Monthly Archives: December 2019

Wind At His Sails

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In England and Scotland and Wales
Young Boris has wind at his sails
A thumping great win
To Labour’s chagrin
Has put Brexit back on the rails

As well, from the US, the news
Is bears need start singing the blues
The trade deal is done
At least for phase one
Thus more risk, investors did choose

An historic victory for PM Boris Johnson yesterday has heralded a new beginning for the UK. Historic in the sense that it is the largest majority in Parliament for either party since Margret Thatcher’s second term, and historic in the sense that the Labour party won the fewest seats since 1935. One can only conclude that Jeremy Corbyn’s vision of renationalization of industry and high taxes was not the direction in which the UK wants to head. Perhaps the only concern is the Scottish National Party winning 49 of the 58 seats available and will now be itching to rerun the Scottish independence referendum. But that is an issue for another day, and today is all about a huge relief rally in equities as the threat of a hard Brexit essentially disappears, while the pound has also benefitted tremendously, rising 1.7% from yesterday’s closing level and having traded almost a full percent higher than that in the early aftermath of the results. So here we are this morning at 1.3390, right at my forecast for the initial move in the event of a Johnson victory. The question of course, is where do we go from here?

Before I answer, I must also mention the other risk positive story, about which I’m sure you are already aware, the news that President Trump has signed off on terms of a phase one trade deal with China. The details thus far released indicate China has promised to buy $50 billion of agricultural products from the US, and will be more vigilant in protection of IP rights, while the US is set to reduce the tariff rates already imposed and delay, indefinitely, the tariffs that were due to come into effect this Sunday. Not surprisingly, equity markets around the world rallied sharply on this news as well while haven investments like Treasuries, Bunds and the yen (and the dollar) have all fallen.

So everyone is feeling good this morning and with good reason, as two of the major political uncertainties that have been hanging over the market have been resolved. With this in mind, we can now try to answer the question of what’s next in the FX markets.

History has shown that while macroeconomic factors have some impact on the relative value of currencies, that impact is driven by the corresponding interest rates in each nation. So a nation that has strong economic growth and relatively tighter monetary policy is likely to see a strong currency while the opposite is also true. Now this correlation is hardly perfect, and financial theory cannot be completely ignored regarding a country’s fiscal balances (current account, trade and budget), where deficits tend to lead to a weaker currency, at least in theory, and surpluses the opposite. Obviously, one need only look at the dollar these days to recognize that despite the US’s significant negative fiscal position, the dollar remains relatively quite strong.

But ever since the financial crisis, there has been another part of monetary policy that has had a significant impact on the FX market, namely QE. As I’ve written before, when the US was implementing QE’s 1, 2 and 3, the dollar fell markedly each time, by 22%, 25% and 17% over a period of 9 months, 11 months and 22 months respectively. Clearly that pattern demonstrates the law of diminishing returns, where a particular action has a weaker and weaker effect the more frequently it is used. Of course, in each of these cases, the Fed funds rate was at 0.00%, so QE was the only tool in the toolbox. This brings us to the current situation; positive interest rates but the beginning of QE4. I know that none of us think 1.5% is a robust return on our savings, but remember, US interest rates are the highest in the G10, by a lot. In addition, the economy seems to be doing pretty well with GDP ticking over above 2.0%, Unemployment at 50 year lows and wage gains solidly at 3.0% or higher. Equity markets in the US make new highs on a regular basis and measured inflation is running right around 2.0%. And yet…the Fed is clearly looking at QE despite all their protestations. Buying $60 billion per month of T-bills with the newly stated option of extending those purchases to coupons is clearly expanding the balance sheet and driving risk accumulation further. And that is QE!

So with the knowledge that the Fed is engaged in QE4, and the history that shows the dollar has fallen pretty significantly during each previous QE policy, my view is that we are about to embark on a reasonable weakening of the US dollar for the next year or so. Now, clearly the initial conditions this time are different, with positive growth and interest rates, but while that will likely limit the dollar’s decline to some extent, it won’t prevent it. If pressed, I would say that we are likely to see the dollar fall by 10% or so over the next 12-18 months. And that is regardless of the outcome of the US elections next year. In the event that we were to see a President Warren or President Sanders, I think the dollar would suffer far more aggressively, but right now, removing the effect of the election still points to a slow decline in the buck. So for receivables hedgers, it is likely to be a situation where patience is a virtue.

Turning to the data story, last night we saw the Japanese Tankan report fall to 0, below expectations of 3 and down from its previous reading of 5. But the yen’s 0.35% decline overnight has more to do with risk appetite than that particular number. However, I’m sure PM Abe and BOJ Governor Kuroda are not thrilled with the implications for the economy. Otherwise, there has been precious little else of note released leaving us to ponder this morning’s Retail Sales data (exp 0.5%, 0.4% ex Autos) and wait to hear pearls of wisdom from NY Fed President Williams at 11:00. Of course, given the fact the Fed just finished meeting and there appears very little uncertainty over their immediate future course, my guess is the only thing he can try to defend is ‘not QE’ and how they are on top of the repo situation. But today is a risk on day, so while we may not extend these movements much further, I feel we are likely to maintain the gains vs. the dollar across the board.

In a final note, this will be the last poetry until January as I will be on vacation and then will return with my prognostications for 2020 to start things off.

Good luck, good weekend and happy holidays to all
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Up, Up and Away

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Said Powell, “We’re in a good place”
On growth, but we don’t like the pace
That prices are rising
And so we’re surmising
More QE’s what needs to take place

Today, then, we’ll hear from Christine
Who is now the ECB queen
This is her first chance
To proffer her stance
On policy and what’s foreseen

And finally, in the UK
The vote’s taking place through the day
If Boris does badly
Bears will sell pounds gladly
If not, it’s up, up and away

There is much to cover this morning, so let’s get right to it.

First the Fed. As universally expected they left rates on hold and expressed confidence that monetary policy was appropriate for the current conditions. They lauded themselves on the reduction in unemployment, but have clearly changed their views on just how low that number can go. Or perhaps, what they are recognizing is that the percentage of the eligible labor force that is actually at work, which forms the denominator in the unemployment rate, is too low, so that there is ample opportunity to encourage many who had left the workforce during the past decade to return thus increasing the amount of employment and likely helping the Unemployment Rate to edge even lower. While their forecasts continue to point to 3.5% as a bottom, private sector economists are now moving their view to the 3.0%-3.2% level as achievable.

On the inflation front, to say that they are unconcerned would greatly understate the case. They have made it abundantly clear that it will require a nearly unprecedented supply shock to have them consider raising rates anytime soon. However, they continue to kvetch about too low inflation and falling inflation expectations. They have moved toward a policy that will allow inflation to run higher than the “symmetric 2% target” for a while to make up for all the time spent below that level. And the implication is that if we see inflation start to trend lower at all, they will be quick to cut rates regardless of the economic growth and employment situation. Naturally, the fact that CPI printed a touch higher than expected (2.1%) was completely lost on them, but then given their ‘real-world blinders’ that is no real surprise. The dot plot indicated that they expect rates to remain on hold at the current level throughout all of 2020, which would be a first during a presidential election year.

And finally, regarding the ongoing concerns over the short term repo market and their current not-QE policy of buying $60 billion per month of Treasury bills, while Powell was unwilling to commit to a final solution, he did indicate that they could amend the policy to include purchases of longer term Treasury securities alongside the introduction of a standing repo facility. In other words, not-QE has the chance to look even more like QE than it currently does, regardless of what the Chairman says. Keep that in mind.

Next, it’s on to the ECB, which is meeting as I type, and will release its statement at 7:45 this morning followed by Madame Lagarde meeting the press at 8:30. It is clear there will be no policy changes, with rates remaining at -0.5% while QE continues at €20 billion per month. Arguably there are two questions to be answered here; what is happening with the sweeping policy review? And how will Madame Lagarde handle the press conference? Given she has exactly zero experience as a central banker, I think it is reasonable to assume that her press conferences will be much more political in nature than those of Signor Draghi and his predecessors. My fear is that she will stray from the topic at hand, monetary policy, and conflate it with her other, nonmonetary goals, which will only add confusion to the situation. That said, this is a learning process and I’m sure she will get ample feedback both internally and externally and eventually gain command of the situation. In the end, though, there is precious little the ECB can do at this point other than beg the Germans to spend some money while trying to fend off the hawks on the committee and maintain policy as it currently stands.

Turning to the UK election, the pound had been performing quite well as the market was clearly of the opinion that the Tories were going to win and that the Brexit uncertainty would finally end next month. However, the latest polls showed the Tory lead shrinking, and given the fragmentation in the electorate and the UK’s first-past-the-post voting process, it is entirely possible that the result is another hung Parliament which would be a disaster for the pound. The polls close at 5:00pm NY time (10:00pm local) and so it will be early evening before we hear the first indications of how things turn out. The upshot is a Tory majority is likely to see a further 1%-1.5% rally in the pound before it runs out of momentum. A hung Parliament could easily see us trade back down to 1.22 or so as all that market uncertainty returns, and a Labour victory would likely see an even larger decline as the combination of Brexit uncertainty and a program of renationalization of private assets would result in capital fleeing the UK ASAP. When we walk in tomorrow, all will be clear!

Clearly, those are the top stories today but there is still life elsewhere in the markets. Ffor example, the Turkish central bank cut rates more than expected, down to 12.0%, but the TRY managed to rally 0.25% after the fact. Things are clearly calming down there. In Asia, Indian inflation printed higher than expected at 5.54%, although IP there fell less than expected (-3.8%) and the currency impact netted to nil. The biggest gainer in the Far East was KRW, rising 0.65% after a strong performance by the KOSPI (+1.5%) and an analyst call for the KOSPI to rise 12% next year. But other than the won, the rest of the space saw much less movement, albeit generally gaining slightly after the Fed’s dovish stance.

In the G10, the pound has actually slipped a bit this morning, -0.2%, but otherwise, movement has been even smaller than that. Yesterday, after the Fed meeting, the dollar fell pretty sharply, upwards of 0.5% and essentially, the market has maintained those dollar losses this morning.

Looking ahead to the data today we see Initial Claims (exp 214K) and PPI (1.3%, 1.7% core). However, neither of those will have much impact. With the Fed meeting behind us, we will start to hear from its members again, but mercifully, not today. So Fed dovishness has been enough to encourage risk takers, and it looks for all the world like a modest risk-on session is what we have in store.

Good luck
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Inflation’s Not Bubbled

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Ahead of the Fed’s tête-à-tête
The CPI reading we’ll get
Though Jay remains troubled
Inflation’s not bubbled
The rest of us know that’s bullshet

Yes, it is Fed day with the FOMC set to announce their policy stance at 2:00 this afternoon and Chairman Jay scheduled to meet the press at 2:30. At this point, he and his colleagues have done an excellent job of leading market expectations toward no change, with the futures market pricing in a 0.0% probability of a cut. Interestingly, there is the tiniest (just 5.8%) probability of a rate hike, although that is even less likely in my view. While there will be a great deal of interest in the dot plot, certainly there has not been enough data to change Powell’s oft-stated view that the economy and monetary policy are both in “a good place.”

What should be of greater concern to all of us, as individuals and consumers, is that there has been an increase in discussions about the Fed changing their inflation targeting regime to achieving an average inflation rate of 2.0% over time, meaning that for all the time inflation remains below target (the past 10 years), they will allow it to run above target to offset that outcome. Now, we all know that the Fed’s constant complaints about too-low inflation ring hollow in our ears every time we go to the supermarket, or even the mall (assuming anyone else still goes there) as prices for pretty much everything other than flat screen tv’s has consistently risen for years. But given the way the Fed measures such things; they continue to register concern over the lack of inflation. And remember, too, that the Fed uses PCE, Personal Consumption Expenditures, in their models, which reflects not what we pay, but the rate of change of prices at which merchants sell goods. It is a subtle difference, but the construct of PCE, with a much lower emphasis on housing, and inclusion of the costs that the government pays for things like healthcare (obviously at a lower rate than the rest of us) insures that PCE will always track lower over time. In fact, it is an open question as to whether the Fed can even achieve a higher inflation rate, however it is measured, as long as they maintain their financial repression.

All of that is a prelude to today’s CPI release, where the market is anticipating a reading of 2.0% for the headline and 2.3% for the core. Arguably, this should be an important data point for the folks in the Mariner Eccles building today, but I forecast that they will only see weakness here as noteworthy, arguing for even more stimulus. However, whatever today’s print, it will simply be background noise in the end. It would take some remarkable news to change today’s outlook.

But inflation is important elsewhere in the world as well. For example, this morning Sweden’s CPI rose to 1.8%, a tick higher than expected and basically confirmed to the market that the Riksbank, who seem desperate to exit their negative rate policy, are likely to do so at their February meeting. (Expectations for movement next week remain quite muted.) Nonetheless, the Swedish krona has been a major beneficiary in the market, rallying 0.65% vs. the dollar (0.5% vs. the euro), and is today’s top performer.

Another place we are seeing prices rise more rapidly is in Asia, specifically in both China and India. In the former, CPI rose to 4.5% in November, higher than the expected 4.3% and the highest level since January 2012. This is a reflection of the skyrocketing price of pork there as African swine fever continues to decimate the hog population. (It is this problem that is likely to help lead to a phase one trade deal as President Xi knows he needs to be able to feed his people, and US pork is available and cheap!) In India, the October data jumped to 4.62% (what precision!) and November is forecast to rise to 5.3%. Here, too, food prices are taking a toll on the price index, and we need to be prepared for the November release due tomorrow. When the October print hit the tape, the rupee gapped lower (dollar higher) by nearly 1%, and although it has been slowly clawing back those losses, another surprise on the high side could easily see a repeat.

In contrast to those countries, the Eurozone remains an NPZ (no price zone), a place where price rises simply do not occur. Now, I grant that I have not been there in some time, so cannot determine if the European measurements are reflective of most people’s experience, but certainly on a measured basis, inflation remains extremely low, hovering around 1.0% per annum throughout most of the continent. Remember, tomorrow, Christine Lagarde leads her first ECB meeting and while she has spoken about how fiscal policy needs to pick up the pace and how the ECB needs to be more focused on issues like climate change, we have yet to hear her views on what she actually was hired to do, manage monetary policy. While there is no doubt that she is an exceptional politician, it remains to be seen what kind of central banking chops she possesses. Based solely on her commentary over the years, she appears firmly in the dovish camp, but given Signor Draghi’s parting gift of a rate cut and renewed QE, it seems most likely that she will simply stay the course and exhort governments to spend more money. One thing to keep in mind is that markets have a way of testing new central bank heads early in their terms with some kind of stress. That initial response is everything in determining if said central banker will be seen as strong or weak. We can only hope that Madame Lagarde measures up in that event.

The only other story is the UK election, certainly critical, but given it takes place tomorrow, we will look to discuss outcomes then. One interesting thing was that a Yougov poll released last evening showed PM Boris and the Tories would win 339 seats, still a comfortable majority, but a smaller one than the same poll from two weeks earlier. The pound fell sharply on the news, having traded as high as 1.3215 late yesterday afternoon it was actually just above 1.3100 when I left the office. This morning, it is right in the middle at 1.3150, which is apparently where it was at 5:00 last evening as the stated movement today is virtually nil. Barring a major faux pas by either candidate at this late stage, I think we will see choppiness in the pound until the results are released, early Friday morning. While a vic(Tory) by Boris will likely see a knee-jerk response higher in the pound, I remain of the view that any rally will be modest, perhaps 1%-2% at most, and should be seen as an opportunity to add hedges for receivables hedgers.

And that’s really it for today. I would look for modest movement overall, and don’t anticipate the FOMC meeting to generate much excitement.

Good luck
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A New Paradigm

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In Germany for the first time
In months, there’s a new paradigm
The pundits are cheering
A rebound that’s nearing
As data, released, was sublime

Perhaps sublime overstates the case a bit, but there is no doubt that this morning’s German ZEW data was substantially better than forecast, with the Expectations index rising to 10.7, its highest level since March 2018. This follows what seems to be some stabilization in the German manufacturing economy, which while still under significant pressure, may well have stopped declining. It is these little things that add up to create a narrative change from; Germany is in recession (which arguably was correct, albeit not technically so) to Germany has stabilized and is recovering on the back of solid domestic demand growth. On the one hand, this is good news for the global growth story, as Germany remains the fourth largest economy in the world, and if it is shrinking that bodes ill for the rest of the world. However, for all those who are desperate for German fiscal stimulus, this is actually a terrible number. If the German economy is recovering naturally, it beggars belief that they will spend any more money than currently planned.

It is important to remember that the Eurozone fiscal stimulus argument is predicated on two things: the fact that monetary policy is now impotent to help stimulate growth throughout the Eurozone; and the belief that if the German government spends more money domestically, it will magically flow through to those nations that really need help, like Italy, Portugal and Greece. Alas for poor Madame Lagarde, this morning’s data has likely lowered the probability of German fiscal stimulus even more than it was before. The euro, however, seems to like the data, edging higher by 0.15% this morning and working its way back to the levels seen just before the US payroll report turned the short-term crowd dollar bullish. There was other Eurozone data released, but none of it (French and Italian IP) was really that interesting, printing within a tick of forecasts. On the euro front, at this point all eyes are on the ECB to see what Lagarde tells us on Thursday. Remember, the last thing she wants is to come across as hawkish, in any manner, because the ECB really doesn’t need the added pressure of a strong euro weighing on already subpar inflation data.

With two days remaining before the UK election, the polls are still pointing to a strong Tory victory and a PM Boris Johnson commanding a majority of Parliament. At this point, the latest polls show the Tories with 44%, Labour with 32% and the LibDems with just 12%. The pound is higher by 0.2% on the back of this activity, despite a mildly disappointing GDP reading of 0.0% (exp 0.1%). A quick look back at recent GBP movement shows that since the election was called on October 30, the pound has rallied 1.8%. While that is a solid move, it isn’t even the largest mover during that period (NZD is higher by 2.45% since then). In fact, the pound really gained ground several weeks earlier after Boris and Irish PM Leo Varadkar had a lunch where they seemed to work out the final issues for Brexit. Prior to that, the pound had been hovering in the 1.22-1.24 area, but gained sharply in the run up to the previous Brexit deadline.

I guess the question is; just how much higher the pound can go if the polls are correct and Boris wins with a Tory majority. There are two opposing views, with some analysts calling for another solid leg higher, up toward 1.40, as the rest of the market shorts get squeezed out and euphoria for UK GDP growth starts to rebound. The other side of that argument is that the shorts have already been squeezed, hence the move from 1.22 to 1.32 in the past two months, and that though finalization of Brexit will be a positive, there are still numerous issues to address domestically that will prevent a sharp rebound in the UK economy. As I’m sure you are all aware, I fall into the second camp, but there is certainly at least a 25% probability that a larger move is in the cards. The one thing that seems clear, though, is that market implied volatility will fall sharply past the election if the Tories win as uncertainty over Brexit will recede quickly.

Turning south of the border, it seems that the USMCA is finally making its way through Congress and will be enacted shortly. The peso has been the quiet beneficiary of this news over the past week as it has rallied 2% in the past week in a very steady fashion, although so far, this morning, it is little changed. One other thing of note regarding the Mexican peso has been the move in the forward curve over the past three weeks. For example, since November 19, 1-month MXN forwards have fallen from 1030 to this morning’s 683. In the 1-year, the decline has been from 10875 to this morning’s 10075. The largest culprit here appears to be the very large long futures position, (>150K contracts) that need to be rolled over by the end of the week, but there is also a significant maturity of Mexican government bonds that will require MXN purchases. At any rate, added to the USMCA news, we have a confluence of events driving both spot and forward peso rates higher. It is not clear how much longer this will continue, so for balance sheet hedgers with short dated exposures, this is probably a great opportunity to reduce hedging costs.

Beyond these stories, there is far less of interest in the market. This morning’s US data consists of Nonfarm productivity (exp -0.1%) and Unit Labor Costs (3.4%) neither of which is likely to move the needle. This is especially so ahead of tomorrow’s FOMC meeting and Thursday’s ECB meeting and UK election. Equity markets are pointing lower this morning, but that feels more like profit taking than a change of heart, as bonds are little changed alongside oil and gold. In other words, look for more choppy markets with no direction ahead of tomorrow’s CPI data and FOMC meeting.

Good luck
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Hawks Would Then Shriek

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Lagarde and Chair Powell both seek
Consensus, when later this week
Their brethren convene
While doves are still keen
To ease more, though hawks would then shriek

Markets are relatively quiet this morning as investors and traders await three key events as well as some important data. Interestingly, neither the Fed nor ECB meetings this week are likely to produce much in the way of fireworks. Chairman Powell and his minions have done an excellent job convincing market participants that the temporary cyclical adjustment is finished, that rates are appropriate, and that they are watching everything closely and prepared to act if necessary. Certainly Friday’s blowout NFP data did not hurt their case that no further easing is required. By now, I’m sure everyone is aware that we saw the highest headline print since January at 266K, which was supported by upward revisions of 41K to the previous two months’ data. And of course, the Unemployment Rate fell to 3.5%, which is back to a 50-year low. In fact, forecasts are now showing up that are calling for a 3.2% or 3.3% Unemployment Rate next November, which bodes well for the incumbent and would be the lowest Unemployment Rate since 1952!

With that as the economic backdrop in the US, it is hard for the doves on the Fed to make the case that further easing is necessary, but undoubtedly they will try. In the meantime, ECB President Lagarde will preside over her first ECB meeting where there are also no expectations for policy changes. Here, however, the situation is a bit tenser as the dramatic split between the hawks (Germany, the Netherlands and Austria) and the doves (Spain, Portugal and Italy) implies there will be no further action anytime soon. Madame Lagarde has initiated a policy review to try to find a consensus on how they should proceed, although given the very different states of the relevant economies, it is hard to believe they will agree on anything.

Arguably, the major weakness in the entire Eurozone construct is that the lack of an overarching continent-wide fiscal authority means that there is no easy way to transfer funds from those areas with surpluses to those with deficits. In the US, this happens via tax collection and fiscal stimulus agreed through tradeoffs in Congress. But that mechanism doesn’t exist in Europe, so as of now, Germany is simply owed an extraordinary amount of money (~€870 billion) by the rest of Europe, mostly Italy and Spain (€810 billion between them). The thing is, unlike in the US, those funds will need to be repaid at some point, although the prospects of that occurring before the ECB bails everyone out seem remote. Say what you will about the US running an unsustainable current account deficit, at least structurally, the US is not going to split up, whereas in Europe, that is an outcome that cannot be ruled out. In the end, it is structural issues like this that lead to long term bearishness on the single currency.

However, Friday’s euro weakness (it fell 0.45% on the day) was entirely a reaction to the payroll data. This morning’s 0.15% rally is simply a reactionary move as there was no data to help the story. And quite frankly, despite the UK election and pending additional US tariffs on China, this morning is starting as a pretty risk neutral session.

Speaking of the UK, that nation heads to the polls on Thursday, where the Tories continue to poll at a 10 point lead over Labour, and appear set to elect Boris as PM with a working majority in Parliament. If that is the outcome, Brexit on January 31 is a given. As to the pound, it has risen 0.2% this morning, which has essentially regained the ground it lost after the payroll report on Friday. At 1.3165, its highest point since May 2019, the pound feels to me like it has already priced in most of the benefit of ending the Brexit drama. While I don’t doubt there is another penny or two possible, especially if Boris wins a large majority, I maintain the medium term outlook is not nearly as robust. Receivables hedgers should be taking advantage of these levels.

On the downside this morning, Aussie and Kiwi have suffered (each -0.2%) after much weaker than expected Chinese trade data was released over the weekend. Their overall data showed a 1.1% decline in exports, much worse than expected, which was caused by a 23% decline in exports to the US. It is pretty clear that the trade war is having an increasing impact on China, which is clearly why they are willing to overlook the US actions on Hong Kong and the Uighers in order to get the deal done. Not only do they have rampant food inflation caused by the African swine fever epidemic wiping out at least half the Chinese hog herd, but now they are seeing their bread and butter industries suffer as well. The market is growing increasingly confident that a phase one trade deal will be agreed before the onset of more tariffs on Sunday, and I must admit, I agree with that stance.

Not only did Aussie and Kiwi fall, but we also saw weakness in the renminbi (-0.15%), INR (-0.2%) and IDR (-0.2%) as all are feeling the pain from slowing trade growth. On the plus side in the EMG bloc, the Chilean peso continues to stage a rebound from its worst levels, well above 800, seen two weeks ago. This morning it has risen another 0.85%, which takes the gain this month to 4.8%. But other than that story, which is really about ebbing concern after the government responded quickly and positively to the unrest in the country, the rest of the EMG bloc is little changed on the day.

Turning to the data this week, we have the following:

Tuesday NFIB Small Business Optimism 103.0
  Nonfarm Productivity -0.1%
  Unit Labor Costs 3.4%
Wednesday CPI 0.2% (2.0% Y/Y)
  -ex Food & Energy 0.2% (2.3% Y/Y)
  FOMC Rate Decision 1.75%
Thursday ECB Rate Decision -0.5%
  PPI 0.2% (1.2%)
  -ex Food & Energy 0.2% (1.7%)
  Initial Claims 215K
Friday Retail Sales 0.4%
  -ex autos 0.4%

Source: Bloomberg

While there is nothing today, clearly Wednesday and Thursday are going to have opportunities for increased volatility. And the UK election results will start trickling in at the end of the day on Thursday, so if there is an upset brewing, that will be when things are first going to be known.

All this leads me to believe that today is likely to be uneventful as traders prepare for the back half of the week. Remember, liquidity in every market is beginning to suffer simply because we are approaching year-end. This will be more pronounced next week, but will start to take hold now.

Good luck
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A Paean to John Maynard Keynes

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The positive vibe still remains
Encouraging stock market gains
Likewise bonds are sold
With dollars and gold
In paeans to John Maynard Keynes

As the market walks in ahead of today’s jobs report, once again poor data has been set aside and the equity bulls are leading the parade to acquire more risk assets. Stock markets are rallying, bond markets selling off and there is pressure on gold and the dollar. Granted, the moves have not been too large, but the reality is that the default market activity is to buy stocks regardless of valuation.

Let’s start with a quick look at current data expectations:

Nonfarm Payrolls 183K
Private Payrolls 179K
Manufacturing Payrolls 40K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.4
Michigan Sentiment 97.0

Source: Bloomberg

These are all pretty good numbers, and if the forecasts are right, it would certainly reinforce the idea that the US economy is ticking over nicely. Of course, the problem is that we have seen some pretty bad data in the past week which may call this evaluation into question. Recall Monday’s terrible ISM Manufacturing data, as well as Wednesday’s double whammy of ISM Non-Manufacturing and ADP Employment, both of which sharply disappointed. While yesterday’s Durable Goods was right on the mark, I would argue that based on the data seen this week, the US economy is clearly slowing down into the fourth quarter.

Adding to the general gloom is the data we have seen from elsewhere, notably Europe, where this morning’s German IP report (-1.7%) was the worst monthly print since April and took the year on year decline to -5.3%, the slowest pace since the financial crisis in 2009! Remember, Factory orders in Germany were awful yesterday, and the PMI data, while not as bad as expected regarding manufacturing, was much worse than expected in the service sector. The point is Europe is clearly not going to be driving the global economy higher anytime soon.

And of course, the other main engine of growth, China, has continued to present a picture of an economy in slow decline with excess leverage and financial bubbles still abundant, and with a central bank that is having trouble deciding which problem to address, excess leverage or slowing growth.

With this as a starting point, it is easy to see why there are so many bears in the market. But there is an antidote to this unrequited bearishness…the Fed! While Chairman Powell has repeatedly explained that the FOMC’s current practice of purchasing $60 billion per month of Treasury bills is NOT QE, it is certainly QE. And remember, the Fed is not just purchasing T-bills, they are also adding liquidity through overnight, weekly and monthly repo operations on a regular basis. In fact, they are taking all the collateral offered and lending money against it, not even targeting an amount they want to add. It certainly appears that they are simply adding as much liquidity to the markets as possible to prevent any of those bears from gaining traction. So in reality, it is no real surprise that risk assets remain in demand.

In fact, the Fed’s ongoing active stance in the money markets has me reconsidering my long-held views on the dollar’s future. The macroeconomic story remains, in my estimation, a USD positive, but one need only look at the dollar’s performance during QE1, QE2 and QE3 where we saw dollar declines of 22%, 25% and 16% respectively to force one to reconsider those views. ‘Not QE’ could easily undermine the dollar’s strength and perhaps, despite the ECB’s ongoing efforts, drive the dollar much lower. In conversations with many clients, I have been hard pressed to come up with a scenario where the dollar falls sharply, short of another shocking US electoral outcome where, as a nation we vote for left wing populism, à la Senator Warren or Senator Sanders, rather than our current stance of right wing populism. However, if the Fed maintains its current stance, expanding the balance sheet and adding liquidity with abandon to the money markets, there is every reason to believe that the dollar will suffer. After all, we continue to run a massive current account deficit, alongside our trade and budget deficits, and we are flooding the markets with newly issued Treasury debt. At some point, and perhaps in the not too distant future, the market may well decide the US dollar is no longer the haven asset that it has been in the past. In any case, while I consider the issues, it would be sensible, in my estimation, for hedgers to consider them as well.

And with that cheery thought, let us look forward to this morning’s market activity. My sense is that the combination of modestly higher than expected Initial Claims data during the survey week, as well as weak ISM employment sub-indices, and of course, the weak ADP number, will result in a disappointing outcome today. I fear that we could see something as low as 100K, which could see a knee-jerk reaction lower in the dollar as expectations ratchet up for more Fed monetary ease.

One other thing to keep in mind is that as we approach year-end, market liquidity starts to dry up. There should be no problems today, nor next week, I expect, but after that, trading desks see staffing thin out for vacations and risk appetite for the banks shrinks significantly. Nobody wants to risk a good year, and nobody will overcome a bad one in the last week of the year. So to the extent possible, I strongly recommend taking care of year end activity by the end of next week for the best results.

Good luck and good weekend
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No Panacea

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Fiscal stimulus
Is no panacea, but
Welcome nonetheless

At least by markets
And politicians as well
If it buys them votes!

Perhaps the MMTer’s are right, fiscal rectitude is passé and governments that are not borrowing and spending massive amounts of money are needlessly harming their own countries. After all, what other lesson can we take from the fact that Japan, the nation with the largest debt/GDP ratio (currently 236%) has just announced they are going to borrow an additional ¥26 trillion ($239 billion) to spend in support of the economy, and the market response was a stock market rally and a miniscule rise in JGB yields of just 1bp. Meanwhile, the yen is essentially unchanged.

Granted, despite the fact that this equates to nearly 5% of the current GDP, given JGB interest rates are essentially 0.0% (actually slightly negative) it won’t cost very much on an ongoing basis. However, at some point the question needs to be answered as to how they will ever repay all that debt. It seems the most likely outcome will be some type of explicit debt monetization, where the BOJ simply tears up maturing bonds and leaves the cash in the economy, thus reducing the debt and maintaining monetary stimulus. However, macroeconomic theory explains following that path will result in significant inflation. And of course, that’s the crux of the MMT philosophy, print money aggressively until inflation picks up.

The thing is, every time this process has been followed in the past, it basically destroyed the guilty country. Consider Weimar Germany, Zimbabwe and even Venezuela today as three of the most famous examples. And while inflation in Japan is virtually non-existent right now, that does not mean it cannot rise quite rapidly in the future. The point is that, currently, the yen is seen as a safe haven currency due to its strong current account surplus and the fact that its net debt position is not terribly large. But the further down this path Japan travels, the more likely those features are to change and that will be a distinct negative for the currency. Of course, this process will take years to play out, and perhaps something else will come along to change the trajectory of these long term processes, but the idea that the yen will remain a haven forever needs to be constantly re-evaluated. Just not today!

In the meantime, markets remain in a buoyant mood as additional comments from the Chinese that both sides remain in “close contact”, implying a deal is near, has the bulls ascendant. So Tuesday’s fears are long forgotten and equity markets are rallying while government bond yields edge higher. As to the dollar, it is generally on its back foot this morning as well, keeping with the theme that risk is ‘on’.

Looking at specific stories, there are several of note today. Overnight, Australia released weaker than expected GDP figures which has reignited the conversation about the RBA cutting rates in Q1 and helped to weaken Aussie by 0.3% despite the USD’s overall weakness. Elsewhere in the G10, British pound traders continue to close out short positions as the polls, with just one week left before the election, continue to point to a Tory victory and with it, finality on the Brexit issue. My view continues to be that the market is buying pounds in anticipation of this outcome, and that once the election results are final, there will be a correction. It is still hard for me to see the pound much above 1.34. However, there are a number of analysts who are calling for 1.45 in the event of a strong Tory majority, so be aware of the differing viewpoints.

On the Continent, German Factory Order data disappointed, yet again, falling 0.4% rather than rising by a similar amount as expected. This takes the Y/Y decline to 5.5% and hardly bodes well for a rebound in Germany. However, the euro has edged higher this morning, up 0.15% and hovering just below 1.11, as we have seen a number of stories rehashing the comments of numerous ECB members regarding the idea that negative interest rates have reached their inflection point where further cuts would do more harm than good. With the ECB meeting next Thursday, expectations for further rate cuts have basically evaporated for the next year, despite the official guidance that more is coming. In other words, the market no longer believes the ECB can will ease policy further, and the euro is likely edging higher as that idea makes its way through the market. Nonetheless, I see no reason for the euro to trade much higher at all, especially as the US economy continues to outperform the Eurozone.

In the emerging markets, the RBI surprised the entire market and left interest rates on hold, rather than cutting by 25bps as universally expected. The rupee rallied 0.35% on the news as the accompanying comments implied that the recent rise in inflation was of more concern to the bank than the fact that GDP growth was slowing more rapidly than previously expected. In a similar vein, PHP is stronger by 0.5% this morning after CPI printed a bit higher than expected (1.3%) and the market assumed there is now less reason for the central bank to continue its rate cutting cycle thus maintaining a more attractive carry destination. On the other side of the ledger, ZAR is under pressure this morning, falling 0.5% after data releases showed the current account deficit growing more rapidly than expected while Electricity production (a proxy for IP) fell sharply. It seems that in some countries, fiscal rectitude still matters!

On the data front this morning, we see Initial Claims (exp 215K), Trade Balance (-$48.5B), Factory Orders (0.3%) and Durable Goods (0.6%, 0.6% ex transport). Yesterday we saw weaker than expected US data (ADP Employment rose just 67K and ISM Non-Manufacturing fell to 53.9) which has to be somewhat disconcerting for Chairman Powell and friends. If today’s slate of data is weak, and tomorrow’s NFP report underwhelms, I think that can be a situation where the dollar comes under more concerted pressure as expectations of further Fed rate cuts will build. But for now, I am still in the camp that the Fed is on hold, the data will be mixed and the dollar will hold its own, although is unlikely to rally much from here for the time being.

Good luck
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No Longer Appealing

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Today pound bears seem to be feeling
That shorts are no longer appealing
The polls keep on showing
The Tory lead growing
Look for more complaining and squealing

As well, from the trade front we’ve heard
That progress has not been deterred
Some sources who know
Say Phase One’s a go
With rollbacks the latest watchword

Yesterday was so…yesterday. All of that angst over the trade deal falling apart after President Trump indicated that he was in no hurry to complete phase one has completely disappeared this morning after a story hit the tape citing ‘people familiar with the talks’. It seems that the president was merely riffing in front of the cameras, but the real work has been ongoing between Mnuchin, Lighthizer and Liu He, and that progress is being made. Naturally, the market response was to immediately buy back all the stocks sold yesterday and so this morning we see equity markets in Europe higher across the board (DAX +1.1%, CAC +1.3%) and US futures pointing higher as well (DJIA +0.5%, SPY +0.45%). Alas, that story hit the tape too late for Asia, which was still reeling from yesterday’s negative sentiment. Thus, the Nikkei (-1.1%), Hang Seng (-1.25%) and Shanghai (-0.25%) all suffered overnight.

At the same time, this morning has seen pound Sterling trade to its highest level since May as the latest polls continue to show the Tory lead running around twelve percentage points. Even with the UK’s first-past-the-poll electoral system, this is seen as sufficient to result in a solid majority in Parliament, and recall, every Tory candidate pledged to support the withdrawal agreement renegotiated by Boris. With this in mind, we are witnessing a steady short squeeze in the currency, where the CFTC statistics have shown the size of the short Sterling position has fallen by half in the past month. As a comparison, the last time short positions were reduced this much, the pound was trading at 1.32 which seems like a pretty fair target for the top. Quite frankly, this has all the earmarks of a buy the rumor (Tory victory next week) sell the news (when it actually happens) situation. In fact, I think the risk reward above 1.30 is decidedly in favor of a sharper decline rather than a much stronger rally. Again, for Sterling receivables hedgers, I think adding to positions during the next week will be seen as an excellent result.

Away from the pound, however, the dollar is probably stronger rather than weaker this morning. One of the reasons is that after the euro’s strong performance on Monday, there has been absolutely no follow-through in the market. Remember, that euro strength was built on the back of the dichotomy of slightly stronger than expected Eurozone PMI data, indicating stabilization on the Continent, as well as much weaker than expected US ISM data, indicating things here were not so great after all. Well, this morning we saw the other part of the PMI data, the Services indices, and across all of the Eurozone, the data was weaker than expected. This is a problem for the ECB because they are building their case for any chance of an eventual normalization of policy on the idea that the European consumer is going to support the economy even though manufacturing is in recession. If the consumer starts backing away, you can expect to see much less appealing data from the Eurozone, and the euro will be hard-pressed to rally any further. As I have maintained for quite a while, the big picture continues to favor the dollar vs. the rest of the G10 as the US remains the most robust economy in the world.

Elsewhere in the G10, Australia is today’s major underperformer as the day after the RBA left rates on hold and expressed less concern about global economic issues, they released weak PMI data, 49.7, and saw Q3 GDP print at a lower than expected 0.4%. The point here is that the RBA may be trying to delay the timing of their next rate cut, but unless China manages to turn itself around, you can be certain that the RBA will be cutting again early next year.

In the EMG bloc, the biggest loser was KRW overnight, falling 0.6% on yesterday’s trade worries. Remember, the positive story didn’t come out until after the Asian session ended. In fact, the won has been falling pretty sharply lately, down 3.5% in the past month and tracking quickly toward 1200. However, away from Korea, the EMG space is looking somewhat better in this morning’s risk-on environment with ZAR the big gainer, up 0.5%. What is interesting about this result is the South African PMI data printed at 48.6, nearly a point worse than expected. But hey, when risk is on, traders head for the highest yielders they can find.

Looking to this morning’s US session, we get two pieces of data starting with ADP Employment (exp 135K) at 8:15 and then ISM Non-Manufacturing at 10:00 (54.5). Quite frankly, both of these are important pieces of data in my mind as the former will be seen as a precursor to Friday’s NFP report and the latter will be scrutinized to determine if Monday’s ISM data was a fluke, or something for more concern. The ISM data will also offer a direct contrast to the weak Eurozone PMI data this morning, so a strong print is likely to see the euro head back toward 1.10.

And that’s really it today. Risk is back on, the pound is rolling and whatever you thought you knew from yesterday is ancient history.

Good luck
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Started To Fade

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On Monday, the data released
Showed growth in the US decreased
As well, hope ‘bout trade
Has started to fade
And snow overwhelmed the Northeast

In a word, yesterday sucked. At least that’s the case if you were bullish on essentially any US asset when the session started. Early equity market gains were quickly reversed when the ISM data printed at substantially worse than expected levels. Not only did the headline release (48.1) miss expectations, which was biased toward a modest improvement over the October readings, but all of the sub-indices along with the headline number actually fell further from October. Arguably the biggest concern came from the New Orders Index which printed its lowest level (47.2) since the financial crisis. Granted, this was the manufacturing sector and manufacturing represents only about 12% of the US economy, but still, it was a rout. The juxtaposition with the green shoots from Europe was not lost on the FX market either as the dollar fell sharply across the board. In fact, the euro had its best day since early September, rallying 0.6%.

This morning, the situation hasn’t improved either, as one of the other key bullish stories for equity sentiment, completion of the phase one trade deal with China, was dealt a blow when President Trump explained that he was in no hurry to complete the deal and would only do so when he was ready. In fact, he mused that it might be better to wait until after the 2020 elections before agreeing a deal with China, something that is clearly not priced into the market. When those comments hit the tape, US equity futures turned around from small gains to losses on the order of 0.3%. Bullishness is no fun yet.

Perhaps it’s worth a few moments to consider the essence of the bullish US case and determine if it still holds water. Basically, the broad consensus has been that despite its sluggish pace, growth in the US has been more robust than anywhere else in the developed world and that with the FOMC having added additional stimulus via 75 bps of interest rate cuts and, to date, $340 billion in non-QE QE, prospects for continued solid growth seemed strong. In addition, the tantalizing proximity of that phase one trade deal, which many had assumed would be done by now or certainly by year end, and would include a reduction in some tariffs, was seen as a turbocharger to add to the growth story.

Now, there is no doubt that we have seen some very positive data from the US, with Q3 GDP being revised higher, the housing market showing some life and Retail Sales still solid. In fact, last week’s data releases were uniformly positive. At the same time, the story from Europe, the UK, China and most of the rest of the world was of slowing or non-existent growth with central banks having run out of ammunition to help support those economies and a protracted period of subpar growth on the horizon. With this as a backdrop, it is no surprise that US assets performed well, and that the dollar was a key beneficiary.

However, if that narrative is going to change, then there is a lot of price adjustment likely to be seen in the markets, which arguably are priced for perfection on the equity side. The real question in the FX markets is, at what point will a risk-off scenario driven by US weakness convert from selling US assets, and dollars by extension, to buying US dollars in order to buy US Treasuries in a flight to safety? (There is a great irony in the fact that even when the US is the source of risk and uncertainty, investors seek the safety of US Treasury assets.) At this point, there is no way to know the answer to that question, however, what remains clear this morning is that we are still in the sell USD phase of the process.

With that in mind, let’s look at the various currency markets. Starting with the G10, Aussie is one of the winners after the RBA left rates on hold, as widely expected, but sounded less dovish (“global risks have lessened”) than anticipated in their accompanying statement. Aussie responded by rallying as much as 0.65% initially, and is still higher by 0.35% on the day. And that is adding to yesterday’s 0.85% gain taking the currency higher by 1.2% since the beginning of the week. While the longer term trend remains lower, it would not be a surprise to see a push toward 0.70 in the next week or so.

The other major winner this morning is the British pound, currently trading about 0.4% higher after the latest election poll, by Kantar, showed the Tories with a 12 point lead with just nine days left. Adding to the positive vibe was a modestly better than expected Construction PMI (45.3 vs. 44.5 expected) perhaps implying that the worst is over.

Elsewhere in the G10, things have been far less interesting with the euro maintaining, but not adding to yesterday’s gains, and most other currencies +/- a few bps on the day. In the EMG bloc, the noteworthy currency is the South African rand, which has fallen 0.55% after a much worse than expected Q3 GDP release (-0.6% Q/Q; 0.1% Y/Y). The other two losing currencies this morning are KRW and CNY, both of which have suffered on the back of the Trump trade comments. On the plus side, BRL has rallied 0.4% after its Q3 GDP release was better than expected at +0.6% Q/Q. At least these moves all make sense with economic fundamentals seeming to be today’s driver.

And that’s really it for the day. There is no US data this morning, although we get plenty the rest of the week culminating in Friday’s payroll report. Given the lack of economic catalysts, it feels like the dollar will remain under general pressure for the time being. The short term narrative is that things in the US are not as good as previously had been thought which is likely to weigh on the buck. But for receivables hedgers, this is an opportunity to add to your hedges at better levels in quiet markets. Take advantage!

Good luck
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A Future Quite Bright

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The data from China last night
Implied that growth might be all right
The PMI rose
And everyone knows
That points to a future quite bright!

Is it just me? Or does there seem to be something of a dichotomy when discussing the situation in China? This morning has a decidedly risk-on tone as equity markets in Asia (Nikkei +1.0%, Hang Seng +0.4%, Shanghai +0.15%) rallied after stronger than expected Chinese PMI data was released Friday night. For the record, the official Manufacturing PMI rose to 50.2, its first print above 50.0 since April, while the non-Manufacturing version rose to 54.4, its highest print since March. Then, this morning the Caixin PMI data, which focuses on smaller companies, also printed a bit firmer than expected at 51.8. These data releases were sufficient to encourage traders and investors to scoop up stocks while they dumped bonds. After all, everything is just ducky now, right?

And yet…there are still two major issues outstanding that have no obvious short-term solution, both of which can easily deteriorate into a much worse situation overall. The first, of course, is the trade fiasco situation, where despite comments from both sides that progress has been made, there is no evidence that progress has been made. At least, there is no timeline for the completion of phase one and lately there has been no discussion of determining a location to sign said deal. Certainly it appears that the current risk profile in markets is highly dependent on a successful conclusion of these talks, at least as evidenced by the fact that every pronouncement of an impending deal results in a stock market rally.

The second issue is the ongoing uprising in Hong Kong. China has begun to use stronger language to condemn the process, and is extremely unhappy with the US for passing the Hong Kong Human Rights and Democracy Act last week. However, based on China’s response, we know two things: first that completing a trade deal is more important than words about Hong Kong. This was made clear when the “harsh” penalties imposed in the wake of the Act’s passage consisted of sanctions on US-based human rights groups that don’t operate in China and the prevention of US warships from docking in Hong Kong. While the latter may seem harsh, that has already been the case for the past several months. In other words, fears that the Chinese would link this law to the trade talks proved unfounded, which highlights the fact that the Chinese really need these talks to get completed.

The second thing we learned is that China remains highly unlikely to do anything more than complain about what is happening in Hong Kong as they recognize a more aggressive stance would result in much bigger international relationship problems. Of course, the ongoing riots in Hong Kong have really begun to damage the economy there. For example, Retail Sales last night printed at -24.3%! Not only was this worse than expected, but it was the lowest in history, essentially twice as large a decline as during the financial crisis. GDP there is forecast to fall by nearly 3.0% this year, and unless this is solved soon, it seems like 2020 isn’t going to get any better. But clearly, none of the troubles matter because, after all, PMI rose to 50.2!
Turning to Europe, PMI data also printed a hair better than expected, but the manufacturing sector remains in dire straits. Germany saw a rise to 44.1 while France printed at 51.7 and the Eurozone Composite at 46.9. All three were slightly higher than the flash data from last week, but all three still point to a manufacturing recession across the continent. And the biggest problem is that the jobs sub-indices were worse than expected. At the same time, Germany finds itself with a little political concern as the ruling coalition’s junior partner, the Social Democrats, just booted out their leadership and replaced it with a much more left wing team who are seeking changes in the coalition agreement. While there has been no call for a snap election, that probability just increased, and based on the most recent polls, there is no obvious government coalition with both the far left and far right continuing to gain votes at the expense of the current government. While this is not an immediate problem, it cannot bode well if Europe’s largest economy is moving toward internal political upheaval, which means it will pay far less attention to Eurozone wide issues. This news cannot be beneficial for the euro, although this morning’s 0.1% decline is hardly newsworthy.

Finally, with less than two weeks remaining before the British (and Scottish, Welch and Northern Irish) go to the polls, the Conservatives still hold between a 9 and 11 point lead, depending on which poll is considered, but that lead has been shrinking slightly. Pundits are quick to recall how Theresa May called an election in the wake of the initial Brexit vote when the polls showed the Tories with a large lead, but that she squandered that lead and wound up quite weakened as a result. At this point, it doesn’t appear that Boris has done the same thing, but stranger things have happened. At any rate, the FX market appears reasonably confident that the Tories will win, maintaining the pound above 1.29, although unwilling to give it more love until the votes are in. I expect that barring any very clear gaffes, the pound will range trade ahead of the election and in the event of a Tory victory, see a modest rally. If we have a PM Corbyn, though, be prepared for a pretty sharp decline.

Looking ahead to this week, we have a significant amount of US data, culminating in the payroll report on Friday:

Today ISM Manufacturing 49.2
  ISM Prices Paid 47.0
  Construction Spending 0.4%
Wednesday ADP Employment 140K
  ISM Non-Manufacturing 54.5
Thursday Initial Claims 215K
  Trade Balance -$48.6B
  Factory Orders 0.3%
  Durable Goods 0.6%
  -ex Transport 0.6%
Friday Nonfarm Payrolls 190K
  Private Payrolls 180K
  Manufacturing Payrolls 40K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.0% Y/Y)
  Average Weekly Hours 34.4
  Michigan Sentiment 97.0

Source: Bloomberg

As we have seen elsewhere around the world, the manufacturing sector in the US remains under pressure, but the services sector remains pretty robust. But overall, if the data prints as expected, it is certainly evidence that the US economy remains in significantly better shape than that of most of the rest of the world. And it has been this big picture story that has underpinned the dollar’s strength overall. Meanwhile, with the Fed meeting next week, they are in their quiet period, so there will be no commentary regarding policy until the next statement and press conference. In fact, next week is set to be quite interesting with the FOMC, the UK election and then US tariffs slated to increase two weeks from yesterday.

And yet, despite what appear to be numerous challenges, risk remains the primary choice of investors. As such, equities are higher and bonds are selling off although the dollar remains stuck in the middle for now. We will need to get more news before determining which way things are likely to break for the buck in the near term.

Good luck
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