December Rate Hike Probabilities:

USD   80.2% – (Still in the cards)

EUR     3.9% + (Think December 2019)

GBP   85.6% + (Done deal, probably in November)

CAD   46.1% + (NAFTA uncertainty impact)

Fed Rhetoric               25bps

The UK continues to suffer

As May seeks an interim buffer

‘Gainst Brexit’s effects

While Europe rejects

Her pleas thus its sure to get rougher

The dollar is mixed this morning, gaining against a handful of currencies while falling against a similar amount. In fact, I would say that the dollar is the least interesting currency today with markets focused on other individual currency stories. For example, the largest movement has been seen in NZD, which has fallen by 1.65% after a government coalition was finally formed. The reaction was due to the fact that the Labour Party was the one that led the coalition, despite winning only ~37% of the vote, as they brokered a deal with the New Zealand First party, an upstart nationalist leaning group that entered Parliament there for the first time. The party platform included planks on reforming the central bank and addressing social issues, neither of which have been seen by the market as a harbinger of future economic or monetary strength. So a far less certain future has resulted in a sharp decline in the Kiwi. While New Zealand is generally too small to have any substantive global impact, this reaction does highlight the ongoing market belief set that a strong economy and independent central bank are two keys for currency stability.

The other notable loser in the G10 space was the pound, falling 0.35%, after it released much weaker than expected Retail Sales figures (-0.8%, exp -0.1%). So some of the first hard data that will be part of Q3’s GDP reading is extremely disappointing. It is interesting to me that while the pound suffered (and has more to come) the market probability of a rate hike next month actually rose slightly. If anything I believe this signals the market sees the BOE move as a ‘one and done’ concept and not the beginnings of a policy tightening program. In fact, I would estimate that the BOE, if they move in November, will not adjust policy for at least another two years following. And if they do, it will be to ease it again as the UK exits the EU rather than to take another tightening step. All of this continues to play to my view that the pound has much further to decline.

On the other side of the ledger, both the Swiss franc and Japanese yen are the best performers in the G10, rising 0.6% and 0.4% respectively. As both of these currencies are seen as haven assets, and given that US equity futures are actually quite a bit lower this morning alongside equities throughout Europe and Asia, we may well be looking at a bit of a risk-off reaction. There has been precious little other news to drive these two currencies, and it is certainly reasonable to expect at least some correction in the equity markets. I’m not saying this is the beginning of a major move, simply that as investors shed some of their risk, these currencies are prone to benefit. Otherwise, the G10 space has been rather dull with the ongoing Spanish drama having little impact on the euro and no substantive news from the US.

In the EMG world, we have also seen a mixed picture although if forced to choose I would say there are probably a few more gainers than losers. What makes this confusing is that in a risk off scenario, I would have expected things to be the other way round. It is this conundrum that prevents me from calling, at this time, that the market is ready to moderate its risk appetite, even temporarily. Of course, if equity market declines continue or accelerate that would certainly change my view.

Arguably the most noteworthy thing happening in this space is the Chinese Communist Party Conference, where President Xi has outlined his plans to stay in office until he dies and all the while strengthen state control over the economy. Interestingly, PBOC governor Zhou claimed that they are going to continue to focus on making the renminbi a more freely convertible currency, but there is no plan to either widen the trading band or reduce intervention. It seems to me that, like the Cheshire Cat, words mean exactly what Zhou wants them to mean, regardless of a more conventional definition elsewhere. At any rate, CNY has given up all of its gains since the week-long national holiday at the beginning of October, and seems simply to be continuing its slow decline vs. the dollar that began back in early September. Ultimately, I believe that a weaker CNY is in our future, but I don’t expect anything to happen quickly.

Yesterday’s US housing data was not very inspiring with both Housing Starts and Building Permits falling well short of expectations. As I wrote yesterday, it certainly appears to me that this part of the economy has plateaued and may be rolling over. This morning we see Initial Claims (exp 240K), Philly Fed (22.0), and Leading Indicators (+0.1%). Given the robust reading from the Empire Manufacturing data earlier this week, I wouldn’t be surprised to see Philly surprise on the high side. Yesterday afternoon’s Beige Book told us that the economy continues to grow at a moderate pace, and that the Hurricane trio of August/September is unlikely to have very long lasting effects. Despite the Housing plateau, I believe the Fed remains on track to raise rates in December and that my underlying thesis remains intact. This points to the dollar ultimately gaining further ground going forward.

Good luck

Adf

December Rate Hike Probabilities:

USD   83.6% + (Still in the cards)

EUR     3.1% + (Think December 2019)

GBP   84.9% – (Done deal, probably in November)

CAD   44.2% – (NAFTA uncertainty impact)

Fed Rhetoric               25bps

As government’s try to conclude

The series of talks they’ve pursued

Enhancing relations

On trade betwixt nations

They’re finding they lack fortitude

Thus most trade agreements in place

Have lately been labeled disgrace

While market reactions

Have caused more distractions

And made outcomes hard to embrace

It couldn’t have been ten minutes after I finished writing yesterday about how the pound was outperforming its peers on the back of the high inflation readings in the UK that BOE Governor Mark Carney disappointed markets in his testimony to Parliament by saying policy adjustments would likely be made in the coming months rather than pinpointing November. This was seen as far less hawkish than anticipated and the pound suffered immediately, falling 50 pips in minutes and ultimately nearly a big figure. It simply goes to show that there are myriad potential catalysts for movement and many come out of the blue. This morning’s UK Labor market data was largely in line with expectations as the Unemployment Rate remained at cycle lows of 4.3% while wages grew slightly faster than expected at 2.1%. The problem is that Inflation is still running near 3.0%, so real wages continue to shrink. Adding to this is the ongoing impasse in Brexit negotiations, where the EU’s chief negotiator, Michel Barnier, claimed that no progress would be made at this week’s summit thus making December the earliest point for a substantive breakthrough. As I type, the pound is little changed on the day, although it did trade lower by as much as 50 pips earlier this morning. And as I have consistently written, the pound is going to suffer further during the Brexit process and I continue to look for it to fall well below 1.30 and test even the 1.20 level over time. Receivables hedgers need to take note.

But Brexit is not the only trade pact in the news these days, NAFTA is still front and center as well. The renegotiation of that pact is going through its own ups and downs, which has been evidenced by the peso’s underperformance during the past month, having fallen 5.5%. And that decline has been flattered by yesterday’s 1.4% rally on the news that despite tough going, the original December deadline that had been mooted by the US has been extended into next year. NAFTA is also having a direct impact on the Canadian dollar, which has seen its own gyrations based on headlines on the subject. There is a secondary impact as well, on the BOC’s reaction function. Recent comments from BOC Governor Poloz have cast doubt on how rapidly he will tighten policy because of the uncertainty of any potential outcome in those trade talks. Thus, as the rate probabilities at the top of the note point out, what had seemed a sure thing for one more rate hike this year has now fallen to less than a 50/50 chance. Let me say that if the BOC is going to react to NAFTA, I am not going to try to opine on the likelihood of any action there. However, given the fact that the Fed still seems slated to raise rates in December, I believe USDCAD probably has some short term upside potential.

Away from these specific stories, the dollar continues to perform relatively well, rising against all its G10 counterparts and most EMG counterparts today, as the Fed has shown no signs of backing off their December move. Adding to that is the belief that President Trump may appoint a more hawkish Fed Chair, with three of the five on the short list (Warsh, Taylor and Powell) seen as hawks. The other two are arguably just one, reappointing Chair Yellen, as I believe that Gary Cohen has virtually no chance. So if I am correct about Cohen, and you consider that Yellen is the one currently advocating further rate hikes, despite her history of dovishness, it seems to me that US policy is going to continue to tighten, narrative be damned. And that is going to support the dollar against all comers going forward. We will need to see other central banks start to become far more hawkish to change that dynamic, and I continue to believe we are just not close to that situation. No matter what the narrative says about the ECB on the cusp of tightening, the reduction in QE is likely more a technical problem than a statement of intent (they are running out of bonds to buy) and they are not going to actually raise rates for at least another 18 months, if not longer. Look for the dollar to continue to gain.

This morning brings Housing Starts (exp 1175K) and Building Permits (1245K), with both those expectations modestly lower than last month’s outcomes. After a long slow rebound in housing, it seems that this sector may be leveling off. We also get the Beige Book this afternoon, which ought to provide some insights into the ongoing economic situation. Of late, it has pointed to continued moderate growth with only small signs of wage price pressures. We shall see.

As I wrote earlier this week, my sense is the dollar is gathering itself for the next leg higher as the Fed remains resolute while other central banks falter.

Good luck

Adf

December Rate Hike Probabilities:

USD   80.2% + (Still in the cards)

EUR     2.0% – (Think December 2019)

GBP   86.6% + (Done deal, probably in November)

CAD   45.8% – (Actually falling pretty sharply)

Fed Rhetoric               25bps

Inflation in England’s attained

A level that must be restrained

Another tick higher

And feet to the fire

For Carney, by law its ordained

It’s always difficult to figure out exactly what drives the dollar (or any market) during a particular session. Ultimately, I always revert to the economic fundamentals, as they ought to exhibit the most influence over time. But in any given session, there are any number of things that can do the job. The dollar is generally stronger this morning as pundits point to a meeting President Trump had with Stanford economist John Taylor regarding chairmanship of the Fed. Ostensibly, Trump was quite impressed. Taylor is best known for his eponymous Taylor Rule, which derives the proper rate for Fed Funds based on specific economic and financial criteria. And that rule, right now, signals that Fed Funds should be near 3.75%, not 1.25%. So the idea that the next Fed chair will be more hawkish gained a great deal of credence overnight and the dollar benefitted directly.

One minor exception, however, is the pound, which had rallied a bit after September’s CPI data printed at 3.0% as expected (It has actually started to give back some of this gain but continues to outperform other G10 currencies). UK legislation requires the BOE Governor to write an open letter of explanation if the headline inflation rate moves more than 1% in either direction from the statutory target of 2.0%. So despite the fact that market participants were anticipating this outcome, the reality was still enough to move the market. Essentially, this has made it clear that the UK will be raising rates at their November meeting, removing the emergency 25bp rate cut they implemented immediately in the wake of the Brexit vote in June of last year. What makes this surprising is that given the otherwise desultory UK data, it seems hard to believe that they would go down this path, but it does seem to be highly probable at this time. What is truly interesting, though, is the fact that the market isn’t looking for another move by the BOE for more than a year after this. The point is that a hike in three weeks’ time is not the beginning of a tightening cycle as much as it is a knee-jerk response to recent inflation readings. And of course, the weak pound has dramatically impacted those inflation readings, which despite its recent performance is still lower by 10% since the Brexit referendum.

Speaking of Brexit, I have not seen any news that indicates the current stalemate between sides has changed and so the odds of ‘no deal’ seem to be climbing every day. As I read about the ongoing talks, it almost seems to me that neither side really wants a deal. The EU is terrified that if they give anything away in a deal, other members are going to raise their hands for the same benefits. At the same time, the UK has made it clear that while a financial settlement is possible, they are not going to pay a lot of money without getting something in return. I have suspected for a while that a transitional deal would be highly problematic, and nothing I have heard or read lately has changed that view. We will know for sure when the UK Treasury starts allocating funds for contingency issues in the event of a ‘no deal’ outcome. I think that will be a very negative signal for the pound as the rest of the market will come around to the idea that the UK is about to exit the EU with no contingency plans. I maintain that receivables hedgers need to be taking advantage of this short-term rally.

Away from the UK, the euro has been one of the worst performers overnight as the ongoing Spain/Catalonia saga continues to sap good will from the currency. Spain reduced its own growth outlook for 2018 (2.3% down from 2.6%) due to the repercussions from the secessionist impulse in Catalonia. Since Spain has been an important bright spot for the Eurozone, especially from the southern portion, as long as this crisis remains unresolved I expect further pressure on the euro. At the same time, this morning’s data reconfirmed that inflation is nowhere near the ECB’s target of ‘just below 2.0%’ with core CPI printing at 1.1%. We even saw some softness in the German ZEW figures (17.6 vs. exp 20.0). None of this bodes well for the narrative of an early end to QE or tighter policy and it has resulted in a 0.4% decline in the euro this morning.

In the Emerging markets, we have seen some more significant movement this morning, led by ZAR (-0.65%), whose political machinations rarely seem to be a positive for either the economy or the currency. Today’s story has revolved around Cabinet changes made by President Zuma there as he tries to consolidate whatever power he has remaining. We have also seen a sharp decline in KRW (-0.4%) after North Korea rejected diplomatic talks and said a nuclear war “…may break out any moment.” Finally, CNY has fallen by 0.45% overnight as the Communist Party congress opens in Beijing. Surveying the situation there over the past months shows that President Xi, far from being embracing markets to help the economy, has decided that centralized control is the best way forward. It is an open question, in my mind, whether they will be able to control both the currency and economy in the manner they like, and when push comes to shove, I expect them to let the currency correct, not the economy. So while I am pretty bearish the renminbi in the long term, for now I suspect it will not be allowed to move very far. In fact, last night’s decline is quite surprising to me.

This morning’s data brings IP (exp 0.3%) and Capacity Utilization (76.2%). These generally don’t move the market. Yesterday morning we saw a much stronger than expected Empire Manufacturing print (30.2 vs. exp 20.4) indicating that US industrial growth remains on track. My sense is it is time for the dollar’s uptrend from early September to begin to reassert itself as the combination of ongoing strong data, a potentially hawkish new Fed chair and problems elsewhere in the world all point to strength. Hedgers beware!

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% = (Still in the cards)

EUR     3.1% = (Think December 2019)

GBP   84.8% + (Done deal, probably in November)

CAD   49.7% – (Actually falling pretty sharply)

Fed Rhetoric               25bps

This weekend we heard from a bunch

Of policymakers whose hunch

Is prices will rise

As each of them tries

To stop short the next global crunch

Last week saw the dollar retreat overall as the bullish case was negatively impacted by continued disappointment in the actual inflation data despite the ongoing Fed rhetoric that another rate hike is coming by Christmas. Of course, there were other stories to help the cause including stronger commodity prices underpinning that bloc and comments from several European officials that an interim deal with the UK might be possible. This morning, however, the dollar has regained its footing and has edged higher on balance.

It seems that the mood from the G30 conference in Washington this weekend was somewhat schizophrenic. While the US contingent remained upbeat about economic prospects in the near term, looking at improving growth and the strong employment picture as leading to their desired, if elusive, rise in inflation, both European and Japanese leaders were far less positive in their outlook.

Kuroda-san made clear that the BOJ was not even contemplating the ending of QQE in Japan, nor the targeting of 10-year JGB yields at 0.0%. With inflation in Japan running at 0.7%, well short of the 2.0% goal, Kuroda said, “The Bank of Japan will consistently pursue aggressive monetary easing with a view to achieving the price-stability target at the earliest possible time.  Achieving the 2% target is still a long way off.” 

Meanwhile, Draghi and friends were at pains to point out that inflation in Europe also remains far from its goals but that their current policy settings were doing the job. “Therefore, we’ve got to be persistent with our monetary policy,” Draghi said. “We also have to be prudent” and will maintain “an extraordinary degree of monetary accommodation.” I don’t know about you, but that certainly sounds to me like any changes that are coming will be minimal, at best.

Of course, the ECB hawks couldn’t let Draghi have the last word and commented on the fact that based on the ECB’s current, self-imposed restrictions, they can only purchase another €200 billion or so to add to the €2.3 trillion already purchased. The implication here being that QE doesn’t have much more time in it after all. However, despite this unwelcome hawkish tilt from Jens Weidmann, President of the Bundesbank, the market appears to be more in step this morning with Draghi and the doves, hence the euro’s 0.25% decline.

If I were to sum up the G30, then, I would say that financial officials are not adhering to the prevailing FX market narrative. The G30 sees stronger growth leading to higher inflation and higher rates in the US while the rest of the world continues to see inflation as elusive and will continue to pursue extraordinary monetary policy ease. That is not a prescription for the dollar to fall!

Away from the G3, the biggest surprise to me is the consistent decline in the market perception of Canada’s rate hike prospects. Just a month ago, the market was pricing in a 75% probability that the BOC would raise rates by December. That has fallen to less than 50% today. What’s interesting is that during that time, Canadian data has maintained a solid performance, with growth and employment doing well, and inflation edging ever higher. During that period the Loonie has also weakened nearly 4%, although in fairness, it has done little over the past two weeks. What I would say is that if we continue to see that probability slide lower, USDCAD has room to move higher. It seems that, for now, CAD has disconnected from commodity prices.

In the EMG bloc, the most noteworthy action has been the decline of the Mexican peso, falling 0.75% on renewed concerns that the ongoing NAFTA negotiations are starting to turn negative for the country. This has the added impact of helping the electoral prospects of AMLO, the hard-left Presidential candidate, and that combination will not be a positive for the Mexican economy. With the peso through 19.00 this morning, for the first time in 5 months, I fear there is further room for decline there. Otherwise, this broad bloc of currencies has shown unimpressive activity overnight and has maintained the bulk of last week’s gains vs. the dollar.

On the data front this week, we see the following:

Today                           Empire Manufacturing                        20.5

Tuesday                       IP                                                              0.2%

Capacity Utilization                              76.2%

Wednesday                 Housing Starts                                        1175K

Building Permits                                    1240K

Fed Beige Book

Thursday                    Initial Claims                                            240K

Philly Fed                                                   22.0

Leading Indictors                                     0.1%

Friday                         Existing Home Sales                                5.30M

It strikes me that this list of data is not that likely to drive the FX markets although if everything leans in one direction we could certainly see a cumulative effect. We also hear from six more Fed speakers, including Chair Yellen on Friday evening, but given the timing of her speech, any impact there won’t be felt until Sunday in Asia.

Lately, however, the FX market seems to be all-in on the narrative of slowing Fed activity and imminent policy tightening elsewhere. Certainly equity markets continue to believe that story as there is no evidence the inflating bubble is of any concern to most investors. As such, it is hard to make a case that the dollar will rally in the short term, although if we see strong data across the board this week, it may be enough for a little benefit. That said, nothing has changed my view that the narrative is wrong here, and as it adjusts over time the dollar will strengthen. However, I am hard pressed to make a case that the dollar weakens much from these levels either.

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% = (Will CPI drive this higher?)

EUR     3.2% = (Think December 2019)

GBP   81.2% = (Done deal, probably in November)

CAD   59.1% = (Not as confident as before)

Fed Rhetoric               25bps

The word out of Brussels was that

The EU just might arrive at

An interim deal

With modest appeal

For each Eurozone bureaucrat

The pound, on that news jumped to highs

But then, in what’s no real surprise

The Germans said ‘nein!,

We have a timeline’

It’s money first, then compromise

As we walk in on this Friday the 13^th, FX markets are little changed on a broad basis. If pushed, I would say the dollar is a bit softer, but we continue to lack a strong short-term theme for now. The one place we have seen movement is in the British pound, where an article yesterday afternoon indicated that EU Brexit negotiator, Michel Barnier, may be willing to offer a two year transitional deal to help smooth the break-up. Not surprisingly, the pound rallied sharply on the news, jumping more than a penny in minutes. Alas, earlier this morning, after a bit more euphoria that had driven the pound back above 1.33, European Commission President Jean-Claude Juncker dismissed that idea out of hand, repeating his mantra of no trade discussions until they agree the money owed. The pound quickly gave back most of this morning’s gains and is now just slightly higher on the day. I guess the idea that the EU is now allegedly discussing a transition deal is seen as a positive for the pound, although it appears to me that it will be difficult to agree anything here. Remember too, that Germany, the most critical EU country, is not really focused on these issues for now as Chancellor Merkel is too busy trying to create her governing coalition after last month’s inconclusive elections. The point is I believe it would be a mistake to assume a more significant boost in the pound on the basis of the EU giving ground at this stage. And there has certainly been nothing out of the UK that indicates they are on track to make concrete proposals. All told, I remain a committed seller of pounds at these levels as the odds of a hard Brexit seem to grow every day.

Elsewhere, the annual IMF and World Bank meetings brought nothing but platitudes from the likes of Mme LaGarde, although the IMF did raise its global GDP forecast by 0.1% for 2018. However, despite a plethora of central bank speakers at the event, nobody really said anything noteworthy, and so markets have largely moved on.

The one constant this morning is that commodity currencies are modestly firmer on the back of stronger commodity prices in general. WTI is back above $51/bbl and both the base metals complex and agricultural prices are firmer. A key driver here seems to have been the Chinese Trade Data from overnight that showed a continued surge in import growth (+18.7%) and, surprisingly, a sharp narrowing in the Trade Surplus to $28.5B down from $41.9B last month. The skeptic in me would point out that the Party Conference is next week and, while I have no knowledge or proof of this, the idea that the Chinese government might manipulate this data for what they perceive is a beneficial political effect cannot be ruled out. After all, a shrinking Chinese Trade surplus will certainly play well in the White House, and growing imports would indicate that the Chinese transition away from its mercantilist past is proceeding apace. Interestingly, there was essentially no impact on the renminbi, although the firmer commodity prices have helped both AUD and NZD to rise by about 0.3%.

For volatility traders, the gift that keeps on giving is South Africa, where the rand has rallied a further 0.65% this morning (3.6% this week) after a court ruled that President Zuma would be able to face corruption charges after all. My take is that the market would like to see him deposed and someone less venal in his place. Or at least someone more market friendly. But away from the rand, the EMG bloc has been quite dull as well.

Yesterday’s PPI data was exactly on expectations, and the Initial Claims number actually fell further than anticipated. Given this week is the Survey week for the monthly NFP report, that bodes well for what we will see in early November. This morning we get CPI (exp 0.6%, 0.2% ex food & energy); Retail Sales (1.7%, 0.9% ex autos); Michigan Sentiment (85.3) and Business Inventories (0.7%). Clearly it will be the two 8:30 numbers that matter, and given the robust expectations, one would expect the chance to fall short is great. What does seem clear is that the market will respond in a logical manner to the outcome so strong data will result in higher interest rates and a stronger dollar and vice versa. While the Fed’s official focus is PCE, which isn’t released for another two weeks, a strong print in today’s CPI would not be ignored and I think we could easily see the market probability for the December rate hike pick up further alongside the dollar. Plus a strong reading this morning would give ammunition to Chair Yellen that the transitory factors are beginning to fade away. And that would strengthen her hand against the remaining doves on the board.

Net net, I still like the dollar story better than others and remain convinced that hedgers need to take advantage of current levels in the dollar for better long-term performance.

Good luck and good weekend

Adf

December Rate Hike Probabilities:

USD   76.7% = (The Minutes should help confirm)

EUR     3.6% − (Think December 2019)

GBP   81.0% − (Done deal, probably in November)

CAD   59.2% − (Not as confident as before)

Fed Rhetoric               25bps

Like any religious consistory

The FOMC looks at history

Though it can’t explain

Why prices remain

So stable, it’s truly a mystery!

In the wake of the FOMC minutes released yesterday afternoon, and ahead of Friday’s CPI release, the dollar has taken a breather overnight, showing very little net movement. While that broad stability masks some individual movement, the big picture remains of a dollar that appears to have halted its year-long slide, but is not ready yet to accelerate higher.

A quick look at the Minutes showed that the Fed’s models are still not doing a very good job in forecasting inflation. The hawks continue to discuss one-off idiosyncrasies, like the decline in cell-phone data charges as a possible hindrance to higher inflation. The doves are coming round to the idea that the inability of wages to rise is a result of the increasing global supply of labor.   In other words, they have no idea why prices are behaving as they are, and are throwing every idea they can against the wall to see which one sticks. The one thing that seems clear, however, is that they will not be deterred from raising rates again in December unless the interim data takes a significant turn for the worse. And given the uncertain impact of the hurricanes on that data, it seems that they will be able to look through any weakness as merely another transitory factor. However, having said all this, it appears that the market’s interpretation of the Minutes was far more dovish than mine, hence the dollar’s late afternoon sell-off.

It is fair, however, to ask if the three rate hikes for next year that the FOMC have, themselves, penciled in are going to see the light of day. I continue to believe that one of the key reasons they are so anxious to raise rates is to have room to cut them when the next downturn arrives, although they cannot actually admit that. My point is that we will need to see extremely weak data in order to derail that plan, and as of now, there is no indication that will be the case. One other thing to keep in mind is that we are fast approaching the announcement of the next Fed Chair, and I keep reading that Kevin Warsh is the front-runner. He is decidedly more hawkish than Ms. Yellen, and would almost certainly seek to push rates higher still. Of course, all of this matters to us in FX because of the current dollar narrative, which despite all evidence to the contrary, continues to assume that the Fed will be less hawkish than their rhetoric and the ECB and BOE more hawkish. Nothing in these Minutes has changed my view that the narrative is wrong and will change with the dollar benefitting over time.

The other story of note this morning is the ongoing angst in the UK over the progress, or lack thereof, in the Brexit negotiations. The latest round of talks, which are due to end this week, have produced nothing of note and it appears that both sides are waiting for the other to crack on something. If forced to handicap this outcome, I am leaning toward a hard Brexit with no transitional deal. Ultimately, the biggest sticking point is going to be money, and the EU is going to continue to insist that the UK owes an astronomical number, which I bet will grow to be €100 billion before the talks are done. At the same time, the UK is going to insist that without a transitional agreement, there will be no payment, and even with one, the number is in the €20 billion range. That’s a pretty big gulf to overcome, and based on the ongoing dysfunction within PM May’s government, I just don’t see a resolution. No matter the long-term potential benefit for the UK to regain its sovereignty, the near term is going to be messy, and the pound is going to suffer. Folks, above 1.30 the pound remains a screaming sale in my view. Ironically, as I was typing this, the pound just fell 50 pips on this BBG headline “*GBP/USD FALLS TO 1.3170; BARNIER SAYS DEADLOCK IN BREXIT TALKS”

Looking elsewhere, the yen continues to edge ever so slightly higher on the back of a series of polls showing that PM Abe is set to win a resounding victory in the upcoming Japanese elections with a chance to capture a two-thirds majority of the lower house, enough to make constitutional changes. The Nikkei has been performing well while the yen has arrested its month-long decline and found a new stability. In the commodity bloc, both AUD and NZD are firmer by about 0.5% this morning as a result of renewed Japanese investor buying of both currencies.

Meanwhile, in the EMG bloc, amid a session with an equal number of gainers and losers, no currency has moved more than 0.3%, and there are no stories of note to reflect.

This morning brings the first real hard data of the week, PPI (exp 0.4%, 0.2% ex food & energy) as well as Initial Claims (250K). The thing is the FX market doesn’t typically pay close attention to PPI, especially with CPI to be released tomorrow morning, and the Initial Claims data continues to be roiled by the aftermath of the hurricanes last month. As such, I don’t see either one having a substantive impact on the FX markets today. That leaves us with Central bank speakers as the most likely catalyst for movement today. It seems the bulk of them are in Washington for the annual IMF and World Bank meetings with Powell and Brainard from the Fed on the schedule as well as Draghi, and we will also hear from Germany’s outgoing FinMin, Wolfgang Schaeuble. While I don’t anticipate too much new news, one can never be sure in these circumstances.

Net, I don’t anticipate much movement overall today, but if I had to guess, the dollar’s corrective fall is likely close to an end.

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% = (The Minutes should help confirm)

EUR     4.1% + (Think December 2019)

GBP   81.2% − (Done deal, probably in November)

CAD   62.0% − (Not as confident as before)

Fed Rhetoric               25bps

Though FX has been so quiescent

Most stock markets are effervescent

Investors are thrilled

While skeptics get grilled

To me, markets seem quite tumescent

Once again, ennui is the best descriptor of the FX markets this morning. The overnight price action has been de minimus in the G10 space, with a mixed performance and no currency moving more than 20bps. Yesterday did see the dollar give back a bit more of its recent gains, but the reality is that recent price movement is completely ordinary in terms of the normal ebb and flow of trading. What seem to be, on the surface, major risks to stability have been either accepted or ignored by traders. So the potential split in Spain has been ignored. Possible war with North Korea has been downgraded as an afterthought, and the dominant narrative continues to be the central banks are in control of things. And it is this narrative that continues to drive global equity markets higher as it has become quite clear that the central bank reaction function is now highly dependent on financial market outcomes. In other words, if stock markets start to fall, central banks will immediately stop reducing policy accommodation and in all likelihood start to add to QE. But for now, the everything bubble continues to inflate.

There was an interesting Bloomberg story this morning regarding central bank communication policies, where two economists at the SNB showed that overcommunication (something with which we are all very familiar in the case of the Fed and ECB) is actually detrimental to policy as it reduces clarity. Rather, they propose that ‘less is more’ with regards to central bank communications policy, as the central banks that speak less are more effective at both achieving policy aims and keeping investors and businesses informed. Personally, I am not surprised by this at all, and would be a strong advocate of hearing less from the central bank community on the whole. I think markets would be far less likely to move to extremes as independent opinions would not be coerced into a particular view. In other words, if there was doubt as to the next move in interest rate policy, every bond trader and investor might not be positioned the same way! Alas, if there is one thing we have learned in the wake of the financial crisis in 2008-09, it is that central bankers are particularly enamored of their own voices! So I doubt either Janet or Mario are likely to take this suggestion to heart.

Away from the G10, we have had a few outliers with TRY far and away the leading gainer, higher by more than 1.3%, and ZAR and MXN also having solid performances. On the down side, CNY has given back a slug of its post vacation gains, falling 0.3% overnight. The Turkey story is quite straightforward as US Ambassador to Turkey, John Bass, indicated that talks were ongoing to address the visa spat that started the lira’s downfall. If that were resolved, I would expect TRY to regain the last 2% it ceded during the short-term crisis. In South Africa, the story seems to be a combination of the solid IP data released yesterday morning and a potential calming effect on the political landscape as one of the favored candidates to replace President Zuma, Zweli Mkhize, is claiming the ability to be a unity candidate for the ANC. Certainly the investor community would welcome any reduction in political infighting in South Africa and that is likely to help the currency further.

Finally, south of the border, while the peso has gained some 0.5% overnight, that must be seen in context, as the peso has fallen more than 6% during the past three weeks. The proximate causes here are twofold: first the ongoing NAFTA talks have not been seen as a particular benefit for Mexico; but more importantly, AMLO continues to perform well in the polls and the market is starting to price in the probability that he becomes the next president of Mexico. He is a left-wing populist firebrand who is seen as likely to unwind recent policy changes on both international (read American) access to Mexico’s energy industry and changes in the labor laws that have added freedom to company actions. Neither of these is seen as a positive for Mexico, and if his candidacy continues to gain traction, it is quite easy to believe that USDMXN will head back above 20.00 and beyond.

This morning brings the JOLTS Jobs report (exp 6.125M) at 10:00 and then we see the FOMC Minutes at 2:00pm. Many are looking for the Minutes to be quite informative on FOMC policy for the rest of this year but I disagree. It seems to me that not only were they quite explicit at the September meeting that they would begin allowing the balance sheet to shrink slowly starting this month and raise rates again in December, but that has been the consistent message from every speaker since then. In fact, I think far more attention should be paid to Friday’s CPI data as that will help drive the narrative more ably. Expectations there are for a pretty big jump of 0.6% in the headline number, which translates into 2.3% Y/Y, certainly firm enough to continue with the current rate hike plans.

Until then, look for modest back and forth trading in the G10 currencies as we await the next key piece of information. I still like the dollar over time and continue to believe receivables hedgers need to take advantage of current levels.

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% − (Getting ever clearer)

EUR     2.4% − (Think December 2019)

GBP   82.5% +  (Done deal, probably in November)

CAD   62.5% − (Not as confident as before)

Fed Rhetoric               25bps

Though Spain’s on the cusp of a split

And French growth continues like sh*t

The buck’s in arrears

Vs. all of its peers

As dollar bulls just won’t commit

The dollar is on its heels this morning as recent gains are pared back somewhat through the normal ebb and flow of FX trading. This morning’s data releases showed a mixed picture with Italian IP outperforming expectations (+5.6% vs exp +2.5%), while the same French data disappointed (-0.3% vs exp +0.4%). In what cannot be a great surprise, the German trade data remains robust (€20B vs exp €19.5B) though the same data from the UK showed a much larger deficit than forecast (-£14.245B vs exp -£11.15B). And lurking behind the data is the Spanish situation, where Catalan leader, Carles Puigdemont, is set to speak to his Parliament today and there is a very real prospect that he will declare independence for the province. That would almost certainly cause a severe reaction in Madrid and potentially force Spanish PM Rajoy into more drastic action. Remember the outcry two weeks ago when the secession vote was held and the National police force was attacking voters. My point is not that I agree or disagree with either side of this conflict, just that there remain a number of areas within the Eurozone that are not happy with the current state of affairs. And that, it seems to me, ought to weigh heavier on the currency. For the most part, the FX markets will be driven by monetary and fiscal policies, but it is hard to ignore the constant rebukes to the European experiment. Consider that despite the political animosity that reigns in the US, there is no serious discussion of secession by any area. All I’m saying is that it will be difficult to get excited about the euro as an investor if the members aren’t excited about it themselves.

But that is a much longer-term concept. This morning I would argue we are simply seeing the regular gyrations that are part of FX. While the dollar is weaker across the board today, it was just two days ago that it was stronger across the board. And in the big scheme of things, we really haven’t moved very far over the past week. Rather, the dollar has maintained the bulk of what it gained during the past month when views started to shift regarding the FOMC’s likely future path. One other thing that is getting press this morning is the ongoing political feud between President Trump and Senator Corker of Tennessee. The idea is that if this keeps up, there will be less probability that tax reform will come to fruition and that the US economy will miss out on a potential benefit. While I continue to read that this is an important part of the mix, I find it hard to believe that traders are basing their dollar views on the extremely uncertain outcome of a tax policy debate. So while it may, at the margins, be weakening the dollar slightly, I would contend it has had minimal impact.

So the entire G10 bloc of currencies is stronger this morning, but the biggest mover, SEK has been less than 0.5% with no particular story driving it. This is far more likely the result of some order flow than a change in fundamental thinking. In the EMG space, though, we have had some more impressive movement, notably by CNY, KRW and ZAR. Starting with CNY, today is the first day since September 29 that the markets there were opened and the renminbi’s 0.9% rally is actually quite impressive. In fact, during that period, the dollar has generally performed quite well, so if CNY were catching up, I would have expected it to weaken, not strengthen. Rather, I believe that this movement is in anticipation of the upcoming Party Conference next week with expectations that there is the opportunity for policies that aim to allow market forces to have a bigger impact on the currency going forward. The PBOC head, Zhou Xiaochuan, has continued to discuss the need for liberalization of the currency, and given the economy there continues to outperform expectations, and the government has cracked down on international investment, it seems natural that CNY would strengthen. Of course, this is all subject to reverse in the event that the potential banking crisis expands or if there is some other hiccup in the current designs of President Xi.

As to KRW, the movement seems to be a response to the equity market’s strong rally overnight with investment continuing to flow into the country. However, despite the impressive gains overnight, it is important to remember than the won has traded within a 4% range for the past six months and currently sits right in the middle of that range. It seems that the improving economic situation is simply being offset by tensions from the North, thus keeping the currency in check. Finally, the ZAR story is easy, with its Manufacturing Production data printing at a much better than expected +1.5% (exp -0.1%) thus encouraging those investors who continue to seek yield that the currency won’t collapse.

As to US data today, the NFIB Small Biz index fell to 103.0, it’s worst showing in a year, as the hurricanes seemed to have sapped some of the recent giddiness in this sector of the economy. We also hear from the ultra-dovish Neel Kashkari this morning at 10:00, and he will almost certainly tell us that there is no reason for the Fed to act until inflation is much higher. But the market knows what he will say and thus would only react to anything sounding hawkish. A quick look at the market probabilities for rate hikes shows that they have edged lower overnight in general, but remain on course for the US, the UK and Canada to all raise rates again this year. As I have maintained for a long time, the narrative is falling behind the times with its insistence that the Fed is going to do less than they say and the ECB more. For now, I will go with the rhetoric. Receivables hedgers, sell rallies in euros and pounds, it is still the best long run bet.

Good luck

Adf

December Rate Hike Probabilities:

USD   80.2% + (Getting ever clearer)

EUR     2.5% − (Think December 2019)

GBP   81.7% +  (Done deal, probably in November)

CAD   64.0% − (Not as confident as before)

A nation that sits in between

Both Asia and Europe has seen

It’s currency tumble

As diplomats grumble

‘Bout visas that once were routine

Ordinarily, the Turkish lira is not a highlight of the FX markets, as the nation’s economy is neither too large (19^th largest globally) nor international, thus trade flows remain muted overall. But I would be remiss if I did not lead with the TRY this morning as it has fallen more than 2% (and was previously lower by as much as 6.6%) after a spat between the US and Turkey intensified today. The issue revolves around the arrest of a Turkish employee at the US consulate in Istanbul, and the rights of consulate employees. So while there is no direct financial impact, the market is clearly concerned that if tensions continue to escalate, there could be economic issues down the road. Is this a harbinger for other EMG currencies to see pressure? While anything is possible, it doesn’t seem to be the case as this is very specific to Turkey and the US. However, contagion is a funny thing and one cannot completely rule out a wider impact, however unlikely.

But on this Columbus Day holiday in the US, away from TRY, there is very little going on in the FX markets. The pound has been the biggest mover in the G10 (in fact the only currency to have moved more than a few pips) as it has rallied 0.65%. This rally, breaking a multi-day slide, is on the back of revised Unit Labor Cost data (+2.4% in Q2 up from +1.6% previously reported), which has helped the cause of the BOE hawks. As can be seen above, the probability of a rate hike in the UK continues to grow, and while I have been using December in deference to the Fed, the BOE is likely to go at its November meeting when it publishes new inflation forecasts as well. However, while I understand the positive sentiment today, the reality continues to be that the pound has far more reasons to fall than rise. The politics of Brexit continue to rage in the UK and there continues to be limited progress with negotiations. And no matter the long-term outcome, a hard Brexit, which seems now to be the most likely scenario, will be a decided short term negative for the pound. Rallies are to be sold in the pound.

But with little else on the docket today, we can review Friday’s Payroll data. The headline payroll numbers were shockingly worse than expected (-33K, exp +80K) with similar misses for Private and Manufacturing data. But the Unemployment Rate tumbled to 4.2% and Average Hourly Earnings jumped to 0.5% (2.9% Y/Y) amid growth in the Participation rate. Given the uncertainty surrounding the impact of the two major hurricanes that made landfall in September, it is not surprising that economic models did not forecast the data well. However, the balance of good and bad data was enough to inspire investors, and more importantly, should certainly be enough to keep the FOMC on target for its rate hike in December. Even the Fed Funds futures market, which has been extremely skeptical of the Fed to date, has priced in a greater than 80% probability of Fed action come December. Looking ahead, I continue to see the dollar improving as this market grudgingly accepts the Fed rhetoric and starts pricing in more rate hikes in 2018.

As to the week ahead, it is inflation week here in the US, with both PPI and CPI to be released, following Wednesday’s release of the Minutes of the September FOMC meeting.

Tuesday                        NFIB Small Biz Optimism                        105.0

Wednesday                   JOLTS Jobs Report                                    6160K

FOMC Minutes

Thursday                       Initial Claims                                            252K

PPI                                                               0.4%

-ex food & energy                                    0.2%

Friday                            CPI                                                               0.6%

-ex food & energy                                    0.2%

Michigan Sentiment                                95.0

Business Inventories                               0.6%

So between now and Friday, we will need to find other catalysts to drive markets (my sense is the Minutes will not teach us anything new). Fortunately, Fed speakers have the chance to fill the void. There are six speakers during the week (seemingly more doves than hawks) and with the annual IMF meetings in Washington DC, certainly, headline risk is a real possibility, although it would be shocking if anyone other than Kashkari disagrees with the plans to raise rates in December. Finally, Chair Yellen speaks next Sunday morning at a G30 event, so we will have something to look forward to next Monday morning as well.

All told, nothing has changed that I can see. The Fed is still on track to continue to tighten policy and while both the BOE and the BOC are moving in that direction, neither is likely to be as aggressive as the Fed. I believe it is a mistake to assume the ECB is going to get on board that quickly and the BOJ may never get on board. I still like the dollar overall.

Good luck

Adf

December Rate Hike Probabilities:

USD   73.3% + (The hawks are winning)

EUR     4.1% +   (Think December 2019)

GBP   79.6% −   (Done deal, probably in November)

CAD   64.9% + (Not as confident as before)

Fed rhetoric       25bps

Ahead of the Payrolls report

The dollar has gained more support

The pound keeps on sliding

While sellers are biding

Their time, any rallies to thwart

The dollar continued its strong performance overnight, especially against the pound, which is making a beeline for 1.30 and below. Yesterday’s US data continued to show that the US economy is performing well, with the Initial Claims report recovering from the hurricane situation more rapidly than expected, while both Factory and Durable Goods orders beat expectations. And despite this strength, the Trade deficit actually shrank a bit more than expected. So on all counts, the US data continues to perform extremely well and the market is becoming increasingly convinced that the Fed will raise rates come December. Of course, my thesis is that the dollar has further to climb because the market is discounting the idea that the Fed will continue their tightening into 2018 despite very clear intentions as signaled by the Fed’s own dot plot. So the US half of the equation continues to pressure those who are short dollars. Adding to that pressure is the technical picture, where the dollar index has breeched a key downward trend line and key Fibonacci resistance. (While I am not a fan of technical studies, there are enough people who are that result in some aspect of self-fulfillment in these situations. So if they think there are dollar-buying signals, they will buy dollars and help drive the market.)

How about the other side of the proverbial coin? Well, certainly, the fallout from UK PM May’s dismal performance at her party conference continues. The pound is trading at its lowest level in a month and appears to have plenty of momentum to continue falling. While housing price data did tick higher last month, there has been enough negative news on the economic front (remember softer PMI data) that combined with growing concerns over ineptitude in the Brexit negotiations, the pound is not the currency of choice to hold any more. I maintain it has much further to fall.

And the euro? Well, the data there continues to show ongoing moderate strength, albeit still somewhat unevenly distributed. Last night’s German Factory Orders data was quite robust at 3.6% in August, but at the same time Italian Retail Sales badly disappointed, falling -0.3% rather than growing, and that was after a downward revision to last month’s number. The point is that while Germany is still going gangbusters, much of the rest of Europe, especially the southern portion, is doing far less well. Add to that the ongoing Spanish crisis and you have the recipe for a weaker currency. So while the euro is little changed this morning, after I wrote yesterday, it declined a further 0.4%.

Away from the pound, which has fallen 1.20% during the past two sessions, the commodity bloc is the next worst performing group, with AUD (-1.15%) and CAD (-0.75%) both feeling the heat. The proximate cause Down Under was a weak Retail sales print yesterday, while north of the border, Canada’s Trade Deficit grew far more than expected. Given the underlying USD strength we have observed during the last two weeks, there need only be a small catalyst to have a large impact on a currency. All told, I see little reason for this bloc to outperform in the current environment.

Pivoting to the emerging markets, MXN has been a significant underperformer, falling 1.3% yesterday and maintaining those losses this morning. The combination of concerns over NAFTA negotiations degrading and a domestic boost for left wing presidential candidate Antonio Manuel Lopes Obrador (AMLO) has weighed heavily on the currency. His platform includes ending international investment in the energy sector, one of the biggest economic successes of the current administration. As to the overnight moves, TRY has been the big loser, down 0.9% as the market continues to react to an increased probability of Fed action in December. Beyond these two currencies though, while the dollar is generally higher, it is not decidedly so.

Which brings us to this morning’s data. Here are the current expectations:

Nonfarm Payrolls                                  80K

Private Payrolls                                     74K

Manufacturing Payrolls                       10K

Unemployment Rate                             4.4%

Average Hourly Earnings                    0.3% (2.5% Y/Y)

Average Weekly Hours                        34.4

Obviously, these numbers will have been impacted by the hurricanes, hence the very low bar. The funny thing is that I think if the data surprises to the upside, something like 100K, that the market will be quick to read that as a much better than expected number and we could see the dollar extend its recent gains. Meanwhile, the opposite is not true. A weak number will be attributed to the hurricane mess, and while there may be a very short term reaction lower in the dollar, I would expect it to rebound quickly.

I will repeat what I have been preaching for a while. The narrative is changing, albeit slowly. The Fed is going to be more hawkish than market pricing, and the ECB and BOE more dovish than market pricing. That combination is going to continue to benefit the greenback going forward. Hedgers, keep that in mind!

Good luck and good weekend

Adf