Author Archives: fxpoet

The New Weasel Word

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The bulk of the FOMC
Explained their preferred policy
More government spending,
Perhaps never ending,
Is what almost all want to see

Meanwhile, ‘cross the pond, what we heard
Is ‘bove 2% is preferred
They’ll soon change their stance
To give growth a chance
Inflation’s the new weasel word

Another day, another central bank explanation that higher inflation is just what the doctor ordered to improve the economy.  This time, Banque de France’s Governor, Francois Villeroy de Galhau, explained that the current formulation used by the ECB, “below, but close to, 2%”, is misunderstood.  Rather than 2% being a ceiling, what they have meant all along is that it is a symmetrical target.  Uh huh!  I’ve been around long enough to remember that back in 1988, when the ECB was first being considered, Germany was adamant that they would not accept a central bank that would allow inflation, and so forced the ECB to look just like the Bundesbank.  That meant closely monitoring price pressures and preventing them from ever getting out of hand.  Hence, the ECB remit, was absolutely designed as a ceiling, with the Germans reluctant to even allow 2% inflation.  Of course, for most of the rest of Europe, inflation was the saving grace for their economies.  Higher inflation begat weaker currencies which allowed France, Italy, Spain, et.al. to continue to compete with a German economy that became ever more efficient.

But twenty-some years into the experiment of the single currency, and despite the fact that the German economy remains the largest and most important in the Eurozone, the inflationistas of Southern Europe are gaining the upper hand.  These comments by Villeroy are just the latest sign that the ECB is going to abandon its price stability rules, although you can be sure that they will never say that.  Of course, the problem the ECB has is similar to that of Japan and the US, goosing measured inflation has been beyond their capabilities for the past decade (more than two decades for the BOJ), so simply changing their target hardly seems like it will be sufficient to do the job.  My fear, and that of all of Germany, is that one day they will be successful in achieving this new goal and will not be able to stop inflation at their preferred level, but instead will see it rise much higher.  But that is not today’s problem.  Just be aware that we are likely to begin hearing many other ECB members start discussing how inflation running hot for a while is a good thing.  Arguably, the only exceptions to this will be the Bundesbank and Dutch central bank.

And once again, I will remind you all that there is literally no chance that the ECB will sit back and watch, rather than act, if the Fed actually succeeds in raising inflation and weakening the dollar.

Speaking of the Fed, this week has seen a significant amount of Fedspeak already, with Chairman Powell on the stand in Congress for the past three days.  What he, and virtually every other Fed speaker explained, was that more fiscal stimulus was required if the government wanted to help boost growth.  The Fed has done all they can, and to listen to Powell, they have been extremely effective, but the next step was Congress’s to take.  The exception to this thought process came from St Louis Fed President Bullard, who explained that based on his forecasts, the worst is behind us and no further fiscal stimulus is needed.  What makes this so surprising is that he has been one of the most dovish of all Fed members, while this is a distinctly hawkish sentiment.  But he is the outlier and will not affect the ultimate outcome at this stage.

Powell was on the stand next to Treasury Secretary Mnuchin, who made the comment with the biggest impact on markets.  He mentioned that he and House Speaker Pelosi were back to negotiating on a new stimulus package, which the equity market took as a sign a deal would be reached quickly.  We shall see.  Clearly, there is a great deal of angst in Congress right now, so the ability to agree on anything across the aisle is highly questionable.

With that in mind, a look at markets shows what had been a mixed opening is turning into a more negative session.  Overnight saw Asian equity markets with minimal gains and losses (Nikkei +0.5%, Hang Seng -0.3%, Shanghai -0.2%), but Europe, which had been behaving in a similar manner early in the session has turned sharply lower.  At this time, the DAX (-1.95%) and CAC (-2.0%) are leading the way lower, with the FTSE 100 (-0.8%) having a relatively better day.  At the same time, US futures turned from flat to lower, with all three indices now pointing to -0.6% losses at the open.

It is difficult to point to a specific comment or piece of news driving this new sentiment, but it appears that the bond market is in the same camp as stocks.  Treasury yields, while they remain in a narrow range, have slipped 1bp, to 0.65%, and we are seeing Bunds (-2bps) and Gilts (-3bps) also garner demand as havens are in play.  Apparently, central bank desire for inflation is not seen as a serious situation quite yet.

Commodity prices have turned around as well, with oil falling 2% from morning highs, and gold dropping 1%.  In other words, this is a uniform risk reduction, although I would suspect that gold prices should lag the decline elsewhere.

As to the dollar, it is starting to pick up a more substantial bid with EUR (-0.3%) and GBP (-0.35%) sliding from earlier levels.  NOK (-1.15%) remains the worst performer in the G10, which given the decline in oil prices and evolving risk sentiment should be no surprise.  But at this point in the day, the entire bloc is weaker vs. the buck.  EMG currencies, too, have completely reversed some modest early morning strength, and, once again, ZAR (-1.2%) and MXN (-1.0%) lead the way lower.  One must be impressed with the increased volatility in those currencies, as they start to approach levels seen in the initial stages of the Covid crisis.  For anyone who thought that the dollar had lost its haven status, recent price action should put paid to that notion.

On the data front, today brings Durable Goods (exp 1.4%, 1.0% ex Transport) and we hear from two more Fed speakers, Williams and Esther George.  While Williams is almost certain to repeat Powell’s current mantra of more fiscal support, Ms George is one of the more hawkish Fed members and could well sound more like James Bullard than Jay Powell.  We shall see.

This has been a risk-off week, with equity markets down across the board and the dollar higher vs. every major currency in the world.  It seems highly unlikely that the Durable Goods number will change that broader sentiment, and so the ongoing equity market correction, as well as USD rebound seems likely to continue into the weekend.  Remember, short USD positions are still the rule, so there is plenty of ammunition for a further short covering.

Good luck, good weekend and stay safe
Adf

Further To Go

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The contrast could not be more clear
Twixt Powell and Christine this year
The Fed jumped in first
But now they’ve disbursed
As much aid as like to appear

Meanwhile Ms Lagarde in Berlin
Was clearly quite slow to begin
But Europe depends
On banks to extend
Its aid, so can still underpin

More growth by increasing the flow
Of cash, through TLTRO
Thus, traders now see
The buck vis-à-vis
The euro, has further to go

It was less than two months ago when the most prominent theme in the market was the imminent demise of the dollar, not merely in the short-term, but in the long run.  The idea that was being circulated was that because of the US’s excessive and growing twin deficits (Budget and Current Account), investors would soon decide that holding dollar’s would be too risky and thus demand a different unit of account and store of value.  During this period, we did see the dollar sell off, with the greenback falling nearly 6.5% vs. the euro during the month of July.  But that was basically that.  It was a great story, and probably a good trade for some early movers, but explaining short term market volatility by referring to ultra-long-term financial theory was always destined to fail.  And fail it has.  After all, since then, the dollar has actually appreciated (+2.2% vs. the euro) and yet, if anything, the US has seen its budget and current account deficits widen further.

Rather, short-term dollar movement tends to be driven by things like relative monetary policy and relative macroeconomic performance.  Looking back at that time, the prevailing sentiment was that the Fed, despite having already implemented an unfathomable amount of monetary ease already, was preparing to do even more.  Recall, leading up to, and through, the Jackson Hole symposium, market participants were sure that the Fed was going to not merely allow inflation to run hot, but help it do so.  Meanwhile, the ECB, in its typical plodding manner, was very quiet and the punditry saw little in the way of additional ease on the horizon.  In fact, there were complaints that the ECB was not doing nearly enough.

However, as seems to happen quite frequently, the punditry turns out to have gotten things backwards.  Last week, the Fed announced their new policy goals, counting on average inflation targeting to help them achieve significantly lower unemployment, although they still couldn’t didn’t explain how they were going to achieve said higher inflation.  And then earlier this week, Chairman Powell, in as much, admitted that the Fed has done all they can and that it was up to Congress to expand fiscal stimulus in order to give the economy the support it needed to cope with the Covid inspired recession.  In other words, the Fed is out of bullets.

One of the problems the Fed has is that transmission of monetary policy is effected by banks, that is the way the system is designed.  But the bulk of the Fed programs have only supported markets, by them buying Treasuries, Mortgage-backed securities, Corporates (IG and Junk) and Munis.  But for small companies who don’t access the capital markets directly, virtually none of the Fed’s activities have had an impact as the bank’s are reluctant to lend in this environment of economic uncertainty.  Europe, on the other hand, relies on banks for the majority of capital flow to its economy, as European corporate debt markets remain much smaller and more fragmented across countries.  So, when the ECB created the TLTRO, targeted lending facility, where they PAY banks 1.00% to lend money to companies, who also pay the banks interest, it turns out to be a more efficient way to prosecute monetary policy ease.  And this morning, the latest tranche of this program saw an additional €174.5 billion taken up.  This is on top of the €1.3 trillion that was taken up last time there was a tender, three months ago.

The point is, suddenly investors and traders are figuring out that the ECB has the ability to promulgate policy ease more effectively than the Fed, and just as importantly, are doing so.  Add it all up and you have ECB policy looking easier than Fed policy at the margin, a clear recipe for the euro’s decline.  This move in the euro is just beginning, and it would not be surprising to see the single currency head back toward 1.12 before the end of the year.  As I have written in the past, there was no way the ECB would sit back and allow the dollar to fall unhindered.  They simply cannot afford that outcome to occur.

Which brings us to today’s session, where risk is being jettisoned across equity markets globally, although several European markets are starting to turn things around.  Overnight, following a very weak US session, Asia was red across the board led by the Hang Seng (-1.8%), but with weakness in Shanghai (-1.7%) and the Nikkei (-1.1%). Europe, however, while starting lower in every market has now seen a little positivity as the DAX (+0.15%) and Italy’s FTSE MIB (+0.7%) are offsetting increasingly modest weakness in the CAC (-0.1%) and FTSE 100 (-0.4%).  Finally, US futures, which had also been lower by more than 0.5% earlier in the session, have rebounded to flat.

The bond market, however, remains enigmatic lately, with yields continuing to trade in extremely tight ranges regardless of the movement in risk assets.  At this time, Treasury yields are unchanged, after remaining essentially unchanged during yesterday’s US equity sell-off.  Bunds have seen yields edge lower by 1.5 basis points, while Gilt yields have edged higher by less than a basis point.  It seems that the bond markets, globally, are unwilling to follow every twist and turn of the recent stock market manias.

As to the dollar, it is firmer vs. most of its counterparts, but just like we are seeing in European equities, we are beginning to see a bit of a rebound in some currencies as well.  In the G10, the biggest story is NOK (-0.65%) where the Norgesbank disappointed one and all by seeming to be more dovish than anticipated.  Many had come to believe they would be putting a timeline on raising interest rates, but they did no such thing, thus the krone has continued its recent poor performance (-5.8% vs. the dollar in the past month).  But we are seeing weakness elsewhere with SEK (-0.8%) actually the worst performer, albeit absent any specific news, and both NZD (-0.5%) and AUD (-0.3%) suffering at this point.

In the EMG bloc, overnight saw weakness across the Asian currencies led by KRW (-0.7%) and THB, IDR and TWD (all -0.5%) as risk was shed across the board.  But with the recent turn in events, early losses by ZAR (+0.7%) and MXN (+0.3%) have turned to gains.  It is those two currencies, however, which remain the most volatile around, so be careful if hedging there.

On the data front, yesterday’s US PMI data was right on expectations and showed continued progress in the economy, a sharp contrast to the European situation.  This morning saw modestly weaker than expected German IFO data (Expectations 97.7), which is not helping the euro.  Later today we see Initial Claims (exp 840K), Continuing Claims (12.275M) and finally New Home Sales (890K) at 10:00.  Once again, the tapes will be painted with Fedspeak, led by Powell at 10:00 in front of the Senate Banking Committee, but also hearing from six more FOMC members. While I would not be surprised if Powell tried to walk back his comments about the Fed being done, it’s not clear he will be able to do so.

For now, the dollar’s trend remains pretty solid, and I expect that it will continue to grind higher until we get a substantive change in policies.

Good luck and stay safe
Adf

Growth Has Now Faltered

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The working assumption had been
That governments soon would begin
To lift their restrictions
Across jurisdictions
From Lisbon to well past Berlin
 
But Covid had other designs
By spreading, despite strict guidelines
So, growth has now faltered
And views have been altered
Regarding recovery times
 
Remember how smug so many publications around the world seemed when comparing the spread of Covid in the US and throughout Europe?  The narrative was that despite a devastating first wave in Italy and Spain, nations on the Continent handled the situation significantly better than the chaos occurring in the US.  Much was blamed on the different types of healthcare systems, and of course, there was significant opprobrium set aside for the US president. But a funny thing has happened to that narrative lately, and it was reinforced this morning by the preliminary PMI data that was released.  Suddenly, the growth in Covid cases throughout Europe is expanding to what seems very much like a true second wave, with France and Spain leading the way, each reporting more than 10,000 cases yesterday, while in the US, we continue to see a true flattening of the curve.  The discussion in many European countries is whether or not to impose a second lockdown, as governments there try to decide if their economies and budgets can withstand such an outcome.  (I don’t envy them their choice as no matter the outcome, some people will suffer and scream loudly about the decision.)
 
But a funny thing seems to be happening within economies, despite this government wariness to act, people are making the decisions for themselves.  And so, service businesses are seeing real declines in activity as people naturally avoid restaurants, travel and entertainment companies.  And that’s just what the data shows.  PMI Services surveys showed significantly worse outcomes in France (47.5 vs. 51.5 expected), Germany (49.1 vs. 53.0) and the Eurozone as a whole (47.6 vs. 50.6).  In other words, it appears that people are pretty good at self-preservation, and will not put themselves knowingly at risk without a good reason.  Getting a pint at the local pub is clearly not a good enough reason.
 
For elected policymakers, however, this is the worst of all worlds.  Not only does economic activity contract, for which they will be blamed, but they are not making the decisions for the people, which appears to be their primary motivation in so many cases.  Of course, there is a class of policymakers to whom this outcome is seen as a pure benefit…central bankers.  It is this group who gets to continue to preen about all they have done to support the markets economy, and while the Fintwit community blasts them regularly, the bulk of the population sees them as saviors.  Central banking continues to be a pretty good gig.  Lots of power, no responsibility.
 
Meanwhile, the investment community, including those blasting the central bankers on Fintwit, continue to take advantage of the ongoing central bank largesse and pump asset prices ever higher.  While there was a very short correction back at the beginning of the month, now that merely seems like a bad dream.  And if the data continues to turn lower, the one thing we know is that central banks will step further on the accelerator, announcing greater asset purchase programs, and potentially dragging a few more countries (is the UK next?) into the negative rate world.
 
But that is the world in which we live, whether or not we like it, or agree with the policies.  And as our focus is on markets, we need to be able to describe them and try to understand the evolving trends.  Today, and really this week, that trend continues to see the dollar grind higher despite the fact that we have seen both up and down equity market activity.  In other words, this does not appear to be simply a risk-off related USD rally.  Rather, this appears to be a USD rally built on short-term economic fundamentals.  Remember, FX is a relative game, and even if things in the US are not great, if they are perceived as better than elsewhere, that is sufficient to help drive the value of the dollar higher.  One other thing to note regarding the current market activity is that the hysteria over the dollar’s ‘imminent collapse’, which was all the rage throughout the summer, seems to have completely disappeared. 
 
So, turning to this morning’s session, we find equity markets in the green around the world.  Yesterday’s US rally was followed by a fairly dull Asian session (Nikkei -0.1%, Hang Seng +0.1%) but Europe has really exploded higher.  It seems that the weakening economic data has convinced investors the ECB will be even more active in their policy mix, thus adding more support to equity markets there.  Hence today’s gains (DAX +1.6%, CAC +1.8%, FTSE 100 +2.3%) are a direct response to the weaker data.  It appears we are in the bad news is good phase for investors.  Not to worry, US futures are also pointing higher, albeit not quite as aggressively as we are seeing in Europe.
 
Bond markets remain somnolent as 10-year Treasury yields are at 0.675%, essentially unchanged from yesterday and right in the middle of the tiny 7 basis point range we have seen since September 1st.  (For those of you who were disappointed the Fed did not announce yield curve control, the reason is that they already have it, there is no need to announce it!)  At the same time, German bunds are unchanged on the day, and also mired within a fairly tight, 10bp range.  But the ongoing winners are Italy and Greece, who have seen their 10-year yields decline by 2 and 3 basis points, respectively today, with Italy’s down more than 25 basis points since the beginning of the month.
 
The strong dollar is having a deleterious impact in one market, gold, which has fallen 0.4% today and is now lower by nearly 10% from the highs seen in early August.  The driving forces of the rally remain in place, with real rates still under pressure and inflation still percolating, but it was a very overcrowded trade that seems to be getting unwound lately.
 
Finally, a look at the dollar vs. its G10 brethren shows that commodity currencies are the worst performers today with AUD and NZD both lower by -0.6%, while NOK (-0.5%) and CAD (-0.2%) complete the list.  However, at this hour, the entire bloc is softer vs. the dollar.  In the emerging markets, one needn’t be prescient to have guessed that MXN (-0.85%) and ZAR (-0.75%) are the leading decliners given the combination of their recent volatility and connection to commodity prices.  RUB (-0.6%) is also a leading decliner, suffering from the commodity market malaise, but frankly, APAC and CE4 currencies are also somewhat softer this morning.  This is all about USD strength though, not specific currency story weakness.
 
On the data front, yesterday’s Existing Home Sales were right on the button at 6.0M, as I mentioned, the highest reading since the middle of 2007.  Today the only thing to see is Markit’s US PMI data, expected to print at 53.5 for Manufacturing and 54.5 for Services.  Given the European readings, it will be quite interesting to see if the same pattern is evolving here.
 
Yesterday we also heard from Chairman Powell, but all he said was that the Fed has plenty of ammo and has done a great job, but things would be better if Congress passed another fiscal stimulus bill.  No surprises there.
 
This morning’s USD strength, while broad-based, is shallow.  Perhaps the biggest thing working in the dollar’s favor right now is the size of the short-USD positioning and the fact that recent price action is starting to warm up the technicians for a more sustained move higher.  I think that trend remains but believe we will need to see some real confirmational data to help it extend.
 
Good luck and stay safe
Adf
 
 

Congressional Sloth

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The Chairman is set to appear
Near Mnuchin, and both will make clear
Congressional sloth
Is killing off growth
Thus, action’s required this year

The subtext, though, is that the Chair
Has realized his cupboard is bare
No ammo remains
To prop up the gains
That stocks have made ‘midst much fanfare

Yesterday’s risk-off session may well have set the tone for the week, as there has been precious little rebound yet seen.  In addition to the virus story, and the news of large bank misdeeds, the US election story remains a critical factor, although at this point, any impact remains difficult to discern.  The one thing that is quite clear is that there is a very stark choice between candidates.  Given the prevailing meme that it is going to be a very close election, and the outcome could be in doubt for weeks following November 3rd, and assuming that the market response will be quite different depending on who eventually wins, one cannot blame traders and investors for omitting the issue from their current calculations.  While eventually, there is likely to be a significant market response, at this point, it seems there is little to be gained by positioning early.

In the meantime, however, the current administration continues to seek to do what it thinks best for the economy, and today we will get to hear from Chairman Powell, as well as Treasury Secretary Mnuchin, in Congressional testimony.  As is always the case in these situations, the text of Powell’s speech has been pre-released and it continues to focus on the one (apparently only) thing that is out of his control, more fiscal stimulus.  In his opening remarks he will describe the economy as improving but with still many problems ongoing.  He will also explain that monetary stimulus needs the help of fiscal stimulus to be truly effective.  In other words, he will explain that the Fed is now ‘pushing on a string’ and if Congress doesn’t enact new stimulus measures, there is little the Fed will be able to do to achieve their statutory goals.  Of course, he won’t actually use those words, but that will be the meaning.  It is abundantly clear that the Fed’s ability to support the real economy, as opposed to financial markets, has reached its end.

However, it is not just the Fed that has reached its limit, essentially every G10 central bank has reached the limit of effective central banking.  It has been argued, and I agree with the sentiment, that the difference between ‘normal’ positive interest rates and the zero and negative rates we currently see around the world is similar to the difference between Newtonian and Quantum mechanics in Physics.  In the positive rate environment, things are exactly as they seem.  Investment decisions are based on estimated returns, and risk of repayment is factored into the rate charged. There is a concept called the time value of money, where one dollar today is worth more than that same dollar in the future.  It is the basis on which Economics, the subject, was formulated.  This is akin to Newton’s well-known laws like; Every action has an equal and opposite reaction, or a body in motion will stay in motion unless acted on by another force.  They are even, dare I say, intuitive.

But in the zero (or negative) interest rate world, investment decisions are completely different.  First, the time value of money doesn’t make sense as it becomes, a dollar today is worth less than a dollar in the future.  As well, the addition of forward guidance is self-defeating.  After all, if they know that interest rates are going to remain zero for the next three years, what is the hurry for a company to borrow money now? Especially given the extreme lack of demand for so many products.  Instead, managements have realized that there is no need to worry about increasing production, they will always be able to do that when demand increases.  Rather, their time can be better spent reconfiguring their capital structure to reduce equity (lever up) and show ever increasing EPS growth without risking a poor investment decision.  This is akin to the difficulty in understanding the quantum realm, where uncertainty reigns (thank you Heisenberg) and the accuracy of measuring the position (EPS) and momentum (growth) of a particle are inversely related.

The problem is that central bankers are all Newtonians (or Keynesians), and so simply plug zero and negative numbers into their models and expect the same reactions as when they plug in positive numbers. And the output is garbage, which is a key reason they have been unable to stimulate economic activity effectively.  Alas, as long as problems persist, central bankers will feel compelled to “do something” when doing nothing may be the best course of action.  In the end, look for more monetary stimulus as it is the only tool they have.  Unfortunately, its effectiveness has been diminished to near zero, like their interest rates.

In the meantime, a look around markets shows that risk is neither off nor on this morning, but mostly confused.  Asian equity markets followed yesterday’s US losses, with declines of around 1% in those markets open.  (The Nikkei remained closed).  But European bourses have turned modestly higher on the day as the results of some regional elections in Italy have been taken quite positively.  There, the League’s Matteo Salvini lost seats to the current government, thus reducing the probability of a toppling government and easing pressure on Italian assets.  In fact, the FTSE MIB is the leading gainer today, higher by 1.2%, but we also see the DAX (+1.0%) and CAC (+0.5%) shaking off early losses to turn up.  US futures are mixed at this time, although well off the lows seen during the Asia session.

In the bond market, yesterday saw Treasury yields decline about 3 basis points amidst the ongoing risk reduction, but this morning, prices are edging lower and the yield has backed up just about 1bp.  In Europe, things have been much more interesting as Italian BTP’s have rallied sharply during the day, with yields now down 3.5 basis points, after opening with a similar sized rise in yields.  Bunds, meanwhile, are selling off a bit, as fears of an eruption of Italian trouble recede.

And finally, the dollar, which had been firmer much of the evening, is now ceding much of those gains, and at this hour I would have to describe as mixed.  In the G10, NOK (-0.5%) remains under the most pressure as oil prices continue to soften and there is now a controversy brewing with respect to the investment strategy of the Norwegian oil fund.  But away from NOK, the G10 is +/- 0.15%, which means it is hard to describe the situation as significant.

In the emerging markets, ZAR (+1.1%) continues to be the most volatile currency around, with daily movements in excess of 1%.  It has become, perhaps, the best sentiment gauge out there.  When investors are feeling good, ZAR is in demand, and it is quick to be sold in the event that risk is under pressure.  CNY (+0.45%) is the next best performer.  This is at odds with what appears to be the PBOC’s intentions as they set the fix at a much weaker than expected 6.7872, or 0.4% weaker than yesterday.  It seems the PBOC may be getting concerned over the speed with which the renminbi has been rising, as in the end, they cannot afford for the currency to appreciate too far.  On the red side of the ledger, KRW and IDR both fell 0.6% last night as risk mitigation was the story at the time.

Aside from Chairman Powell speaking today, we also see Existing Home Sales (exp 6.0M), which if it reaches expectations would be the highest print since 2007.  If risk is back in vogue, then I would look for the dollar to continue to edge lower.  And you can be sure that Chairman Powell will not do anything to upset that apple cart.

Good luck and stay safe
Adf

Absent Demand

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With Autumn’s arrival at hand
The virus has taken a stand
It won’t be defeated
Nor barely depleted
Thus, markets are absent demand

Risk is definitely on the back foot this morning as concerns grow over the increase in Covid-19 cases around the world.  Adding to the downward pressure on risk assets is the news that a number of major global banks are under increased scrutiny for their inability (unwillingness?) to stop aiding and abetting money laundering.  And, of course, in the background is the growing sense that monetary authorities around the world, notably the Fed, have run out of ammunition in their ongoing efforts to support economic growth in the wake of the government imposed shutdowns.  All in all, things look pretty dire this morning.

Starting with the virus, you may recall that one of the fears voiced early on was that, like the flu, it would fade somewhat in the summer and then reassert itself as the weather cooled.  Well, it appears that was a pretty accurate analysis as we have definitely seen the number of new cases rising in numerous countries around the world.  Europe finds itself in particularly difficult straits as the early self-congratulatory talk about how well they handled things vis-à-vis the US seems to be coming undone.  India has taken the lead with respect to the growth in cases, with more than 130,000 reported in the past two days.  The big concern is that government’s around the world are going to reimpose new lockdowns to try to stifle growth in the number of cases, but we all know how severely that can impact the economy.  So, the question with which the markets are grappling is, will the potential long-term benefit of a lockdown, which may reduce the overall caseload outweigh the short-term distress to the economy, profits and solvency?

At least for today, investors and traders are coming down on the side that the lockdowns are more destructive than the disease and so we have seen equity markets around the world come under pressure, with Europe really feeling the pain.  Last night saw the Hang Seng (-2.1%) and Shanghai (-0.6%) sell off pretty steadily.  (The Nikkei was closed for Autumnal Equinox Day.)  But the situation in Europe has been far more severe with the DAX (-3.2%), CAC (-3.1%) and FTSE 100 (-3.5%) all under severe pressure.  All three of those nations are stressing from an increase in Covid cases, but this is where we are seeing a second catalyst, the story about major banks and their money laundering habits.  A new report has been released that describes movement of more than $2 trillion in illicit funds by major (many European) banks, even after sanctions and fines have been imposed.  It can be no surprise that bank stocks throughout Europe are lower, nor that pre-market activity in the US is pointing in the same direction.  As such, US future markets showing declines of 1.5%-2.0% are right in line with reasonable expectations.

And finally, we cannot ignore Chairman Powell and the Fed.  The Chairman will be speaking before Congress three times this week, on both the need for more fiscal stimulus as well as the impact of Covid on the economy.  Now we already know that the Fed has implemented “powerful” new tools to help support the US, after all, Powell told us that about ten times last week in his press conference.  Unfortunately, the market is a bit less confident in the power of those tools.  At the same time, it seems the ECB has launched a review of its PEPP program, to try to determine if it has been effective and how much longer it should continue.  One other question they will address is whether the original QE program, APP, should be modified to be more like PEPP.  It is not hard to guess what the answers will be; PEPP has been a huge success, it should be expanded and extended because of its success, and more consideration will be given to changing APP to be like PEPP (no capital key).  After all, the ECB cannot sit by idly and watch the Fed ease policy more aggressively and allow the euro to appreciate in value, that would be truly catastrophic to their stated goal of raising the cost of living inflation on the Continent.

With all that in mind, a look at FX markets highlights that the traditional risk-off movement is the order of the day.  In other words, the dollar is broadly stronger vs. just about everything except the yen.  For instance, in the G10 space, NOK (-1.45%) is falling sharply as the combination of risk aversion and a sharply lower oil price (WTI -2.5%) has taken the wind out of the krone’s sails.  But the weakness here is across the board as SEK (-0.8%) and the big two, GBP (-0.5%) and EUR (-0.45%) are all under pressure.  It’s funny, it wasn’t that long ago when the entire world was convinced that the dollar was about to collapse.  Perhaps that attitude was a bit premature.  In fact, the euro bulls need to hope that 1.1765 (50-day moving average) holds because if the technicians jump in, we could see the single currency fall a lot more.

As to the emerging markets, the story is the same, the dollar is broadly higher with recent large gainers; ZAR (-2.0%) and MXN (-1.4%), leading the way lower.  But the weakness is broad-based as the CE4 are all under pressure (CZK -1.3%, HUF -1.1%, PLN -0.95%) and even CNY (-0.2%) which has been rallying steadily since its nadir at the end of May, has suffered.  In fact, the only positive was KRW (+0.2%) which benefitted from data showing that exports finally grew, rising above 0.0% for the first time since before Covid.

As to the data this week, it is quite light with just the following to watch:

Tuesday Existing Home Sales 6.01M
Wednesday PMI Manufacturing (Prelim) 53.3
Thursday Initial Claims 840K
Continuing Claims 12.45M
New Home Sales 890K
Friday Durable Goods 1.1%
-ex Transport 1.0%

Source: Bloomberg

The market will be far more interested in Powell’s statements, as well as his answers in the Q&A from both the House and Senate.  The thing is, we already know what he is going to say.  The Fed has plenty of ammunition, but with interest rates already at zero, monetary policy needs help from fiscal policy.  In addition to Powell, nine other Fed members speak a total of twelve times this week.  But with Powell as the headliner, it is unlikely they will have an impact.

The risk meme is today’s story.  If US equity markets play out as the futures indicate, and follow Europe lower, there is no reason to expect the dollar to do anything but continue to rally.  After all, while short dollar positions are not at record highs, they are within spitting distance of being so, which means there is plenty of ammunition for a dollar rally as shorts get covered.

Good luck and stay safe
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Prices Keep Falling

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Suga-san’s ascent
Has not altered the landscape
Prices keep falling

The distance between stated economic goals and actual economic outcomes remains wide as the economic impact of the many pandemic inspired government ordered lockdowns continues to be felt around the world.  The latest example comes from Japan, where August’s CPI readings fell, as expected, to 0.2% Y/Y at the headline level while the ex-fresh food measure (the one the BOJ prefers) fell to -0.4%.  Although pundits in the US have become fond of ridiculing the Fed’s efforts at raising inflation to 2.0%, especially given their inability to do so since defining that level as stable prices in 2012, to see real ineptitude, one must turn east and look at the BOJ’s track record on inflation.  In the land of the rising sun, the favored measure of CPI ex-fresh food has averaged 0.5% for the last 35 years!  The point is the Fed is not the first, nor only, central bank to fail in its mission to generate inflation via monetary policy.

(As an aside, it is an entirely different argument to discuss the merits of seeking to drive inflation higher to begin with, as there is a strong case to be made that limited inflation is a necessary condition for economic success at the national level.)  But 2.0% inflation has become the global central banking mantra. And though the favored inflation measure across nations often differs, the one key similarity is that every G10 nation, as well as many in the emerging markets, has been unable to achieve their goal.  The few exceptions are those nations like Venezuela, Argentina and Turkey that have the opposite problem, soaring inflation and no ability to control that.

But back to Japan, where decades of futility on the inflation front have put paid to the idea that printing money is all that is needed to generate rising prices.  The missing ingredient for all central banks is that they need to pump money into places that result in lending and spending, not simply asset purchases, or those excess funds will simply sit on bank balance sheets with no impact.

Remember, GDP growth, in the long run, comes from a combination of population growth and productivity growth.  Japan has the misfortune, in this case, of being one of the few nations on earth where the population is actually shrinking.  It is also the oldest nation, meaning the average and median age is higher there than any other country on earth (except Monaco which really doesn’t matter in this context).  The point here is that as people age, they tend to consume less stuff, spending less money and therefore driving less growth in the economy.  It is these two factors that will prevent Japan from achieving a much higher rate of inflation until such time as the country’s demographics change.  A new Prime Minister will not solve this problem, regardless of what policies he supports and implements.

Keeping this in mind, the idea that Japan is far more likely to cope with ongoing deflation rather than rising inflation, if we turn our attention to how that impacts the Japanese yen, we quickly realize that the currency is likely to appreciate over time.  Dusting off your Finance 101 textbooks, you will see that inflation has the side effect of weakening a nation’s currency, which quickly feeds into driving further inflation.  Adding to this impact is if the nation runs a current account deficit, which is generally the case when inflation is high and rising.  Harking back to Argentina and Venezuela, this is exactly the behavior we see in those economies.  The flip side of that, though, is that deflation should lead to a nation’s currency appreciating.  This is especially so when that nation runs a current account surplus.  And of course, you cannot find a nation that fits that bill better than Japan (well maybe Switzerland).  The upshot of this is, further JPY appreciation seems to be an extremely likely outcome.  Therefore, as long as prices cease to rise in Japan, there will be upward pressure on the currency.  We have seen this for years, and there is no reason for it to stop now.

Of course, as I always remind everyone, FX is a relative game, so it matters a great deal what is happening in both nations on a relative basis.  And in this case, when comparing the US, where prices are rising and the current account has been in deficit for the past two decades, and Japan, where prices are falling and the current account has been in surplus for the past four decades, the outcome seems clear.  However, the market is already aware of that situation and so the current level of USDJPY reflects that information.  However, as we look ahead, either negative surprises in Japanese prices or positive surprises in the US are going to be important drivers in the FX market.  This is likely to be seen in interest rate spreads, which have narrowed significantly since March when the Fed cut rates aggressively but have stabilized lately.  If the Fed is, in fact, going to put forth the easiest monetary policy around, then a further narrowing of this spread is quite possible, if not likely, and further JPY appreciation will ultimately be the result.  This is what we have seen broadly since the middle of 2015, a steady trend lower in USDJPY, and there is no reason to believe that is going to change.

Whew!  That turned out to be more involved than I expected at the start.  So let me quickly survey the situation today.  Risk is under modest pressure generally, although there were several equity markets that put in a good performance overnight.  After a weak US session, Asia saw modest gains in most places (Nikkei +0.2%, Hang Seng +0.5%) although Shanghai (+2.1%) was quite strong.  European markets are far less convinced of the positives with the DAX (+0.4%) and CAC (-0.1%) not showing much movement, and some of the fringe markets (Spain -1.3%) having a bit more difficulty.  US futures are mixed, although the top performer is the NASDAQ (+0.4%).

Bond markets continue to trade in a tight range, as central bank purchases offset ongoing issuance by governments, and we are going to need some new news or policies to change this story.  Something like an increase in the ECB’s PEPP program, or the BOE increasing its purchases will be necessary to change this, as the Fed is already purchasing a huge amount of paper each month.

And finally, the rest of the FX market shows that the dollar is broadly, but not universally under pressure.  G10 activity shows that NZD (+0.4%) is the leader, although JPY (+0.3%) is having another good day, while NOK (-0.25%) is the laggard.  But as can be seen by the modest movements, and given the fact it is Friday, this is likely position adjustments rather than data driven.

In the EMG space, KRW (+1.2%) was the biggest gainer overnight, which was hard to explain based on outside influences.  The KOSPI rose 0.25%, hardly a huge rally, and interest rates were unchanged.  The best estimate here is that ongoing strength in China is seen as a distinct positive for the won, as South Korea remains highly dependent on the mainland for economic activity.  Beyond the won, though, while there were more gainers than losers, the size of movement was not that significant.

On the data front, speaking of the current account, we see the Q2 reading this morning (exp -$160.0B), as well as Leading Indicators (1.3%) and Michigan Sentiment (75.0).  We also hear from three Fed speakers (Bullard, Bostic and Kashkari) but having just heard from Powell on Wednesday, it seems unlikely they will give us any new information. Rather, today appears to be a consolidation day, with marginal movements as weak positions get unwound into the weekend.

Good luck, good weekend and stay safe
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Risk is in Doubt

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The chatter before the Fed met
Was Powell and friends were all set
To ease even more
Until they restore
Inflation to lessen the debt

And while Jay attempted just that
His efforts have seemed to fall flat
Now risk is in doubt
As traders clear out
Positions from stocks to Thai baht

Well, the Fed meeting is now history and in what cannot be very surprising, the Chairman found out that once you have established a stance of maximum policy ease, it is very difficult to sound even more dovish.  So, yes, the Fed promised to maintain current policy “…until labor market conditions have reached levels consistent with the Committee’s assessments of maximum employment and inflation has risen to 2 percent and is on track to moderately exceed 2 percent for some time.”  And if you really parse those words compared to the previous statement’s “…maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals”, you could make the case it is more dovish.  But the one thing at which market participants are not very good is splitting hairs.  And I would argue that is what you are doing here.  Between the old statement and Powell’s Jackson Hole speech, everybody already knew the Fed was not going to raise rates for a very long time.  Yesterday was merely confirmation.

In fact, ironically, I think the fact that there were two dissents on the vote, Kaplan and Kashkari, made things worse.  The reason is that both of them sought even easier policy and so as dovish as one might believe the new statement sounds, clearly some members felt it could be even more dovish than that.  At the same time, the dot plot added virtually nothing to the discussion as the vast majority believe that through 2023 the policy rate will remain pegged between 0.00%-0.25% where it is now.  Also, while generating inflation remains the animating force of the committee, according to the Summary of Economic Projections released yesterday, even their own members don’t believe that core PCE will ever rise above 2.0% and not even touch that level until 2023.

Add it all up and it seems pretty clear that the Fed is out of bullets, at least as currently configured with respect to their Congressional mandate and restrictions.  It will require Congress to amend the Federal Reserve Act and allow them to purchase equities in order to truly change the playing field and there is no evidence that anything of that nature is in the cards.  A look at the history of the effectiveness of QE and either zero or negative interest rates shows that neither one does much for the economy, although both do support asset markets.  Given those are the only tools the Fed has, and they are both already in full use (and not just at the Fed, but everywhere in the G10), it is abundantly clear why central bankers worldwide are willing to sacrifice their independence in order to cajole governments to apply further fiscal stimulus.  Central banks seem to have reached the limit of their capabilities to address the real economy.  And if (when) things turn back down, they are going to shoulder as much blame as elected officials can give with respect to who is responsible for the bad news.

With that as background, let’s take a peek at how markets have responded to the news.  Net-net, it hasn’t been pretty.  Equity markets are in the red worldwide with losses overnight (Nikkei -0.7%, Hang Seng -1.6%, Shanghai -0.4%) and in Europe (DAX -0.7%, CAC -0.8%, FTSE 100 -1.0%).  US futures are pointing lower after equity markets in the US ceded all their gains after the FOMC and closed lower yesterday.  At this time, all three futures indices are lower by about 1.0%.

Meanwhile, bond markets, which if you recall have not been tracking the equity market risk sentiment very closely over the past several weeks, are edging higher, at least in those markets truly seen as havens.  So, Treasury yields are lower by 2bps, while German bunds and French OATS are both seeing yields edge lower, but by less than one basis point.  However, the rest of the European government bond market is under modest pressure, with the PIGS seeing their bonds sell off and yields rising between one and two basis points.  Of course, as long as the ECB continues to buy bonds via the PEPP, none of these are likely to fall that far in price, thus yields there are certainly capped for the time being.  I mean even Greek 10-year yields are 1.06%!  This from a country that has defaulted six times in the modern era, the most recent being less than ten years ago.

Finally, if we look to the FX markets, it can be no surprise to see the dollar has begun to reverse some of its recent losses.  Remember, the meme here has been that the Fed would be the easiest of all central banks with respect to monetary policy and so the dollar had much further to fall.  Combine that with the long-term theme of macroeconomic concerns over the US twin deficits (budget and current account) and short dollars was the most popular position in the market for the past three to four months.  Thus, yesterday’s FOMC outcome, where it has become increasingly clear that the Fed has little else to do in the way of policy ease, means that other nations now have an opportunity to ease further at the margin, changing the relationship and ultimately watching their currency weaken versus the dollar.  Remember, too, that essentially no country is comfortable with a strong currency at this point, as stoking inflation and driving export growth are the top two goals around the world.  The dollar’s rebound has only just begun.

Specifically, in the G10, we see NOK (-0.5%) as the laggard this morning, as it responds not just to the dollar’s strength today, but also to the stalling oil prices, whose recent rally has been cut short.  As to the rest of the bloc, losses are generally between 0.15%-0.25% with no specific stories to drive anything.  The exception is JPY (+0.2%) which is performing its role as a haven asset today.  While this is a slow start, do not be surprised to see the dollar start to gain momentum as technical indicators give way.

Emerging market currencies are also under pressure this morning led by MXN (-0.7%) and ZAR (-0.6%).  If you recall, these have been two of the best performing currencies over the past month, with significant long positions in each driving gains of 5.3% and 7.1% respectively.  As such, it can be no surprise that they are the first positions being unwound in this process.  But throughout this bloc, we are seeing weakness across the board with average declines on the order of 0.3%-0.4%.  Again, given the overall risk framework, there is no need for specific stories to drive things.

On the data front, yesterday’s Retail Sales data was a bit softer than expected, although was generally overlooked ahead of the FOMC.  This morning saw Eurozone CPI print at -0.2%, 0.4% core, both still miles below their target, and highlighting that we can expect further action from the ECB.  At home, we are awaiting Initial Claims (exp 850K), Continuing Claims (13.0M), Housing Starts (1483K), Building Permits (1512K) and the Philly Fed index (15.0).

Back on the policy front, the BOE announced no change in policy at all, leaving the base rate at 0.10% and not expanding their asset purchase program.  However, in their effort to ease further they did two things, explicitly said they won’t tighten until there is significant progress on the inflation goal, but more importantly, said that they will “engage with regulators on how to implement negative rates.”  This is a huge change, and, not surprisingly the market sees it as another central bank easing further than the Fed.  The pound has fallen sharply on the news, down 0.6% and likely has further to go.  Last night the BOJ left policy on hold, as they too are out of ammunition.  The fear animating that group is that risk appetite wanes and haven demand drives the yen much higher, something which they can ill afford and yet something which they are essentially powerless to prevent.  But not today.  Today, look for a modest continuation of the dollar’s gains as more positions get unwound.

Good luck and stay safe
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Whom He Must Obey

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The question is, what can he say?
You know, course, I’m talkin’ ‘bout Jay
Can he still, more, ease?
In order to please
The markets whom he must obey

Fed day has arrived, and all eyes are on the virtual Marriner Eccles Building in Washington, where the FOMC used to meet, prior to the current pandemic.  In the wake of Chairman Powell’s speech at the end of August, during the virtual Jackson Hole symposium, where he outlined the new Fed framework; analysts, economists and market participants have been trying to guess when there will be more details forthcoming regarding how the Fed plans to achieve their new goals.  Recall, stable prices have been redefined as ‘an average inflation rate of 2.0% over time’.  However, Powell gave no indication as to what timeline was considered, whether it was fixed or variable, and how wide a dispersion around their target they are willing to countenance.  So generally, we don’t know anything about this policy tweak other than the fact that, by definition, inflation above 2.0% will not be considered a sufficient reason to tighten monetary policy.  There are as many theories of what they are going to do as there are analysts propagating them, which is why this meeting is seen as so important.

As it is a quarterly meeting, we will also see new Fed economic forecasts and the dot plot will be extended to include the FOMC membership’s views of rates through 2023.  As to the latter, the working assumption is that virtually the entire committee expects rates to remain at current levels throughout the period.  Reinforcing this view is the futures market, where Fed Funds futures are essentially flat at current levels through the last listed contract in August 2023.  Eurodollar futures show the first full rise in rates priced for June 2024.  In other words, market participants are not looking for any policy tightening anytime soon.

Which begs the question, exactly what can Jay say that could be considered dovish at this point?  Certainly, he could explain that they are going to increase QE, but that is already defined as whatever is deemed necessary to smooth the functioning of markets.  Perhaps if he defines it as more than that, meaning it is supposed to help support economic activity, that would be interpreted as more dovish.  But isn’t infinite QE already as much as they can do?

It seems highly unlikely that the committee will give a fixed date as to when policy may eventually tighten.  But it is possible, though I think highly unlikely as well, that they define what level of inflation may require a change in policy.  The problem with that theory is there are too many potential paths down which inflation can wander.  For instance, if core PCE increased to 2.5% (a BIG if) and remained stable there for six months, would that be enough to force an adjustment to policy?  Would one year be the right amount?  Five years?  After all, core PCE has averaged 1.6% for the past ten years.  For the past twenty, the average has been 1.72%.  In fact, you have to go back over the past 32 years in order to calculate the average core PCE at 2.0%.  And of course, this is the problem with the Fed’s new framework, it doesn’t really tell us much about the future of policy other than, it is going to be ultra-easy for a long, long time.

It is with this in mind that the market has embraced the idea that the dollar must naturally fall as a consequence.  And that is a fair point.  If the Fed continues to out-ease all other central banks, then the dollar is quite likely to continue to soften.  But as we have seen already from numerous ECB speakers, and are likely to see from the BOE tomorrow, the Fed is not acting in a vacuum.  FX continues to be a relative game, as the differential in policies between currencies is the driving factor.  And while Madame Lagarde did say she was not concerned about the euro’s strength, you may recall that she also indicated, once upon a time, that it was not the ECB’s job to worry about Italian government bond yields.  That was her position for at least a day before the ECB figured out that was their entire job and created the PEPP.  My point is, if Jay comes across as more dovish somehow, you can be certain that every other central bank will double down on their own policy ease.  No country wants to be the one with the strong currency these days.

But for now, the market is still of the opinion that the Fed is out in the lead, and so the dollar continues to drift lower.  This morning, we see the dollar weaker against the entire G10 bloc with NOK (+0.6%) the leader on the back of oil’s 2.5% rally, although GBP (+0.5%) is also firmer after UK inflation data showed smaller declines than forecast, perhaps alleviating some of the pressure on the BOE to ease further.  At least that’s the thought right now.  But even the euro, after ultimately slipping yesterday, has rallied a modest 0.15% although it remains below 1.19 as I type.

Emerging market currencies are behaving in a similar manner, as the entire bloc is firmer vs. the greenback.  Once again ZAR (+0.95%) leads the pack on the combination of firmer commodity prices (gold +0.5%), the highest real yields around and faith that the Fed will continue to ease further.  But we are seeing MXN (+0.5%) gaining on oil’s rally and CNY (+0.35%) following up yesterday’s gains with a further boost as expectations grow that China’s economy is truly going to be back to pre-Covid levels before the end of the year.  Overall, it is a day of dollar weakness.

Other markets have shown less exuberance as Asian equity markets were essentially flat (Nikkei +0.1%, Hang Seng 0.0%, Shanghai -0.3%) and European bourses are also either side of flat (DAX -0.1%, CAC +0.1%, FTSE 100 -0.1%).  US futures, naturally, continue to rally, with all three indices looking at gains of 0.4%-0.6% at this time.

Government bond markets remain dull, with another large US auction easily absorbed yesterday and 10-year yields less than a basis point different than yesterday’s levels.  In Europe, actually, most bond yields have edged a bit lower, but only one to two basis points’ worth, so hardly a sign of panic.

As to the data story, yesterday saw a much better than forecast Empire Manufacturing number (+17.0) boding well for the recovery.  This morning brings Retail Sales (exp 1.0% headline, 1.0% ex autos) at 8:30, and then the long wait until the FOMC statement is released at 2:00pm.  Chairman Powell will hold his press conference at 2:30, and if he manages to sound dovish, perhaps we see further dollar declines and equity rallies.  But I sense the opportunity for some disappointment and perhaps a short-term reversal if he doesn’t invent a new dovish theme.  In that case, look for the dollar to recoup today’s losses at least.

Good luck and stay safe
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Fear Has Diminished

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From Asia, last night, what we learned
Was China, the corner, has turned
The lockdowns are finished
And fear has diminished
Thus spending, in spades, has returned

The major news overnight comes from China, where the monthly release of data on IP, investment and Retail Sales showed that the Chinese economy is clearly regaining strength.  Arguably, the most noteworthy number was Retail Sales, which while still lower by -8.6% YTD, has rebounded to be 0.5% higher than August of last year.  Anecdotally, movie theaters there have seen attendance return to ~90% of pre-Covid levels, obviously far above anything seen here or in most of Europe.  In addition to the Retail Sales data, IP there rose 5.6% Y/Y and Property Investment rose a greater than forecast 4.6% on a YTD basis.  Overall, while these numbers are still well below the data China had been reporting pre-Covid, they point to Q3 GDP growth in excess of 3.0%, with some analysts now expecting GDP to grow as much as 6% in the third quarter.

With this unalloyed good economic news, it should be no surprise that the renminbi has performed well, and in fact, CNY is one of the top performers today, rising 0.5% and trading to levels not seen since May of last year.  While there are still numerous concerns regarding different aspects of China’s economy, notably that its banking sector is insolvent amid massively underreported bad loans, on the surface, things look better than almost anywhere else in the world.  Perhaps what is more surprising is that the equity market in Shanghai, which rose 0.5% overnight, did not have a better day.

Down Under, the RBA noted
That Aussie, though not really bloated
Would be better off
In more of a trough
Thus, helping growth there be promoted

Meanwhile, the Minutes of the most recent RBA meeting showed that while they couldn’t complain that the Aussie dollar was overvalued, especially given the recent rebound in commodity prices, they sure would like to see it lower to help the export sector of the economy.  However, despite reaffirming they would continue to support the economy, and that yield curve control wasn’t going anywhere, they gave no indication they were about to increase their support.  As such, AUD (+0.6%) is the top G10 performer of the session, and it is now pushing back to the 2-year highs seen earlier this month.

Turning to Europe, the two stories of note come from the UK and the ECB.  In Parliament, PM Johnson had the first reading of his bill that is set to unilaterally rewrite the Brexit deal with the EU, and it passed handily.  It appears that Boris believes he needs even more leverage to force the EU to accede to whatever demands remain in the negotiations, and he is comfortable playing hardball to achieve his ends.  The Europeans, however, continue to believe they have the upper hand and claim they are prepared to have the UK leave with no deal.  Politics being what it is, I imagine we won’t know the outcome until the last possible date, which is ostensibly next month at the EU Summit.

In the meantime, the market is starting to get concerned that a hard Brexit is back on the table and that the pound has much more to fall if that is the outcome.  While the market is not at record long GBP position levels, it is still quite long pounds.  The options market has been pricing more aggressively, with implied volatility around 12% for year-end (compared to 3-month historic volatility of just 9%) and risk reversals 2.5 points for the GBP puts.  While the pound has fallen a bit more than 4% since its peak on September 1st, it is still well above levels seen when fears of a hard Brexit were more prevalent.  As this new bill makes its way through Parliament, I suspect the pound will have further to decline.

As to the ECB, we have had yet more verbal intervention, this time from Italian Executive Board member, Fabio Panetta, who repeated that the ECB needs to remain vigilant and that though they have done a great job so far, they still may need to do more (i.e. ease further) in order to achieve their inflation goals.  The euro, however, continues to drift higher, up another 0.25% this morning, as the market appears to be preparing for a more aggressive FOMC statement and implicit further easing by the Fed.  While I believe it is too early for the Fed to more clearly outline their explicit plans on how to achieve average inflation of 2.0%, clearly there are many market participants who believe the Fed will be the most aggressive central bank going forward and that the dollar will suffer accordingly.  We shall see, but as I have repeatedly indicated, and Signor Panetta helped reiterate, the ECB will not stand idly by and allow the euro to rally unabated.

And those are really today’s stories.  Risk appetite continues to be fed by perceptions of further easy money from all central banks and we have seen equity markets continue their rebound from the short correction at the beginning of the month.  While Asia was mixed, Europe is in the green and US futures are pointing higher as well.  Treasuries are a touch lower, with yields up about 1 basis point, but the reality here is that yields have been in a very tight range for the past month.  In fact, the idea that the Fed needs to introduce yield control is laughable as it appears to already be in place.

As to the rest of the FX market, the dollar is under pressure everywhere, although Aussie and cable are the two leaders in the G10 space.  Elsewhere, there appears to be less conviction, or at least less rationale to buy the currency aggressively.  In the EMG bloc, ZAR is the leader, rising 1.2% this morning, continuing its strengthening trend that began back in August and has seen a nearly 7% appreciation in the interim.  Otherwise, there has been less excitement, with more modest gains on the back of generic USD weakness.

For today, we see Empire Manufacturing (exp 6.9) this morning as well as IP (1.0%) and Capacity Utilization (71.4%).  Alas, with the Fed meeting tomorrow and all eyes pointed to Washington, it seems unlikely that the market will respond to any of this data.  Instead, with the market clearly comfortable selling dollars right now, I see no reason for the buck to do anything but drift lower on the day.

Good luck and stay safe
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Nations Regress

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When two weeks ago I last wrote
The narrative was to promote
A dollar decline
Which did intertwine
With hatred for Trump ere the vote

But since then the dollar’s rebounded
While experts galore are confounded
Poor Europe’s a mess
While nations regress
On Covid, where hope had been founded

I told you so?  Before my mandatory leave began, the market narrative was that the dollar was not merely falling, but “collapsing” as everything about the US was deemed negative.  The background story continued to be about US politics and how global investors were steadily exiting the US, ostensibly because of the current administration.  Adding to that was Chairman Powell’s speech at the virtual Jackson Hole symposium outlining average inflation targeting, which implied that the Fed was not going to respond to incipient inflation by raising rates until measured inflation was significantly higher and remained there sufficiently long to offset the past decade’s period of undershooting inflation.  In other words, if (when) inflation rises, US interest rates will remain pegged to the floor, thus offering no support for the dollar.  While there were a few voices in the wilderness arguing the point, this outcome seemed assured.

And the dollar did decline with the euro finally breeching the 1.20 level, ever so briefly, back on September 1st.  But as I argued before leaving, there was no way the ECB was going to sit by idly and watch the euro continue to rally without a policy response.  ECB Chief economist Philip Lane was the first to start verbal intervention, which was sufficient to take the wind out of the euro’s sails right after it touched 1.20.  Since then, the ECB meeting last week was noteworthy for not discussing the euro at all, with market participants, once again, quickly accepting that the ECB would allow the single currency to rally further.  But this weekend saw the second volley of verbal intervention, this time by Madame Lagarde, VP Guindos, Ollie Rehn and Mr Lane, yet again.  Expect this pattern to be repeated regularly, every euro rally will be met with more verbal intervention.

Of course, over time, verbal intervention will not be enough to do the job, which implies that at some point in the future, we will see a more intensive effort by the ECB to help pump up inflation.  In order of appearance look for a significant increase in QE via the PEPP program, stronger forward guidance regarding the timing of any incipient rate hikes (never!), a further cut to interest rates and finally, actual intervention.  In the end, there is absolutely no way that the ECB is going to allow the euro to rally very much further than it already has.  After all, CPI in the Eurozone is sitting at -0.2% (core +0.4%), so far below target that they must do more.  And a stronger euro is not going to help the cause.

Speaking of inflation, I think it is worth mentioning the US situation, where for the second straight month, CPI data was much higher than expected.  While many analysts are convinced that the Fed’s rampant asset purchases and expansion of the money supply are unlikely to drive inflation going forward, I beg to differ.  The lesson we learned from the GFC and the Fed’s first gargantuan expansion of money supply and their balance sheet was that if all that money sits in excess reserves on commercial bank balance sheets, velocity of money declines and inflation is absent.  This time, however, the new funds are not simply sitting on the banks’ collective balance sheets but are rather being spent by the recipients of Federal government largesse.  This is driving velocity higher, and with it, inflation.  Now, whatever one may think of Chairman Powell and his Fed brethren, they are not stupid.  The Jackson Hole speech, I believe, served two purposes.  First, it was to help investors understand the Fed’s reaction function going forward, i.e. higher inflation does not mean higher interest rates.  But second, and something that has seen a lot less press, is that the Fed has just moved the goalposts ahead of what they see as a rising tide of inflation.  Now, if (when) inflation runs hot over the next 12-24 months, the Fed will have already explained that they do not need to respond as the average inflation rate has not yet achieved 2.0%.  It is this outcome that will eventually undermine the dollar’s value, higher inflation with no monetary response, but we are still many months away from that outcome.

Turning to today’s activity, after two weeks of broad dollar strength, as well as some equity market pyrotechnics, we are seeing a bit of a dollar sell-off today.  It would be hard to characterize the markets as risk-on given the fact that European bourses are essentially flat on the day (DAX -0.1%, CAC +0.1%) while Asian equity markets showed only modest strength at best (Nikkei, Hang Seng and Shanghai all +0.6%).  Yes, US futures are pointing higher by 1.0%, but that seems more to do with the two large M&A deals announced than anything else.

In the meantime, bond markets have shown no indication of risk being on, with 10-year Treasury yields essentially unchanged since Friday at 0.67%, and effectively unchanged since I last wrote on August 28!  The same is largely true across European government bond markets, with, if anything, a bias for risk-off as most of those have seen yields slide one to two basis points.

And finally, the dollar’s specifics show GBP (+0.6%) to be the top G10 performer, which given its recent performance, down more than 4% since I last wrote, seems to be a bit of a breather rather than anything positive per se.  In the UK, today sees the beginning of the Parliamentary debate regarding PM Johnson’s proposed rewrite of aspects of Brexit legislation, which many think, if passed, will insure a hard Brexit.  As to the rest of the bloc, gains are mostly in the 0.25% range, with the most common theme the uptick in economists’ collective forecasts for economic prospects compared with last month.

Interestingly, in the EMG bloc, movement is less pronounced, with MXN (+0.4%) the biggest gainer, while RUB (-0.4%) is the laggard.  Clearly, as both are oil related, oil is not the driver.  However, when EMG currencies move less than 0.5%, it is hard to get too excited overall.

On the data front this week, the big story is, of course, the FOMC meeting on Wednesday, but we have a bunch of things to absorb.

Tuesday Empire Manufacturing 6.0
IP 1.0%
Capacity Utilization 71.4%
Wednesday Retail Sales 1.0%
-ex autos 1.0%
Business Inventories 0.2%
FOMC Rate Decision 0.00%-0.25%
Thursday Initial Claims 850K
Continuing Claims 13.0M
Housing Starts 1480K
Building Permits 1520K
Friday Leading Indicators 1.3%
Michigan Sentiment 75.0

Source: Bloomberg

What we have seen lately is the lagging indicators showing that the bounce after the reopening of the economy was stronger than expected, but there is growing concern that it may not be sustainable.  At the same time, the only thing interesting about the FOMC meeting will be the new forecasts as well as the dot plot.  After all, Jay just told us what they are going to do for the foreseeable future (nothing) two weeks ago.

Good luck and stay safe
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