My friends, this is quite consequential
In fact it could be existential
When asked about trade
Mnuchin portrayed
A trade war as having potential

But Sunday when pressed on the subject
His softer tone saying that in effect
He just didn’t think
We were on the brink
Of a trade war with China in retrospect

Trade continues to be the primary focus of markets as Friday’s jitters have abated somewhat over the weekend. In what can only be described as the norm in this administration, there are conflicting views amongst not only different spokespeople, but seemingly, as Mnuchin demonstrated, amongst individuals themselves. If pressed, I would say that it is certainly not the president’s intention to initiate a trade war, but that he is quite focused on adjusting the terms of trade with China, as well as the rest of the world. After all, it was a key campaign promise. The problem for markets is that the volatility that accompanies the various statements and interpretations of those statements is significantly greater than we have seen for a number of years and is likely to continue to be so. Interestingly, comments from Fed Chair Powell on Friday were notable in their complete lack of concern over the current situation regarding trade. It remains clear to me that Mr Powell is unlikely to demonstrate concern if equity markets fall further, barring a complete, October 87 like crash. This may, in fact, be the biggest change in the Powell Fed compared to the previous three iterations, the expiration of the Fed put.

Speaking of Powell’s comments, his message Friday was that a steady pace of rate increases was appropriate policy in order to prevent inflation from building up too large a head of steam. These comments were echoed by both Chicago’s Evans and the NY president-select Williams, which is pretty good evidence that the core of the Fed remains on track to continue raising rates, with the next move to come in June.

The other feature of Friday’s markets was the payroll report, where the headline NFP number was a quite disappointing 103K and the previous two months saw downward revisions totaling 50K. However, that still leaves the 3-month average at ~200K, a very healthy clip. In addition, the AHE number was right on the button at 2.7%, so wages continue to edge higher, although are certainly not running away. The recent economic story in the US, as well as elsewhere in the developed world, is one of moderating economic activity. I have pointed out several times that the ISM/PMI survey data appeared to peak back in December and has been trending lower since. German IP fell a surprising 1.6% on Friday and this morning’s data from the Eurozone showed their trade balance shrinking as well. Economists and policymakers have grown to believe that growth potential in the Eurozone tops out at 2.0%, assuming it can even maintain that pace over time. The fact that last year saw output grow at 2.4%, well above potential has resulted in a greater likelihood of a slowing pace of growth, and with it, the removal of any inflationary impulse, assuming there was one to begin with. This is Signor Draghi’s problem, that despite a year with very positive tidings, that things may be sliding back toward a more lackluster economy, with a reducing in inflation pressure. Under this circumstance, it is awfully difficult to make the case that tightening policy is the appropriate response. And while the hawkish wing of the ECB, led by Germany’s Jens Weidmann, are quite keen to not only end QE but raise rates, there is still a sizable contingent, notably from the peripheral nations, that see no reason for that at all. I continue to believe that the ECB’s actions this year willl be far less hawkish than the narrative.

Of course it is the combination of these views that helps inform my sense that the dollar has further to rebound. That and the policy mix of US loose fiscal and (relatively) tight monetary policy. But there is another side to the dollar, one that I have not addressed, but one that ought to be an important part of the discussion, namely the budget/trade deficits. In the world of capital flows, the fact remains that as the US sees both its budget deficit increase and its trade deficit increase, the money has to come from somewhere to fund it. This is why the US capital account is in such large surplus (all those funds flowing in to buy Treasuries). But the point that dollar bears make is that as both those deficits grow, the US is going to need to offer more attractive terms to get the rest of the world to finance them. That means that not only do rates need to rise, but that the dollar needs to fall.

Here’s a thought experiment. Consider that you are a foreign investor with a euro functional balance sheet. In order to be attracted to Treasuries, you would want not only a higher coupon, which of course you clearly have at this time, but also to have confidence that the dollar would at least not decline, if it doesn’t increase. However, given the recent trend, with the dollar falling for the past fifteen months, it is hard to remain sanguine about its near-term prospects. I would describe this as the transitional phase, where the dollar may not yet have adjusted to a level sufficient to attract that critical inward capital flow. If that is the case, then a further downward adjustment in the dollar may be required before foreign buyers feel confident that the risks are outweighed by the coupon advantage. In other words, as long as the twin deficits continue to climb, the US will effectively have to offer better terms to the buyers of their debt, and that means higher rates and a weaker dollar. In fact, it is a compelling argument and a key part of many forecasts for a weaker dollar. However, when I consider all the evidence, I continue to believe that the dollar is unlikely to fall further, or at least much further, and will begin to rebound when the market understands the change in tone from the ECB. Remember that the entire FX market is a relative one, with important information from both sides of the trade.

A look at this morning’s price action shows that the dollar has edged slightly higher, but in truth, other than against the RUB (which has fallen nearly 3% due to new sanctions on the oligarchs), most of the movement has been relatively muted. In fact, if you consider the past three months, the dollar really has done very little overall.

Looking ahead to this week, the data flow is significantly lighter, with the highlight certainly Wednesday’s CPI print.

So Wednesday is clearly the big day, with both CPI and the FOMC Minutes. At this point, it seems pretty clear that inflation indicators continue to slowly grind higher, but the risk to markets will be for a bigger jump. Given the consistent Fed stance that rates are going to only rise gradually, any data that indicates the Fed are falling behind the curve will likely see a reaction. As to the Minutes, given how much we have already heard from Fed speakers, it doesn’t seem like there can be much new information there. And we have four more Fed speakers this week as well, all likely to reinforce the message save Neel Kashkari, the confirmed uber-dove.

In the end, the market is still beholden to the trade rhetoric, and so choppy markets are the most likely outcome for the week. The one thing of which I am sure is that the trade story is nowhere near over.

Good luck
Adf

Investors collectively squealed
When tariffs, by Trump, were revealed
That opening tactic
Proved anticlimactic
When ongoing talks were revealed

Then last night from out of the blue
Amid a great hullabaloo
The Prez indicated
That he was frustrated
Thus more tariffs now will debut

Meanwhile a few hours from now
The employment report takes its bow
The critical gauge is
The hourly wages
Where strength could give Powell a cow

Just when you thought it was safe to go back in the water…

Let’s consider the recent timeline for a moment:

Tuesday night – Trump imposes tariffs on $50 billion of Chinese goods, the Chinese immediately respond and equity prices collapse around the world
Wednesday mid-day – Wilbur Ross and Larry Kudlow explain that senior level negotiations are ongoing between the US and China and that no trade war is imminent. Stock prices immediately turn around, rallying sharply around the world as FOMO grips the investor community
Thursday night – after a two day global equity rally, President Trump surprises one and all by announcing an additional $100 billion in tariffs on Chinese goods with China responding immediately and saying, “The Chinese side will follow suit to the end, not hesitate to pay any price, resolutely counterattack and take new comprehensive measures in response.” I don’t know about you, but when the Chinese invoke the specter of Winston Churchill, it sounds pretty warlike to me!

It should be no surprise that risk has been jettisoned yet again after this latest round of commentary with equity markets in Asia and Europe both falling while US equity futures are pointing lower. Interestingly, the dollar, which has been performing quite well lately, is little changed this morning, as are Treasuries and gold, neither of which seems to be benefitting from a flight to safety. My take is that investors are simply confused at this point and don’t really know which way to turn. And in fairness, how can you know what to expect at this point? The one constant of the Trump administration for market participants is that there is no surety as to what will happen.

So since I have no idea what will occur with the trade situation (does anybody?), I guess its time to focus on the payroll report. Current expectations are as follows:

The clues that we have seen lately seem to point to another strong report. ADP Employment was a much stronger than expected 241K. The ISM data showed both firmer employment sub-indices as well as firmer price indices, implying that wages remain robust. And of course, Core PCE was firmer than expected last week, adding to the idea that price pressures are increasing. Anecdotally we have seen teachers around the country going on strike for pay raises, and getting them, with the smallest increase I have seen being 5.0%. That certainly smacks of wage inflation and by all accounts, that is the thing the Fed is most focused on. It is hard for me to look at the evidence without getting the feeling that any data surprise will be on the high side.

The question, of course, is how will the market respond to a surprise of any sort. Inflation remains the key driver of policy decisions at this point. In fact, if the Unemployment rate does fall to 4.0%, it will only add further angst to the FOMC as they watch it decline further below NAIRU and given their ongoing belief in the Phillips Curve, prepare for even more inflation. So I continue to believe the AHE number is the most important part of the report. I’m sure you all remember what happened in the February release when AHE jumped to 2.9% and equity markets subsequently fell 10% in a few days. Quite frankly, I don’t rule out a repeat of that type of performance. After all, it is clear that the Fed is geared up to continue raising rates. It has also become clear that Chairman Powell, unlike his three predecessors, is quite comfortable watching equity market volatility rise amid uncertainty and a declining stock market. Finally, it also appears that the FOMC is very keen to ‘normalize’ monetary policy, which I take to mean Fed Funds back at long-term levels of 3% – 4% alongside a much smaller balance sheet. I assure you, another 2.9% print will encourage all of that behavior. In fact, I would argue it will cement four rate hikes for this year. In that event, I like the dollar to continue its recent modest strength, I think equities will suffer, and I expect Treasuries will be caught between concerns over higher inflation driving rates higher and flight to safety driving them lower, so likely not move much at all.

On the other hand, a weak print today will be unambiguous across markets. Equities will recoup their trade war induced losses (unless the rhetoric increases), the dollar will suffer immediately and Treasuries will simply rally, with yields probably falling back to the bottom of the recent trading range. We shall see.

One other thing to note about today, Chairman Powell speaks about the economic outlook at 1:30 this afternoon. Given his penchant for straight talk, I expect that we will have a very good idea about how his thoughts have evolved since the March FOMC meeting. So its not just trade and payrolls today, but Powell as well. I would err on the side of being long dollars here, as the evidence points to both solid payroll gains and higher wages.

Good luck
Adf

Concerns about trade have matured
With markets now more reassured
That all the trade bluster
Was just meant to muster
Both nations while deals are secured

One has to be impressed with the ability of investors to change their collective mind in a hurry. When I wrote yesterday morning, it felt as though the world economy was about to hit a very big roadblock toward future growth as the trade rhetoric between the US and China got quite heated. But by the middle of the day, after comments from Commerce Secretary Ross and new National Economic Advisor, Larry Kudlow, as well as from some Chinese counterparts, it became clear that all the huffing and puffing was simply the first part of a more substantial negotiation on the trade relationship between the two nations. And the market breathed a huge sigh of relief, with equities rebounding some 2.5% from their intraday lows and Treasuries giving up their early gains as the risk-off meme reversed into a risk-on day.

The dollar, meanwhile, regained all its lost ground and then some against the yen, ultimately rallying 0.2% on the day, which was a solid 0.7% from early yesterday morning. The other big mover of note during yesterday’s session was the Mexican peso, which rallied more than 1% from its early morning lows on the back of both the changing perception in the US-China trade spat and increasing confidence that the NAFTA negotiations are going to be concluded successfully. One other thing has helped the peso lately and that was the announcement two days ago by AMLO (the leading, far-left presidential candidate) that he was not considering renationalizing strategic companies if he is elected. This had been a great fear amongst investors and so relieves additional pressure on the economy and currency.

So if trade is moving to the back burner (although I imagine there will be periodic comments and tweets that can have market moving effects), we are back to looking for the next big thing. Or perhaps more accurately, we are back to looking at the previous big thing, central bank activity. Remember, prior to the escalated trade dialog, global central bank activity had been the primary driver of markets. So has anything changed in the past few days? Not really.

In the US, the data continue to point to a robust labor market, with yesterday’s ADP Employment figure printing at a higher than expected 241K with particular growth in the manufacturing sector. At the same time, the ISM non-manufacturing index slipped a bit more than expected to a still robust 58.8. We also saw Factory Orders rebound less than expected, growing only 1.2%, not the 1.7% forecast by economists. In fact, this pattern mirrors what we are seeing throughout the developed world, with economic activity seeming to have slowed from its Q4 peak around the world, although employment continues to ramp up. Now this is not unusual given the fact that employment data has always been a lagging indicator, meaning that it essentially looks back to where the economy has been rather than ahead to where it is going. So while politicians love to crow about their policies driving employment, and despite the fact that the market reacts more forcefully to the NFP report than virtually any other, arguably, it doesn’t tell us much about the future. In fact, the entire purpose of the ISM data (PMI data elsewhere in the world) is to get a read on the potential future activity, which is arguably much more important for policymakers. And it is why I highlight the fact that the forward-looking growth data is beginning to trend lower, because that is going to impact central bank thinking. In addition, the forward looking price data is continuing to trend higher, which implies that measured inflation is going to continue to increase as the year progresses. It is also why I am far more concerned about a recession before the end of 2018 than are most pundits.

But the market continues to rationalize the data in the following manner; ongoing strong employment data implies growth remains strong and even though the ‘soft’ indicators like ISM are starting to roll over, they remain quite high on a historic basis, and therefore are not indicative of weakening future growth. At least that’s what I can determine based on the fact that despite still high valuations in markets, there appears to be little concern that a further correction in asset prices can come along.

So all of this takes us to the dollar and its future. Given the fact that there has been no real change in the underlying fundamentals, it should be no surprise that my views haven’t changed. Yesterday’s Fed speakers offered little new information, with Cleveland’s Mester not even discussing policy in her speech about increasing diversity in economics while St Louis’s Bullard, a confirmed dove, said he thought policy right now was sufficiently tight and didn’t need any additional action based on his view of the economy. In other words, despite the fact that the Fed seems set to raise rates at least twice more this year, he sees no reason for the action. But as a dove, that is to be expected. In the end, I believe that not only is the market anxiously awaiting tomorrow’s payroll report, but so is the Fed, as they keep a close eye on potential wage gains. It is why I continue to believe that the AHE number tomorrow is the key feature of the report.

At the same time, we have not heard anything new from any of the Fed’s brethren central bankers, with the policy trajectories for the ECB, BOJ, BOE and PBOC all unchanged from before the trade story. As to data elsewhere, in the Eurozone this morning, the PMI Services and Composite data was a touch softer than expected, again pointing to the slowing growth momentum. We saw the same outcome in the UK, and we have seen that in both Japan and China in the past week as well. The difference is that the inflationary impulse that is quite clear in the US, with CPI already above 2.0% and PCE fast approaching the target, is not evident in either the Eurozone or Japan, especially at the core level. It is this lack of inflation, plus the fact that the Unemployment rate in Europe, which at 8.5% is at its lowest level in more than a decade, is still quite high, that continues to inform my view that the ECB is just not going to be as aggressive tightening policy as the current narrative suggests. And it is why I think the euro is toppish here and has far more downside than upside.

As to today, there are two data points of note, Initial Claims (exp 230K) and the Trade Balance (-$56.7B). Given the current trade rhetoric, the latter number could lead to some inflammatory comments, but my take is that will continue to be posturing. We also hear from Atlanta’s Rafael Bostic this afternoon. However, tomorrow is really the key day because not only do we get the payroll report, but Chairman Powell speaks at 1:30pm, so all ears will be attuned to his comments then. For the rest of the day, with equity markets continuing yesterday’s afternoon rally, my take is that the dollar, which is broadly stronger this morning, will actually give back a bit. But with so much news set for tomorrow, I don’t imagine today’s price action will be significant.

Good luck
Adf

Investors are very afraid
That things will get worse in re trade
Trump’s latest attack
Caused China to back
More tariffs as patience has frayed

Once again trade is the key topic of the market conversation this morning as the US imposition of tariffs on $50 billion of Chinese imports, announced last evening, was followed by the Chinese response of tariffs on $50 billion of US goods announced overnight. While the trajectory of this process is certainly disconcerting, there are still many policy pundits who seem to believe that all this can be contained without having too large a negative impact on economic growth. I hope they’re right, but at the very least we will need to see evidence that the two nations are discussing the issues beyond the simple tit-for-tat actions that have been announced. And thus far, evidence of that is scant. The thing to keep in mind is that trade has been one of the most important drivers of global economic growth in the post WWII era, and has benefitted virtually every nation on earth. If this paradigm is changing, it will have far reaching consequences beyond simply the economic data. Rather, it will almost certainly change the political dynamic in countries in every region including such topics as migration and defense. And compared to the world in which we have lived for essentially all of our lives, prospects could well be darker. But that is a discussion beyond the purview of this note, which is focused on markets with particular emphasis on FX.

So heading back to markets, it should be no surprise that equity markets have taken this news poorly given the potential ramifications on specific company profitability as well as general economic performance. In the US, equity futures are currently lower by ~1.5%, more than offsetting yesterday’s rebound, while we are seeing weakness throughout European shares and saw such in Asia as well overnight. Treasuries, meanwhile, continue to perform well despite the increased supply, as they remain the number one safe haven asset for large money managers. This morning, the yield on the 10-year has fallen 2bps, although that is after having risen about 3bps during yesterday’s stock market rally. Gold has also benefitted, rising about 0.7% overnight, as it remains a clear safe haven. (As an aside, it is interesting to me that Bitcoin, the alleged digital gold, has fallen some 3% overnight. Perhaps it does not seem as safe as its strongest adherents claim!)

In the FX markets, we have seen a very traditional risk-off response. In the G10, that means the yen is the leading gainer, +0.5%, followed by the Swiss franc, +0.25%. The other currency gaining against the dollar has been the euro, but that is a very muted 0.1%. Regarding the euro, two things need to be addressed: first that yesterday it fell about 0.3%, so this morning’s rally still leaves it lower than this time yesterday morning, and second, the release of the flash March CPI estimate (headline 1.4%, Core 1.0%, both as expected) has generated some discussion that the ECB will be better able to take the next steps in ending QE later this year. I take issue with the latter idea as the fact that the core data continues to run at half their target rate, and has remained between 0.8% and 1.2% since 2014 implies that the underlying inflationary impulse that the ECB needs to see before abandoning QE remains absent. The euro bulls continue to suffer the costs of negative carry and unfortunately for them, the data has not solved their problems yet. As to the rest of the G10 space, the dollar is modestly firmer as might be expected.

Turning to the EMG bloc, it should be no surprise that the dollar has been the main beneficiary of the trade spat. Interestingly, the renminbi has fallen more than 0.5%, which is a pretty big move given the normal volatility in the currency. I guess the PBOC wanted to try to add further pressure on the US given the situation. But weakness abounds in the space with MXN down by 0.5%, RUB down a similar amount, TRY -0.8% and ZAR also lower by 0.8%. Most of the other currencies have also fallen, just by lesser amounts, but the theme is quite clear. After all, given that every one of these countries is heavily reliant on trade, and that the US continues to be the largest trading partner for so many of them, the idea that the US is going to be raising trade barriers cannot be seen as a positive for any currency in the bloc.

And while trade has been THE story of the overnight session, and will certainly continue to get play as an issue, this morning we start to see some data points that may also have a market impact. We start with the ADP Employment number (exp 185K), which while much lower than last month’s NFP outcome is in line with the recent monthly average gain. In other words, the employment situation appears to continue to be quite positive in the US. That is followed by the ISM Non-Manufacturing Index (exp 59.0) and Factory Orders (1.7%) with the former likely to have a larger impact than the latter. We also have two Fed speakers today, St Louis’s James Bullard and Cleveland’s Loretta Mester, a dove and a hawk respectively, so at the very least we should hear both ends of the Fed spectrum. As such, I expect Bullard to argue that the lack of inflation in evidence so far means the Fed should slow down while Mester will be focused on making sure the Fed doesn’t fall behind the curve.

While today’s data might impact markets at the margin, I think once it has been released, all eyes are going to begin to focus on Friday’s Payroll report, and more specifically on the AHE number released. The one thing that remains clear is that the escalation in the trade ‘war’ is going to add to what I believe is already a rising inflationary picture in the US (and elsewhere round the world) and that the Fed is not blind to this process. Given that inflation remains the Fed’s primary focus right now, it seems a very plausible path going forward is more trade tension leading to still higher inflation readings and the Fed responding more aggressively. This cycle is not going to end soon, and accordingly, in combination with the growing risk-off sentiment, I see the dollar remaining as the main beneficiary of the current situation (excepting, of course, the yen which will rise most).

Good luck
Adf

There’s no question fear is pervasive
But which argument is persuasive?
Is everyone scared
‘Cause Donald Trump dared
To tweet something highly abrasive?

As we have seen for much of the past eighteen months, the tech sector continues to lead the overall equity markets around the world. Alas for most investors, these days the direction is lower. Continuing concerns over the potential government response to privacy on social media have been a hallmark of recent sessions. But there is plenty more that is taking the shine off of markets these days. For example, the president has been lambasting a leading tech company on a regular basis, and while it doesn’t yet appear that the government will take any actions, it is clearly in the forefront of investor’s minds. In addition, the trade situation continues to deteriorate with the Chinese imposing their tariff response to the US’s Steel and Aluminum tariffs announced several weeks ago. In addition, they stand ready to impose more when the Section 301 tariffs get finalized in coming weeks. (As an aside, arguably the Fed should be cheering on the impending trade war, as the one thing it will certainly do is cause inflation. And after all, hasn’t that been their stated goal since the financial crisis? While that is said with tongue partly in cheek, what it does highlight is either the absurdity of their position, or the incredible nuance they need to try to communicate and their failure to do so effectively. But either way, inflation is clearly heading higher and along with it, so are US short-term rates. That much is clear.)

But let us not forget the economy. Thursday’s data showed Core PCE rising more than expected at 1.6%. Yesterday’s data showed a slightly weaker than expected ISM print at a, still robust, 59.3, but more ominously a jump in the prices paid index to 78.1, its highest level since 2011, and a clear harbinger of rising prices. Here are two more indicators that the inflation story is starting to get ahead of the Fed. Arguably, one of the biggest equity market concerns is that inflation data starts to rise more sharply and the Fed feels it is necessary to quicken the pace of rate hikes. It seems to me that we are seeing just that scenario playing out. After all, virtually every price indicator in the past month has been higher than expected. I assure you if Friday’s AHE number prints above current estimates, the response will be dramatic.

The upshot of all this has been a clear flight to safety, and so it should be no surprise that the dollar has continued to hold its own during this period. While the yen continues to be the primary currency haven of choice right now, the dollar is a close second.

FX traders find themselves in an uncomfortable position because there are two very conflicting ideas making the rounds. The prevailing narrative remains that the dollar will weaken further this year on the back of tighter policy by other central banks while the market has already accounted for the Fed’s tightening. The problem with this is twofold. First, as LIBOR continues to rise daily, the carrying cost of maintaining a short dollar position is growing every day and becoming quite significant. As I wrote yesterday, in a negative carry short position, not falling is the same as rising over time. It is a loser. Combining this idea with the recent data showing rising inflation in the US and increasing odds that the Fed gets more aggressive has made life tough for the narrative.

But that’s not all! The idea that both the ECB and BOJ are going to be tightening soon also has to be called into question based on the recent data from both places. For example, last night’s Eurozone PMI data showed continued slowing in the pace of growth, with the 56.6 reading the lowest level in a year. This is the third consecutive decline in the reading and is starting to seem like a trend. (Remember, Japanese data is also tipping over.) Perhaps, the evidence is showing that Eurozone growth may be slowing down a bit. The difference between this and the US situation is the inflation question. Thus far, Eurozone inflation data has shown no penchant to increase unlike in the US. If this is so, please explain why the ECB will be so quick to tighten policy. Rather, I would argue that Signor Draghi will be quite happy to continue his gradualism by reducing, but still extending, QE to €15 billion per month for Q4 of this year before stopping in 2019. And at that point, it will still be at least six to nine months before they actually begin raising rates. I continue to believe that the prevailing narrative will be proven wrong as the year progresses which means the dollar still has upside.

As to the BOJ, the growth story there seems to be the same as elsewhere, with Q4 2017 the pinnacle and a slow erosion since then. Japanese inflation remains far below the targeted 2.0%, and although Kuroda-san continues to discuss the idea that the BOJ will raise rates at some point, that point is clearly a long ways off. The BOJ’s biggest problem is that if the equity markets continue to correct (and they have plenty of room left to do so) and it continues to drive a flight to safety, the yen will strengthen without any help from tighter BOJ policy. In fact, that will serve to put further downward pressure on inflation, and by extension likely undermine any USDJPY strength. At the beginning of the year my expectation was for the dollar to broadly gain against all comers except the yen. That still looks like a good bet to me.

As for today’s session, the dollar has had a mixed overnight session with both gainers and losers but neither side showing a clear advantage. Aussie and Kiwi are showing a little strength, but that seems odd given the dovish RBA comments when they left rates on hold at 1.50%. USDJPY is actually higher this morning, but that seems more like a trading bounce than based on fundamentals. In fact, the biggest mover today is NOK (+0.7%), which seems to be responding to the rebound in the price of oil. Emerging market currencies have done virtually nothing of note, which is interesting in that I would have expected more general weakness given the risk situation.

There is no data of note released today so FX is likely to be driven by the ongoing equity market gyrations. While futures in the US are pointing slightly higher as I type, European markets are lower across the board. It strikes me that we will continue to see equity markets pressured without a new catalyst. This is especially so since the technicians will be jumping on board now that the three major indices have all closed below their 200-day moving averages, a key technical selling signal. With that in mind, I like the dollar and yen to edge higher during the day.

Good luck
Adf

The sixty-one days of Q1
Resulted in somewhat less fun
Than all of last year
And there’s a real fear
This craziness isn’t near done

So looking ahead to Q2
The question is what should you do?
Where hawks see inflation
Most doves fear stagnation
It just rests on your point of view

Easter Monday is a holiday throughout Europe and equity markets there are closed across the board. While banks are open, trading staffs are skeletal and FX price action has been quite muted. If pushed, I would say the dollar is slightly softer, but there has really been very little to discuss. The biggest news overnight was the Japanese Tankan Survey, which mildly disappointed by printing at 24, but remains near its highest level in more than a decade. So perhaps growth in Japan has plateaued, but there is no strong evidence it is beginning to decline. Meanwhile, the impact on the FX market was virtually nil, as USDJPY has rallied just 4 pips. We also got Caixin PMI data from China, which was a disappointing 51.0 (exp 51.8) with the renminbi sliding 0.1% in the wake of the data. As I said, there was very little of note overnight.

So now seems like a good time to discuss bigger picture views of the market as we begin the second quarter. As always, there are many pieces of the story that appear contradictory and the question becomes which ones capture the market’s fancy at any point in time. It has been said many times, nothing matters until it Matters. In other words, while information may be available, until it becomes the focus of the market, it is merely background noise.

Historically, from a policy perspective, the best way to strengthen a currency is to run tight monetary and loose fiscal policy. The opposite is also true, loose monetary and tight fiscal policy will weaken a currency. So when looking around the world today, what do we see?

I would argue that the US is running the tightest monetary policy of all developed nations and arguably the loosest fiscal policy. Consider, the Fed has raised rates six times in this cycle while reducing the size of its balance sheet some $60 billion since October and seems set to continue both processes with three more rate hikes this year and probably another $150-$200 billion in balance sheet reduction. At the same time, the ECB continues to add to their QE to the tune of €30 billion per month and will be doing so through September at which point they are likely to reduce the purchase amount and maybe even stop buying completely, but certainly not sell any back! And rate hikes? It will be at least eighteen months before they go there. What about the BOJ, you may ask. Well they, too, are continuing to expand their balance sheet, buying JGB’s, and equity ETF’s to the tune of ¥6 trillion per year. Short-term rates in both places remain negative and the prospects of the BOJ raising rates also seem quite remote in the near future, as inflation there remains anchored below 1%. While both the BOE and BOC have raised rates in the past year, the pace has been much slower than the Fed (once in the UK, twice in Canada) and expectations remain that they will continue to lag the US in this policy adjustment. As to China, the PBOC has raised rates slightly, but also at a much slower pace than the Fed and they continue to be reactive rather than proactive in this process. China does have its own domestic struggles regarding excess leverage and the PBOC is trying to wring that out of the system via macro prudential policy adjustments without crashing things, so overall monetary policy there is probably the second tightest around. But I think it is clear that the US is running the tightest monetary policy in the world right now.

So let’s look at fiscal policy. Well, we all know that the US not only cut taxes massively, but also just signed an omnibus spending bill that will increase deficits by $300 billion (at least) over the next two years. That, my friends, is loose fiscal policy. A quick peek at the Eurozone shows the largest economy, Germany, running a 1.5% budget surplus! While throughout the Eurozone different countries have different situations, the net is an area running a basically balanced budget while every discussion on taxes has been about raising them (3% tax on tech company revenues anyone?). In other words, no one would accuse the Europeans of running loose fiscal policy right now. Japan? The Japanese continue to run budget deficits as they continue to try to prime the pump of the economy. They also have the fastest aging population in the world and are paying increasing sums for pensions and healthcare, so it is hard to call their fiscal policy tight. But is it looser than in the US? Debatable, and arguably since the US has just adjusted its policy, the impacts remain in the future as opposed to the Japanese who have been in this policy position for years. Elsewhere fiscal policy is loosening somewhat, but not nearly to the extent we have seen here in the US.

Add it all up and I would argue that the dollar ought to be the beneficiary of the policy settings. Of course, markets are forward looking and the argument that all these policies are already priced in is a valid one. But as I have maintained all year, it appears to me that the market is overestimating the future monetary policy moves elsewhere, although it might have finally caught up to the Fed.

Of course there are other issues that impact the dollar’s value with a recent favorite topic being trade. There is no question the US’s recent more protectionist bent on trade is having an impact. In the previous two periods where the US imposed tariffs on specific products, steel in 2001 and autos in the 1980’s, the dollar did suffer, falling about 8% each time. But monetary and fiscal policy settings were quite different then, so it is not really an apples-to-apples comparison. However, as I wrote above, nothing matters until it matters and apparently, the market is keenly focused on the FX impact of tariffs right now. At least that is one explanation for the dollar’s weakness and it may be the best we have.

Another factor is prospects for future growth. While the synchronized global growth story continues to be a popular meme, I am starting to wonder how much longer it will continue. My concern stems from the fact that we have seen a series of data releases that not only missed forecasts but also have actually turned lower. Last night’s Tankan is a perfect example, but so too is the PMI data we have seen in Q1 throughout the world, as well as US Retail Sales data and a host of other factors. It is entirely possible that Q4 represented the pinnacle of this cycle’s growth and that we are going to see a reduced rate going forward. If that is the case, then the relative timing of those changes will drive the FX market. For example, if the US data starts slowing appreciably faster than that of the Eurozone, I would expect a weaker dollar and vice versa. As I have written before, one of my key concerns is that virtually the entire economist community is so sanguine about the prospects for a recession by the end of this year, with mid 2019 seen as the earliest opportunity. Again, my observation is that when all agree an event will occur in the distant future, it tends to occur sooner than expected. So a recession before 2018 ends would not shock me, but it would shock markets. Depending on how it evolved, the dollar could clearly suffer in that scenario, but it could just as well rally if the US seemed set to weather it best.

What is surprising is that for those carrying short USD positions, the negative carry is becoming quite significant as LIBOR rates continue to rise almost daily. The point is that it is a painful position to hold if it is not working, and for the past several weeks, the dollar has been relatively stable. That is costing the shorts a lot ofmoney. At some point for a negative carry position, not falling is the same as rising, although I don’t know at what point that will occur now.

Other issues that pundits have mentioned are concerns over the volatility in the US administration, with a lot of turnover in the White House, but I don’t think that markets really see that is a critical day-to-day issue. There is much more concern with policy action rather than with personalities, at least in my view.

So add it all up and I still see the rationale for the dollar to rebound as the year progresses unless we see significant changes in policy elsewhere. And as it stands right now, that doesn’t seem to be likely.

Before I finish, we do have a lot of important data this week, culminating in Friday’s payroll report.

So we should get our first idea as to how Q1 is shaping up and as to whether the Fed is going to be on further alert. Last week, the PCE data on Thursday did print higher than expected with the core at 1.6%. Continued strength in the AHE number will certainly be a keen focus. Imagine, if you will, a 3.0% print there on Friday. That would cause some fireworks in both the bond and equity markets! In addition, we hear from five more Fed speakers, with a chance for the first nuance from the new data. In the end, I fear we will continue to see pressure on the equity markets this week as we have reached the good news is bad scenario, and if Friday’s data is strong, it will simply feed the process. While today is likely to be benign given the holiday hangover, the rest of the week could well be quite interesting.

Good luck
Adf

Said Harker, the Philly Fed chief
Two more hikes this year’s my belief
The issue I fear
Is inflation’s near
At which point things could come to grief

As equity markets around the world remain roiled on the back of concerns over the changing political and regulatory landscape for the tech sector, it is refreshing to have a Fed member ignore the issue in comments. This is all the more surprising since virtually everybody else who gets in front of a camera gives us his or her “insights” into what is causing the increase in volatility. But the reason this is refreshing to me is that it implies the new Fed leadership is far less concerned with equity price movement than the old. Rather, they are focused on their actual mandate of price stability and full employment. So in an interview yesterday, Philly Fed President Patrick Harker indicated he had increasing concerns that inflation was picking up and that he was now fully on board with two more rate hikes this year. Granted, according to the dot plots from last week’s FOMC meeting, it still appears that the core of the Fed is expecting three more hikes, but the fact that every Fed comment we have heard since the meeting has touched on the inflation risk is indicative of the fact that the hawks remain in command. And remember, Harker is not a voter this year, so while his opinion matters, he can’t vote against a fourth hike. In a nutshell, this is further proof that the Fed put is fading and that most Fed member’s individual economic models are pointing to higher inflation going forward. The real question seems to be the pace of rising inflation they expect, not whether it will come about.

This is all with a piece of another big market story, the rise in short term interest rates beyond what the Fed has actually done. This morning, the 2yr-10-yr spread in Treasuries is down to 50bps, it’s flattest since before the financial crisis, and after a two-month respite, seems set to continue flattening. Remember, an inverted yield curve remains one of the most well-known signals of a future recession. In fact, the argument in pundit circles is whether the Fed is about to make a key policy error, raising rates too far or too fast and thus driving the economy into recession. The way I view the issue is that despite the Fed having raised rates six times in this cycle, rates continue to be near historically low levels. If a few more hikes, such that Fed Funds was at 2.25% or 2.50% is sufficient to tip the US into recession then the long term damage that QE inflicted on the economy is even a bigger issue to be addressed. Apparently, a decade without actual price signals is a bad thing! Who’d have thunk it? It is still premature to say that things are going downhill, and after all, Q4 GDP grew by a more than expected 2.9% according to yesterday’s data, but I am very concerned over the timing of the next recession. My first concern is that we are already in the second longest growth period in the post-war years and so are likely coming close to the end. My second concern is that virtually every pundit and economist out there is so sanguine on the subject with forecasts that a recession won’t happen until late 2019 or early 2020. My experience with consensus forecasts is that if everybody agrees something will happen but is confident it will take a long time to occur, it will happen much sooner than expected. As such, my fear is that by the end of this year the picture will be much worse and recession either upon us or imminent.

And what will this do to the dollar? Well, that is a tougher question. My gut tells me that as the synchronized global growth story begins to unravel, as it will if I am correct, then expectations for the ECB and BOJ to halt their QE programs will rapidly diminish, and correspondingly, both the euro and the yen will suffer. In addition, our key trading partners, Mexico and Canada, would almost certainly see their own economies suffer and their currencies alongside them. Of course, the flip side to that argument is that the Fed would need to reverse its policy tightening and so perhaps undermine the appeal of the dollar. Much of this will depend on the exact timing of when it becomes clear that the global economic cycle has turned. However, I fear that the turn is much sooner than currently expected.

As to the overnight session, markets are clearly getting tired from the increased volatility that we have seen around the world, and so movement has been much less impressive heading into the long Easter holiday weekend. In fact, broad-based dollar indices are essentially unchanged, which given that both the euro and the yen are essentially unchanged makes sense. But in truth, looking across all currencies, I think the largest movement I saw was just 0.3%, not nearly enough to need an explanation. We continue to see European data point to the idea that Q4 2017 was the peak in growth there, with last night’s Swiss KOF index falling to 106 and extending its trend lower from last year. UK housing prices were also soft, although German employment remains quite robust. The one thing to remember about employment data though, is it is a lagging indicator and so will be the last thing to fall in the downturn. But on the whole, it has been a dull session.

This morning, however, holds the promise of some activity as we get a series of key data points. Personal Income (exp 0.4%), Personal Spending (0.2%), and Initial Claims (228K) will all pale compared to the PCE (1.7%, 1.5% core) which are the Fed’s key inflation inputs in their models. Any higher print in that series should have an immediate impact on markets, with an increased concern that the Fed will get even more hawkish driving equities lower and the dollar higher. Similarly, a soft number is likely to see equities rally and the dollar fall as relief spreads. Then at 9:45 Chicago PMI is released (62.8) and finally at 10:00 we get Michigan Sentiment (102.0) to finish the data for the week. In the end, I continue to look for the dollar to benefit from the data but do not see any large movement in the near future, especially with the holiday tomorrow and with much of Europe closed on Monday.

Good luck and good weekend
Adf

There once was a long stretch of time
When markets were truly sublime
But six weeks ago
A sudden outflow
Of funds caused a new paradigm

Volatility continues to be the watchword in markets these days, especially in the equity space. The last three sessions have seen a rout, a boom and then another rout with each move pushing 2% or more. This is proof positive, if it wasn’t already obvious, that the days of somnolence and steady gains that we experienced in 2017 are well and truly over. It is actually quite difficult to keep up with all the stories that are whipsawing sentiment as they come fast and furious each day. Trade wars, a renewal of the cold war, increased regulatory scrutiny on the tech sector, higher inflation, softening economic data and political turmoil are just some of the factors that have been blamed for the recent price action. And while I am sure that each one of those factors had some impact at some point in time, I would ultimately point to a single overriding issue that has changed things, the removal of central bank support from markets continues apace.

For nearly ten years the major central banks around the world printed and injected $21 Trillion (with a T) into global markets in their efforts to support economic growth. This was a hyper-Keynesian play that all their models told them would prevent further damage. But this was essentially an enormous experiment in monetary policy with no certain outcome. And while it seems that the central banks may have stopped a sharp decline in economic activity back then, the unintended consequences of their actions are starting to be felt. Now as the Fed leads the way in removing that support, markets are having a difficult time coping with the change. Remember, even though the Fed is reducing its balance sheet, the ECB and BOJ continue to add to theirs, so right now, it seems there as a fragile equilibrium in total central bank balance sheet size. But there is every indication that the latter two are preparing to reduce theirs as well which, as I have written time and again, is part and parcel of the current market narrative and a key rationale behind expectations of a weaker dollar going forward.

But something else occurred during this period as well; we saw a significant increase in computer-led, automated trading including AI processes. And all of those models were built based on the most recent market data, which happened to include the unprecedented stimulus of the world’s central banks. However, it is becoming abundantly clear that this fact was not seen as a variable, rather simply as part of the initial conditions. The upshot is not only do we have an entire generation of traders who have never seen a down market, but we have an entire industry segment of computer trading models that never assumed it was part of the equation. Having been involved in markets for a pretty long time, I can tell you that volatility is the norm, not the exception. And while there may be a specific catalyst to any given move, the underlying market paradigm has very clearly shifted to one where price movement going forward is going to be fast and uncertain rather than last year’s remarkable slow and steady in one direction.

While equity markets get the most press, this phenomenon has been the reality across every market and that means each one is going to seem increasingly unstable compared to what we got used to seeing last year. So be prepared, this is going to be the state of play for quite a while.

Now, with all that said, the overnight session was actually pretty tame. While yesterday’s US equity market rout saw some follow through in Asia, with both Chinese and Japanese markets falling sharply, as well as a significant Treasury rally taking the 10-year yield down to 2.76%, breaking both the bottom of its trading range and the 50-day moving average (a key technical indicator), European markets have been soft but not excessively so, and the FX market has shown a muted response. In fact, surprisingly, the dollar is slightly stronger against most currencies, with the biggest surprises being the yen and Swiss franc, the two best-known havens. In a market like this I would have expected both those currencies to rally, and yet both are lower as I type, with the CHF (-0.4%) actually the weakest of the G10 bloc. As there was no data released in either nation, these moves are clearly not data related but rather seem to be of a piece with the broad dollar trend today.

And what, you may ask, is driving the dollar higher? That is the $64,000 question, but one with no obvious answer. Scanning the broad markets, my sense is one thing supporting the dollar these days is the ongoing rise in short dated US rates, notably LIBOR, which continues to power ahead and has reached its highest point since 2008 at 2.30%. While most analysts continue to highlight the technical reasons driving the rise, the rate has clearly become an attractive carry target. In addition, given the last time that the LIBOR-OIS spread had widened this much the market was in the midst of the Eurozone bond crisis, and this spread has historically been a harbinger of systemic credit concerns, there are clearly some investors who are simply more comfortable in dollars than other currencies. Consider that prior to QE, the dollar was the ultimate safe haven currency. If the central banks are heading back toward that status again, doesn’t it make sense for the dollar to reacquire that mantle of the safest currency around? Once again I will point out that as the paradigm shifts in central banks and monetary policy, the impacts are going to be felt throughout markets in some unexpected ways.

With all that in mind, let’s discuss what to expect today. Yesterday’s data showed us that Housing prices are still rising and consumer confidence may well have peaked. This morning we await the final look at Q4 US GDP (exp 2.7%) along with an advanced Trade report (goods only expected at -$74.0B). Since the former is so backward looking, it would take quite a revision to move markets. However, given the current focus on trade, it is very possible that a larger than expected number in the trade report could have some knock-on effects, especially if we hear commentary from the White House, as it could reignite trade war fears. Yesterday we also heard from the Atlanta Fed’s Rafael Bostic who said he is comfortable with the current rate path at this time although he and his fellow FOMC members were closely watching the data to see if things change. He speaks again today and it would be remarkable if he changed his tune.

Speaking of the Fed, one thing that I believe has already changed under Chair Powell is that the idea the Fed will step in to allay concerns if equity markets tumble, the so-called Fed put, has been significantly devalued in the new Fed. If it still exists, I would at the very least that the strike price has been moved far out of the money. In other words, a stock market decline would need to be so large and so fast that the Fed believes it would destabilize the economy itself, and that is a much higher bar than markets had gotten used to from the previous three Fed Chairs. This, too, is part of the new paradigm. Taking everything into account, my sense is that the dollar will continue to hold onto its modest gains today, but that large movements will need to await further data. Remember, tomorrow we have PCE data released, and any surprise to the high side will simply reinforce the idea that the Fed is not going to be deterred in raising rates. But that is not today’s concern.

Good luck
Adf

On Friday the story was trade
That caused folks to be so dismayed
But Monday’s returns
Allayed those concerns
Thus buyers, no more, are afraid

But what of the data released
From Europe, that showed growth decreased
That story remains
Their ‘conomy’s gains
Are fragile at the very least

Wow! What more can one say regarding the breathtaking rally in the equity markets yesterday, which has essentially extended around the world this morning. Does this mean that all our problems are behind us? I kind of doubt it, but you would never know that from the way things have traded in the past twenty-four hours. Ultimately, my sense is that we are going to continue to see market volatility increase and that it is going to seem worse than it actually is because of the extended period, right up until the end of January 2018, where market volatility had been unnaturally suppressed by central bank actions. Given the human tendency toward recency bias, many investors are watching the past few weeks of more historically normal price volatility and thinking that the world has come unglued. However, volatility is barely back to its long run average and arguably we can see it go much higher. In fact, if central banks actually continue to remove the excess liquidity they have been injecting into markets for the past ten years, it is very likely to do so. In other words, this is the new ‘new’ normal.

But this isn’t a note about equities, rather one about FX, and that story continues to unfold as well. This morning, the dollar has recouped some of yesterday’s losses after Eurozone economic data disappointed yet again. First up was Spanish inflation printing at a softer than expected 1.3% and showing no signs of heading back toward the ECB’s target of “just below 2.0%.” Then came the Eurozone sentiment indicators with Business Confidence falling to 1.34 (exp 1.39) and Economic Sentiment falling more than expected to 112.6 from last month’s 114.2 reading. While it is important to remember that these numbers are still strong historically, the recent trend indicates that the Eurozone economy likely peaked in Q4 2017. If this trend continues it is going to be much more difficult for Signor Draghi to completely kill QE at the end of September. Rather, it is more likely that he will wind up extending it, at a lower rate of perhaps €10 billion or €15 billion per month at least through the end of the year. This will also have the effect of delaying any movement on the interest rate front, maybe even until 2020. My point is that expectations that the ECB is going to tighten policy sooner rather than later seem to be misplaced, and any strength the euro has shown on that basis should be unwound. In fact, this morning we heard from Erkki Liikanen, the Finish representative on the ECB, who explained that ongoing low price pressures mean there is no hurry to tighten policy.

But it’s not just the euro under pressure this morning; the dollar is performing well across the board. The pound is down more than a penny on what largely seems to be a correction to the past two days impressive rally. Given the dearth of news regarding the UK this morning, this is likely to have been driven by a large order, especially as the pound was trading near its highest levels since the Brexit vote in 2016. The market continues to price in a high probability that the BOE is going to raise rates in May, and that has underpinned a great deal of the bullishness on the currency. The thing is, UK data, too, has started to miss the mark. And while the economy has definitely performed far better than had been forecast two years ago in the event of a Brexit vote, the numbers still show slow growth, something on the order of 1.5%, with inflation well above their 2.0% target (most recently at 2.7%). I continue to believe the hawkish case is overstated, but clearly much will depend on how the Brexit negotiations evolve.

As to the rest of the G10, the dollar is pretty consistently firmer on the order of 0.2%-0.3%, which is clearly all about the dollar rather than any currency per se. EMG currencies are also generally under some pressure this morning, although here, too, the movements have not been that large. I have not seen any significant stories other than the news that the US and South Korea have agreed details of a revised trade pact which has helped the won rally about 1.5% in the past two sessions. In LATAM, while MXN is little changed this morning, it has been strutting its stuff all year having rallied nearly 6.0% and is the best performing currency against the dollar this year. As we continue to hear of positive results from the NAFTA talks, it seems clear that the peso will gain further. The biggest risk here is in this summer’s election, where Antonio Manuel Lopez Obrador (better known as AMLO) continues to lead the polls and could well be the next president. The thing is he makes Bernie Sanders seem conservative, and markets are quite fearful of some major shifts in policy if he is elected. But right now, that is not on traders’ collective minds.

This morning brings two minor pieces of data, Case Shiller House Prices (exp 6.2%) and Consumer Confidence (131.0), neither of which seems likely to impact markets. Atlanta Fed President Bostic speaks this morning as well, although based on the complete lack of coverage of the three Fed speakers yesterday; it seems unlikely that he will break new ground in the narrative. In other words, the FX market will continue to look elsewhere for catalysts, with the equity market the most likely driver. Futures there are pointing to further gains as I type, which based on recent correlations are probably a dollar negative. However, this year, given the increase in equity market volatility, I am reluctant to say that a higher opening will lead to a higher close. If anything, yesterday’s rally seemed a bit overdone, and I wouldn’t be surprised to see a modest decline in stocks by the end of the day alongside a little bit more USD strength.

Good luck
Adf

While last week the world almost ended
This morning all things seem just splendid
It seems a trade war
May not be in store
Here’s hoping the rally’s extended!

I guess the world is actually not going to end this morning. I know that if you watched the price action Friday afternoon, it certainly seemed like it was the beginning of the end. Between the imminent trade war with China and the ongoing reputational destruction of US mega cap tech companies, the leaders of the equity market rally, there was no place to hide. Treasuries, which did rally sharply last week on their haven status, find themselves subject to the largest weekly supply surge in history this week, with the Treasury looking to sell $294 billion worth, so it is reasonable to expect some pressure there. And the dollar? Well everybody continues to hate the buck with a vengeance and keeps calling for an imminent collapse. So what’s a risk manager to do?

Well first off, it now appears as if the trade talk was not quite as dangerous as previously thought. This morning’s storyline is that the US and China have been engaged in an active trade dialog behind the scenes covering autos, steel and financial services, and that real headway has been made. In addition, it turns out that the US and South Korea have reached an updated trade agreement covering autos and steel and that the Koreans will not be subject to any steel tariffs. So one of the biggest concerns from Friday has been ameliorated.

Second, and in a related fashion, the background threat of the Chinese stepping away from the US Treasury market as a weapon against the US also seems to have abated. To begin with, that threat has always been oversold in my view, as the Chinese have virtually no alternatives when it comes to investing their reserves. The fact is that US Treasuries are the only market that can handle the flow while simultaneously offering liquidity and safety. Ask yourself this, if they sold their Treasury holdings, ignoring the fact that it would destroy hundreds of billions of dollars of value by simply doing it, where would they put the money they got? No other market is capable of receiving that type of investment without severe distortion. But on top of that, given the new story about the ongoing trade dialog, it seems clear that there will be no perceived need for the Chinese to do so. As such, I think we can expect that they will continue to participate in US Treasury auctions and that the bond market is not going to collapse. That said, I still do believe that Treasury yields rise throughout the year, just not that rapidly.

In fact, of the big concerns last week, the only one that has not seemingly been addressed is the tech stock story, with news this morning that Europe is now seeking to break up Google hitting the tape. This story, which is truthfully outside the purview of this note, probably still has legs, and in many ways is likely more impactful on equity markets, and by extension the global market situation. The one thing I will say is that from all that I have read, it has become abundantly clear that there are going to be changes forced on this sector through either legislation or regulation, and that the business models are going to be forced to change to the detriment of shareholders.

With all this in mind, let’s now look at the dollar. This morning, the trade has been one-way, with the dollar under pressure against both G10 and EMG currencies. It seems that the underlying FX narrative, that the Fed will behave less hawkishly than their own rhetoric while the ECB and BOJ will be more hawkish continues to drive the debate. There is also a growing expectation that central bank reserve managers, who have been increasing their share of USD reserves over the past several years, may start to reverse that trend. Historically, the dollar has represented between 60%-64% of international reserves with the euro next at between 20%-24%, and then a smattering of other currencies like the yen, pound, Canadian and Australian dollars, and ever since the renminbi was named part of the SDR, a small portion of renminbis. However, based on the idea that the global trade situation is going to change given the potential for increased tariffs and quotas, it seems the idea is that other nations won’t need as many dollars to manage their affairs. At least that was clearly the thought before the news that the imminent US-Chinese trade war may not actually be imminent. Certainly, as reserve managers adjust their ratios it impacts the FX markets. But history has shown that those adjustments tend to come after large movements in the dollar have already taken place, they don’t precede them. And while the dollar did fall between 8%-10% last year, that simply doesn’t qualify as a large move historically. In addition, that comes after the dollar had rallied more than 25% in the prior two years, so I would contend that reserve managers are not quite ready to act. However, the story is getting play.

As to the movers overnight, there was very little data released to drive things. In the G10, the pound has been the best performer, rising 0.7%, after news that the Labour Party has tabled a bill that would seek to prevent a hard Brexit in the event an agreement isn’t reached on time. What I find interesting about that is the idea that if the UK and EU fail to agree on a timely basis, who’s to say the EU will be willing to extend the interim package, regardless of whether the UK is willing. But the market saw this as a positive. However, we have seen strength in the euro as well, and Aussie has performed well on the abatement of trade tensions. Interestingly, the yen is virtually unchanged this morning.

In the EMG bloc, it should be no surprise that CNY is stronger, up 0.65%, on the lessened trade tensions. But also we have seen RUB rally 0.5% on continued strength in the oil price and ZAR rally after Moody’s left their Baa3 rating intact and moved them up to a stable outlook. This prevents many international bond funds from being forced to liquidate their positions and has relieved some pressure on the currency. Overall, the APAC and EEMEA blocs have performed quite well, with the reduced trade tensions the obvious catalyst.

Data this week is limited but important and as follows:

My take is all eyes will be on the PCE data given the Fed continues to focus on that. With the FOMC meeting out of the way, we also get a decent number of Fed speakers starting with Mester, Quarles and Dudley today, then Bostic tomorrow and Wednesday and finally Harker on Thursday. Given the fact that the important data this week doesn’t appear until Thursday, it seems unlikely that any of these speakers will be giving us new information. Rather they are far more likely to discuss how their view fits with the prevailing Fed narrative.

In the end, it feels like the dollar will have a hard time making much headway this week, unless there is a more definitive outcome on trade, one which satisfies all parties. My sense on that is it will take a bit longer to come about, so look for the dollar to remain under pressure.

Good luck
Adf