According to data today
From Europe and from the UK
Those stories ‘bout growth
Depicted by both
Are now showing signs of decay

Remember when the Eurozone was growing above potential? Yeah, me neither! But in fairness, in 2017, the bloc did have a (relatively) blockbuster year, where GDP in the Eurozone grew 2.4%, which is well above most economists’ estimates of how fast it can grow over time. And it was faster than US growth as well, which of course was one of the reasons that the euro rallied 11% vs. the dollar last year. You might remember the meme that arose from that story, ‘global synchronous growth,’ which was going to be the key behind the ECB exiting QE and starting to normalize monetary policy. That was also the rationale behind the UK preparing to raise rates despite Brexit, and the main argument as to why the dollar was destined to fall much further.

But that is so last year. We are now five months into 2018, a pretty good chunk of the way, and the data we continue to see from both the Eurozone and the UK has basically demonstrated that 2017’s growth meme seems to have ended. Thus far, the euro bulls have relied on the idea that the slowdown in Q1 was a result of extremely cold weather, a flu epidemic and some labor strife. But now we are two-thirds of the way through Q2 and the data is simply continuing to trend lower with no sign of slowing down. (For example, German manufacturing PMI fell to 56.8, its lowest level since February 2017, with all the major subcomponents falling.) The point is that Mario Draghi and his compatriots at the ECB have to be looking at the data and starting to ask themselves just how anxious they are to change their current monetary policy settings. Continuing down the path of reducing accommodation amid slowing growth will be very difficult to explain to both the markets, and perhaps more importantly for them, to the politicians across the Eurozone. Ask yourself how the new antiestablishment government in Italy will respond given that nation’s desperate need for both NIRP and QE to continue.

In fact, the breadth of disappointing data today was impressive. From the Eurozone, we saw weaker than expected flash PMI data from Germany, France and the Eurozone as a whole, most of it the weakest since the beginning of 2017. We also saw French Unemployment tick higher to 9.2%, above expectations although not yet sufficient to describe as reversing a trend. From the UK we got both disappointing PMI data and lower than expected inflation data, with CPI falling to 2.4%, continuing its retreat from the November highs of 3.1%, and reducing the probability that the BOE will feel compelled to raise rates this year. Two things seem to be driving the inflation data, and both seem likely to continue. First is the fact that in the immediate wake of the Brexit vote nearly two years ago, the pound sold off sharply and remained there for quite a while. That led to higher import prices, which pushed up inflation. However, since then, the pound has rebounded quite smartly and as time has passed, that initial wave of price increases has passed out of the data. The second is that the overall growth rate in the UK economy is very clearly slowing down, thus undermining the idea that higher demand will drive prices up.

It can be no surprise that given the data releases, both the euro and the pound are sharply lower this morning (EUR -0.7%, GBP -0.9%) and plumbing depths not seen since December. In fact, both currencies are now lower YTD, and as I’m sure you must be aware by now, in my view have further to fall.

But today’s story is more than simply poor data from Europe; it really has the feel of an old-fashioned risk –off session. For example, the yen has rallied more than 1%, US Treasuries are up nearly half a point with the yield back down to 3.03%, and equity markets around the world are falling, with most down 1% or more. It seems that adding to the poor data story are some broader issues, things like a less sanguine attitude by markets regarding the trade situation between the US and China, the sudden sense that the meeting between President Trump and North Korea’s Kim Jong-Un may not occur after all, thus unwinding so much good will that the market had embraced, and the ongoing collapse of the Turkish Lira, which has fallen another 4% this morning and is working hard to catch up to Argentina for the title of worst-performing currency this year.

It is with all this in mind that we look forward to today’s session, where the FOMC will release the Minutes from its meeting back on May 1st and 2nd. If you recall, the big story then was the use of the word symmetric twice with regard to the inflation target of 2.0%. Pundits read that to mean there was a growing willingness by the FOMC to allow the inflation rate to run above target for a while before tightening too aggressively. Now, everyone is looking for a deeper explanation as to the rationale behind the change in language, and to see if we can get a clearer view of the future rate path. Remember, the market is currently pricing in rate hikes in both June and September, with a ~50% chance of one in December. Given that the data we have seen since the meeting has continued to show solid economic growth, I continue to look for that fourth rate hike, and for the markets to continue to favor the dollar as the year progresses. While I understand that long term questions about fiscal sustainability and its impact on the currency, which are decidedly negative in the dollar’s case, we are going through a period where cyclical relationships dominate the structural, and where long-established relationships, like the dollar following the path of US rates, have resumed their trends. This morning’s New Home Sales data (exp 677K) seems unlikely to change any views. Rather, the market is likely to remain in thrall to the ongoing deterioration of Europe and assorted emerging markets while it awaits those Minutes. In other words, look for the dollar to continue to perform well today.

Good luck
Adf

The nation that’s shaped like a boot
Is causing some problems acute
Their fiscal adherence
Is lacking coherence
And frankly it does not compute

Once again the euro is under pressure this morning, although it has recently rebounded from its worst levels of the day, as the Italian political saga has taken another lurch forward. It appears that the anti-establishment coalition of Five Star and the League have agreed on a neutral party to be prime minister, Giuseppe Conte, a law professor from Florence University with no previous political experience. And while it is bad enough that the third largest economy in Europe is going to be led by a political neophyte, I think of much greater concern is the story about Italy issuing BOT’s as a means of financing the new government’s spending plans.

While there is not much information on this yet, these BOT’s are seen as potentially quite destabilizing to the euro with the possibility that they become a parallel currency in Italy. The last thing that the euro needs is another structural question. I assure you that Signor Draghi has not forgotten just how close the euro came to breaking up back in 2012 amid the Euro government bond crisis (remember “whatever it takes”?). Unfortunately for him, his home country has never been able to regain the ground it lost during that crisis and the economy there remains more than 5% smaller than it was prior to the crisis unfolding. Issuance of this new paper will be strongly opposed by virtually all the members of the Eurozone, but at this stage, it seems unlikely that the new Italian government will care. After all, their hallmark is that they are anti-establishment! While nothing has been agreed at this stage, and it may simply be another trial balloon similar to the story about the ECB writing off €250billion that circulated at the beginning of last week, the fact that it is even under consideration is testimony to just how difficult things are in Italy, and just how difficult it will be to bring that nation back into the Eurozone fiscal fold. While this process continues to unfold, I believe the euro will remain under significant pressure. Hedgers, keep that in mind.

While that was a new twist in the Italian story, the reality is that there has been very little else in the market narrative that is new. Trade talks between the US and China were inconclusive when they ended on Friday, but Secretary Mnuchin’s comment that ‘the trade war is on hold for now’ seems to have allayed fears within the equity investor community as stock markets around the world have rallied modestly.

Otherwise, there has been virtually no data of note released anywhere in the world. This morning’s pattern shows that the idiosyncratic stories from the EMG space, (Turkey, Argentina, Malaysia, Hong Kong, Brazil) have all continued along their previously determined paths. Perhaps the biggest news is that the IMF and Argentina have finally sat down to begin to negotiate the stand-by loan that the country desperately needs. But otherwise, today’s price action is simply an extension of what we have been seeing for the past several weeks.

Looking ahead to the rest of this week, data is sparse with Wednesday’s FOMC Minutes the clear highlight.

And that’s all on the data front. We do, however, hear from seven Fed speakers in a total of ten speeches with Friday’s comments from Chairman Powell likely to be the ones that everybody watches most closely. Of course, remember that Friday is the day before the Memorial Day holiday weekend here in the US, and so trading desks are likely to be lightly staffed then. That just means that if he were to say anything surprising (which I doubt) there would be the opportunity for more movement than usual given the likely reduced amount of liquidity that will be available.

All told, while things appear quiet for now, it is critical to remember that there are several important stories that continue in the background and that market liquidity is going to diminish as we hit the summer vacation season. That means that volatility is likely to resume its uptrend, especially if any one of these background stories comes to the fore. Nothing has occurred to change my view that the dollar has further to rally vs. all its counterparts, and until we see weak US data or a distinct change in tone from the Fed, things are likely to remain that way.

Good luck
Adf

The League and Five Star have agreed
That looking ahead what they need
Is tax rates to fall
Plus income for all
And who knows, perhaps they’ll secede!

It’s official; the coalition between the two anti-establishment parties in Italy has been signed. While they haven’t yet named a PM, they are heading to President Matterella for official sanctioning and then will be presenting their government to parliament. The key platforms are the creation of a Universal Basic Income (UBI) for everyone below a certain level of earnings, and the imposition of a relatively flat tax structure, with just two rates, 15% and 20%. Given the way that fiscal policy is ‘scored’ by central banks and analysts, both of these proposals imply that Italy’s fiscal situation is going to deteriorate sharply. The combination of higher spending on the UBI with reduced income from the lower tax rates is a direct rebuke of Eurozone fiscal rules. And I understand that concern. But one thing that is important to remember is that Italians are notorious for not paying their taxes now, with much higher tax rates. They are almost Greek in their disdain for the process. Perhaps by cutting tax rates so dramatically, it will change some behaviors and, at least, maintain the current revenue stream, if not actually increase it. This would not be unprecedented. In Russia in 2010, tax revenues increased substantially after they changed the tax rates to a remarkably low 13% flat tax, as compliance improved significantly. The thing is the current scorecards don’t take into account human behavioral changes, and so it is entirely possible that the situation will not be as bad as some fear.

However, for now the situation has increased market uncertainty significantly. This is clearest in the Italian government bond market, where BTP’s have seen their spread to German bunds rise significantly in the past two weeks, from below 100bps to more than 150 today. It has also been felt in the Italian stock market, where the MIB Index has fallen 3% since Tuesday when the prospects for this outcome started to crystallize. And naturally, the euro has also been under pressure, with many pointing to Italy as one of the key reasons for the single currencies recent weakness. Of course, there are other reasons for the euro’s decline, notably the weakening growth and inflation data that we keep seeing, but Italy is not helping the cause. This morning, the euro is extending its losses, albeit slightly, as it remains anchored below 1.18 and is down a further 0.1%. I see no reason for this trend to end without a change in the data metrics. So if Eurozone data does not start to improve, look for a continued slide in the euro.

Poor Kuroda-san
Despite all he tries to do
Inflation’s absent

The other news of note overnight was the Japanese inflation data, where it once again disappointed, rising only 0.6% on a headline basis and 0.4% ex fresh food & energy. Not only was that below forecasts, but it also remains miles away from the 2.0% target. And there doesn’t seem to be any reason to expect that Japanese inflation is going to rise soon. Interestingly, with unemployment in Japan down to 2.5%, wages are rising more rapidly, with the latest reading showing a 3.1% gain. It seems to me that if I were PM Abe or BOJ Governor Kuroda I would be touting just how good things are for the country, with real wages rising sharply and prices remaining stable for those on a fixed income. But central bank orthodoxy won’t allow that type of thinking. Damn it, we need inflation to be at 2.0%!!!

The yen fell further after the news, now down 0.25% on the day, and trading back above 111.00 again. For now, it appears that this trend, too, will remain in tact. After all, it is abundantly clear that the BOJ is in no position to begin normalizing monetary policy given the inflation readings, while the Fed is not going to be deterred from its current path. I think we will continue to see Japanese investors looking at the dollar’s trend and the 300bp spread between 10-year Treasuries and JGB’s and decide that it is too good to miss, especially on an unhedged basis. Look for outbound Japanese flows to continue and the dollar to keep rising here as well.

In fact, the dollar is broadly higher this morning, although in most instances the movement has been modest. In the emerging markets we continue to see TRY crumble slowly (-3.7% this week), ARS crumble swiftly (-7.0% this week) and the other problem currencies (IDR, BRL, ZAR) all under pressure. Despite the fact that Brent crude pushed to $80/bbl, MXN is under pressure, as it appears the NAFTA story (No deal is imminent) is weighing on the peso. In fact, while each country has its own idiosyncrasies, right now the story is plainly based on the dollar. And until we start to see the data story change, with either US data missing or other nations showing better than expected outcomes, the dollar will continue to rule. A simple example was yesterday’s Philly Fed release jumping back up to 34.4, it’s highest reading in a year and putting paid to any idea that the US economy is slowing like the rest of the world. The sequence, for now, remains stronger US growth leading to higher US interest rates and a stronger US dollar.

There is no US data today although we will hear from two more Fed speakers, Brainerd and Kaplan. Thus far, we continue to hear that some FOMC members are thinking two more rate hikes this year while others see three. However, the big changes will come when it becomes clear that the ECB and BOJ, who have been touted to start reducing stimulus, have to admit that process will be delayed further. The week of June 11 should be quite interesting as on Wednesday, the Fed will have raised rates by 25bps, and on Thursday, both the ECB and BOJ meet. The divergence will be extraordinarily clear at that time, and we could well see the next leg higher in the dollar at that point. For today, however, given it is Friday and traders tend to square positions into the weekend, and given the dollar has performed quite well recently, I expect we could see a little profit taking and the dollar ease off a bit. But the long-term story remains clearly for a stronger dollar.

Good luck and good weekend
Adf

Perhaps today’s story is trade
Where NAFTA fans now are dismayed
Meanwhile ‘cross the pond
The EU has donned
The cloak of a partner betrayed

Some days, there is very little to discuss regarding the big picture, and even less to discuss regarding specific issues. Today appears to be one of those days, so I will be brief as I touch on the few things that seem to matter.

The Asia session revealed only two new data points of note, Australian jobs and Japanese outbound investment. The former showed an increase in full-time jobs of 32.7K that was larger than expected, and even though the Unemployment Rate rose to 5.6%, up 0.1%, the market looked at the jobs data and pushed the Aussie dollar up 0.5% at its peak, although it has since drifted back a smidge. However, it remains the best performing G10 currency vs. the dollar this morning. Meanwhile, Japanese investors increased the pace of foreign bond investment substantially, buying ¥827 billion last week as US yields are obviously becoming too attractive to ignore. The yen fell 0.25% on the news, trading back to its lowest levels since late January. One cannot be surprised at this given the BOJ’s ongoing efforts at yield curve control as they maintain 10-year JGB yields near 0.0%. When looking at that in comparison to US 10-year’s at 3.10%, the trade is pretty straightforward. This is especially true if investors are less concerned that the dollar is going to fall sharply, which of late seems to be the case.

Moving on to Europe, there was a distinct lack of data released and the only noteworthy comments came in the wake of an EU meeting in Sofia, Bulgaria, where the leadership coalesced around a position on trade. Essentially they said they were happy to negotiate a free trade deal, but would not do so with the threat of US steel and aluminum sanctions hanging over their head. In fact, they have a slate of retaliatory tariffs prepared to go in the event that the US tariffs go into effect next month. Interestingly, the euro, which had edged higher earlier in the session, fell after the news. Now it is possible that there was some other rationale for the euro’s decline, but I have not been able to find one. The single currency’s earlier strength had been predicated on the latest news from Italy, where yesterday’s story about seeking a write-off of €250 billion of debt has been walked back to where the Italians now want to be able to simply exclude debt held by the ECB from debt/GDP calculations. I guess that would help them move back toward previously agreed targets, but it certainly wouldn’t change the reality.

And finally, the news from the Western Hemisphere consisted of a surprise ‘no change’ by the Brazilian central bank, as they left the SELIC rate at 6.50% and appear to have abruptly come to the end of their easing cycle. Given the fact that the BRL has fallen 10% in the past month, their lack of a cut ought not be that surprising. And while Argentina continues to be a disaster, with no IMF agreement yet complete, more attention was paid to Mexico and Canada, where it appears that any completion of a new NAFTA deal will not be happening soon. Today marks the deadline discussed by House Speaker Ryan regarding the ability of the House to take up new legislation before the election season begins. And with the Mexican presidential election also looming in July, it seems like these talks will be on hold for a while. It is not clear to me if that means NAFTA will die, or if the status quo will remain until they resume. I am assuming the latter situation will prevail given the certain disruption a collapse of the agreement would bring to all three economies.

Taking all of this into account, markets are clearly undecided as to what to do next. Equity markets around the world are mixed with limited movement and the same is true with government bond markets and the dollar. In other words, traders are biding their time for the next potential catalyst. This morning’s US data brings only Initial Claims (exp 215K) and Philly Fed (21.0). Traders will be far more focused on the latter than the former as a strong number, like we saw from the Empire Manufacturing Survey, would likely serve as a reinforcement to the view that the Fed is not going to change its tack anytime soon. And given the Treasury market response to the Retail Sales and Empire data on Tuesday, a move that has not been retraced at all, I expect that a strong print could see another leg lower in Treasuries and another leg higher in the dollar. The narrative is slowly evolving from synchronous global growth to the US leading the way, and as data corroborates that view, the Treasury and dollar trends should extend further. I guess the real question is how long that can go on without equity markets coming under more renewed pressure. As to today, I expect the dollar to maintain its upward momentum barring an extremely weak Philly Fed print.

Good luck
Adf

Apparently there’s some concern
Investors will soon start to spurn
New Treasury debt
Which could be a threat
To equity prices in turn

It seems that we could be heading back to the ‘good news is bad’ situation that existed several years ago. Yesterday’s Retail Sales data printed pretty much as expected at 0.3% although there were revisions higher to the previous data making the report, on the whole, seem quite robust. The immediate market reaction was a sharp sell-off in Treasury bonds with the 10-year yield touching as high as 3.09% before settling up 8bps at 3.077% at the end of the day. This is the highest level since March 2011 and has reignited the conversation about just how high yields will go. This morning’s punditry has seen an increase in the number of stories talking about a move to 3.25% or 3.50% before long and what might be the potential consequences of such a move. This cannot be that surprising as it has become increasingly clear that inflationary pressures in the US continue to point higher. Another tidbit is the fact that the Fed Funds futures market is now pricing in a 55% chance of a fourth Fed hike this year, its highest level to date.

The market impact beyond Treasuries was quite clear as the dollar surged to new highs for the move while equity prices suffered, albeit less than they might have. Interest rate spreads between the US and the rest of the G10 continue to widen in the US’ favor and as long as this continues you can expect to see the dollar supported. The historic link between rates and the dollar is firmly back in place at this stage, and I see no reason for it to break in the near future. As such, with US rates looking very much like they have further to rise, I’m confident the dollar will come along for the ride.

But that is not the only thing helping the dollar this morning, there are two other stories that have helped feed the evolving narrative of US growth leading the pack. First, Japanese GDP in Q1 shrank -0.2%, its first decline since Q4 2015, and a surprise to most forecasters. While the discussion is that this is a temporary phenomenon having to do with bad weather and uncertainty over the global trade situation, the reality is that while the US continues to see data at or better than expectations, the rest of the world is lagging. Interestingly, while the yen did fall during yesterday’s session, it has actually rebounded slightly, just 0.15%, this morning. The other story that is getting some press, although not as much as I expect it will eventually, is from Italy, where the League and Five-Star parties continue their negotiations to form an anti-establishment government, and have discussed the idea of writing off €250 billion of Italian government bonds! Given that Italy’s debt/GDP ratio is an unhealthy 132%, it can be no surprise that a completely new and reactionary government doesn’t want to be held back by their predecessors’ profligacy (after all, they have their own profligacy to consider!) However, if this actually moves into the Italian government platform, it is going to be devastating to government bond markets throughout the world, and I assure you that the euro will not fare well either. In fact, this morning the euro is down a further 0.4%, trading below 1.18 for the first time since December 2017. The trend here remains very clear and I continue to believe the euro has further to fall.

I have written before about the idea of a debt jubilee, where central banks tear up maturing bonds and leave the cash in the system thus reducing government debt outstanding and expanding the money supply. This would be highly inflationary. When looking around the world at record high debt levels, it is something that has to be considered possible. While I have always believed that Japan with its 230% debt/GDP ratio would be the first country to consider it, Italy had to be a candidate. And since it is evident that the new government is willing to consider radical changes in the way things are done there, I guess it shouldn’t be a big surprise. But it would have a monumental impact on financial markets if they were to do this, with risk being shunned everywhere and haven assets exploding higher. I’m not saying this is going to happen, just that the probability has clearly turned non-zero. Watch this space!

With all that in mind, the dollar continues to power ahead vs. both G10 and EMG currencies although most of the individual stories are less interesting. The one outlier this morning is ARS, which actually rallied nearly 4% yesterday after the government was able to roll over $26 billion equivalent of local currency debt, albeit paying between 38% and 40% to do so. While the market did take the news well, I don’t have to remind you that paying 40% interest is not really sustainable. If the IMF deal isn’t closed soon, I fear things there will really get out of hand. But that was the only bright spot on the day. We continue to see TRY (-1.8%), BRL (-0.9%), IDR (-0.5%) and KRW (-0.9%) lead the way lower across the board. And here, too, there is no reason to expect that the situation will change. In fact, the ongoing issue with the emerging market currencies is that higher US interest rates are beginning to compete effectively with investment opportunities in those countries. As such, investors are looking at 3.0% in the 10-year Treasury, a riskless yield, and it is starting to compare favorably to everything else available. Complicating the cycle for EMG economies is that they have been on a USD borrowing binge for the past eight years and it is becoming increasingly more expensive to service and repay that debt, weakening those economies. Here too, I think the dollar has further room to run.

Looking ahead to this morning’s data we see Housing Starts (exp 1.325M) and Building Permits (1.35M) along with IP (0.6%) and Capacity Utilization (78.4%). What we have learned from the inflation data is that the housing market remains robust. And given the tax changes, there is a clear expectation for gains in Capex, which should help the other data this morning. In other words, it is difficult to look at the data and come away with a rationale for either Treasuries or the dollar to reverse course. In fact, my take is that we could see the dollar continue to rally through the end of the week, whereupon traders are more likely to start taking profits before they go home for the weekend.

Good luck
Adf

In Germany, GDP’s easing
An outcome that’s surely displeasing
A recent assessment
Of Chinese investment
Highlights global growth could be wheezing

The synchronous global growth story took a few more body blows today as both Chinese Retail Sales (actual 9.4%, exp 10.0%) and Fixed Investment (actual 7.0%, exp 7.4%) disappointed markets. In fairness, IP rose a more than expected 7.0%, but the net outcome was a depiction of an economy that is being slowed by the government’s efforts to reduce leverage. And while that is no bad thing, it still results in slowing economic activity. In fact, the slowdown in investment points to a continued future slowing in economic activity in China. A little while later, Germany reported that Q1 GDP actually rose only 0.3% (1.3% annualized), half the rate of Q4 and lower than the 0.4% expected. This has variously been attributed to extreme cold weather in March, a flu epidemic and a series of IG Metal strikes during their wage negotiations. These explanations are an effort to highlight that this was a temporary phenomenon, rather than the beginning of a trend. And perhaps they are correct, although the April data thus far have not borne out that case. And it was not only Germany that came up short, but also both the Netherlands and Portugal failed to meet expectations. The point here is that thus far in Q2, the data have not indicated that Q1 was a temporary blip. Now it may well be that things have improved significantly and that will start to show up in the data soon, but to date, the evidence is scant.

It can be no surprise that the dollar has held its own in the wake of these releases, with the euro edging lower on the day while the renminbi has fallen 0.25%. Yesterday’s price action was a bit more volatile as the euro made a run at 1.20 in NY’s morning session (remember the Villeroy comments), but then declined steadily all afternoon essentially closing unchanged on the day. One of the themes I have seen lately is that the dollar’s recent strength can be entirely attributed to a short squeeze in positioning. I agree that the large outstanding short positions played a role, in fact I wrote about it several times in the past month. But despite the fact that there are long-term structural issues affecting the dollar, my read is that the short-term cyclical factors remain the dominant driver for now. With 10-year yields trading back above 3.0% this morning, and the data stream continuing to point to ongoing US growth vs. slowing growth elsewhere in the world, it is hard for me to make the case that the cyclical story is over. It is why I continue to look for the dollar to perform well in the near term.

Adding to the dollar’s overall luster is the fact that the problematic emerging market currencies are just getting more problematic. Both Turkey and Argentina have fallen to new historic lows this morning as their local situations deteriorate. In Turkey, President Erdogan has explained to the market that after the election next month, he expects to take more direct control over the economy, which implies that he will be cutting interest rates there. That is certainly not the traditional policy for a nation with rising inflation and a weakening currency, but in this case, I expect he is a man of his word. TRY has further to fall. In Argentina, there are essentially no bids for the peso, which fell another 7.5% yesterday as the central bank has stopped wasting reserves in an effort to slow the decline. Right now, the only hope is that the IMF stand-by loan of $30-$40 billion is agreed soon and investors are willing to believe that it will stabilize the situation. We’ll see. But it is not just those two currencies that are suffering. BRL fell more than 2 big figures yesterday, (0.6%) and is steadily marching toward 4.00 as the presidential election process there heats up. A mixed data picture in Brazil shows the consumer still hanging in there, but production data slipping. Certainly not the best of circumstances. And India has also been suffering lately, falling another 0.5% overnight after inflation data highlighted that the RBI likely needs to be a bit more aggressive in raising rates. And while the rupee has not yet traded to new historic lows, it is a scant 1% from those levels.

My point is that it feels premature to dismiss the dollar rally at this stage. This is especially so in view of the fact that there is zero evidence that the Fed is going to change its strategy of tightening policy via both interest rate increases and a reduced balance sheet. And so I won’t do so. Rather I remain confident that the ongoing data situation will point to the dollar continuing its rally for now. With that said, all eyes will be on Mario Draghi tomorrow morning when he speaks, as if he has turned hawkish at all, that would signal that the ECB is ready to actually change policy, something I don’t believe will occur, but something that would clearly underpin a less bearish case for the euro.

This morning brings arguably the most important US data of the week in Retail Sales (exp 0.3%, -ex autos 0.5%). We also see Empire Manufacturing (15.5) at the same time, but the sales data should dominate.

One other thing, the politics of trade policy has almost certainly had a market impact, even beyond the potential for it to drive inflation higher. The recent turn on the Chinese phone company ZTE, where the administration is now working to reduce the draconian sanctions imposed earlier has been taken by some as a sign that the trade negotiations with China may be moving forward. As there were many who expected the dollar to weaken in the event that the US became significantly more protectionist, this is likely a mild benefit as well. In fact, it is hard to point to something that is a clear dollar negative right now. Granted, weak US data would help to turn the tide, but it would need to be quite consistent in order to do so. In the end, based on the current evidence, I see no reason to alter my views. And for today, I think all signs point to a bit more dollar strength.

Good luck
Adf

Said Mester the US is strong
And lest it goes terribly wrong
As I’ve been advising
Our rates will keep rising
That’s 2018’s theme song

Said Villeroy who spoke thereupon
When QE is finally gone
It’s quarters not years
Ere a rate hike appears
And the euro bulls called, “pile on!”

The dollar is broadly, but not universally, softer this morning as it continues to consolidate its strength of the past month. The latest driver was a series of comments by Banque de France governor, and ECB governing council member, Francois Villeroy de Galhau. Interviewed by Bloomberg TV before an event in Paris, he dismissed the slowdown in Q1 as temporary, but more importantly he said that once QE ends, which he confirmed would be in 2018, the “…extended period of time, well past the horizon of the net asset purchases” that the ECB has promised will follow before the first rate hike, will be measured in quarters not years. In other words, at its most aggressive interpretation, the ECB is looking to raise rates in the early summer of 2019. That is appreciably sooner than the market had been pricing, especially since the weak Q1 data was confirmed by weak April data. It should be no surprise that the euro rallied (+0.35%) in the wake of those comments, as part of its recent weakness has been attributed to the belief that the ECB would be forced to delay its policy changes. At the same event, Cleveland Fed President Loretta Mester, a current FOMC voter, reiterated her view that the Fed would continue raising rates and that eventually Fed Funds would rise above the neutral rate. However, given she is likely the most hawkish Fed member, there was no new information in her comments and so it did nothing to offset the Villeroy remarks.

If Villeroy is correct, and the Eurozone sees faster growth resume from Q2 forward, then we may well head back to the synchronous global growth narrative. This is likely to undermine the dollar somewhat going forward. But that remains to be seen, especially as the most recent data has not supported the idea that the Eurozone is rebounding. Until we see that data change, however, I see no reason to alter my view that the US is continuing to lead this economic cycle. In other words, last week’s mild dollar weakness seems far more likely to have been trading consolidation than the beginning of a new trend lower.

Away from those comments, the other Eurozone news was the agreement in Italy between 5 Star and the League to join forces and lead the country. This is by far the most radical antiestablishment outcome from recent European elections and their mooted programs, led by a Universal Basic Income and a low flat income tax, seem to be logically inconsistent and it is unclear how they will be able to implement them. It also seems that if they do, Italy’s fiscal problems are likely to grow with potential negative consequences for the euro. But it is early days, and talk is cheap. Let’s wait until we see something more concrete come from this new alliance.

The pound has also rallied this morning (+0.4%) as there seems to be a modestly more bullish take on the latest Brexit discussions within the British government, but that is not to say that anything has been agreed. Otherwise, within the G10, the dollar is only modestly softer with little in the way of news.

Emerging market currencies, however, have had a less successful session, with a number of them still struggling to find traction. We have discussed Turkey and Argentina, both of which have significant structural problems. Malaysia’s markets reopened last night for the first time since the surprising election results that brought Mahathir Mohamed back to power. With the nation’s markets closed on Thursday and Friday last week, today was the first time to see how things would respond to the results. MYR opened lower by more than 1%, as the equity market there fell sharply on the opening as well, but as the day progressed, it regained the bulk of those losses and, in fact, MYR is essentially unchanged from its pre-election levels at this time. As to the rest of APAC, the dollar was mixed, gaining vs. some and falling vs. others, but with no rhyme or reason and no large movers. EMEA currencies have generally fared better, with most stronger this morning, although TRY continues to suffer, and MXN, the only LATAM currency open as I type, has regained a bit of its recently lost luster. Watch BRL, where the presidential election is beginning to heat up, and its growing current account deficit combined with the political uncertainty has led to a steady decline all year, almost 9% so far. I fear it may have further to fall.

Data this week is far less interesting than last, but is as follows:

Arguably, Retail Sales tomorrow will be the biggest draw, but given that inflation has been the watchword, not growth, it doesn’t feel like it will have that big an impact. We also hear from four more Fed speakers this week, and we get some important Chinese data on Retail Sales and Fixed Investment. In the end, though, it doesn’t feel like there is good reason to believe that FX is going to be that interesting this week. My sense is that the dollar will continue to consolidate as we await the next grouping of data. If we continue to see relative strength in the US data compared with the Eurozone and the UK, the dollar should resume its recent uptrend. However, watch Wednesday when Signor Draghi speaks, as if he confirms the Villeroy comments, it could have a big impact with the euro rallying more sharply.

Good luck
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There once was a banker named Mark
Who four months ago sounded stark
In warning that rates
Might rise at more dates
As UK growth steepened its arc

But yesterday morning we learned
The BOE was quite concerned
The growth they expected
Could not be detected
And so any rate hike was spurned

There is a new narrative evolving, but as it remains early days the accuracy of this narrative is going to be called into question periodically. Yesterday was a perfect example. In the old narrative, synchronous global growth was the theme alongside dormant inflation pressures in the US with the two factors leading to the Goldilocks economy of strong growth, low inflation and no urgency to increase policy interest rates. But all of that started to sound less plausible once it became clear that, at least in Q1, synchronous global growth was actually strong US growth with many laggards, and Fed commentary hewed more hawkish than had previously been expected. The results have been evident over the past month with the dollar moving higher amid rising inflation, (and by extension interest rate) expectations, combined with weaker than expected foreign data. This has caused interest rate differentials to increase in the dollar’s favor.

One of the key reversals has been in the UK, where back in February, Governor Carney sounded extremely hawkish, explaining to the market that rates would likely rise more, and more frequently than had been expected at that time. The market promptly repriced and expectations for a hike yesterday rose as high as 90% at one point. Alas, the data never supported Carney’s thesis, showing the UK economy slowing sharply and the Brexit negotiations made no significant progress thus adding further uncertainty to the situation. As this unfolded, Carney walked back his earlier hawkishness and now the question is will the BOE still find it appropriate to raise rates this year at all? My gut tells me that they will not and that as the Fed continues on its merry way, the pound will continue to suffer. Yesterday’s market response to the MPC vote showed an initial dovish read with the pound falling sharply on the news (-0.7%), but then recovering most of that ground before the close and the rest of it this morning. So as I type, the pound is exactly where it was just before the MPC announcement.

Of course, the question is, why did the pound rebound yesterday? And that is down to the other part of the recent narrative that did not hold to form, US inflation. Yesterday’s CPI data was lower than expected with headline rising 0.2% (2.5% Y/Y) but core rising only 0.1% (2.1% Y/Y), a tick lower than expected. Now my good friend Mike Ashton, (@inflation_guy) whom you all should follow if you are interested/concerned about inflation, pointed out that the low print was driven by used car prices, which fell quite sharply. That is pretty aberrational and likely not indicative of the inflation story, which showed that things like medical expenses, housing and apparel all continued their trajectory higher. However, the market saw the headline, breathed a sigh of relief, and bought stocks and bonds while selling the dollar. That outcome is directly in opposition to what the new narrative is supposed to explain, and there were many who were quick to highlight how the old narrative was really still holding sway.

The thing is, as central banks, and thus market participants, focus more keenly on each data point, surprises in those data points are going to result in market responses. For what its worth, my take is that the new narrative remains a better description of the current market situation, and that it has further to evolve. In other words, I expect to see US growth outpace the rest of the world’s for a little while longer, US inflation to continue be felt and the Fed to continue its hawkish sentiment, all of which leads to the dollar continuing to climb. Adding to that is the oil picture, which because it seems to be rising on supply issues, rather than demand issues, is actually supporting the dollar through the inflation connection. In other words, its not that demand is so great it is driving oil prices higher thus leading to its own self-moderation of higher production, but the fact that concerns about Venezuela’s oil production continuing to slip and worries about the impact of the US withdrawing from the Iran nuclear pact on potential Iranian output that are driving prices higher, thus impacting inflation more directly.

So given that extremely messy backdrop, the dollar this morning is mildly extending the selloff that started in the wake of the CPI data. Looking across the G10, the pound is today’s biggest winner; rallying 0.4% to fully regain the BOE induced losses yesterday. As to the rest of the group, movement has been much smaller, on the order of 0.1%-0.2%. There has been very little data of note overnight to drive things, which is arguably one of the reasons that movement has been so muted. Switching to the EMG bloc, other than the Turkish lira, which continues its slow-motion collapse falling 1.1%, the dollar is modestly softer. However, while there are clearly a growing number of idiosyncratic stories regarding currencies in this bloc (TRY, ARS, IDR, MYR) each of which has led to sustained weakness, the bulk of the bloc continues to trade as per the dollar overall. So strong dollar days impact all of them similarly, and weak dollar days do the same thing. Today happens to be a weak dollar day. But not excessively so.

The only data of note this morning is the Michigan Confidence report (exp 99.0), but that is rarely a market mover. St Louis Fed President Bullard speaks at 8:30, which has potential to move things, but as he is already a known dove, it is unlikely that dovish comments from him regarding yesterday’s CPI will have much impact. If he were hawkish, however, that would be a different story. Looking it over, and with the weekend fast approaching, I would say we are far more likely to see the dollar continue to soften today as those traders who have jumped on the strong dollar bandwagon lately will be more likely to take profits ahead of the weekend and with the CPI data still ringing in their ears. But the medium term trend of a stronger dollar remains fully intact in my view.

Good luck and good weekend
Adf

Persistent easing
Remains policy of choice
But inflation still hides

As the market awaits the BOE’s rate decision this morning, the dollar has edged lower amid muted activity. Last night the Minutes of the BOJ’s April policy meeting were released and it should be no surprise that the commentary focused on the need to maintain their current monetary ease in order to achieve their inflation target. You may recall that at the April meeting, they discarded the timeline for achieving their goal, and now are simply trying to get there as quickly as they can. Of course, it has been more than five years since Kuroda-san was first appointed and expanded the BOJ’s asset purchase program in an effort to eliminate the deflationary spiral that had come to dominate the Japanese economy. And they haven’t come close to being successful yet.

I’m not sure how many of you remember the ‘Misery index’, a term coined by economist Arthur Okun in the 1970’s and effectively used by then presidential candidate Ronald Reagan in 1979, which was simply the sum of the inflation and unemployment rates. The idea was to show just how bad things were in the US economy back then, and in fact, that was the height of the stagflation era and the index was around 20%. In the US today that number is ~6.0% depending on which measure of inflation you use. In Japan, that number is 3.6%! My point is that things in Japan are hardly dire despite all the angst at the BOJ. I’m not saying that the debt situation there is sustainable, merely that the ongoing conversation regarding the horror over the lack of inflation seems to be misplaced. It remains extraordinary to me that central bankers the world over are so focused on driving inflation higher. Inflation is a problem in Argentina, running at 40%. Inflation running at 1% in Japan seems pretty manageable. (In fairness, higher inflation would reduce the real value of Japan’s massive debt load, so I do understand that rationale. But that doesn’t help the man on the street!) The yen did little in response to the Minutes, although it has definitely been under pressure for the past several sessions. However, that may well be more a result of general dollar strength than specific yen weakness.

Moving on there are two key stories for the rest of the day. First is the aforementioned BOE rate decision. A month ago, the market had been pricing upwards of a 90% chance of a 25bp rate hike today. Now that number stands below 10%. In the interim, we have seen both less hawkish commentary from several BOE members, notably Governor Carney when he reminded everyone that there was more than one opportunity for the BOE to raise rates this year if they had to. And shortly thereafter, Q1 GDP printed at just 0.1%, significantly lower than expected. Meanwhile, the most recent CPI data fell to 2.5%, below expectations and seeming to be trending lower. Add it all up, and there seems little reason for the BOE to get aggressive here. During the past month, the pound has fallen some 5% and the market is now awaiting the next BOE signals. Any further dovishness, which could be signaled by a unanimous vote to remain on hold, could easily lead to another 1%-2% decline, although if there are more than the 2 votes to raise rates we have seen the past several meetings, the market would likely interpret that as hawkish, and the pound should add to this morning’s rebound of 0.45%

The other data point of note this morning is CPI from the US. Current expectations are for CPI to rise 0.3% (2.5% Y/Y) with the ex food & energy number to be 0.2% (2.2% Y/Y). I continue to believe the risk is for a higher print and the reaction would be for the dollar to resume its rally. Whether or not you believe that the Fed is mistaken to be tightening so aggressively, it seems clear to me that Chairman Powell is on a mission and is going to keep going for the rest of the year at least. And while one of my concerns is that a recession in the US could be coming sooner than most pundits expect, there is no obvious sign that it is imminent, and so the Fed will keep going. Despite the fact that the Fed uses PCE in their models, they are not blind to the recent swift rise in CPI.

Other than that, and unless we get some new information from unexpected places (read the White House), it feels like the dollar, which has softened somewhat overnight, is likely to rebound a bit. Treasury yields continue to support the greenback, and interestingly, the rally in oil prices has had very little impact. One of the things people point to regarding oil is that there is a strong negative correlation between oil and the dollar. My question is which way is the causality? It is not clear to me that oil drives the dollar, nor that the dollar drives oil. And it is very possible that the causality changes over time, although the correlation has remained pretty consistent. In fact, the recent simultaneous strength of the two is the outlier. In the end, I’m not prepared to opine on whether continued oil price strength will weaken the dollar’s support. But my gut tells me that right now, the two are trading on different issues, and so are somewhat independent. If that is the case, then be prepared for the dollar to continue its ascent even if oil heads toward $80/bbl.

Good luck
Adf

Chair Powell said it’s just not true
That all of the things that we do
Impact EMG
Instead what we see
Is our actions hardly pass through

Price volatility throughout the emerging markets continues to be one of the dominant discussions amongst traders and investors. But interestingly that discussion has now spread to central bankers as well. Early this morning Chair Powell, in a speech in Zurich, tried to explain that Fed policy is not a very big driver of market activity in the EMG space, although there have been instances in the past where that seemed to be the case, notably the Taper Tantrum in 2013. However, looking at his charts and listening to him, I was not really convinced. Certainly my observation from a long career in the markets is that Fed policy impacts every other country, just some more than others. Interestingly, yesterday the economists at the San Francisco Fed released a paper saying that FOMC policies clearly had an impact on other economies, with the biggest impact on those economies that run large current account deficits. Now that is research that I can appreciate as it coincides with my (and many other) observations over time. In fact, I wrote about this just yesterday and this has been a common theme amongst many analysts. In the end, the market didn’t seem to pay too much attention to Powell’s speech.

The President’s soon to decide
If sanctions will be reapplied
On oil from Iran
Imposing a ban
And impacting prices worldwide

The other key story in the market this morning is the imminent decision from the White House on whether the US will be exiting the Iran nuclear deal and potentially reimposing sanctions on Iranian companies. If the US does exit the deal, it is expected to result in a reduction of Iranian oil exports of approximately 500K bbl/day, a pretty significant amount, although not enough to cripple supply. Remember, oil prices have risen >10% in the past month as this process has evolved and it is a fair question to ask whether or not we have seen the worst already. However, the overall uncertainty has been a definite issue for the market, and while the oil price might have already adjusted, it is likely there will be knock-on effects in other markets, as well as on the prices of specific companies who benefitted from the reengagement with Iran. The point is that we have the opportunity for another volatility inducing event occurring in the near future which means that havens are likely to perform well today.

Which brings us to the dollar and its recent activity. One of the key features we have seen lately has been the dollar’s ongoing rebound after last year’s weakness. In fact, the euro is now trading below 1.1900 this morning, which is its lowest level this year. The pound, too, is back to its YTD lows, although hasn’t broken through those levels yet, and only the yen has not yet ceded all its gains for the year. Of course, given the yen’s status as a safe haven currency, it should be no surprise that it has outperformed the other two major currencies. The question really is can this dollar rally continue, and if so, how much farther can it go?

At this point you all know that I believe the dollar has further to rally. It has become abundantly clear that the US economy continues to lead the way forward as much of the rest of the developed world has seen a trend of slowing growth develop. Meanwhile, there is absolutely no indication that the FOMC is going to change its current plan, of at least two more rate hikes this year alongside the continued reduction in the size of its balance sheet. In fact, though a number of Fed speakers (most recently, Atlanta’s Bostic) have been clear that they are comfortable with some overshoot in inflation, that comfort is likely to have limits. It remains difficult for me to see the Fed passing off, say, 2.5% inflation as unconcerning, certainly not based on the more hawkish makeup of the current voters. Given that background, and the fact that the correlation between US interest rates and the dollar has reasserted itself of late, I continue to see higher rates in the US and a stronger dollar. We will need to see either a reversal of the slowing growth data elsewhere or a significant turn lower in the US data to change this trend. Right now, neither seems likely, but given the uncertainty created by the current administration’s policies, anything is possible.

So looking at the overnight activity, the dollar continues to rally. This morning it is higher by 0.4% vs. the euro, 0.3% vs. the pound and 0.8% vs. the Australian dollar. A quick look at the overnight data shows Japanese household spending to have been a disappointment in March, actually falling -0.1% rather than rising the expected 0.7%. Australian Retail Sales were disappointingly flat, undermining the Aussie. Halifax House prices in the UK fell -3.1% in April, much more than expected, which can be seen in the pound’s weakness, while from the Eurozone, German IP rose 1.0%, pretty much as expected, and not nearly enough to change the recent trend of weaker data from the continent.

Remember, too, that market positioning shows speculative dollar shorts are still quite large and while they have been reduced lately, still have much further to go. This means that there is going to be a natural bid for the dollar for a while yet unless the data turns abruptly. In fact, my take is that we will continue to see the dollar outperform almost all other currencies until at least the middle of summer, at which point the specs are likely to be square.

I understand the structural issues that are going to weigh on the dollar in the longer term, but there is no indication those are going to make themselves felt in the near future. Rather, the current trend is quite strong and growing stronger, and as such, barring something truly dramatic from the US (a collapse in data or an about face from the Fed) I see the dollar continuing along its merry way. Is my year-end forecast of 1.05 for the euro really out of court? Right now it doesn’t seem so!

Good luck
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