Author Archives: fxpoet

Somewhat Restrictive

Posted on by

Said Evans, if I were predictive
A setting that’s somewhat restrictive
Might be just the thing
To slightly hamstring
This growth that’s become quite addictive

Chicago Fed president Charles Evans, a reliable dovish voice on the FOMC, spoke yesterday and made news because of his more hawkish tone. “If inflation [PCE] continues to be on the order of 2, 2.2 (percent) — I’m not expecting it to get as high as 2.5 — that suggests only a modest amount of restrictiveness above our neutral rate might be called for in 2020,” he said and continued, “ It would not surprise me at all if we make a judgment to move to a somewhat restrictive setting.” For a dove, that is a remarkable admission of the strength of the economy and the growing belief that monetary policy is now sending the wrong signals.

Remember, despite the fact that the Fed has raised rates seven times for a total of 175bps since December 2015, Fed funds remain well below the inflation rate so real interest rates remain negative. In fact, this morning we will see just how far below as CPI is due to be released at 8:30 and expected to print at 3.0% with the core rate at 2.3%. Historically, real interest rates have been positive to the tune of 2.0% and while there have clearly been fundamental changes in the economy that may warrant a lower real interest rate (e.g. technological advances driving efficiencies, globalization), negative real rates are only called for during a recession or worse. If the doves are now on board the rate raising train, and these comments seem to suggest that they are, the Fed could become even more aggressive in 2019, with a press conference after every meeting, and therefore the opportunity to explain their actions. Don’t be surprised if they raise rates in January 2019 especially if the emerging markets don’t completely crater. And if you want a hint of how this will impact the dollar, last night’s price action, with the DXY rising 0.5% and the euro finally breaking out of its recent trading range, falling by a similar amount, are very good prognosticators.

But the caveat is, if the emerging markets don’t crater, and that is an important caveat. Last night, the Turkish lira saw a significant escalation in the recent market tension as it fell nearly 10% at one point and though it has recovered slightly, remains down by 7% as I type. The thing is, nothing new has been revealed. It appears that as the week is drawing to a close, traders and investors are simply coming to the conclusion that President Erdogan is not going to allow the central bank the leeway it needs to manage the economy in an orthodox manner, and that things could well spiral out of control. The fact that Turkey and the US remain at odds over the arrest of an American pastor by Istanbul, and that sanctions are being imposed, is just adding fuel to the fire. This is the proverbial falling knife. Don’t try to catch it. Until the politics changes, the currency is likely to continue in freefall.

The question is, will this infect other emerging markets, and by extension developed country markets? If last night is any indication, it may just be starting to do so. Equity markets throughout Europe are lower, some pretty sharply (Germany -1.5%, Italy -1.7%) as concerns have been raised over some of the large European banks’ exposures to Turkey. We saw weakness in Japanese equities (-1.3%) despite the fact that GDP growth there in Q2 was shown to be a better than expected 1.9% annualized. US equity futures are also softer, down about 0.5% at this point, and Treasury yields are falling (10yr -4bps) as investors are fleeing to safe havens. In other words, it is beginning to look like that infection is starting to spread.

As is often the case, these concerns make themselves known in almost random fashion. Certain currencies respond to the news in a negative way, while others that you may assume would see the same type of response don’t move. It is also important to watch the movement over a week or two, rather than on a given day, as those trends can be more revealing. For example, RUB is barely softer this morning, down just 0.3%, despite increased sanctions imposed by the US because of the poisoning of an ex Russian spy in London earlier this year. But this week it has fallen 5.6%, a pretty hefty move, and indicative of the fact that there is growing concern there. Another currency feeling the pressure this morning is ZAR, which has fallen 1.1% and 4% on the week. But as it had strengthened sharply through Q1, it is only down 2% in the past year. However, the recent trend is ominous and it certainly appears that ZAR has further to fall. MXN is another interesting case, where it has fallen 1.25% overnight and 2.6% this week, but remains far stronger than its levels earlier this summer in the run up to the presidential election there. However, regardless of the market’s relief that AMLO does not seem to be as radical as initially feared, emerging market disease can be quite contagious, and it would not surprise me at all to see the peso fall another 5% or even more if we see additional pressure elsewhere.

The key to remember here is that there is a great deal of herd behavior demonstrated by investors, especially emerging market investors, and if they start to leave one market because there is fear of a serious problem, it can easily spread to other markets, especially if liquidity in that first market dries up. We have been witnessing individual market problems all year, and each one seemed isolated due to specific local events. But I am getting the feeling that we may have reached a tipping point, where there have been enough individual events to cause a re-evaluation of the general trend. If this is indeed the case, then the Fed may well slow the pace of its rate hikes, but the dollar should benefit anyway as the safest haven of all.

Do not be surprised if we see wider spread weakness across emerging market currencies going forward, and by extension, the G10 as well. There are likely to be two exceptions to this rule, JPY and CHF, but otherwise, I fear thin summer markets may lead us to some larger moves across the board. So stay alert and maintain those hedge ratios.

Good luck and good weekend
Adf

 

Up To New Tricks

Posted on by

The nation that first tried to fix
Its price target’s up to new tricks
Last night it explained
That rates would remain
Unchanged til growth, up, finally ticks

You know it has been a relatively uneventful session when the most interesting story is about New Zealand! For those with a bent toward history, it was then-RBNZ Governor Donald Brash, who in 1988 set the first inflation target for a nation, 3.0% at that time, and who was able to maintain the RBNZ’s independence from government meddling ( a new philosophy then) to help achieve that target and eventually bring interest rates down from more than 15% to low single digits. Well, last night when the RBNZ met, they left rates on hold at a record low level of 1.75%, as was universally expected, but they added a sentence to their policy statement “…that rates will remain at this level through 2019 and into 2020”, adding forward guidance to the mix and surprising markets completely. The result was that the NZD fell a bit more than 1% instantly and has continued lower to currently trade down 1.4% on the session and back to its lowest level since March 2016.

This action simply underscores the policy divergence that we have seen over the past two and a half years. Since the Fed’s first, tentative steps towards tightening in December 2015, it has been clear that the US remains ahead of the global growth cycle. And now we find ourselves in a world where several countries are trending higher (US, Canada, India, Sweden) in growth and inflation, while others are seeing the opposite outcome (China, New Zealand, Australia). Of course there are those who are in between, like the Eurozone and Japan, where they want to believe that things are getting better so they can normalize policy, but just don’t quite have the confidence yet. Maybe soon. And it is these policy differences, as well as expectations for their evolution, that will continue to be the key drivers of currencies going forward.

However, away from New Zealand, the G10 has been a dull affair. There has been limited data released and currency movement has been extremely modest, generally less than 0.1% since yesterday’s closing levels.

Emerging markets, though, have been a different story, with several of them really taking a tumble. Starting with Turkey, which has, of course, been under pressure for the past several months, last night saw yet another significant decline of 2.2%, which makes 6.5% this week and more than 50% in the past year. Additional US sanctions driven by the arrest of a US pastor in Turkey have been the recent catalyst, but the reality is that there is an increasing sense of doom attached to President Erdogan’s economic management theories, which include the idea that high interest rates cause inflation; they don’t fight it. But high inflation is what they have there, with the annual rate now running above 16% and rising. The lira has further to fall, mark my words.

Next on the list is the Russian ruble, which has recovered as I write to only be down by 0.6%, after having been lower by as much as 1.3% earlier in the session. However, this week it is lower by 4.2% and nearly 7% this month. The story here is a combination of both new US sanctions as the latest response to the poisoning of an ex Russian agent in the UK earlier this year, as well as the sharp decline in oil prices yesterday, WTI fell 3.2% after storage data indicated there was much more oil and products around than expected. The Russian economy is definitely feeling the squeeze of US sanctions and I expect that the ruble will continue to be pressured lower for a while yet.

But once we get past those currencies, there is precious little to discuss in this space as well. Which takes us to the upcoming data releases. This morning we see Initial Claims (exp 220K) and PPI (3.4%, 2.8% core) at 8:30 and then we hear from Chicago Fed president Evans at 9:30. Evans is a known dove, so the only possibility of a newsworthy event would be if he sounded hawkish. Yesterday, Richmond Fed president Barkin said it was time to get rates back to ‘normal’ and that two more hikes this year seem reasonable. While the futures market is not yet pricing in great confidence in a December move by the Fed, it seems a foregone conclusion to me.

In the end, nothing has happened to alter my views that the Fed will continue to lead the way in tighter monetary policy and that the dollar will be the main beneficiary of that action.

Good luck
Adf

 

A Torch Song

Posted on by

As summer meanders along
Two stories are still going strong
In China the yuan
Is just hanging on
While Brexit’s become a torch song

Last night was yet another session of modest activity in foreign exchange as market participants’ focused on the same two stories that have been hogging the headlines for months; Brexit and its fallout on the pound; and China and the deteriorating trade situation. In fact, there is one other story that gets some press, the collapsing Turkish lira, but given the fact that TRY is a relatively inconsequential currency in the broad scheme of things, it is sufficient to know that the problems there are unlikely to get better soon, but also unlikely to have a wider impact on markets.

Let’s start with China today. Last night’s trade data showed that their surplus shrank substantially, to $28B, as imports surged more than 27% while export growth was a more modest 12%. At the same time, their surplus with the US fell only slightly, from $28.9B to $28.1B. It is the latter data that has been driving the current US trade policy, and the modest improvement seems unlikely to change anything. Already, tariffs on the next $16B are set to be put in place in two weeks’ time, and the list of products for the following grouping of $200B is being finalized and tariffs could be imposed as soon as September 6th. The Chinese have not yet blinked, but by all accounts, the situation in the Chinese economy is starting to get a bit more concerning.

The PBOC has flooded the market there with liquidity as evidenced by the fact that Chinese interest rates across the curve have fallen to the lowest levels seen in more than three years. (If you recall three years ago was when the PBOC instituted their ‘mini-devaluation’ in the yuan, which led to massive capital outflows and forced them to spend in excess of $1 trillion of reserves defending the yuan.) Regardless of the fact that those capital controls remain in place, it is pretty clear that money is flowing out of China right now. The question is, will those flows increase to a more troubling level forcing more aggressive PBOC action? Interestingly, a recent survey of traders and economists showed a strong belief that the PBOC will be able to contain CNY weakness and there is limited expectation for the currency to weaken beyond 7.00. Adding to this view, last night the PBOC called the major banks into a meeting and ‘encouraged’ them to insure their clients don’t become caught up in the “herd behavior” of selling yuan. This verbal suasion is in addition to their recent re-imposition of excess capital requirements for short CNY forward positions as well as the PBOC’s significantly increased activity in the FX swaps market, where they have sold so many dollars forward that the points have fallen to a discount, despite the fact that a pure interest rate calculation would put them at a substantial premium. As powerful as the PBOC is, and as much control as they exert over the currency, the market is still bigger than they are. If the Chinese population fears that the yuan is going to weaken further, they will find ways to get their money out of China, and it will be a self-fulfilling event. The benefit for hedgers is that with one-year USDCNY forwards at a discount, hedging assets and receivables is now very cost effective.

Turning to the UK and the ongoing Brexit story, there actually seems to have been little new in the way of news overnight. However, just before NY walked in, the pound extended its losses and is now down more than 0.5% on the day and trading at one year lows. The problem for the pound is that as the timeline leading to Brexit shrinks, no news is no longer good news. The lack of activity is an indication that the probability of a no-deal Brexit is growing, and as I have written several times recently, if there is no deal, the pound is likely to fall sharply. In fact, at this point in time, there is probably a short-term risk that the pound can move sharply higher in response to something positive in this process. For example, if the EU were to soften its stance, or make a serious accommodation, the pound could easily rise a few percent on the news. However, that doesn’t seem very likely, at least based on anything that has been reported in the past several weeks.

Beyond those stories, though, there is precious little to discuss. Yesterday, as expected, the JOLTs report showed that there are many jobs available in the US, 6.66M to be exact, which is simply in line with the strong employment situation that we all know exists. Today, however, there is no new data to absorb, and really, until Friday’s CPI, the FX market will be looking elsewhere for catalysts. My sense is that the trade story will remain the single biggest driver, and that it still points to a stronger dollar for now. Keep that in mind as you look ahead.

Good luck
Adf

Ere Brexit’s Birthday

Posted on by

The UK Prime Minister May
Is seeking an outcome one day
Where Europe realizes
That some compromises
Are needed ere Brexit’s birthday

It has been a painfully quiet FX market overnight with very limited new information crossing the tapes. Lately, the biggest market moves have been seen in the Turkish lira, which after falling nearly 5% yesterday has rebounded just under 2% today. The thing is that Turkey’s importance in the broad scheme of the market is so marginal, it is tiresome to mention too frequently. And let’s face it; as long as President Erdogan is running things, this situation is unlikely to improve.

Arguably the only other noteworthy story overnight is the continued angst in the UK over International Trade Secretary, Liam Fox’s comments about the increasing probability of a hard Brexit. Certainly the analyst community all jumped on the bandwagon yesterday with regard to the discussion, but in the end, there is still precious little movement in the negotiations. There was a Bloomberg article this morning that was quite disconcerting, at least if you want to see a deal put in place. It basically hypothesized that PM May was counting on an increased willingness by the EU to compromise in order that the bloc may show a unified stance to President Trump at the G20 meeting scheduled for November in Buenos Aires. That seems pretty thin gruel for negotiating tactics and doesn’t sound like a winning play to me, but then I’m not a politician.

Reviewing the key issues outstanding, I still don’t see how the Irish border situation can be resolved effectively. Northern Ireland demands that there is no ‘hard’ border between themselves and Ireland, but as that will now be the only land border between the UK and the EU, something will be necessary to insure the proper movement of people and goods between nations. (Perhaps they can use the Shrodinger’s Cat model, where the border simultaneously does and doesn’t exist until someone looks to cross it.) In effect, one side is going to have to cave in, and right now, neither side is willing to do so. As long as this remains the case, I maintain that a hard Brexit is the most likely outcome and that the pound has further to fall.

But away from that, there is just not much to discuss. The dollar, overall, is slightly softer, giving back some of its recent gains, but that remains trading activity not news driven movement. Data has been sparse with soft German IP offset by ongoing strong trade data the most noteworthy Eurozone prints. The RBA left rates on hold, as universally expected, although perhaps the statement was seen as a bit more hawkish than anticipated as the Aussie dollar is actually today’s top performer in the G10, rising 0.6%. But after that, there is nothing to note.

And quite frankly, the only thing on the calendar this morning in the US is the JOLTs Jobs Report, which is simply going to show that the employment situation in the US remains quite strong. But we know that already and it was reconfirmed last Friday with the payroll report.

All told, it is shaping up to be an uninspiring day in the FX markets. Given we have seen some pretty steady strength in the dollar for the past week, I wouldn’t be surprised to see this morning’s mild weakness extend further. But I wouldn’t read any long-term thoughts into a day with low volumes where prices are correcting.

Good luck
Adf

Turning To Fearing

Posted on by

The deadline for Brexit is nearing
And hoping is turning to fearing
No deal’s yet in sight
But both sides delight
In claiming that they’re persevering

This morning, the two stories that have captured the FX market’s attention are Brexit and its impact on the pound and Chinese policy changes and their impact on the yuan.

Starting in the UK, the pound is under pressure this morning, down 0.55%, as comments from International Trade Secretary, Liam Fox, have rattled traders. According to Fox, the odds that there is no Brexit deal have now risen to 60%, certainly enough to qualify as “uncomfortably high”, Governor Carney’s description last week in his comments following the BOE meeting. It appears that both sides remain committed to their positions and there has been very little movement from either London or Brussels of late. Meanwhile, in the UK, the politics of the situation has resulted in the new favorite pastime of guessing who will replace PM May when she finally loses a no-confidence vote. And while March 31 is the technical deadline, the reality is that if there is no agreement in place by October, it is likely to be too late. Remember that once an agreement is reached, it needs to be enacted into law by all the nations in the EU as well as the UK, with any one of them able to derail the process. Last year I posited that the odds of reaching a deal were extremely low. I believe this is exactly what is playing out now.

The consequences for the pound are unlikely to be pretty. I expect that we will see pressure continue to increase as it becomes clear that there is no deal forthcoming. So unlike the market action right after the initial Brexit vote in June 2016, where the pound fell more than 10% overnight, and shed another 10% in the ensuing four months, I expect that this will be steady downward pressure, although the net 20% decline cannot be ruled out. After all, there will be no announcement that talks have ended, merely a lack of progress to be seen. Consider that a further 20% decline from here will put the historic low level of 1.06, set back in 1985, on the radar. And while that may well be too pessimistic, it remains extremely difficult to make a bullish pound case at this time. Unless we see a negotiating breakthrough in the next month or so, hedgers need to be prepared for a much lower pound over time.

Turning to China, late Friday night the PBOC imposed a new restriction on FX trading by reinstituting a 20% reserve requirement against short yuan forward positions. The idea here is that Chinese banks will not be willing to allocate the funds necessary to maintain those positions, and therefore will not allow clients to sell CNY forward. In 2015, during the last CNY devaluation, when capital outflows really gathered pace, this was one of the tools that the PBOC employed to stem the yuan’s weakness. What this tells me is that despite the rhetoric from the government about the trade situation and their willingness to tough it out, there is growing concern that if USDCNY reaches 7.00, citizens will start to become much more aggressive in their efforts to reduce their exposure to the yuan, and flee to other, safer currencies. Ironically, given what has started this process, this includes the dollar as well as the yen and Swiss franc. As is typical of the Chinese, they announced this change late Friday night when markets were closed. And while the initial market reaction to the news in China’s morning was for the yuan to strengthen a bit, that strength has reversed and USDCNY is now higher by 0.25%. If 7.00 is truly the pain point, I fear we are going to see some fireworks before the end of the summer.

Beyond those two stories, the dollar is firmer overall, but there is less specificity than it simply being a strong dollar day. The euro is lower by 0.25% after German Factory Orders fell a much worse than expected -4.0%, taking the Y/Y level negative for the first time in two years. But given the breadth of the dollar’s strength this morning, I would argue the euro would have declined no matter the number. As the trade rhetoric continues apace, I expect the dollar to remain well bid against all comers.

Turning to the data this week, it is far less interesting than last week’s onslaught, but we do end the week with CPI.

Tuesday JOLT’s Job Openings 6.646M
  Consumer Credit $16.0B
Thursday Initial Claims 220K
  PPI 0.2% (3.4% Y/Y)
  -ex food & energy 0.2% (2.8% Y/Y)
Friday CPI 0.2% (3.0% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Beyond the inflation data, we have only two Fed Speakers, and given the continued strong run of data, it remains hard to believe that we will hear any new dovishness by anyone. I am hard-pressed to derive a scenario that leads to significant dollar weakness in the short run. Until the US data turns, I believe that the Fed will continue to tighten policy and that the dollar will benefit. And that seems likely to last through at least the end of the year.

Good luck
Adf

Uncomfortably High

Posted on by

Said Carney, exhaling a sigh
The odds are “uncomfortably high”
More pain will we feel
If there is no deal
When England waves Europe bye-bye

Yesterday the BOE, in a unanimous decision, raised its base rate by 25bps. This outcome was widely expected by the markets and resulted in a very short-term boost for the pound. However, after the meeting, Governor Carney described the odds of the UK leaving the EU next March with no transition deal in hand as “uncomfortably high.” That was enough to spook markets and the pound sold off pretty aggressively afterwards, closing the day lower by 0.9%. And this morning, it has continued that trend, falling a further 0.2% and is now trading back below 1.30 again.

By this time, you are all well aware that I believe there will be no deal, and that the market response, as that becomes increasingly clear, will be to drive the pound still lower. In the months after the Brexit vote, January 2017 to be precise, the pound touched a low of 1.1986, but had risen fairly steadily since then until it peaked well above 1.40 in April of this year. However, we have been falling back since that time, as the prospects for a deal seem to have receded. The thing is, there is no evidence that points to any willingness to compromise among the Tory faithful and so it appears increasingly likely that no deal will be agreed by next March. Carney put the odds at 20%, personally I see them as at least 50% and probably higher than that. In the meantime, the combination of ongoing tightening by the Fed and Brexit uncertainty impacting the UK economy points to the pound falling further. Do not be surprised if we test those lows below 1.20 seen eighteen months ago.

This morning also brought news about the continuing slowdown in Eurozone growth as PMI data was released slightly softer than expected. French, German and therefore, not surprisingly, Eurozone Services data was all softer than expected, and in each case has continued the trend in evidence all year long. It is very clear that Eurozone growth peaked in Q4 2017 and despite Signor Draghi’s confidence that steady growth will lead inflation to rise to the ECB target of just below 2.0%, the evidence is pointing in the opposite direction. While the ECB may well stop QE by the end of the year, it appears that there will be no ability to raise rates at all in 2019, and if the current growth trajectory continues, perhaps in 2020 as well. Yesterday saw the euro decline 0.7%, amid a broad-based dollar rally. So far this morning, after an early extension of that move, it has rebounded slightly and now sits +0.1% on the day. But in the end, the euro, too, will remain under pressure from the combination of tighter Fed policy and a decreasing probability of the ECB ever matching that activity. We remain in the 1.1500-1.1800 trading range, which has existed since April, but as we push toward the lower end of that range, be prepared for a breakout.

Finally, the other mover of note overnight was CNY, with the renminbi falling to new lows for the move and testing 6.90. The currency has declined more than 8% since the middle of June as it has become increasingly clear that the PBOC is willing to allow it to adjust along with most other emerging market currencies. While the movement has been steady, it has not been disorderly, and as yet, there is no evidence that capital outflows are ramping up quickly, so it is hard to make the case the PBOC will step in anytime soon. And that is really the key; increases in capital outflows will be the issue that triggers any intervention. But while many pundits point to 7.00 as the level where that is expected to occur, given the still restrictive capital controls that exist there, it may take a much bigger decline to drive the process. With the Chinese economy slowing as well (last night’s Caixin Services PMI fell to 52.8, below expectations and continuing the declining trend this year) a weaker yuan remains one of China’s most important and effective policy tools. There is no reason for this trend to end soon and accordingly, I believe 7.50 is reasonable as a target in the medium term.

Turning to this morning’s payroll report, here are the current expectations:

Nonfarm Payrolls 190K
Private Payrolls 189K
Manufacturing Payrolls 22K
Unemployment Rate 3.9%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5
Trade Balance -$46.5B
ISM Non-Manufacturing 58.6

Wednesday’s ADP number was much stronger than expected at 213K, and the whisper number is now 205K for this morning. As long as this data set continues to show a strong labor market, and there is every indication it will do so, the only question regarding the Fed is how quickly they will be raising rates. All of this points to continued dollar strength going forward as the divergence between the US economy and the rest of the world continues. While increasing angst over trade may have a modest impact, we will need to see an actual increase in tariffs, like the mooted 25% on $200 billion in Chinese imports, to really affect the economy and perhaps change the Fed’s thinking. Until then, it is still a green light for dollar buyers.

Good luck and good weekend
Adf

For How Long?

Posted on by

The US economy’s strong
Denial of this would be wrong
It’s not too surprising
That rates will be rising
The question is just, for how long?

Despite the Trump administration’s recent discussion of imposing 25% tariffs on $200 billion of Chinese imports, rather than the 10% initially mooted, the Fed looked at the economic landscape and concluded that things continue apace. While they didn’t adjust rates yesterday, as was universally expected, the policy statement was quite positive, highlighting the strength in both economic growth and the labor market, while pointing out that inflation is at their objective of 2.0%. Market expectations for a September rate hike increased slightly, with futures traders now pricing in a nearly 90% probability. More interestingly, despite the increased trade rhetoric, those same traders have increased their expectations for a December hike as well, with that number now hovering near 70%. At this point, despite President Trump’s swipe at higher rates last week, it appears that the Fed is continuing to blaze its rate-hiking path undeterred.

The consequences of the Fed’s stance are starting to play out more clearly now, with the dollar once again benefitting from expectations of higher short term rates, and equity markets around the world, but especially in APAC, feeling the heat. The chain of events continues in the following manner. Higher US rates have led to a stronger US dollar, especially vs. many emerging market currencies. The companies in those countries impacted are those that borrowed heavily in USD over the past ten years when US rates were near zero. They now find themselves struggling to repay and refinance that debt. Repayment is impacted because their local revenues buy fewer dollars while refinancing is impacted by the fact that US rates are that much higher. With this cycle in mind, it should not be surprising that equity markets elsewhere in the world are struggling. And those struggles don’t even include the potential knock-on effects of further US tariff increases. Quite frankly, it appears that this trend has further to run.

Meanwhile, the week’s central bank meetings are coming to a close with this morning’s BOE decision, where they are widely touted to raise the Base rate by 25bps, up to 0.75%. It is actually quite amusing to read some of the UK headlines talking about the BOE raising rates to the ‘highest in a decade’, which while strictly true, seems to imply so much more than the reality of still exceptionally low interest rates. However, given the ongoing uncertainty due to the Brexit situation, I continue to believe that Governor Carney is extremely unlikely to raise rates again this year, and if we are headed to a ‘no-deal’ Brexit, which I believe is increasingly likely, UK rates will head back lower again. Early this morning the UK Construction PMI data printed at a better than expected 55.8, its highest since late 2016, but despite the strong data and rate expectations, the pound has fallen 0.35% on the day.

Other currency movement has been similar, with the euro down 0.35%, Aussie and Kiwi both falling more than 0.5% and every other G10 currency, save the yen declining. The yen has rallied slightly, 0.2%, as interest rates in Japan continue to respond to Tuesday’s BOJ policy tweaks. JGB’s seem to have quickly found a new home above the old 0.10% ceiling, and there is now a growing expectation that as the 10-year yield there approaches the new 0.2% cap, the longer end of the JGB curve will rise with it taking the 30-year JGB to 1.00%. While that may not seem like much to the naked eye, when considering the nature of international flows, it is potentially quite important. The reason stems from the fact that Japanese institutional investors tend to hedge the FX exposure that comes from foreign fixed income purchases thus reducing their net yield from the higher rates received overseas to something on the order of 1.0%. And if the Japanese 30-year reaches that 1.0% threshold (it is currently yielding 0.83%), there is a growing expectation that those same investors will sell Treasuries and other bonds and bring the money home. That will have two impacts. First, I would be far less concerned over an inverting yield curve in the US as yields across the back end of the US curve would rise on those sales, and second, the dollar would likely rally overall on higher rates, but decline further against the yen. These are the type of background flows that impact the FX market, but may not be obvious to most hedgers.

Turning to the emerging markets, the dollar is firmer against virtually all of these currencies as well. One of the biggest movers has been CNY, falling 0.5% and now trading at its weakest level since May 2017. The renminbi’s decline has been impressive since mid-April, clocking in at nearly 9%, and clearly offsetting some of the impact of the recent tariffs. But remember, the renminbi’s decline began well before any tariffs were in place, and has as much to do with a slowing Chinese economy forcing monetary policy ease in China as with the recent trade spat. At this point, capital outflows have not yet become a problem there, but if history is any guide, as we get closer to 7.00, we are likely to see more pressure on the system as both individuals and companies seek to get their money out of China and into a stronger currency. I expect that there are more fireworks in store here.

Aside from China, the usual suspects continue to fall, with TRY having blasted through 5.00 overnight and now down 1.5% on the day. But we have also seen significant weakness in ZAR (-1.75%), KRW (-1.15%), and MXN (-0.75%). Even INR is down 0.5% despite the RBI having raised rates 0.25% overnight to try to rein in rising inflation pressures there. So today’ story is clear, the dollar remains in the ascendancy on the back of optimism in the US vs. increasing pessimism elsewhere in the world.

A quick peek at today’s data shows that aside from the weekly Initial Claims (exp 220K) we see only Factory Orders (0.7%). Yesterday’s ADP Employment data was quite strong, rising 219K, while the ISM Manufacturing report fell to a still robust 58.1, albeit a larger fall than expected. However, given the Fed’s upbeat outlook, the market was able to shake off the news. At this point, however, I expect that eyes are turning toward tomorrow’s NFP report, which will be seen as taking a much more accurate reading on the economy. All in all, I see no reason for the dollar to give back its recent gains, and in fact, expect that modest further strength is in the cards.

Good luck
Adf

 

Percent Twenty-Five

Posted on by

The story, once more’s about trade
As Trump, a new threat, has conveyed
Percent twenty-five
This fall may arrive
Lest progress in trade talks is made

President Trump shook things up yesterday by threatening 25% tariffs on $200 billion of Chinese imports unless a trade deal can be reached. This is up from the initial discussion of a 10% tariff on those goods, and would almost certainly have a larger negative impact on GDP growth while pushing inflation higher in both the US and China, and by extension the rest of the world. It appears that the combination of strong US growth and already weakening Chinese growth, has led the President to believe he is in a stronger position to obtain a better deal. Not surprisingly the Chinese weren’t amused, loudly claiming they would not be blackmailed. In the background, it appears that efforts to restart trade talks between the two nations have thus far been unsuccessful, although those efforts continue.

Clearly, this is not good news for the global economy, nor is it good news for financial markets, which have no way to determine just how big an impact trade ructions are going to have on equities, currencies, commodities and interest rates. In other words, things are likely more uncertain now than in more ‘normal’ times. And that means that market volatility across markets is likely to increase. After all, not only is there the potential for greater surprises, but the uncertainty prevailing has reduced liquidity overall as many investors and traders hew to the sidelines until they have a better idea of what to do. And, of course, it is August 1st, a period where summer vacations leave trading desks with reduced staffing levels and so liquidity is generally less robust in any event.

Moving past trade brings us straight to the central bank story, where the relative hawkishness or dovishnes of yesterday’s BOJ announcement continues to be debated. There are those who believe it was a stealth tightening, allowing higher 10-year yields (JGB yields rose 8bps last night to their highest level in more than 18 months) and cutting in half the amount of reserves subject to earning -0.10%. And there are those who believe the increased flexibility and addition of forward guidance are signals that the BOJ is keen to ease further. Yesterday’s price action in USDJPY clearly favored the doves, as the yen fell a solid 0.8% in the session. But there has been no follow-through this morning.

As to the other G10 currencies, the dollar is modestly firmer against most of them this morning in the wake of PMI data from around the world showing that the overall growth picture remains mixed, but more troubling, the trend appears to be continuing toward slower growth.

The emerging market picture is similar, with the dollar performing reasonably well this morning, although, here too, there are few outliers. The most notable is KRW, which has fallen 0.75% overnight despite strong trade data as inflation unexpectedly fell and views of an additional rate hike by the BOK dimmed. However, beyond that, modest dollar strength was the general rule.

At this point in the session, the focus will turn to some US data including; ADP Employment (exp 185K), ISM Manufacturing (59.5) and its Prices Paid indicator (75.8), before the 2:00pm release of the FOMC statement as the Fed concludes its two day meeting. As there is no press conference, and the Fed has not made any changes to policy without a press conference following the meeting in years, I think it is safe to say there is a vanishingly small probability that anything new will come from the meeting. The statement will be heavily parsed, but given that we heard from Chairman Powell just two weeks ago, and the biggest data point, Q2 GDP, was released right on expectations, it seems unlikely that they will make any substantive changes.

It feels far more likely that this meeting will have been focused on technical questions about how future Fed policies will be enacted. Consider that QE has completely warped the old framework, where the Fed would actually adjust reserves in order to drive interest rates. Now, however, given the trillions of dollars of excess reserves, they can no longer use that strategy. The question that has been raised is will they try to go back to the old way, or is the new, much larger balance sheet going to remain with us forever. For hard money advocates, I fear the answer will not be to their liking, as it appears increasingly likely that QE is with us to stay. Of course, since this is a global phenomenon, I expect the impact on the relative value of any one currency is likely to be muted. After all, if everybody has changed the way they manage their economy in the same manner, then relative values are unlikely to change.

Flash, ADP Employment prints at a better than expected 219K, but the initial dollar impact is limited. Friday’s NFP report is of far more interest, but for today, all eyes will wait for the Fed. I expect very limited movement in the dollar ahead of then, and afterwards to be truthful.

Good luck
Adf

 

Is That Despair?

Posted on by

Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
adf

Still At Its Peak

Posted on by

Three central bank meetings this week
Seem unlikely, havoc to wreak
When they all adjourn
Attention will turn
To joblessness, still at its peak

In the current central bank calendric cycle, the ECB meeting was the first to be completed, and last Thursday we learned virtually nothing new about Mario Draghi’s plans. The ECB is going to reduce QE further starting in October and is due to end it completely by year end. As to interest rates, ‘through summer’ remains the watchword, with markets forecasting a 10bp rate rise in either September or October of next year.

This week brings us the other three big central bank meetings, starting with the BOJ’s announcement tomorrow evening, then the FOMC on Wednesday and finally the BOE on Thursday. Going in reverse order, the market remains convinced that Governor Carney will raise rates 25bps, with a more than 80% probability priced in by futures traders. While I think it is a mistake, it does seem increasingly likely it will be the outcome. As to the Fed, there are no expectations of any policy adjustments at this meeting, and as there is no press conference following, I expect that the statement, when released Wednesday afternoon, will have little market impact.

This takes us to tomorrow evening’s BOJ meeting, which is the only one where there seems to be any real uncertainty. Last week I discussed the questions at hand which boil down to whether or not Kuroda and company have come to believe that QQE is not only ineffective, but actually beginning to have a detrimental impact on the Japanese economy. After all, they have been at it for the better part of five years and have still had zero success in achieving their 2.0% inflation goal. The three biggest problems are that Japanese banks have seen their business models decimated by increasingly narrow lending spreads; the ETF purchase program has had an increasingly large distortive impact on the Japanese stock markets as the BOJ now owns roughly 4% of all Japanese equities; and finally, the yield curve control plan has essentially broken the JGB market as evidenced by the fact that they continue to see sessions where there are actually no trades in the 10-year JGB. (Consider what would happen if there were no trades in 10-year Treasuries one day!)

With all of this as baggage, there has been increasing discussion that the BOJ may seek to tweak the program to try to make it more effective. However, they have painted themselves into a corner because if they reduce their activity in the JGB market, the market is likely to see it as a reduced commitment to QE and it is likely to result in higher yields there, which can easily lead to two separate but related outcomes. First, USDJPY is likely to fall further, as higher JGB yields lead to more interest for Japanese investors to bring their funds home. Given the disinflationary impact of a stronger currency, this would be a disaster. And second, if there is less support for JGB’s, given the fungibility of money and the open capital markets that exist, we are likely to see yields rise in US, UK, European and other developed markets. While Chairman Powell may welcome this as it will reduce concern over the Fed inverting the yield curve, the rest of the world, which retains far easier monetary policy, is likely to be somewhat less welcoming of that outcome. And this is all based on anonymous reports that the BOJ is going to make some technical adjustments to their program, not change the nature of what they are doing. So if you are looking for some fireworks this week, the BOJ is your best bet.

However, beyond the central banks, the market will turn its attention to Friday’s employment report here in the US. Last Friday saw a robust GDP report, as widely expected, and further proof of the divergence between the US and the rest of the global economy. This Friday could simply add to that impression. Here is the full listing of this week’s data, which is quite robust:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Case-Shiller Home Prices 6.4%
  Chicago PMI 62.0
Wednesday ADP Employment 185K
  ISM Manufacturing 59.5
  ISM Prices Paid 75.8
  FOMC Rate Decision 2.00% (unchanged)
Thursday BOE Rate Decision 0.75% (+0.25%)
  Initial Claims 221K
  Factory Orders 0.7%
Friday Nonfarm Payrolls 190K
  Private Payrolls 185K
  Manufacturing Payrolls 22K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (2.7% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$46.2B
  ISM Non-Manufacturing 58.7

So, as you can see there is much to be learned this week. With the focus on the central banks and Friday’s payroll data, don’t lose sight of tomorrow’s PCE report, because remember, that is the Fed’s go-to number on inflation. Overall, looking at forecasts, things remain remarkably strong in the US economy this long into an expansion, which is something that has many folks concerned. We also continue to see important corporate earnings releases this week for Q2, which given the high profile misses we had last week, could well impact markets beyond individual equity names.

As to the dollar through all this, it is a touch softer this morning, but remains on the strong side of its recent trading range. While I still like it higher, there is so much potential new information coming this week, it is probably wisest to remain as neutral as possible for now. For hedgers, that means the 50% rule is in effect.

Good luck
Adf