While FX remains rather dreary

The market for Bitcoin’s quite cheery

With futures now started

One can’t be fainthearted

When trading, though I’d still be leery

Undoubtedly the biggest news over the weekend was the inauguration of futures trading on Bitcoin by the CBOE. It has received all the press and all the hype although actual trading volumes have not been very large. It will be interesting to see how it progresses through the day, and of course, the CME begins trading in their own contract next Sunday. My one observation is that regardless of how one would value Bitcoin fundamentally, in a market environment the ability of the price of an asset to climb exponentially for any extended length of time is extremely limited. In other words, while it may eventually be worth much more than today’s value, my gut tells me that we are due for a very significant correction at some point, something on the order of 60% or more if history is any guide. Just beware if you own any.

But away from the excitement there, FX remains in the doldrums. In the G10 space there have been two movers of note, NOK and NZD. The former fell 1.0% as CPI data released this morning was softer than expected and traders took the news as a sign that Norway will be lagging the global move toward higher rates. Inflation there continues at around 1.1%, nowhere near the targeted 2.0% and it seems that the Norges Bank has been having only limited success turning things around. On the opposite side of the spectrum, NZD rallied 1.0% as the RBNZ had a new governor named. Adrian Orr, previously the CEO of the country’s sovereign wealth fund, was a mild surprise and is seen as somewhat more hawkish than the outgoing governor, Grant Spencer. Year to date, kiwi has been the worst performing currency in the G10 and the only one to actually decline vs. the dollar. This has seen quite a buildup of short positions, and with the prospect of a more hawkish RBNZ, last night saw a great deal of short covering. It is not clear to me this will last, but another day or two of a squeeze doesn’t seem improbable.

But boy, away from those two, it is hard to get excited about anything. Perhaps the most interesting situation is that of the British pound, which continues to drift slowly lower despite the ‘breakthrough’ in the Brexit negotiations a week ago. If you recall, when the news was announced the pound jumped up as high as 1.3520. But here we are this morning, as more sober views have been incorporated, with the pound trading more than 1.2% lower and continuing to drift in that direction. As I have written repeatedly in the past, it is difficult to see a medium term positive framework for the pound.

Turning to the emerging markets, it has also been an extremely dull session. While there are more currency gainers than losers, the biggest winner has been BRL, which opened higher by just 0.35%. And if that is all you can get out of an EMG currency, it tells you that interest continues to be elsewhere rather than in FX markets.

Looking ahead to the rest of the week, we have some important data, notably CPI, but of even greater interest we hear from both the Fed on Wednesday and the ECB on Thursday. While I don’t anticipate any surprises on the rate front (Fed +25bps, ECB unchanged) all eyes will be on their respective forecasts for how 2018 will play out on the rate front. But ahead of that, here is the week’s data:

Certainly, an unexpected CPI print right before the FOMC announcement will lead to questions about how next year plays out, especially if it is stronger than expected. I would argue that market concerns are the Fed may move faster than their current rhetoric, and certainly faster than the market is pricing rather than slower. In the end, the dollar is going to find itself beholden to the changing trajectories of the FOMC and the ECB. It seems to me that the dollar’s weakness this year has been a result of the improvements in GDP growth elsewhere in the world and the idea that other central banks will be adjusting policy more rapidly than previously expected. This week’s meetings will help us all understand if that narrative remains appropriate, or if a new one is in the making.

Good luck

Adf

There once was a Minister Prime

Who found herself quite pressed for time

Without an accord

She’d be headed toward

The opposite of what’s sublime

So PM May crumbled like chalk

In order to break the deadlock

Hence now the UK

More cash will they pay

As backbenchers grumble and squawk

Undoubtedly, the biggest story overnight was the operation to remove British PM May’s spine the announcement that the UK and EU had agreed the framework for the settlement of the Brexit bill. At approximately 1:30 this morning, EU Commission President Jean Claude Juncker announced the fact to the world and explained he would be sending the details to each of the remaining EU nations for approval. This opens the way for the beginning of talks about the trade deal that the UK is desperate to put together with the EU. In essence, the UK caved on all the issues, although the money seems like the least of the problems. From what I’ve read, it appears that she just sold out Northern Ireland by agreeing that there would be no hard border between the two nations on the island, and, critically, that unless other arrangements are made to avoid that hard border, “the United Kingdom will maintain full alignment” with EU rules needed to maintain economic and political cooperation between Northern Ireland and Ireland. In other words, Northern Ireland will not have left the EU despite Belfast’s stated desire to do so. Needless to say, there will be much more of this story going forward as the details of the deal are worked out and the trade agreement begins to take shape. The pro-Brexit crowd is already quite worked up over the issue and it wouldn’t surprise me if May loses control, and her position, during the next few months. In fact, I kind of expect another election in the UK before the end of 2018. PM Corbyn anyone?

However, for our purposes the impact was pretty much as expected, the pound jumped sharply on the announcement, rising 0.5% and trading to 1.3520, its highest level since mid September. Interestingly, since the initial burst, the pound has actually given back all those gains and is now lower on the day, albeit by just 0.1%. I guess, in the end, the market was expecting a deal to occur. Going forward, this is certainly a benefit for the pound, but I expect there will be more than a few hiccups before everything is settled.

Aside from that news, a look at the dollar shows another day of broad-based but modest gains. The euro has traded down to three-week lows and feels as though there is further room for decline. Data from the Eurozone was mixed with French IP’s gains offset by weaker German trade data but I don’t get the feeling that is the issue. Of perhaps more importance is the ongoing stalemate in Germany regarding a new governing coalition with more talk of the creation of a minority government. Chancellor Merkel does not want that as it will result in a weaker administration, something that the rest of Europe is also loathe to see. However, younger members of her own party are clearly sharpening their knives and seem ready to push Merkel out if they can. I guess twelve years at the top has taken its toll on the next generation. At any rate, if Germany does wind up with a minority government, that is not likely going to help the euro. At the end of the day, though, political stories have had a limited impact on currencies lately, with the central bankers still the drivers. Next week we hear from both the Fed and the ECB, and it is their actions that remain the market’s key focus.

But before we get to the Fed next week, let’s look at today’s payroll data. Expectations are as follows:

Nonfarm Payrolls                 195K

Private Payrolls                    195K

Mfg. Payrolls                         15K

Unemployment Rate             4.1%

Average Hourly Earnings    0.3% (2.7% Y/Y)

Average Weekly Hours        34.4

Wholesale Inventories        -0.4%

Michigan Sentiment              99.0

Certainly if the data is close to expectations, there will be nothing to change the FOMC’s collective mind about raising rates next week. In fact, we would need to see a dramatic fall in NFP or a significant rise in the Unemployment rate for that to be the case, neither of which seems likely. In fact, what seems more possible would be an earnings uptick such that the ‘mystery’ of missing inflation starts to be answered. If we were to see more robust growth there then I think we might hear a bit more hawkishness from the FOMC next week. Remember, futures markets continue to price in just 40bps of tightening for all of 2018, a far cry from the 75bps the Fed is discussing. As we saw this year, the futures market and the Fed will converge at some point, with my continued belief being that the Fed is now on a path where they will raise rates every quarter for the next two years. In fact, the most interesting thing about next week’s FOMC is likely to be the forecasts and the dot plot. Strong data today combined with the ongoing positive global growth news could well result in higher terminal rate expectations. In other words, the Fed is likely to see a higher long-term equilibrium rate in the US, something that will certainly give the dollar a boost. So today’s data is quite important in the big picture. FWIW, my view is that we will see a headline number of 200K, but I am expecting to see the Earnings number higher. Anecdotal observation shows me that companies are paying lower wage workers more in order to get them and keep them, and that has to feed through to the data eventually.

With that, I expect the dollar’s recent modest uptrend to continue for now, as there is nothing obvious to derail it.

Good luck

Adf

The tale of two nations’ concerns

Has taken surprising new turns

Frau Merkel can’t find

Enough folks aligned

With her, while some others she spurns

In England Prime Minister May

Keeps searching for ways to allay

The Irish up north

So she can go forth

And get EU members to play

The dollar is having another fine day in the markets as the political confusion elsewhere in the world seems to be outweighing the political confusion here at home. The story from Germany continues to be the inability of Chancellor Merkel to form a working coalition government after the September elections. Three months on, and in the wake of the unsurprising failure to bring the Green Party and Free Democrats together, she is now wooing the SPD. The center-left Social Democrats had vowed to remain in opposition immediately after losing badly in the election. They felt that their previous time spent as the junior partner in government resulted in a loss of identity. But now, Merkel’s options are limited. She has rejected outright, along with the rest of the parties, working with AfD, the far-right party that won nearly 12% of the vote. She has refused to create a minority government, as she believes it will be too unstable. And nobody really wants new elections as, first, polls show the results would be similar to September’s outcome and not advance the process; and second, a bigger concern that any new election would allow AfD to garner an even larger minority, something which is anathema to everyone who doesn’t actually support AfD. While she currently manages a caretaker government, the loss of German leadership in the Eurozone seems to be taking a toll. While the bloc’s data has remained generally quite good, the lack of initiative for the future seems to be an issue. Even though the euro is only lower by 0.1% this morning, this marks five consecutive sessions of decline totaling roughly 1.5%.

Next week both the Fed and ECB meet and expectations remain that the Fed will raise rates 25bps while the ECB will make no changes at all. I think the bigger questions are what updated forecasts will look like from both banks, including any tips to changes in policy trajectory. And there is one more thing to consider, market technicals are starting to point to a lower euro in the short term. Essentially, the short-term trend has reversed course from its recent upward trajectory and is now pointing to further losses in the currency. Keep an eye as we head into the ECB meeting next week.

Meanwhile, poor Ms. May finds herself at odds with nearly everybody else in the UK. Ostensibly, she will be presenting modified language to her Northern Irish allies shortly, in an effort to smooth over the Irish border issue I discussed yesterday. The thing is, the positions of Ireland and Northern Ireland seem irreconcilable. Ireland refuses to accept any type of border, which given the UK’s pending exit from the customs union will be impossible unless the North agrees to the same rules as the EU. At the same time Northern Ireland refuses to do just that, adamantly preferring to stay within the UK.   Keep in mind that these two sides have been at odds since the early 1600’s over myriad different issues. It cannot be a surprise that changing the status quo in what had been the most peaceful period in 400 years might rekindle age-old differences. While there is still a chance of some fudged agreement, I would estimate there is at least a 50% probability that this issue is never resolved and Brexit occurs with no trade deal and limited prospect of one in the near future. Once again, I will reiterate that the pound will suffer with this outcome and that current levels remain attractive for hedgers despite the pound’s nearly 2% decline from recent highs. The combination of uncertainty and creeping inflation will continue to undermine the currency.

But the dollar’s strength is broader today, with the biggest losers being the commodity bloc. It appears that oil prices may have topped for now, as the OPEC-Russia accord seems to be fully priced and recent data showed significant increases in product in storage. But we have also seen softness in the metals space and agricultural prices are under pressure. In other words, whatever stuff you mine, drill or grow, you’re getting less money for it today. With that as a backdrop, it can be no surprise that the leading G10 decliners are AUD and NZD while in the emerging markets, BRL, ZAR and MXN are leading the way lower. All of these would fit within the commodity sphere.

As to the data front, yesterday saw the ADP number exactly at the expected 190K, although Productivity and Labor Costs were both a touch soft. This morning we see Initial Claims (exp 240K) and then Consumer Credit ($17.0B) this afternoon. Neither of these will cause even a minor fluctuation. Tomorrow, however, we get the payroll report and that has the potential to be far more interesting. While the Fed’s move next week is baked in the cake, there is still ample opportunity for the market to price more movement for 2018, an area where Fed rhetoric remains well ahead of the futures market. As to the rest of today, I see no reason for the dollar to reverse its recent modest uptrend.

Good luck

Adf

As many’ve already observed

The market’s becoming unnerved

While risk is forsaken

More gains will be taken

So overall wealth is preserved

The dollar is broadly higher this morning as market participants are starting to become a little nervous. Three consecutive lower closes in the equity markets have led to a risk-off scenario. My observation is that there may have been an actual change in sentiment lately based on the following idea: throughout the raging bull market in equities, even on days when prices opened lower, by the end of the day we consistently saw traders ‘buy the dip’ thus preventing the market from closing lower. Every decline in the market was seen as a buying opportunity. But during this short run, and I grant it is short, just three days so far, early gains have melted into late losses. To me this implies that one of the great supports for the bull market may be losing its potency. As I’ve written before, markets don’t always need an obvious catalyst to change their direction or sentiment. Oftentimes, it is only clear long after a move as to what was the cause.   A fourth consecutive lower close in the equity markets (and futures are lower as I type) just might signal a trend change. If the narrative to date has been: risk remains in vogue because of the so-called goldilocks scenario (solid growth with low inflation allows for continued low interest rates and ever higher equity prices), then every signal that something there is changing, most likely low interest rates, could well force a change in that narrative. And that, my friends, offers the opportunity for a much more significant risk-off move. I’m not saying it is happening, just that we need to watch it very carefully.

Once again, the pound is leading the way lower, down 0.6%, as PM May’s lunch yesterday clearly gave the market indigestion. The Northern Irish are not willing to compromise their views and neither are the Dubliners. All the hope that was seen last week regarding the next steps in Brexit are fading quickly, and from what I’ve read this morning, it seems hard to believe that a solution will be found by the end of the week. Another delay in opening the trade negotiations will certainly weigh further on the pound, and as I have been writing all along, support a move back down toward 1.30 as a start. In fact, it seems increasingly likely that PM May will lose her support and perhaps force yet another election in the near term, further reducing chances for a satisfactory outcome. This will not help overall market risk sentiment, I assure you.

But the fading risk sentiment is manifesting itself in Japan as well, where the yen has rallied 0.4% after another down day by the Nikkei, its third of the past four sessions during which it has fallen nearly 4%. We are seeing similar price action in Europe, with lower equity prices and the euro declining for the past four sessions and this despite substantially better than expected German Factory Order data (+0.5% vs. -0.2% expected). I’m sensing a trend! Remember, as we approach year-end with equity markets having shown gains globally, it would not be surprising to see some profits taken, removing risk from portfolios. Historically, the dollar has benefitted in these times.

Turning to the emerging markets, the story is similar, with the dollar broadly higher and movement a little more pronounced than we have witnessed lately. South African rand is the leader on the downside, falling 0.9%, in what has clearly been a straight risk-off move. But KRW is lower by 0.7% after another weak close in the KOSPI has encouraged further unwinding of risk. And while the losses haven’t been quite as large elsewhere, all of EEMEA and most of APAC are under pressure. Here’s the thing, remember how much momentum helped risk appetite on the way up? I assure you it can hurt that much, and more, on the way down. Again, I am not saying this is the turn, but at this point, you cannot rule it out either.

To the extent that data matters, which I don’t feel is the case right now, there are three releases this morning: ADP Employment (exp 190K); Nonfarm Productivity (3.3%); and Unit Labor Costs (0.2%). We also hear from the Bank of Canada today at 10:00, but there is no expectation of a policy move there.

As I survey the markets, the story today is going to be whether or not we have a fourth consecutive lower close in equities. Breaking the current streak will likely result in further benign activity across equities and FX, but if the streak continues then I would look for it to begin to accelerate somewhat, bringing further risk-off sentiment and dollar gains.

Remember, markets can be very perverse, rising and falling significantly without any obvious catalyst. But once momentum starts to take over, then very little can stop those moves. We have observed upward momentum in asset prices for a long time. If it turns, we can expect downward momentum to last for a while as well. For hedgers, that should help inform your decision-making process. In markets that are moving, price taking is the only way to insure execution. And that is very different than what we have experienced for the past eight years!

Good luck

Adf

Ere lunching in Brussels Ms May

Much progress had tried to downplay

The Irish condition

While long on ambition

Was not prepared for light of day

It turns out Ms May was correct

Her allies, the deal, did reject

And, too, there’s the question

Of legal digression

Thus both sides are still circumspect

In what cannot be very surprising to any onlookers, the enthusiasm for a deal between the UK and EU regarding the Irish border fell apart yesterday almost immediately after it had seemingly been agreed. Apparently, PM May’s supporters in the DUP, the Northern Irish Democratic Union Party, who remain critical to her maintaining her leadership role, are adamant that they want a physical border to be put in place between Northern Ireland and Ireland. Meanwhile, the Irish are adamant that no such border should be allowed to exist. The framework agreement had ostensibly agreed to the Irish demand and essentially created a border between Northern Ireland and the rest of the UK. However, the Northern Irish would have none of that and rejected the deal. At the same time, both Scotland and Wales, asked for the same treatment as Northern Ireland with regard to the EU, as, if you recall, both of those nations had voted to remain in the bloc. While PM May continues to sound hopeful, it seems pretty clear that one side is going to have to cave, and if history is any guide on these two nations, that is not going to happen. (Perhaps they can create a Heisenberg-type border, one that is either there or not there depending on when you look!) Not to be forgotten, the issue over the ECJ’s eventual jurisdiction of EU citizens living in the UK post-Brexit has also not yet been resolved. This one is much harder for me to understand. How an unrelated judicial system should be able to have sway over things impacting residents in a different country is beyond me. Consider if the EU, as part of a trade agreement with the US, demanded that EU citizens living in the US would be subject to ECJ rulings, not US Supreme Court rulings. It’s the same thing, and the height of hubris on the European’s part in my view.

At any rate, if you recall when I wrote yesterday morning, the pound had rallied sharply after word that a compromise had been reached. Well not surprisingly, the pound is today’s worst performer, having given up most of those gains yesterday afternoon in NY and then continuing its decline this morning. Right now, the pound is lower by 0.4% on the day, which has also seen UK PMI data released at somewhat weaker than expected levels. While Services growth remains decent, it appears to be slowing at the same time pricing pressures continue to increase. If you are Governor Carney, you remain stuck between rising prices and slowing growth, situations that require exactly opposite monetary policies. It is not an enviable position.

Away from the pound, however, the dollar is actually a bit softer overall, albeit not very much. The reality is that there has been very little direction in FX trading across the board for the past several weeks, with daily gyrations largely offsetting the previous day’s movements. If I were to highlight a broad theme it is the uncertainty that exists over the potential pace of monetary accommodation withdrawal by the world’s central banks. Certainly that continues to be the single most important question to be answered. Just how quickly will the central banks withdraw QE, and how will they respond if markets get unruly. And remember, over the course of the next two years, we are likely to see new central bank heads at all the big banks, adding further uncertainty. But that is an issue for another day, as trading today has certainly not been directly impacted.

Touring the rest of the world, there is very little of note to address. The Eurozone PMI data was right on expectations and points to continued GDP growth in the 0.5%-0.6% area. At the same time, Eurozone Retail Sales were a bit on the soft side, which has not helped the single currency this morning. Both Swedish and Norwegian data also continue to point to solid growth, and in those cases, the currencies have benefitted today. But again, the movements just aren’t very large.

Emerging market currencies have also been uninspiring with BRL the biggest gainer thus far, opening firmer by 0.55%, as the market continues to applaud what appears to be a turn in the economic trend there to one of more robust growth. Market participants, though, remain on tenterhooks regarding the ongoing pension discussion there. Unlike some nations, Brazil is attempting to address its state pension issues, a laudable goal although one that is fraught with short-term potential problems. (But that we addressed these issues back in the 1980’s!) From what I have read, I believe they will be successful in making needed changes to insure long-term solvency of the system, which will only help the currency going forward. But there were no nuclear tests, no comments of note and no new news to drive this bloc otherwise.

We continue to see equity rotation out of tech stocks into financials and industrials as investors are looking for those sectors that they believe will benefit most from tax reform in the US. My concern is that given the tech sector’s outsized role in driving broad indices higher, if this process continues, we could well see those broad indices retrace a significant amount of their YTD gains. And that might change a few minds regarding things like market volatility and next steps by the Fed.

In the meantime, we await the Trade Balance this morning (exp -$47.2B) and then the ISM Non-Mfg reading at 10:00 (exp 59.0). A strong reading for the latter could well add to flattening pressure on the yield curve, which has now fallen to 57bps in the 2y-10y spread. Historically, a bear flattening (when short term rates rise faster than long term rates) has been beneficial for the dollar. If I had to forecast today’s movement, I like the dollar to outperform by the end of the day, just not very far.

Good luck

Adf

From Brussels the market has learned

The talks about Brexit have turned

Further disorder

At Ireland’s border

May soon have both sides unconcerned

In what cannot be very shocking

To pounds, many traders are flocking

But elsewhere the buck

Has had all the luck

As stocks in the US keep rocking

This weekend’s press focused on the still glacial pace of Brexit negotiations and the increasing odds that no compromise would be reached regarding the Irish border before the key EU meeting at the end of next week. While PM May and the EU’s Michel Barnier are scheduled for lunch to discuss things today, hopes were not high that sufficient progress had been made to move the process on to the trade situation. The biggest problem had been the resolution of the Irish border that I discussed on Friday, but it seems that questions over the European Court of Justice’s role in legal questions for EU citizens in the UK had also resurfaced. With this as the backdrop, it was no surprise to have seen the pound cede some of Friday’s gains. In fact, at its nadir, the pound had given up about 0.75% of that move. But then, the following headline hit the tape: *BARNIER TOLD MEPS BREAKTHROUGH IS LIKELY TODAY: LAMBERTS.* Philippe Lamberts is a Belgian MEP and his comment was all the pound needed to regain all of its lost ground and then some, with it now sitting 0.4% higher than Friday’s close. While no details have been released, the fact that progress continues to be made is seen as a key support for Sterling.   And today, support for currencies other than the dollar has been rare.

In fact, the dollar is having its best overall day in a while, having rallied against virtually every currency aside from the pound. It seems that investors continue to pour money into the US equity markets, as evidenced by their regular record setting performances, and, of course, in order for foreign investors to by US equities, they need first to convert their cash into dollars. While I remain uncomfortable that equity markets can maintain their momentum, clearly I remain in a minority.

But something else supporting the dollar this morning is Treasury yields, with the 10-year higher by ~4bps and the 2-year, which typically has much smaller movements, rising by 2.5bps. Concerns continue to grow in the market that the yield curve is getting set to invert soon, and as I’m sure you are all aware by now, an inverted yield curve has historically been a harbinger of a recession. The Fed continues to be puzzled by the flattening as their models consistently point to a strong correlation between short end rates and the long end. Thus as they push the front end higher, they expected to see the back move up alongside it. The thing is, as long as they and their central bank brethren continue to buy bonds, demand for safe fixed income assets will remain, and those yields are unlikely to rise very much. Which is, of course, the reason they are so concerned over the shrinking of their balance sheet. While the conundrum of rising front end rates and falling back end rates may be somewhat concerning, although arguably quite logical as I just highlighted, a situation where back end rates are rising more rapidly than the front will be of much greater concern. That means they are no longer in control, and based on the history of the past decade, that is what they fear most, lack of control.

How might that come about? Consider the reality of your personal inflation, as opposed to the measured sort on which they focus. There are many inflation indicators (e.g. NY Fed’s Underlying Inflation Gauge (UIG) that just printed at 2.96%, its highest level since 2006!) that are pointing to inflation being much higher than the Core PCE reading the Fed worships. And it is entirely possible that we are going to see real price pressures make a far more sudden appearance in the CPI or PCE readings than the Fed seems to currently anticipate. I assure you if PCE jumps to 1.9% in Q1 of next year, they will not be happy. Inflation is something that can only be addressed with a lag, and a surprisingly sharp rise would force a much more aggressive Fed policy response. For a group that has preached gradualism, having their hand forced will be very problematic for their policies and for the current benign attitude toward market risk. In other words, things will could get messy. And as I have consistently highlighted, messy markets tend to drive people into dollars.

As to this week, we have a combination of ongoing political stuff, with hopes high that a tax package will come closer to reality, as well as that the government won’t shut down on Friday. And this doesn’t even include the ongoing investigations and recent bombshells about potential election issues. We also have a decent amont of data, culminating on Friday with the monthly payroll report:

Today                                                Factory Orders                                    -0.4%

Durable Goods                                    -1.0%

Tuesday                                    Trade Balance                                                -$47.4B

ISM Non-Manufacturing                        59.0

Wednesday                                    ADP Employment                                    190K

Nonfarm productivity                                    3.3%

Unit Labor Costs                                    0.2%

Thursday                                    Initial Claims                                                240K

Consumer Credit                                    $16.75B

Friday                                                Nonfarm Payrolls                                    198K

Private payrolls                                    200K

Manufacturing Payrolls                        17K

Unemployment Rate                                    4.1%

Avg Hourly Earnings                                    0.3%

Avg Weekly Hours                                    34.4

Michigan Sentiment                                    99.0

In addition, a number of central banks meet this week, including Australia and Canada, although neither is expected to change policy or even hint at it.

For the past week, the dollar has made no headway in either direction. Barring an extraordinary outcome from Congress, or some new significant political bombshell, I feel like the ongoing consolidation in the euro will continue. FX markets are not the primary focus of investors, except perhaps in the UK where the Brexit situation remains fluid. But otherwise, its bitcoin, equities and bonds, in that order!

Good luck

Adf

The pound has been buoyant of late

As progress in the key debate

Implies that next week

(O’er bubble and squeak?)

A deal just might break the stalemate

For the past month, the pound has been on a tear, rising nearly 3.0%. Expectations continue to build that a preliminary agreement over the first items in the Brexit negotiation will set the stage for opening trade discussions. Those first three items are: 1) the disposition of EU citizens living in the UK and their rights going forward; 2) the divorce bill; and 3) the eventual status of the border between Ireland and Northern Ireland. The first of these was addressed some time ago, and seems no longer to be an issue. It was at the beginning of this week when stories made the rounds about a breakthrough on the divorce bill, where ostensibly the headline number was increased substantially from the initial talk of £20 billion, but the timeline of the payout was extended so greatly that it appears the present value of the number is little changed. Which brings us to the third issue.

It appears that market participants have been pretty sanguine about the resolution of the Irish border issue, because it was not something that was getting much press. However, it may well be the most intractable problem of all. Consider that the border in question will be the only land border between the UK and the EU once Brexit has been completed. Consider also the long history of violence that exists there, and the fact that one of the key features of the Good Friday Agreement of 1998, which established the peace between the UK and Ireland, was the fact that there was no visible border left between the two nations. This worked because both sides were members of the EU and therefore part of the same trade and customs union. But Brexit will change that. This is especially problematic because PM May relies upon the votes of the Northern Irish DUP party for her majority in Parliament, and they are adamant about maintaining their sovereignty, which means they want a border. Meanwhile Ireland is adamant that no visible border should be erected. If May caves to the Irish demand, she may well lose her majority and potentially a no-confidence vote. Whatever the outcome of a new election, I assure you that the timing would not be perceived as a positive for the pound. A change in government with just fifteen months left in the Brexit timeline would be a significant problem for the process and certainly would weigh on the currency. On the flipside, if May sticks by the Northern Irish demands, then trade talks will slip further into the future, if they are to come about at all. This, definitively, would be bad for the pound given that its recent rally has been based on progress in this area. In other words, there are several compelling cases to be made that the pound is a bit overextended on the high side. Hedgers beware! While the overnight decline has been small, it would be easy to foresee a breakdown over this issue resulting in a retracement of all the recent gains and then some. I might consider some GBP options here as they remain inexpensive, especially for puts given the recent change of tone. For example, a 3-month 1.3250 put costs just over a penny.

As to the rest of the market, the overnight session can best be characterized as mixed. In the G10 space, no currency has moved more than 0.3% (NZD’s short-covering rally) while no other currency moved even 20bps. Something that has gotten a little press has been the surprising rise in EONIA fixings the past two days. This jump of 6bps each day has opened a substantial gap between the ECB’s base rate and market transactions. Given the timing, at the end of the month, my sense is that there was a short squeeze for funding at some bank, but that it is not a long-term issue. However, it does highlight the flaws in looking at market probabilities for future central bank rate activity. I would contend that there has been absolutely no change in the zero probability of a rate hike later this month by the ECB, yet if calculated off the futures markets, that number has risen to 23% because of this move. Look for it to disappear at today’s fix. However, if EONIA fixes near yesterday’s rate of -0.24% again, then something else may be afoot, and will need to be investigated.

Also demonstrating how lackluster FX has been overnight is the fact that across the 24 EMG currencies of note, none have moved more than 0.35%, with both gainers and losers about equally split. For movement that small, it is hardly worth looking for rationales. Rather, that is just part and parcel of the ordinary price activity.

Turning to the data front, yesterday’s US data showed PCE was ever so slightly firmer than expected, Personal Income and Spending were right in line and Chicago PMI fell a bit less than expected, to a still very high 63.9, from its previous reading of 66.2. Clearly, equity markets were enthused by the data as we saw a remarkably powerful rally in the Dow, taking us to new highs there. However, the story overnight that the Senate vote on a tax bill would be delayed has dented some of that enthusiasm and thus equity futures are all pointing to a lower opening this morning following European shares lower. Meanwhile, we have ISM Manufacturing data to be released at 10:00. Expectations are for a print of 58.3, with the Prices Paid index coming at 67.0. This would highlight continued robust performance from the manufacturing sector in the US. The Eurozone data released this morning showed strength continues there as well, which means global growth remains in solid shape at this time.

As to the future of the dollar, other than the pound, which I feel has gotten way ahead of itself, it is hard to make the case for significant movement without a new catalyst. That could be finalized tax legislation, a breakdown in equity markets, or more likely, something that we would not even consider important at this time. Remember this though, nothing matters to markets until it MATTERS to markets. Highlighting the current keys doesn’t necessarily tell us about what will drive things in the future. And that is why FX markets, in particular, seem so perverse.

Good luck and good weekend

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Poor Mario can’t catch a break

Despite all his efforts to slake

The scourge of deflation

The last iteration

Of data showed progress opaque

It was a wild and wooly session in equity markets yesterday, with a significant divergence between tech stocks and the rest of the market. Meanwhile, Bitcoin exploded to new heights above $11k before tumbling more than 20%. I mention these to start because a pattern of increased volatility in markets is becoming far more obvious, and I am quite confident if this is the case, volatility in the FX market will be rising as well.

One of the hallmarks of the post crisis era, beginning sometime in mid-2009, was the extraordinary decline in the volatility of asset prices. This was caused by the extraordinary monetary policy decisions that expanded central bank balance sheets by some $15 trillion during that period. In fact, this was the explicit goal of the central banks.

Ben Bernanke explained it thusly in Jackson Hole in 2012, “In using the Federal Reserve’s balance sheet as a tool for achieving its mandated objectives of maximum employment and price stability, the FOMC has focused on the acquisition of longer-term securities–specifically, Treasury and agency securities, which are the principal types of securities that the Federal Reserve is permitted to buy under the Federal Reserve Act.  One mechanism through which such purchases are believed to affect the economy is the so-called portfolio balance channel, which is based on the ideas of a number of well-known monetary economists, including James Tobin, Milton Friedman, Franco Modigliani, Karl Brunner, and Allan Meltzer. The key premise underlying this channel is that, for a variety of reasons, different classes of financial assets are not perfect substitutes in investors’ portfolios. For example, some institutional investors face regulatory restrictions on the types of securities they can hold, retail investors may be reluctant to hold certain types of assets because of high transactions or information costs, and some assets have risk characteristics that are difficult or costly to hedge.”

So in essence, the Fed bought a lot of Treasuries and MBS forcing other investors to buy other assets, driving their prices inexorably higher.   And as long as the Fed reinvested the proceeds from maturing bonds, which they did assiduously until just last month, those assets remained unavailable to other investors. Guess what? All asset prices rose during this period, not just financials, but real estate, collectibles, and even virtual assets. And since the central bank bid was always there, fear of asset price declines disappeared. All told, if you were seeking to reduce volatility in markets, there was no better way to do so than to flood them with excess liquidity.

But now the Fed is turning the ship, reducing its reinvestment of maturing bonds and raising rates simultaneously. The ECB is on the cusp of reducing its purchases and we have seen higher rates in the UK and Canada as well. I assure you, we will be seeing much more volatility going forward as this process continues. After all, there is no way that the expansion of central bank balance sheets can do so many things while their contraction, however slowly, will not reverse those same effects, no matter what they say.

Now back to the headline. Despite Signor Draghi’s best efforts, Eurozone CPI printed at a lower than expected 1.5% with a core reading at 0.9%. This is clearly not the outcome that the ECB was seeking as not only does it draw them slightly further away from their goals, but also it puts their recent decision to begin the tapering under more pressure. The market’s initial reaction was a quick selloff of 0.3% in the euro, but since the release, we have essentially clawed back those losses. The thing is, the dollar is actually having a pretty good day overall, with only the British pound showing any strength vs. the greenback this morning amongst G10 currencies. The dollar strength seems to be predicated on several things; economic data continues to perform well; anticipation of a tax package passing Congress is growing thus boosting the economy further; and the idea that the Fed will respond to the continued growth with tighter policy. Quite frankly, it makes a lot of sense. To my mind, there is one other feature, the idea that if my opening monologue on increasing volatility is correct, then with the shedding of risk will come demand for dollars too.

A quick look at the pound, which has rallied another 0.4% this morning, shows that ongoing positive press about the prospects of a Brexit deal are causing the speculative elements in the FX market to unwind short positions in the pound. This is evident not only in the spot market, but also in the change in relative option prices for both puts and calls, with puts suddenly under significant pressure. After all, if you no are longer worried about the pound collapsing, why would you buy protection against such? This may have further to run for now. Longer term, however, I continue to believe that the pound will suffer, but if a deal is agreed, it may take a while for that to happen.

In the EMG space, KRW was the big loser, down 1.0% overnight despite the fact that the BOK raised rates by 25bps. There was one dissenting vote on the committee, so perhaps that was deemed to be the negative. More likely, however, given the won’s 4% appreciation in the past two weeks, this was simply a case of selling the news after all of those folks bought the rumor. But otherwise, even this space has been uninteresting. There are far more losers than winners, but I am hard pressed to find a critical story to discuss.

On the data front, yesterday saw GDP revised even higher than expected, up to 3.3%, the best quarterly print since Q3 2014, which undoubtedly helped push Treasury prices lower on the day. It also highlighted the schizophrenia in equities as the Dow made new record highs while the NASDAQ fell more than 1%. Today brings a raft of important data as follows: Initial Claims (exp 240K); Personal Income (0.3%); Personal Spending (0.3%); the Fed’s favorite PCE Core Deflator (1.4%); and Chicago PMI (63.0). There was also a story out this morning that the CBO claims that the US economy is now growing at ‘full potential’ for the first time since 2007. What that says is the Fed is not going to slow down its policy direction any time soon, so higher rates and a smaller Fed balance sheet are in our future. As I pointed out above, it was the growth in the balance sheet along with ZIRP that led to the current asset valuations. Things are going to change, and the dollar is going to be a big beneficiary of this going forward!

Good luck

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Two things occurred in Tuesday’s session

That led to implied vol repression

First Powell agreed

There was still a need

For rates to rise with some discretion

Then later a story explained

The UK and EU attained

A framework accord

England could afford

Though different than Brexit campaigned

The North Koreans launched their latest, most sophisticated ballistic missile and it comes third in terms of importance to the market, maybe fourth if you consider the hype surrounding Bitcoin’s breaching the $10,000 level! We live in interesting times.

Arguably, yesterday’s morning session was dominated by Fed Chair-designee Jay Powell’s confirmation testimony before the Senate Banking Committee. In it, he displayed the requisite characteristics of a Fed Chair, he only spoke clearly about what he wanted to discuss, and evaded all other questions effectively. However, he seemed extremely explicit in effectively confirming that the FOMC would be raising rates by 25bps next month, and that the wind-down of the Fed’s balance sheet would continue at a gradual pace, probably draining some $2 trillion from markets over the next few years. He would not be drawn into a discussion of Fiscal policy, and he signaled his belief that there is sufficient regulation of financial markets at this time, perhaps even too much. The dollar response to his comments was generally positive as the broad dollar index rose about 0.4% in the aftermath.

But then, around 12:45, news hit the tape that the UK and EU had agreed a framework for the so-called divorce bill resulting from Brexit. This has been one of the key issues preventing the opening of trade negotiations and so was rightly heralded as a huge breakthrough in the process and a positive for the pound. The market response was an immediate 1.25% jump in the pound. Since then, it has actually traded somewhat higher and is the G10 leader today, up nearly 0.5% vs. the dollar. Of course, there is still the question of the Irish border to be addressed and that is no easy task. While Ireland wants to have no physical border between itself and Northern Ireland, one has to wonder how that can work if both sides are in different economic unions. My point is all the progress can still be scuttled, but for now the market is quite pleased with the terms. An interesting side note is that the probability of a BOE rate hike moved from December to September next year on the news implying tighter monetary policy is coming sooner to a screen near you. While that was arguably part of the reason for the rally in cable, it still makes no sense to me. UK data continues to underwhelm and when the BOE did raise rates earlier this month, it seemed pretty clear this was a one-off event, trying to remove the excess accommodation offered in the immediate wake of the Brexit vote last year. However, the fact that the UK economy didn’t collapse subsequently has convinced them that rate cut was no longer needed. That is a far cry, though, from the idea that they need to raise rates into the greatest economic uncertainty for the UK economy since the financial crisis. I continue to believe that the BOE will not be raising rates until well after March 2019, when the UK actually leaves the EU. As to the pound, it continues to feel overvalued to me here as I believe the market is ascribing too much benefit from this outcome.

Moving on, the market response to the North Korean missile launch was remarkably sanguine, with a short-term rally in the yen of just 0.4%, which eroded steadily throughout the session. In fact, on the back of the Powell dollar bullishness, the yen actually ended the session weaker by 0.35%. Since then, there has been little additional movement. Perhaps even more remarkable was the fact that KRW actually rallied throughout the session, finishing stronger on the day despite the dollar rally and further extending those gains overnight. The point is despite the Nork’s claiming they can now launch a nuke anywhere in the world; neither investors nor traders seem to care. I mean what’s more important, the growing possibility of a nuclear war or the fact that Bitcoin has risen above $10,000? Obviously, it is the latter! (As Bitcoin does not yet qualify as a currency in my mind, it is not likely something I will mention frequently. However, it is important to be aware of the story because if you are looking for a potential catalyst for increased volatility, the bursting of that bubble has to be one candidate.)

And there you have it. Aside from the pound, the G10 has been far less interesting with regard to price movement. The laggard this morning is SEK (-0.3%) after Sweden released softer than expected GDP figures. However, the Riksbank doesn’t seem to have changed its tune regarding policy because of one number. There has also been some discussion about AUD, where two-year yields have crossed under their US counterparts for the first time since 2001. Back then, AUD fell to its historic lows of ~0.50, and while the Fed continues to push rates higher, there is no sign that the RBA is going to follow. Frankly, it seems there is further room for the Aussie dollar to fall. Happily for hedgers, the cost of hedging AUD receivables has collapsed due to the differing rate expectations. So don’t miss out here. Even five year forwards are only a one cent discount.

This morning’s data will be watched carefully, I believe, as the release of the second cut of Q3 GDP (exp 3.2%) along with the concurrent Price data has the potential for an impact if it is off target. We also get the Fed’s Beige Book this afternoon, and quite soon, German CPI is due to print (exp 1.7%) which is a precursor to tomorrow’s Eurozone number. However, if the GDP data is in line with expectations, I imagine that we will continue to see equity markets drive investor sentiment ever higher, which means that risk will continue to be embraced. In this market, that actually means EMG currencies should do well, and ironically, so should the dollar. Interesting times indeed!

Good luck

Adf

Kuroda implied

Too much of a good thing might

Not be very good

The best (?) thing about keeping up on the global markets is that you learn so many new things all the time. For example, how many of you have ever heard of the ‘Reversal Theory’? If you haven’t been paying close attention to the arcana of central banking, then my guess is you haven’t.

Here is what BOJ Governor Kuroda had to say recently, “Another issue that has recently gained attention with regard to the impact on the functioning of financial intermediation is the “reversal rate.” This refers to the possibility that if the central bank lowers interest rates too far, the banking sector’s capital constraint tightens through the decline in net interest margins, impairing financial institutions’ intermediation function, so that the effect of the monetary easing on the economy reverses and becomes contractionary.”

This ‘theory’ sounds a great deal like the wisdom of the masses with regard to zero and negative interest rates, to wit, if the returns I earn on my savings are zero, then I need to save more money to achieve my retirement goals, therefore I will spend less money now. For banks replace ‘spend’ with ‘lend’. In fact, this is exactly the behavior that we have seen around the world since the initiation of ZIRP and NIRP, especially in those nations with the highest savings rates like Germany and the Netherlands. And yet it has been one of the ‘mysteries’ to central bankers who don’t seem to understand why with rates at zero, people don’t simply spend more money boosting economic activity! The fact that governor Kuroda needed to concoct a theory to explain simple rational behavior is ample proof of just how out of touch the central banking community is with the way the rest of us live.

But there is a larger point to this idea, and that is that the BOJ is publicly warning that QEternity, which has defined their policy stance for the past eight years, may actually be coming to an end at some point. This is not to say it is going to happen this month, but economists estimates are now pointing to a raising of the target for 10-year JGB yields from the current 0.0% to 0.25% sometime next spring or summer as well as a reduction in asset purchases to just ¥40 trillion next year down from this year’s ¥60 trillion. And while that will still represent extraordinarily easy monetary policy, it will be tighter than the current situation. So despite the fact that inflation in Japan remains pegged at 1.0% or below, and has shown no signs of moving up toward their 2.0% target, it seems that the BOJ is preparing the ground for tighter policy. The Fed is already actively tightening; the BOE and BOC have both recently raised rates as well, although are currently on hold; the ECB has already described its path toward tighter policy which is to begin in January; and now the BOJ is moving in that direction. The message I take from this activity is that after nearly a decade of free money, which has led to generally anemic GDP growth alongside virtually no inflation but excessive rallies in asset prices, the central banking community has figured out that they need to try something else. If we see a concerted tightening effort by all the major central banks, even at an extremely slow pace, then I assure you that asset prices are going to suffer. The question is not ‘if’ it will happen but ‘when’ it will happen.

This matters for the FX markets because anything that results in significant asset price adjustments (a euphemism of sharp declines in the stock markets around the world) is going to change the risk profile of the market. And the outcome will be ‘risk-off’ in spades. If you recall how far and fast the dollar rallied during the financial crisis in 2008 and 2009, I would estimate you can look for similar type of price action. I am not saying this is going to happen right away, but my experience has been that it will happen much more quickly than most investors or traders expect. It is for this reason that I remain a strong advocate of maintaining hedge ratios, if not increasing them. I assure you that when things start to get out of hand, there will be no opportunity to address risks then!

With that discussion of the future behind us, a look at the overnight activity shows a very desultory market. Arguably, the dollar is a bit stronger this morning, albeit not excessively so. In the G10, the weakest currency has been NOK (-0.5%), which looks to be following the price of oil lower. WTI has fallen 2.3% since Friday’s closing levels as the mooted extension of the OPEC production cuts have been called into question by Russia’s lack of agreement. As such, it should be no surprise to see the krone fall. But the rest of the G10 space is trading +/- 0.25% of yesterday’s closing levels and so hardly telling much of a story. Interestingly, yesterday after early weakness, the dollar did rebound slightly and this morning’s prices are merely adding to that trend. The point is there is no strong conviction currently about the next significant move in the dollar.

In EMG space, TRY continues to vie with ZAR as the least desirable currency, and today is winning the race by falling 0.6%. It seems that a Turkish banker is going on trial this morning for helping Iran evade economic sanctions. I guess the concern is that if found guilty, the US may impose further sanctions on Turkey and negatively impact the economy and lira by extension. But away from that, this bloc has not shown much life to it, with the daily fluctuations well within the ordinary course of trading.

On the data front, arguably the most interesting numbers are CaseShiller Home Prices (exp 6.04%) and Consumer Confidence (124.0), but I am hard pressed to believe either will change views. More importantly, Jerome Powell will be testifying to the Senate in his confirmation hearings for Fed Chair. Based on the statement he released last night, it doesn’t appear that he is planning significant changes at the Fed in the near term, but it is possible that some Senator could ask an interesting question. In the end, I don’t anticipate any issues for his confirmation on either side, and expect very little in the way of new news from this. So once again, it is shaping up as a pretty uninspiring day in the FX markets, and that’s not necessarily a bad thing. Quiet markets are the best time to update hedges. Don’t miss out!

Good luck

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