December Rate Hike Probabilities:

USD   69.9% + (The hawks are winning)

EUR     1.7% +   (Think December 2019)

GBP   81.1% +   (Done deal, probably in November)

CAD   63.2% = (Not as confident as before)

Fed rhetoric       25bps

The market is starting to wonder

If voting for May was a blunder

As confidence wanes

The erstwhile gains

Of Sterling have been torn asunder

This morning’s market focus seems to be on the pound Sterling, which has fallen another 0.5% and has now retraced all the gains it made in the wake of the BOE’s decidedly hawkish turn last month. The proximate cause seems to be a negative reaction to PM May’s closing speech to the Conservative Party conference, where she encountered a heckler, a serious coughing spell and some scenery failures. All told, the impression was one of a politician facing serious problems with no good answers at this time. But perhaps of even more concern to the market is the fact that Labour Party leader Jeremy Corbyn, who is essentially a Marxist, continues to gather support in the country and has a realistic chance of becoming the next prime minister. His platform includes renationalizing the utilities and transportation companies while raising taxes and bringing back rent control, all failed policies of the past, just for starters. Certainly, a Corbyn administration in the UK would be a decided negative for not just the pound, but also for UK equities and likely Gilts. It would further confuse the Brexit negotiations and, on the whole, be quite the disaster. It is telling that the pound has fallen 3.5% since it peaked two weeks ago, and that is without any additional hard news. While this morning’s New Car registration data was disappointing, (-9.3% in Sept), the pound is clearly suffering far more from the potential for bigger problems ahead. I continue to believe that receivables hedgers need to be active here, especially in GBP, as there is further weakness in our future.

As to the euro this morning, it is essentially unchanged as the market awaits the minutes of the ECB meeting last month. Signor Draghi gave away very little in terms of details at the press conference last time, and with the next meeting still three weeks away, traders are anxious to know just how the ECB is going to go about reducing QE. Personally, I believe there will be little new information from these Minutes, and that we won’t really know until the end of the month. Mostly, I believe that is because the ECB doesn’t yet know how it will play out exactly, and so will not have had anything to say in the September meeting, even amongst themselves. Nothing has changed my views here for a weaker single currency as the market slowly realizes that the Fed’s not kidding and that they market is way ahead of itself with regard to ECB tightening.

In the commodity bloc, Aussie is having a tough day, falling nearly 0.6% after Retail Sales data disappointed badly. Not only was the headline number down (-0.6%), but last month’s number was revised lower as well, to -0.2% from a previous reading of flat. While the trend is a little less pronounced here, the USD still seems to be ascendant and have further room to rise. CAD, meanwhile, is little changed this morning and continuing to consolidate its losses from last month. My sense here is that while the US dollar has further to run, CAD will be one of the better performers and hold its own for a while. We would need to see either a significant decline in energy prices or some particularly negative news on the NAFTA front to get the Loonie to fall sharply.

Most of the emerging market set has shown little movement, but you can always count on ZAR for volatility, with last night being no exception. The rand has fallen 0.5% this morning, helping to maintain its yo-yo approach to pricing. Ongoing political infighting and concerns over the loss of its investment grade rating next month have been weighing on the currency and are likely to continue to have outsized impacts until we hear from both Moody’s and S&P in November. If either one cuts their rating and joins Fitch below BBB-, as much as $14 billion of government bonds may need to be sold by emerging market bond funds. I assure you that would be a decided negative for the currency. However, away from the rand, the EMG bloc has been quite dull today.

On the data front, yesterday’s ADP number was right on the money while the ISM Non-Mfg. printed at 59.8, its highest level ever, helping to underpin the Fed hawks. This morning brings a bit more data including Initial Claims (exp 265K); Factory Orders (1.0%); and Durable Goods (1.7%). However, even though tomorrow’s NFP data will be corrupted by last month’s hurricanes, it still appears that the market has more interest in that than today’s data. In the end, the strong dollar thesis remains intact, and it will take a significant deceleration of US data or very definitive dovish commentary by numerous Fed speakers in order to change that view. Take advantage of short-term dollar declines to add to your hedges.

Good luck

Adf

December Rate Hike Probabilities:

USD   66.4%  (The hawks are winning)

EUR     0.3%   (Think December 2019)

GBP   80.6%   (Done deal, probably in November)

CAD   63.1%  (Not as confident as before)

Fed rhetoric       25bps

The data continues to show

That Europe continues to grow

However inflation

Keeps showing stagnation

So tight money’s not apropos

Foreign exchange seems to be an afterthought this morning with the dollar under modest pressure, but really just consolidating its recent gains. The ongoing releases of PMI data show that Europe continues to recover from its sclerotic past, although it does not appear to be accelerating further. GDP growth of the 2.0% variety seems to be in store for the continent going forward, which given its history since the European bond crisis, is really not too bad at all. But given that inflation remains quiescent there, I continue to believe that the ECB is extremely unlikely to become hawkish any time soon. This is not to say that they will not begin to taper their QE purchases, which is clearly set for the beginning of next year, but the idea that the ECB will quickly follow up with rate rises remains a fantasy for those long euros. To date, ECB speakers have been consistent in their comments about the sequencing of events, and have not changed their tune regarding the extended period of low rates following the end of QE. I maintain that the ECB will not even adjust the deposit rate there from its current -0.40% until the beginning of 2019 at the earliest, and it could take another year simply to get back to 0.0%! I would argue that the narrative continues to compress this timeline and the longer it drags on the more likely the euro is to give back some of this year’s gains. As such, I wouldn’t read very much into this morning’s 0.25% gain in the euro, which is arguably just trading noise and not representative of any new trends.

If we look elsewhere, we see a similar pattern of price action. For example, the pound has rallied 0.35% this morning, arguably on the strength of a modestly better than expected Services PMI report (53.6, exp 53.2), but then this follows the pound’s 1.65% decline during the past week. So the direction makes some sense in the short run, but it becomes increasingly difficult to remain bullish pounds in the medium and long term in my view. After all, the Brexit negotiations have not been conclusive, at least not the public commentary, and it is easy to argue that a ‘hard Brexit’ with no transitional deal will be a significant negative for the UK economy in the short run at least. In fact, if that grows to be the most likely outcome, I would expect that the pound to suffer quite substantially. But even in the case where some agreement is reached, it appears that the UK is likely to come away with lesser terms, and I would expect further pressure on the pound then too.

The commodity bloc, meanwhile, has also rallied softly this morning, with metals prices seeming to be the key sector today. There was a positive Bloomberg story about increases in iron ore shipments from Australia to China and that appears to have encouraged traders to bet on the Aussie. CAD has been a relative laggard, up just 0.1%, but given the gradual slide in oil prices we have seen over the past week, it is not that surprising that CAD has had trouble making gains. After all, the correlation between oil and CAD remains strong at 0.4%, albeit that is a bit lower than we have seen in the past.

In the emerging markets, the big winner has been INR, which rallied 0.8% after the RBI left rates on hold and a large order to sell dollars entered the market. Despite the Fed’s penchant toward tighter policy, the RBI has been moving in the opposite direction, having cut rates 7 times since the beginning of 2015, with expectations for further declines as inflation remains under control. But given today’s general dollar weakness, we have also seen solid gains from PLN (+0.7%) and ZAR (+0.6%), with the rest of the space firm, but to a much lesser extent. Regarding Poland, the NBP left rates unchanged at 1.50% again, which was widely expected for today, but has seemed to add pressure to the view that they will be forced to raise rates in the not too distant future amid a rising inflation environment. Interest rate markets have been increasing their bets on just such an outcome, and the zloty has benefitted accordingly. The rand, meanwhile, seems to have simply recouped yesterday’s losses, which were fanned by concerns over both the ongoing political turmoil there as well as weaker PMI data.

This morning we get back to data with ADP Employment (exp 135K) and ISM Non-Mfg. (55.5) on the docket. After Monday’s very strong ISM Manufacturing data, hopes are rising for a good print here as well. The ADP number, however, will be skewed by the recent hurricanes and so ought not be seen as indicative of the underlying situation. Friday’s payroll data is also likely to be far less informative than usual because of the hurricanes impacts last month. In fact, I would guess that next month’s numbers will still be somewhat skewed. Interestingly, I think the upshot of that is there will be very little data released between now and December to alter the Fed’s thinking on raising rates then. In other words, December is a done deal!

Chair Yellen does speak this afternoon, but it would be surprising, given the venue of a Community Banking Event, that she would focus on monetary policy. As such, my take is any positive data surprises will be seen as dollar positives, while negative ones can be waved away as hurricane related. All told, a consolidation day seems in the cards, but there has been no change to the story yet.

Good luck

Adf

December Rate Hike Probabilities:

USD   69.9% è (The hawks are winning)

EUR     0.6% ê   (Think December 2019)

GBP   84.1% ê   (Done deal, probably in November)

CAD   63.3% é  (Not as confident as before)

Fed rhetoric       25bps

In Europe the construct of nations

Is quaking down to its foundations

The news out of Spain

Engenders disdain

For Europe with fraught implications

The dollar remains well bid across the board, although in fairness the movement has not been universal. The key themes in the market remain the ongoing positive US story, where yesterday’s ISM data printed at its highest level in 13 years and the Prices Paid data jumped to 6 year highs, while in Europe, despite an ongoing economic recovery, the political picture shows continued angst amongst several segments of the population, as evidenced by both the Catalan vote over the weekend and last month’s German election where the AfD party, campaigning on less European integration, was able to enter the German parliament for the first time ever. Adding to the current theme were comments from ECB Chief economist Peter Praet, describing an extremely cautious view of the removal of policy ease. As I have written repeatedly, there has been nothing in the past several weeks/months of data and information that would have changed the Fed’s clear goal of raising rates, not only in December, but at least several times next year. And there has been nothing during that same time frame that would lead one to believe ECB President Draghi has suddenly become a hawk. So for now, regardless of the minor day-to-day fluctuations, the dollar’s trend is higher. We will need to see a long string of weak US data to shift the Fed, and we will need to see significant price pressures in Europe to change those views. To sum it up, I believe the euro narrative is wrong and that as the market accepts that, however grudgingly, the euro will continue to decline.

As to the rest of the world, the pound remains under pressure as well with this morning’s Construction PMI data (48.1, exp 51.1) showing that confidence in the UK may be ebbing faster than expected. The ongoing Brexit negotiations have offered no positive news for the pound, and the latest round of UK data has been broadly underwhelming. While this morning’s decline is just 0.15%, over the past week the pound has given up 1.5%, and more than 3% since it peaked two weeks ago. There is no reason to think the pound will rebound anytime soon and I expect to see it continue to fall.

In Japan, the yen continues to fall, taking its movement over the past month to -5.5%! Aside from the US side of things, we have seen a combination of increased risk appetite globally, higher US yields and some initial concerns about PM Abe’s electoral prospects. Last week he dissolved the Diet and called for new elections. Any weakening in his current power structure, which based on electoral results from the entire developed world over the past two years seems likely, could result in more concerns about the yen. But ultimately, I think the biggest driver here will be the spread between 10-year yields in the US and Japan. Right now, that gap stands at 2.30%, and historically, when it rises to 2.50%, Japanese investors will shift from JGB’s to Treasuries with corresponding USD buying pressure. I like USDJPY higher as well.

Beyond the G3 overnight, the Commodity bloc has fallen ever so slightly, just adding to its recent run of modest weakness. Again, given the big dollar’s underlying strength, none of these currencies has exhibited anything particularly special.

In the Emerging markets, the biggest loser overnight has been ZAR, where concerns over a government bailout of South African Airways have brought forward concerns about a further ratings downgrade. The rand is lower by 0.5% since yesterday and 7.5% in the past month. On the plus side here, the CE4 lead the way, but the biggest gainer, HUF, is up only 0.3%. There is no clear news story and after its own sell-off vs. the dollar over the past month, this appears to be more profit taking related than fundamental.

There is neither data nor Fedspeak on the schedule for today, which implies, as ever, that the FX markets will take their cues from equity and Treasury markets.

Equity futures are pointing ever so slightly higher at this time, and Treasury prices continue under pressure with the 10-year yield up another 1.5bps at 2.36%. FWIW it seems to me the dollar is ripe for a consolidation after what has been another solid week of gains. With key economic data upcoming the rest of the week, and a slew of Fed speakers still on the calendar, I imagine today will be quiet. However, the underlying USD strength remains in place, in my view, and I expect to see it reassert itself as the week progresses.

Good luck

Adf

There once was a fellow named Fate

Who’s Monday last week wasn’t great

His boss said bye-bye

With no reason why

But stick wth me, it’ll be worth the wait!

As some of you may now know, as of last Monday, I am no longer employed by RBC, hence the lack of poetry since then. However, that was then, and this is now. Unfortunately, I do not have a complete list of contact details at this time, so if colleagues who had received FX Poetry before are not on this list, please have them reach out to me at andy@fately.com and I will be happy to add them back.

Now onto the markets

December Rate Hike Probabilities:

USD   69.9%       (The hawks are winning)

EUR     1.1%       (Think December 2019)

GBP   84.6%       (Done deal, probably in November)

CAD   58.8%       (Not as confident as before)

Fed rhetoric     25bps

The euro is feeling the strain

From voters in Catalan, Spain

Two million plus voted

And most there promoted

A split from the Spanish domain

When I last wrote, I had been discussing the idea that the dollar had further to climb, and I continue to expect that to be the case. As this morning’s price action shows, my thesis remains in play. The narrative almost certainly remains that the Fed is not going to be as hawkish as Fed rhetoric and that the ECB is going to be more hawkish than ECB rhetoric. That change in view from twelve months ago has been the key feature of the dollar’s decline this year. Alas for the narrative, it is not actually playing out that way. Last week, Chair Yellen once again sounded hawkish alarms in her speech. A growing concern amongst FOMC members is that the Fed is inflating an asset price bubble (duh!) and that if they maintain ultra-easy monetary policy, it will continue to grow larger. And even the Fed knows that the popping of an asset bubble is not a good thing for either markets or the economy. So look for a continuation of Fed discussion of tighter policies, and then for those tighter policies to materialize. And one other thing that will help that cause is the growing likelihood that President Trump will name Kevin Warsh the next FOMC Chair. He was a hawk when he was a Governor, and he has been explicit that current policy is no longer appropriate for the economic situation. All told, barring a collapse in US economic data, the Fed is going to continue to tighten, and with Warsh, probably faster than people think. And the ECB is not about to rock the boat, especially given the latest story from Spain. All this continues to point to dollar strength going forward. Receivables hedgers beware!

As to the overnight session, it has been broad based dollar strength vs. both G10 and EMG currencies. Interestingly, while bond yields continue to rally (US 10-years now up to 2.34%) we continue to see the equity juggernaut roll on. In fact, throughout Europe, only Spain is suffering today (for obvious reasons), and US futures are pointing higher. I guess that investors are now looking at the US tax proposals and ascribing both a high probability of successfully being implemented and that they will have a large impact. I remain skeptical of both claims, but then I can be skeptical.

We did see some PMI data showing German manufacturing remains robust, UK manufacturing is sliding, but still strong, and Italian manufacturing is looking peaky. But the Spanish story has dominated the single currency today. As to the pound, it has fallen back to its lowest level in two weeks and certainly has the look of a currency that has seen the top. 1.30 anyone?

Given it is the first week of the month we will be inundated with US data culminating with payrolls on Friday. This is what to expect:

Today                                    ISM Manufacturing                            58.0

ISM Prices Paid                                   63.5

Construction Spending                       0.4%

Wednesday                        ADP Employment                                 143K

ISM Non-Manufacturing                     55.5

Thursday                        Initial Claims                                             265K

Trade Balance                                            -$42.7B

Factory Orders                                            1.0%

Friday                             Nonfarm Payrolls                                    85K (hurricane impacted)

Private Payrolls                                       73K

Mfg. Payrolls                                            10K

Unemployment Rate                              4.4%

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

Average Weekly Hours                           34.4

So obviously, the payrolls number is the big story. Do not read too much into the large decline from last month as all the hurricanes will be accounted for in this number. Certainly the drop will not concern the Fed this month, although if it persists for a few more months, that may cause some concern. And as I wrote above, it seems to me that the hawks are ascendant there. We also hear from 10 more Fed speakers this week, although Yellen’s comments at a community banking event don’t seem likely to be ripe for new policy discussions.

As I consider the events of the past week, I feel my arguments have been reinforced and that the dollar is set to continue to gain going forward.

Good luck

Adf

In hours the Minutes will print
Perhaps they will give us a hint
Of when the Fed’s caper
The now famous taper
Will help them to slow down the Mint

The dollar continues to perform well against the Emerging market set, but is rallying against its G10 brethren as well this morning. Pretty much everything you read today prefaces some point with “…before the Fed minutes are released.” I don’t know that I can ever remember the Minutes being so anxiously awaited. The question is whether they will be that meaningful. I mean the release this afternoon has taken on almost mythical significance. I have a feeling we could all be very disappointed as they won’t actually reveal the starting date. I think we already know everything; that the Fed is watching the data closely and if the numbers continue to show their recent slow improvement, the Fed will slow down its rate of purchases. How will that disappointment play out? My guess is the initial move will be a dollar sell-off and equity rally. But ultimately, it remains clear the Fed is strongly considering a reduction of QE and so the dollar will eventually benefit further, likely even before the end of the session.

Perhaps just as interesting to FX markets has been the story from Germany where FinMin Wolfgang Schaeuble admitted yesterday that the Eurozone would have to resort to the “further measures and assistance” for Greece that were agreed last November. Cutting through the euphemisms, he is saying that Greece is going to benefit from either having loans forgiven or receive direct aid. As I have written consistently for the past 3 years, Greece is broke and there is nothing that the country can ever do to repay the current debt outstanding. They have already forced the private sector to take its haircuts and now most Greek debt is owned by the public sector. Thus, Schaeuble is starting to pave the way for the public sector to actually pay the freight. Now he and Merkel want to prevent any problems ahead of the German election in about 5 weeks, but there is no doubt that within a relatively short time after the election, we will awaken to a story about the Eurozone writing down debt or putting up straight aid, not loans. This highlights the ongoing problems for the euro, and remains one of the key reasons that I find it difficult to see a significant rally. However, I respect the flow story and the ongoing changes in the balance sheets of the Fed and the ECB continue to be a key support for the single currency.

In the UK, we saw modestly weaker data with the PSNB falling a smaller than expected £1.6 Billion indicating that the recent better than expected UK data has not yet led to an increase in tax revenues. But the market didn’t seem to care much as the pound is essentially unchanged this morning. The other stories about the pound are of the Mark Carney variety, with more analysis on the newly invoked BOE guidance efforts. While guidance had been modestly successful for the Fed, I believe that markets are becoming wise to the idea that guidance is an effort by the central banks to NOT do something, and as I wrote yesterday, markets are pining for action not words. I believe that we will continue to see markets push hard to force central banks to act, and will punish either government debt markets or currencies or both if guidance is all that they see. In this case, I actually think the pound has room to rally further because the BOE guidance has been an effort to continue low rates without spending any resources. One of the natural outcomes would be a weaker pound, something welcomed by the British manufacturing community. So a stronger pound would be the market response to force the issue.

In the commodity space, both CAD and AUD have traded lower, with CAD back at its lowest levels in a month. This seems to be a combination of general USD strength, combined with some softness in commodities and somewhat weaker minor data released yesterday. The options community seems to be focused on 1.0450, but the big psychological level will be 1.0500. While we did spend some time above that level back in June, it has represented a pretty strong resistance level during the past several years. Unless the Fed spells out a taper timeline, I think we fail at that level for now.

USDINR traded to yet another historic high overnight, falling some 1.2% as the RBI has proven incapable of convincing anyone that they can manage the situation. My big concern is that we are at the beginning of a legitimate currency crisis there and that we are going to see an imposition of restrictions and other measures as capital flees the country as quickly as it can. Who knows, maybe it will force the politicians to act, which is desperately needed, but of that I’m not confident. At the same time BRL has stabilized for the moment, seemingly finding a short term home around 2.40. While I continue to look for further depreciation in the Real, it will probably be a few sessions before that starts again. Across the rest of the space, most currencies are suffering this morning as well, but that is part of the general market activity rather than country specific news.

Later this morning we will see Existing Home Sales (exp 5.15M) but nobody really cares about anything except the Fed Minutes at 2pm. Equity futures are soft right now, but don’t look for anything until the Minutes are released.

Good luck
Adf

We all know a banker named Ben
As part of a group of old men
Who used all their weight
To try to inflate
Large bubbles in stocks, bonds and yen

But markets of late have decided
Those efforts have been quite misguided
So stock markets fall
And bonds hit the wall
While currency moves are one-sided

It seems that all the carefully constructed theories about how central bankers should be doing their jobs, including the idea that just because interest rates were cut to zero didn’t prevent those same central banks from easing policy further, are starting to come undone of late. Guidance, the next step after QE, has become all the rage in the central bank community, but it seems to be losing its effectiveness. It all began when Bernanke uttered the famous word “taper” as part of an answer to a Congressman’s question back in May. Suddenly, the idea that the Fed would print money forever was dashed and markets have been responding ever since. Yesterday, 10 year Treasuries traded at their highest yield in 30 months, and while they have rebounded a bit this morning, this move still has legs. We are watching EMG equity markets get decimated, led by Indonesia down more than 20% from its recent peak. EMG currencies are falling dramatically. INR traded to new all-time lows (dollar highs) overnight, and the folks in Sao Paolo are really starting to get nervous about the BRL’s weakness (new 4+ year lows yesterday again). I have seen the BRL movie before and it doesn’t end well for the Real. At the same time what is so interesting, is that all the G10 currencies are holding up very well. If you think back to 2008, what we saw was that investors fled from every currency and asset class that wasn’t US Treasuries, and the price movements seen then were quite clear. That was the period where we coined the term risk-on/risk-off. It was a simple paradigm and easy for everyone to trade. But that is not what is going on in these markets. In fact, these seem far more reminiscent of the Asia Crisis of 1997 than the Financial Crisis of 2008. The constant refrain is that funds are flowing out of emerging markets, both direct investment and equity and fixed income securities, and heading back to the developed world. While that is certainly true, at this point the question is, just how much more of this will occur? My sense is that we have a lot more selling to come.

So let’s look at the far less interesting G3 currencies for a moment. The euro continues to perform well, edging up toward 1.34 for the third time in the past three months. If it cannot break that level convincingly, I think the technicians are going to have a field day calling for a major reversal lower. As I wrote yesterday, though, even with the taper of QE assumed, the Fed’s balance sheet is growing much more rapidly than the ECB’s, which actually seems to be shrinking a bit. I continue to believe this is one of the underlying drivers of the euro’s recent surprisingly strong performance, and it doesn’t seem like it will change in the near term. In fact, yesterday the Bundesbank, playing to its home audience, was explicit in its comments that the ECB’s pledge of low rates for an extended period didn’t mean that rates couldn’t be raised to combat inflation. Now, there don’t seem to be many inflationary pressures in Europe right now, but the Germans have always been hyper vigilant on the issue. The problem for the ECB, and especially for Signor Draghi, is that the Bundesbank continues to muddy the message he is trying to convey. This goes back to the idea that markets are running out of patience with guidance by central banks and want to see actions. But in this context, if the ECB’s actions are of the balance sheet shrinking variety, then the euro will remain underpinned despite all the problems with the economies in its member countries. The ECB has always been more constrained by its mandate than the other big central banks, and right now, that seems to be a key euro support.

In the UK, the market has also shown some doubts about Governor Carney’s promised guidance as he left himself too many opt-outs of the low rates for a long time thesis. So, the combination of an economy that has been producing surprisingly better economic results and doubts about the central bank’s willingness to keep rates at rock bottom levels has led to support for the pound. In fact, over the course of the past 6 weeks, from just after the time that Carney stepped in, the pound has rallied almost 6% a better performance than the euro or any other G10 currency other than the CHF (barely).

Finally, in Japan, we have seen very little in the way of movement lately. While the longer term view for the yen remains for a much weaker currency, the market is waiting for more actions, this time by the Abe government, to implement the promised, and desperately needed, structural changes to labor laws, and agricultural subsidies. Of course the politics of those moves were always going to be difficult, but perhaps given Abe’s commanding strength in both housed of government there, he will be able to get things done. In the meantime, Kuroda-san has not turned off the printing press and his promise of ¥7 Trillion of JGB buying per month is doing its job to expand the BOJ balance sheet. Remember, Kuroda’s target is to double the money supply over his first 2 years. Further yen weakness will come.

The overnight data was not of the market moving variety nor will today’s US data do anything. At this point, all eyes remain on the FOMC minutes to be released tomorrow at 2:00pm here in NY. Until then, look for EMG currencies to continue to suffer and majors to range trade.

Good luck
Adf

Away from the G10 we’ve seen
That traders are really quite keen
To sell the Rupee
And while on that spree
The Rand and Real they demean

Mixed is the best description of the FX markets this morning as we are seeing the dollar weak against the euro and pound, rallying slightly against the yen and much stronger vs. a number of EMG currencies, notably BRL, INR, ZAR and MXN.

Starting with the G3, the euro seems to be benefitting from the realization that the ECB’s balance sheet has actually been shrinking over the past 3 months, and is now actually $400 billion smaller than the Fed’s. And that trend shows no signs of slowing. European banks continue to repay the LTRO loans, (some $57 billion since May) reducing the ECB balance sheet. At the same time, the Fed continues to buy $85 billion in Treasuries and Mortgage-backs each month, inflating theirs further. With no actual QE by the ECB, its balance sheet has no prospects for growth. So even though the taper is going to reduce the rate at which the Fed acquires assets, they are going to continue acquiring them for a while yet under virtually any circumstance. I believe this has been an important and little known fact that has helped underpin the euro’s relative strength of late. Every time I look at the big picture in Europe, I can see no good reason for the euro to maintain its current levels, but this information may be why the single currency has been so resilient. It is also why the taper is so important for the dollar’s value, as when the Fed stops ballooning its balance sheet, the dollar should find more significant support. As to the pound, it has been dragged higher by the euro, but there has been very little in the way of information as a driver. Meanwhile, the yen is softer this morning, down 0.50%, after the release of a much larger than expected Trade Deficit last night. The decision to shutter its entire nuclear fleet continues to have a major impact on the Japanese economy in two ways. First, there are concerns over the ability to generate sufficient power to insure that air conditioners stay on and factories continue to run at peak efficiency, and second, the Trade deficit continues to widen as the high cost of importing fuel impacts that directly. But given the general lack of volatility of late, and the fact that the summer vacation schedule continues to detract from market liquidity, right now these currencies don’t seem so interesting.

So let’s look at the EMG space instead, where we see USDBRL having traded to its highest level since March 2009 just below 2.40. If you recall, it was several months ago that I called for a move to 2.50, and now the market has really started to roll. While the central bank continues to try to minimize volatility, it does not have sufficient reserves, nor apparently credibility, to do the job properly. Weekend comments highlighted internal dissent between the government and the central bank and that is only likely to help the weakness continue. The thing about currencies like BRL is that once they get rolling, they have an opportunity to really overshoot any semblance of reality. So while I think 2.50 is almost a certainty now, I think there is a very real chance that it could trade to 2.75 or even beyond. And it can do this far more rapidly than you might think, so beware. India, too, is having serious problems as the central bank there is also running out of tools to help it manage the weak currency. As I have written consistently, slowing growth and rising inflation are a very difficult mixture for a central bank to manage effectively. At some point, they have to decide which issue they will attack first, to the detriment of the other. So if they go after inflation, growth will slow further, while if they attack inflation, then a recession is quite possible (likely). It should be no surprise that the INR is falling further, down another 2.25% overnight to yet another new low and now above 63.00. It was several weeks ago that I called for 65.00, but 70.00 now feels very realistic. Remember, the thing about EMG currencies is once they get started on a move of this nature, it is very difficult to slow them down without significant policy changes. As to the ZAR, it has moved back above 10 for the first time in a month as continued unrest by unions combines with further rate rises in the US Treasury market giving investors two reasons to exit the currency. In MXN, the big figure is 13.00, but here too it has been more than a month since we have traded at these levels. The story here is more focused on the US side of the equation, with better growth and higher Treasury yields sufficient to dissuade investors from emerging markets in general and seeking the safety of dollars. The dollar is strong throughout the EMG space and as long as we continue to see Treasury yields rally, I think this situation will continue.

While there is no data today, we do learn about the housing market this week, as well as get the FOMC minutes from the last meeting. Here is a look at everything expected:

My guess is that the minutes will be the most interesting information unless the housing data miss forecasts dramatically. Of course, if the equity market weakness of last week continues more dramatically, then we could see a bit more volatility than we have been in the G10 currencies, but right now it does not feel like there is much to get excited about.

Good luck
Adf

In Europe they’re starting to feel
That growth is beginning to heal
So euros are strong
And pounds are along
For the ride. Its all somewhat surreal

First the big news – yesterday was my first day at RBC. As time progresses you can be sure I will be reaching out to sit down and discuss things, but for now, as I am all alone on the desk in NY, the occasional phone call and my morning note will remain my MO.

Data out of the Eurozone this morning showed export performance improving while inflation remained under control. This combination has encouraged the FX community to bid up all G10 currencies relative to the dollar, with the euro and Aussie leading the way. The GDP data earlier this week was the first sign that things were getting better, although a closer look shows that stronger growth in Germany and, surprisingly, France offset still very weak situations in Italy, Spain and the Netherlands. So is the situation uniformly better in Europe? Clearly not yet. But at least it seems that they may have found the bottom in the economy. And that, when combined with the mostly mixed data that we have been seeing in the US, (yesterday’s IP, Capacity Utilization and Empire Mfg were all softer while Initial Claims fell to their lowest level in 5 years and Retail Sales were strong) has been enough to adjust attitudes. Hence the dollar’s current weakness. This morning we add the Housing picture to the markets with Housing Starts (exp 900K) and Building Permits (945K) at 8:30 followed by Michigan Confidence (85.2) at 10:00. As I wrote earlier in the week, the data would give us the opportunity to evaluate the ongoing recovery here, and so far it remains tepid at best.

But the question remains, is tepid good enough for the Fed to still consider the taper? Everything that I read, including St Louis Fed President Bullard’s comments last night, lead me to believe that the Fed has become quite concerned over the possible downsides of exploding its balance sheet from a bit less than $1 trillion prior to the 2008 crisis to almost $4 trillion now. And remember, even the taper won’t stop that growth, merely slow it down slightly. While they certainly take comfort in the continuing low inflation readings, I am certain that the FOMC is aware of the potential for inflation given the amount of reserves that are in the system. While they have not really been a problem to date, recent data shows that they may be starting to migrate from the excess category to the utilization category. And that is where inflation will start to show itself. At any rate, the betting is still for the taper to begin next month and I believe the market has a $20 billion reduction penciled in. So any difference from that will be the mover when the Fed finally speaks again.

In the emerging space, INR has traded to yet another record low, breeching 62 for the first time, although it has since rallied back a bit. This show is not over folks, and I continue to look for at least 65 and perhaps an eventual move toward 70 as it evolves. The RBI is losing reserves, down 7% so far this year, which means their ability to manage the currency will be impaired further. They are running out of things to do short of significant changes in fiscal policy. Alas, given the current political situation that is nigh on impossible. Brazil, too, is finding themselves on the wrong side of the market right now, and my view of 2.50 remains intact. Last night the central bank announced they would be rolling over their currency swaps on some $5 billion and they continue to intervene to try to smooth the market. While inflation printed slightly below the top of their range at 6.27%, it remains a grave concern. This is especially so in light of the fact that growth has shown no spark. It appears that Brazil is redefining the term stagflation, and that is going to weigh on the Real for a while yet.

The flip side of that is China, where the Renmimbi has been remarkably stable over the past months, stuck between 6.11 and 6.15 for months now. This has prompted discussion that the PBoC may widen the trading band again, perhaps to 2% or 3% from its current 1%. This is all part of the Chinese effort to achieve a convertible currency so that the CNY gains in global prominence. However, that goal remains a distant one as there is no indication they are going to suddenly remove exchange controls and it remains a question as to whether or not the Chinese banks could even withstand the pressures of a fully convertible currency. You know that the government will want the local banks to dominate the currency trading, but they won’t have the ability to do so in their current state.

For today, I think we see modest further USD weakness against the rest of the G10. However, if Treasuries accelerate their recent decline, that might change some views, further hampering the equity market and likely forcing some traders out of short USD positions.

Good luck and good weekend
Adf

In England the MPC showed
That not all the members bestowed
Their blessing on speech
Designed to beseech
To the market they’re on the right road

The two biggest stories overnight were the MPC minutes failing to show unanimity over Governor Mark Carney’s new guidance idea and the GDP data release for the Eurozone printing higher than forecast. Interestingly, adding the modestly better UK employment data to the mix did nothing to move the FX markets at all. Both the euro and the pound are virtually unchanged from yesterday despite the news…or perhaps because of it. At any rate, the MPC voted 8-1 to approve the new guidance concept with the naysayer being confirmed hawk Andrew Weale. His concern was the timeline was too long for some of Carney’s opt-outs on the low rate guidance. But the UK employment picture showed the Unemployment Rate unchanged at 7.8%, the claimant count falling and was generally perceived as better than expected. Net, the pound is marginally higher this morning but the movement has been well within the recent trading range.

As to the euro, perhaps this is a greater disappointment. It is unchanged from yesterday’s closing levels despite Q2 GDP growth of 0.3% (exp 0.2%) led by Germany and France both printing higher than forecast. Remember, Europe has been in the midst of a 6 quarter long recession, so this more robust growth should be seen as quite a good outcome. Both Italian and Spanish 10yr yields have fallen a bit and more importantly, they have narrowed their premium over German Bunds to the tightest in 2 years. That spread narrowing should also be seen as quite a positive for the euro as it implies the bond market is becoming more comfortable that the worst is over for the peripheral nations. (Personally, I am not a believer in that idea). But the euro has been unable to gain any traction at all. What to make of this outcome? I think a combination of summer holiday doldrums and insufficient pizzazz in the numbers have left traders unwilling to commit to new positions.

In the EMG space, Brazil was notable for its weakness yesterday, setting new lows for the move and continuing its march toward 2.50. It seems the only news of note was the Brazilian House of Representatives passing a bill that would prevent the administration from cutting spending already authorized by the House. However, I believe the bigger problem here is ongoing concern over China’s growth leading to softness in commodity prices as well as the continued competition for investment dollars from higher interest rates in the US. The central bank was not seen in the market yesterday, but if USDBRL continues to rise, I expect it will show up today. They are clearly concerned about allowing the BRL to weaken too rapidly.

Meanwhile in India, inflation data printed higher than expected, at 5.79%, well above the 5% target they have. The INR has moved back to within pips of its recent historic lows and I expect it to breech those and move further in the next weeks and months. Despite a faltering growth outlook, the central bank is more likely to have to raise rates than lower them in the near term to fight an inflation situation that is beginning to get out of hand. The government has imposed 10% tariffs on the importation of gold and silver as a means to prevent the current account from getting too far out of balance, but as long as the government there remains unable to cut away red tape and allow the country to grow more rapidly, the Rupee is likely to continue to suffer. I continue to look for 65.00 before it’s done.

This morning brings only the PPI data here in the US (exp 0.3%, 0.2% core) and so is not likely to move things. However, with a bunch of data tomorrow, including CPI, Empire Mfg and Initial Claims, perhaps we will see a bit more action then. In the meantime, keep your eyes pealed for any comments by Fed players as that is the best chance for market moving information, although none are scheduled to speak today.

Good Luck
adf

Is Europe beginning to grow?
Economists claim that they know
It’s nearly two years
That growth’s in arrears
But now it’s moved up to so-so

The dollar continues its rebound from last week’s depths with the yen suffering the greatest fall, but most currencies declining. The Japanese story was a combination of better than expected data (Japanese Machine Orders grew 4.9% in the past year compared to expectations of 2.6%) and a story that in order to offset the potential fiscal tightening of the increased national sales tax, PM Abe is considering a cut in corporate tax rates to help stimulate growth. This was sufficient to bring out the yen sellers and spot has jumped more than 1.6% as I write. From the charts I think there is still room for a bit more upside, but barring any further news from Japan, I think 99.00 will certainly cap this rally. Of course, the opportunity for further news of this nature remains quite significant as Abe is struggling to get Japan back to its former glory. If he perceived this has had a salutary impact, look for another announcement of some newly tweaked policy in the near future. But not today.

In Europe all the discussion is on the narrowing gap between German Bunds and the yields of Italian, Spanish and Portuguese debt. The claim is that expectations of a resumption of growth in the Eurozone (Q2 GDP is expected at +0.2% tomorrow) will lead to a further reduction in any tensions with the peripheral nations. In fact, there are some who are expecting these nations (excepting Greece) to start to show positive GDP numbers by the end of the year. While nothing is impossible, the trajectory of Eurozone growth has not been such that I feel that is likely. Remember, the two key elements that started all these problems were the massive sovereign debt loads and the extremely weak banking sectors of these nations. And to the best of my knowledge, neither one of these issues has been even remotely resolved. While banks are trying to raise more capital, their loan portfolios continue to deteriorate, and all of the peripheral nations continue to see their debt/GDP ratios growing rather than shrinking. Many very serious problems remain in Europe and the political will to actually address them has yet to be found. I don’t think we will see too much activity ahead of the German election next month, but if we do see something, the likelihood is that it will be a negative event. So the euro remains little changed this morning near 1.33 but I think a slow drift lower is the most likely short term path. As I said yesterday, 1.30 is the target, but it will be a gradual move.

In the EMG space, ZAR has been the biggest loser, falling about 1% after unrest at some mining sites has raised the specter of a repeat of last summer’s activities. The rand can ill afford more problems like the striking that was seen last year given the alternative investment opportunities, not least of which are US Treasuries with a much higher yield, than last time this occurred. ZAR has already fallen more than 18% since the beginning of 2013 and all indications are that there is more to go. Meanwhile, MXN is weaker this morning after the market registered disappointment over President Nieto’s ‘reforms’ of PEMEX and the oil industry. This is one of the great tragedies of Mexico, the slow collapse of its energy infrastructure because of the nationalism that is attached to the issue in the country. The inability of PEMEX to even utilize the expertise of the international oil community to help improve its output has reached a point where it is on the political agenda. But the initial proposals were minimal, and the peso has suffered accordingly. While we are nowhere near the lows seen back in June, given the dollar’s underlying strength and no reasons to believe that further policy changes are forthcoming, a move toward 13.00 seems a reasonable bet here. Finally in this space, HUF has fallen some 0.75% after releasing softer than expected inflation numbers. This has the market talking about further rate cuts by the central bank there, with the natural currency response being a decline.

For one day at least, it seems there has been some logic in the FX markets. However, I wouldn’t get used to it.

This morning we will see Retail Sales (exp 0.3%, 0.4% ex autos) and then Business Inventories (0.2%) at 10:00. Equity futures are higher this morning after a recent weak run and Treasuries have fallen a bit with the 10yr yielding 2.66% right now. While market conditions remain relatively light due to holiday schedules, I continue to look for marginal USD strength, especially if we see a strong Retail Sales number. That said, there is no reason to look for a significant move today barring some Fedspeak or other comments out of the blue.

Good Luck
Adf