Abenomics failed
To increase GDP growth
Last quarter, at least

The dollar is firmer this morning, breaking its recent downtrend as the Asian session opened with news that Japan’s GDP grew a much less than expected 2.6% in Q2 (exp 3.6%). The yen weakened immediately and has retained those losses and the dollar has fared well against pretty much all currencies. In Japan, the ongoing debate remains about increasing the national sales tax, with a 3% rise slated for April 2014 followed by another 2% rise in October 2015. However, the weaker GDP numbers have called into question the country’s ability to withstand a tightening of fiscal policy at this stage, especially given the extraordinary focus on increasing growth and core inflation. Traders are starting to discuss the idea that there will be another round of easing by the BOJ as a response to the weaker data with yen weakness a natural outcome. While the timing of further stimulus remains uncertain, I am in the camp of believers that the BOJ will do more, and probably sooner rather than later. My sense is a rally back toward 98.50 or so is likely in the next several sessions.

Both the euro and the pound are also weaker this morning, although not falling nearly as much as the yen. The weekend press in Europe has been generally quiet due to the preponderance of summer holidays being taken right now, but in several places I have read about further concerns over Portugal and Greece. While Ireland seems set to make a tentative exit from its bailout requirements on a timely basis, Portugal is slipping on its commitments and Greece has never even come close. Despite some modest progress, both these nations are going to miss their budget deficit targets and require further financing. The problem is the Troika, or at least the IMF, seems increasingly unwilling to put up the cash. Greece remains in the worst shape of all with a budget hole of some €4.4 billion for 2014 and a larger one going forward. Growth continues to elude the nation and unemployment continues to expand. There has been no political will to actually dismiss government employees, one of the key measures required by the Troika. Asset sales have been de minimus and continue to lag the targets that were assumed as part of the financing package. In other words, virtually nothing of import has changed, so it can be no surprise that the country remains mired in a depression with a sense of hopelessness attached. I can see no situation where the Greeks repay their debt. It is simply a matter of time before the political cognoscenti in Europe see admit that as well. Perhaps after the German election we will see some views altered in public. While Portugal’s situation is not quite as dire, it too has been unable to generate the political will to make the changes required by the Troika. This has led to the government there losing key support and only a fragile coalition remains in place. These problems highlight the ongoing concerns in Europe, without even mentioning Italy’s increasing political difficulties. All in all, things in Europe remain quite problematic from a policy perspective. That said, it appears that the continent may be exiting its 6 quarter long recession as forecasts are for growth of 0.2% in Q2 (to be released Wednesday). While that would be a welcome outcome, it is hardly sufficient to change the monetary policy framework and we can continue to look forward to either no change or further ease from the ECB for now. All of this is a long way of saying that the euro has likely peaked after its recent modest rally, and I think it heads back toward 1.30 in the sessions ahead.

Looking ahead to this week, the data calendar is far more interesting than last week and some data has market moving potential. We will learn more about inflation and housing as well as the manufacturing situation in the Northeast of the country.

While the Fed has clearly been more focused on unemployment than inflation, any surprises on the high side of CPI will almost certainly hit the bond market and are likely to support the dollar further. In addition, strong Philly or Empire numbers will be equally dollar positive.  After all, there seems to be a growing consensus that the Fed will begin to taper its QE come next month. So all in all, I think the dollar has reason to perform well this week. Not explosively, but certainly I expect it to be higher on Friday than it is right now.

Good luck
Adf

Last night from the Chinese we learned
That growth there just might have returned
The market reaction
Showed some satisfaction
‘Bout Aussie, while dollars it spurned

Under the heading, less is more, today’s note will be extremely brief. Recent price action does not make for a very compelling story in any currency. Broad underlying themes remain in place, but the day-to-day activity is just uninteresting right now. As such we have once again seen a pretty dull overnight session. While the USD is generally softer, it is by no means universal. Norway and Australia are the leading gainers, with the Aussie story predicated on stabilization in China’s economic data (IP, Fixed Asset Investment and Retail Sales all released in-line to modestly better) and the Norwegian saga one of higher inflation readings indicating potential higher interest rates in the future. But you know that when I am leading with AUD and NOK that things are just not that interesting. The euro, yen and pound are all trading within pips of yesterday’s closing levels and quite frankly there has been little of real interest regarding any of these currencies. It appears that we are in the midst of the summer doldrums and the combination of thinly staffed trading desks due to summer holidays and lack of new policy information has reduced activity. In fact, CLS, which is an interbank, intraday settlement system, announced that daily volume has fallen by 16% in the past month. I think that is a pretty good indication of the reduced interest in the FX market right now.

In the emerging market space, yesterday saw both BRL and CLP rally more than 1%, with BRL the beneficiary of central bank intervention while CLP was responding to the rally in Copper. But outside of those two currencies, even this space has been quite dull.

I have not changed my long term views (equities and bonds are overpriced and the dollar has room to rally) but with no US data on which to focus and no scheduled speakers of note today, quite frankly I believe hedgers will be able to spend their time better on other tasks today.

Good luck and good weekend
Adf

Twixt England, Australia and here
The words we’re most likely to hear
Are jobs need to be
Created you see
Elect me or they’ll disappear

The thing that these fellows don’t say
Is government gets in the way
Of companies which
Do try to enrich
Themselves, and thus hire and pay

The fundamental fallacy that is pushed by President Obama, PM Rudd of Australia and Ed Miliband, UK’s Labour Party leader, is that the government creates jobs. We hear it incessantly in every political campaign from leaders and politicians on the left side of the spectrum. It is, however, false. Companies create jobs, at least the ones that are meaningful. Government jobs serve one of two purposes: defense, which is meaningful but a small proportion of those created, or reallocating the value created by the private sector to the areas desired by the government in power. There is no value creation and therefore no permanence attached to these positions. I am reminded of this again this morning as the weaker than expected jobs data from Australia overnight was a blow to PM Rudd’s reelection campaign. Aussie fell on the release initially and was trading quite poorly until the Chinese Trade data was released ninety minutes later. Those numbers showed both exports and imports climbing significantly more than expected (by 5% and 11% respectively) and indicate that the Chinese economy is not slowing further but rather is stabilizing after its recent slowdown. Again, one data point does not a trend make, but the news was clearly positive for Australia and Aussie jumped on the report. It is now trading back at its highest level this month, although it remains down more than 14% since April.

But back to jobs and their connection to the FX markets. There is no argument that significant unemployment is both a short and long term negative for an economy. The erosion of skills that occurs, the stress on the public finances and the general malaise of the unemployed population are all very real and very problematic. (Just look at Spain and Greece) The question is how do policymakers deal with the situation and what are the most effective solutions. And the problem is that in the current situation across most developed nations, policymakers have not been able to address the problem effectively. In most cases this seems to be a partisan issue, where the most likely solutions, like freeing up the labor market from its many restrictions, are anathema to the party in power. And the proposed solutions, like raising the minimum wage, are exactly the wrong medicine for the problem. The more a country pushes this type of process, the worse it is for that economy and by extension the currency attached. So here in the US, for example, we have that exact situation in place. Calls for a higher minimum wage, dismissiveness towards potential job creation of major private projects, like the Keystone XL pipeline, and a weakening currency. As I continue to try to understand the FX market, I look at US monetary policy, which while still quite easy has pretty clearly reached an inflection point as to the extent of that ease. They will be tightening soon with the taper. Fiscal policy could hardly be considered tight, although the sequestration did tighten it somewhat. The economy is showing signs of more stable growth and the employment situation, at least as measured by the Unemployment Rate, is improving. And yet the dollar remains on the defensive. Arguably, amongst the major currencies, the situation in the US is the best of the bunch. So why is the dollar soft? I cannot attribute it all to the misguided ramblings of the president with regard to his ‘jobs’ ideas, but underlying investment decisions are clearly predicated on expectations of future policy. The US may not seem as attractive an investment destination if the government continues to interfere more broadly than it has historically in the labor market. I mean when it comes to real investment like building factories and production capabilities, labor market policies matter a great deal.

And when it comes to the FX market, changes in perception of government policies matter a great deal. Remember, markets respond to changes in relative policies, not absolute measurements. So if a country tightens monetary policy, or fiscal policy or labor market policy relative to what it had been doing, that is the catalyst for market movement. And arguably, tightening labor policy is akin to tightening fiscal policy, which has historically been a currency negative. I am beginning to think that the G10 governments are addressing fiscal policy issues through other than direct means, like labor policy, as the channel to address them directly is too politically difficult. I have a feeling we will be seeing much more in the way of this type of market intervention as we go forward, mostly to the detriment of the currencies involved.

Aside from Aussie’s rally, the rest of the G10 space has been pretty dull. The BOJ did nothing, as expected, left their economic assessment unchanged and the yen is modestly higher. BOJ Governor Kuroda went on record saying the sales tax hike was necessary and important, and more importantly implied that the BOJ would support the economy with further monetary ease when it comes into effect. Again, it is hard to see this as a yen positive, but market momentum remains for a stronger yen right now.

In the EMG space, Brazil made new lows yesterday, trading up to 2.3162 at its worst and continues, in my view, on toward 2.50. While the China news will be seen as a positive, it will not be enough to stop this trend. INR also benefitted from the China news, rallying a bit, but remains within one Rupee of its record low. MXN, ZAR, KRW and the other larger currencies in this space have all rallied modestly overnight although this appears to be more general USD weakness rather than specific currency strength. Today’s Initial Claims data is not likely to have a substantial impact, so as we continue with summer markets, I expect the dollar’s slide to extend a bit further. Ultimately, I am still a dollar bull, but the market is telling us that being bullish the dollar right now is the wrong trade. So receivables hedgers, take advantage of this dollar weakness as I am convinced it will dissipate as we head into the fall.

Good luck
Adf

Said Carney, Inflation? Whatever
Our mandate requires we endeavor
To help England grow
When it’s apropos
Its fortunate we are quite clever

The pound is higher this morning although I’m not sure I get the rationale. Carney, in his first Quarterly Inflation Report (QIR), explained that the BOE’s inflation mandate was really quite flexible. In other words, he doesn’t really care about it at all. Right now growth is the focus and to that end he promised that until Unemployment falls to 7.0%, the MPC won’t even consider cutting back on QE. And when it reaches that level, they will simply reassess the situation to determine what they think is best at that point. And what of inflation? The fact that it remains well above the 2.0% target and has been there essentially since March, 2006 (with just two blips lower) simply is not relevant in the discussion. As UK GDP has not yet attained its pre-crisis levels, Carney is going all in to insure growth is sustainable going forward. So monetary policy in the UK is going to remain on the ultra-ease setting for many months to come.

At the same time, two Fed speakers yesterday, Lockhart and Evans, both were on the tape saying that the ‘taper’ could begin as soon as September. While Lockhart has been modestly on the hawkish side, Evans is a confirmed dove and to have him agreeing with a reduction in QE likely means that it is coming soon. It has become increasingly apparent that the FOMC is uncomfortable with a Fed balance sheet that has reached $3.6 Trillion in size and Chairman Ben wants to get the unwinding process started before he leaves.

Now if we combine these two stories, imminent tightening by the Fed and a medium-term promise of no tightening by the BOE one might expect the pound to suffer a bit. However, once again the perversity of the FX markets shows through and instead we see the pound higher. I wish I had a good explanation for that, but alas, I just don’t know. Arguably positioning ahead of the QIR has played an important role in the move, but for now, it seems momentum favors a continuation to at least 1.5540 and perhaps as high as 1.5750.

Elsewhere in the G3, the yen has been strengthening further, trading below 97 overnight as the BOJ heads into its 2-day meeting tonight. There is no expectation for the BOJ to ease further now and surveys point to no expectations for any policy adjustment until next April or May. The 2.0% inflation target remains far from the current readings, but it seems that the market is more focused on the fiscal picture and Abe’s regulatory efforts rather than more BOJ activity. That’s not to say that buying ￥7 Trillion/month is not significant activity, its just already factored into the price. While my long term view remains a much weaker yen, the shorter term picture is far less clear. Could we trade back to 94-95? Clearly that is viable. However, if I were a yen recievables hedger, I would see that as a golden opportunity to manage my risk.

The euro is the least interesting major today, little changed despite more good news from Germany (IP +2.4% in June). As we are just in the beginning of August and holidays are rampant throughout the Continent, I expect there to be little in the way of new news to drive things here for several weeks yet.

But while the dollar has suffered vs. the pound and the yen, it has rallied vs. the AUD ahead of the Australian labor report tomorrow. That report is expected to show a rise in the Unemployment Rate to 5.8%, which would be its highest since January 2010. We continue to see the INR decline, although it has not yet reached the historic lows set earlier this week. The new RBI Governor, Raghuram Rahan, will have his work cut out for him to try to get India back on track when he starts on September 5. BRL remains a mess, still hovering at the 2.30 level as the Central Bank keeps on trying to prevent any further mishaps there. The bulk of the EMG currencies are a bit weaker this morning, apparently having taken the FedSpeak into account, but movements have not been very large overall.

There is no data of note today in the US, but what we are seeing is lack of liquidity having a real impact on price action. The key to managing risk in this type of market is to leave orders at a comfortable level. This demands patience.  So be certain you (and your management) have that if necessary.

Good luck
Adf

From Europe the news is improving
The British economy’s grooving
And there’s no mistaking
That Germany’s making
An effort to keep things there moving

It’s been something of a mixed bag in the FX markets overnight as the dollar has fallen against its G10 peers but rallied vs. many emerging currencies. This morning’s data from Germany and the UK has shown continued improvement in those nations although across the rest of the Eurozone things are less robust. Starting with the euro, it has edged higher on the back of strong German Factory orders (+3.8% in June), which set the tone for euro strength, albeit not an overwhelming amount. UK IP was stronger than expected (+1.1%) and House Prices there rose more than expected (+0.9%), with both pieces of data adding to the picture that the UK is climbing to a level of sustainable growth. The pound has mirrored the euro, rallying a small amount, and both currencies have maintained a positive tone over the past several sessions. Meanwhile, Italy continues to be mired in recession, with the GDP having fallen 2.0% in the past 12 months. While that was better than the -2.2% expected, it still highlights just how big are the problems that remain.

The bigger movers in the G10 space have been AUD and NZD. Aussie seems to have been the beneficiary of the adage: sell the rumor, buy the news. The RBA cut rates 25bps last night, which was almost universally expected, but in the accompanying statement they indicated that there was little reason to expect further cuts in the near term. The market had been short AUD overall prior to the announcement so the rally is not that surprising. Meanwhile in New Zealand, the fears over the milk powder issues I mentioned yesterday seem to be abating as the government there has made a strong effort to downplay any long term impacts on the economy.

And what of the yen? It has been edging higher over the past several sessions as the market awaits the outcome of the debate on raising the consumption tax there in October. If you recall, the plan was to raise the national sales tax to 8% in October and 10% in October, 2014, but PM Abe and his crew are concerned that raising taxes in a still weak economic environment may derail the recovery. Of course with a debt/GDP ratio approaching 250%, the government needs to show that they are looking at the revenue side of the equation in addition to the spending side. The IMF has added pressure on the Japanese to implement the tax hike with a statement overnight (of course, the IMF’s only known solution to all problems is raising taxes), and there continues to be concern over the idea that the BOJ is monetizing Japanese debt. So what can one expect? The long term situation in Japan has not changed meaning the yen has much further to decline. The catalyst for the next leg is still most likely to be the revamped ‘third arrow’ of policy from the government. However, given how tenuous the situation remains with regards to the massive debt position, it is quite feasible that something else triggers the next sell-off there. I see no reason for USDJPY to trade below its recent lows of 97.65, but markets are perverse and if positioning is more heavily short yen than I think, that move could be larger. In the end, the yen will eventually weaken further, but for now it has legs for modest strength.

In the EMG universe, INR is noteworthy for having traded to yet another historic low, this time at 61.806 before bouncing on intervention stories. Traders and investors continue to be concerned over the massive C/A deficit and are fleeing the local stock markets. This currency has further to fall as the RBI will not have the firepower to do much more than smooth the decline. I am still looking for 65.00 before the end of the year. And in Brazil, we are once again seeing the dollar above 2.30. The central bank there is doing all it can to prevent a freefall, with rate hikes trying to fight increasing inflation and slow the currencies decline. But the market is not yet a believer in the preferred outcome and sellers of BRL continue to materialize everywhere. Remember last year when the central bank was fighting a ‘too strong’ BRL? They created all kinds of rules to prevent inward investment and a rising currency. I’ll bet they would be pretty happy with that issue right now! USDBRL is on its way to 2.50, with the central bank there simply slowing the trajectory. Mark my words.

This morning in the US we see the Merchandise Trade Balance (exp -$43.0B) but unless it is a big miss, I doubt it will matter much to the market. As I wrote yesterday, there seems to be very little that has people willing to get involved here. Without comments from a Fed personality, I expect we close the day within 0.2% of where currencies are right now.

Good luck
Adf

The ice throughout Europe’s still thin
Can Angela Merkel yet win?
And what of Rajoy?
He’s no altar boy
While Silvio’s soon a has-been

The FX markets are remarkably dull this morning, with perhaps the most exciting movement that of the New Zealand Dollar which has fallen almost 1% on a story about China banning milk powder imports from Fonterra, the big dairy producer there. Otherwise, in the G10 space, things are little changed. Friday’s payroll data were mixed with the NFP number disappointing at +161K but the Unemployment Rate falling to 7.4%. However, given the buildup in expectations from the strong ADP number as well as the relatively stronger US data we had been seeing, it was no surprise to see the dollar fall in the wake of the number. Just not that far.

With regard to the major currencies, the weekend merely brought a rehash of the ongoing problems in Europe. In order of importance (at least in my opinion) these are: the upcoming German election; the fallout from the upholding of Berlusconi’s tax fraud conviction by the Italian Supreme Court; the ongoing inquiry into Spanish PM Rajoy and the PP’s slush fund; and Greece’s continuing struggle to reform itself to both satisfy its paymasters at the Troika and its long suffering population. The thing is that for now, market players are quite sanguine over the prospects of any of these becoming an issue. After all, it is the beginning of August and many, if not most, of the important players in Europe are on summer holiday. However, I feel it would be a mistake to dismiss these issues. After all, the flip-side to traders and politicians being on holiday is that markets are far less liquid during this time of year. And any news from one of these stories, or any other major surprise, can have a disproportionate impact on prices. So while it is hard to point to a cause for a large move in the near term, especially since we won’t be seeing important data for at least several weeks, it is not hard to see how a surprising piece of information could lead to an outsized move. And this, my friends, is why companies hedge their FX risks!

A brief look at Emerging markets shows that Chinese non-manufacturing PMI data was released marginally better than expected at 54.1 over the weekend. The pundits in China were quick to point out that the slowing growth story there is ending and China remains on track for 7.5% growth in 2013. Now on the one hand, I would say that a modest positive blip in a survey outcome is hardly the start of a trend and so further weakness may yet appear. On the other hand, we are talking about China, and quite frankly, they can print any number they choose as the official growth statistic. Who is going to call them out on it? Again, my concern remains that growth there is slowing a bit more rapidly than the government would like and my money is still on GDP much nearer 7% if not below when it is all tallied up at year end. I will say this, a stronger China number would normally lead to a positive performance by the AUD, but as we look this morning, the Aussie has traded to fresh 3 year lows and shows no signs of stopping. It seems to me the market is still betting on a further slowdown in China.

As you can see from the table below, there is very little data this week, with this morning’s non-mfg ISM likely the most interesting data point. However, I doubt any of this results in much movement.

My best advice is make sure the current low volatility environment allows you to keep appropriate hedges in place while they’re cheap. Because when we get the next move, the price of hedging will surely increase.

Good luck
Adf

In Italy, tremors anew
As Silvio’s problems just grew
His tax fraud is real
He’s got no appeal
We may soon bid Letta adieu

What then? Will the euro decline?
Or will traders say its just fine?
Depends if we see
A hiring spree
From Payrolls this morning ere nine

As we await this morning’s NFP data and the accompanying Unemployment Rate, markets are continuing their recent trends. Equities have been rallying strongly based on the continuation of the free money QE paradigm which was reinforced yesterday by both the BOE, which said nothing to change last month’s actions, and the ECB, where Signor Draghi claimed any rate rises were “unwarranted” as the ECB will be keeping rates low for an “extended period”. Treasuries are softer after more good US data has traders getting excited that the Fed’s tapering operation will begin in September, and the dollar is generally stronger on a combination of higher US yields and optimism that the US growth path is sustainably improving. Will all this continue? While I like the dollar higher and bonds lower, I remain concerned over the valuation in the equity markets.

A quick rundown of markets shows the following:

EUR – it has been rallying steadily for 3 weeks but appears to have lost its momentum. While data in the Eurozone has improved, it still lags that of both the US and UK. With Draghi promising no rate movements for an extended period and the market looking for the Fed to ‘taper’ QE, it feels like the euro is rolling over. We never made it to 1.34 on this move and it feels like a test of 1.30 is more likely soon.

JPY – The Fed meeting was the catalyst for the rebound from the 97.75 level and here we are pushing 100 as I type. The Nikkei rallied on the back of the weak yen and the yen remains weak on prospects for further US rate rises. The interest rate spread between JGB’s and Treasuries has widened again and that draws in Japanese buyers of dollars. A strong number this morning should see a break back above 100 and perhaps a test of the early July levels of 101.50.

GBP – The pound has been a bit more volatile than the euro, showing real strength since early July although giving some of it up in the past week. The economic data there has been improving (last night Nationwide House prices roles 0.8%, better than expected and Construction PMI jumped to 57.0, its highest since March, 2012) and Carney continues to have the market’s confidence that he will manage things for growth. I think the pound will outperform the euro but lag the dollar for now, assuming payrolls today confirms the recent USD trend.

BRL – Well, yesterday we traded through 2.30 for the first time since March, 2009, and while the central bank was actively in the market trying to prevent further weakness, the much weaker than expected Trade data (-$1.9 Billion, exp +$400Million), has caused concern amongst investors and added pressure on the currency. My crystal ball still sees 2.50 as a target, although I imagine the central bank will fight it all the way. (I wonder if FinMin Mantega is still worried about a currency war?)

INR – As I pointed out earlier this week, the Rupee has lost the confidence of the FX market. We are currently trading barely below the historic highs in USDINR and seem poised to break well beyond. Strong data this morning will simply add to the pressure on the Rupee and 65.00 is very much in play in the near term. The country cannot seem to address either its weakening growth or rising inflation issues, neither of which is going to support the currency.

Wednesday morning I suggested that the only certainty was that FX rates would move a lot through the end of the week. Even before the payroll report, let’s recap the movements thus far:

As you can see, we’ve already had good movement with more in store today.

Good luck and good weekend
adf

The Fed is concerned if inflation
Remains too low then this great nation
Will have trouble growing
And so they’re foregoing
All thoughts that less money they’ll ration

in·fla·tion [in-fley-shuhn]

noun

1.
Economics . a persistent, substantial rise in the general level of prices related to an increase in the volume of money and resulting in the loss of value of currency (opposed to deflation ).

Sometimes I think it is useful to go back to the basics and remember what we discuss each day.  According to Dictionary.com, this is the definition of inflation, and I think it does a very good job of highlighting the two aspects of why inflation is seen as a problem.  Rising prices lead to the devaluation of money.  Now other than the fact that I buy things and see how prices change, I am no expert in inflation.  (If you want an expert in inflation, read my friend Mike Ashton’s blog E-piphany, http://mikeashton.wordpress.com or follow him on Twitter, @inflation_guy).  However, I have been giving it some thought lately since every economist will agree that high inflation reduces the value of a currency.  This value needs to be considered as both the value of the goods one can purchase with a given amount of money as well as the relative value of one currency vs. another.  Now mostly I write about the latter, relative values, but this morning I wanted to register my annoyance at Chairman Ben with regard to the first point.

Yesterday the Fed left policy completely unchanged and the accompanying statement modified the growth outlook from “moderate” to “modest”.  But it also said the following: “The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.”  Now I understand that they measure inflation by the Core PCE Deflator, which is currently the lowest reading out there.  But I look at things a bit differently.  Consider what the Fed’s Financial Repression is doing for you these days.  If, after a lifetime of hard work, you save $1,000,000 as your nest egg, the idea was always that you could then earn a low risk interest rate in the long term of something around 5%-6%, which would generate $50-$60k of annual income without touching your principal.  Certainly not a fortune, but enough to help you live in retirement.  However, this option is no longer available to you with the Fed’s current activities.  In fact, you can only earn 2.5% nowadays in 10 year Treasuries, and less via CD’s and other savings instruments.  (I saw a bank offering 5-year CD’s at 1.01% yesterday!)  So despite all your hard work, the Fed has effectively cut the value of your savings in half, from $50k per year to $25k per year.  While the government may not measure inflation that way, I’m pretty confident this counts as a devaluation of your currency holdings.  A 50% reduction in purchasing power over the course of the past 5 years seems to me like inflation is pretty high, (something like 15% per year) regardless of how the Fed measures it.

You may ask how this impacts the FX markets.  Well, since the Fed is not the only central bank engaging in these policies, the relative value of the dollar has held up remarkably well vs. the other countries that are also engaged in Financial Repression.  But not every country is so engaged.  And if you look at Poland or Mexico or the Czech Republic, where central bank policies remain more standard, those currencies have outperformed the USD over the past year.  In the G10 space, it has been the Euro and the Danish Krone that have been best.  Of course the Danes track the euro and the ECB has only more recently begun its own efforts at Financial Repression, so it hasn’t yet built up the momentum or track record of the Fed.  The yen, on the other hand, has 20 years of experience at Financial Repression, and it has doubled down lately, leading to the weakest currency performance in the world over the past 12 months.

But on to more immediate concerns.  The BOE left policy completely on hold, as expected and there was no ensuing statement.  Next week, Governor Carney will release a report on the BOE’s analysis of other monetary tools, like forward guidance, which has obviously had an impact on their actions.  It has become increasingly clear that central bankers around the world have become enamored with the idea of forward guidance because it seems to help them without spending any actual money or adjusting their respective balance sheets.  Carney pioneered this idea at the Bank of Canada and it was taken up enthusiastically by Bernanke.  Now, Draghi and his ECB buddies are on board, as are the BOJ and SNB.  Even the RBA is toying with it through the discussions of scope for further rate cuts.  I wonder what they’ll do when this tool wanes in effectiveness.  Meanwhile, the ECB also left rates on hold, also as expected, and Draghi has not yet met with reporters so we don’t know what he will say.  But today’s data showed that Manufacturing PMI’s in Europe were generally stronger than expected as well as higher than last month.  In the UK, the number was actually quite robust at 54.6.  However, the euro has been unable to gain any traction this morning and is a bit softer, while the pound has responded positively to the data and bounced a bit.  Later this morning we get the ISM Manufacturing data here (exp 52.0) but first Initial Claims (345K).  And of course, tomorrow is payrolls, so I doubt today’s data will foster too much more activity.  Unless Draghi says something completely new, it appears that markets will remain more or less rangebound until tomorrow morning.

Good luck
Adf

This afternoon Ben will be speaking
And pundits will do their critiquing
But ere that occurs
The stat he prefers
Will show the economy’s creaking

Welcome to Wednesday, the first big data day of the week! But both tomorrow, with the BOE and ECB decisions and Friday with the US payroll report are set for excitement as well. Early on today we will see the ADP Employment figures (exp 180K) then Q2 GDP (1.0%, down from 1.8% in Q1). Chicago PMI will probably be lost in the shuffle (54.0) and finally, this afternoon at 2:15, the FOMC Rate Decision (no change at 0.25%) and more importantly its accompanying statement. All eyes will be on the statement as market participants await clues for the next move by the Fed and the corresponding impact those moves will have on every market. What we have learned since the last meeting is that the Fed has begun to seriously consider the issue of ending QE. However, given the tangle of policy initiatives; QE, rates and forward guidance, they have had some difficulty fine-tuning the exact process. It has been 2 weeks since Bernanke testified before both the House and Senate, and we have not heard very much in the interim. Markets have seemed to stabilize during this period, but there remains significant uncertainty over when and how monetary policy will be adjusted further.

With all that said, I think this morning’s data should be seen as quite important. After all, the Fed has made it clear they are watching the data closely and have created formal data triggers for policy adjustments. The ADP data should be seen as a harbinger for Friday’s numbers, and the GDP data is important as a gauge of the Fed’s success. Strong numbers should lead to a stronger dollar, at least somewhat, but this data is really just adding to the body of knowledge with regard to when QE is going to end. And of course, this afternoon’s statement will have a much more direct influence on that. I continue to like the idea I mentioned yesterday, put forth by Professor Tim Duy of Oregon, that the Fed is trying to adjust the mix of policy but not the amount of ease. We shall see.

It is no surprise that the overnight session has been rather dull as everyone awaits today’s news. G10 currencies are all trading within recent ranges with only the AUD on the verge of a breakout. It has slipped a bit more after yesterday’s RBA comments.

In EMG, LATAM currencies seem to be the worst performers of late, especially BRL which has traded to its weakest point in almost 5 years. The situation there is starting to get out of control. President Rousseff seems to be losing her authority, the people are demonstrating in the streets, inflation is trending higher and growth continues to slow. This is not a combination of events that favors a strong currency, and as I wrote back on June 21, the odds of USDBRL rising to 2.50 or beyond are growing. We have just breached the highs made that day and it feels as though there is plenty of momentum for further movement right now. But it is not just BRL that is weak, both MXN and CLP are amongst the worst performers in the emerging markets during the past week as well.

What I have observed of late is that there is no broad dollar trend. Rather than simple risk-on/risk-off, we are seeing markets differentiate between specific national risks, like Australia’s pending rate cuts weakening the AUD or Poland’s move to a Current Account surplus leading to a stronger PLN. On the whole, this is a healthy situation as markets do a better job of allocating risks and assets in this environment. Alas, my concern is that the Fed will have the ability to undo this process by its statement this afternoon. We are about to embark on several days of significant information flow, and I think the only thing of which we can be sure is that FX markets will not be at the same levels Friday afternoon as they are right now.

As I type here are the rates:
EUR – 1.3260
JPY – 97.75
GBP – 1.5205
AUD – 0.9030
BRL – 2.2825
MXN – 12.7050
INR – 60.374

Let’s see where they are Friday afternoon.

Good luck
Adf

Down Under the problems remain
(Though nothing at all like in Spain)
Investment is falling
So Stevens is calling
For rate cuts to limit the pain

As I scan the FX markets this morning two currencies jump out as interesting, AUD and INR, and the rest have much less to recommend. The G3 currencies are essentially unchanged and most other currencies have seen only limited movement. So let’s talk AUD. Last night, RBA governor Glenn Stevens made a speech where he intimated that as the mining investment boom of the past 3 years wanes, nothing else has picked up the slack. He also noted that inflation was well below target and that the RBA’s previously mentioned scope for further interest rate cuts was likely to be utilized. In other words, look for the RBA to cut at least 25 bps next Monday night, and I would now put a modest probability on a 50bp cut. Market reaction was predictable and immediate with Aussie falling one cent almost instantly and then grinding lower from there. At this point, AUD is less than 1% away from its 3-year lows at 0.8999, but as I have written before, I feel it is just a matter of time before that level is breeched and we head toward the longer term average near 0.80. The combination of further RBA easing and potential Fed tightening (we will get back to this in a moment) will be too much for the AUD to withstand.

As to INR, the decline was pretty steady throughout the overnight session as the market responded to comments by the RBI’s Governor, Duvvuri Subbarao. Last night he was talking about many things, including the Rupee, which he claims the RBI will be able to manage effectively, at least with respect to mitigating volatility. Of course, last night’s 1.7% decline may call that ability into question, but given the ongoing issues in India, with a growing C/A deficit, slowing growth and rising inflation, it will take all the central bank’s skills to keep the currency from tumbling. Frankly, though I have been sanguine about the problems in India in the past, I am losing faith in their ability to manage things at this point. Given the overall slowdown in global growth and the policy paralysis that continues to exist in India it is difficult to be overly optimistic about the currency. I think the RBI will do all it can to mitigate the decline, but at this point, I have come to believe that the INR has further to fall. Could we reach 65? I think the answer is yes.

Now back to the idea about potential Fed tightening. As we all know, this morning the FOMC begins a two-day meeting with the next policy statement to be released tomorrow afternoon at 2:15pm. The Fed is not going to change policy in any way tomorrow, of that I am certain. But the nuances of what they are doing are worth discussing. University of Oregon Professor Tim Duy has made a very interesting observation about the Fed’s policies. (http://economistsview.typepad.com/timduy/) Right now, policy consists of zero interest rates, QE and forward guidance, each designed to add to easy money. However, there is a growing concern, both inside and outside the Fed, that QE may have reached the end of its usefulness. As I have written, along with many others, unwinding QE will be a very big issue with significant ramifications in the market including increased volatility and likely sharp declines in asset prices. Professor Duy’s observation is that it seems that Bernanke is trying to alter the mix of policies while keeping the same total amount of monetary easiness in place. So the talk of tapering asset purchases is to be taken hand-in-hand with additional forward guidance. In this way, he can start to remove the policy piece that is getting out of hand, while still supporting the market as aggressively as he has been doing all along. This would likely take the form of a reduced economic outlook or even more definitive guidance on when rates are likely to rise again based on further information. Remember, the taper was based on the idea of growth increasing toward 3.0%-3.5% next year. If that outlook is moderated, then the market will expect tapering later, although it would be unlikely to see an increase in QE. But it also could be that a diminished outlook for growth simply means that the taper happens and rates stay at zero for even longer. It is worth reading Professor Duy’s piece for the full explanation. It is quite interesting.

So today is shaping up to be fairly dull with only Case/Shiller and Consumer Confidence. Look for limited activity today, but be prepared for tomorrow, as we open with ADP Employment and then get Q2 GDP and the FOMC statement as the day moves on.

Good luck
Adf