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Quite Frankly Floored

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Most pundits were, quite frankly, floored
That leaving the ECB Board
Was one of the hawks
Who tired of talks
‘bout QE the Germans abhorred

The dollar is stronger than where I left it Tuesday evening after a rally in yesterday’s NY session. Determining the catalyst for that rally has been difficult given the only economic data of note was New Home Sales (713K), which while quite strong are generally not seen as market moving, and the limited commentary overheard. However, there are three things that conspired, I believe, to drive the dollar higher.

First was the surprise resignation of Sabine Lautenschlaeger from the ECB Executive Board. Ms. Lautenschlaeger was one of the most ardent hawks on the ECB and was quite vocal that there was no need to resume QE at the current time. In fact, she had been proffering that message since the last meeting when Mario first hinted that QE2 was on the table. In the end, though, she was not able to garner enough support to dissuade Signor Draghi from going ahead with it, and it appears she decided that her voice was no longer taken into consideration. Whomever is chosen as her replacement is almost certain to have less hawkish views, and so the market recognized that the tone of the ECB has turned more dovish. A dovish ECB is likely to result in easier policies and correspondingly a weaker euro.

We also heard from Chicago Fed President Charles Evans, a known dove, who indicated that he saw no reason for further rate cuts this year. It appears that he was one of the dots in the middle, comfortable with last week’s cut but calling it quits then. He highlighted that if the economy deteriorated for some reason, he would not be against further cuts, but at the present time, they were not necessary. So, a Fed dove was mildly hawkish, helping cement the idea that the Fed was less likely to cut rates again this year. This can only be seen as dollar bullish.

Finally, we have the calendar as we approach quarter-end and the financing requirements necessary for banks and other financial firms when they report positions. The stricter regulatory environment that has been in place since the financial crisis means that there is an increased demand for dollars on virtually every institution’s balance sheet. That is one reason we have seen issues within the Fed Funds market with all the discussion about the Fed’s repo facility and recent activities. However, there are many institutions that simply buy dollars in order to put their balance sheet in order.

Add them all up, and you have the makings of a dollar rally, which has seen the euro decline 0.85% since yesterday morning, the pound fall 1.2% and the yen fall 0.5%. Granted, the pound has its own issues relating to Boris’s return to Parliament and the inflamed rhetoric on both sides of the aisle there leading to an increase in belief that a hard Brexit is still possible. But the tell that this is simply a dollar rally and not a risk off event is the fact that the yen fell sharply, alongside a rally in equities and decline in the bond market.

The question at this time is whether the rally continues, or if it was merely a one-day event. At this point, the evidence seems to indicate that a slow continuation of the dollar rally is the most likely outcome. Certainly, there will be nothing hawkish coming from ECB policymakers as the hawks seem more willing to quit than continue to lose their battle. Eurozone data continues to implode and another key German institute, the DIW Institute, announced its expectation that when German GDP for Q3 is released on November 14, it will show growth at -0.2%, the second consecutive decline and put Germany in a technical recession. As an aside, it is interesting to see just how crucial the idea of monetary discipline is to Germans, in general, and German bankers in particular. Despite the fact that Germany probably has the weakest growth in the Eurozone, its ECB members are amongst the most hawkish. If that ever changes, you can be sure the euro will fall far more rapidly!

As to the Fed, it seems to me that there is a clear level of comfort developing on the FOMC that two cuts were sufficient in the current circumstances to stanch any bleeding in the economy, and barring an escalation in the trade war, they seem ready to stand pat. If that is the case, then dollars will retain their relative attractiveness. And of course, the calendar is beyond all our reach, but we will need to see if Friday, when the spot value date turns to October 1, whether or not there is reduced demand for the greenback. My sense is that pressure will dissipate quickly, and possibly reverse as those dollars are seen as short-term needs. But for the rest of the day, I think the dollar has room to run a little further.

Turning to today’s session, we do get the final reading of Q2 GDP (exp 2.0%) as well as the ancillary data that comes with that report. I always look at the Personal Consumption component (4.7%) as the best measure of demand, so keep an eye there. And of course, we get Initial Claims (212K), but that series’ stability has been extraordinary and largely taken it out of the conversation. If we do start to see that rise, however, beware of weakening nonfarm numbers and a lot more dovish rhetoric from the Fed.

As to the Fed, we have six, count ‘em, speakers today with nary a hawk in sight. As such, amongst Kaplan, Bullard, Clarida, Daly, Kashkari and Barkin, I expect rationales as to why another rate cut or two makes sense, or at the very least highlights of weakening global growth and impending problems like Brexit which require easier Fed policy as a response. However, given they are all known on the dovish side, I don’t think it matters that much. For now, I don’t see anything derailing the dollar and look for a modest further increase throughout the session.

Good luck
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What He’s Wrought

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The High Court within the UK
Explained in a ruling today
That Boris cannot
Complete what he’s wrought
A win for those who want to stay

As I wrote last Tuesday, the Supreme Court ruling in the UK cannot be a surprise to anyone. The issue was that twelve justices who were appointed to their seats from lives of privilege and wealth, and who almost certainly each voted to Remain two years ago, were going to decide whether Boris Johnson, a rebel in every conceivable way, would be allowed to lead the UK out of the EU against their personal views. These are folks who have greatly benefitted from the UK being within the EU, and they were not about to derail that gravy train. Thus, this morning’s ruling should have been the default case in everyone’s mind.

Interestingly, the ruling went far beyond simply the legality of the prorogation, but included a call for Parliament to reconvene immediately. Naturally, John Bercow, the speaker of the House of Commons, and an alleged non-partisan player, called on both sides of the aisle to get back to work post haste. Given that prorogation was nothing new in Parliament, having occurred on a fairly regular basis since 1628 when King Charles I first did so, and since there is no written constitution in the UK by which to compare laws to a basic canon, it will be interesting in the future when another PM seeks prorogation at a time less fraught than the current Brexit induced mania, whether or not they have the ability to do so.

Nonetheless, we can expect Parliament to reconvene shortly and try to do more things to insure that Boris cannot unilaterally ignore the current law requiring the PM to ask for an extension if there is no deal agreed at the deadline. In other words, there is still plenty of action left in this process, with just 37 days left until the current deadline.

And what of Sterling you ask? When the announcement hit the tape at 5:30 this morning, it jumped a quick 0.4% to just below 1.2500. That move had all the hallmarks of short covering by day traders, and we have since removed half of that gain. Interestingly, Boris is currently at the UN session in NY meeting with his EU counterparts and trying to get a deal in place. In the end, I still believe that the EU is ready to relent on some issues to pave the way for a deal of some sort. As European economic data continues to melt down (German IFO Expectations fell to 90.8, well below forecasts and the lowest in more than a decade), there is a growing sense of urgency that the EU leadership cannot afford to allow a hard Brexit. Combining that view with the fact that everybody over there is simply tired of the process and wants it to end means that a deal remains far more likely than not. As such, I remain pretty confident that we will see a deal before the deadline, or at least agreement on the key Irish backstop issue, and that the pound will rebound sharply.

Away from that story, however, things are far less exciting and impactful. On the trade front, news that China has allowed exemptions from soybean tariffs for a number of Chinese importers has been met with jubilation in the farm belt, and has imparted a positive spin to the equity market. Last week’s trepidations over the canceling of the Chinese delegation’s trip to Montana and Nebraska is ancient history. The narrative is back to progress is being made and a deal will happen sooner or later. Equity markets have stabilized over the past two days, although in order to see real gains based on the trade situation we will need to see more definitive progress.

Bond prices continue to focus on the global industrial malaise that is essentially made evident every day by a new data release. Yesterday it was PMI, today IFO and later this week, on Thursday, we will see Eurozone confidence indicators for Industry, Services and Consumers. All three of these have been trending lower since the winter of 2017 and there is no reason to expect that trend to have changed. As such, it is no surprise that we continue to see government bond yields slide with Treasuries down a further 3bps this morning as are JGB’s. Bunds, however, have seen less buying interest and have seen yields fall just 1bp. The story with Bunds is more about the increasing calls for fiscal stimulus in the Eurozone. Signor Draghi has tried his best but the Teutons remain stoic in the face of all his pressure. But Draghi is an economist. Incoming ECB President Christine Lagarde is a politician and may well be the best choice for the role after all. If she has the political nous to change Merkel’s views, that will be enough to open the taps, arguably support growth in the EU and reduce the need for further monetary ease. However, that is a BIG if.

One other story out of China describes comments from PBOC Governor Yi Gang that essentially said there was no reason for them to ease policy aggressively at this time, although they have plenty of tools available if they need to do so in the future. It is clear they are still quite concerned over inflating a housing bubble and will do all they can to prevent any further excess leverage in the real estate sector. It should not be surprising that the renminbi benefitted from these comments as it is 0.25% stronger than yesterday. The combination of a slightly more hawkish PBOC and the positive trade news was all it took.

Turning to this morning’s session, things are pretty quiet at this time. There are only two minor pieces of data, Case Shiller House Prices (exp 2.90%) and Consumer Confidence (133.0). On the speaker front, nobody is scheduled today although yesterday we heard from a number of doves, Bullard, Daly and Williams, all of whom agreed with the recent rate cut. With the day’s big news out of the way, I anticipate a relatively uneventful session. Overall the dollar is slightly softer on the day, and it seems reasonable to believe that trend will stay in place so look for a modest decline as the day progresses.

Good luck
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Not a Chance

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From Germany and, too, from France
We saw the economy’s stance
Their prospects are dire
And though they aspire
To growth, it seems they’ve not a chance

Surveying the markets this morning, the theme seems to be that the growth scare continues to be real. PMI data from Europe was MUCH worse than expected across the board, with Services suffering as well as the manufacturing data which has been weak for quite a while already. This is how things stacked up:

Event Expectations Release
German Manufacturing PMI 44.0 41.4
Services PMI 54.3 52.5
Composite PMI 51.5 49.1
French Manufacturing PMI 51.2 50.3
Services PMI 53.2 51.6
Composite PMI 52.6 51.3

Source: Bloomberg

Anybody that claims Germany is not in recession is just not paying attention. Friday evening, the Bundestag agreed to a new €54 billion bill to address climate change, which some are looking at as an economic stimulus as well. However, a stimulus bill would need to create short term government spending, and the nature of this bill is decidedly longer term in nature. And a bigger problem is the German unwillingness to run a budget deficit means that if they put this in place, it will restrict their ability to add any stimulus on a more timely basis. It also appears that the ECB and IMF will continue to call them out for their austere views, but thus far, the German people are completely backing the government on this issue. Perhaps when the recession is in fuller flower, der mann on der strasse will be more willing for the government to borrow money to spend.

It ought not be that surprising that European equity markets suffered after the release with the DAX down a solid 1.2% and CAC -1.0% with the bulk of the move coming in the wake of the releases. This paring of risk also resulted in a rally in Bunds (-6bps), OATS (-3bps) and Treasuries (-3bps) while the dollar rallied (EUR -0.4%, GBP -0.3%).

But I think this begs the question of whether or not a recession is going to be solely a European phenomenon or if the US is going to crash that party. What we have learned in the past two weeks is that the ECB is basically spent, and that the market’s review of their newest policy mix was two thumbs down. Ironically, Draghi’s clear attempts to weaken the euro are now being helped by the significantly weaker than expected Eurozone data that he’s trying to fix. Apparently, you can’t have it both ways. Much to his chagrin, however, I believe that there is plenty more downside for the euro as the Eurozone economy continues its slow descent into stagnation. When Madame Lagarde takes over on November 1st, she will have an empty cupboard of tools to address the economy and will be forced to rely on verbal suasion. I expect that we will hear from the Mandame quite frequently as she tries to change the narrative. I also expect that her efforts will do very little, especially if China continues to falter.

Away from the weak European data, there was not that much else of interest. Friday, if you recall, the US equity markets suffered after the low-level Chinese trade delegation canceled a trip to Montana and Nebraska as the perception was the talks broke down. It turns out, however, that the request came from the US for other reasons, and that the talks, by all accounts, went quite well. At this point, the market is now looking forward to Chinese Vice-Premier, Liu He, coming to Washington on October 10, so barring any further tweets on the subject that topic may well slip to the back burner.

Brexit was also in the news as Boris makes his way to NY for the UN session this week He has scheduled meetings with all the key players from Europe including Chancellor Merkel, President Macron and Taoiseach Varadkar. At the same time, the Labour party’s conference is in disarray as leader Jeremy Corbyn wants to campaign on a second referendum but will not definitively back Remain. In other words, it’s not just the Tories who are split over Brexit, it is both parties. And don’t forget, we are awaiting the UK Supreme Court’s decision on the legality of Boris’ move to prorogue parliament for five weeks, which could come any day this week. In the end, the pound is still completely beholden to Brexit, so look for a Supreme Court ruling against the government to result in a rally in the pound as it will be perceived as lowering the probability of a no-deal Brexit. Again, my view remains that at the EU summit in the middle of next month, there will be an announcement of a breakthrough of some sort to fudge the Irish backstop and that the pound will rally sharply on the news.

Looking ahead to this week, we have a fair amount of new information as well as a host of Fed speakers:

Tuesday Case-Shiller House Prices 2.90%
  Consumer Confidence 133.3
Wednesday New Home Sales 656K
Thursday Q2 GDP (2ndrevision) 2.0%
  Initial Claims 211K
Friday Personal Income 0.4%
  Personal Spending 0.3%
  Durable Goods -1.1%
  -ex transportation 0.2%
  Core PCE Deflator 0.2% (1.8% Y/Y)
  Michigan Sentiment 92.0

Source: Bloomberg

We also hear from 11 different Fed speakers this week, two of them twice! At this point I expect they will be working hard to get their individual viewpoints across which should actually help us better understand the mix of views on the board. So far we have a pretty good understanding of where Bullard, George and Rosengren stand, but none of them are speaking this week. This means we will get eleven entirely new viewpoints. And my take is that the general viewpoint is going to be unless the data really turns lower; there is no more cause to ease at this point. I don’t think the equity market will like that, nor the bond market, but the dollar is going to be a big beneficiary. The euro is back below 1.10 this morning. Look for it to continue lower as the week progresses.

Good luck
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Past Its Shelf Life

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The narrative most of this year
Described central banks full of fear
So rates they would cut
Which might help somewhat
But so far that hasn’t been clear

Instead every meeting’s been rife
With conflict, dissension and strife
For NIRP, the doves pine
While hawks like to whine
That policy’s past its shelf life

At the end of a week filled with numerous central bank meetings, it’s time to consider what we’ve learned. Arguably, the first thing is that groupthink in the central banking community is not quite as widespread as we previously believed. This was made evident by the three dissenting votes at the FOMC on Wednesday as well as last week’s ECB meeting, where at least five members of the council argued vociferously for no further stimulus. The funny thing is that while I understand the European monetary hawks’ zeitgeist, (German hyperinflation of the 1920’s) the fact remains that Europe is slipping into recession and arguably the ECB is correct in trying to address that. With that said, I would argue they would have been far better off extending the TLTRO’s to an even longer maturity and cut rates there, allowing banks to earn from the ECB while they lend to clients at a positive rate. Simply cutting the deposit rate to -0.50% is very unlikely to spur growth further, at least based on the fact that it has not helped yet.

At the same time, the FOMC also has a wide range of opinions on display. Not only were there two hawkish dissents, there was a dovish one as well. And based on the dot plot, after this cut, there are now ten of the seventeen members who see no further rate action in 2019. Meanwhile, the market is still pricing in a 69% probability of a cut by the December meeting. There was a comment by a famous hedge fund trader that Chairman Powell is the weakest chairman in decades, based on these dissents, but it was just three years ago, in the September 2016 meeting when Janet Yellen chaired the Fed, that there were also three dissents at a meeting, with all three seeking a rate hike, while the Fed stood pat. The point is, it is probably a bit unfair to be claiming Powell is weak because some members have different views. And in the big picture, shouldn’t we want a diversity of ideas at the Fed? I think that would make for a healthier debate.

Two other meetings stand out, the BOJ and the PBOC, or at least actions by those banks stand out. While the BOJ left policy on hold officially, they not only promised a re-evaluation of the current monetary policy framework, but last night, they significantly reduced the amount of JGB’s that they purchased in the longer maturities. The absent ¥50 billion surprised market players and helped drive the yields on the back end higher by between 3-4bps. The BOJ have made it clear that they are interested in a steeper yield curve, and that’s just what they got. Their problem is that despite decades of ZIRP and then NIRP, as well as a massive QE program, their inflation target remains as far away as ever. Last night, for example, CPI was released at 0.5% Y/Y ex fresh food, the lowest level since mid-2017. It seems pretty clear that their actions have been a failure for decades and show no sign of changing. Perhaps they could use a little dissent!

Finally, the PBOC cut its 1-year Loan Prime Rate (its new monetary benchmark) by 5bps last night, the second consecutive cut and an indication that they are trying to add stimulus without inflating any financial bubbles. While this move was widely anticipated, they did not change the level of the 5-year Rate, which was also anticipated. The overall difference here, though, is that the PBOC is clearly far less concerned with what happens to investors than most Western central banks. After all, they explicitly take their marching orders from President Xi, so the overall scope of policy is out of their hands.

When looking at the impact of these moves, though, at least in the currency markets, the thrust was against the grain of what was desired by the central banks. If you recall last week, the euro initially declined, but then rallied sharply by the end of the day after the ECB meeting and has largely maintained those gains. Then yesterday we saw JPY strength, with no reprieve overnight after their change of stance, while the renminbi has actually strengthened 0.2% overnight in the wake of the rate cut. As I have been writing, central banks are slowly losing their grip on the markets, a situation which I believe to be healthy, but also one that will see increased volatility over time.

Looking at the market activity overnight, the screen shows that one of the best performers was INR, with the rupee gaining 0.5%. This comes on the back of the government’s announced $20 billion stimulus plan of corporate tax cuts. While equity markets there responded joyfully, Sensex +5.3%, government bonds fell sharply, with 10-year yields rising 15bps as bond investors questioned the ability of the government to run larger deficits. But away from that, the FX market was quite dull. EMG currencies saw both gainers and losers, with INR the biggest mover. G10 currencies were pretty much the same story with NZD the biggest mover, falling 0.4% after S&P explained that New Zealand banks still had funding problems.

The other two big stories have had mixed impact, with positive trade vibes being felt as low-level talks between the US and China have been ongoing this week, while the UK Supreme Court is now done with its hearings and we all simply await the decision. At the same time, EC President Juncker sounded positive that a Brexit deal could be done although Ireland continues to claim that nothing is close. The pound rallied on Juncker’s comments, but fell back below 1.25 after Ireland weighed in. Ask yourself if you think the rest of the EU will tolerate a solo Irish dissent on getting to a deal. It ain’t gonna happen.

As to today’s session, there is no data to be released but we will hear from three Fed speakers, Williams first thing, then Rosengren and Kaplan. It will be interesting to see how they try to spin things as to the Fed’s future activities. With that in mind, the biggest surprise seems like it can come from the UK , if we hear from the Supreme Court later today. While there is no clarity when they will rule, it is not out of the question. As to the dollar, it has no overall momentum and I see no reason for it to develop any without a catalyst.

Good luck and good weekend
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Not the Nadir

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The Chairman explained to us all
Preventing the ‘conomy’s stall
Required a cut
Of twenty-five but
Don’t look for, rates, further to fall

However, it’s not the nadir
For all rates, that’s certainly clear
Brazil cut a half
While BOJ staff
Will check if they’re now too austere

As I mentioned on Monday, the Fed was merely the first in a long list of major central banks meeting this week. By now we all know the FOMC cut rates by 25 bps and released a statement that was certainly more hawkish than many had hoped for expected. The vote was largely as expected, with the July dissenters, George and Rosengren, continuing to vote for no change, while this month, St. Louis Fed President James Bullard also dissented, voting for a 50bp cut. Of more interest was the dot plot, which showed five members forecasting no further cuts this year, five looking for one more cut and seven looking for two cuts. That is actually quite a bit more hawkish than expected going into the meeting. In the end, equity markets sold off initially, but rallied late in the day to close essentially unchanged. Treasuries rallied all day leading up to the meeting, but ceded those gains in the wake of the announcement and press conference while the dollar rallied against most currencies, although it has given back those gains overnight.

Powell’s explanation for cutting was that the committee was still concerned over issues like global growth, trade policy and Brexit, and so felt a cut was merited to help insure steady growth. My impression is Powell is not anxious to cut again, but arguably it will depend on how the data evolves between now and the October meeting.

Meanwhile, late yesterday afternoon the Central Bank do Brazil cut their SELIC rate by 50bps to 5.50%, a new record low for the rate, but also a widely expected move by the market. Inflation in Brazil continues to slow, and with growth extremely sluggish, President Roberto Campos Neto made clear that they expect inflation to remain quiescent and will do what they can to help bolster the economy there. Look for another 50bps this year and potentially more next year as well. It should be no surprise that the real weakened yesterday, falling 0.8%, and I expect it has further to fall as Neto was clear that a weaker currency would not deter him.

Then overnight we heard from a number of central banks with Bank Indonesia cutting the expected 25bps top 5.25%, while the HKMA also cut in order to keep step with the US. Both currencies, IDR and HKD, were virtually unchanged overnight as the market had fully priced in the moves. Arguably of more importance was the BOJ meeting, where they left policy unchanged, but where Kuroda-san explained that the BOJ would undertake a full review of policy by the October meeting to insure they were doing everything they could to support the economy. There were a number of analysts who were expecting a rate cut, or at least further QE, and so the disappointment led to a 0.5% rally in the yen.

When Europe walked in, there were three central bank meetings scheduled with the Swiss maintaining policy rates but adjusting the amount of reserves exempt from the deposit rate of -0.75%. While Swiss banks have been complaining about this, given there was already a tiered system it was not anticipated that things would change. The upshot is that the franc is firmer by 0.6% in the wake of the announcement, although traders are a bit on edge given the SNB was clear that intervention remained on the table.

The biggest surprise came from Norway, which hiked rates 25 bps to 1.50%. While several of the Norwegian banks were calling for the hike, the market at large did not believe the Norgesbank would raise rates while the rest of the world was cutting. But there you go, the situation there is that the economy is doing fine, inflation is perking up and because of the government’s ability to tap the oil investment fund, they are actually utilizing fiscal policy as well as monetary policy in their economic management. With all that in mind, however, they were pretty clear this is the last hike for the foreseeable future. NOK rallied 0.5% on the news, but it has given all those gains back and now sits unchanged on the day.

Finally, in what is no surprise at all, the BOE just announced that policy remains unchanged for the time being as all eyes turn toward Brexit and what will happen there. The UK also released Retail Sales data which was bang on expectations and so the pound remains beholden entirely to the Brexit situation.

Speaking of Brexit, today is the third day of hearings at the UK Supreme Court regarding the two lawsuits against the Johnson government’s decision to prorogue parliament for five weeks. If you recall, late Tuesday when word got out that the justices seemed to be very hard on the government, the pound rallied. Interestingly, this morning there are stories all over the press about how the likelihood of a no-deal Brexit seems to be growing quickly. Everybody is tired of the process and thus far, neither side has blinked. I maintain the EU will blink as the economic damage to Germany, the Netherlands and Ireland adding to the entire EU’s economic malaise will be too much to tolerate. But we shall see. As I have been typing, the pound has been edging lower and is now down 0.2% on the day, but in the big picture, that is the same as unchanged.

Turning to this morning’s US data, we start with Philly Fed (exp 10.5) and Initial Claims (213K) and then at 10:00 see Existing Home Sales (5.38M). Yesterday’s housing data, starts and permits, were much better than expected, which given the sharp decline in mortgage rates and still robust employment situation, should not be that surprising. As to Fed speakers, there is no one on tap for today, but three (Williams, Rosengren and Kaplan) due to speak tomorrow. Equity futures are pointing slightly lower right now and if I had to guess, the dollar is more likely to rally slightly than not as the day progresses although large moves are not on the cards.

Good luck
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The Question at Hand

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There is an old banker named Jay
Who’ll cut Fed Funds later today
The question at hand
Is, are more cuts planned?
Or is this the last one he’ll weigh?

Well, no one can describe the current market situation as dull, that’s for sure! The front burner is full of stories but let’s start with the biggest, the FOMC announcement and Chairman Powell’s press conference this afternoon. As of now, futures markets are fully pricing in a 25bp cut this afternoon, with a small probability (~18%) of a 50bp cut. They are also pricing in a 50% chance of a cut at the October meeting, so despite the hawkish rhetoric and relatively strong data we have seen lately, the doves are keeping the faith. In fact, it would be shocking if they don’t cut by 25bps, although I also expect the two regional Fed presidents (George and Rosengren) who dissented last time to do so again. What has become clear is that there is no overriding view on the committee. The dot plot can be interesting as well, as given there are only two meetings left this year, it will give a much better view of policy preferences. My guess is it will be split pretty evenly between one more cut and no more cuts.

Then it’s all on Chairman Jay to explain the policy thinking of the FOMC in such a way that the market accepts the outcome as reasonable, which translates into no large moves in equity or bond markets during or after the press conference. While, when he was appointed I had great hopes for his plain spoken comments, I am far less confident he will deliver the goods on this issue. Of course, I have no idea which way he will lean, so cannot even guess how the market will react.

But there’s another issue at the Fed, one that is being described as technical in nature and not policy driven. Yesterday saw a surge in the price of overnight money in the repo market which forced the Fed to execute $53 billion of repurchase agreements to inject cash into the system. It turns out that the combination of corporate tax payments in September (removing excess funds from the banking system and sending them to the Treasury) and the significant net new Treasury issuance last week that settles this week, also in excess of $50 billion, removed all the excess cash reserves from the banking system. As banks sought to continue to manage their ordinary business and transactions, they were forced to pay up significantly (the repo rate touched 10% at one point) for those funds. This forced the Fed to execute those repos, although it did not go off smoothly as their first attempt resulted in a broken system. However, they fixed things and injected the funds, and then promised to inject up to another $75 billion this morning through a second repo transaction.

It seems that the Fed’s attempt at normalizing their balance sheet (you remember the run-off) resulted in a significant drawdown in bank excess reserves, which are estimated to have fallen from $2.8 trillion at their peak, to ‘just’ $1.0 trillion now. There are a number of economists who are now expecting the Fed to begin growing the balance sheet again, as a way to prevent something like this happening again in the future. Of course, the question is, will this be considered a restarting of QE, regardless of how the Fed tries to spin the decision? Certainly I expect the market doves and equity bulls to try to spin it that way!

Ultimately, I think this just shows that the Fed and, truly, all central banks are losing control of a process they once felt they owned. As I have written before, at some point the market is going to start ignoring their actions, or even moving against them. Last week the market showed that the ECB has run out of ammunition. Can the same be said about Powell and friends?

Moving on to other key stories, oil prices tumbled ~6% yesterday as Saudi Arabia announced that 41% of their production was back on line and they expected full recovery by the end of the month. While oil is still higher than before the attacks, I anticipate it will drift lower as traders there turn their collective focus back toward shrinking growth and the potential for a global recession. Chinese data continues to look awful, Eurozone data remains ‘meh’ and last night Tokyo informed us that their trade statistics continued to deteriorate as well, with exports falling 8.2%, extending a nearly year-long trend of shrinking exports. The point is, if the global economy continues to slow, demand for oil will slow as well, reducing price pressures quite handily. In a direct response to the declining oil price we have seen NOK fall 0.5% this morning, although other traditional petrocurrencies (MXN, RUB) have shown much less movement.

On the Brexit story, Boris met with European Commission President, Jean-Claude Juncker on Monday, and while he spun the meeting as positive, Juncker was a little less optimistic. His quote was the risk of a no-deal Brexit was now “palpable” while the EU’s chief Brexit negotiator, Michel Barnier, said, “nobody should underestimate the damage of a no-deal Brexit.” It should be no surprise the pound fell after these comments, but that is a very different tone to yesterday’s NY session. Yesterday, we saw the pound rally more than a penny after word got out that the UK Supreme Court justices were ostensibly very skeptical toward the government’s argument and sympathetic to the plaintiffs. The market perception seems to be that a ruling against the government will essentially take a no-deal Brexit off the table, hence the rally, but that is certainly not this morning’s tale. In the end, the pound remains binary, with a deal of any sort resulting in a sharp rally, and a hard Brexit on Halloween, causing just the opposite. The UK hearings continue through tomorrow, and there is no official timeline as to when an opinion will be released. I expect the market will continue to follow these tidbits until the announcement is made. (And for what it’s worth, my sense is the Supremes will rule against the government as based on their biographies, they all voted remain!)

Finally, a look at the overnight data shows that UK inflation fell to its lowest level, 1.7%, since December 2016. With the BOE on tap for tomorrow, it beggars belief they will do anything, especially with Brexit uncertainty so high. At the same time, Eurozone inflation was confirmed at 1.0% (0.9% core), another blow to Signor Draghi’s attempts to boost that pesky number. As such, the euro, too, is under some pressure this morning, falling 0.25% after yesterday’s broad dollar sell-off. In fact, vs. the G10, the dollar is higher across the board, although vs. its EMG counterparts it is a much more mixed picture.

Ahead of the FOMC at 2:00 we see Housing Starts (exp 1250K) and Building Permits (1300K), but they will not excite with the Fed on tap. Equity markets are modestly higher in Europe though US futures are pointing slightly lower. Overall, barring something from the UK ahead of the Fed, I expect limited activity and then…

Good luck
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Gone To Extremes

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In England, the Court of Supremes
Will soon rule on Boris’s dreams
He thought it a breeze
To prorogue MP’s
But they think he’s gone to extremes

Meanwhile oil markets are stressed
With traders, quite rightly, obsessed
‘bout all of the facts
From last week’s attacks
And if a response will be pressed

As New York walks in this morning, markets are still on edge regarding the unprecedented attack on Saudi oil infrastructure over the weekend. Yesterday’s price action saw oil close higher by more than 13%, although this morning WTI has backed off by $1.00/bbl or 1.5%. The short-term issue is how long it will take the Saudis to restore production. Initial estimates seemed a bit optimistic, and the latest seem to be pointing to at least several months before things are back. The long-term issue is more focused on supply disruption risk, something which the market had essentially removed from prices prior to yesterday. It seems that the ongoing problems in Venezuela and Libya, where production gets shuttered regularly, had inured the market to the idea that a short-term disruption would impact prices. After all, oil prices are still well below levels seen a year ago. Now all the talk is how the oil market will need to permanently price in a risk assessment, meaning that prices will default higher. I challenge that view, though, as history shows traders and investors have very short memories, and I would estimate that once the Saudi production is back up and running, it will only be a matter of months before any risk premium is removed. This is especially true if the global growth story continues to deteriorate meaning oil demand will diminish.

The other story of note comes from the UK, where two separate lawsuits against PM Johnson’s act to prorogue (suspend) parliament for five weeks leading up to the Brexit deadline are to be heard by the UK Supreme Court. The government’s argument is that this is not a legal matter, but a political one, and therefore is fine. Of course, Brexit opponents are doing everything they can to prevent Boris from his stated intentions of leaving on October 31 ‘come hell or high water.’ The thing is, unlike the US, where we have a written constitution, there is no such document in the UK. The upshot is twelve unelected officials will be making what may be the most momentous decision in UK history based solely on their personal views of the law, and no doubt, Brexit. And while I am in no way trying to disparage this group, who I am certain are all well-deserved of their roles, the fact that there is neither a guiding document nor precedence results in the opportunity for whichever side loses the argument to scream quite loudly, and I’m sure they will!

A funny thing about this situation is that if the Supremes declare the prorogation illegal, I think the market will see that as a sign that a no-deal Brexit is now off the table completely. And you know what that means for the pound, a significant rally. So for all of you Sterling hedgers out there, the next several days are going to be critical. Hearings are scheduled to take place through Thursday with a decision possible as early as Friday, although more likely next week. So gaming out possible scenarios consider the following choices: 1) Supreme Court (SC) rules against the government and parliament reconvenes => pound rallies sharply, probably back toward 1.30 as markets assume Brexit is dead; 2) SC rules government is within its rights to prorogue parliament for an extended time => pound sells off back to 1.20 as chance of no-deal Brexit grows. Remember, however, that the law in the UK is now that the PM must ask for an extension if there is no deal by the October 18 EU summit. The question, of course, is whether Boris will do so despite the political consequences of not asking, and whether the EU will grant said extension. The latter is not a given either.

With all of that ongoing, the FOMC begins their two-day meeting this morning with the market convinced that they will be cutting rates by 25 bps tomorrow afternoon. Changes to the narrative of late have shown a reduced expectation for a December rate cut, now 53% from more than 90% earlier in the month. Doves will certainly point to the rise in geopolitical risks from the attacks on Saudi oil infrastructure this weekend while hawks will continue to point to solid US data. However, that is a discussion for tomorrow morning.

Turning to market activity overnight, risk is definitely under pressure this morning as most haven type bonds (Treasuries, Bunds, Gilts, etc.) have rallied while Italy, Spain and Portugal have all seen yields rise. Equity markets are somewhat softer, although by no means collapsing, and the dollar is generally, though not universally, stronger. In the G10 space, the Skandies are under the most pressure, with both SEK and NOK falling about 0.4%, as the former is suffering after a terrible employment report which saw the Unemployment Rate rise to 7.4%, rather than decline to 6.8%. NOK, meanwhile, seems to be tracking the price of oil. In the EMG space, KRW was the big loser, still suffering over the much weaker than expected Chinese data and concerns over slowing growth in the economy there.

Data early this morning showed the German ZEW falling more than expected to -19.9, simply highlighting the problems in Germany and increasing the likelihood that the nation enters a technical recession this quarter. Yesterday’s Empire Manufacturing data was a touch weaker than expected, but hardly disastrous. This morning we see IP (exp 0.2%) and Capacity Utilization (77.6%), neither of which is likely to move markets. At this point, it is difficult to make the case for significant movement today as market participants will be waiting for tomorrow’s FOMC decision. Look for a dull one, but with a chance of fireworks on the horizon.

Good luck
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Calm’s Been Restored

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Remarkably, though oil soared
Responding to Yemen, who roared
Most markets of note
Have taken a vote
And seen to it calm’s been restored

Of course the big news over the weekend was the attack on Saudi oil production by a number of unmanned drones on Saturday. It was quite successful, at least in terms of the attackers (Yemen’s Houthi rebels claimed responsibility) seeming goals, as it shut down half of Saudi production for an unspecified period. That means that 5% of the world’s oil production is off-line, although between reserves stored around the globe and the ability of US producers to ramp up production, the impact seems to be less substantial on world markets. Naturally oil prices are higher, with WTI currently +8.25%, although that is well off the initial highs which showed a 15% jump. And Treasury prices are higher as well, with the 10-year higher by half a point and yields falling 6.5bps. Gold is up 1.0%, and equity markets are softer, but not that much with only Italy’s market down even 1.0% and the rest of Europe lower by somewhere on the order of 0.6%. APAC stocks were also modestly softer, and US futures are pointing to a softer opening, but none of this speaks to any panic.

Finally, the dollar can only be described as mixed, at least at this point in the session. Granted, APAC currencies were mostly softer, led by INR’s 0.85% decline, which is directly attributed to the jump in oil prices (India imports virtually all their oil.) But that is actually the largest move on the day. Remember, in the wake of the ECB meeting last week, the euro rallied more than 1.0%! The point is, the FX market is not hugely concerned about this situation and seems unlikely to become so unless there are more attacks and the supply situation changes far more dramatically and permanently.

The only conclusion I can draw from this price action is that the market is still entirely focused on central bank activity with this week the culmination of a series of meetings. By Thursday, we will have heard from the Fed, the BOJ, the BOE, Bank Indonesia and the Norgesbank regarding any new policy actions. Expectations are as follows:

Wednesday FOMC Cut 0.25%
Thursday BOJ No rate change
  Bank Indonesia Cut 0.25%
  Norgesbank No rate change
  BOE No rate change

But in reality, the only one that matters is the Fed, which is driving the entire global conversation. If you recall, it was only a few weeks ago when expectations were rampant that they would cut 50bps. Treasury yields had fallen to 1.45% and there was a growing belief that recession was on its way. But then the US employment data was decent, Retail Sales were strong and CPI came in higher than expected for the third consecutive month. It became much harder with that economic backdrop for the doves to be squawking about adding stimulus aggressively. And remember, in July, there were already two dissensions, so the concept of unanimity has long been missing. At this point, the question is more about Chairman Powell’s press conference and whether or not he puts forth a dovish message. (Arguably, anything that is not outright dovish will be seen as hawkish by the market.)

While the Fed and ECB are clearly in different places, it is also important to remember that as much as the market is focused on the Fed, the same was true of the ECB right up until last week, when it became clear the ECB had run out of ammunition. It is every central banker’s greatest fear to find themselves with no ability to impact the market and push it in the direction they choose. My sense is that day is coming soon for many major central banks. Other than the ECB, it has not yet arrived, but trust me; it is coming sooner than you might think.

With all that in mind, the narrative has quickly moved beyond oil and is now back to discussing the FOMC meeting. Other than that, we have a bit of data, and after the meeting a number of Fed speakers.

Today Empire Manufacturing 4.0
Tuesday IP 0.2%
  Capacity Utilization 77.6%
Wednesday Housing Starts 1250K
  Building Permits 1300K
  FOMC Rate Decision 2.00% (-0.25%)
Thursday Initial Claims 213K
  Philly Fed 10.0
  Leading Indicators 0.1%
  Existing Home Sales 5.37M

So all in all, not too exciting. I would be remiss if I didn’t highlight that Chinese data overnight was uniformly awful, with the big three indicators; Retail Sales (7.5%), IP (4.4%), and Fixed Asset Investment (5.5%) all falling short of estimates and all reaching levels not seen since records began to be kept. And this was data from August, before the latest round of tariffs kicked in. Growth in China is slowing rapidly and the PBOC has not been able to adjust policy sufficiently to offset it. The renminbi weakened a bit, but in line with today’s general lack of movement, the 0.25% decline is hardly significant.

And that’s really all there is. The modest risk-off scenario seems likely to remain in place, but it is hard to see a significant extension of the overnight moves absent another catalyst. And right now, there is none on the horizon. Look for a dull day, with limited movement from the opening levels.

Good luck
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A Major Broadside

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The question that needs to be asked
Is, have central bank powers passed?
The ECB tried
A major broadside
But markets ignored Draghi’s blast

There has certainly been no shortage of interesting news in the past twenty-four hours, however from a markets perspective, I think the ECB actions, and the market reactions are the most critical to understand. To recap Signor Draghi’s action, the ECB did the following:

1. cut the deposit rate 10bps to -0.50%;
2. restarted QE in the amount of €20Bio per month for as long as necessary;
3. reduced the rate and extended the tenor of TLTRO III loans; and
4. introduced a two-tier system to allow some excess liquidity to be exempt from the -0.50% deposit rate.

Certainly the market was prepared for the rate cut, which had been widely telegraphed, and the talk of tiering excess liquidity had also been making the rounds. Frankly, TLTRO’s had not been a centerpiece of discussion but I think that is because most market participants don’t see them as a major force in the policy debate, which leaves the start of QE2 as the most controversial thing Draghi introduced. Well, maybe that and the fact that forward guidance is now based on achieving a “robust convergence” toward the inflation target rather than a particular timeframe.

Remember, in the past two weeks we had heard from the Three Hawksketeers (Weidmann, Lautenschlager and Knot) each explicitly saying that more QE was not appropriate. We also heard that from the Latvian central banker, Rimsevics, and perhaps most surprisingly of all, from Franҫois Villeroy de Galhau, the French central bank chief. And yet despite clearly stiff opposition, Draghi got the Council to agree. Perhaps, though, he went too far in describing the “consensus as so broad, there was no need to take a vote.” Now, while I have no doubt that no vote was taken, that statement stretches credulity. This was made clear when Robert Holzmann, the new Austrian central bank president and first time member of the ECB, gave an interview yesterday afternoon explicitly saying that the ECB could well have made a mistake by reintroducing QE.

But let’s take a look at what happened after the ECB statement and during the press conference. The initial move was for the euro to decline sharply, trading down 0.65% in the first 10 minutes after the release. When Draghi took to the stage at 8:30 and reiterated the points in the statement, the euro declined a further 30 pips, touching 1.0927, its lowest level since May 2017. But that was all she wrote for the euro’s decline. As Draghi continued to speak and answer questions, traders began to suspect that the cupboard was bare regarding anything else the ECB can do to address further problems in the Eurozone economies. This was made abundantly clear in his pleas for increased fiscal stimulus, which much to his chagrin, does not appear to be forthcoming.

It was at this point that things started to turn with the euro soaring, at one point as much as 1.5% from the lows, and closed 1.3% higher than those levels. And this morning, the rally continues with the euro up to 1.1100 as I type, a solid 0.3% gain. But the big question that now must be asked is; has the market decided the ECB is out of ammunition? After all, given the relative nature of the FX market and the importance of monetary policy on exchange rates, if the market has concluded the ECB CANNOT do anymore that is effective, then by definition, the Fed is going to promulgate easier policies than the ECB with the outcome being a rising euro. So if the Fed follows through next week and cuts 25bps, and especially if it does not close the door on further cuts, we could easily see the euro rally continue. That will not help the ECB in their task to drive inflation higher, and it will set a difficult tone for Madame Lagarde’s tenure as ECB President going forward.

Turning to the Fed, the market is still fully priced for a 25bp cut next week, but thoughts of anything more have receded. However, a December cut is still priced in as well. The problem for the Fed is that the economic data has not been cooperating with the narrative that inflation is dead. For instance, yesterday’s CPI data showed Y/Y core CPI rose 2.4%, the third consecutive outcome higher than expectations and the highest print since September 2008! Once again, I will point to the anecdotal evidence that I, personally, rarely see the price of anything go down, other than the gyrations in gasoline prices. But food, clothing and services prices have been pretty steady in their ascent. Does this mean that the Fed will stay on hold? While I think it would be the right thing to do, I absolutely do not believe it is what will happen. However, it is quite easy to believe that the accompanying statement is more hawkish than currently expected (hoped for?) and that we could see this as the end of that mid-cycle adjustment. My gut is the equity market would not take that news well. And the dollar? Well, that would halt the euro’s rise pretty quickly as well. But that is next week’s story.

As if all that wasn’t enough, we got more news on the trade front, where President Trump has indicated the possibility of an interim trade deal that could halt, and potentially roll back, tariff increases in exchange for more promises on IP protection and agricultural purchases. That was all the equity market needed to hear to rally yet again, and in fairness, if there is a true thawing in that process, it should be positive for risk assets. So, the dollar declined across the board, except against the yen which fell further as risk appetite increased.

Two currencies that have had notable moves are GBP and CNY. The pound seems to be benefitting from the fact that there was a huge short position built over the past two months and the steady stream of anti-Brexit news seems to have put Boris on his back foot. If he cannot get his way, which is increasingly doubtful, then the market will continue to reprice Brexit risk and the pound has further to rally. At the same time, the renminbi’s rally has continued as well. Yesterday, you may recall, I mentioned the technical position, an island reversal, which is often seen as a top or bottom. When combining the technical with the positive trade story and the idea that the Fed has a chance to be seen as the central bank with the most easing ahead of it, there should be no surprise that USDCNY is falling. This morning’s 0.45% decline takes the two-day total to about 1.0%, a big move in the renminbi.

Turning to this morning’s data, Retail Sales are the highlight (exp 0.2%, 0.1% ex autos) and then Michigan Sentiment (90.8) at 10:00. Equity futures are pointing higher and generally there is a very positive attitude as the week comes to an end. At this point, I think these trends continue and the dollar continues to decline into the weekend. Longer term, though, we will need to consider after the FOMC next week.

Good luck and good weekend
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Another False Dawn

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Will Mario cut rates again?
And if so, by twenty or ten
Plus when will he start
To fill up his cart
With more bonds to piss off Wiedmann

Today is all about the ECB which will release its policy statement at 7:45 this morning. Then at 8:30, Signor Draghi will hold his press conference where reporters will attempt to dig deeper. At this stage, markets have priced in a 0.10% cut in the base rate, to -0.50%, with a 32% chance of a 0.20% cut. Just last week markets had priced in a 50% chance of that larger cut, so clearly the commentary from the hawks had an impact. At the same time, 80% of analysts surveyed are expecting a restart to QE with estimates of €30B – €35B per month as the jumping off point. This remains the case despite the vocal opposition by German, Dutch and French central bankers. Clearly, Draghi will have a lot of convincing to do in order to get his way. As I mentioned yesterday, bond prices have retreated driving yields higher which in the case of Bunds and other European paper implies a somewhat lower expectation of more QE.

It is also important to see what type of forward guidance we get as this has become one of the most powerful tools in central bank toolkits. Promises of a continuation in this policy until a specific inflation target is met would be quite powerful. Similarly, any indication that the ECB’s self-imposed limits on QE are under review would also be seen as quite bond bullish with both of these messages sure to undermine the euro. And perhaps that is the interim goal, weakening the euro such that the Eurozone can import a little inflation. Of course with Chinese prices declining and the huge trade uncertainty restricting business investment thus keeping a lid on growth, even a weak euro doesn’t seem that likely to drive inflation higher. At least not the time being. But central bankers remain convinced that they must do something, even if they know it will be ineffective. Finally, you can be sure there will be further pleas for fiscal stimulus to help address the current economic malaise. (Of course, Brussels will still seek to prevent the Italians from adding stimulus, of that you can be sure.)

The US-Chinese rapprochement
Has bolstered the Chinese yuan
Thus equities rose
Although I suppose
This could be another false dawn

It wouldn’t be a complete day without some new trade story and today’s is clearly on the positive side. President Trump delayed the imposition of the additional 5% tariffs on Chinese goods by two weeks, so they will now not go into effect until October 15. This gesture of good will is allegedly to allow the Chinese to celebrate their founding day without new clouds. The Chinese were appreciative and indicated they were now looking at imports of agricultural items, something they have purposely shunned in an attempt to pressure President Trump politically. Of course, given the swine fever that has decimated more than half the Chinese hog population, it seems likely that they are pretty keen to import US pork. At any rate, look for the next round of trade talks to occur during the first half of October while the détente is ongoing. The market response was immediately positive with the Nikkei and Shanghai indices both closing higher by 0.75%, although Eurozone equity markets are little changed, clearly waiting the ECB decision. Perhaps even more impressively, the renminbi has rallied 0.4% to its strongest level since August 23 and closing the gap on the charts that opened up when China last raised tariffs on US goods. At this point, market technicians may get involved as there is an island top in place on the charts. Don’t be surprised if USDCNY falls back to at least 7.00 before this move is over, and perhaps below if the trade situation seems to be easing.

Finally, the last of our big 3 stories, Brexit, has seen more political machinations and an uproar in the UK as the government was forced to release its planning document for a no-deal Brexit. Despite the fact that there were several potential scenarios, all the focus was on the worst-case which described massive potential shortages of food, fuel and medicine along with potential rioting. I have not seen the probability estimates for that scenario, and I’m pretty sure that no news source that favors Remain (all of them?) will publish one. However, despite the uproar in the papers, the pound is unchanged on the day. Remember, parliament is not in session, nor will it be until October 14. It will be fascinating to watch how this plays out. As to the pound, it remains a binary play; hard Brexit leads to 1.10 or below; any deal agreed leads to 1.30-1.35. Place your bets!

This morning we see the most important data of the week, CPI (exp 1.8%, 2.3% ex food & energy) as well as the weekly Initial Claims number (215K). If we see the recent trend continue, where CPI edges higher (was as low as 1.5% in February), that could well give pause to the FOMC. After all, cutting rates when inflation is rising and growth is stable at trend is much tougher to justify. That said, if the FOMC doesn’t cut I would expect a market bloodbath and a cacophony from the White House that would be unbearable, especially if Mario somehow manages to be extremely dovish.

Finally, a short time ago the Central Bank of Turkey cut rates more than expected to 16.5%, with new Central Bank head, Murat Cetinkaya, clearly accepting President Erdogan’s view that high rates cause inflation. At any rate, the lira has been the best performer of the day, rallying 1.1% as I type. Broadly, the dollar is softer ahead of the ECB, but that is simply position squaring before the decision. All the action will come after that.

Good luck
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