Funding is Lacking

The government in the US
Has lately been under some stress
Considering backing
For funding is lacking
This could turn into quite a mess

While I don’t necessarily agree that it is a crucial issue for the FX market, the fact that there is a threat of another government shutdown in the US has certainly been the most discussed topic in the press this morning. But I question whether the trading community is in accord. Ostensibly, the dollar’s recent weakness can be partially attributed to the fact that there is a broad loss of confidence in the US due to the current administration’s combination of policies and internal discord, and so investors are seeking other homes for their funds. But that doesn’t make sense to me given that the US economy continues to lead the G10 in the economic cycle, has shown no sign of slowing down yet, and has had continued substantive gains in its equity markets. Those are hardly reasons to shun a market. Rather, I believe the dollar’s recent weakness is a product of the ongoing narrative that the recent uptick in growth elsewhere in the world is going to cause other G10 central banks to tighten policy more quickly than the Fed on a relative basis. Or perhaps more accurately, FX traders are betting that the Fed will tighten less than current market pricing anticipates while the ECB, BOJ and other G10 central banks will tighten more. That would certainly explain the dollar’s weakness, but I think it is a mistake. If anything, I believe that the exact opposite will be the outcome in 2018 and that the dollar will be higher when all is said and done. We shall see.

But weaker the dollar is this morning, albeit not dramatically so. In the G10, the yen has been the best performer, rising a further 0.3% as the discussion in Tokyo continues to be about the timing of any change in policy there. There seems to be a growing belief that Kuroda-san will begin hinting at the end of QE in next week’s meeting despite the fact that inflation in Japan remains at 0.9%, well below the target of 2.0%. This is especially troubling because services inflation is running at just 0.1% and wage pressures have not yet made themselves felt. So though oil prices are higher and goods prices are beginning to rise, based on current central bank groupthink, it is not yet time to get aggressive. In fact, we could be having virtually the identical discussion about the ECB here, where the market has become quite keen on the idea that the end of QE is nigh, or at the very least the announcement of that timing is at hand despite the fact that the inflation story in the Eurozone remains equally stagnant. My money is on both Kuroda and Draghi to remain dovish in their statements next week.

One interesting thing about the yen this morning is the fact that it is stronger despite the fact that the UST-JGB spread has expanded to its widest level since 2010, and is more than 250bps. This is due to the fact that the 10-year Treasury continues to climb in yield. Historically, a yield spread of this magnitude has been a signal for Japanese investors to switch into Treasuries from JGB’s and the dollar has been the beneficiary. But thus far, we have not seen that play out.

The one other newsworthy item from the G10 was the weaker than expected December Retail Sales print from the UK (exp -1.0%, actual -1.6%) which has weighed on the pound helping it to fall 0.2% despite broad-based USD weakness.

In the EMG space, alongside Japanese strength we have seen the rest of APAC outperforming the greenback today with much of the space up nearly 0.5%. It has become increasingly clear that investors are quite enamored of APAC again. This is evidenced by the equity market performance there (Nikkei, Hang Seng and Shanghai indices are all up more than 7% so far this year) and the ongoing search for yield which leads many to these countries where yields dwarf G10 yields. While this story is in full swing currently, I wonder how well things will hold up as US policy tightens further. If you recall, I highlighted the 10-year Treasury yield of 2.627% as a key technical point for traders. That was the highest yield we saw back in March during the reflation trade craze. Well, this morning, we are higher, breeching 2.63% and, in my view, set to head toward 3.00% in the near term. As the US Treasury market sells off and yields rise, look for many of the current assumptions underlying asset prices to be called into question. As to the rest of the EMG space, interestingly, despite strength in the euro, EEMEA is actually under pressure today. TRY is the worst performer, down 0.75%, on the back of discussions of Syrian attacks by Turkish forces and an increase in chaos in the region. Meanwhile ZAR is lower by 0.5% in what seems like some profit-taking after an extended run of strength. The CE4 are all slightly softer, although there don’t seem to be any significant news items there.

While yesterday’s housing data showed Starts falling in a surprise and Permits holding up, the only data point this morning is Michigan Sentiment (exp 97.0). We will hear from Atlanta’s Raphael Bostic shortly, although it would be shocking to hear anything new at this time. While the Fed doesn’t meet until the 31st, next week brings both the BOJ and ECB meetings, which will be watched closely for any hints of tighter policy. Essentially, the market is pricing in movement in that direction, but I don’t believe we will see it. As for today, if the 10-year yield continues to climb, and I believe it will, I think the dollar will find its footing. Look for a modest USD rebound into the weekend.

Good luck and good weekend

How Much is Real?

From China, the print on the screen
Showed GDP growth unforeseen
But how much is real?
And how much the zeal
Of regions where lying’s routine?

The dollar has retreated almost universally this morning after a pretty solid two-day run. Despite very strong US data yesterday (IP +0.9%, exp +0.5%; Capacity Utilization 77.9%, exp 77.4%) and continued positive results from the Fed’s Beige Book, traders have turned their focus elsewhere. In fact, yesterday’s themes have been largely forgotten. With all the discussion about whether or not we had seen the top in equity markets, it felt as though broad sentiment was beginning to change. But that was so yesterday! The powerful rally on Wall Street has been repeated in Asia and Europe and Tuesday’s late day hiccup largely forgotten.

With that in mind, the story with the most traction today is China, where last night they reported 2017 full-year GDP growth at a better than expected 6.9%. This comes despite the ongoing admissions by different regions within China that they have been overstating their growth rates for the past several years in order to meet central government quotas. This also comes despite the fact that some of the underlying data, notably Retail Sales, IP and Fixed Asset Investments are clearly trending lower. There is a large group of market watchers and investors, myself amongst them, which have maintained a certain level of skepticism about Chinese data. After all, given the draconian methods that the Chinese government has historically used with regard to punishment for any crimes, what regional administrator is going to willingly say that he has not achieved the government’s goals? But, it is the only data we have, and given what has very clearly become a global upswing, it shouldn’t be a huge surprise that China is growing rapidly as well. The renminbi has responded by extending its recent rally, rising 0.2% overnight, which makes a total of 1.3% in the past week. In fact, we are pushing to levels not seen since December 2015. I have to admit, that the momentum in this market certainly points to further CNY strength although I am not convinced it remains intact.

Pivoting to the G10 space, CHF is the leading gainer today, up 0.7%, although the euro has gained a solid 0.5% and is making an effort to regain its early morning highs from yesterday. And all this is occurring despite the fact that 10-year yields in the US are back above 2.60%. If you recall, one of the background stories has been the recent rise in 10-year yields here on the back of ongoing economic strength. Market technicians are focused on a yield of 2.627%, the highest level achieved last March amid the then popular reflation narrative. If yields trade above there, which could well happen today with another burst of strong US data, expectations are that we may see a fairly sharp continuation rally in those yields. That would have an interesting impact on the prevailing narrative as it would help reduce the chance of a yield curve inversion, point to a market that is expecting accelerating US growth and allow the Fed more room to tighten policy more aggressively. As I have written consistently, the Fed’s actions relative to expectations are the real market driver, and I continue to look for tighter than expected policy. Corroborating my thesis were comments from two Fed Presidents yesterday, Cleveland’s Loretta Mester and Dallas’ Richard Kaplan, both highlighting concerns that growth would outpace current forecasts and that Unemployment could well fall much lower leading to higher inflation. In other words, they are both ready to hike rates to keep ahead of the inflation curve. At the same time, Charles Evans, President of the Chicago Fed and one of the more dovish members on the FOMC, called for less policy tightening in 2018 than currently penciled in by the FOMC itself.

(Perhaps the most enjoyable story on Bloomberg this morning was the one discussing how certain cities in the west are experiencing much higher inflation than the nation as a whole, with Seattle, San Francisco and Los Angeles all sporting local inflation rates above 3.0%. This has been a theme I have discussed repeatedly in the past year. Knowing that Chair Yellen will be returning to her home in San Francisco, perhaps she will be confronted with the fact that her national data may not be indicative of much of the nation’s reality. At the very least, she will know what the rest of us are living with!)

However, this is a conundrum for me. If US yields break out higher, I think the impact on the dollar will be quite positive. And so it is surprising to me that the dollar remains under pressure as we approach levels in the Treasury market that may define that breakout. Consider, too, that the Bank of Canada raised rates 25bps yesterday, as widely expected, but highlighting the turn in broad central bank policies. In the end, my thesis remains that the Fed is more aggressive than currently expected by markets, and that the dollar benefits accordingly.

This morning brings us new data including Initial Claims (exp 249K); Philly Fed (25.0); Housing Starts (1275K); and Building Permits (1295K). Further strength in this data set, especially the housing data, should continue to lay the groundwork for a more aggressive Fed. It’s funny, when there is a discussion of equity markets, a common theme is ‘don’t fight the Fed’. But in the FX markets, I would argue that is exactly what we have seen for the past year. I still like the dollar higher over time, but unless today’s data is extraordinary, we probably have a little more weakness in the immediate future.

Good luck

Somewhat Less Assured

There once was a market in thrall
To central banks who overall
Had fueled the craze
For three thousand days
Preventing an equity fall

But recently views have matured
With traders somewhat less assured
The future will be
So calm and risk-free
Especially those unsecured

For the second day running, the dollar is broadly higher, although the movement has not been sufficient to come close to unwinding its early weakness this year. But what is more interesting to me is the fact that so many stories that I have been reading are focused on the idea that we may have seen a top, even a temporary one, to recent market moves.

Certainly, it would be fair to characterize some aspects of market behavior as mania-like (maniacal?), naturally starting with the cryptocurrency sphere, but also with the idea that changing the name of a company to include ‘blockchain’ is worth a 100% or 500% gain in the value of that company. The fact that stories continue to be told of people who gave up their day jobs to become Bitcoin traders or short volatility traders certainly reminds me of the run-up to the tech bubble, where equity day trading played a similar role. Or perhaps, of more recent vintage, was the house-flipping we saw in the run-up to the financial crisis nearly ten years ago, the very situation that started the new party on the back of central bank extraordinary monetary policy.

Most of you know that I have been somewhat skeptical that the extraordinary gains we have seen across markets will continue, recognizing that they cannot go on forever. And I have repeatedly said there doesn’t actually need to be a definitive catalyst to change views. Markets can be quite perverse, and there will be no announcement that the top has been achieved. But one thing of which I am pretty sure is that the more stories written about this particular subject, the more likely it will be a self-fulfilling prophecy. For the newer market entrant, the combination of an increase in warnings and the lack of new gains in your portfolio could easily be sufficient to cause a change of heart. Although, history shows that they will wait until they are much further under water before acting. At the very least, the idea of a more significant correction getting underway is quite viable, so be nimble.

But back to the FX market. Certainly part and parcel of the narrative of late has been the dollar’s weakness, which last year added up to a nearly 11% decline vs. its major counterparts. Almost every analyst call for 2018 has been for a continuation of that move, with some calling for another 15%-20%. I strongly disagree with that idea, and wouldn’t be surprised if we have already put in the bottom for the dollar this year. From a historic perspective, there have been numerous years (e.g. 2015) where the previous year’s trend reversed early on amid expectations of a continuation. And as I look at the fundamentals, notably monetary policy issues, I continue to see the Fed as the most likely to be more aggressive than expected and the dollar to benefit accordingly.

Early this morning the Eurozone data reconfirmed that there is no inflationary impulse yet on the Continent as the core CPI remained at 0.9%. Simultaneously, we got our first ‘dovish’ commentary from an ECB member in what seems like a year, when Vitor Constancio basically called into question the euro’s recent strength saying, “I am concerned about sudden movements which don’t reflect changes in the fundamentals. Looking at fundamentals, inflation declined slightly in December.” Of course, the market trades on the narrative, which anticipates the future fundamentals, but as I have said repeatedly, it would be very surprising if Signor Draghi turned hawkish at next week’s ECB meeting. Meanwhile, Dallas Fed President, Robert Kaplan, was out talking about the probability that we could see more than the three Fed hikes currently forecast for this year. Certainly that combination is worth a little dollar strength!

The point is, for the first two weeks of the year, we have seen an acceleration in the trends that held for last year, with equities exploding higher and the dollar falling broadly. If nothing else, my sense is things are overdone in the short run and that a correction, long overdue, may be coming soon. For all of you receivables hedgers, these are the best levels we have seen in three years and I would be keen to take advantage.

On the data front, IP (exp 0.5%) and Capacity Utilization (77.4%) are released this morning and then the Fed’s Beige Book comes out at 2:00pm. There has been nothing to suggest that the US economy is slowing down and I expect this data to reconfirm the recent trend. We also will hear more from Kaplan as well as Charles Evans and Loretta Mester, so watch the tape this afternoon. But from that crew, I expect a more hawkish bent, which means the dollar should behave well. While equity futures are pointing higher, that was yesterday’s story as well, right up until they tanked. All I’m saying is that change is coming, and it feels like we are beginning to see it more clearly.

Good luck

Awful Darn Fast!

Two weeks of the year have now passed
With dollar bulls feeling downcast
The ECB hinted
The euros they’ve minted
Could be withdrawn awful darn fast!

While the dollar is a tad stronger this morning compared to Monday’s abbreviated trading, it remains well below the levels seen on Friday. In fact, year-to-date, the dollar has ceded almost 2.0% vs. its major counterparts. The FX narrative that is dominant right now goes as follows: the ECB, BOJ, BOE, etc. will begin to more aggressively reduce their QE policies amid increasing growth while the Fed has already executed the bulk of its policy adjustment. This was highlighted yesterday when Estonian ECB member, Ardo Hansson, said the following in an interview with the German newspaper, Boersen-Zeitung: “There are certainly good reasons to reduce the importance of the net
purchases in our communication soon — also with a view to a potential end to
these purchases. If growth and inflation continue to evolve broadly in line with the ECB’s latest projection, it would certainly be conceivable and also appropriate to end the purchases after September,” he said.
“The last step to zero is not a big deal anymore, you do not have to do a lot of fine-tuning. I think we can go to zero in one step without any problems.”

In other words, the ECB’s hawks are ready to roll immediately, but are willing to wait until March before announcing such. He even touched on the issue of the likely rise in the euro given such comments and said that an appreciating euro “is not a threat to the inflation outlook” and shouldn’t be overdramatized. So there you have it, another dyed in the wool ECB hawk out on the tape. It should be no surprise that the euro jumped after the release of these comments, and rightfully so. Basically, he is arguing for an immediate end to QE with no further transition past the current September date. We shall learn more next Thursday when the next council meeting is held, but I expect that Signor Draghi is unlikely to tip his hand. In fact, if anything, given how much press the hawks have received of late, I wouldn’t be surprised to hear him sing a particularly dovish tune in an effort to offset the other comments. Of course, before we hear from the ECB next week, we will see the latest Eurozone CPI numbers, released tomorrow and expected to show a reading of 1.4% with a core print of 0.9%. Let me just say that those are not numbers that will inspire a quickening in the pace of tightening by the ECB.

Away from the euro, we saw UK inflation data this morning and it printed a touch softer than anticipated, 3.0% and 2.5% core. Governor Carney will be thrilled he doesn’t have to write another letter to the Chancellor, and given the lagging increase in wages, it is good news for the UK population on the whole. But does it really signal a potential change in policy? If anything, the news that the EU continues to play hardball with the UK over Brexit terms strikes me as a further detriment to the currency. It remains difficult for me to foresee any interest rate adjustments by the BOE until the Brexit deadline has passed, while during that period, I could easily see the Fed raise rates five or six more times. The pound has no business above 1.37 in my view.

The other big mover over the past weekend has been the Chinese renminbi, which has rallied 0.8% since Friday and nearly 1.5% in the past week. I put very little credence in the idea that the Chinese comments about US Treasury bonds were meant as a threat of some sort as the reality is they have literally no other choices to maintain their reserves. Certainly they could diversify some portion of their reserves to other currencies, but the size and liquidity of the markets in Bunds or Gilts or JGB’s pales in comparison to Treasuries, as does the yield. And this is especially so because the ECB and BOJ continue to buy those bonds as well, further reducing liquidity and the availability of securities. Rather, to me what we are seeing is an ongoing tightening in Chinese policy as the country attempts to reduce the amount of leverage outstanding, and the corresponding uptick in the currency. Given the broad-based weakness in the dollar that we have witnessed since the beginning of the year, it should be no real surprise that CNY has gained in value as well. So for now, the dollar weaker narrative remains in place. However, I am not convinced it has that much staying power.

Looking ahead to this week’s data releases we see a more limited schedule as follows:


Today Empire Manufacturing 19.0
Wednesday IP 0.4%
  Capacity Utilization 77.3%
  Fed Beige Book Released  
Thursday Housing Starts 1275K
  Building Permits 1295K
  Initial Claims 250K
  Philly Fed 24.8
Friday Michigan Sentiment 97.0

We also hear from Evans, Kaplan and Mester tomorrow, with the potential for some nuance, but my sense is that ahead of the FOMC meeting on the 31st, they are unlikely to break new ground, especially since the data hasn’t really changed much.

For now, the trend is your friend, and it is clear that the market is keen to push the dollar lower. But at some point, I continue to believe the rubber will meet the road and we will see higher inflation in the US leading to a quicker pace of Fed tightening and a stronger dollar. We shall see.

Good luck

Squared The Circle

The ECB said that it might,
According to their own foresight,
Be forced to increase
The pace that they cease
To buy bonds, thus making things tight

The euro responded with glee
Exploding past One and Twenty
If this is the plan
And not a straw man
The dollar, much lower, will be

And one other thing of real note
So many months after the vote
Seems Chancellor Merkel
Might have squared the circle
With new ministers to promote

Wow is all I can say this morning as the euro has virtually exploded higher during the past twenty-four hours. It started with the release of the ECB Minutes yesterday morning, which were read as quite hawkish. The belief that has gained widespread credence is that the time gap between the end of QE, now almost certainly to take place in September, and the first rate hike has been significantly shortened. Prior to the Minutes, the market was pricing in just a one-third chance of a 10bp rate hike by the end of this year. This morning that probability has jumped to almost two-thirds with a full hike priced in for March 2019 (it was December 2019 prior to the Minutes). It should be no surprise that the euro has rallied on the back of that change in sentiment. And in fairness, if the ECB is actually going to be more aggressive in their removal of monetary accommodation, it is the correct market response. Then, adding fuel to the fire was the announcement by Chancellor Merkel that after extensive negotiations between her CDU/CSP party and the center-left SPD, they have come to agreement for yet another ‘grand coalition’ government to lead Germany for the next four years. It has been over 100 days since the Germans went to the polls and concerns were growing that the much less palatable alternatives of either a minority government or a second vote were coming to fruition. But now, the market sees only blue skies ahead and the single currency has been the main beneficiary. In the past twenty-four hours, the euro has rallied 1.50% and is now trading at its highest level vs. the dollar since the beginning of 2015 (and at that point it was in the midst of a 25% decline!)

Of course, it remains to be seen if the ECB will follow through with the now mooted policy tightening, at least at the pace the market is expecting. Remember, while ECB policy is clearly still on emergency settings and almost certainly inappropriate for an economic area growing above trend, the Fed was in the same situation for several years before it finally started to get a bit more aggressive. Signor Draghi has not changed his stripes and remains a dove at heart, so while the pressure to tighten policy may well increase going forward, I continue to believe that he will do so only reluctantly and at a much slower pace than currently forecast. But for now, the euro bulls are in the ascendancy and I expect that the single currency has further room to run.

Meanwhile, on this side of the Atlantic, yesterday’s PPI data was shockingly weak, with both headline and core data printing at -0.1%, well below the +0.2% expectations and encouraging the narrative that the Fed was going to slow down its pace of tightening. This morning’s CPI data (exp 0.1%, 0.2% core) will be far more important, but it is certainly a disconcerting harbinger of today’s data. So adding it all up, the dollar has been under constant pressure since I wrote yesterday.

But there have been other things as well, notably Chinese Reserves data out overnight surprised everyone by showing a significant reduction in the pace of money growth and new loans. The government’s attempt to reign in leverage seems to be biting with expectations growing that Chinese interest rates are on course to rise soon. It can be no surprise that this data in combination with the largest Trade Surplus ($275B) ever recorded by the Chinese, and the softer US inflation data has resulted in a much stronger CNY. In fact, this morning the renminbi has gained 0.7% and is back at levels not seen since early 2016. But it’s not just CNY that has rallied in the emerging market bloc, virtually all of the space has outperformed. Not surprisingly, given the euro’s move, EEMEA has been the best performing region, but in truth we are seeing strength from all three regions.

So what are we to make of all this? In the constant ebb and flow of market activity, there is no question that things are pointing to a weaker dollar in the near term, at least before we see this morning’s CPI and Retail Sales data. If those numbers print as expected (Retail Sales exp 0.5%, 0.3% ex autos), then the dollar should remain under pressure for the rest of the day. Surprising strength in either of these data releases, especially CPI, however, could stop the dollar’s decline in its tracks. Given the narrative of increasing global growth, it seems hard to believe that suddenly the Fed will turn dovish. Rather, I would expect that we could see a hawkish turn from some of the centrists there, especially when they consider the situation elsewhere in the world. I continue to believe the Fed will lead the way in tighter monetary policy and the dollar will find support accordingly. But maybe not today.

Good luck



It now seems that yesterday’s story
‘Bout China was just transitory
Bond bears are frustrated
As fears have abated
Though any replay could be gory

This morning has seen a far less interesting array of stories with which to drive markets than we had been reading and hearing about earlier this week. Despite all the initial angst about China changing their tune on US Treasuries, the reality is that they have no choice but to remain invested, as there is no other market available where they can maintain their reserves safely. In addition, the fact is with the stability of the yuan lately, they are just not as likely to accumulate new reserves, and therefore not likely to increase their appetite. Remember, too, there is no possibility that they would discuss the idea of selling part of their holdings before they actually did so as it would work to their own disadvantage. It has been mooted that this was some type of signal from the Chinese to the Trump administration, although I doubt it had much impact. From the time I wrote yesterday morning, 10-year yields are lower by 5bps. However, this doesn’t change my view that we are going to continue to see those yields rise, but that is based on my view that measured inflation is going to return to the US.

Similar to the reversal in the Treasury market, the FX market has also returned to levels prevailing before that story made the rounds. While the dollar was under clear pressure yesterday morning, it too rebounded alongside the bond market and this morning sits little changed from Tuesday’s levels. In fact, the story today is there is no story. When looking at the FX markets broadly, compared to yesterday’s closing levels, in the G10 space, only AUD and NZD have moved more than 20bps, both rallying about 0.35% on the back of the continued strength in commodity prices. Meanwhile, in EMG world, though the movements have been slightly larger, there has been no discernible pattern. The biggest movement came from MYR, which rallied just 0.4% overnight on the back of the ongoing rise in oil prices (WTI is up to $64/BBL, its highest level since June 2015). Interestingly, the worst EMG performer overnight, though it fell just 0.25%, was MXN, despite the rise in oil prices. It seems there were some comments by the central bank governor regarding future peso weakness if NAFTA comes undone. That is a situation that I believe is entirely possible, and one about which I would be very cognizant if I had hedging activity in MXN.


Moments ago the ECB released the Minutes from the December meeting and the upshot is that the hawkish commentary we have been hearing from some members seemed to be confirmed by the Minutes. The key statement was:

“The view was widely shared among members that the Governing Council’s
communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further toward the Governing Council’s aim. The language pertaining to various dimensions of the
monetary-policy stance and forward guidance could be revisited early [in 2018][my emphasis].”

It was the “revisited early” part that got the market going and the euro, although it had been virtually unchanged ahead of the release, jumped 50 pips and is now back near 1.20. The thought process seems to be that they are hinting at acting more quickly with regard to reduction in QE than previously stated, which if true is certainly bullish for the euro. However, I want to hear from Signor Draghi before I change my tune there. He has been consistently dovish and until that changes, I feel the euro will have difficulty.

While the Minutes added some excitement just now, overall it was a dull session. This morning brings US PPI data (exp 0.2% for both headline and core) although unless those numbers are significantly different, PPI generally has a limited impact on markets. Tomorrow’s CPI is a different story however. We also see Initial Claims (exp 245K) but that, too, doesn’t feel like it will matter much to markets. We hear from Bill Dudley this afternoon, and perhaps he will have something new to discuss, although I wouldn’t count on that either.

At this point, the euro is going to be the story for the day, and I wouldn’t be surprised to see it extend gains as the day progresses. But other currencies don’t appear to be all that interesting.

Good luck


A New Tale Resonates

Most traders apparently think
That Treasury prices will sink
If China stops buying
And so they are trying
Their profits, from this, to unlink

But strangely despite higher rates
The dollar, today, demonstrates
Low yields aren’t all
The buck needs to fall
Sometimes a new tale resonates

The biggest news overnight was the unsourced story out of Beijing that the Chinese had lost their appetite for US Treasuries. In fact, the rumor (or at least the concern) is that they may not simply stop buying them, but actively start to sell part of their holdings. This has been a key driver in the recent sharp rise in 10-year Treasury yields, which as I type are at new nine-month highs of 2.59%. (We need to go back to June 2014 for the last time yields were higher than this past March, and December of 2013, in the wake of the Taper Tantrum, for the last time they touched 3.0%.) Remember, the Chinese are the largest holder of US Treasuries which serve as the main vehicle to hold the bulk of their $3.1 Trillion of FX reserves. Last year, as the renminbi appreciated, their reserves continued to grow and alongside that, so did their demand for Treasuries. However, it is apparent they are no longer willing to tolerate further CNY strength, reducing the growth rate in their reserves, and correspondingly their demand for Treasuries. The multi-billion dollar question is, will they start to actively sell Treasuries, or simply stop buying them? A related question is will they seek to diversify their reserves away from dollars into other currencies?

It is the latter theory that seems to be driving the euro this morning, as despite the highest US yields in more than nine months, and the widest spreads between Bunds and Treasuries in nine years, the euro has rallied a solid 0.6% and is back above 1.20. The theory is that if the Chinese choose to diversify their reserves, they will be selling dollars and buying euros with the proceeds, thus driving the single currency higher. Also aiding the euro has been the non-stop rhetoric from the hawkish wing of the ECB, with Wiedmann et al hitting the tape regularly and discussing the end of QE while the doves remain silent. This has the market convinced that QE is ending in September with the most aggressive views calling for an early end. With regard to that thesis, tomorrow’s publication of the Minutes of the ECB’s December meeting might add some clarity. But in reality, we will need to hear more from Signor Draghi defending his view that QE is still necessary for the market to take heed. Ultimately, I continue to believe that the US inflation situation will play out more aggressively than that of Europe and that the Fed will continue to lead the way, dragging the dollar along for the ride. But that is not today’s theme!

But the G10 currency with the biggest move overnight was the yen, which has rallied a further 1.2% as I type. This seems to be a continuation from yesterday’s price action, which, if you recall, was driven by the news that the BOJ was going to be buying less JGB’s in their effort to control the yield curve. So now, in the course of just two days, the yen has rallied nearly 2%. This is proof positive that the central banks remain the key drivers of market activity. I would also argue that the combination of these two stories is a harbinger of what 2018 is going to look like, namely far more volatile markets than we experienced in 2017. As we continue to see the central banking community try to unwind their excessive extraordinary monetary policy experiments from the past eight years, the coma in which markets have found themselves is almost certainly going to end abruptly. And there is one other yen nugget to add, BOJ Governor Haruhiko Kuroda’s term is due to end in April. As of yet, PM Abe has not reappointed him, nor named a successor. This has led to concerns that a new BOJ Governor may have a different view of policy settings and therefore may adjust them more quickly than currently envisaged. That, too, would add to the volatility we are likely to see.

These stories have been enough to drive virtually the entire FX market with the result being the dollar is lower almost across the board. Of course, there is always an outlier, and today is no different. The ZAR continues to be the most volatile currency with a 1% decline after the ruling ANC declared that a discussion of removing President Zuma was NOT on their meeting agenda today. This implies that some decent portion of the rand’s recent strength has been due to a series of bets that they would get rid of Jacob Zuma, and more importantly, his destructive policy agenda. Meanwhile, TRY has also been under pressure seemingly on the back of position unwinding. In an example of a more classic market reaction, investors are responding to higher US yields by unwinding their carry trades in TRY and getting back into USD. If Treasury yields continue to rise, and I think they will, this trade has further to go, and will expand to numerous other EMG currencies. Remember, the carry trade is far more fraught when volatility increases, and that is something in which I have a great deal of confidence coming to pass. Hedgers, take note of the potential for higher volatility, it will have an impact!

There is no US data today, although tomorrow and, Friday especially, will bring us some important new information. In the meantime, we get three Fed speakers today, Evans, Kaplan and Bullard, all of whom hew closer to dovish than hawkish. So as I look ahead to today’s prospects, everything certainly points to further dollar weakness. This is supported by both the equity market weakness we are seeing overseas and in the US futures as well as the strength in commodities. Something that has not been getting much press, but which I think could be quite interesting, is that gold has rallied nearly 7% since the middle of December. The question here is whether this is a result of the broad based commodity rally, typically a harbinger of good economic times, or if this is a measure of fear increasing as it regains its status as a safe haven. I sense the latter may be closer to the truth. Look for more volatility, especially if we see Treasury yields pierce their March highs of 2.627%. That will open many more technical doors to further market shakeups.

Good luck