Don’t Be a Cheapskate

Said Trump, though the ‘conomy’s great
The Fed needs to still cut its rate
A full point will do
And more QE too
Come on Jay, don’t be a cheapskate!

It appears market participants are a little less upbeat this morning, although overall, there has been limited market movement. Yesterday’s risk-on events saw modest follow through in Asia, but European equity markets have languished while demand for haven bonds and yen has increased. There have been relatively few interesting stories with, arguably, the most noteworthy being President Trump’s call for the Fed to cut rates 100bps and restart QE in order to really supercharge the US economy. While the ongoing pressure continues to weigh on markets in the background, and certainly informs views that the Fed will cut rates further this year, there is no expectation that Mr. Trump’s wishes will be met. Quite frankly, it is hard to even see any market reaction to what he said. My observation is that with respect to interest rates, the president is turning into the boy who cried wolf.

Of more interest to markets, I believe, was an interview with Boston Fed President Eric Rosengren yesterday, where he continued to push back on market expectations regarding any rate cuts in September. If you recall he was one of the two dissents at the July 31st meeting and his views haven’t changed. In essence, he sees the economy performing reasonably well and strongly believes that as long as the data remains solid, cutting rates is not necessary. He dismissed the idea that Fed rate cuts will help the rest of the world, and he highlighted that both employment and inflation are in pretty good places. However, his comments did nothing to change market expectations for the Fed’s next meeting. In fact, this morning there is a 21% probability of a 50bp cut, which is ever so slightly higher than yesterday’s levels, while 25bps remains fully priced.

As to the dollar’s reaction to this, yesterday saw steady dollar strength across the board, and while this morning’s market is slightly more mixed, there is no indication that the dollar is going to fall back anytime soon. I guess if the Fed did listen to the President and cut 100bps next month, the initial dollar reaction would be a sharp sell-off. However, after a while my sense is that market participants might wonder why they changed tack and start to shed risk quickly causing a reversal. In the end, though, I don’t think we need to worry very much about that scenario.

In the G10 space, this morning’s biggest loser is the pound, which has fallen 0.45% and is back below 1.2100 near the lows seen at the beginning of the month. This is a reaction to PM Johnson’s latest move where he sent a letter to the EU explaining that the Irish backstop, as currently configured, remains unacceptable, and that a better strategy would be a legally binding pledge that neither side would impose a hard border going forward while they deal with the trade questions. Of course, the EU rejected this out of hand, but Johnson is headed to Berlin and Paris next week to pick up the conversation. From a political perspective, I would contend that Johnson has far more to lose than the EU, as he has staked his entire PMship on leaving the EU on October 31. In addition, come September, when the ECB meets and puts forward its latest economic forecasts, it will be abundantly clear that Europe is sliding into a recession across the board. There is no way they can afford the hit from Brexit on top of an already very weak economic situation. It is this train of thought that informs my view that the EU is going to blink first and there will be some deal cobbled together to save face. At that time I expect the pound to rally sharply, pretty quickly getting back to the 1.30-1.35 area, but in the meantime, the pound will remain under pressure.

One thing to consider for GBP payables hedgers is that despite the fact that implied volatility remains higher in GBP than other G10 currencies, it is still low on a historic basis, and the skew remains heavily bid for puts, meaning purchased calls can be quite attractive.

Away from those two stories though, there is precious little else to discuss. Much has been made of Germany issuing a new 30-year bund with a 0.00% coupon, but that is more the novelty of the process than anything else. There has been a dearth of economic data to help drive decisions and here in the dog days of August, it appears more people are on holiday than in the office.

A quick look at this morning’s movers shows a very modest risk-off flavor with both JPY and CHF rising 0.2% alongside a modest rally in Treasuries and bunds with both seeing yields lower by 4-5bps. Gold is also stronger this morning, but equity markets are essentially flat, which if there was a true risk-off move, seems out of place.

While the market awaits Chairman Powell’s speech on Friday, I expect that we will continue to chop back and forth. Remember, there is very little new data, and if I am correct about President Trump’s tweets on interest rates losing their impact, ask yourself what else can move things. Arguably, very little. The big picture trend of steady dollar strength remains my base case and will do so until something finally changes.

Good luck