mixed. Equity markets in Asia were generally weak (Nikkei -0.5%, Shanghai -1.0%), but in Europe, investors are feeling fine, buying equities (DAX +0.6%, FTSE + 0.8%) alongside bonds. Arguably, the European view is that Madame Lagarde is going to follow in the footsteps of Signor Draghi and continue to ease policy aggressively going forward. And despite Mester’s comments, US equity futures are pointing higher as well, with both the DJIA and S&P looking at +0.3% gains right now.

Gold prices, too, are anticipating lower interest rates as after a short-term dip last Friday, with the shiny metal trading as low as $1384, it has rebounded sharply and after touching $1440, the highest print in six years, it is currently around $1420. I have to admit that the combination of fundamentals (lower global interest rates) and market technicals (a breakout above $1400 after three previous failed attempts) it does appear as though gold is heading much higher. Don’t be surprised to see it trade as high as $1700 before this rally is through.

Finally, the dollar continues to be the least interesting of markets with a mixed performance today, and an overall unchanged outcome. The pound continues to suffer as the Brexit situation meanders along and the uncertainty engendered hits economic activity. In fact, this morning’s PMI data was awful (50.2) and IHS/Markit is now calling for negative GDP growth in Q2 for the UK. Aussie data, however, was modestly better than expected helping both AUD and NZD higher, despite soft PMI data from China. EMG currencies are all over the map, with both gainers and losers, but the defining characteristic is that none of the movement has been more than 0.3%, confirming just how quiet things are.

As to the data story, this morning brings Initial Claims (exp 223K), the Trade Balance (-$54.0B), ISM Non-Manufacturing (55.9) and Factory Orders (-0.5%). While the ISM data may have importance, given the holiday tomorrow and the fact that payrolls are due Friday morning, it is hard to get too excited about significant FX movement today. However, that will not preclude the equity markets from continuing their rally on the basis of more central bank largesse.

Good luck
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Still Writing Obits

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The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
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