Just Dreams

Last night saw a rocket attack
On assets, US, in Iraq
The oil price surged
While stocks were submerged
’neath selling by bulls who cut back

This morning, however, it seems
Concerns about war were just dreams
The losses reversed
As traders still thirst
For assets now priced at extremes

What a difference a day makes…or does it? Yesterday saw market participants’ initial evaluation of the threat of escalation in Iran/Iraq as limited with the result that early price action favoring haven assets reversed and most markets closed within a few basis points of Monday’s prices. The one exception to that rule was the dollar, which maintained its bid all day long, actually extending its gains late into the session. Other than the idea that international investors are buying dollars so they can buy US stocks, it is hard to come up with a short term rationale for the dollar’s recent strength. If anything, news this morning that the Fed’s balance sheet has grown even further, to $4.17 trillion, would imply that a weaker dollar is in the offing.

Of course, last night, shortly after the US markets closed, came the news that Iran fired a number of missiles at two different military bases in Iraq that are jointly used by the US and Iraqi militaries. There was a great deal of huffing and puffing from Iran, they announced the attacks themselves on Iranian TV, but in the end, they were nothing more than damp squibs. There was no material damage and no personnel killed, or even severely wounded. (And that is a good thing!) But at the time the news hit the tape, this outcome was not clear and risk assets plunged while haven assets soared. Thus, overnight saw gold trade up to $1610/oz, WTI rise to $65.65 (Brent to $71.75), Treasury yields fall to 1.74% and the yen rise to 107.65 (0.75%). But that price action, and the fear driving it, was quite short-lived. Once it became clear that the Iranian retaliation was completely ineffective, and they announced they were not interested in a major conflict, essentially all of that movement was reversed. So this morning we see gold at $1579/oz, WTI at $62.60, Treasury yields back to 1.82% and the yen actually net weaker on the day, at 108.70 (-0.25%).

This begs the question of how to consider this new potential risk going forward. The first rule of an exogenous market risk is the law of diminishing returns. In other words, even if there is another attack of some sort, you can be sure that the haven rally will be smaller and risk assets will not decline as much as the first time. And since this entire affair is occurring in a locale that, other than oil production, has almost no impact on the global economy, the impact is likely to be even smaller. Now I waved off oil production as though it is not important, but there is no question that the remarkable rise of US oil production has significantly altered the global politics of oil. When the Middle East was responsible for more than 50% of global production, OPEC ruled the roost, and anything that happened there had a global impact. But as oil production elsewhere in the world has grown and OPEC’s market share sinks below 40% (remember, the US is the world’s largest oil producer now), the impact of Middle Eastern conflagrations has fallen dramatically. The point is that short of a major attack by Iran on Saudi oil facilities or attempts to close the Persian Gulf, this situation has probably driven all the market excitement it is going to. In other words, we need to look elsewhere for market catalysts.

With that in mind, if we turn to the ongoing data releases, we find that German Factory Orders once again missed the mark, falling 6.5% Y/Y in November, highlighting that the industrial malaise in the engine of Europe continues. French Consumer Confidence fell more than expected, and Eurozone Confidence indices were almost uniformly worse than expected. It is difficult to look at this data and conclude that the situation in Europe is improving, at least yet. I guess, given this situation it should be no surprise that the euro is lower again this morning, down 0.3%, and actually trading at its lowest point this year (a little unfair, but the lowest level in two weeks). But the dollar’s strength is evident elsewhere in the G10 as the pound remains under pressure, -0.1% today and 0.45% this week. And the same is true pretty much throughout the space.

In the EMG bloc, the results have been a bit more mixed overnight with THB the worst performer (-0.5%) after comments from the central bank decrying the baht’s strength and implying they may do something about it. Remember, too, that APAC currencies, in general, saw weakness on the fear story, which dissipated after those markets closed. On the flip side, ZAR is the day’s biggest gainer, +0.6%, completely recouping its early-session Middle East related losses, as investors apparently focused on the incipient US-China trade deal and how it will benefit the global economy and South African interests.

On the US data front, yesterday saw a smaller than expected Trade Deficit and better than expected ISM data (55.0 vs. 54.5 exp). This morning we are awaiting the ADP Employment numbers (exp 160K) and Consumer Credit ($16.0B) this afternoon. We also hear from Fed Governor Lael Brainerd this morning, but it doesn’t appear as though she will focus on monetary policy as part of her discussion on the Community Reinvestment Act.

In the end, US data has continued to perform well, which thus far has been enough to offset the early impact of the Fed’s (not) QE. However, as the Fed balance sheet continues to grow, I continue to look for the dollar to decline throughout the year. As such, payables receivers should consider taking advantage of the dollar’s early year strength.

Good luck
Adf

 

What’s Most Feared

For almost two days it appeared
That havens were to be revered
But with rates so low
Investors still know
That selling risk is what’s most feared

By yesterday afternoon it had become clear that market participants were no longer concerned over any immediate retaliation by Iran. While there have been a number of comments and threats, the current belief set is that anything that occurs is far more likely to be executed via Iranian proxies, like Hezbollah, rather than any direct attack on the US. And so as the probability of a hot war quickly receded in the minds of the global investment community, all eyes turned back toward what is truly important…central bank largesse!

As I briefly mentioned yesterday, there was a large gathering of economists, including many central bankers past and present, this past weekend in San Diego. The issue that seemed to generate the most interest was the idea of negative interest rates and whether their implementation had been successful, and more importantly, whether they ever might appear as part of the Fed’s policy toolkit.

Chairman Powell has made clear a number of times that there is no place for negative rates in the US. This sentiment has been echoed by most of the current FOMC membership, even the most dovish members like Kashkari and Bullard. And since the US economy is continuing to grow, albeit pretty slowly, it seems unlikely that this will be more than an academic exercise anytime soon. However, a paper presented by some San Francisco Fed economists described how negative rates would have been quite effective during the throes of the financial crisis in 2008-2009, and that stopping at zero likely elongated the pain. Ironically, former Fed chair Bernanke also presented a paper saying negative rates should definitely be part of the toolkit going forward. This is ironic given he was the one in charge when the Fed went to zero and had the opportunity to go negative at what has now been deemed the appropriate time. (Something I have observed of late is that former Fed chairs are quite adept at describing things that should be done by the Fed, but were not enacted when they were in the chair. It seems that the actuality of making decisions, rather than sniping from the peanut gallery, is a lot harder than they make out.)

At any rate, as investors and analysts turn their focus away from a potential war to more mundane issues like growth and earnings, the current situation remains one of positive momentum. The one thing that is abundantly clear is that the central bank community is not about to start tightening policy anytime soon. In fact, arguably the question is when the next bout of policy ease is implemented. The PBOC has already cut the RRR, effective yesterday, and analysts everywhere anticipate further policy ease from China going forward as the government tries to reignite higher growth. While Chairman Powell has indicated the Fed is on hold all year, the reality is that they are continuing to regrow the balance sheet to the tune of $60 billion / month of outright purchases as well as the ongoing repo extravaganza, where yesterday more than $76 billion was taken up. And although this is more of a stealth easing than a process of cutting interest rates, it is liquidity addition nonetheless. Once again, it is this process, which shows no signs of abating, which leads me to believe that the dollar will underperform all year.

Turning to today’s session we have seen equity markets climb around the world following the US markets’ turn higher yesterday afternoon. Bond prices are little changed overall, with 10-year Treasury yields right at 1.80%, and both oil and gold have edged a bit lower on the day. Certainly, to the extent that there was fear of a quick reprisal from Iran, the oil market has discounted that activity dramatically.

Meanwhile, the dollar is actually having a pretty good session today, rallying against the entire G10 space despite some solid data from the Eurozone, and performing well against the bulk of the EMG bloc. The dollar’s largest gains overnight have come vs. the Australian dollar, which is down nearly 1.0% this morning after weak employment data (ANZ Job Adverts -6.7%) reignited fears that the RBA was going to be forced to cut rates further in Q1. But the greenback has outperformed the entire G10 space. The other noteworthy data were Eurozone Retail Sales (+1.0%) and CPI (+1.3% headline and core) with the former beating expectations but the latter merely meeting expectations and the core data showing no impetus toward the ECB’s ‘just below 2.0%’ target. Alas, the euro is lower by 0.15% this morning, dragging its tightly linked EEMEA buddies down by at least that much, and in some cases more. Finally, the pound has dipped 0.3%, but given the dearth of data, that seems more like a simple reaction to its inexplicable two-day rally.

In the EMG space, APAC currencies were the clear winners, with CNY rallying 0.5% as investment flows picked up with one of this year’s growing themes being that China is going to rebound sharply, especially with the trade situation seeming to settle down. It can be no surprise that both KRW and IDR, both countries that rely on stronger Chinese growth for their own growth, have rallied by similar amounts this morning. Meanwhile, EEMEA currencies have been under pressure, as mentioned above, despite the little data released (Hungarian and Romanian Retail Sales) being quite robust.

As to this morning’s session we get our first data of the week with the Trade Balance (exp -$43.6B), ISM Non-Manufacturing (54.5) and Factory Orders (-0.8%). Mercifully, there are no Fed speakers scheduled, so my sense is the market will be focused on the ISM data as well as the equity market. As things currently stand, it is all systems go for a stock market rally and assuming the ISM data simply meets expectations, the narrative is likely to shift toward stabilizing US growth. Of course, with the Fed pumping money into the economy in the background, that should be the worst case no matter what. FWIW it seems the dollar’s rally is a touch overdone here. My sense is that we are going to see it give back some of this morning’s gains as the session progresses.

Good luck
Adf

 

No Rapprochement

The topic du jour is Iran
Where threats, to and fro, carry on
Risk appetite’s fallen
And bears are now all in
That this time there’s no rapprochement

The rhetoric between the US and Iran over the weekend has escalated with both sides threatening retaliation for anything the other side does. Stories of cyber-attacks on the US as well as an attack on a base in Kenya where three Americans were killed seem to be the first steps, but with the US deploying reinforcements to the Middle East, and President Trump promising disproportionate responses to any further actions, the situation has become fraught with danger.

Not surprisingly, financial markets are stressing with risk appetites throughout the world dissipating and haven assets in demand. So, for a second day we have seen equity markets fall around the world (Nikkei -1.9%, Hang Seng -0.8%, DAX -1.6%, CAC -1.1%, FTSE -1.0%) and US futures are following along with all three indices currently lower by approximately 0.8%. Treasuries and German bunds have rallied, albeit Friday’s price action was far greater than this morning’s movement which has seen yields on each fall just one more basis point. Gold has soared to its highest level since April 2013 and is now pressing up toward $1600/oz. Oil continues to rise on supply fears, up another 1.0% this morning and nearly 6.0% since Friday morning. But recall that prior to the US action against Soleimani, oil was up more than 20% since October.

And finally, the dollar this morning is…lower. At least mostly that’s the case. In some ways this is quite surprising as the dollar tends to be a haven in its own right, but markets have been known to be fickle prior to today. In the G10 space, the pound is leading the way higher overnight, up 0.5%, which may well be a response to modestly better than expected UK data (New Car Registrations +3.4%, Services PMI 50.0) rather than to the geopolitical risks. Of course, PMI at 50.0 is hardly cause for celebration, but I guess that’s better than further sub-50 readings. The euro has also benefitted this morning, +0.35%, after PMI data across the region was also modestly better than the flash numbers from the week before last. However, based on the latest data, according to most econometric models, GDP for Q1 in the Eurozone is still running at just 0.1%, or less than 0.5% annualized. Again, it’s hard to get too excited about the situation yet.

And then there is the yen, which is essentially unchanged on the day, perhaps the biggest surprise of all. This is because even when the dollar has not run true to course on a risk basis, the yen has been extremely consistent. Granted, since New Year’s Eve, the yen has been the top G10 performer but its 0.5% rally in that time is hardly inspirational. My take is that even heightened rhetoric from either side is likely to see the yen gain further, but remember there are market technicals involved in the trade, with 108.00 having demonstrated strong support since early October. It appears we will need a bit more of a ‘kinetic’ action in Iraq/Iran before the yen takes its next steps higher.

In the EMG bloc, the situation is a bit different, with EEMEA currencies all trading in a tightly linked manner to the euro, and so higher by about 0.35%, but modest weakness seen across most of the APAC region. As to LATAM, CLP is opening much lower (-1.75%) as the central bank backed away from its USD sale program. The bank announced this morning that it would not be selling the $150mm in the spot market it has been executing every day since last autumn. If nothing else, this should be a good indication for hedgers of just how little liquidity exists within that market.

Turning to Friday’s FOMC Minutes, it can be no surprise that the Fed nearly twisted their own arm, patting themselves on the back, for setting policy at just the right place. And then there was the American Economic Association conference this past weekend where the Fed loomed large in the paper production. Former Fed chairs Bernanke and Yellen once again explained that things beyond their control (demographics and technology) were the reason that they could not achieve their policy targets, but both assured us that more of the same policies that have been ineffective for the economy (but great for the stock market) would get the job done! Meanwhile, current Fed members all expressed satisfaction with the current settings, although it is clear there is far more concern over economic weakness than rising price pressures. What is clear is that higher prices are coming to a store (every store) near you.

As to this week, the data parade starts tomorrow and runs through Friday’s payroll report as follows:

Tuesday Trade Balance -$43.9B
  ISM Non-Manufacturing 54.5
  Factory Orders -0.7%
Wednesday ADP Employment 160K
  Consumer Credit $15.8B
Thursday Initial Claims 220K
Friday Nonfarm Payrolls 162K
  Private Payrolls 152K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.5%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.4

Source: Bloomberg

In addition, we hear from five more Fed speakers, with many more doves than hawks slated to discuss their views. In truth, I think it would be more effective if they would simply shut up rather than constantly reiterate their opinion that they have done a great job and will continue to do so unless things change. However, with the reduced risk appetite due to the Iran situation, I guess they feel the need to try to support stock prices at all costs.

In the medium term, I think the dollar will continue to come under pressure. In the short term, I think it is much harder to have a view given the highly volatile nature of the current situation in the Middle East. This is why you hedge; to prevent significant problems, but take care in executing those hedges, markets are skittish on the opening, and market depth may be a bit less robust than normal.

Good luck
Adf

Unease In Iraq

While yesterday, risk basked in glory
This morning risk-off is the story
Unease in Iraq
Had markets give back
The gains seen in each category

Well, this is probably not the way most of us anticipated the year to begin, with a retaliatory strike against Iran inside Iraq, but that’s what makes markets interesting. So yesterday’s bright beginning, where the PBOC reduced its reserve requirement ratio (RRR) by 0.50% to add further liquidity to the Chinese economy which led to broad based positive risk sentiment has been completely reversed this morning. Briefly recapping yesterday’s activity, equity markets around the world soared on the news of further central bank easy money, but interestingly, Treasury bonds rallied (yields declined) and gold rallied as did the dollar. This is a pretty unusual combination of market movements, as generally, at least one of that group would sell off in a given session. Perhaps it speaks to the amount of spare cash on the sidelines looking for investment opportunities to start the year.

However, that was soooo yesterday. At about 7:45 last night the news hit the tape that a senior Iranian general from the QUDS force had been killed by a US drone attack near Baghdad airport. When this was confirmed all of the positive sentiment that had been permeating markets disappeared in an instant. Equity prices went from a strong opening in Asia to closing with declines. The dollar and the yen both rallied sharply as did gold and oil. And not to be left out, Treasury yields have plummeted along with Bund and Gilt yields. In other words, today is a classic risk-off session.

So a quick look at markets as NY starts to walk in shows European equity markets under pressure (DAX -1.65%, CAC -0.5%, FTSE -0.5%) and US futures similarly falling (DJIA -1.2%, Nasdaq 1.5%, SPY -1.3%). In the bond market, Treasury yields are down 7.5bps to 1.80% while German Bunds are down 7bps to -0.30%. Gold prices have rallied a further 1.4% and are back to the highs touched in September at $1550/oz, a level which had not been seen since early 2013 prior to that. Oil prices have rocketed higher, up 3.9%, as fears of supply interruptions make the rounds. Of course, given that the US shale producers have essentially become the swing producers in the market, my sense is that we are not likely to see a permanently higher price level here. Remember, when Iran attacked Saudi oil facilities last September, the oil price spike was extremely short-lived, lasting just a couple of days before settling right back down.

And finally, the dollar has rallied sharply this morning against virtually all its counterparts except, naturally, the yen. During the last week of 2019, the dollar sold off broadly, losing about 2.0% against a wide range of currencies as investors and traders seemed to be preparing for a scenario of continued low US interest rates supporting stocks while undermining the dollar’s value. Of course, my view of ‘not QE’ having a significant impact on the dollar has not changed, and although the US economy continues to outperform its G10 peers and US interest rates remain higher than pretty much every other country in that bloc, the history of QE is that it will undermine the dollar this year.

But for right now, long-term structural issues are taking a back seat to the immediacy of growing concern over escalating tensions in Iraq and the Middle East. If a larger conflict erupts, then we are far more likely to see protracted USD and JPY strength alongside weaker equity markets, higher prices for gold and oil and lower Treasury yields. And the thing to remember right now is that traders were establishing short USD positions for the last several weeks, so this sudden reversal could well have further to run on position squaring alone. Markets remain less liquid than normal as most trading desks will not be fully staffed until Monday. So keep that in mind if some hedging needs to be executed today.

With that as an introduction, what else can we anticipate today? Well, we do get a bit of US data, ISM Manufacturing (exp 49.0) and ISM Prices Paid (47.8) as well as Construction Spending (0.4%) and then at 2:00 the FOMC Minutes from the December meeting will be released. Those have garnered a great deal of interest as even though Chairman Powell has essentially told us all that rates are on hold for a long time, all eyes will be searching for further discussion of the repo issue and how the Fed plans to handle it going forward. While they were able to prevent any untoward movement for the year-end turn, they are still buying $60 billion / month of T-bills and the balance sheet has grown more than $400 billion since October. Not coincidentally, equity prices have rallied sharply since October as well. The point is that the Fed remains on a path where they have promised to re-inflate the balance sheet until at least late Spring, and given the direct relationship between the Fed’s balance sheet and equity prices, as well as the demonstrated fear the Fed has shown with respect to doing anything that could be blamed for causing the stock market to decline, it seems awfully likely that ‘not QE’ is going to continue for a very long time. And that is going to weigh on the dollar going forward…just not today.

One more thing to look for this afternoon is a series of comments from a bevy of Fed doves (Brainard, Daly, Evans and Kaplan) who are attending a conference in San Diego. Do not be surprised to hear comments that continue to raise the bar for any possible rate hikes, but allow the idea of rate cuts to filter into the discussion. However, this too, is unlikely to undermine the dollar during a risk-off session. The theme here is that payables hedgers need to consider taking advantage of this short-term dollar strength.

Good luck
Adf

 

Powell at the (Printing) Press

With apologies to Ernest Lawrence Thayer

The outlook isn’t brilliant for the dollar late this year
As Powell’s pushed his printing press into a higher gear
Just like we’ve seen each time the Fed has started up QE
The consequence is weakness in the greenback you will see

Despite the fact that growth at home is better than elsewhere
It seems Jay feels the need to do some more so just beware
The idea that with stocks at highs the Fed will further ease
Is crazy, but, this President, he feels he must appease

So with this as a start let’s take a look around our orb
And see which things we should ignore and which we need absorb
Our first stop is in Europe where the continent’s a mess
With interest rates still negative and banks under duress

The ECB’s new president, the elegant Lagarde
Will quickly find omnipotence was simply a canard
The toolkit there is empty, while unrest proceeds to build
And likely it is that her goals there cannot be fulfilled

So GDP most surely will remain near one percent
And prices, as they’re measured, will not make a real ascent
As to the euro which has slowly ebbed the past two years
Its time has come to rebound somewhat as QE appears

So come December next if you should gaze upon your screen
Don’t be surprised if what you see is One point Seventeen
North of the Channel is the Kingdom near a century old
Where Boris is Prime Minister and Brexit will unfold

The question now at hand is how that nation will perform
Will growth see sunny days or will there be a thunderstorm?
The Old Lady of Threadneedle now has a brand new boss
Who’ll quickly find his toolkit, too, is mostly filled with dross

And don’t forget that Boris promised by December next
A new trade deal with Europe will be written into text
But what if talks on trade devolve into a great morass?
A not unlikely outcome that could clearly come to pass

Then once again the pound will suffer greatly, like ‘Nineteen
When everybody feared the worst would come on Halloween
While that crisis was dodged, come New Year’s Eve some twelve month’s hence
The pound could once again be subject to some real suspense

But in the end QE is what will drive the dollar’s price
As Boris will not risk collapse of his new paradise
So Christmas next when thinking if, to London, you should go
Look for the pound to trade somewhere near One and point Four-Oh

In Asia two great nations vie to lead the world in trade
Both China and Japan, though, know the sting of Trump’s blockade
In China growth keeps slowing as their exports further sink
As well, the People’s Bank has seen supply of money shrink

And China finds itself with debt exploding nationwide
While bankruptcies are multiplying cross their countryside
The Phase One trade deal’s likely not enough to make a dent
And Xi will surely look for ways, the deal, to circumvent

While tariffs may not rise, much further cutting’s not the call
And even though the Chinese really need the Yuan to fall
The Fed’s QE will dominate the market dialogue
So look for Six point Sixty as investors, dollars, flog

Meanwhile the archipelago where Abe rules supreme
Is desperate to develop an inflationary scheme
QE on steroids hasn’t been enough to change the rate
Nor how people behave there while price levels won’t inflate

The population there is not just aging but reduced
And Abenomics hasn’t been enough, it for to boost
As well Japan continues, C/A surpluses, to run
Which history has shown leads yen to mime a rising sun

Combining this with Powell’s move, the balance sheet to build
A wish for weaker yen this year will just not be fulfilled
A year from now expect to see the yen climb to a peak
Of Ninety-five (or stronger) by the end of Christmas week.

North of our border, nervousness has much increased of late
As GDP is slowing and employment feels the weight
Of interest rates now higher even than in the US
While housing debt keeps growing, an old sign of new distress

The central bank has paused its modest path toward tighter rates
But not yet seen the light that everybody advocates
By late this year you can be sure the BOC will cut
Alas the Loonie will already have increased somewhat

Twixt QE here and tightness there the thing that I contrive
Is that come Boxing Day CAD will trade One point Twenty-Five
Next turn your gaze south of the border, to old Mexico
Where growth is nearly stagnant but inflation, too, is low

The central bank’s been cutting rates, though they remain quite high
And I would look for four more cuts ere we wave ‘Twenty bye
As well the prospects for investment there have just improved
As USMCA, in all its glory’s, been approved

Thus higher rates, investment flows and QE will all mix
To drive the peso higher, think Eighteen point Twenty-Six
Two other nations further south, Australia and Brazil
Bear watching, too, as many of you hedges need fulfill

Down Under growth continues, on the Chinese, to rely
As well as on the prices of the metals they supply
The RBA has only two more rate cuts to support
Their growth, which means that QE might just be their last resort

But they will wait till rates are nought ere buying Aussie debt
While Jay is wasting no time growing balance sheet assets
Despite their slowing growth, you ought not be too thunderstruck
When Aussie finishes the year Three Quarters of a buck

The largest nation in LATAM, Brazil, is working hard
To pass reforms in order, Socialism, to discard
Their growth has suffered lately and employment’s been a drag
Encouraging the central bank to cut rates, with a lag

But pundits everywhere believe with rates at record lows
No further cuts are coming lest a black swan moment shows
This leads me to believe that like most currencies around
The Real will get stronger as the dollar still heads down

So, Summer Solstice in Sao Paolo, next, don’t be dismayed
When Three point Six real you get for each greenback you trade
While that completes the currencies, I’d like to spend some time
On equities and bonds and gold, in this new paradigm

The Dow Jones, S&P and Nasdaq all seem overpriced
With stock buybacks supporting EPS and the zeitgeist
And with the Fed still adding cash to help expand reserves
Most pundits see a market rally and steeper yield curves

And while this seems quite reasoned for the first part of the year
Inflation moving higher will have consequence, I fear
As summer wanes, election nears, and chill invades the air
Don’t be surprised if equities have turned from bull to bear

The Dow begins the decade nearly, thousand, Twenty-nine
But I fear it is set for a nine thousand point decline
As well, the 10-year trades right now at One point Nine percent
But when inflation rises look for quite a sharp ascent

The Fed has shown they’ve lost control of money market rates
With repo volatility a cause of great debates
So as QE evolves to coupons from its T-bill start
Beware a steeper curve as bullish bets all fall apart

At Christmas do not be surprised if 10-year Treasuries
Are yielding Two point nine percent completing a short squeeze
And finally there’s gold which will see growth in its demand
As dollars are debased and stocks sink into a quicksand

Though modernists and technophiles all will say pooh-pooh
Our history has shown that even central banks accrue
The barbarous relic as part of assets that they hold
So at year end Two Thousand ought to be the price of gold

And so complete my current thoughts on how, will, markets trend
A weaker dollar, weaker stocks, is how I fear we’ll end
Regardless, though I want to say I do appreciate
Your readership throughout the year, to me, you all are great!

Good luck and have a very happy, healthy and successful 2020!
Adf

 

Wind At His Sails

In England and Scotland and Wales
Young Boris has wind at his sails
A thumping great win
To Labour’s chagrin
Has put Brexit back on the rails

As well, from the US, the news
Is bears need start singing the blues
The trade deal is done
At least for phase one
Thus more risk, investors did choose

An historic victory for PM Boris Johnson yesterday has heralded a new beginning for the UK. Historic in the sense that it is the largest majority in Parliament for either party since Margret Thatcher’s second term, and historic in the sense that the Labour party won the fewest seats since 1935. One can only conclude that Jeremy Corbyn’s vision of renationalization of industry and high taxes was not the direction in which the UK wants to head. Perhaps the only concern is the Scottish National Party winning 49 of the 58 seats available and will now be itching to rerun the Scottish independence referendum. But that is an issue for another day, and today is all about a huge relief rally in equities as the threat of a hard Brexit essentially disappears, while the pound has also benefitted tremendously, rising 1.7% from yesterday’s closing level and having traded almost a full percent higher than that in the early aftermath of the results. So here we are this morning at 1.3390, right at my forecast for the initial move in the event of a Johnson victory. The question of course, is where do we go from here?

Before I answer, I must also mention the other risk positive story, about which I’m sure you are already aware, the news that President Trump has signed off on terms of a phase one trade deal with China. The details thus far released indicate China has promised to buy $50 billion of agricultural products from the US, and will be more vigilant in protection of IP rights, while the US is set to reduce the tariff rates already imposed and delay, indefinitely, the tariffs that were due to come into effect this Sunday. Not surprisingly, equity markets around the world rallied sharply on this news as well while haven investments like Treasuries, Bunds and the yen (and the dollar) have all fallen.

So everyone is feeling good this morning and with good reason, as two of the major political uncertainties that have been hanging over the market have been resolved. With this in mind, we can now try to answer the question of what’s next in the FX markets.

History has shown that while macroeconomic factors have some impact on the relative value of currencies, that impact is driven by the corresponding interest rates in each nation. So a nation that has strong economic growth and relatively tighter monetary policy is likely to see a strong currency while the opposite is also true. Now this correlation is hardly perfect, and financial theory cannot be completely ignored regarding a country’s fiscal balances (current account, trade and budget), where deficits tend to lead to a weaker currency, at least in theory, and surpluses the opposite. Obviously, one need only look at the dollar these days to recognize that despite the US’s significant negative fiscal position, the dollar remains relatively quite strong.

But ever since the financial crisis, there has been another part of monetary policy that has had a significant impact on the FX market, namely QE. As I’ve written before, when the US was implementing QE’s 1, 2 and 3, the dollar fell markedly each time, by 22%, 25% and 17% over a period of 9 months, 11 months and 22 months respectively. Clearly that pattern demonstrates the law of diminishing returns, where a particular action has a weaker and weaker effect the more frequently it is used. Of course, in each of these cases, the Fed funds rate was at 0.00%, so QE was the only tool in the toolbox. This brings us to the current situation; positive interest rates but the beginning of QE4. I know that none of us think 1.5% is a robust return on our savings, but remember, US interest rates are the highest in the G10, by a lot. In addition, the economy seems to be doing pretty well with GDP ticking over above 2.0%, Unemployment at 50 year lows and wage gains solidly at 3.0% or higher. Equity markets in the US make new highs on a regular basis and measured inflation is running right around 2.0%. And yet…the Fed is clearly looking at QE despite all their protestations. Buying $60 billion per month of T-bills with the newly stated option of extending those purchases to coupons is clearly expanding the balance sheet and driving risk accumulation further. And that is QE!

So with the knowledge that the Fed is engaged in QE4, and the history that shows the dollar has fallen pretty significantly during each previous QE policy, my view is that we are about to embark on a reasonable weakening of the US dollar for the next year or so. Now, clearly the initial conditions this time are different, with positive growth and interest rates, but while that will likely limit the dollar’s decline to some extent, it won’t prevent it. If pressed, I would say that we are likely to see the dollar fall by 10% or so over the next 12-18 months. And that is regardless of the outcome of the US elections next year. In the event that we were to see a President Warren or President Sanders, I think the dollar would suffer far more aggressively, but right now, removing the effect of the election still points to a slow decline in the buck. So for receivables hedgers, it is likely to be a situation where patience is a virtue.

Turning to the data story, last night we saw the Japanese Tankan report fall to 0, below expectations of 3 and down from its previous reading of 5. But the yen’s 0.35% decline overnight has more to do with risk appetite than that particular number. However, I’m sure PM Abe and BOJ Governor Kuroda are not thrilled with the implications for the economy. Otherwise, there has been precious little else of note released leaving us to ponder this morning’s Retail Sales data (exp 0.5%, 0.4% ex Autos) and wait to hear pearls of wisdom from NY Fed President Williams at 11:00. Of course, given the fact the Fed just finished meeting and there appears very little uncertainty over their immediate future course, my guess is the only thing he can try to defend is ‘not QE’ and how they are on top of the repo situation. But today is a risk on day, so while we may not extend these movements much further, I feel we are likely to maintain the gains vs. the dollar across the board.

In a final note, this will be the last poetry until January as I will be on vacation and then will return with my prognostications for 2020 to start things off.

Good luck, good weekend and happy holidays to all
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Up, Up and Away

Said Powell, “We’re in a good place”
On growth, but we don’t like the pace
That prices are rising
And so we’re surmising
More QE’s what needs to take place

Today, then, we’ll hear from Christine
Who is now the ECB queen
This is her first chance
To proffer her stance
On policy and what’s foreseen

And finally, in the UK
The vote’s taking place through the day
If Boris does badly
Bears will sell pounds gladly
If not, it’s up, up and away

There is much to cover this morning, so let’s get right to it.

First the Fed. As universally expected they left rates on hold and expressed confidence that monetary policy was appropriate for the current conditions. They lauded themselves on the reduction in unemployment, but have clearly changed their views on just how low that number can go. Or perhaps, what they are recognizing is that the percentage of the eligible labor force that is actually at work, which forms the denominator in the unemployment rate, is too low, so that there is ample opportunity to encourage many who had left the workforce during the past decade to return thus increasing the amount of employment and likely helping the Unemployment Rate to edge even lower. While their forecasts continue to point to 3.5% as a bottom, private sector economists are now moving their view to the 3.0%-3.2% level as achievable.

On the inflation front, to say that they are unconcerned would greatly understate the case. They have made it abundantly clear that it will require a nearly unprecedented supply shock to have them consider raising rates anytime soon. However, they continue to kvetch about too low inflation and falling inflation expectations. They have moved toward a policy that will allow inflation to run higher than the “symmetric 2% target” for a while to make up for all the time spent below that level. And the implication is that if we see inflation start to trend lower at all, they will be quick to cut rates regardless of the economic growth and employment situation. Naturally, the fact that CPI printed a touch higher than expected (2.1%) was completely lost on them, but then given their ‘real-world blinders’ that is no real surprise. The dot plot indicated that they expect rates to remain on hold at the current level throughout all of 2020, which would be a first during a presidential election year.

And finally, regarding the ongoing concerns over the short term repo market and their current not-QE policy of buying $60 billion per month of Treasury bills, while Powell was unwilling to commit to a final solution, he did indicate that they could amend the policy to include purchases of longer term Treasury securities alongside the introduction of a standing repo facility. In other words, not-QE has the chance to look even more like QE than it currently does, regardless of what the Chairman says. Keep that in mind.

Next, it’s on to the ECB, which is meeting as I type, and will release its statement at 7:45 this morning followed by Madame Lagarde meeting the press at 8:30. It is clear there will be no policy changes, with rates remaining at -0.5% while QE continues at €20 billion per month. Arguably there are two questions to be answered here; what is happening with the sweeping policy review? And how will Madame Lagarde handle the press conference? Given she has exactly zero experience as a central banker, I think it is reasonable to assume that her press conferences will be much more political in nature than those of Signor Draghi and his predecessors. My fear is that she will stray from the topic at hand, monetary policy, and conflate it with her other, nonmonetary goals, which will only add confusion to the situation. That said, this is a learning process and I’m sure she will get ample feedback both internally and externally and eventually gain command of the situation. In the end, though, there is precious little the ECB can do at this point other than beg the Germans to spend some money while trying to fend off the hawks on the committee and maintain policy as it currently stands.

Turning to the UK election, the pound had been performing quite well as the market was clearly of the opinion that the Tories were going to win and that the Brexit uncertainty would finally end next month. However, the latest polls showed the Tory lead shrinking, and given the fragmentation in the electorate and the UK’s first-past-the-post voting process, it is entirely possible that the result is another hung Parliament which would be a disaster for the pound. The polls close at 5:00pm NY time (10:00pm local) and so it will be early evening before we hear the first indications of how things turn out. The upshot is a Tory majority is likely to see a further 1%-1.5% rally in the pound before it runs out of momentum. A hung Parliament could easily see us trade back down to 1.22 or so as all that market uncertainty returns, and a Labour victory would likely see an even larger decline as the combination of Brexit uncertainty and a program of renationalization of private assets would result in capital fleeing the UK ASAP. When we walk in tomorrow, all will be clear!

Clearly, those are the top stories today but there is still life elsewhere in the markets. Ffor example, the Turkish central bank cut rates more than expected, down to 12.0%, but the TRY managed to rally 0.25% after the fact. Things are clearly calming down there. In Asia, Indian inflation printed higher than expected at 5.54%, although IP there fell less than expected (-3.8%) and the currency impact netted to nil. The biggest gainer in the Far East was KRW, rising 0.65% after a strong performance by the KOSPI (+1.5%) and an analyst call for the KOSPI to rise 12% next year. But other than the won, the rest of the space saw much less movement, albeit generally gaining slightly after the Fed’s dovish stance.

In the G10, the pound has actually slipped a bit this morning, -0.2%, but otherwise, movement has been even smaller than that. Yesterday, after the Fed meeting, the dollar fell pretty sharply, upwards of 0.5% and essentially, the market has maintained those dollar losses this morning.

Looking ahead to the data today we see Initial Claims (exp 214K) and PPI (1.3%, 1.7% core). However, neither of those will have much impact. With the Fed meeting behind us, we will start to hear from its members again, but mercifully, not today. So Fed dovishness has been enough to encourage risk takers, and it looks for all the world like a modest risk-on session is what we have in store.

Good luck
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