Lost Their Zeal

While yesterday Brexit seemed real
As both sides looked close to a deal
This morning we hear
A deal’s not so near
As Ireland’s North lost their zeal

Meanwhile from the Far East, the news
Is that China just might refuse
To buy pork and grain
Unless we refrain
From publicly airing our views

While the same two stories remain atop the leaderboard, the score has clearly changed. This morning, much of yesterday’s Brexit optimism has dissipated as the DUP, Boris Johnson’s key Northern Irish ally in Parliament, explained they could not support the deal that Johnson has been furiously negotiating over the past few days. Remember, DUP stands for Democratic Unionist Party, and the Union of which they speak is that of Northern Ireland and the rest of the UK. As such, they cannot countenance the idea of a soft border in the Irish Sea between Northern Ireland and the rest of the UK. They want to be treated exactly the same. At the same time, they don’t want a hard border between themselves and the Republic of Ireland, so it seems that they are the ones that need to make up their collective mind. As time is very clearly running out, the conversation has reached a very delicate phase. Remember, the Benn Act requires PM Johnson to request an extension by this Saturday if there is no deal agreed, and of course, Boris has said he “would rather be dead in a ditch” than request such an extension.

From what I have read, it appears that the soft border would be time limited, and so in the end, I think the pressure on the DUP will be too great to bear and they will cave in. After all, they also don’t want to be the ones responsible for the failure of reaching a deal. The pound, after having traded as high as 1.2800 yesterday, has been extremely volatile this morning, trading in a more than 1.0% range and having touched both the highs at 1.2790 and the lows near 1.2660 twice each. As I write, the pound is lower by 0.3% on the day, but at this point, it is entirely headline driven. The one thing that is clear is that many of the short positions that had been built up over the past year have been reduced or eliminated completely.

Turning to China, the story is about Beijing’s anger over two bills passed by the House of Representatives in support of the pro-democracy protests in Hong Kong. The Chinese are adamant that anything that happens in Hong Kong is a domestic affair and that everybody else, especially the US, should keep their noses out of the discussion. In fairness, it is a Chinese territory legally, unlike the situation in Taiwan where they claim ‘ownership’ with less of a legal claim. Nonetheless, they are quite serious and are threatening retaliation if any law addressing Hong Kong is passed by the US. Now a bill passing the House is a far cry from enacting a law, but this does seem to be something where there is bipartisan support. Remember, too, that the standoff with China is one of the few things where the Democrats and President Trump see eye to eye.

At the same time, somewhat behind the scenes, the PBOC injected CNY 200 billion into its money markets last night, surprising everyone, as a measure of further policy ease. Thursday night the Chinese will release their Q2 GDP data and while the median forecast is for a 6.1% annualized outcome, there are a number of forecasts with a 5 handle. That would be the slowest GDP growth since at least 1992 when records started to be kept there. At any rate, the cash injection helped weaken the renminbi with CNY falling 0.3% in the overnight session. One thing to remember here is that part of the ostensible trade deal is the currency pact, but if that deal falls apart because of the Hong Kong issue, it opens the door for CNY to weaken a bit more.

It ought not be surprising that the change in tone on those two stories has dampened overall market enthusiasm and this morning can clearly be described as a risk-off session. In the G10, the dollar is stronger against everything except the yen and Swiss franc (both higher by 0.1%). In fact, both NOK (-0.9%) and NZD (-0.7%) lead the way lower with the former responding to oil’s ongoing weakness as well as the potential negative impact of a hard Brexit. Meanwhile, the kiwi has suffered after the RBNZ reiterated that lower rates were likely still in store despite CPI printing a tick higher than expected last night at 1.5%.

In the EMG space, things have been less dramatic with ZAR today’s weakest component, falling 0.5% after news that the troubled utility, Eskom, will be forced to create rolling blackouts, further highlighting its tenuous financial position and putting more pressure on the government to do something (read spend money they don’t have) to fix things. Without a solution to this issue, which has been hanging over the economy for several years, look for the rand to continue its broad move lower. While at 14.97, it is well off the lows seen in August, the trend remains for the rand to continue falling. Otherwise, this space has been far less interesting with KRW dipping just 0.25% overnight after the BOK cut rates by 25bps. The thing is, comments from BOK members indicated a reluctance to cut rates much further, thus limiting the downward movement.

This morning brings us Retail Sales (exp 0.3%; -ex autos 0.2%) and Business Inventories (0.2%). Then, at 2:00 the Fed’s Beige Book is released with analysts set to look for clues about economic activity to drive the Fed’s next activity. We also hear from three Fed speakers, Evans, Kaplan and Brainard, who all lean to the dovish side of the spectrum. With European equities under pressure and US futures pointing lower, it seems that risk will remain out of favor, unless there is a change of heart in the UK. But for now, think risk-off as a guide to today’s activity.

Good luck
Adf

Talks Remain Tough

In Brussels they’re starting to say
A soft Brexit’s soon on the way
Though talks remain tough
There could be enough
To reach an agreement today!

Nothing has changed with regard to which stories are market drivers, although on the equity front we now get to add Q3 earnings to the mix. But as far as FX is concerned, Brexit and trade still dominate the discussion. Regarding Brexit, the rumblings from Brussels have been far more positive this morning, with the EU’s chief negotiator, Michel Barnier, explaining that a deal was still possible before the EU Summit on Thursday, but difficult. Apparently, the UK has submitted detailed plans of how they would like to address the Irish border situation, and there is serious consideration although negotiations continue. From Parliament, the word is that the votes will be there to pass any deal agreed by PM Johnson, as the Tories and Brexiteers recognize that Boris was a Brexiteer from the get-go. The Summit begins in two days, and I continue to expect that a deal, ‘in principal’ will be agreed beforehand. It should be no surprise that the pound has rallied on the news, after giving up some of Friday’s gains during the European session yesterday. This morning, Sterling is higher by 0.4%, although since we closed Friday, it is actually lower by 0.2%. Nonetheless, I continue to see scope for significant advancement here upon the news that deal has been reached.

As to the trade story, Friday also proved to be something of a false dawn as the Chinese backed away from the idea that a deal has been struck and are seeking continued discussions. This morning, however, there seems to be a bit more upbeat tone, even with the Chinese, as it is clear that talks will continue over the next few weeks at both mid-level and high-level (Mnuchin, Lighthizer and Liu He) conference calls. The Chinese have also figured out that they need to import a LOT if pork and that is something of which the US possesses a great deal. Overnight, Chinese data showed PPI falling 1.2%, meaning factories continue to lose pricing power, but CPI rose 3.0%, above expectations and starting to put pressure on the government. As part of that CPI rise, pork prices rose 69%! African swine fever is clearly taking its toll on the Chinese swine herd. This morning, the Chinese offered to remove tariffs on $50 billion of agricultural products if the US would remove a similar amount. While no decision has been made, I expect that there will be agreement on this subject as for President Trump, the demographics of the beneficiaries of this action would be his biggest supporters. Despite broad dollar strength since Friday, we continue to see the renminbi (+0.2% since Friday) perform well, a testimony to the PBOC’s efforts to prevent the currency from weakening, but also in response, I think, to the idea that there is positive movement on the trade front.

Away from those stories, we continue to see weak Eurozone growth data, with the German ZEW Survey falling to -22.8, slightly better than expected but still miles below its longer term average of +12.8. On top of that, a survey of 53 economists by Bloomberg has forecast that German GDP will shrink 0.1% in Q3, defining a technical recession in the country, and weighing further on the entire Eurozone. As I have repeatedly pointed out, the EU cannot afford a hard Brexit and are highly incented to reach an agreement this week. The euro, which had been holding its own of late has given up 0.2% this morning and a bit more since Friday and is back at the 1.1000 level, although that is in the upper half of performers in the G10 space. The biggest loser is NZD, which is down 1.1% since Friday after the RBNZ bid for bonds, which traders read as a form of QE, and which is tracking Aussie lower after remarks from the RBA indicate that further easing is on the way.

The other big loser this morning is the Norwegian krone, which has fallen 0.8% since Friday following oil prices’ downward trajectory. The latter is due to a combination of concerns over slowing global growth reducing demand for oil, while inventories continue to rise.

In the EMG space, INR is today’s largest mover, sliding 0.75% after CPI data was released at a higher than expected 3.99% in September. The rupee had been a beneficiary of inward investment based on the idea that quiescent inflation would allow further RBI rate cuts and enhanced growth and equity market performance. However, if inflation has bottomed, it seems that investors are likely to be a little more circumspect. Overnight there was clear selling of Indian bonds by international investors leading to the currency’s decline. However, beyond that movement, the EMG bloc had more losers than gainers, but none with a significant move or story.

On the data front this week, we see a bunch of middle tier data with the highlight arguably Retail Sales.

Wednesday Retail Sales 0.3%
  -ex autos 0.2%
  Business Inventories 0.2%
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Housing Starts 1320K
  Building Permits 1350K
  Philly Fed 8.0
  IP -0.2%
  Capacity Utilization 77.7%
Friday Leading Indicators 0.1%

In addition to the data, we hear from a total of ten Fed speakers this week, ranging from the uber-dove James Bullard to the uber-hawk Esther George and every spot along the spectrum in between. Overall, the Fed message has been that they feel the economy is in a ‘good’ place, but they won’t hesitate to ease further if the data turns downward. Of course, their message was also that buying $60 billion / month of T-bills to help ease reserve conditions was in no way more QE. That is a much tougher circle to square.

Looking ahead, the market remains headline driven so care needs to be taken. There is no clear risk view this morning with both equity futures and Treasuries higher, and the dollar is mixed, again clouding any view. My expectation is that the market will likely tread water ahead of the next piece of news. And my money remains on that being a positive Brexit story.

Good luck
Adf

Time’s Crunch

When Boris and Leo had lunch
No panties were balled in a bunch
The signals showed promise
And no doubting Thomas
Appeared, as both sides felt time’s crunch

Meanwhile, though there’s been no bombshell
The trade talks have gone “very well”
Today Trump meets He
And then we will see
If a deal betwixt sides can now gel

And finally from the Mideast
The story ‘bout risk has increased
A tanker attack
Had market blowback
With crude a buck higher at least

There is no shortage of important stories today so let’s jump right in. Starting with Brexit, yesterday’s lunch meeting between Boris Johnson and Leo Varadkar, the Irish PM, turned into something pretty good. While the comments have been very general, even EU president Donald Tusk as said there were “promising signals.” It is crunch time with the deadline now less than three weeks away. Apparently, the rest of the EU is beginning to believe that Boris will walk with no deal, despite the Benn Act requiring him to ask for an extension if there is no deal in place. At the same time, everybody is tired of this process and the EU has many other problems, notably a declining economy, to address. And so, I remain confident that we will soon hear, probably early next week, about a ‘deal in principle’ which will be ratified by Parliament as well as the EU. Though all the details will not have been completed, there will be enough assurances on both sides to get it through. Remember, Boris has Parliament on his side based on the deal he showed them. I’m pretty sure that his conversation with Leo yesterday used that as the starting point.

When that news hit the tape yesterday morning a little past 10:00, the pound started a significant rally, ultimately gaining 2% yesterday and it is higher by a further 1.0% this morning after more promising comments from both sides of the table. Remember, too, that the market remains extremely short pound Sterling and has been so for quite a while. If I am correct, then we could see the pound well above 1.30 as early as next week. Of course, if it does fall apart, then a quick trip back to 1.20 is on the cards. As I have said, my money is on a deal. One other thing to note here is what happened in the FX options market. For most of the past twelve years, the risk reversal (the price the market pays for 25 delta puts vs. 25 delta calls) has traded with puts at a premium. In fact earlier this year, the 1mo version was trading at a 2.5 vol premium for puts. Well, yesterday, the risk reversal flipped positive (bid for calls) and is now bid more than 1.0 vol for GBP calls. This is a huge move in this segment of the market, and also seen as quite an indicator that expectations for further pound strength abound.

Regarding the trade talks, risk assets have taken a very positive view of the comments that have come from both sides, notably President Trump describing things as going “very well” and agreeing to meet with Chinese Vice-premier Liu He this afternoon before he (He) returns to Beijing. The information that has come out points to the following aspects of a deal; a currency pact to insure the Chinese do not weaken the renminbi for competitive advantage; increased Chinese purchases of grains and pork; a US promise not to increase tariffs going forward as the broader negotiations continue; and the lifting of more sanctions on Chinese companies like Huawei and COSCO, the Chinese shipping behemoth. Clearly, all of that is positive and it is no surprise that equity markets globally have responded with solid gains. It is also no surprise that Treasury and Bund yields are much higher this morning than their respective levels ahead of the talks. In fact, Treasuries, which are just 1bp higher this morning, are up by more than 15bps since Tuesday. For Bunds, today’s price action shows no change in yields, but a 12bp move (less negative rates) since then. The idea is a trade deal helps global economic growth pick back up and quashes talk of deflation.

The last big story of the morning comes from the Persian Gulf, where an Iranian oil tanker, carrying about 1 million barrels of oil, was attacked by missiles near the Saudi port of Jeddah. At first the Iranians blamed the Saudis, but they have since retracted that statement. It should be no surprise that oil prices jumped on the news, with WTI futures quickly rallying more than a dollar and maintaining those gains since then. One of the key depressants of oil prices has been the global economic malaise, which does not yet look like it is over. However, if the trade truce is signed and positive vibes continue to come from that area, I expect that oil prices will benefit greatly as well.

As to the FX market per se, the dollar is overall under pressure. Of course, the pound has been the biggest mover in the G10 space, but AUD has gained 0.55% and the rest of the block is higher by roughly 0.3%. The only exceptions here are the yen (-0.3%) and Swiss franc (-0.1%) as haven assets are unloaded.

Turning to the EMG bloc, ZAR is today’s big winner, rallying more than 1.1% on two features; first the general euphoria on trade discussed above and second on the news that former President Jacob Zuma must face corruption charges. The latter is important because it demonstrates that the rule of law may be coming back into favor there, always a benefit for an emerging market. But most of the space is firmer this morning, with many currencies higher by between 0.5% and 0.6% (RUB, KRW, PLN, HUF, MXN, etc.) In fact, the only loser this morning is TRY (-0.4%), which remains under pressure as President Erdogan presses his military campaign against the Kurds in Syria.

On the data front, the only US news is Michigan Sentiment (exp 92.0) but we also get the Canadian employment picture (exp 7500 new jobs and a 5.7% Unemployment Rate). Three more Fed speakers, Kashkari, Rosengren and Kaplan, are on the slate, but so far, the only clarity of message we have received this week is that everybody is watching the data and will respond as they see fit. Hawks are still hawks and doves are still doves.

I see no reason for the dollar to regain ground today assuming the good news from Trade and Brexit continue. So look for a further decline into the holiday weekend.

Good luck and good weekend
Adf

PS. While typing, the pound jumped another 1.0%.

A Currency Pact

The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
Adf

 

Too Effing High

Said Powell, we’re going to buy
More assets in order to try
To make sure that rates
Stay where the Fed states
And stop trading too effing high

“This is not QE; in no sense is this QE!” So said Fed Chairman, Jerome Powell, yesterday at a conference in Denver when describing the fact that the Fed would soon resume purchasing assets. You may recall right around the time of the last FOMC meeting, there was sudden turmoil in the Fed Funds and other short-term funding markets as reserves became scarce and interest rates rose above the Fed’s target. That resulted in the Fed executing a series of short-term reverse repos in order to make more reserves available to the banking community at large. Of course, the concern was how the Fed let itself into this situation. It seems that the reduction of the Fed balance sheet as part of the normalization process might have gone a little too far. Yesterday, Powell confirmed that the Fed was going to start buying 3-month Treasury bills to expand the size of the balance sheet and help stabilize money markets. However, he insisted that given the short-term nature of the assets they are purchasing, this should not be construed as a resumption of QE, where the Fed bought maturities from 2-years to 30-years. QE was designed to lower longer term financing rates and boost investment and correspondingly economic growth. This action is meant to increase the availability of bank reserves in the system so that no shortages appear and money markets remain stable and functioning.

As far as it goes, that makes sense given commercial banks’ regulatory needs for a certain amount of available reserves. But Powell also spoke about interest rates more generally and hinted that a rate cut was a very real possibility, although in no way certain. Of course, the market is pricing in an 80% probability of a cut this month and a 50% probability of another one in December. Certainly Powell didn’t dispute those ideas. And yet a funny thing happened in the markets yesterday despite the Fed Chairman discussing further policy ease; risk was reduced. Equity markets suffered in Europe and the US, with all major indices lower by more than 1.0% (S&P -1.5%). Treasury yields fell 3bps and the dollar rallied steadily all day along with the yen, the Swiss franc and gold.

It is the rare day when the Fed Chair talks about easing and stock prices fall. It appears that the market was more concerned with the escalation in trade war rhetoric and the apparent death of any chance for a Brexit deal, both of which have been described as key reasons for business and investor uncertainty which has led to slowing growth, than with Fed policy. And for central banks, that is a bigger problem. What if markets no longer take their cues from the central bankers and instead trade based on macroeconomic events? What will the central banks do then?

On the China front, yesterday’s White House actions to blacklist eight Chinese tech firms over their involvement in Xinjiang and the Uigher repression was a new and surprising blow to US-China relations. In addition, the US imposed visa restrictions on a number of individuals involved in that issue and has generally turned up the temperature just ahead of the next round of trade talks which are due to begin tomorrow in Washington. It has become abundantly clear that the ongoing trade war is beginning to have quite a negative impact on the US economy as well as that of the rest of the world. President Trump continues to believe that the US has the advantage and is pressing it as much as he can. Of course, Chinese President Xi also believes that he holds the best cards and so is unwilling to cave in on key issues. However, this morning there was a report that China would be quite willing to sign a more limited deal where they purchase a significantly greater amount of agricultural products, up to $30 billion worth, as well as remove non-tariff barriers against US pork and beef in exchange for the US promising not to implement the tariffs that are set to go into effect next Tuesday and again on December 15. In addition, the PBOC fixed the renminbi last night at a lower than expected 7.0728, indicating that they want to be very clear that a depreciation in their currency is not on the cards. It is not hard to view these actions and conclude that China is starting to bend a little, especially with the Hong Kong situation continuing to escalate.

It also seems pretty clear that the talks this week have a low ceiling for any developments, but my sense is some minor deal will be agreed. However, the big issues like state subsidies and IP theft are unlikely to ever be resolved as they are fundamental to China’s economic model and there are no signs they are going to change. In the end, if we do get some de-escalation of rhetoric this week, I expect risk assets to respond quite favorably, at least for a little while.

Turning to Brexit, all we have heard since yesterday’s phone call between Boris and Angela is recriminations as to who is causing the talks to fall apart. Blame is not going to get this done, and at this point, the question is, will the UK actually ask for an extension. Ostensibly, Boris is due to speak to Irish PM Varadkar today, but both sides seem pretty dug in right now. The EU demand that Northern Ireland remain in the EU customs union in perpetuity appears to be a deal breaker, and who can blame them. After all, the purpose of Brexit was to get out of that customs union and be free to negotiate terms as they saw fit with other nations. However, as European economic data continues to deteriorate, the pressure on the EU to find a deal will continue to increase. While you cannot rule out a hard Brexit, I continue to believe that some type of fudge will be agreed before this is over. Yesterday the pound suffered greatly, falling below 1.22 for a bit before closing lower by 0.6%. This morning, amid a broadly weaker dollar environment, the pound is a laggard, but still marginally higher vs. the dollar, up 0.1% as I type.

The rest of the FX market was singularly unimpressive overnight, with no currency moving even 0.5% as traders everywhere await the release of the FOMC Minutes this afternoon. Ahead of the Minutes, we only see the JOLTS jobs report (exp 7.25M) which rarely matters to markets. Yesterday’s PPI data was surprisingly soft, falling -0.3% and now has some analysts reconsidering their inflation forecasts for tomorrow. Of course, quiescent inflation plays into the hands of those FOMC members who want to cut rates further. At this point, the softer dollar seems to be more of a reaction to yesterday’s strength than anything else. I expect limited movement ahead of the Minutes, and quite frankly, limited afterwards as well. Tomorrow’s CPI feels like the next big catalyst we will see.

Good luck
Adf

 

The UK Wants to Shun

This morning as part of his plan
For Brexit, the PM began
A series of talks,
Before Britain walks,
With Angela as middleman

Alas, when the phone call was done
The odds of a deal approached none
The EU made clear
The (Northern) Irish adhere
To rules the UK wants to shun

The pound is suffering this morning, down 0.5%, after news that a phone call between Boris and Angela resulted in Johnson explaining that a Brexit deal is “essentially impossible” at the current time. If you recall, Boris’s plan was for Northern Ireland to adhere to EU rules on manufactured goods and agricultural products while customs activities would take place a number of miles from the actual border. Finally, Northern Ireland would be allowed to vote every four years to determine if they were happy with that situation. The EU view is that Northern Ireland must remain a part of the customs union in perpetuity, something that would essentially split them from the rest of the UK. It is no surprise that both Boris and Northern Ireland rejected that outcome, and so the Johnson government has increased preparations for a hard Brexit.

There are two interesting tidbits ongoing as well, both of which bode ill for a deal. First is that Irish Taoiseach Leo Varadkar is terrified that he and his nation will be blamed if no deal is reached. And when I say terrified, it means that he is afraid that a no-deal Brexit will result in a significant (~5%) hit to Ireland’s economy and that he will be tossed from office because of that. Remember, every politician’s number one priority during any situation is to be reelected, hence his terror. His response has to increase the rhetoric about how Boris is the problem, further poisoning the well. The second interesting thing is that a survey in the EU by Kantar (a European polling company) showed that between 47% and 66% of citizens in six EU nations (France, Germany, the Netherlands, Ireland, Spain and Poland) believe the EU should not extend the Brexit deadline, with a solid majority in all nations except the Netherlands. Perhaps Boris will get his wish that Europe won’t offer an extension or agree to one if asked. It appears that this saga is reaching its denouement. And despite all of this, I continue to see a strong possibility that the EU blinks as they figure out Boris is serious. My impression is that Merkel and the EU continue to believe that the UK will come begging, hat in hand, for another extension and that a new vote will lead to the end of this process with the UK revoking Article 50. And so they continue to believe they are dealing from a position of strength. We shall see.

Of course, the reason we care so much about this is not just for the impact on the British pound, but actually the impact on the global economy. Consider that the global economy has been slowing steadily for the past eighteen months under pressure from the ongoing trade war between the US and China and the uncertainty that has engendered. If the estimates of the economic impact of a hard Brexit are even halfway correct, we are looking at a sharp decline in economic activity in the UK, Ireland, Germany, France and the Netherlands, ranging between 0.5% and 5.0%. I assure you that will not help the global growth situation. It will also result in immediate additional policy ease by the world’s central banks, notably the Fed. The impact on equity markets will be significant, bond markets will rally sharply as will haven currencies. In other words, it could easily be the catalyst required to bring on that recession on the horizon.

Beyond Brexit, the other big story overnight was on trade as the US put 28 Chinese firms on an export blacklist under the guise of those companies helping in repression of Muslim minorities in northwest China. Not surprisingly, the Chinese were not amused and ‘instructed’ the US to correct its mistake. They also told the world to “stay tuned” for any retaliation that will be forthcoming. Fortunately, this has not changed the plans for the trade talks to be held on Thursday and Friday in Washington with Vice-premier Liu He, at least not yet. But that remains a huge concern, that He will not make the trip and that the trade impasse will harden. At this point it has become pretty clear that a big trade deal is not in the offing. The Chinese appear to be betting that President Trump will lose the election and so are waiting him out. However, this is the one area where the President truly has bipartisan support so it is not clear to me that a President Warren, Biden or Sanders would be any more inclined to come to an agreement that didn’t meet hurdles regarding IP theft and state subsidies.

The combination of these two events has served to undermine equity markets in Europe with virtually every major index having fallen by more than 1% this morning. While Asian equity markets performed well (Nikkei +1.0%, KOSPI +1.2%, Shanghai +0.25%) that was before the Boris-Angela call. US futures have turned lower in the past hour with all three exchanges now pointing to 0.5% declines on the opening. Meanwhile, Treasury yields continue to fall with the 10-year at 1.52%, down 4bps and Bunds are following with yields there down 1.5bps.
As to the dollar, it is no surprise the yen (+0.4%) and Swiss franc (+0.35%) have rallied, but a bit more surprising that aside from the pound, most other G10 currencies are firmer. That said, the movement has not been that large and if we see a true risk-off session in the US, I would expect the dollar to strengthen. In the EMG space, ZAR is the biggest loser today, falling 0.65%, after Renaissance Capital put out a report that the country’s debt would be downgraded to junk status next month. Given their recent track record, correctly calling 8 of the past 9 ratings moves, it is being given some credence. After that, RUB has fallen 0.5% on the back or weaker oil prices, which are down 1.3% this morning and more than 11% from before the attack on the Saudi oil facility in the middle of September.

As to data today, NFIB was already released at a slightly weaker than expected 101.8. While that remains at the high end of its historic readings, it is clear that this series has rolled over and is heading lower. We also get PPI (exp 1.8%, 2.3% ex food & energy) at 8:30 but most folks ignore that and are looking for CPI on Thursday. Chairman Powell speaks again today at 2:30 this afternoon, so all eyes will be focused on Denver to see how he responds to the most recent gyrations in the big stories.

Overall, it feels like a day of uncertainty and risk reduction. Look for further yen and Swiss franc strength as well as for the dollar to regain its footing against the rest of its counterparts.

Good luck
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Digging In Heels

In Europe they’re digging in heels
Ignoring all UK appeals.
So, Brexit is looming
With Boris assuming
They’ll blink, ratifying his deal

Brexit and the Trade Wars sounds more like a punk rock band than a description of the key features in today’s markets, but once again, it is those two stories that are driving sentiment.

Regarding the former, the news today is less positive that a deal will be agreed. A wide group of EU leaders have said Boris’s latest offering is unacceptable and that they are not willing to budge off their principles (who knew they had principles?). It appears the biggest sticking point is that the proposal allows Northern Ireland to be the final arbiter of approval over the workings of the deal, voting every four years to determine if they want to remain aligned with the EU’s rules on manufactured goods, livestock and agricultural products. This, of course, would take control of the process out of the EU’s hands, something which they are unwilling to countenance.

French President Emmanuel Macron has indicated that if they cannot agree the framework for a deal by this Friday, October 11, there would be no chance to get a vote on a deal at the EU Summit to be held next week on October 17. It appears, at this point, that the EU is betting the Benn Act, the legislation recently passed requiring the PM to ask for an extension, will be enforced and that the UK will hold a general election later this year in an attempt to establish a majority opinion there. The risk, of course, is that the majority is to complete Brexit regardless and then the EU will find itself in a worse position. All of this presupposes that Boris actually does ask for the extension which would be a remarkable climb-down from his rhetoric since being elected.

Given all the weekend machinations, and the much more negative tone about the outcome, it is remarkable that the pound is little changed on the day. While it did open the London session down about 0.35%, it has since recouped those losses. As always, the pound remains a binary situation, with a hard Brexit likely to result in a sharp decline, something on the order of 10%, while a deal will result in a similar rally. However, in the event there is another extension, I expect the market will read that as a prelude to a deal and the pound should trade higher, just not that much, maybe 2%-3%.

Otherwise, the big story is the trade war and how the Chinese are narrowing the scope of the negotiations when vice-premier Liu He arrives on Thursday. They have made it quite clear that there will be no discussion on Chinese industrial policy or subsidies, key US objectives, and that all the talks will be about Chinese purchases of US agricultural and energy products as well as attempts to remove tariffs. It appears the Chinese believe that the impeachment inquiry that President Trump is facing will force him to back down on his demands. While anything is possible, especially in politics, based on all his actions to date, I don’t think that the President will change his tune on trade because of a domestic political tempest that he is bashing on a regular basis. The market seems to agree with that view as well, at least based on today’s price action which can best be described as modestly risk-off. Treasury and Bund yields are lower, albeit only between 1-2bps, the yen (+0.1%) and Swiss franc (+0.2%) have strengthened alongside the dollar and US equity futures are pointing to a decline of 0.2% to start the session. Ultimately, this story will remain a market driver based on headlines, but it would be surprising if we hear very much before the meetings begin on Thursday.

Looking ahead to the rest of the week, the FOMC Minutes will dominate conversation, but we also see CPI data:

Today Consumer Credit $15.0B
Tuesday NFIB Small Biz Optimism 102.0
  PPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday JOLTS Job Openings 7.25M
  FOMC Minutes  
Thursday Initial Claims 220K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Michigan Sentiment 92.0

Source: Bloomberg

Over the weekend we heard from both Esther George and Eric Rosengren, the two FOMC members who dissented against the rate cuts. Both said they see no reason to cut rates again right now, but if the data do deteriorate, they have an open mind about it. Meanwhile, Friday Chairman Powell gave no hints that last week’s much weaker than expected data has changed his views either. This week brings seven more Fed speakers spread over ten different events, including Chairman Powell tomorrow.

At the same time, this morning saw German Factory Orders decline a more than expected 0.6%, which makes the twelfth consecutive Y/Y decline in that series. It is unambiguous that Germany is in a recession and the question is simply how long before the rest of Europe follows, and perhaps more importantly, will any country actually consider fiscal stimulus? As it stands right now, Germany remains steadfast in their belief it is unnecessary. Maybe a hard Brexit will change that tune!

The big picture remains intact, with the dollar being the beneficiary as the currency of the nation whose prospects outshine all others in the short run. As it appears highly unlikely a trade deal will materialize this week, I see no reason for the dollar to turn around. Perhaps the only place that is not true is if there is, in fact, a break though in the UK.

Good luck
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