A Good Place

Said Clarida, “We’re in a good place”
With regard to the policy space
Later Bullard explained
That inflation’s restrained
And a rise above two he’d embrace

“At this point I think it would be a welcome development, even if it pushed inflation above target for a time. I think that would be welcome, so bring it on.” So said St Louis Fed President James Bullard, the uber-dove on the FOMC, yesterday when discussing the current policy mix and how it might impact their inflation goals. Earlier, Vice-chairman Richard Clarida explained that while things currently seem pretty good, the risks remain to the downside and that the Fed would respond appropriately to any unexpected weakness in economic data. Not wanting to be left out, BOE member Silvana Tenreyo, also explained that she could easily be persuaded to vote to cut rates in the UK in the event that the economic data started to slow at all.

My point is that even though the central banking community has not seemed to be quite as aggressive with regard to policy ease lately, the reality is that they are collectively ready to respond instantly to any sign that the current global economic malaise could worsen. And of course, the ECB is still expanding its balance sheet by €20 billion per month while the Fed is growing its own by more than $60 billion per month. Any thought that the central bank community was backing away from interventionist policy needs to be discarded. While they continue to call, en masse, for fiscal stimulus, they are not about to step back and reduce their influence on markets and the economy. You can bet that the next set of rate moves will be lower, pretty much everywhere around the world. The only question is which bank will move first.

This matters because FX is a relative game, where currency movement is often based on the comparison between two nations’ monetary regimes and outlooks, with everyone looking at the same data, and central bank groupthink widespread, every response to a change in the economic outlook will be the same; first cut rates, then buy bonds, and finally promise to never raise rates again! And this is why I continue to forecast the dollar to decline as 2020 progresses, despite its robust early performance, the Fed has more room to cut rates than any other central bank, and that will ultimately undermine the dollar’s relative value.

But that is not the case today, or this week really, where the dollar has been extremely robust even with the tensions in Iran quickly dissipating. I think one of the reasons this has been the case is that the US data keeps beating expectations. As we head into the payroll report later this morning, recall that; the Trade Deficit shrunk, ISM Non-Manufacturing beat expectations, Factory Orders beat expectations, ADP Employment beat expectations and Initial Claims fell more than expected. The point is that no other nation has seen a run of data that has been so positive recently, and there has been an uptick in investment inflows to the US, notably in the stock market, which once again traded to record highs yesterday. While this continues to be the case, the dollar will likely remain well bid. However, ultimately, I expect the ongoing QE process to undermine the greenback.

Speaking of the payroll report, here are the latest median expectations according to Bloomberg:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 5K
Unemployment Rate 3.5%
Average Hourly Earnings 0.3% (3.1% Y/Y)
Average Weekly Hours 34.4
Canadian Change in Employment 25.0K
Canadian Hourly Wage Rate 4.2%
Canadian Unemployment Rate 5.8%
Canadian Participation Rate 65.6%

With the better than expected ADP report, market participants are leaning toward a higher number than the economists, especially given the overall robustness of the recent data releases. At this point, I would estimate that any number above 180K is likely to see some immediate USD strength, although I would not be surprised to see that ebb as the session progresses amid profit-taking by traders who have been long all week. Ironically, I think that a weak number (<130K) is likely to be a big boost for stocks as expectations of Fed ease rise, although the dollar is unlikely to move much on the outcome.

On the Canadian front, they have been in the midst of a terrible run regarding employment, with last month’s decline of 71.2K the largest in more than a decade. While inflation up north has been slightly above target, if we continue to see weaker economic data there, the BOC is going to be forced to cut rates sooner than currently priced (one cut by end of the year) as there is no way they will be able to resist the pressure to address slowing growth, especially given the global insouciance regarding inflation. While that could see the Loonie suffer initially, I still think the long term trend is for the USD to soften.

As to the rest of the world, the overnight session was not very scintillating. The dollar had a mixed performance overall, rising slightly against most of its G10 brethren, but faring less well against a number of EMG currencies, notably the higher yielders. For example, IDR was the big winner overnight, rising 0.6% to its strongest point since April 2018, after the central bank explained that it would not be intervening to prevent further strength and investors flocked to the Indonesian bond market with its juicy 5+% yield. Similarly, INR was also a winner, rising 0.4% as investors chased yield there as well. You can tell that fears over an escalation of the US-Iran conflict have virtually disappeared as these are two currencies that are likely to significantly underperform in the event things got hot there.

On the downside, Hungary’s forint was today’s weakest performer, falling 0.5% after PM Victor Orban explained that Hungary joining the euro would be “catastrophic”. While I agree with the PM, I think the market response is based on the idea that if the Hungarians were leaning in that direction, the currency would likely rally before joining.

On the G10 front, both French and Italian IP were released within spitting distance of their expectations and once again, the contrast between consistently strong US data and lackluster data elsewhere has weighed on the single currency, albeit not much as it has only declined 0.1%. And overall, the reality is that the G10 space has seen very little movement, with the entire block within 0.3% of yesterday’s closes. At this point, the payroll data will determine the next move, but barring a huge surprise in either direction, it doesn’t feel like much is in store.

Payables hedgers, I continue to believe this is a great opportunity as the dollar’s strength is unlikely to last.

Good luck and good weekend
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