The dollar continues to reel
As traders collectively feel
That central bank timing
On interest rates climbing
Outside the US has appeal

Once again the dollar is under pressure as yesterday’s comments by Treasury Secretary Mnuchin continue to be main source of market discussion and questions arise as to whether the US is going to start using the dollar’s value as another policy tool. Given the efforts by the Administration to walk back the importance of Mnuchin’s comments and reiterate that they believe in a market-determined value for the dollar, I doubt that is the case. However, traders will be very alert to any further commentary regarding the dollar. Remember, President Trump has been very focused on the US trade imbalance and has mentioned the benefits of a weak dollar in that context. The funny thing is, the dollar has been falling for upwards of a year now without any Administration commentary, and so it seems unlikely that it is a focus for the US government. In fact, the story continues to be that although the Fed has been tightening policy for more than a year and is set to continue to do so, the big change has been the idea that other nations are starting to catch up and are beginning their own journey toward tighter monetary policy. In this reading, the FX market is simply anticipating the eventual higher rates we will be seeing from both Europe and Japan and buying those currencies now.

We have the potential to learn more about how this will play out in a short while as the ECB meeting concludes. While there is no expectation for any policy changes, thus the deposit rate will remain at -0.4% and the Asset Purchase Program will continue at €30 billion per month through September, all eyes will be on the language in the statement released and then even more keenly focused on Signor Draghi at the press conference following the meeting to see if he comes clean about what discussions are actually taking place. Some believe that the statement will remove the possibility that QE will be extended beyond the September date, which would be seen as another bullish euro cue. However, one thing to keep in mind is the old adage; buy the rumor, sell the news. It is entirely possible, if not likely, that the euro’s recent run-up already reflects this expectation and that if the statement is indeed changed, traders will take profits and drive the euro lower. Remember, that prior to the BOJ meeting earlier this week, expectations were growing for a change in the statement there as well, and although there were some subtle ones, clearly they did not satisfy the trading community who have only grown more anxious to see the beginning of the end of QE in Japan. As such, the rumor is still the driver with no news yet released.

I read an interesting take on markets yesterday that I think is worth sharing. This may get a bit arcane so bear with me. The idea is that the 30-year swap spread may be a harbinger of future market and economic activity and the fact that it is rapidly moving back toward positive territory is important. To begin with, the 30-year swap spread is the interest rate differential to exchange the payments between a fixed rate payment in a simple interest rate swap and a Treasury bond with the same maturity. The idea is that since there is no credit risk to hold Treasuries, one would need to receive a higher rate to accept the credit risk associated with a swap counterparty, which is typically a large bank. However, since the financial crisis, these spreads have been negative, meaning that accepting the credit risk of the bank resulted in a lower interest rate than owning Treasury bonds. On the surface, that doesn’t make much sense, but it was a reaction to the changes that occurred due to the crisis. As Kevin Muir, a well regarded trader and pundit explains, “Swap spreads dove because the supply of bank balance sheet was dramatically curtailed. Basically, banks, faced with more regulations and increased capital requirements, withdrew their participation in the swap market. The demand for swaps fell but not as quickly as the supply. The end result was that this mismatch of demand-supply meant that the previously unthinkable occurred, and swap spreads went negative. What would have usually been arbitraged away by proprietary trading desks at banks and other financial institutions was left to persist for years.”

So it is key to understand that this is a historically unusual situation, although it has been with us for the past nine years. It is important because it was an indication of how banks were managing their total balance sheets, meaning that they were husbanding capital and private credit was tight despite the fact that interest rates were low. The lack of private credit creation (aka bank loans) has been one of the features (bugs?) of the recovery from the financial crisis and has also been directly related to the decline in the velocity of money. That combination has arguably been behind the lack of measured inflation despite QE; the slow pace of economic growth; and the previous strength of the dollar. Well the reason I bring it up is because those spreads are racing back toward positive, which implies that private credit creation is making a comeback. Alongside that process we are likely to see inflation move higher as the supply of dollars that the Fed has created start to move around. The other likely outcome is that interest rates are going to go higher. Not only will this activity keep the Fed in active tightening mode, but the growth in demand for credit will push rates higher.

What does this have to do with the dollar? Well, there are two potential dollar drivers here. First, as the velocity of money increases, it will effectively create a significant increase in supply of dollars and therefore likely put further downward pressure on the buck. But at the same time, as interest rates rise, the appeal of the dollar for investors will increase. Currently the market is pricing in less Fed tightening than the Fed itself has penciled in. The narrative continues to be that quiescent inflation will prevent the Fed from having to raise rates aggressively. However, I would argue that inflation will not remain quiescent, that the Fed will find itself behind the curve before very long and they be forced to be more aggressive than they have currently planned, let alone what the market is pricing. Ultimately, if (when) the Fed becomes more aggressive tightening policy this year, look for the dollar to rebound.

As to today, aside from the ECB press conference, we see Initial Claims (exp 240K) and New Home Sales (680K), neither of which is likely to move markets. Meanwhile, the ECB statement was unchanged, so no hints about the future purchase plan that some had hoped for. However, the euro was little changed in the aftermath as all eyes are on Draghi at 8:30. My sense is that for now, the dollar will remain under pressure, with tomorrow’s GDP data, or more likely Monday’s PCE data the next chance for the narrative to come under pressure.

Good luck
Adf

In Davos, Mnuchin explained
A weak dollar wasn’t harebrained
It helps to upgrade
Both exports and trade
Thus for the US much is gained

The dollar is on the outs this morning with one key story the driver. Treasury Secretary Steve Mnuchin has basically moved away from the strong dollar mantra that had been official US policy for at least two decades by telling reporters the following, “Obviously a weaker dollar is good for us as it relates to trade and opportunities, but again, I think longer term the strength of the dollar is a reflection of the strength of the US economy and the fact that it is and will continue to be the primary currency in terms of the reserve currency.” Given the evolution of policies around the world lately, and the fact that President Trump has been consistent in his mercantilist philosophy of trade, the only surprise is the clarity with which he stated his case. After all, almost every major country seems to be seeking to weaken their currency in order to help their own trade situation, and these days as a way to import some inflation. However, comments have usually been about ‘excessive strength’ in a currency needing to be addressed, rather than a specific endorsement for a weaker currency. It appears ‘Beggar Thy Neighbor’ policies are coming back into the light.

This clearly changes a great deal in terms of short and medium term expectations, but do not be surprised if we see an increase in rhetoric about the strength of other currencies by other central banks and governments in the near future. However, for now, the dollar certainly has room to decline further after having made new three-year lows this morning.

In fairness, there was some pretty good data elsewhere as well, which helped underpin other currencies. For example, UK employment data showed a much larger than expected increase in the 3M/3M jobs numbers (exp -12K, actual +102K) and an uptick in average weekly earnings. The upshot is the pound has traded back to 1.4100, its highest point since the day before the Brexit vote in June 2016. While I continue to believe the BOE will be very reluctant to raise rates before the end of the Brexit process when the UK leaves the EU, my view is clearly in the minority with the market pricing in a 77% probability of another 25bp hike before the end of this year.

Turning to the Eurozone, PMI data was released showing modest underperformance in manufacturing but strength in services and in the composite numbers. In fact, we are looking at the strongest composite data here since the immediate aftermath of the financial crisis and ensuing recession, when the global economy was rebounding from a very low base. But for sustained growth, this is the best data for more than a decade. This has merely served to further support for the idea that the ECB is going to be ending QE this year. All eyes are turned to the ECB meeting tomorrow, although it would be quite surprising if Signor Draghi succumbed to the growing pressure to describe changes so soon. All told, however, the euro has rallied to its strongest point in more than three years and the trend remains for further strength.

Meanwhile, USDJPY has traded back below 110 for the first time since September despite Japanese trade data showing a less than expected increase to $3.2B in December. Given the importance of trade to the Japanese economy, currency strength is a much more critical issue, but also given the current US stance on its own trade deficits, I expect the Japanese will be loathe to raise too big a fuss.

The rest of the G10 has also benefitted, as have commodity prices and EMG currencies. In fact, there is nary a currency out there that has weakened vs. the dollar this morning. Ultimately, the question becomes how long can this go on in the face of increasingly tighter US monetary policy. As I have written before, it is clear the FX market believes that other central banks will be more aggressive than current interest rate futures are pricing while the Fed will be less aggressive. Despite the fact that US Treasury yields continue to edge higher, it has not been enough to stop the dollar’s decline. And at this point, it remains to be seen if anything will be able to do that. The next important data points in the US are Q4 GDP on Friday and then the PCE data on Monday, both leading into next Wednesday’s FOMC meeting. Remember, the Fed is entirely focused on Core PCE, which last printed at 1.5% and is forecast to tick up to 1.6%. If that data point is firmer than expected (something which I believe is quite possible) then it may serve to slow the dollar’s decline while pushing US rates higher. However, if it is benign, or softer than expected, look for the pressure on the dollar to continue.

This morning brings only Existing Home Sales data (exp 5.70M), which seems highly unlikely to impact the FX markets. There are no Fed speakers due, but beware of further comments from Davos, where Mnuchin will find himself with more microphones in front of him. Remember, too, President Trump will be speaking there on Friday and there can be no doubt he will discuss trade, and if the currency is mentioned, it will be in a weaker light. So for now, the dollar will remain under pressure with its only hope a Fed that feels forced to respond to faster than expected inflation. But until we see that type of inflation data, the dollar is unlikely to find much support.

Good luck
Adf

It’s not surprising
The BOJ did nothing
At least, not this time

And though Kuroda
Claimed policy won’t soon change
Traders disagreed

The BOJ meeting last night resulted in no policy changes, as universally expected, but the press conference that followed found Kuroda-san disagreeing with the current market narrative. As a reminder, that narrative has the BOJ soon getting set to slow down their QE program and begin to follow the Fed toward somewhat tighter monetary policy. However, Kuroda was quite clear that he saw no reason to change things now as per the following comment,
“Given there is still a distance to the
achievement of the 2 percent price
stability target, I don’t think that we are
at a stage where we consider the timing
for a so-called exit or how to deal with
it. The Bank of Japan thinks it’s necessary
to continue tenaciously with the current powerful easing for the sake of the economy.” [My emphasis] And yet, despite a session where the dollar is broadly higher, the yen has rallied by nearly 0.5%. You would almost think that FX traders don’t believe what Kuroda-san is saying.

Certainly, inflation in Japan remains far below target. The BOJ’s bellwether is CPI ex fresh food and energy, which is currently running at 0.3%, an awfully long way from their 2.0% price target. It is hard to believe that the BOJ would tighten policy until that reading is at least 1.0% or arguably even higher than that. After all, how could they justify tighter policy if inflation is still essentially zero? Kuroda did address the reduction in JGB buying though, pointing out that they are trying to manage the yield on 10-year JGB’s, not buy a certain amount of them. And given that they own nearly half the outstanding paper, it can be no surprise that they now need to buy less to have a given level of control. As a price check, 10-year JGB’s yield just 0.068%, well within their control band. Clearly, buying less has not diminished their ability to achieve that end. When will their policy actually change? My gut tells me they are in no hurry to slow down QE and that the market is well ahead of itself in this regard. It could easily be another four or five years before the BOJ actually raises rates, although the current narrative clearly disagrees. Ironically, given how critical trade is to the Japanese economy, any yen strength is quickly passed on to the inflation data, driving it still lower and delaying the tightening further. At some point, it will become clear to the market that the BOJ is not going to adjust anything anytime soon, but for now, traders continue to have visions of USDJPY trading at par. Maybe not today, but sometime soon.

Looking elsewhere for inspiration, the pickings are sparse. The only data from Europe was the German ZEW data, which printed slightly better than expected, but not enough to change any opinions. And in truth, otherwise there has been little of note in the G10. Perhaps I can give a shout out to Sweden, where home prices have started to fall a bit more sharply, down 10% in the past quarter. While I don’t expect a global crisis on the back of this story, it may well be a harbinger of other bubbles getting set to burst. And given that virtually every asset is in a bubble state, that could be more concerning. But not yet.

In the EMG space, Mexico wears today’s crown for the largest decline, falling 0.8% on the back of the tariffs the US has imposed on solar panels and washing machines. This move, which the President promised, is seen as yet another blow to global trade, and in Mexico’s case, likely added further concern over the NAFTA situation. It certainly doesn’t bode well for NAFTA if the US is willing to impose tariffs on goods that come from Mexico. The point is, if the US does go down the road of more trade restrictions, and NAFTA should crumble, the peso will have much further to decline. In fact, a quick trip back to 20.00 and beyond is easily viable. Otherwise, nipping at the peso’s heels in the race for biggest decliner, ZAR has fallen a similar amount as concerns have arisen about the timing of President Zuma’s departure. Recall, the recent rally has been predicated on Ramaphosa starting soon. Any delay will inevitably be felt by the currency.

But the dollar is broadly higher this morning against the entire space, with those two currencies merely the laggards. I guess it is possible that the dollar has responded to the end of the US government shut-down, but it wasn’t clear to me that its decline was caused by the shut-down, so that seems a little strange. Of course, the equity market rallied on the news that the shut-down ended despite not falling over the threat of imposition of the shut-down, so I guess it is possible. As I have often said, markets are perverse.

Looking ahead to today’s session, there are no obvious catalysts on the horizon to drive movement. There is no data of note and no Fedspeak until Chicago’s Evans makes some remarks this evening. Commodity prices are mixed, with energy slightly higher but metals and ags a touch softer, so no real clear signal there. Equity prices, as seemingly always, are higher with US futures pointing in that direction as well, and Treasuries are little changed, with the 10-year hanging around just above that breakout level of 2.627%. In other words, it has all the markings of a quiet session at this time.

Good luck
Adf

With government here being shuttered
The question that’s lately been muttered
Is will the impact
Leave growth here intact?
Or will the shutdown soon have sputtered?

As we begin a new week, political events are dominating the market. Of course, Friday’s US government shutdown is the big, ongoing news story and one which doesn’t seem set to end quite yet. The most disheartening thing that I read was that every week the government is closed results in a reduction in US GDP of between 0.1% and 0.2% for that quarter. It is disheartening to me because it demonstrates just how large the Federal government has become, a situation that is fraught with economic risks going forward, for example, when it ceases to work like now. Interestingly, the equity market certainly didn’t concern itself with the issue, continuing its rally on Friday, although this morning’s futures markets are essentially unchanged. Treasury bond prices have, however, continued their recent decline and the yield on the 10-year note has now firmly traded through the 2.627% level that was seen as a key point. I continue to look for Treasury yields to climb and expect 3.0% in the near future. The dollar, on the other hand, seems to be the one thing that has suffered from the shutdown, having fallen against all its G10 and most of its EMG counterparts in the session today. However, it remains to be seen if this is specifically due to the shutdown or if there are other issues involved.

The other political story with some traction is from Germany, where the center-left SPD has voted to enter negotiations with Chancellor Merkel’s center-right CDU/CDS to once again form a grand coalition government. This is the pairing that had been in charge prior to the election, and despite the fact that both parties lost a significant number of votes to more extreme voices, I will wager they will come to some agreement. The aphrodisiac of power is far too strong for those who have tasted it to concede it willingly! Arguably, this has helped underpin the euro to some extent this morning as any reduction in uncertainty over the leadership in Germany, and by extension the entire Eurozone, will be seen as a positive.

In fairness, there is one other political story that has had a direct impact on the relevant currency, and that has been in South Africa. It seems that President Jacob Zuma is closer to being removed from office by his ANC party and likely to be replaced by Deputy President, Cyril Ramaphosa, a successful businessman there. Given the problems within the economy there as well as the recent attempts by Zuma to change rules in order to entrench his own status as president, the idea that he will be removed shortly has been warmly greeted by the market. This morning, the rand has rallied a further 1.25%, taking the appreciation since the middle of November, when Ramaphosa was first mooted to take over, to more than 17.5%.

On a different tack, I want to highlight something that I have observed during the first few weeks of 2018. It seems that almost everyone with a forecast has said that while a recession is clearly going to occur at some point, and an equity market correction along with it, 2018 will not be the year for this to occur. The combination of growth momentum and the recently passed tax legislation will serve to insure yet another year of banner results. My concern is that markets are funny things, often perverse in their behavior relative to broad expectations. In this context, that implies to me that with virtually every expectation that the ‘overdue’ recession/correction is not coming this year, I fear that is exactly what will happen. Markets have a habit of reacting far more quickly than economists, so my antennae are definitely tingling.

Away from the politics, and into a week with relatively limited economic data (which may be delayed due to the shutdown), we do have two key central bank meetings. Tonight the BOJ meets although expectations are for no policy adjustments. Of course, we just saw a subtle change in their JGB buying last week, which had a significant impact on markets. Given inflation in Japan remains well below the 2.0% target, it seems highly unlikely they will do anything here. But market chatter continues to focus on a growing concern by some BOJ members that QE is beginning to have negative consequences on the economy leading to excess leverage and potential future problems.

Then on Thursday the ECB meets and there the situation is more nuanced. While there is no expectation for any actual policy changes, the question of how forward guidance will evolve has come to the fore recently. This is due to the fact that at the December press conference, when asked about discussions on QE changes, Signor Draghi emphatically explained that there were no discussions on the topic. However, the recently released Minutes showed that there were, in fact, numerous discussions on the topic. So you can be sure that the press conference on Thursday will be quite spirited. The one thing that is clear is that the hawks on the ECB remain in the ascendancy, and that will continue to help underpin the euro. Remember, my stronger dollar thesis remains based on the idea that the Fed will be forced to tighten policy more aggressively as inflation in the US accelerates, while the ECB will wind up doing a bit less as inflation there continues to lag. But right now, the narrative remains the other way round and the euro continues to rise accordingly.

Here is a quick look at the planned releases for this week:

So the key data is due Friday, but if the government shutdown persists, it may well be delayed. My take is that is indeed what will occur, and therefore markets will be focused on the non-US stories, most notably the ECB on Thursday. For now, the dollar remains under pressure and I don’t see a catalyst to change that on the horizon.

Good luck
Adf

The government in the US
Has lately been under some stress
Considering backing
For funding is lacking
This could turn into quite a mess

While I don’t necessarily agree that it is a crucial issue for the FX market, the fact that there is a threat of another government shutdown in the US has certainly been the most discussed topic in the press this morning. But I question whether the trading community is in accord. Ostensibly, the dollar’s recent weakness can be partially attributed to the fact that there is a broad loss of confidence in the US due to the current administration’s combination of policies and internal discord, and so investors are seeking other homes for their funds. But that doesn’t make sense to me given that the US economy continues to lead the G10 in the economic cycle, has shown no sign of slowing down yet, and has had continued substantive gains in its equity markets. Those are hardly reasons to shun a market. Rather, I believe the dollar’s recent weakness is a product of the ongoing narrative that the recent uptick in growth elsewhere in the world is going to cause other G10 central banks to tighten policy more quickly than the Fed on a relative basis. Or perhaps more accurately, FX traders are betting that the Fed will tighten less than current market pricing anticipates while the ECB, BOJ and other G10 central banks will tighten more. That would certainly explain the dollar’s weakness, but I think it is a mistake. If anything, I believe that the exact opposite will be the outcome in 2018 and that the dollar will be higher when all is said and done. We shall see.

But weaker the dollar is this morning, albeit not dramatically so. In the G10, the yen has been the best performer, rising a further 0.3% as the discussion in Tokyo continues to be about the timing of any change in policy there. There seems to be a growing belief that Kuroda-san will begin hinting at the end of QE in next week’s meeting despite the fact that inflation in Japan remains at 0.9%, well below the target of 2.0%. This is especially troubling because services inflation is running at just 0.1% and wage pressures have not yet made themselves felt. So though oil prices are higher and goods prices are beginning to rise, based on current central bank groupthink, it is not yet time to get aggressive. In fact, we could be having virtually the identical discussion about the ECB here, where the market has become quite keen on the idea that the end of QE is nigh, or at the very least the announcement of that timing is at hand despite the fact that the inflation story in the Eurozone remains equally stagnant. My money is on both Kuroda and Draghi to remain dovish in their statements next week.

One interesting thing about the yen this morning is the fact that it is stronger despite the fact that the UST-JGB spread has expanded to its widest level since 2010, and is more than 250bps. This is due to the fact that the 10-year Treasury continues to climb in yield. Historically, a yield spread of this magnitude has been a signal for Japanese investors to switch into Treasuries from JGB’s and the dollar has been the beneficiary. But thus far, we have not seen that play out.

The one other newsworthy item from the G10 was the weaker than expected December Retail Sales print from the UK (exp -1.0%, actual -1.6%) which has weighed on the pound helping it to fall 0.2% despite broad-based USD weakness.

In the EMG space, alongside Japanese strength we have seen the rest of APAC outperforming the greenback today with much of the space up nearly 0.5%. It has become increasingly clear that investors are quite enamored of APAC again. This is evidenced by the equity market performance there (Nikkei, Hang Seng and Shanghai indices are all up more than 7% so far this year) and the ongoing search for yield which leads many to these countries where yields dwarf G10 yields. While this story is in full swing currently, I wonder how well things will hold up as US policy tightens further. If you recall, I highlighted the 10-year Treasury yield of 2.627% as a key technical point for traders. That was the highest yield we saw back in March during the reflation trade craze. Well, this morning, we are higher, breeching 2.63% and, in my view, set to head toward 3.00% in the near term. As the US Treasury market sells off and yields rise, look for many of the current assumptions underlying asset prices to be called into question. As to the rest of the EMG space, interestingly, despite strength in the euro, EEMEA is actually under pressure today. TRY is the worst performer, down 0.75%, on the back of discussions of Syrian attacks by Turkish forces and an increase in chaos in the region. Meanwhile ZAR is lower by 0.5% in what seems like some profit-taking after an extended run of strength. The CE4 are all slightly softer, although there don’t seem to be any significant news items there.

While yesterday’s housing data showed Starts falling in a surprise and Permits holding up, the only data point this morning is Michigan Sentiment (exp 97.0). We will hear from Atlanta’s Raphael Bostic shortly, although it would be shocking to hear anything new at this time. While the Fed doesn’t meet until the 31st, next week brings both the BOJ and ECB meetings, which will be watched closely for any hints of tighter policy. Essentially, the market is pricing in movement in that direction, but I don’t believe we will see it. As for today, if the 10-year yield continues to climb, and I believe it will, I think the dollar will find its footing. Look for a modest USD rebound into the weekend.

Good luck and good weekend
Adf

From China, the print on the screen
Showed GDP growth unforeseen
But how much is real?
And how much the zeal
Of regions where lying’s routine?

The dollar has retreated almost universally this morning after a pretty solid two-day run. Despite very strong US data yesterday (IP +0.9%, exp +0.5%; Capacity Utilization 77.9%, exp 77.4%) and continued positive results from the Fed’s Beige Book, traders have turned their focus elsewhere. In fact, yesterday’s themes have been largely forgotten. With all the discussion about whether or not we had seen the top in equity markets, it felt as though broad sentiment was beginning to change. But that was so yesterday! The powerful rally on Wall Street has been repeated in Asia and Europe and Tuesday’s late day hiccup largely forgotten.

With that in mind, the story with the most traction today is China, where last night they reported 2017 full-year GDP growth at a better than expected 6.9%. This comes despite the ongoing admissions by different regions within China that they have been overstating their growth rates for the past several years in order to meet central government quotas. This also comes despite the fact that some of the underlying data, notably Retail Sales, IP and Fixed Asset Investments are clearly trending lower. There is a large group of market watchers and investors, myself amongst them, which have maintained a certain level of skepticism about Chinese data. After all, given the draconian methods that the Chinese government has historically used with regard to punishment for any crimes, what regional administrator is going to willingly say that he has not achieved the government’s goals? But, it is the only data we have, and given what has very clearly become a global upswing, it shouldn’t be a huge surprise that China is growing rapidly as well. The renminbi has responded by extending its recent rally, rising 0.2% overnight, which makes a total of 1.3% in the past week. In fact, we are pushing to levels not seen since December 2015. I have to admit, that the momentum in this market certainly points to further CNY strength although I am not convinced it remains intact.

Pivoting to the G10 space, CHF is the leading gainer today, up 0.7%, although the euro has gained a solid 0.5% and is making an effort to regain its early morning highs from yesterday. And all this is occurring despite the fact that 10-year yields in the US are back above 2.60%. If you recall, one of the background stories has been the recent rise in 10-year yields here on the back of ongoing economic strength. Market technicians are focused on a yield of 2.627%, the highest level achieved last March amid the then popular reflation narrative. If yields trade above there, which could well happen today with another burst of strong US data, expectations are that we may see a fairly sharp continuation rally in those yields. That would have an interesting impact on the prevailing narrative as it would help reduce the chance of a yield curve inversion, point to a market that is expecting accelerating US growth and allow the Fed more room to tighten policy more aggressively. As I have written consistently, the Fed’s actions relative to expectations are the real market driver, and I continue to look for tighter than expected policy. Corroborating my thesis were comments from two Fed Presidents yesterday, Cleveland’s Loretta Mester and Dallas’ Richard Kaplan, both highlighting concerns that growth would outpace current forecasts and that Unemployment could well fall much lower leading to higher inflation. In other words, they are both ready to hike rates to keep ahead of the inflation curve. At the same time, Charles Evans, President of the Chicago Fed and one of the more dovish members on the FOMC, called for less policy tightening in 2018 than currently penciled in by the FOMC itself.

(Perhaps the most enjoyable story on Bloomberg this morning was the one discussing how certain cities in the west are experiencing much higher inflation than the nation as a whole, with Seattle, San Francisco and Los Angeles all sporting local inflation rates above 3.0%. This has been a theme I have discussed repeatedly in the past year. Knowing that Chair Yellen will be returning to her home in San Francisco, perhaps she will be confronted with the fact that her national data may not be indicative of much of the nation’s reality. At the very least, she will know what the rest of us are living with!)

However, this is a conundrum for me. If US yields break out higher, I think the impact on the dollar will be quite positive. And so it is surprising to me that the dollar remains under pressure as we approach levels in the Treasury market that may define that breakout. Consider, too, that the Bank of Canada raised rates 25bps yesterday, as widely expected, but highlighting the turn in broad central bank policies. In the end, my thesis remains that the Fed is more aggressive than currently expected by markets, and that the dollar benefits accordingly.

This morning brings us new data including Initial Claims (exp 249K); Philly Fed (25.0); Housing Starts (1275K); and Building Permits (1295K). Further strength in this data set, especially the housing data, should continue to lay the groundwork for a more aggressive Fed. It’s funny, when there is a discussion of equity markets, a common theme is ‘don’t fight the Fed’. But in the FX markets, I would argue that is exactly what we have seen for the past year. I still like the dollar higher over time, but unless today’s data is extraordinary, we probably have a little more weakness in the immediate future.

Good luck
Adf

There once was a market in thrall
To central banks who overall
Had fueled the craze
For three thousand days
Preventing an equity fall

But recently views have matured
With traders somewhat less assured
The future will be
So calm and risk-free
Especially those unsecured

For the second day running, the dollar is broadly higher, although the movement has not been sufficient to come close to unwinding its early weakness this year. But what is more interesting to me is the fact that so many stories that I have been reading are focused on the idea that we may have seen a top, even a temporary one, to recent market moves.

Certainly, it would be fair to characterize some aspects of market behavior as mania-like (maniacal?), naturally starting with the cryptocurrency sphere, but also with the idea that changing the name of a company to include ‘blockchain’ is worth a 100% or 500% gain in the value of that company. The fact that stories continue to be told of people who gave up their day jobs to become Bitcoin traders or short volatility traders certainly reminds me of the run-up to the tech bubble, where equity day trading played a similar role. Or perhaps, of more recent vintage, was the house-flipping we saw in the run-up to the financial crisis nearly ten years ago, the very situation that started the new party on the back of central bank extraordinary monetary policy.

Most of you know that I have been somewhat skeptical that the extraordinary gains we have seen across markets will continue, recognizing that they cannot go on forever. And I have repeatedly said there doesn’t actually need to be a definitive catalyst to change views. Markets can be quite perverse, and there will be no announcement that the top has been achieved. But one thing of which I am pretty sure is that the more stories written about this particular subject, the more likely it will be a self-fulfilling prophecy. For the newer market entrant, the combination of an increase in warnings and the lack of new gains in your portfolio could easily be sufficient to cause a change of heart. Although, history shows that they will wait until they are much further under water before acting. At the very least, the idea of a more significant correction getting underway is quite viable, so be nimble.

But back to the FX market. Certainly part and parcel of the narrative of late has been the dollar’s weakness, which last year added up to a nearly 11% decline vs. its major counterparts. Almost every analyst call for 2018 has been for a continuation of that move, with some calling for another 15%-20%. I strongly disagree with that idea, and wouldn’t be surprised if we have already put in the bottom for the dollar this year. From a historic perspective, there have been numerous years (e.g. 2015) where the previous year’s trend reversed early on amid expectations of a continuation. And as I look at the fundamentals, notably monetary policy issues, I continue to see the Fed as the most likely to be more aggressive than expected and the dollar to benefit accordingly.

Early this morning the Eurozone data reconfirmed that there is no inflationary impulse yet on the Continent as the core CPI remained at 0.9%. Simultaneously, we got our first ‘dovish’ commentary from an ECB member in what seems like a year, when Vitor Constancio basically called into question the euro’s recent strength saying, “I am concerned about sudden movements which don’t reflect changes in the fundamentals. Looking at fundamentals, inflation declined slightly in December.” Of course, the market trades on the narrative, which anticipates the future fundamentals, but as I have said repeatedly, it would be very surprising if Signor Draghi turned hawkish at next week’s ECB meeting. Meanwhile, Dallas Fed President, Robert Kaplan, was out talking about the probability that we could see more than the three Fed hikes currently forecast for this year. Certainly that combination is worth a little dollar strength!

The point is, for the first two weeks of the year, we have seen an acceleration in the trends that held for last year, with equities exploding higher and the dollar falling broadly. If nothing else, my sense is things are overdone in the short run and that a correction, long overdue, may be coming soon. For all of you receivables hedgers, these are the best levels we have seen in three years and I would be keen to take advantage.

On the data front, IP (exp 0.5%) and Capacity Utilization (77.4%) are released this morning and then the Fed’s Beige Book comes out at 2:00pm. There has been nothing to suggest that the US economy is slowing down and I expect this data to reconfirm the recent trend. We also will hear more from Kaplan as well as Charles Evans and Loretta Mester, so watch the tape this afternoon. But from that crew, I expect a more hawkish bent, which means the dollar should behave well. While equity futures are pointing higher, that was yesterday’s story as well, right up until they tanked. All I’m saying is that change is coming, and it feels like we are beginning to see it more clearly.

Good luck
Adf

Two weeks of the year have now passed
With dollar bulls feeling downcast
The ECB hinted
The euros they’ve minted
Could be withdrawn awful darn fast!

While the dollar is a tad stronger this morning compared to Monday’s abbreviated trading, it remains well below the levels seen on Friday. In fact, year-to-date, the dollar has ceded almost 2.0% vs. its major counterparts. The FX narrative that is dominant right now goes as follows: the ECB, BOJ, BOE, etc. will begin to more aggressively reduce their QE policies amid increasing growth while the Fed has already executed the bulk of its policy adjustment. This was highlighted yesterday when Estonian ECB member, Ardo Hansson, said the following in an interview with the German newspaper, Boersen-Zeitung: “There are certainly good reasons to reduce the importance of the net
purchases in our communication soon — also with a view to a potential end to
these purchases. If growth and inflation continue to evolve broadly in line with the ECB’s latest projection, it would certainly be conceivable and also appropriate to end the purchases after September,” he said.
“The last step to zero is not a big deal anymore, you do not have to do a lot of fine-tuning. I think we can go to zero in one step without any problems.”

In other words, the ECB’s hawks are ready to roll immediately, but are willing to wait until March before announcing such. He even touched on the issue of the likely rise in the euro given such comments and said that an appreciating euro “is not a threat to the inflation outlook” and shouldn’t be overdramatized. So there you have it, another dyed in the wool ECB hawk out on the tape. It should be no surprise that the euro jumped after the release of these comments, and rightfully so. Basically, he is arguing for an immediate end to QE with no further transition past the current September date. We shall learn more next Thursday when the next council meeting is held, but I expect that Signor Draghi is unlikely to tip his hand. In fact, if anything, given how much press the hawks have received of late, I wouldn’t be surprised to hear him sing a particularly dovish tune in an effort to offset the other comments. Of course, before we hear from the ECB next week, we will see the latest Eurozone CPI numbers, released tomorrow and expected to show a reading of 1.4% with a core print of 0.9%. Let me just say that those are not numbers that will inspire a quickening in the pace of tightening by the ECB.

Away from the euro, we saw UK inflation data this morning and it printed a touch softer than anticipated, 3.0% and 2.5% core. Governor Carney will be thrilled he doesn’t have to write another letter to the Chancellor, and given the lagging increase in wages, it is good news for the UK population on the whole. But does it really signal a potential change in policy? If anything, the news that the EU continues to play hardball with the UK over Brexit terms strikes me as a further detriment to the currency. It remains difficult for me to foresee any interest rate adjustments by the BOE until the Brexit deadline has passed, while during that period, I could easily see the Fed raise rates five or six more times. The pound has no business above 1.37 in my view.

The other big mover over the past weekend has been the Chinese renminbi, which has rallied 0.8% since Friday and nearly 1.5% in the past week. I put very little credence in the idea that the Chinese comments about US Treasury bonds were meant as a threat of some sort as the reality is they have literally no other choices to maintain their reserves. Certainly they could diversify some portion of their reserves to other currencies, but the size and liquidity of the markets in Bunds or Gilts or JGB’s pales in comparison to Treasuries, as does the yield. And this is especially so because the ECB and BOJ continue to buy those bonds as well, further reducing liquidity and the availability of securities. Rather, to me what we are seeing is an ongoing tightening in Chinese policy as the country attempts to reduce the amount of leverage outstanding, and the corresponding uptick in the currency. Given the broad-based weakness in the dollar that we have witnessed since the beginning of the year, it should be no real surprise that CNY has gained in value as well. So for now, the dollar weaker narrative remains in place. However, I am not convinced it has that much staying power.

Looking ahead to this week’s data releases we see a more limited schedule as follows:

We also hear from Evans, Kaplan and Mester tomorrow, with the potential for some nuance, but my sense is that ahead of the FOMC meeting on the 31st, they are unlikely to break new ground, especially since the data hasn’t really changed much.

For now, the trend is your friend, and it is clear that the market is keen to push the dollar lower. But at some point, I continue to believe the rubber will meet the road and we will see higher inflation in the US leading to a quicker pace of Fed tightening and a stronger dollar. We shall see.

Good luck
Adf

The ECB said that it might,
According to their own foresight,
Be forced to increase
The pace that they cease
To buy bonds, thus making things tight

The euro responded with glee
Exploding past One and Twenty
If this is the plan
And not a straw man
The dollar, much lower, will be

And one other thing of real note
So many months after the vote
Seems Chancellor Merkel
Might have squared the circle
With new ministers to promote

Wow is all I can say this morning as the euro has virtually exploded higher during the past twenty-four hours. It started with the release of the ECB Minutes yesterday morning, which were read as quite hawkish. The belief that has gained widespread credence is that the time gap between the end of QE, now almost certainly to take place in September, and the first rate hike has been significantly shortened. Prior to the Minutes, the market was pricing in just a one-third chance of a 10bp rate hike by the end of this year. This morning that probability has jumped to almost two-thirds with a full hike priced in for March 2019 (it was December 2019 prior to the Minutes). It should be no surprise that the euro has rallied on the back of that change in sentiment. And in fairness, if the ECB is actually going to be more aggressive in their removal of monetary accommodation, it is the correct market response. Then, adding fuel to the fire was the announcement by Chancellor Merkel that after extensive negotiations between her CDU/CSP party and the center-left SPD, they have come to agreement for yet another ‘grand coalition’ government to lead Germany for the next four years. It has been over 100 days since the Germans went to the polls and concerns were growing that the much less palatable alternatives of either a minority government or a second vote were coming to fruition. But now, the market sees only blue skies ahead and the single currency has been the main beneficiary. In the past twenty-four hours, the euro has rallied 1.50% and is now trading at its highest level vs. the dollar since the beginning of 2015 (and at that point it was in the midst of a 25% decline!)

Of course, it remains to be seen if the ECB will follow through with the now mooted policy tightening, at least at the pace the market is expecting. Remember, while ECB policy is clearly still on emergency settings and almost certainly inappropriate for an economic area growing above trend, the Fed was in the same situation for several years before it finally started to get a bit more aggressive. Signor Draghi has not changed his stripes and remains a dove at heart, so while the pressure to tighten policy may well increase going forward, I continue to believe that he will do so only reluctantly and at a much slower pace than currently forecast. But for now, the euro bulls are in the ascendancy and I expect that the single currency has further room to run.

Meanwhile, on this side of the Atlantic, yesterday’s PPI data was shockingly weak, with both headline and core data printing at -0.1%, well below the +0.2% expectations and encouraging the narrative that the Fed was going to slow down its pace of tightening. This morning’s CPI data (exp 0.1%, 0.2% core) will be far more important, but it is certainly a disconcerting harbinger of today’s data. So adding it all up, the dollar has been under constant pressure since I wrote yesterday.

But there have been other things as well, notably Chinese Reserves data out overnight surprised everyone by showing a significant reduction in the pace of money growth and new loans. The government’s attempt to reign in leverage seems to be biting with expectations growing that Chinese interest rates are on course to rise soon. It can be no surprise that this data in combination with the largest Trade Surplus ($275B) ever recorded by the Chinese, and the softer US inflation data has resulted in a much stronger CNY. In fact, this morning the renminbi has gained 0.7% and is back at levels not seen since early 2016. But it’s not just CNY that has rallied in the emerging market bloc, virtually all of the space has outperformed. Not surprisingly, given the euro’s move, EEMEA has been the best performing region, but in truth we are seeing strength from all three regions.

So what are we to make of all this? In the constant ebb and flow of market activity, there is no question that things are pointing to a weaker dollar in the near term, at least before we see this morning’s CPI and Retail Sales data. If those numbers print as expected (Retail Sales exp 0.5%, 0.3% ex autos), then the dollar should remain under pressure for the rest of the day. Surprising strength in either of these data releases, especially CPI, however, could stop the dollar’s decline in its tracks. Given the narrative of increasing global growth, it seems hard to believe that suddenly the Fed will turn dovish. Rather, I would expect that we could see a hawkish turn from some of the centrists there, especially when they consider the situation elsewhere in the world. I continue to believe the Fed will lead the way in tighter monetary policy and the dollar will find support accordingly. But maybe not today.

Good luck
Adf

It now seems that yesterday’s story
‘Bout China was just transitory
Bond bears are frustrated
As fears have abated
Though any replay could be gory

This morning has seen a far less interesting array of stories with which to drive markets than we had been reading and hearing about earlier this week. Despite all the initial angst about China changing their tune on US Treasuries, the reality is that they have no choice but to remain invested, as there is no other market available where they can maintain their reserves safely. In addition, the fact is with the stability of the yuan lately, they are just not as likely to accumulate new reserves, and therefore not likely to increase their appetite. Remember, too, there is no possibility that they would discuss the idea of selling part of their holdings before they actually did so as it would work to their own disadvantage. It has been mooted that this was some type of signal from the Chinese to the Trump administration, although I doubt it had much impact. From the time I wrote yesterday morning, 10-year yields are lower by 5bps. However, this doesn’t change my view that we are going to continue to see those yields rise, but that is based on my view that measured inflation is going to return to the US.

Similar to the reversal in the Treasury market, the FX market has also returned to levels prevailing before that story made the rounds. While the dollar was under clear pressure yesterday morning, it too rebounded alongside the bond market and this morning sits little changed from Tuesday’s levels. In fact, the story today is there is no story. When looking at the FX markets broadly, compared to yesterday’s closing levels, in the G10 space, only AUD and NZD have moved more than 20bps, both rallying about 0.35% on the back of the continued strength in commodity prices. Meanwhile, in EMG world, though the movements have been slightly larger, there has been no discernible pattern. The biggest movement came from MYR, which rallied just 0.4% overnight on the back of the ongoing rise in oil prices (WTI is up to $64/BBL, its highest level since June 2015). Interestingly, the worst EMG performer overnight, though it fell just 0.25%, was MXN, despite the rise in oil prices. It seems there were some comments by the central bank governor regarding future peso weakness if NAFTA comes undone. That is a situation that I believe is entirely possible, and one about which I would be very cognizant if I had hedging activity in MXN.

FLASH – ECB MINUTES SEEN AS HAWKISH, EURO RALLIES

Moments ago the ECB released the Minutes from the December meeting and the upshot is that the hawkish commentary we have been hearing from some members seemed to be confirmed by the Minutes. The key statement was:

“The view was widely shared among members that the Governing Council’s
communication would need to evolve gradually, without a change in sequencing, if the economy continued to expand and inflation converged further toward the Governing Council’s aim. The language pertaining to various dimensions of the
monetary-policy stance and forward guidance could be revisited early [in 2018][my emphasis].”

It was the “revisited early” part that got the market going and the euro, although it had been virtually unchanged ahead of the release, jumped 50 pips and is now back near 1.20. The thought process seems to be that they are hinting at acting more quickly with regard to reduction in QE than previously stated, which if true is certainly bullish for the euro. However, I want to hear from Signor Draghi before I change my tune there. He has been consistently dovish and until that changes, I feel the euro will have difficulty.

While the Minutes added some excitement just now, overall it was a dull session. This morning brings US PPI data (exp 0.2% for both headline and core) although unless those numbers are significantly different, PPI generally has a limited impact on markets. Tomorrow’s CPI is a different story however. We also see Initial Claims (exp 245K) but that, too, doesn’t feel like it will matter much to markets. We hear from Bill Dudley this afternoon, and perhaps he will have something new to discuss, although I wouldn’t count on that either.

At this point, the euro is going to be the story for the day, and I wouldn’t be surprised to see it extend gains as the day progresses. But other currencies don’t appear to be all that interesting.

Good luck
Adf