Turning the Screws

There once was a great city state
That introduced rules and debate
However its heirs
Lead muddled affairs
Thus Roman woes proliferate

Meanwhile from the UK, the news
Gave Johnson’s opponents the blues
Improvements reported
In confidence thwarted
The Sterling bears, turning the screws

Italian politics has once again risen to the top of the list of concerns in the Eurozone. This morning, 5-Star leader, Luigi Di Maio, is on the cusp of resigning from the government, thus forcing yet another election later this year. The overriding concern from the rest of Europe is that the man leading the polls, Silvio Matteo, is a right-wing populist and will be quick to clash with the rest of the EU on issues ranging from fiscal spending to immigration policy. In other words, he will not be welcome by the current leading lights as his views, and by extension the views of the millions who vote for him, do not align with the rest of the EU leadership. Of course, there has been steady dissent from that leadership for many months, albeit barely reported on this side of the Atlantic. For example, the gilets jaunes continue to protest every week around the country, as they voice their disagreement with French President Macron’s attempts to change the rules on issues ranging from pensions to taxes to labor regulations. And they have been protesting for more than a year now, although the destructive impact has been greatly reduced from the early days. As well, there are ongoing protests in the Catalonia region of Spain with separatists continuing to try to make their case. The point is that things in Europe are not quite as hunky-dory as the leadership would have you believe.

However, for today, it is Italy and the potential for more dissent regarding how Europe should be managed going forward. The result has been the euro reversing its early 0.25% gains completely, actually trading slightly lower on the day right now. While there is no doubt the recent Eurozone data has been better than expected, it remains pretty awful on an absolute basis. But markets respond to movements at the margin, so absent non-market events, like Italian political ructions, it is fair to expect the euro to benefit on this data. In fact, there is an ongoing evolution in the analyst community as a number of them have begun to change their ECB views, with several implying that the ECB’s next move will be policy tightening, and some major Investment Banks now forecasting 10-year German bunds to trade back up to 0.0% or even higher by the end of the year. We shall see. Certainly, if Madame Lagarde hints at tighter policy tomorrow, the euro will benefit. But remember, the ECB is still all-in on QE, purchasing €20 billion per month, so trying to combine the need to continue QE alongside a discussion of tighter policy seems a pretty big ask. At this point, the euro remains under a great deal of pressure overall, but I do expect this pressure to ebb as the year progresses and see the dollar decline eventually.

As to the UK, the hits there just keep on coming. This morning, the Confederation of British Industry (CBI), which is essentially the British Chamber of Commerce, reported that both orders and price data improved modestly more than expected, but more importantly their Optimism Index jumped to +23 from last month’s -44, which is actually its highest level since April 2014, well before Brexit was even a gleam in then-PM David Cameron’s eye. Not surprisingly, the pound has rallied further on this positive jolt, jumping 0.5% this morning and is the leading performer against the dollar overall today. It should also be no surprise that the futures market has reduced its pricing for a BOE rate cut next week to a 47% probability, down from 62% yesterday and 70% on Friday. Ultimately, I think that Carney and company would rather not cut if at all possible, given how little room they have with the base rate at 0.75% currently. If we see solid PMI flash data on Friday, I would virtually rule out any chance for a cut next week, and expect to see the pound rally accordingly.

Away from those two stories though, market activity has been far less interesting. The rest of the G10, beyond the pound, is generally within 10bps of yesterday’s closing levels. As to the Emerging markets, the big winner has been ZAR, which has rallied 0.65% after CPI rose to 4.0%, although that remains well below the midpoint of the SARB’s target range of 3.0% – 6.0%. Expectations are for continued policy ease and continue investment inflows to help support the currency. But other than the rand, it has been far less interesting in the FX market.

The ongoing fears over the spread of the coronavirus seem to be abating as China has been aggressively working to arrest the situation, canceling flights out of Wuhan and being remarkably transparent with respect to every new case reported. In fact, equity markets around the world have collectively decided that this issue was a false alarm and we have seen stocks rally pretty much everywhere (Italy excepted) with US futures pointing higher as well.

And that really sums up the day. The ongoing impeachment remains outside of the framework of the market as nobody believes that President Trump will be removed from office. The WEF participants continue to demonstrate their collective ability to pontificate about everything, but do nothing. And so, we need to look ahead to today’s data, and probably more importantly to equity market performance for potential catalysts for movement. Alas, the only US data of note is Existing Home Sales (exp 5.43M), something that rarely moves markets. This leaves us reliant on equity market sentiment to drive the FX market, and with risk definitively on this morning, I expect to see EMG currencies benefit while the dollar suffers mildly.

Good luck
Adf

 

Cashiered!

In China, a virus appeared
That seems to be worse than first feared
It’s spreading so quickly
That markets turned sickly
And stock market bulls got cashiered!

Some of you may remember the SARS virus from the winter of 2002-3, when a respiratory illness, emanating from Guangdong in China, spread quickly around the world resulting in some 800 odd deaths, but more importantly from the market’s perspective, created a very real risk-off environment. As an example, from January through March of 2003, the Dow Jones fell more than 16%, largely on fears that the virus would continue to spread and ultimately reduce economic activity worldwide. Fortunately, that was not the case, as those diagnosed with the virus were isolated and the spread of the disease ended. Naturally, risk was reignited and all was right with the world…until 2008.

I remind everyone of this history as this morning, there is another coronavirus that has been discovered in central China, this time Wuhan seems to be ground zero, and has begun to spread rapidly from human to human. In just a few weeks, more than 200 cases have been reported with several deaths. However, the big concern is that the Lunar New Year celebration begins on Saturday and this is the heaviest travel time of the year within China and for Chinese people around the world. And if your goal was to spread a virus, there is no better way to do so than by getting infected people on airplanes and sending them around the world! Of course, this is nobody’s goal, however it is a very real potential consequence of the confluence of the new virus and the Lunar New Year. The market has reacted just as expected, with risk aversion seen across markets (equities lower, bonds higher) and specific stocks reacting to anticipated direct effects. For example, every Asian airline stock has been aggressively sold lower, while manufacturers of things like latex gloves and face masks have rallied sharply.

Now, while none of this should be surprising, a quick look at market levels shows us that the current impact of this virus has been widespread, at least from a market perspective. For example, equity markets have suffered across the board, although Asia was worst hit (Nikkei -0.9%, Hang Seng -2.8%, Shanghai -1.4%, DAX -0.25%, CAC -0.85%, FTSE -1.0%). Treasury yields have fallen 2bps, although bund yields are actually higher by 0.5bps this morning on the back of stronger than expected ZEW survey data.

And in the currency market, the dollar is broadly, although not universally, higher. It can be no surprise that APAC currencies are under the most pressure given the risk-off causality, with KRW -0.75% and CNY -0.55%, its largest daily decline since last August. But we are also seeing weakness throughout LATAM with both BRL (-0.45%) and MXN (-0.35%) among the day’s worst performers.

In the G10 space, the results have been a bit more mixed, and actually seem more related to data than the general risk sentiment. For example, the pound is today’s big winner, +0.35% after UK Employment data was released with much better than expected results. While the Unemployment Rate remained unchanged at 3.8%, the 3M/3M Employment Change rose 208K, nearly double expectations and the first really good piece of data seen from the UK in two weeks (recall PMI data was a bit better than expected). This has resulted in some traders questioning whether the BOE will cut rates next week after all. Futures markets continue to price a 61% probability, although that is down from 70% on Friday.

Elsewhere, the euro reversed small early losses and now has small gains after the ZEW Expectations data (26.7 vs. 15.0 expected), while the yen has benefitted ever so slightly on two different fronts. First, the broad risk-off market flavor has helped keep the yen underpinned, but more importantly, the BOJ met last night, and although they left policy unchanged, as universally expected, there continues to be a growing belief that the next move there is going to be a tightening! This was reinforced by the BOJ raising its growth estimates for both 2019 (0.8%, up from 0.6%) and 2020 (0.9% up from 0.7%). Of course, offsetting that somewhat was the decline in the BOJ’s inflation forecast, down to 0.8% in 2020 from the previous expectation of 0.9%. In the end, it is difficult to get overly excited about the Japanese economy’s prospects, with a much greater likelihood of significant yen strength emanating from a more severe risk-off event.

Looking ahead to the week, not only is the Fed in its quiet period, but there is a very limited amount of US data set to be released.

Wednesday Existing Home Sales 5.43M
Thursday Initial Claims 214K
  Leading Indicators -0.2%

Source: Bloomberg

Of course, there are two other events this week that may have a market impact, although my personal belief is that neither one will do so. This morning the US Senate takes up the Articles of Impeachment for President Trump that were finally proffered by the House of Representatives. And while the politicos in Washington and the talking heads on TV are all atwitter over this situation, financial markets have collectively yawned throughout the entire process. I see no reason for that stance to change at this point.

The other event is the World Economic Forum in Davos, the annual get together of the rich and famous, as well as those who want to be so, to pontificate on all things they deem important. However, it beggars belief that anything said from this conference is going to change any investment theories, let alone any fiscal or monetary policies. This too, from the market’s perspective, is unlikely to have any impact at all.

And that’s really it for today. Lacking catalysts, I anticipate a quiet session overall. Short term, the dollar still seems to have some life. But longer term, I continue to look for a slow decline as the effects of the Fed’s QE begin to be felt more keenly.

Good luck
Adf

Throw Her a Bone

Next week at the ECB meeting
We’re sure to hear Christine entreating
The whole Eurozone
To throw her a bone
And spend more, lest growth start retreating

In England, though, it’s now too late
As recent releases all state
The ‘conomy’s slowing
And Carney is knowing
Come month end he’ll cut the base rate

The dollar is finishing the week on a high note as it rallies, albeit modestly, against virtually the entire G10 space. This is actually an interesting outcome given the ongoing risk-on sentiment observed worldwide. For instance, equity markets in the US all closed at record highs yesterday, and this morning, European equities are also trading at record levels. Asia, not wanting to be left out, continues to rally, although most markets in APAC have not been able to reach the levels seen during the late 1990’s prior to the Asian crisis and tech bubble. At the same time, we continue to see Treasury and Bund yields edging higher as yield curves steepen, another sign of a healthy risk appetite. Granted, commodity prices are not uniformly higher, but there are plenty that are, notably iron ore and steel rebar, both crucial signals of economic growth.

Usually, in this type of market condition, the dollar tends to decline. This is especially so given the lack of volatility we have observed encourages growth in carry trades, with investors flocking to high yield currencies like MXN, IDR, BRL and ZAR. However, it appears that at this juncture, the carry trade has not yet come back into favor, as that bloc of currencies has shown only modest strength, if any, hardly the signal that investor demand has increased.

This leaves us with an unusual situation where the dollar is reasonably well-bid despite the better risk appetite. Perhaps investors are buying dollars to jump on board the US equity train, but I suspect there is more to the movement than this. Investigations continue.

Narrowing our focus a bit more, it is worthwhile to consider the key events upcoming, notably next week’s ECB and BOJ meetings and the following week’s FOMC and BOE meetings. Interestingly, based on current expectations, the Fed meeting is likely to be far less impactful than either the ECB or BOE.

First up is the BOJ, where there is virtually no expectation of any policy changes, and in fact, that is true for the entire year. With the policy rate stuck at -0.10%, futures markets are actually pricing in a 5bp tightening by the end of the year. Certainly, Japan has gone down the road of increased fiscal stimulus, and if you recall last month’s outcome, the BOJ essentially admitted that they would not be able to achieve their 2.0% inflation target during any forecastable timeline. With that is the recent history, and given that inflation remains either side of 1.0%, the BOJ is simply out of bullets, and so will not be doing anything.

The ECB, however, could well be more interesting as the market awaits their latest thoughts on the policy review. Madame Lagarde has made a big deal about how they are going to review procedures and policy initiatives to see if they are designed to meet their goals. Some of the things that have been mooted are a change in the inflation target from “close to but below 2.0%” to either a more precise target or a target range, like 1.5% – 2.5%. Of even more interest is the fact that they have begun to figure out that their current inflation measures are inadequate, as they significantly underweight housing expense, one of the biggest expenses for almost every household. Currently, housing represents just 4% of the index. As a contrast, in the US calculation, housing represents about 41% of the index! And the anecdotes are legion as to how much housing costs have risen throughout European cities while the ECB continues to pump liquidity into markets because they think inflation is missing. Arguably, that has the potential to change things dramatically, because a revamped CPI calculation could well inform that the ECB has been far too easy in policy and cause a fairly quick reversal. And that, my friends, would result in a much higher euro. Today however, the single currency has fallen prey to the dollar’s overall strength and is lower by 0.25%.

As I mentioned, I don’t think the FOMC meeting will be very interesting at all, as there is a vanishingly small chance they change policy given the economy keeps chugging along and inflation has been fairly steady, if not rising to their own 2.0% target. The BOE meeting, however, has the chance to be much more interesting. This morning’s UK Retail Sales data was massively disappointing, with December numbers printing at -0.8%, -0.6% excluding fuel. This was hugely below the expected outcomes of +0.8% and +0.6% respectively. Apparently, Boris’s electoral victory did not convince the good people of England to open their wallets. And remember, this was during Christmas season, arguably the busiest retail time of the year. It can be no surprise that the futures market is now pricing a 75% chance of a rate cut and remember, earlier this week we heard from three different BOE members that cutting rates was on the table. The pound, which has been rallying for the entire week has turned around and is lower by 0.2% this morning with every chance that this slide continues for the next week or two until the meeting crystalizes the outcome.

The other noteworthy news was Chinese data released last night, which showed that GDP, as expected, grew at 6.0%, Retail Sales also met expectations at 8.0%, while IP (+6.9%) and Fixed Asset Investment (+5.4%) were both a bit better than forecast. The market sees this data as proof that the economy there is stabilizing, especially with the positive vibe of the just signed phase one trade deal. The renminbi has benefitted, rallying a further 0.3% on the session, and has now gained 4.6% since its weakest point in early September 2019. This trend has further to go, of that I am confident.

On the data front this morning, we have Housing Starts (exp 1380K), Building Permits (1460K), IP (-0.2%), Capacity Utilization (77.0%), Michigan Sentiment (99.3) and JOLT’s Job Openings (7.25M). So plenty of news, but it is not clear it is important enough to change opinions in the FX market. As such, I expect that today’s dollar strength is likely to continue, but certainly not in a major way.

Good luck and good weekend
Adf

Pundits Maligned

Phase one of the trade deal’s been signed
And though many pundits maligned
The outcome, it’s clear
That in the, term, near
Its impact on trading’s been kind

Amid a great deal of hoopla yesterday morning, President Trump signed the long-awaited phase one trade deal with China. The upshot is that the US has promised to roll back the tariffs imposed last September by 50%, as well as delay the mooted December tariffs indefinitely while the Chinese have promised to purchase upwards of $95 billion in US agricultural products over the next two years as well as agreeing to crack down on IP theft. In addition, the Chinese have committed to preventing excess weakness in the renminbi, and in fact CNY has been strengthening steadily for the past month as the negotiations came to an end. For example, this morning CNY is firmer by 0.15% and since mid-December it has rallied nearly 2.0%. Clearly there are larger trade issues outstanding between the two nations, notably forced technology transfer as well as numerous non-tariff barriers, but something is better than nothing.

Taking a step back, though, the bilateral nature of the deal is what has many pundits and economists unhappy. Certainly the economic theories I was taught, and that have been prevalent since David Ricardo first developed the theory of comparative advantage in 1817, indicate that multilateral trade is a better outcome for all concerned. Alas, the current political backdrop, where populism has exploded in response to the unequal outcomes from the globalization phenomenon of the past sixty years, has tarred multilateralism with a very bad reputation. And while it is far outside the purview of this commentary to dissect the issues, it is important to understand they exist and how they may impact markets. Given that the relative value of a nation’s currency is an important driver of trade outcomes, we cannot ignore it completely. Ultimately, as things currently stand, the market has seen this deal as a positive outcome, and risk appetite remains strong. As such, haven assets like the yen, dollar and Swiss franc are likely to remain on the back foot for the time being.

Beside the trade story, there has been scant new information on which to base trading decisions. Important data remains limited with the only notable print being German CPI at 1.5%, exactly as expected, although EU Car registrations bucked the trend and rose sharply, 21.7%, perhaps indicating we have seen a bottom on the Continent. But in reality, the market is now looking for the next big thing, and quite frankly, nobody really knows what that is. After all, the Fed has promised it is on hold, as are the ECB and BOJ, at least for the time being. Perhaps it is the BOE’s meeting in two weeks’ time, where the market continues to price in a growing probability of a rate cut. Of course, if the market is pricing it in, it is not likely to be that big a surprise, is it?

So in an uninspiring market, let’s look at what is coming up in today’s session. On the data front we see Initial Claims (exp 218K) and then Retail Sales (0.3%, 0.5% ex autos) as well as Philly Fed (3.8). Arguably, of just as much importance for the global economic outlook is tonight’s Chinese data where we will see; GDP (6.0%), Fixed Asset Investment (5.2%), Retail Sales (7.9%) and IP (5.9%). Remember, 6.0% growth has been President Xi’s target, and given the recent trajectory lower, any weaker than expected data is likely to be a risk-off sign, although it is likely to see a PBOC response in short order as well. Meanwhile, the US consumer continues to play its supporting role in the global economy, so any downside in this morning’s data is also likely to be a stock market negative.

On the speaker front, there are no Fed speakers today, although Philly’s Patrick Harker will regale us tomorrow. Later this afternoon ECB President Lagarde will be on the tape, and given she is still learning how much impact her words have on markets, there is always a chance of some unintentional excitement. Finally, yesterday, for the first time, we heard a Fed speaker explain that even though not-QE is not QE, the market may still consider it to be QE and the resulting rise in the price of risk assets may well be excessive. Dallas Fed President Kaplan is the first Fed member to publically admit that they may need to address this issue going forward. Certainly, the fact that the short-term repo program continues to be extended, and is now expected to run through April, rather than the original February completion, is an indication that the Fed still does not have control over the money markets. It is this last point which holds the potential to drive more significant market moves in the event of a communication or policy error. Just not today.

The dollar is mildly softer overall this morning, while we are seeing a very modest bias higher in equity markets around the world. Treasury yields are unchanged, just below 1.78%, and the previous narratives regarding recession probabilities and curve inversions as well as ongoing QE activities have just faded into the background. It all adds up to what is likely to be another quiet day in the FX markets, with no compelling story to drive movement.

Good luck
Adf

 

Feelings of Disquietude

In Germany, growth was subdued
In England, inflation’s now food
For thought rates will fall
As hawks are in thrall
To feelings of disquietude

This morning is a perfect lesson in just how little short-term movement is dependent on long-term factors like economic data. German GDP data was released this morning showing that for 2019 the largest economy in the Eurozone grew just 0.6%, which while expected was still the slowest rate in six years. And what’s more, forecasts for 2020 peg German GDP to grow at 0.7%, hardly enticing. Yet as I type, the euro is the best performer in the G10 space, having risen 0.2%. How can it be that weak data preceded this little pop in the currency? Well, here is where the short-term concept comes in; it appears there was a commercial order going through the market that triggered a series of stop-loss orders at 1.1140, and lo and behold, the euro jumped another 0.15%. My point is that any given day’s movement is only marginally related to the big picture and highly reliant on the short term flows and activities of traders and investors. So forecasts, like mine, that call for the euro to rally during this year are looking at much longer term issues, which will infiltrate trading views over time, not a prescription to act on intraday activity!

Meanwhile, the pound has come under modestly renewed pressure after CPI in the UK surprisingly fell to 1.3% with the core reading just 1.4%. This data, along with further comments by the most dovish BOE member, Michael Saunders, has pushed the probability of a UK rate cut at the end of the month, as measured by futures prices, up to 65%. Remember, yesterday this number was 47% and Friday just 25%. At this point, market participants are homing in on the flash PMI data to be released January 24 as the next crucial piece of data. The rationale for this is that the weakness that we have seen recently from UK numbers has all been backward-looking and this PMI reading will be the first truly forward looking number in the wake of the election in December. FYI, current expectations are for a reading of 47.6 in Manufacturing and 49.4 in Services, but those are quite preliminary. I expect that they will adjust as we get closer. In the meantime, look for the pound to remain under pressure as we get further confirmation of a dovish bias entering the BOE discussion. As to Brexit, it will happen two weeks from Friday and the world will not end!

Finally, the last G10 currency of interest today is the Swiss franc, which is vying with the euro for top performer, also higher by 0.2% this morning, as concern has grown over its ability to continue its intervention strategy in the wake of the US adding Switzerland back to the list of potential currency manipulators. Now, the SNB has been intervening for the past decade as they fight back against the franc’s historic role as a safe haven. The problem with that role is the nation’s manufacturing sector has been extraordinarily pressured by the strength of the franc, thus reducing both GDP and inflation. It seems a bit disingenuous to ask Switzerland to adjust their macroeconomic policies, as the US is alleged to have done, in order to moderate CHF strength given they already have the lowest negative interest rates in the world and run a large C/A surplus. But maybe that’s the idea, the current administration wants the Swiss to be more American and spend money they don’t have. Alas for President Trump, that seems highly unlikely. A bigger problem for the Swiss will be the fact that the dollar is likely to slide all year as QE continues, which will just exacerbate the Swiss problem.

Turning to the emerging market bloc, today’s biggest mover is BRL, where the real is opening lower by 0.5% after weaker than expected Retail Sales data (0.6%, exp 1.2%) point to ongoing weakness in the economy and increase the odds that the central bank will cut rates further, to a new record low of just 4.25%. While this still qualifies as a high-yielder in today’s rate environment, ongoing weakness in the Brazilian economy offer limited prospects for a reversal in the near-term. Do not be surprised to see BRL trade up to its recent highs of 4.25 before the bigger macro trend of USD weakness sets in.

And that’s been today’s currency story. I have neglected the signing of the phase one trade deal because that story has been so over reported there is exactly zero I can add to the discussion. In addition, the outcome has to be entirely priced into the market at this point. Equity markets have had difficulty trading higher during the past two sessions, but they certainly haven’t declined in any serious manner. As earnings season gets underway, investors seem to have turned their attention to more micro issues rather than the economy. Treasury yields have been edging lower, interestingly, despite the general good feelings about the economy and risk, but trying to determine if the stock or bond market is “correct” has become a tired meme.

On the data front, this morning brings PPI (exp 1.3%, 1.3% core) but given that we saw CPI yesterday, this data is likely to be completely ignored. We do get Empire Manufacturing (3.6) and then at 2:00 the Fed releases its Beige Book. We also hear from three Fed speakers, Harker, Daly and Kaplan, but at this point, the Fed has remained quite consistent that they have little interest in doing anything unless there is a significant change in the economic narrative. And that seems unlikely at this time.

And so, this morning the dollar is under modest pressure, largely unwinding yesterday’s modest strength. It seems unlikely that we will learn anything new today to change the current market status of limited activity overall.

Good luck
Adf

A Dangerous Game

In ‘Nineteen the story was trade
As Presidents Trump and Xi played
A dangerous game
While seeking to blame
The other for why growth decayed

But ‘Twenty has seen both adjust
Their attitudes and learn to trust
That working together,
Like birds of a feather,
Results in an outcome, robust

In a very quiet market, the bulk of the discussion overnight has been about the upcoming signing ceremony in the East Room of the White House tomorrow, where the US and China will agree the phase one piece of a trade deal. Despite the fact that this has been widely expected for a while, it seems to be having a further positive impact on risk assets. Today’s wrinkle in the saga has been the US’ removal of China from the Treasury list of currency manipulators. Back in August, in a bit of a surprise, the US added China to that list formally, rather than merely indicating the Chinese were on notice, as President Trump sought to apply maximum pressure during the trade negotiations. Now that the deal is set to be signed, apparently the Chinese have made “enforceable commitments” not to devalue the yuan going forward, which satisfied the President and led to the change in status. The upshot is that the ongoing positive risk framework remains in place thus supporting equity markets while undermining haven assets. In other words, just another day where the politicians seek to anesthetize market behavior, and have been successful doing so.

Chinese trade data released last night was quite interesting on two fronts; first that the Chinese trade surplus with the US shrank 11%, exactly what the President was seeking, and second, that the Chinese found many substitute markets in which to sell their wares as their overall trade surplus rose to $425 billion from 2018’s $351 billion. And another positive for the global growth watch was that both exports (+7.6%) and imports (+17.7%) grew nicely, implying that economic growth in the Middle Kingdom seems to be stabilizing. As to the yuan, it has been on a tear lately, rising 1.4% this year and nearly 4.5% since early September right after the US labeled China a currency manipulator. So, here too, President Trump seems to have gotten his way with the Chinese currency having regained almost all its losses since the November 2016 election. Quite frankly, it seems likely that the yuan has further to climb as prospects for Chinese growth brightened modestly and investors continue to hunt for yield and growth opportunities.

But away from the trade story there is precious little else to discuss. The pound remains under pressure (and under 1.30) as the idea of a BOE rate cut at the end of the month gains credence. Currently the market is pricing in a 47% probability of a rate cut, which is up from 23% on Friday. After yesterday’s weak GDP data, all eyes are focused on tomorrow’s UK CPI data as well as Friday’s Retail Sales where any weakness in either one is likely to see the market push those probabilities up even further.

As haven assets are shed, the Japanese yen has finally breached the 110 level for the first time since May and quite frankly there doesn’t appear to be any reason for the yen to stop declining, albeit slowly. Barring some type of major risk-off event, which is always possible, the near term portents are for further weakness. However, as the year progresses, ongoing Fed QE should serve to reverse this movement.

Even the Emerging markets have been dull overnight, with no currency moving more than 0.3%, which in some cases is nearly the bid-ask spread. For now, most market participants have become quite comfortable that no disasters are looming and that, with the US-China trade deal about to be completed, there is less likelihood of any near-term angst on that front. While a phase two deal has been mooted, given the issues that the US has indicated are important (forced technology transfer, state subsidies), and the fact that they are essentially non-starters in China, it seems highly improbable that there will be any progress on that issue this year.

On the data front, this morning brings the first US data of the week, where NFIB Small Business Optimism actually disappointed at 102.7 and the market is now awaiting December CPI data (exp 2.4%, 2.3% ex food & energy) at 8:30. The headline forecast represents a pretty big uptick from November, but that is directly related to oil’s price rally last month. The core, however, remains unchanged and well above the 2.0% Fed target. Of course that target is based on PCE, something that is designed to print lower, and there has been abundant evidence that the Fed’s idea of the target is to miss it convincingly on the high side. In other words, don’t look for the Fed to even consider a tighter policy stance unless CPI has a 3 handle.

And that’s really it for the session. Equity futures are pointing slightly higher as European equity indices are edging in that direction as well. Treasury yields are hovering just above 1.80%, little changed on the day and showing no directional bias for the past several weeks. If anything, the dollar is slightly higher this morning, but I would be surprised if this move extends much further at all.

Good luck
Adf

Growth Can Be Spurred

In England this morning we heard
From Vlieghe, the BOE’s third
Incumbent to say
That given his way
He’d cut rates so growth can be spurred

The pound is under pressure this morning after Gertjan Vlieghe became the third MPC member in the past week, after Carney and Tenreyo, to explain that a rate cut may be just the ticket at this point in time. Adding these three to the two members who had previously voted to cut rates, Haskel and Saunders, brings the number of doves to five, a majority on the committee. It can be no surprise that the pound has suffered, nor that interest rate markets have increased the probability of a 25bp rate cut at the January 30 meeting from below 25% last week to 50% now. Adding to the story was the release of worse than expected November IP (-1.2%) and GDP (-0.3%) data, essentially emphasizing the concerns that the UK economy has a long way to go to recover from the Brexit uncertainty.

However, before you turn too negative on the UK economy, remember that this is backward-looking data, as November was more than 6 weeks ago, and in the interim we have had the benefit of the resounding electoral victory by Boris Johnson. This is not to say that the UK economy cannot deteriorate further, just that there has been a palpable change in the tone of commentary in the UK as Brexit uncertainty has receded. Granted, the question of the trade deal with the EU, which is allegedly supposed to be signed by the end of 2020, remains open. But it is very difficult for market participants to look that far ahead and try to anticipate the outcome. And if anything, Boris has the fact that he was able to renegotiate the original Brexit deal in just six weeks’ time working in his favor. While previous assumptions had been that trade deals take years and years to negotiate, it is clear that Boris doesn’t subscribe to that theory. Personally, I wouldn’t bet against him getting it done.

But for now, the pound is the worst performer of the session, and given today’s news, that should be no surprise. However, I maintain my view that current levels represent an excellent opportunity for payables hedgers to add to hedges.

The other mover of note in the G10 space is the yen, which has fallen 0.4% after traders were able to take advantage of a Japanese holiday last night (Coming-of-age Day) and the associated reduced liquidity to push the dollar above a key technical resistance point at 109.72. Stop-loss orders at that level led to a quick jump at 4:00 this morning, and given the broad risk-on attitude in markets (equity markets worldwide continue to rebound from concerns over further Middle East flare ups), it certainly feels like traders are going to push the dollar up to 110, a level not seen since May. However, the other eight currencies in the G10 have been unable to generate any excitement whatsoever and are very close to unchanged this morning.

In the EMG space, Indonesia’s rupiah is once again the leader in the clubhouse, rising a further 0.7% after the central bank reiterated it would allow the currency to appreciate and following an announcement by the UAE that it would make a large investment in the nation’s (Indonesia’s) sovereign wealth fund. The resultant rally, to the rupiah’s strongest level in almost a year, has been impressive, but there is no reason to believe that it cannot continue for another 5% before finding a new home. This is especially true if we continue to hear good things regarding the US-China trade situation. Trade has also underpinned the second-best performer of the day in this space, KRW, which has rallied 0.5%, on the trade story.

While those are the key stories thus far this session, we do have a full week’s worth of data to anticipate, led by CPI, Retail Sales and Housing data.

Tuesday NFIB Small Biz Optimism 104.9
  CPI 0.3% (2.4% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday PPI 0.2% (1.3% Y/Y)
  -ex food & energy 0.2% (1.3% Y/Y)
  Empire Manufacturing 3.5
  Fed’s Beige Book  
Thursday Initial Claims 218K
  Philly Fed 3.0
  Retail Sales 0.3%
  -ex autos 0.5%
  Business Inventories -0.1%
Friday Housing Starts 1380K
  Building Permits 1460K
  IP -0.1%
  Capacity Utilization 77.0%
  Michigan Sentiment 99.3
  JOLTS Job Openings 7.264M

Source: Bloomberg

So clearly there is plenty on the docket with an opportunity to move markets, and we also hear from another six Fed speakers. While you and I may be concerned about rising prices, it has become abundantly clear that the Fed is desperate to see them rise further, so the only possible reaction to a CPI miss would be on the weak side, which would likely see an equity rally on the assumption that even more stimulus is coming. Otherwise, I think Retail Sales will be the data point of choice for the market, with weakness here also leading to further equity strength on the assumption that the Fed will add to their current policy.

And it is hard to come up with a good reason for any Fed speaker to waver from the current mantra of no rate cuts, but ongoing support for the repo market and a growing balance sheet. And of course, that underlies my thesis that the dollar will eventually fall. Just not today it seems!

Good luck
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