Monthly Archives: January 2020

Pundits Maligned

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Phase one of the trade deal’s been signed
And though many pundits maligned
The outcome, it’s clear
That in the, term, near
Its impact on trading’s been kind

Amid a great deal of hoopla yesterday morning, President Trump signed the long-awaited phase one trade deal with China. The upshot is that the US has promised to roll back the tariffs imposed last September by 50%, as well as delay the mooted December tariffs indefinitely while the Chinese have promised to purchase upwards of $95 billion in US agricultural products over the next two years as well as agreeing to crack down on IP theft. In addition, the Chinese have committed to preventing excess weakness in the renminbi, and in fact CNY has been strengthening steadily for the past month as the negotiations came to an end. For example, this morning CNY is firmer by 0.15% and since mid-December it has rallied nearly 2.0%. Clearly there are larger trade issues outstanding between the two nations, notably forced technology transfer as well as numerous non-tariff barriers, but something is better than nothing.

Taking a step back, though, the bilateral nature of the deal is what has many pundits and economists unhappy. Certainly the economic theories I was taught, and that have been prevalent since David Ricardo first developed the theory of comparative advantage in 1817, indicate that multilateral trade is a better outcome for all concerned. Alas, the current political backdrop, where populism has exploded in response to the unequal outcomes from the globalization phenomenon of the past sixty years, has tarred multilateralism with a very bad reputation. And while it is far outside the purview of this commentary to dissect the issues, it is important to understand they exist and how they may impact markets. Given that the relative value of a nation’s currency is an important driver of trade outcomes, we cannot ignore it completely. Ultimately, as things currently stand, the market has seen this deal as a positive outcome, and risk appetite remains strong. As such, haven assets like the yen, dollar and Swiss franc are likely to remain on the back foot for the time being.

Beside the trade story, there has been scant new information on which to base trading decisions. Important data remains limited with the only notable print being German CPI at 1.5%, exactly as expected, although EU Car registrations bucked the trend and rose sharply, 21.7%, perhaps indicating we have seen a bottom on the Continent. But in reality, the market is now looking for the next big thing, and quite frankly, nobody really knows what that is. After all, the Fed has promised it is on hold, as are the ECB and BOJ, at least for the time being. Perhaps it is the BOE’s meeting in two weeks’ time, where the market continues to price in a growing probability of a rate cut. Of course, if the market is pricing it in, it is not likely to be that big a surprise, is it?

So in an uninspiring market, let’s look at what is coming up in today’s session. On the data front we see Initial Claims (exp 218K) and then Retail Sales (0.3%, 0.5% ex autos) as well as Philly Fed (3.8). Arguably, of just as much importance for the global economic outlook is tonight’s Chinese data where we will see; GDP (6.0%), Fixed Asset Investment (5.2%), Retail Sales (7.9%) and IP (5.9%). Remember, 6.0% growth has been President Xi’s target, and given the recent trajectory lower, any weaker than expected data is likely to be a risk-off sign, although it is likely to see a PBOC response in short order as well. Meanwhile, the US consumer continues to play its supporting role in the global economy, so any downside in this morning’s data is also likely to be a stock market negative.

On the speaker front, there are no Fed speakers today, although Philly’s Patrick Harker will regale us tomorrow. Later this afternoon ECB President Lagarde will be on the tape, and given she is still learning how much impact her words have on markets, there is always a chance of some unintentional excitement. Finally, yesterday, for the first time, we heard a Fed speaker explain that even though not-QE is not QE, the market may still consider it to be QE and the resulting rise in the price of risk assets may well be excessive. Dallas Fed President Kaplan is the first Fed member to publically admit that they may need to address this issue going forward. Certainly, the fact that the short-term repo program continues to be extended, and is now expected to run through April, rather than the original February completion, is an indication that the Fed still does not have control over the money markets. It is this last point which holds the potential to drive more significant market moves in the event of a communication or policy error. Just not today.

The dollar is mildly softer overall this morning, while we are seeing a very modest bias higher in equity markets around the world. Treasury yields are unchanged, just below 1.78%, and the previous narratives regarding recession probabilities and curve inversions as well as ongoing QE activities have just faded into the background. It all adds up to what is likely to be another quiet day in the FX markets, with no compelling story to drive movement.

Good luck
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Feelings of Disquietude

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In Germany, growth was subdued
In England, inflation’s now food
For thought rates will fall
As hawks are in thrall
To feelings of disquietude

This morning is a perfect lesson in just how little short-term movement is dependent on long-term factors like economic data. German GDP data was released this morning showing that for 2019 the largest economy in the Eurozone grew just 0.6%, which while expected was still the slowest rate in six years. And what’s more, forecasts for 2020 peg German GDP to grow at 0.7%, hardly enticing. Yet as I type, the euro is the best performer in the G10 space, having risen 0.2%. How can it be that weak data preceded this little pop in the currency? Well, here is where the short-term concept comes in; it appears there was a commercial order going through the market that triggered a series of stop-loss orders at 1.1140, and lo and behold, the euro jumped another 0.15%. My point is that any given day’s movement is only marginally related to the big picture and highly reliant on the short term flows and activities of traders and investors. So forecasts, like mine, that call for the euro to rally during this year are looking at much longer term issues, which will infiltrate trading views over time, not a prescription to act on intraday activity!

Meanwhile, the pound has come under modestly renewed pressure after CPI in the UK surprisingly fell to 1.3% with the core reading just 1.4%. This data, along with further comments by the most dovish BOE member, Michael Saunders, has pushed the probability of a UK rate cut at the end of the month, as measured by futures prices, up to 65%. Remember, yesterday this number was 47% and Friday just 25%. At this point, market participants are homing in on the flash PMI data to be released January 24 as the next crucial piece of data. The rationale for this is that the weakness that we have seen recently from UK numbers has all been backward-looking and this PMI reading will be the first truly forward looking number in the wake of the election in December. FYI, current expectations are for a reading of 47.6 in Manufacturing and 49.4 in Services, but those are quite preliminary. I expect that they will adjust as we get closer. In the meantime, look for the pound to remain under pressure as we get further confirmation of a dovish bias entering the BOE discussion. As to Brexit, it will happen two weeks from Friday and the world will not end!

Finally, the last G10 currency of interest today is the Swiss franc, which is vying with the euro for top performer, also higher by 0.2% this morning, as concern has grown over its ability to continue its intervention strategy in the wake of the US adding Switzerland back to the list of potential currency manipulators. Now, the SNB has been intervening for the past decade as they fight back against the franc’s historic role as a safe haven. The problem with that role is the nation’s manufacturing sector has been extraordinarily pressured by the strength of the franc, thus reducing both GDP and inflation. It seems a bit disingenuous to ask Switzerland to adjust their macroeconomic policies, as the US is alleged to have done, in order to moderate CHF strength given they already have the lowest negative interest rates in the world and run a large C/A surplus. But maybe that’s the idea, the current administration wants the Swiss to be more American and spend money they don’t have. Alas for President Trump, that seems highly unlikely. A bigger problem for the Swiss will be the fact that the dollar is likely to slide all year as QE continues, which will just exacerbate the Swiss problem.

Turning to the emerging market bloc, today’s biggest mover is BRL, where the real is opening lower by 0.5% after weaker than expected Retail Sales data (0.6%, exp 1.2%) point to ongoing weakness in the economy and increase the odds that the central bank will cut rates further, to a new record low of just 4.25%. While this still qualifies as a high-yielder in today’s rate environment, ongoing weakness in the Brazilian economy offer limited prospects for a reversal in the near-term. Do not be surprised to see BRL trade up to its recent highs of 4.25 before the bigger macro trend of USD weakness sets in.

And that’s been today’s currency story. I have neglected the signing of the phase one trade deal because that story has been so over reported there is exactly zero I can add to the discussion. In addition, the outcome has to be entirely priced into the market at this point. Equity markets have had difficulty trading higher during the past two sessions, but they certainly haven’t declined in any serious manner. As earnings season gets underway, investors seem to have turned their attention to more micro issues rather than the economy. Treasury yields have been edging lower, interestingly, despite the general good feelings about the economy and risk, but trying to determine if the stock or bond market is “correct” has become a tired meme.

On the data front, this morning brings PPI (exp 1.3%, 1.3% core) but given that we saw CPI yesterday, this data is likely to be completely ignored. We do get Empire Manufacturing (3.6) and then at 2:00 the Fed releases its Beige Book. We also hear from three Fed speakers, Harker, Daly and Kaplan, but at this point, the Fed has remained quite consistent that they have little interest in doing anything unless there is a significant change in the economic narrative. And that seems unlikely at this time.

And so, this morning the dollar is under modest pressure, largely unwinding yesterday’s modest strength. It seems unlikely that we will learn anything new today to change the current market status of limited activity overall.

Good luck
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A Dangerous Game

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In ‘Nineteen the story was trade
As Presidents Trump and Xi played
A dangerous game
While seeking to blame
The other for why growth decayed

But ‘Twenty has seen both adjust
Their attitudes and learn to trust
That working together,
Like birds of a feather,
Results in an outcome, robust

In a very quiet market, the bulk of the discussion overnight has been about the upcoming signing ceremony in the East Room of the White House tomorrow, where the US and China will agree the phase one piece of a trade deal. Despite the fact that this has been widely expected for a while, it seems to be having a further positive impact on risk assets. Today’s wrinkle in the saga has been the US’ removal of China from the Treasury list of currency manipulators. Back in August, in a bit of a surprise, the US added China to that list formally, rather than merely indicating the Chinese were on notice, as President Trump sought to apply maximum pressure during the trade negotiations. Now that the deal is set to be signed, apparently the Chinese have made “enforceable commitments” not to devalue the yuan going forward, which satisfied the President and led to the change in status. The upshot is that the ongoing positive risk framework remains in place thus supporting equity markets while undermining haven assets. In other words, just another day where the politicians seek to anesthetize market behavior, and have been successful doing so.

Chinese trade data released last night was quite interesting on two fronts; first that the Chinese trade surplus with the US shrank 11%, exactly what the President was seeking, and second, that the Chinese found many substitute markets in which to sell their wares as their overall trade surplus rose to $425 billion from 2018’s $351 billion. And another positive for the global growth watch was that both exports (+7.6%) and imports (+17.7%) grew nicely, implying that economic growth in the Middle Kingdom seems to be stabilizing. As to the yuan, it has been on a tear lately, rising 1.4% this year and nearly 4.5% since early September right after the US labeled China a currency manipulator. So, here too, President Trump seems to have gotten his way with the Chinese currency having regained almost all its losses since the November 2016 election. Quite frankly, it seems likely that the yuan has further to climb as prospects for Chinese growth brightened modestly and investors continue to hunt for yield and growth opportunities.

But away from the trade story there is precious little else to discuss. The pound remains under pressure (and under 1.30) as the idea of a BOE rate cut at the end of the month gains credence. Currently the market is pricing in a 47% probability of a rate cut, which is up from 23% on Friday. After yesterday’s weak GDP data, all eyes are focused on tomorrow’s UK CPI data as well as Friday’s Retail Sales where any weakness in either one is likely to see the market push those probabilities up even further.

As haven assets are shed, the Japanese yen has finally breached the 110 level for the first time since May and quite frankly there doesn’t appear to be any reason for the yen to stop declining, albeit slowly. Barring some type of major risk-off event, which is always possible, the near term portents are for further weakness. However, as the year progresses, ongoing Fed QE should serve to reverse this movement.

Even the Emerging markets have been dull overnight, with no currency moving more than 0.3%, which in some cases is nearly the bid-ask spread. For now, most market participants have become quite comfortable that no disasters are looming and that, with the US-China trade deal about to be completed, there is less likelihood of any near-term angst on that front. While a phase two deal has been mooted, given the issues that the US has indicated are important (forced technology transfer, state subsidies), and the fact that they are essentially non-starters in China, it seems highly improbable that there will be any progress on that issue this year.

On the data front, this morning brings the first US data of the week, where NFIB Small Business Optimism actually disappointed at 102.7 and the market is now awaiting December CPI data (exp 2.4%, 2.3% ex food & energy) at 8:30. The headline forecast represents a pretty big uptick from November, but that is directly related to oil’s price rally last month. The core, however, remains unchanged and well above the 2.0% Fed target. Of course that target is based on PCE, something that is designed to print lower, and there has been abundant evidence that the Fed’s idea of the target is to miss it convincingly on the high side. In other words, don’t look for the Fed to even consider a tighter policy stance unless CPI has a 3 handle.

And that’s really it for the session. Equity futures are pointing slightly higher as European equity indices are edging in that direction as well. Treasury yields are hovering just above 1.80%, little changed on the day and showing no directional bias for the past several weeks. If anything, the dollar is slightly higher this morning, but I would be surprised if this move extends much further at all.

Good luck
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Growth Can Be Spurred

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In England this morning we heard
From Vlieghe, the BOE’s third
Incumbent to say
That given his way
He’d cut rates so growth can be spurred

The pound is under pressure this morning after Gertjan Vlieghe became the third MPC member in the past week, after Carney and Tenreyo, to explain that a rate cut may be just the ticket at this point in time. Adding these three to the two members who had previously voted to cut rates, Haskel and Saunders, brings the number of doves to five, a majority on the committee. It can be no surprise that the pound has suffered, nor that interest rate markets have increased the probability of a 25bp rate cut at the January 30 meeting from below 25% last week to 50% now. Adding to the story was the release of worse than expected November IP (-1.2%) and GDP (-0.3%) data, essentially emphasizing the concerns that the UK economy has a long way to go to recover from the Brexit uncertainty.

However, before you turn too negative on the UK economy, remember that this is backward-looking data, as November was more than 6 weeks ago, and in the interim we have had the benefit of the resounding electoral victory by Boris Johnson. This is not to say that the UK economy cannot deteriorate further, just that there has been a palpable change in the tone of commentary in the UK as Brexit uncertainty has receded. Granted, the question of the trade deal with the EU, which is allegedly supposed to be signed by the end of 2020, remains open. But it is very difficult for market participants to look that far ahead and try to anticipate the outcome. And if anything, Boris has the fact that he was able to renegotiate the original Brexit deal in just six weeks’ time working in his favor. While previous assumptions had been that trade deals take years and years to negotiate, it is clear that Boris doesn’t subscribe to that theory. Personally, I wouldn’t bet against him getting it done.

But for now, the pound is the worst performer of the session, and given today’s news, that should be no surprise. However, I maintain my view that current levels represent an excellent opportunity for payables hedgers to add to hedges.

The other mover of note in the G10 space is the yen, which has fallen 0.4% after traders were able to take advantage of a Japanese holiday last night (Coming-of-age Day) and the associated reduced liquidity to push the dollar above a key technical resistance point at 109.72. Stop-loss orders at that level led to a quick jump at 4:00 this morning, and given the broad risk-on attitude in markets (equity markets worldwide continue to rebound from concerns over further Middle East flare ups), it certainly feels like traders are going to push the dollar up to 110, a level not seen since May. However, the other eight currencies in the G10 have been unable to generate any excitement whatsoever and are very close to unchanged this morning.

In the EMG space, Indonesia’s rupiah is once again the leader in the clubhouse, rising a further 0.7% after the central bank reiterated it would allow the currency to appreciate and following an announcement by the UAE that it would make a large investment in the nation’s (Indonesia’s) sovereign wealth fund. The resultant rally, to the rupiah’s strongest level in almost a year, has been impressive, but there is no reason to believe that it cannot continue for another 5% before finding a new home. This is especially true if we continue to hear good things regarding the US-China trade situation. Trade has also underpinned the second-best performer of the day in this space, KRW, which has rallied 0.5%, on the trade story.

While those are the key stories thus far this session, we do have a full week’s worth of data to anticipate, led by CPI, Retail Sales and Housing data.

Tuesday NFIB Small Biz Optimism 104.9
  CPI 0.3% (2.4% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday PPI 0.2% (1.3% Y/Y)
  -ex food & energy 0.2% (1.3% Y/Y)
  Empire Manufacturing 3.5
  Fed’s Beige Book  
Thursday Initial Claims 218K
  Philly Fed 3.0
  Retail Sales 0.3%
  -ex autos 0.5%
  Business Inventories -0.1%
Friday Housing Starts 1380K
  Building Permits 1460K
  IP -0.1%
  Capacity Utilization 77.0%
  Michigan Sentiment 99.3
  JOLTS Job Openings 7.264M

Source: Bloomberg

So clearly there is plenty on the docket with an opportunity to move markets, and we also hear from another six Fed speakers. While you and I may be concerned about rising prices, it has become abundantly clear that the Fed is desperate to see them rise further, so the only possible reaction to a CPI miss would be on the weak side, which would likely see an equity rally on the assumption that even more stimulus is coming. Otherwise, I think Retail Sales will be the data point of choice for the market, with weakness here also leading to further equity strength on the assumption that the Fed will add to their current policy.

And it is hard to come up with a good reason for any Fed speaker to waver from the current mantra of no rate cuts, but ongoing support for the repo market and a growing balance sheet. And of course, that underlies my thesis that the dollar will eventually fall. Just not today it seems!

Good luck
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A Good Place

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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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A True Blue Pangloss

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Right now there’s a group of old men
(Though Europe has proffered a hen)
Who feel it’s their right
To hog the limelight
When talking pounds, dollars or yen

Here’s a thought for the conspiracy theorists amongst you. Do you think that the cabal of central bankers get annoyed when something other than their actions and words are responsible for moving markets? And so yesterday they determined it was Carney’s turn to make comments that would dominate the financial wires. I mean, war in the Middle East is completely out of the central bankers’ control, which means they have to be reactive in the event that market moves start to become uncomfortable (i.e. stock prices fall). When you are the leader of a G10 central bank, a key part of your role is to make sure that traders and investors jump at your every word (or so it seems) so if the investment community is worrying about something like war, the central bankers are just not very relevant. And they HATE that! While, of course, this is somewhat tongue in cheek, it is remarkable how quickly we hear from a major central banker after market activity that has been focused on non-monetary issues.

Mark Carney, the Old Lady’s boss
Explained, like a true blue Pangloss
That under the rules
They’d plenty of tools
To ease two percent at a toss

At any rate, arguably, as the relief rally continues, the biggest news overnight was a speech by BOE Governor Carney indicating that despite the fact that the base rate is currently set at 0.75%, the BOE has the capability, if necessary, to ease policy by an effective 250bps through rate cuts, more QE and forward guidance. Interestingly, if you read the speech, he doesn’t say that is what they are going to do, although two MPC members have voted for a rate cut already, he is merely responding to the critics who claim the central banks have no ammunition left to fight an eventual downturn in economic activity. Cable traders, however, must have heard the following: we are going to ease policy immediately, at least based on the fact that the pound is today’s worst performing currency, having fallen 0.65% as I type, and taking its decline thus far in 2020 to nearly 2.0%.

At the same time, the central bank cabal should be pleased because equity markets around the world are rallying aggressively, mostly on the idea that a war between the US and Iran is not imminent, and tangentially on the idea that the central banks remain adamant that they have plenty of ammunition left to keep easing monetary policy ad infinitum.

And that’s really the story, isn’t it? Markets remain almost completely beholden to central bank activity and central bank comments. As long as the prevailing view is that any decline in equity markets is an aberration and will be addressed immediately, we are going to see global equity markets rise. You cannot really fight that story. However, when it comes to the FX markets, there is slightly more opportunity for diversion amongst countries as each nation is likely to add differing amounts of stimulus, thus the relative value of one currency vs. another can react to those differences.

After all, looking at the UK, for example, the combination of the imminent Brexit deal and reduction in policy uncertainty as well as Carney’s comments that the BOE has plenty of room to ease has been more than sufficient to support the FTSE 100, which is higher by 0.6% this morning. And of course, part and parcel of that movement is the pound’s weakness. In fact, I believe this year is going to be all about relative policy ease, at least in the G10 space, with the Fed on track to ease more than any other nation via their not QE and repo programs. And that is why, as the year progresses, I continue to expect the dollar to decline. But so far this year, that has not been the narrative.

With this in mind, a look at the overnight price action shows that equity markets around the world have looked great (Nikkei +2.3%, Shanghai +0.9%, DAX +1.3%, CAC +0.45%) and haven assets have suffered (JPY -0.3%, -0.9% since Tuesday; gold -0.6%; and Treasuries +5bps since yesterday morning). A diminished chance of war and talk of easier policy have worked wonders for risk appetites. Can all this continue? As long as central banks keep playing the same tune they have for the past decade, there doesn’t seem to be any reason for it to stop.

Meanwhile, the dollar has generally been going gangbusters this year, up against all its G10 counterparts, although having a more mixed performance in the EMG space. In truth, US data so far has generally been beating expectations with yesterday’s ADP print of 202K (with a big revision higher for the previous month) the latest proof of that theory. Obviously, Friday’s payroll report will be carefully watched to see if job growth remains abundant, and perhaps more importantly, to see if wages continue to rise. So for the time being, it seems that the FX market is focused on the economic data, and the US data has generally been the best of the bunch, hence the dollar’s strength.

This morning, the only piece of data is Initial Claims (exp 220K) which during payroll week is generally ignored. This means that the dollar’s ongoing short term strength is likely to continue to manifest itself until we get a bad number, or we hear, more clearly, that the Fed is going to ease. I continue to believe that payables hedgers should be taking advantage of what, I believe, will be short term dollar strength. But there is a long way to go this year.

Good luck
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Just Dreams

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Last night saw a rocket attack
On assets, US, in Iraq
The oil price surged
While stocks were submerged
’neath selling by bulls who cut back

This morning, however, it seems
Concerns about war were just dreams
The losses reversed
As traders still thirst
For assets now priced at extremes

What a difference a day makes…or does it? Yesterday saw market participants’ initial evaluation of the threat of escalation in Iran/Iraq as limited with the result that early price action favoring haven assets reversed and most markets closed within a few basis points of Monday’s prices. The one exception to that rule was the dollar, which maintained its bid all day long, actually extending its gains late into the session. Other than the idea that international investors are buying dollars so they can buy US stocks, it is hard to come up with a short term rationale for the dollar’s recent strength. If anything, news this morning that the Fed’s balance sheet has grown even further, to $4.17 trillion, would imply that a weaker dollar is in the offing.

Of course, last night, shortly after the US markets closed, came the news that Iran fired a number of missiles at two different military bases in Iraq that are jointly used by the US and Iraqi militaries. There was a great deal of huffing and puffing from Iran, they announced the attacks themselves on Iranian TV, but in the end, they were nothing more than damp squibs. There was no material damage and no personnel killed, or even severely wounded. (And that is a good thing!) But at the time the news hit the tape, this outcome was not clear and risk assets plunged while haven assets soared. Thus, overnight saw gold trade up to $1610/oz, WTI rise to $65.65 (Brent to $71.75), Treasury yields fall to 1.74% and the yen rise to 107.65 (0.75%). But that price action, and the fear driving it, was quite short-lived. Once it became clear that the Iranian retaliation was completely ineffective, and they announced they were not interested in a major conflict, essentially all of that movement was reversed. So this morning we see gold at $1579/oz, WTI at $62.60, Treasury yields back to 1.82% and the yen actually net weaker on the day, at 108.70 (-0.25%).

This begs the question of how to consider this new potential risk going forward. The first rule of an exogenous market risk is the law of diminishing returns. In other words, even if there is another attack of some sort, you can be sure that the haven rally will be smaller and risk assets will not decline as much as the first time. And since this entire affair is occurring in a locale that, other than oil production, has almost no impact on the global economy, the impact is likely to be even smaller. Now I waved off oil production as though it is not important, but there is no question that the remarkable rise of US oil production has significantly altered the global politics of oil. When the Middle East was responsible for more than 50% of global production, OPEC ruled the roost, and anything that happened there had a global impact. But as oil production elsewhere in the world has grown and OPEC’s market share sinks below 40% (remember, the US is the world’s largest oil producer now), the impact of Middle Eastern conflagrations has fallen dramatically. The point is that short of a major attack by Iran on Saudi oil facilities or attempts to close the Persian Gulf, this situation has probably driven all the market excitement it is going to. In other words, we need to look elsewhere for market catalysts.

With that in mind, if we turn to the ongoing data releases, we find that German Factory Orders once again missed the mark, falling 6.5% Y/Y in November, highlighting that the industrial malaise in the engine of Europe continues. French Consumer Confidence fell more than expected, and Eurozone Confidence indices were almost uniformly worse than expected. It is difficult to look at this data and conclude that the situation in Europe is improving, at least yet. I guess, given this situation it should be no surprise that the euro is lower again this morning, down 0.3%, and actually trading at its lowest point this year (a little unfair, but the lowest level in two weeks). But the dollar’s strength is evident elsewhere in the G10 as the pound remains under pressure, -0.1% today and 0.45% this week. And the same is true pretty much throughout the space.

In the EMG bloc, the results have been a bit more mixed overnight with THB the worst performer (-0.5%) after comments from the central bank decrying the baht’s strength and implying they may do something about it. Remember, too, that APAC currencies, in general, saw weakness on the fear story, which dissipated after those markets closed. On the flip side, ZAR is the day’s biggest gainer, +0.6%, completely recouping its early-session Middle East related losses, as investors apparently focused on the incipient US-China trade deal and how it will benefit the global economy and South African interests.

On the US data front, yesterday saw a smaller than expected Trade Deficit and better than expected ISM data (55.0 vs. 54.5 exp). This morning we are awaiting the ADP Employment numbers (exp 160K) and Consumer Credit ($16.0B) this afternoon. We also hear from Fed Governor Lael Brainerd this morning, but it doesn’t appear as though she will focus on monetary policy as part of her discussion on the Community Reinvestment Act.

In the end, US data has continued to perform well, which thus far has been enough to offset the early impact of the Fed’s (not) QE. However, as the Fed balance sheet continues to grow, I continue to look for the dollar to decline throughout the year. As such, payables receivers should consider taking advantage of the dollar’s early year strength.

Good luck
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What’s Most Feared

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For almost two days it appeared
That havens were to be revered
But with rates so low
Investors still know
That selling risk is what’s most feared

By yesterday afternoon it had become clear that market participants were no longer concerned over any immediate retaliation by Iran. While there have been a number of comments and threats, the current belief set is that anything that occurs is far more likely to be executed via Iranian proxies, like Hezbollah, rather than any direct attack on the US. And so as the probability of a hot war quickly receded in the minds of the global investment community, all eyes turned back toward what is truly important…central bank largesse!

As I briefly mentioned yesterday, there was a large gathering of economists, including many central bankers past and present, this past weekend in San Diego. The issue that seemed to generate the most interest was the idea of negative interest rates and whether their implementation had been successful, and more importantly, whether they ever might appear as part of the Fed’s policy toolkit.

Chairman Powell has made clear a number of times that there is no place for negative rates in the US. This sentiment has been echoed by most of the current FOMC membership, even the most dovish members like Kashkari and Bullard. And since the US economy is continuing to grow, albeit pretty slowly, it seems unlikely that this will be more than an academic exercise anytime soon. However, a paper presented by some San Francisco Fed economists described how negative rates would have been quite effective during the throes of the financial crisis in 2008-2009, and that stopping at zero likely elongated the pain. Ironically, former Fed chair Bernanke also presented a paper saying negative rates should definitely be part of the toolkit going forward. This is ironic given he was the one in charge when the Fed went to zero and had the opportunity to go negative at what has now been deemed the appropriate time. (Something I have observed of late is that former Fed chairs are quite adept at describing things that should be done by the Fed, but were not enacted when they were in the chair. It seems that the actuality of making decisions, rather than sniping from the peanut gallery, is a lot harder than they make out.)

At any rate, as investors and analysts turn their focus away from a potential war to more mundane issues like growth and earnings, the current situation remains one of positive momentum. The one thing that is abundantly clear is that the central bank community is not about to start tightening policy anytime soon. In fact, arguably the question is when the next bout of policy ease is implemented. The PBOC has already cut the RRR, effective yesterday, and analysts everywhere anticipate further policy ease from China going forward as the government tries to reignite higher growth. While Chairman Powell has indicated the Fed is on hold all year, the reality is that they are continuing to regrow the balance sheet to the tune of $60 billion / month of outright purchases as well as the ongoing repo extravaganza, where yesterday more than $76 billion was taken up. And although this is more of a stealth easing than a process of cutting interest rates, it is liquidity addition nonetheless. Once again, it is this process, which shows no signs of abating, which leads me to believe that the dollar will underperform all year.

Turning to today’s session we have seen equity markets climb around the world following the US markets’ turn higher yesterday afternoon. Bond prices are little changed overall, with 10-year Treasury yields right at 1.80%, and both oil and gold have edged a bit lower on the day. Certainly, to the extent that there was fear of a quick reprisal from Iran, the oil market has discounted that activity dramatically.

Meanwhile, the dollar is actually having a pretty good session today, rallying against the entire G10 space despite some solid data from the Eurozone, and performing well against the bulk of the EMG bloc. The dollar’s largest gains overnight have come vs. the Australian dollar, which is down nearly 1.0% this morning after weak employment data (ANZ Job Adverts -6.7%) reignited fears that the RBA was going to be forced to cut rates further in Q1. But the greenback has outperformed the entire G10 space. The other noteworthy data were Eurozone Retail Sales (+1.0%) and CPI (+1.3% headline and core) with the former beating expectations but the latter merely meeting expectations and the core data showing no impetus toward the ECB’s ‘just below 2.0%’ target. Alas, the euro is lower by 0.15% this morning, dragging its tightly linked EEMEA buddies down by at least that much, and in some cases more. Finally, the pound has dipped 0.3%, but given the dearth of data, that seems more like a simple reaction to its inexplicable two-day rally.

In the EMG space, APAC currencies were the clear winners, with CNY rallying 0.5% as investment flows picked up with one of this year’s growing themes being that China is going to rebound sharply, especially with the trade situation seeming to settle down. It can be no surprise that both KRW and IDR, both countries that rely on stronger Chinese growth for their own growth, have rallied by similar amounts this morning. Meanwhile, EEMEA currencies have been under pressure, as mentioned above, despite the little data released (Hungarian and Romanian Retail Sales) being quite robust.

As to this morning’s session we get our first data of the week with the Trade Balance (exp -$43.6B), ISM Non-Manufacturing (54.5) and Factory Orders (-0.8%). Mercifully, there are no Fed speakers scheduled, so my sense is the market will be focused on the ISM data as well as the equity market. As things currently stand, it is all systems go for a stock market rally and assuming the ISM data simply meets expectations, the narrative is likely to shift toward stabilizing US growth. Of course, with the Fed pumping money into the economy in the background, that should be the worst case no matter what. FWIW it seems the dollar’s rally is a touch overdone here. My sense is that we are going to see it give back some of this morning’s gains as the session progresses.

Good luck
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No Rapprochement

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The topic du jour is Iran
Where threats, to and fro, carry on
Risk appetite’s fallen
And bears are now all in
That this time there’s no rapprochement

The rhetoric between the US and Iran over the weekend has escalated with both sides threatening retaliation for anything the other side does. Stories of cyber-attacks on the US as well as an attack on a base in Kenya where three Americans were killed seem to be the first steps, but with the US deploying reinforcements to the Middle East, and President Trump promising disproportionate responses to any further actions, the situation has become fraught with danger.

Not surprisingly, financial markets are stressing with risk appetites throughout the world dissipating and haven assets in demand. So, for a second day we have seen equity markets fall around the world (Nikkei -1.9%, Hang Seng -0.8%, DAX -1.6%, CAC -1.1%, FTSE -1.0%) and US futures are following along with all three indices currently lower by approximately 0.8%. Treasuries and German bunds have rallied, albeit Friday’s price action was far greater than this morning’s movement which has seen yields on each fall just one more basis point. Gold has soared to its highest level since April 2013 and is now pressing up toward $1600/oz. Oil continues to rise on supply fears, up another 1.0% this morning and nearly 6.0% since Friday morning. But recall that prior to the US action against Soleimani, oil was up more than 20% since October.

And finally, the dollar this morning is…lower. At least mostly that’s the case. In some ways this is quite surprising as the dollar tends to be a haven in its own right, but markets have been known to be fickle prior to today. In the G10 space, the pound is leading the way higher overnight, up 0.5%, which may well be a response to modestly better than expected UK data (New Car Registrations +3.4%, Services PMI 50.0) rather than to the geopolitical risks. Of course, PMI at 50.0 is hardly cause for celebration, but I guess that’s better than further sub-50 readings. The euro has also benefitted this morning, +0.35%, after PMI data across the region was also modestly better than the flash numbers from the week before last. However, based on the latest data, according to most econometric models, GDP for Q1 in the Eurozone is still running at just 0.1%, or less than 0.5% annualized. Again, it’s hard to get too excited about the situation yet.

And then there is the yen, which is essentially unchanged on the day, perhaps the biggest surprise of all. This is because even when the dollar has not run true to course on a risk basis, the yen has been extremely consistent. Granted, since New Year’s Eve, the yen has been the top G10 performer but its 0.5% rally in that time is hardly inspirational. My take is that even heightened rhetoric from either side is likely to see the yen gain further, but remember there are market technicals involved in the trade, with 108.00 having demonstrated strong support since early October. It appears we will need a bit more of a ‘kinetic’ action in Iraq/Iran before the yen takes its next steps higher.

In the EMG bloc, the situation is a bit different, with EEMEA currencies all trading in a tightly linked manner to the euro, and so higher by about 0.35%, but modest weakness seen across most of the APAC region. As to LATAM, CLP is opening much lower (-1.75%) as the central bank backed away from its USD sale program. The bank announced this morning that it would not be selling the $150mm in the spot market it has been executing every day since last autumn. If nothing else, this should be a good indication for hedgers of just how little liquidity exists within that market.

Turning to Friday’s FOMC Minutes, it can be no surprise that the Fed nearly twisted their own arm, patting themselves on the back, for setting policy at just the right place. And then there was the American Economic Association conference this past weekend where the Fed loomed large in the paper production. Former Fed chairs Bernanke and Yellen once again explained that things beyond their control (demographics and technology) were the reason that they could not achieve their policy targets, but both assured us that more of the same policies that have been ineffective for the economy (but great for the stock market) would get the job done! Meanwhile, current Fed members all expressed satisfaction with the current settings, although it is clear there is far more concern over economic weakness than rising price pressures. What is clear is that higher prices are coming to a store (every store) near you.

As to this week, the data parade starts tomorrow and runs through Friday’s payroll report as follows:

Tuesday Trade Balance -$43.9B
  ISM Non-Manufacturing 54.5
  Factory Orders -0.7%
Wednesday ADP Employment 160K
  Consumer Credit $15.8B
Thursday Initial Claims 220K
Friday Nonfarm Payrolls 162K
  Private Payrolls 152K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.4

Source: Bloomberg

In addition, we hear from five more Fed speakers, with many more doves than hawks slated to discuss their views. In truth, I think it would be more effective if they would simply shut up rather than constantly reiterate their opinion that they have done a great job and will continue to do so unless things change. However, with the reduced risk appetite due to the Iran situation, I guess they feel the need to try to support stock prices at all costs.

In the medium term, I think the dollar will continue to come under pressure. In the short term, I think it is much harder to have a view given the highly volatile nature of the current situation in the Middle East. This is why you hedge; to prevent significant problems, but take care in executing those hedges, markets are skittish on the opening, and market depth may be a bit less robust than normal.

Good luck
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Unease In Iraq

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While yesterday, risk basked in glory
This morning risk-off is the story
Unease in Iraq
Had markets give back
The gains seen in each category

Well, this is probably not the way most of us anticipated the year to begin, with a retaliatory strike against Iran inside Iraq, but that’s what makes markets interesting. So yesterday’s bright beginning, where the PBOC reduced its reserve requirement ratio (RRR) by 0.50% to add further liquidity to the Chinese economy which led to broad based positive risk sentiment has been completely reversed this morning. Briefly recapping yesterday’s activity, equity markets around the world soared on the news of further central bank easy money, but interestingly, Treasury bonds rallied (yields declined) and gold rallied as did the dollar. This is a pretty unusual combination of market movements, as generally, at least one of that group would sell off in a given session. Perhaps it speaks to the amount of spare cash on the sidelines looking for investment opportunities to start the year.

However, that was soooo yesterday. At about 7:45 last night the news hit the tape that a senior Iranian general from the QUDS force had been killed by a US drone attack near Baghdad airport. When this was confirmed all of the positive sentiment that had been permeating markets disappeared in an instant. Equity prices went from a strong opening in Asia to closing with declines. The dollar and the yen both rallied sharply as did gold and oil. And not to be left out, Treasury yields have plummeted along with Bund and Gilt yields. In other words, today is a classic risk-off session.

So a quick look at markets as NY starts to walk in shows European equity markets under pressure (DAX -1.65%, CAC -0.5%, FTSE -0.5%) and US futures similarly falling (DJIA -1.2%, Nasdaq 1.5%, SPY -1.3%). In the bond market, Treasury yields are down 7.5bps to 1.80% while German Bunds are down 7bps to -0.30%. Gold prices have rallied a further 1.4% and are back to the highs touched in September at $1550/oz, a level which had not been seen since early 2013 prior to that. Oil prices have rocketed higher, up 3.9%, as fears of supply interruptions make the rounds. Of course, given that the US shale producers have essentially become the swing producers in the market, my sense is that we are not likely to see a permanently higher price level here. Remember, when Iran attacked Saudi oil facilities last September, the oil price spike was extremely short-lived, lasting just a couple of days before settling right back down.

And finally, the dollar has rallied sharply this morning against virtually all its counterparts except, naturally, the yen. During the last week of 2019, the dollar sold off broadly, losing about 2.0% against a wide range of currencies as investors and traders seemed to be preparing for a scenario of continued low US interest rates supporting stocks while undermining the dollar’s value. Of course, my view of ‘not QE’ having a significant impact on the dollar has not changed, and although the US economy continues to outperform its G10 peers and US interest rates remain higher than pretty much every other country in that bloc, the history of QE is that it will undermine the dollar this year.

But for right now, long-term structural issues are taking a back seat to the immediacy of growing concern over escalating tensions in Iraq and the Middle East. If a larger conflict erupts, then we are far more likely to see protracted USD and JPY strength alongside weaker equity markets, higher prices for gold and oil and lower Treasury yields. And the thing to remember right now is that traders were establishing short USD positions for the last several weeks, so this sudden reversal could well have further to run on position squaring alone. Markets remain less liquid than normal as most trading desks will not be fully staffed until Monday. So keep that in mind if some hedging needs to be executed today.

With that as an introduction, what else can we anticipate today? Well, we do get a bit of US data, ISM Manufacturing (exp 49.0) and ISM Prices Paid (47.8) as well as Construction Spending (0.4%) and then at 2:00 the FOMC Minutes from the December meeting will be released. Those have garnered a great deal of interest as even though Chairman Powell has essentially told us all that rates are on hold for a long time, all eyes will be searching for further discussion of the repo issue and how the Fed plans to handle it going forward. While they were able to prevent any untoward movement for the year-end turn, they are still buying $60 billion / month of T-bills and the balance sheet has grown more than $400 billion since October. Not coincidentally, equity prices have rallied sharply since October as well. The point is that the Fed remains on a path where they have promised to re-inflate the balance sheet until at least late Spring, and given the direct relationship between the Fed’s balance sheet and equity prices, as well as the demonstrated fear the Fed has shown with respect to doing anything that could be blamed for causing the stock market to decline, it seems awfully likely that ‘not QE’ is going to continue for a very long time. And that is going to weigh on the dollar going forward…just not today.

One more thing to look for this afternoon is a series of comments from a bevy of Fed doves (Brainard, Daly, Evans and Kaplan) who are attending a conference in San Diego. Do not be surprised to hear comments that continue to raise the bar for any possible rate hikes, but allow the idea of rate cuts to filter into the discussion. However, this too, is unlikely to undermine the dollar during a risk-off session. The theme here is that payables hedgers need to consider taking advantage of this short-term dollar strength.

Good luck
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