Category Archives: Uncategorized

Not So Fast

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While everyone thought it was nifty
The Fed was about to cut fifty
Said Jay, not so fast
We’ll not be harassed
A quarter’s enough of a gift-y

Once again, Chairman Powell had a significant impact on the markets when he explained that the Fed is fiercely independent, will not be bullied by the White House, and will only cut rates if they deem it necessary because of slowing growth or, more importantly, financial instability. Specifically, he said the Fed is concerned about and carefully watching for signs of “a loss of confidence or financial market reaction.” In this context, “financial market reaction” is a euphemism for falling stock prices. If ever there was a question about the existence of the Fed put, it was laid to rest yesterday. Cutting to the chase, Powell said that the Fed’s primary concern, at least right now, is the stock market. If it falls too far, too fast, we will cut rates as quickly as we can. Later in his speech, he gave a shout out to the fact that low inflation seems not to be a temporary phenomenon, but that was simply thinly veiled cover for the first part, a financial market reaction.

There are two things to note about these comments. First, the Fed, and really every major central bank, continues to believe they are in complete control of both their respective economies and the financial markets therein. And while it is absolutely true this has been the case since the GFC ended, at least with respect to the financial markets, it is also absolutely true that the law of diminishing returns is at work, meaning it takes much more effort and stimulus to get the same result as achieved ten years ago. At some point, probably in the not too distant future, markets are going to begin to decline and regardless of what those central banks say or do, will not be deterred from actually clearing. It will not be pretty. And second, the ongoing myth of central banks being proactive, rather than reactive, is so ingrained in the central bank zeitgeist that there is no possibility they will recognize the fact that all of their actions are, as the axiom has it, a day late and a dollar short.

But for now, they are still in command. Yesterday’s price action was informed by the fact that despite the weakest Consumer Confidence data in two years and weaker than expected New Home Sales, Powell did not affirm a 50bp cut was on its way in July. Since the market has been counting on that outcome, the result was a mild risk off session. Equity prices suffered in the US and continued to do so around the world last night and Treasuries settled below 2.00%. However, gold prices, which have been rocking lately, gave up early gains when Powell nixed the idea of a 50bp cut. And the dollar? Well, it remains mixed at best. It did rally slightly yesterday but continues to be broadly lower than before the FOMC meeting last week.

We also heard from two other Fed speakers yesterday, Bullard and Barkin, with mixed results. Bullard, the lone dissenter from the meeting made clear that he thought a 25bp reduction was all that was needed, a clear reference to Minneapolis Fed President Kashkari’s essay published on Friday calling for a 50bp cut. However, Thomas Barkin, from the Richmond Fed, sounded far less certain that the time was right for a rate cut. He sounds like he is one of the dots looking for no change this year.

And the thing is, that’s really all the market cares about right now, is what the Fed and its brethren central banks are planning. Data is a sidelight, used to embellish an idea if it suits, and ignored if it doesn’t. The trade story, of course, still matters, and given the increasingly hardened rhetoric from both sides, it appears the market is far less certain of a positive outcome. That portends the opportunity for a significant move on Monday after the Trump-Xi meeting. And based on the way things have played out for the past two years, my money is on a resumption of the dialog and some soothing words, as that will help underpin stocks in both NY and Shanghai, something both leaders clearly want. But until then, I expect a general lack of direction as investors make their bets on the outcome.

One little mentioned thing on the data front is that we have seen every regional Fed manufacturing survey thus far released show significantly more weakness than expected. Philly, Empire State, Chicago, Richmond and Dallas have all fallen sharply. That does not bode well for economic growth in either Q2 or Q3, which, in a twisted way, will play right into the President’s hands as the Fed will be forced to cut rates as a response. Strange times indeed.

This morning, two data points are released; Durable Goods (exp -0.1%, +0.1% ex transports) and the Goods Trade Balance (-$71.8B). Look for weakness in these numbers to help perk of the equity market as anticipation will grow that more rate cutting is in the offing. And look for the dollar to suffer for the same reason.

Good luck
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Fear and Greed

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The two things most traders concede
That drive markets are fear and greed
So lately there’s fear
That trouble is near
But too, FOMO, bulls do still heed

Another day of waiting as the market sharpens its focus on the Trump-Xi meeting to take place on Saturday during the G20 meetings in Osaka, Japan. Yesterday saw extremely limited activity in equity markets in the US, albeit with a negative bias, and we have seen similar price action overnight. Data releases remain sparse (French Business Confidence fell to 102, but that was all there was), which means that investors and traders have time to become contemplative.

On that note, it is a truism that fear and greed are the two most powerful human emotions when discussing financial markets, and both have a history of forcing bad decisions. However, in the classic telling of the story, fear is when investors flee for safety (generally Treasuries, yen, the dollar and gold) while greed is apparent when equity markets rally, corporate credit spreads compress, and high yield bonds outperform everything. I guess we need to throw in EMG excitement as well.

But lately fear has become the descriptor of both bulls and bears, with bulls now driven by FOMO while bears have the old-fashioned sense of fear. The thing that has been remarkable about markets lately is that both types of fear are in full bloom! I challenge anyone to highlight another time when there was so much angst over the current situation while simultaneously there was so much willingness to add risk to portfolios. How can it be that both the safest and riskiest assets are in such demand?

While I am very interested in hearing opinions (please respond) I will offer my own view up front. Global monetary policy in the wake of the financial crisis in 2008-9 has completely altered both the macroeconomic framework as well as how financial markets respond to signals from the economy. The biggest change, in my view, has been the financialization of every major economy, especially the US, where corporate debt issuance has been utilized primarily for financial engineering (either share repurchases or M&A) with only a secondary concern over the development of new, productive assets. This has resulted in a much weaker growth impulse (weakening productivity) with the concurrent effect of having changed the coefficients on all the econometric models in use. It is the latter outcome that has led central banks to become completely incapable of enacting policies that achieve their stated goals. Their reaction functions are based on faulty equipment (models) and so will rarely, if ever, give the right answer. But they are so invested in the current process, the idea of changing it is too far outside the box to even be considered.

Anyway, on a quiet day, I would love to hear other views on the subject.

In the meantime, a look at the markets shows that nothing is going on. The dollar is slightly higher this morning, but then it was slightly lower yesterday. Equity markets are drifting aimlessly (Nikkei -0.5%, FTSE -0.1%, DAX flat, S&P futures -0.1%) as everyone holds their collective breath for Saturday’s Trump-Xi meeting, and haven assets continue to perform well (Treasuries -1bp, Bunds -1bp and within 1bp of historic lows). Well, it is not completely true that nothing is going on, there is one market that has been on fire: gold.

That ‘barbarous relic’ called gold
Has seen its demand rise threefold
To some it is clear
That risks are severe
Although stocks have yet to be sold

Gold ($1432, +1.0% and + 10% this year) has broken out to levels last seen in 2013, when it was on its way down from the historic run-up in the wake of the financial crisis. This is simply the latest evidence of the ongoing conundrum I highlighted above. But beyond this, it has been remarkably quiet. Later this morning we see Case-Shiller Home Price data (exp 2.6%) and New Home Sales (680K) and we hear from NY Fed President John Williams. Yesterday, Dallas Fed prez Kaplan explained that he was concerned over the current situation, but not yet ready to pull the trigger. However, my gut tells me he was one of the ‘dots’ in the plot calling for two cuts by the end of the year. We will see what Mr Williams has to say later.

There is no reason to think that we are going to break out of the doldrums today, or this week at all, as catalysts are few and far between. So look for another quiet day in all markets.

Good luck
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Open and Shut

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Kashakari, on Friday, explained
For US growth to be sustained
The case for a cut
Was open and shut
Since then, talk of fifty has gained

As the new week begins, last week’s late trends remain in place, i.e. limited equity market movement as uncertainty over the outcome of the Trump-Xi meeting continues, continued demand for yield as investors’ collective belief grows that more monetary ease is on the way around the world, and a softening dollar vs. other currencies and commodities, as the prevailing assumption is that the US has far more room to ease policy than any other central bank. Certainly, the last statement is true as US rates remain the highest in the developed world, so simply cutting them back to the zero bound will add much more than the stray 20bps that the ECB, which is already mired in negative territory, can possibly add.

It is this concept which has adjusted my shorter-term view on the dollar, along with the view of most dollar bulls. However, as I have discussed repeatedly, at some point, the dollar will have adjusted, especially since the rest of the world will need to get increasingly aggressive if the dollar starts to really decline. As RBA Governor Lowe mentioned in a speech, one of the key methods of policy ease transmission by any country is by having the local currency decline relative to its peers, but if everyone is easing simultaneously, then that transmission channel is not likely to be as effective. In other words, this is yet another central bank head calling for fiscal policy stimulus as he admits the limits that exist in monetary policy at this time. Alas, the herd mentality is strong in the central bank community, and so I anticipate that all of them will continue down the same path with a minimal ultimate impact.

What we do know as of last week is there are at least two FOMC members who believe rates should be lower now, Bullard and Kashkari, and I suspect that there are a number more who don’t have to be pushed that hard to go along, notably Chairman Powell himself. Remember, if markets start to decline sharply, he will want to avoid as much of the blame as possible, so if the Fed is cutting rates, he covers himself. And quite frankly, I expect that almost regardless of how the data prints in the near-term, we are going to see policy ease across the board. Every central bank is too committed at this point to stop.

The upshot of all this is that this week is likely to play out almost exactly like Friday. This means a choppy equity market with no trend, a slowly softening dollar and rising bond markets, as all eyes turn toward Osaka, Japan, where the G20 is to meet on Friday and Saturday. Much to their chagrin, it is not the G20 statement of leaders that is of concern, rather it is the outcome of the Trump-Xi meeting that matters. In fact, that is pretty much the only thing that investors are watching this week, especially since the data releases are so uninteresting.

At this point, we can only speculate on how things will play out, but what is interesting is that we have continued to hear a hard line from the Chinese press. Declaring that they will fight “to the end” regarding the trade situation, as well as warning the US on doing anything regarding the ongoing protests in Hong Kong. Look for more bombast before the two leaders meet, but I think the odds favor a more benign resolution, at least at this point.

Turning to the data situation, the only notable data overnight was German Ifo, which fell to 97.4, its lowest level since November 2014, and continuing the ongoing trend of weak Eurozone data. However, the euro continues to rally on the overwhelming belief that the US is set to ease policy further, and this morning is higher by 0.25%, and back to its highest point in 3 months. As to the rest of the week, here’s what to look forward to:

Tuesday Case-Hiller Home Prices 2.6%
  Consumer Confidence 131.2
  New Home Sales 680K
Wednesday Durable Goods -0.1%
  -ex transport 0.1%
Thursday Initial Claims 220K
  Q1GDP 3.2%
Friday Personal Income 0.3%
  Personal Spending 0.4%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.1
  Michigan Sentiment 98.0

Arguably, the most important point is the PCE data on Friday, but of more importance is the fact that we are going to hear from four more Fed speakers early this week, notably Chairman Powell on Tuesday afternoon. And while the Fed sounded dovish last week, with the subsequent news that Kashkari was aggressively so, all eyes will be looking to see if he is persuading others. We will need to see remarkably strong data to change this narrative going forward. And that just seems so unlikely right now.

In the end, as I said at the beginning, this week is likely to shape up like Friday, with limited movement, and anxiety building as we all await the Trump-Xi meeting. And that means the dollar is likely to continue to slide all week.

Good luck
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The Doves Are Ascendant

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A recap of central bank actions
Shows sameness across all the factions
The doves are ascendant
And markets dependent
On easing for all their transactions

Yesterday’s markets behaved as one would expect given the week’s central bank activities, where policy ease is the name of the game. Stock markets rose sharply around the world, bond yields fell with the dollar following yields lower. Commodity prices also had a good day, although gold’s rally, as a haven asset, is more disconcerting than copper’s rally on the idea that easier policy will help avert a recession. And while, yes, Norway did raise rates 25bps…to 1.25%, they are simply the exception that proves the rule. Elsewhere, to recap, the three major central banks all met, and each explained that further policy ease, despite current historically easy policy, is not merely possible but likely going forward.

If there were questions as to why this is the case, recent data releases serve as an excellent answer. Starting in the US yesterday, Philly Fed, the second big manufacturing survey, missed sharply on the downside, printing at 0.3, down from last month’s 16.6 reading and well below expectations of 11.0. Combined with Monday’s Empire Manufacturing index, this is certainly a negative harbinger of economic activity in the US.

Japan’s inflation
Continues to edge lower
Is that really bad?

Then, last night we saw Japanese CPI data print at 0.7%, falling 0.2% from the previous month and a strong indication that the BOJ remains far behind in their efforts to change the deflationary mindset in Japan. It is also a strong indication that the BOJ is going to add to its current aggressive policy ease, with talk of both a rate cut and an increase in QE. The one thing that is clear is that verbal guidance by Kuroda-san has had effectively zero impact on the nation’s views of inflation. While the yen has softened by 0.2% this morning compared to yesterday’s close, it remains in a clear uptrend which began in April, or if you step back, a longer-term uptrend which began four years ago. Despite the fact that markets are anticipating further policy ease from Tokyo, the yen’s strength is predicated on two factors; first the fact that the US has significantly more room to ease policy than Japan and so the dollar is likely to have a weak period; and second, the fact that overall evaluations of market risk (just not the equity markets) shows a great deal of concern amongst investors and the yen’s haven status remains attractive.

Closing out our analysis of economic malaise, this morning’s Flash PMI data from Europe showed that while things seem marginally better than last month, they are still rotten. Once again, Germany’s Manufacturing PMI printed well below 50 at 45.4 with the Eurozone version printing at 47.8. These are not data points that inspire confidence in central bankers and are amongst the key reasons that we continue to hear from virtually every ECB speaker that there is plenty of room for the ECB to ease policy further. And while that is a suspect sentiment, there is no doubt that they will try. But once again, the issue is that given the current status of policy, the Fed has the most room to ease policy and that relative position is what will maintain pressure on the buck.

Away from the central bank story, there is no doubt that market participants have ascribed a high degree of probability to the Trump-Xi meeting being a success at defusing the ongoing trade tensions. Certainly, it seems likely that it will help restart the talks, a very good thing, but that is not the same thing as making concessions or coming to agreement. It remains a telling factor that the Chinese are unwilling to codify the agreement in their legal system, but rather want to rely on administrative rules and guidance. That strikes as a very different expectation, compared to the rest of the developed world, regarding what international negotiations are designed to achieve. When combined with the fact that the Chinese claim there is no IP theft or forced technology transfer, which are two of the key issues on the table for the US, I still have a hard time seeing a successful outcome. But I am no trade expert, so my views are just my own.

And finally, Brexit has not really been in the news that much lately, at least not on this side of the pond, but the Tory leadership contest is down to the final two candidates, Boris Johnson and Jeremy Hunt, the Foreign Secretary. The process now heads to the roughly 160,000 active members of the Conservative Party, with Johnson favored to prevail. His stance on Brexit is he would prefer a deal, but he will not allow a delay past the current October 31, 2019 deadline, deal or no deal. It is this dynamic which has undermined the pound lately and driven its lagging performance for the past several months. However, this will take more time to play out and so I expect that the pound will remain in limbo for a while yet.

On the data front, we see only Existing Home Sales (exp 5.25M) this morning, but with the FOMC meeting now past and the quiet period over, we hear from two Fed speakers, Governor Brainerd (a dove) and Cleveland Fed President Mester (a hawk). At this point, all indications are that the Fed is leaning far more dovish than before, so it will be telling to hear Ms Mester. If she comes across as dovish, I would expect that we will see both stocks and bonds rally further with the dollar sinking again. Thus, a tumultuous week is ending with the opportunity for a bit more action. The dollar remains under pressure and I expect that to be the case for the foreseeable future.

Good luck
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QE Will Soon Have Returned

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The ECB started the trend
Which helped the bond market ascend
Then yesterday Jay
Was happy to say
A rate cut he’d clearly portend

Last night from Japan we all learned
Kuroda-san was not concerned
That yields there keep falling
And if growth is stalling
Then QE will soon have returned

This morning on Threadneedle Street
The Governor and his staff meet
Of late, they’ve implied
That rates have upside
But frankly, that tune’s obsolete

This morning, every story is the same story, interest rates are going lower. Tuesday, Signor Draghi told us so. Yesterday Chairman Jay reiterated the idea, and last night, Kuroda-san jumped on the bandwagon. This morning, Governor Carney left policy unchanged, although he continues to maintain that interest rates in the UK could rise if there is a smooth exit from the EU. Gilt markets, however, clearly don’t believe Carney as yields there fall and futures markets are pricing in a 25bp rate cut by the end of the year.

But it is not just those banks that are looking to ease policy. Remember, several weeks ago the RBA cut rates to a new record low at 1.25%, and last night, Governor Lowe indicated another cut was quite realistic. Bank Indonesia cut the reserve requirement by 0.50% last night and strongly hinted that an interest rate cut was on its way. While Bangko Sentral ng Pilipanas surprised most analysts by leaving rates on hold due to an uptick in inflation, that appears to be a temporary outcome. And adding to the Asian pressure is the growing belief that the RBNZ is also set to cut rates right before Australia does so.

In fact, looking around the world, there is only one place that is bucking this trend, Norway, which actually increased interest rates this morning by 25bp to a rate of 1.25%. In fairness, Norway continues to grow strongly, estimated 2.6% GDP growth this year, and inflation there is running above the 2.0% target and forecast to continue to increase. And it should be no surprise that the Norwegian krone is this morning’s best performing currency, rallying 1.0% vs. the euro and 1.5% vs. the dollar.

But in the end, save Norway, every story is still the same story. Global GDP growth is slowing amid increased trade concerns while inflationary pressures are generally absent almost everywhere. And in that environment, policy rates are going to continue to fall.

The market impacts ought not be too surprising either. Equity investors everywhere are giddy over the thought of still lower interest rates to help boost the economy. Or if not boosting the economy, at least allowing corporations to continue to issue more debt at extremely low levels and resume the stock repurchase schemes that have been underpinning equity market performance. Meanwhile, bond market investors are pushing the central banks even further, with new low yield levels in many countries. For example, in the 10-year space, German bunds are at -0.31%; Japanese JGB’s are at -0.18%; UK Gilts yield 0.81%; and Treasuries, here at home, have fallen to 2.01% right now, after touching 1.97% yesterday. It is abundantly clear that the market believes policy rates are going to continue to fall, and that QE is going to be reinstated soon.

As to the FX markets, yesterday saw the beginning of a sharp decline in the dollar with the euro up nearly 1.0% since the FOMC announcement, the pound +0.5% and the yen +0.6%. This makes sense as given the global rate structure, it remains clear that the Fed has the most room to ease from current settings, and thus the dollar is likely to suffer the most in the short term. However, as those changes take effect, I expect that the dollar’s decline will slow down, and we will find a new short-term equilibrium. I had suggested a 3%-5% decline before settling, and that still seems reasonable. After all, despite the fall yesterday, the dollar is simply back to where it was a week ago, before all the central bank fireworks.

With the BOE out of the way, the rest of the morning brings us two data releases, Initial Claims (exp 220K) and Philly Fed (11.0). For the former, there is still real scrutiny there given the weak NFP number earlier this month, and estimates have been creeping slightly higher. A big miss on the high side will likely see rates fall further and the dollar with them. As to the latter, given the huge miss by the Empire Manufacturing print on Monday, there will be wariness there as well. A big miss here will become the second piece of news that indicates a more acute slowing of the US economy, and that will also likely see rates fall further.

In fact, that is the theme for now, everything will be an excuse for rates to fall until the meeting between President’s Trump and Xi next week, with all eyes looking for signs that the trade situation will improve. And one other thing to remember is that tensions in the Middle East are increasing after Iran claimed to have shot down a US drone. Both oil and gold prices are much higher this morning, and I assure you, Treasuries are a beneficiary of this story as well.

So, for the dollar, things look dim in the short and medium term, however, I see no reason for a prolonged decline. Hedgers should take advantage of the weakness in the buck to add to hedges over the next few weeks.

Good luck
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Loosen the Screws

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Said President Trump, come next week
That he and Xi are set to speak
Meanwhile he complains
The euro remains
Too weak, and a boost there he’ll seek

But that was all yesterday’s news
Today Jay will offer his views
On whether the Fed
Is ready to shred
Its old plans and loosen the screws

ECB President Draghi once again proved his mettle yesterday by managing to surprise the market with an even more dovish set of comments when he spoke at the ECB gathering in Sintra, Portugal. Essentially, the market now believes he promised to cut interest rates further and restart QE soon, despite the fact that rates in the Eurozone remain negative and that the ECB has run up against their self-imposed limits regarding percentage of ownership of Eurozone government bonds. In other words, once again, Draghi will change the rules to allow him to go deeper down the rabbit hole otherwise, these days, known as monetary policy.

Markets were Europhoric, on the news, with equities on the Continent all rising 1.5% or so, while government bond yields fell to new lows. German Bund yields touched a new, all-time, low at -0.326%, but we also saw French OAT yields fall to a record low of 0.00% in the 10-year space. In fact, all Eurozone government bonds saw sharp declines in yields. For Draghi, I’m sure the most gratifying result was that the 5 year/5 year inflation swap contract rebounded from 1.18%, up to 1.23%, still massively below the target of “close to, but below, 2.0%”, but at least it stopped falling. In addition, the euro fell, closing the day lower by 0.2% and back below the 1.12 level, and we also saw gold add to its recent gains, as lower interest rates traditionally support precious metals prices.

US markets also had a big day yesterday with both equity and bond markets continuing the recent rally. Clearly, the idea that the ECB was ready to add further stimulus was a key driver of the move, but that news also whetted appetites for today’s FOMC meeting and what they will do and say. Adding fuel to the equity fire was President Trump’s announcement that he would be meeting with Chinese President Xi at the G20 next week, with plans for an “extended meeting” there. This has created the following idea for traders and investors; global monetary policy is set to get much easier while the trade war is soon coming to an end. The combination will remove both of the current drags on global economic growth, so buy risky assets. Of course, the flaw in this theory is that if Trump and Xi come to terms, then the trade war, which has universally been blamed for the world’s economic troubles, will no longer be weakening the economy and so easier monetary policy won’t be necessary. But those are just details relative to the main narrative. And the narrative is now, easy money is coming to a central bank near you, and that means stocks will rally!

Let’s analyze that narrative for a moment. There is a growing suspicion that this is a coordinated attempt by central bankers to rebuild confidence by all of them easing policy at the same time, thus allowing a broad-based economic benefit without specific currency impacts. After all, if the ECB eases, and so does the Fed, and the BOJ tonight, and even the BOE tomorrow, the relative benefits (read declines) to any major currency will be limited. The problem I have with the theory is that coordination is extremely difficult to achieve out in the open, let alone as a series of back room deals. However, it does seem pretty clear that the data set of late is looking much less robust than had been the case earlier this year, so central bank responses are not surprising.

And remember, too, that BOE Governor Carney keeps trying to insist that UK rates could rise in the event of a smooth Brexit, although this morning’s CPI data printed right on their target of 2.0%, with pipeline pressures looking quite subdued. This has resulted in futures markets pricing in rate cuts despite Carney’s threats. This has also helped undermine the pound’s performance, which continues to be a laggard, even with yesterday’s euro declines. The fact that markets are ignoring Carney sets a dangerous precedent for the central banking community as well, because if markets begin to ignore their words, they may soon find all their decisions marginalized.

So, all in all, the market is ready for a Fed easing party, although this morning’s price action has been very quiet ahead of the actual news at 2:00 this afternoon. Futures markets are currently pricing a 23% chance of a rate cut today and an 85% chance of one in July. One thing I don’t understand is why nobody is talking about ending QT this month, rather than waiting until September. After all, the balance sheet run-off has been blamed for undermining the economy just as much as the interest rate increases. An early stop there would be seen as quite dovish without needing to promise to change rates. Just a thought.

And really, these are the stories that matter today. If possible, this Fed meeting is even more important than usual, which means that the likelihood of large movement before the 2:00pm announcement is extremely small. There is no other data today, and overall, the dollar is ever so slightly softer going into the announcement. This is a reflection of the anticipated easing bias, but obviously, it all depends on what the Chairman says to anticipate the next move.

Good luck
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Lingering Issues

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Some pundits now have the impression
That we will soon be in recession
The data of late
Has spurred the debate
And could remove Powell’s discretion

Meanwhile, we just heard from Herr Draghi
That “lingering” issues made foggy
The future of growth
So he and Jay both
Will soon ease ere things turn too quaggy

Some days, there is far more to discuss than others, and today is one of those days. Markets are trying to digest all of the following information: weaker US data, weaker Eurozone data, dovish comments from Signor Draghi, confirmation the RBA is likely to cut rates again, increased likelihood that Boris Johnson will be the next PM in the UK, and increased tensions in the Middle East.

Starting at the top, yesterday’s Empire State Manufacturing survey printed at a much worse than expected -8.6, which represented a 26.4-point decline from May’s survey and the largest fall on record. It was a uniformly awful report, with every sub-index weak. While by itself, this report is generally second tier data, it is adding to the case that the US economy is slowing more rapidly than had previously been expected and is increasing market expectations that the Fed will act sooner rather than later. We will see how that turns out tomorrow.

Then this morning, the German ZEW Survey was released at -21.1, a 19-point decline and significantly worse than expected. This is seen as a potential harbinger of further weakness in the German economy adding to what has been a run of quite weak manufacturing data. Although auto registrations in the Eurozone ticked ever so slightly higher in May (by 0.04%), the trend there also remains sharply downward. All in all, there has been very little encouraging of late from the Continent.

Then Signor Draghi got is turn at the mike in Sintra, Portugal, where the ECB is holding its annual summer festivities, and as usual, he did not disappoint. He explained the ECB has plenty of tools left to address “lingering” risks in the economy and hinted that action may be coming soon. He expressly described the ability for the ECB to cut rates further as well as commit to keep rates lower for even longer. And he indicated that QE is still available as the only rules that could restrict it are self-imposed, and easily changed. Arguably, this had the biggest impact of the morning as Eurozone equities rocketed on the prospect of lower rates, bouncing back from early losses and now higher by more than 1.0% on the day across the board. German bunds have plumbed new yield depths, touching -0.30% while the euro, to nobody’s surprise, has weakened further, ceding modest early gains to now sit lower by -0.3%. This is proof positive of my contention that the Fed will not be easing policy in isolation, and that if they start easing, you can be sure that the rest of the world will be close behind. Or perhaps even ahead!

Adding to the news cycle were the RBA minutes, which essentially confirmed that the next move there will be lower, and that two more rate cuts this year are well within reason as Governor Lowe tries to drive unemployment Down Under to just 4.5% from its current 5.2% level. Aussie has continued its underperformance on the news, falling a further 0.1% this morning and is now back to lows last touched in January 2016. And it has further to fall, mark my words.

Then there is the poor old pound, which has been falling sharply for the past week (-1.75%) as the market begins to price in an increased chance of a no-deal Brexit. This is due to the fact that Boris Johnson is consolidating his lead in the race to be the next PM and he has explicitly said that come October 31, the UK will be exiting the EU, deal or no deal. Given the EU’s position that the deal on the table is not open for renegotiation, that implies trouble ahead. One thing to watch here is the performance of Rory Stewart, a dark horse candidate who is gaining support as a compromise vs. Johnson’s more hardline stance. The point is that any indication that Johnson may not win is likely to see the pound quickly reverse its recent losses.

And finally, the Middle East continues to see increased tensions as Iran announced they were about to breach the limits on uranium production imposed by the ill-fated six-nation accord while the US committed to increase troop deployment to the area by 1000 in the wake of last week’s tanker attacks. Interestingly, oil is having difficulty gaining any traction which is indicative of just how much market participants are anticipating a global economic slowdown. OPEC, too, has come out talking about production cuts and oil still cannot rally.

To recap, bond, currency and commodity markets are all forecasting a significant slowdown in economic activity, but remarkably, global stock markets are still optimistic. At this point, I think the stock jockeys are on the wrong side of the trade.

As to today, we are set to see Housing Starts (exp 1.239M) and Building Permits (1.296M) at 8:30. Strong data is likely to have little impact on anybody’s thinking right now, but weakness will start to drive home the idea that the Fed could act tomorrow. Overall, the doves are in the ascendancy worldwide, and rightly so given the slowing global growth trajectory. Look for more cooing tomorrow and then on Thursday when both the BOJ and BOE meet.

Good luck
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Constant Hyperbole

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On Wednesday the FOMC
Will offer their latest decree
Will Fed funds be pared?
Or will Jay be scared
By Trump’s constant hyperbole?

The one thing that’s patently clear
Is rates will go lower this year
And lately some clues
Show Powell’s new views
Imply NIRP he’ll soon engineer

Once again, market movement overnight has been muted as traders and investors look ahead to Wednesday’s FOMC meeting and Chairman Powell’s press conference afterwards. Current expectations are for the removal of the word ‘patient’ from the statement and some verbiage that implies rates will be adjusted as necessary to maintain the US growth trajectory. Futures markets are pricing just a 25% probability of a rate cut on Wednesday, but a virtual certainty of one at the July meeting in six weeks’ time. With that said, there are several bank analysts calling for a cut today, or a 50bp cut in July. The one thing that seems abundantly clear is that interest rates in the US have reached their short-term peak, with the next move lower.

However, in the Mariner Eccles building, they have another dilemma, the fact that Fed funds are just 2.50%, the lowest cyclical peak in history. It has been widely recounted that the average amount of rate cutting by the Fed when fighting a recession has been a bit more than 500bps, which given the current rate, results in two possibilities: either they will have to quickly move to use other policy tools, like QE; or interest rates in the US are going to go negative before long! And quite frankly, I expect that it will be a combination of both.

Consider, while the Fed did purchase some $3.5 trillion of assets starting with QE1 in 2009, the Fed balance sheet still represents just 19% of US GDP. This compares quite favorably with the ECB (45%) and the BOJ (103%), but still represents a huge increase from its level prior to the financial crisis. Funnily enough, while there was a great deal of carping in Congress about QE by the (dwindling) hard-money set of Republicans, if the choice comes down to NIRP (Negative Interest Rate Policy) or a larger balance sheet, I assure you the politicians will opt for a larger balance sheet. The thing is, if the economy truly begins to slow, it won’t be a choice, it will be a combination of both, NIRP and QE, as the Fed pulls out all the stops in an effort to prevent a downturn.

And NIRP, in the US, will require an entirely new communications effort because, as in Europe and Japan, investors will find themselves on the wrong side of the curve when looking for short term investments. Money market funds are going to get crushed, and corporate treasuries are going to have to find new places to invest. It will truly change the landscape, and it is not clear it will do so in a net positive way. But regardless, NIRP is coming to a screen near you once the Fed starts cutting, although we are still a number of months away from that.

With that in mind, the obvious next question is how it will impact other markets. I expect that the initial reaction will be for a sharp equity rally, as that is still the default response to rate cuts. However, if the Fed is looking ahead and sees trouble on the horizon, that cannot be a long-term positive for equities. It implies that earnings numbers are going to decline, and no matter how ‘bullish’ interest rate cuts may seem, declining earnings are hard to overcome.

Bonds, on the other hand, are easy to forecast, with a massive rally in Treasuries, a lagging rally in corporates, as spreads widen into a weakening economy, but for high-yield bonds, I would expect significant underperformance. Remember, during the financial crisis, junk bond yield spreads rose to 20.0% over Treasuries. In another economic slowdown, I would look for at least the same, which compares to the current level of about 5.50%.

Finally, the dollar becomes a difficult question. Given the Fed has far more room to ease policy than does the ECB, the BOJ, the BOE or the BOC, it certainly seems as though the first move would be lower in the buck. However, if the Fed is easing policy that aggressively, you can be sure that every other central bank is going to quickly follow. Net I expect that we could see a pretty sharp initial decline, maybe 5%-7%, but that once the rest of the world gets into gear, the dollar will find plenty of support.

A quick look at markets overnight shows that the dollar is little changed overall, with some currencies slightly firmer and others slightly softer. However, there is no trend today, nor likely until we hear from the Fed on Wednesday.

Looking at data this week, it is much less interesting than last week’s and unlikely to sway views.

Today Empire Manufacturing 10.0
Tuesday Housing Starts 1.239M
  Building Permits 1.296M
Wednesday FOMC Rates 2.50% (unchanged)
Thursday BOJ Rates -0.10% (unchanged)
  Initial Claims 220K
  Philly Fed 11.0
  Leading Indicators 0.1%
Friday Existing Home Sales 5.25M

As I said, not too interesting. And of course, once the Fed meeting is done, we will get to hear more from the various Fed members, with two speakers on Friday afternoon (Brainard and Mester) likely to be the beginning of a new onslaught.

Yes, the trade situation still matters, but there is little chance of any change there until the G20 meeting next week, and that assumes President’s Trump and Xi agree to meet. So, for now, it is all about the Fed. One last thing, the ECB has their Sintra meeting (their answer to Jackson Hole) this week, and it is likely that we will hear more about their thinking when it comes to easing policy further given their current policy settings include NIRP and a much larger balance sheet already. Any hint that new policies are coming soon will certainly undermine the single currency. Look for that beginning on Wednesday as well.

Good luck
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Totally Thwarted

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The data that China reported
Showed growth there somewhat less supported
Meanwhile in Hong Kong
The protesting throng
Has bullish views totally thwarted

Once again, risk is under pressure this morning as the litany of potential economic and financial problems continues to grow rather than recede. The latest concerns began last night when China reported slowing Investment (5.6%, below 6.1% expected) and IP (5.0%, weakest since 2002) data (although Retail Sales held up) which led to further concerns over the growth trajectory in the Middle Kingdom. PBOC Governor Yi Gang assures us that China has significant firepower left to address further weakness, but traders are a little less comforted. Adding to concerns are the ongoing protests in Hong Kong over potential new legislation which would allow extradition, to mainland China, of people accused of fomenting trouble in Hong Kong. That is a far cry from the separation that has been key in allowing Hong Kong’s financial markets and economy to flourish despite its close ties to Beijing.

The upshot is that stocks in Hong Kong (-0.65%) and Beijing (-1.0%) fell again, while interest rates in Hong Kong pushed even higher. This has resulted in a liquidity shortage in Hong Kong which is supporting the HKD (+0.2% this week and finally pushing away from the HKMA’s floor). The renminbi, meanwhile, has gone the other way, softening slightly since the protests began. Other signs of pressure were evident by the weakness in AUD and NZD, both of which rely heavily on the Chinese market as their primary export destinations.

Risk is also evident in the energy markets where there has been an escalation in the rhetoric between the US and Iran after the tanker attacks yesterday. This morning the US is claiming it has video proof that Iran was behind the attacks, although it has not been widely accepted as such. Oil prices, which rose sharply yesterday, have maintained those gains, although on the other side of the oil equation is the slowing economy sapping demand. In fact, the IEA is out with a report this morning that next year, production increases in the US, Canada and Brazil will significantly outweigh anemic increases in demand, further pressuring OPEC and likely oil prices overall. However, for the moment, the market concerns are focused on the increased tension in the Gulf with the possibility of a conflict there seeming to rise daily. Remember, risk assets tend to suffer greatly in situations like this.

Aside from the weaker Aussie (-0.25%) and Kiwi (-0.55%), we have also seen strength in the yen (+0.2%), a huge rally in Treasuries (10-year yield down 4.5bps), gold pushing higher (+1% and back to its highest level in three years) and the dollar, overall performing well. The latter is evidenced by the decline in the euro (-0.2%), the pound (-0.3%) and basically the rest of the G10 with similar declines.

This is the market backdrop as we await the last major piece of data before the FOMC meeting next week, this morning’s Retail Sales numbers. Current expectations are for a 0.6% increase, with the ex-autos number printing at 0.3%. But recall, last month economists were forecasting a significant gain and instead the headline number was negative. A similar result this morning would certainly add more pressure on Chairman Powell and friends next week. And that is really the big underlying story across all markets, just how soon are we likely to see the Fed or the ECB or the BOJ turn clearly dovish and ease policy.

It has become abundantly clear that inflation is the only data point that the big central banks are focusing on these days. And given their fixation on achieving a, far too precise, level of 2.0%, they are all failing by their own metrics. Wednesday’s US CPI data was softer than expected leading to reduced expectations for the PCE data coming at the end of the month. In the Eurozone, 5y/5y inflation swaps, one of the ECB’s key metrics for inflation sentiment, has fallen below 1.20% and is now at its lowest level since the contract began in 2003. And in Japan, CPI remains pegged just below 1.0%, nowhere near the target level. It is this set of circumstances, more than any questions on growth or employment, that will continue to drive monetary policy. With this in mind, one can only conclude that money is going to get easier going forward. I still don’t think the Fed moves next week, but I could easily see a 50bp cut in July. Regardless, markets are going to continue to pressure all central banks until policy rates are lowered, mark my words.

Regarding the impact of these actions on the dollar, it becomes a question of timing more than anything else. As I have consistently maintained, if the Fed starts to ease aggressively, you can be sure that the ECB and BOJ, as well as a host of other central banks, will be doing so as well. And in an environment of global weakness, I expect the dollar will remain the favored place to maintain assets.

As for today, a weak Retail Sales print is likely to see an initial sell-off in the dollar but look for it to reverse as traders focus on the impacts likely to be felt elsewhere.

Good luck and good weekend
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Powell’s Fixation

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The latest release on inflation
Revealed, despite Powell’s fixation,
That prices have yet
To pose a real threat
So, look for more accommodation

Much to the Fed’s chagrin, yesterday’s inflation data was disappointing, with CPI rising just 1.8% in May, below both expectations and their target. Of course, they don’t target CPI, but PCE instead, however, history has shown that PCE typically runs about 0.3%-0.4% below CPI. Regardless of the statistic they view, what is abundantly clear is that price pressures, at least as measured by the both the Labor and Commerce departments, remain well below the level the Fed believes is consistent with a healthy economy. And it is this outcome which continues to animate the investment community.

If we ignore the comments from the White House and simply focus on the economic data, it is pretty easy to see why expectations of a rate cut are growing rapidly. The employment situation seems to have peaked and started to reverse, price pressures remain quiescent and every Q2 GDP forecast is for a pretty significant slowdown relative to Q1’s 3.1% rate. Given what appears to be a weakening trajectory in the US economy (not even considering the possibility of bigger issues driven by a full-blown trade war) and given that the Fed has implicitly assumed the responsibility to manage economic growth, a rate cut might seem pretty tempting at this point. While next week’s meeting seems quite aggressive for this line of thought, July, where the market is pricing in nearly a 100% probability, makes sense barring a sudden upturn in the data.

One of the things that has been weighing on the inflation data has been the sharp decline in oil prices over the past two months. Even with today’s 3.5% rally on the news of two oil tanker attacks in the Persian Gulf, WTI is lower by more than 20% since the third week of April. And the oil data continues to point to softening demand and growing supplies. Slowing global growth is sapping that demand, but producers continue to drill as quickly as possible. So, the central bank logic continues to be; lower interest rates will help sustain economic growth which will push up demand for energy (read oil prices) and help inflation get back to their comfort zone. Alas, that has been shown to be a pretty tenuous path for central banks to achieve their desired results and there is limited reason to believe it will work this time. In the end, it is becoming abundantly clear that we are about to embark on the next round of monetary ease, even in those nations which never tightened from the last round.

The difference this time is that markets do not seem to be embracing that as a panacea for all their troubles. While equity markets are modestly higher this morning, that follows two lackluster sessions with small losses. We continue to hear pundits highlighting a Fed cut as an important driver, but slowing global growth, especially the continued weakness in China, means that earnings estimates continue to slide and with them, expected equity gains. Add to this mix the unraveling of a few stories (Tesla, government pressure on tech companies) and suddenly the future is not so bright. We have also seen continued concern registered via the Treasury market, where 10-year yields have edged lower again today, trading at 2.11% as I type. While this is a few bps higher than the recent lows, it remains more than 50bps below where we started 2019 and the trend remains firmly downward. And rightly so if inflation is going to continue to decline.

The FX market has weighed all this evidence and remains…confused. While the dollar remains stronger overall in 2019, it has given back some of its gains during the past several weeks, at least against most G10 currencies. Today is a perfect example of the mixed view we’ve seen lately with the euro and the pound within 0.05% of yesterday’s closing levels, albeit the euro is higher and the pound lower. We see Aussie down 0.3% but CHF up 0.3%. You get the picture, there is little in the way of a trend. And quite frankly, that is likely to remain the case until we actually see the Fed (or ECB or BOJ or BOE) actually change policy. Broadly, there is little evidence that global growth is going to improve in the short run, and so FX movement is going to be based on the relative rate of weakness we see in economic data and the corresponding interest rate assumptions that will follow.

Looking at this morning’s data, we really only see Initial Claims (exp 216K), which is generally not a market mover. However, given the heightened sensitivity to the employment situation based on last Friday’s weak NFP report, any uptick here (above, say 230K) might have an outsized impact. Arguably, tonight’s Chinese data in Retail Sales and IP is likely to have a much bigger impact. And that’s really the day. Once again it looks like limited activity and correspondingly, limited movement in markets.

Good luck
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