From Europe today what we learned

Was growth on the Continent’s turned

But in the UK

It’s not the same way

Which should have the Brits quite concerned

The overnight FX session has once again lacked many, if any, highlights. Broadly speaking, the dollar is a bit softer, but we remain well within recent trading ranges in every currency. Perhaps the most salient news overnight was the release of the European Commission’s Autumn economic forecasts in which they highlight the ongoing strength on the Continent as a contrast to lowering expectations for the UK. The new forecasts pencil in growth of 2.2% in 2017 and 2.1% in 2018 for the Eurozone, both of which are higher than the Spring outlook, while they have cut UK forecasts to 1.5% for this year and 1.3% for 2018, the lowest levels since the financial crisis in 2009. It should be no surprise that the market reaction to the news was a short-term sell-off in the pound.

However, in the ensuing two plus hours, the pound has recouped all those losses on what appears to be a reaction to some comments regarding the resumption of the Brexit negotiations. While no substantive progress has yet been made on that front, there was intimation from several EU voices that an extension of the negotiation process was possible, meaning that the March 2019 deadline might be extended. Clearly, both sides need as much time as possible to complete this project, so any opportunity to lengthen the timeline will be welcomed by all involved. However, given the ongoing turmoil in the UK government, it remains a difficult assumption that they will be able to put forth proposals to encourage the process. From everything that I have read, I would estimate that there is still at least a 30%-40% chance the UK exits the EU with no deal in place. In other words, nothing has changed my view that the pound has further to fall over time.

But away from that story, we have seen almost nothing of note. The scant data released overnight showed that the German Trade balance continues to expand, reaching €24.1B in September, closing in on all-time highs. Arguably, the combination of strong German data and the Commission’s updated forecasts has underpinned the single currency today, which has risen 0.3%. The other data overnight showed that Japanese investors continue to liquidate their international bond holdings with limited outward investment in equities. The resultant cash flows are helping the yen recoup some of its recent losses and actually the yen is today’s best G10 performer, having risen 0.5% as I type.

In the EMG bloc, the winners have been largely EEMEA currencies, which seem to be tracking the euro well this morning and have shown little individual impetus. And away from those, we are looking at movement measured at less than 0.2%. This type of price action is indicative of both a lack of interest and a lack of news.   Given the dollar’s general underperformance today, it is no surprise that the bulk of the EMG bloc is slightly firmer as well.

On the data front, we see Initial Claims, as always, this morning (exp 232K) and then Wholesale Inventories (0.3%) at 10:00. There are no scheduled Fed speakers and so the FX market will need to look elsewhere for catalysts.

One possible place of interest will be the equity markets, which are opening on the soft side and have shown increasing divergence between the broad indices and their constituent components. Continued interest in owning the FAANG’s has driven the S&P 500 to steady record highs while the number of companies within the index trading at new 52-week lows continues to increase. My point is that if the long overdue correction in equity prices materializes, we are likely to see an impact on the dollar. Weirdly, despite the historic case of the dollar being one of the ultimate safe haven assets, in the current world, barring another financial crisis type event, I expect the dollar would suffer against the euro, yen and Swiss franc, although would be quite strong vis-à-vis the EMG bloc. I am not suggesting this is going to happen today, just that as the equity market shows continuing internal divergence, the timing of a correction is drawing nearer. Food for thought.

Good luck

Adf

For many who wanted to Tweet

Their thoughts would remain incomplete

But Twitter’s been troubled

And so they have doubled

The size of a Tweet. What a treat!

The most noteworthy news I could find this morning was that Twitter would be doubling the number of characters allowed on their app to 280. Personally, I understand the benefits of this as I used to work hard to tweet my limerick by itself and fit it into the allotted space. This often required significant editing or, at the very least, the creative use of character abbreviations. And while this may have absolutely no impact on the FX markets, I think it is indicative of the broad changes that many businesses will need to make going forward in order to remain competitive. After all, the 140-character limit was the very essence of what Twitter was about. Short, pithy comments were its bread and butter. However, as the market evolved, and growth for Twitter was elusive, they needed to do something. I have no opinion on whether this will help the company, but I do think that it represents something much bigger. For the past nine years, companies were able to achieve a level of success by virtue of the fact that financing was dirt-cheap and financial engineering was a viable, low-risk option. Perhaps we are beginning to see that corporate management is going to refocus on the actual business rather than simply the share price. And even more importantly, perhaps investors are going to do the same, look at the long-term prospects of a company as a critical investment criterion. (One can always dream, no?) Only time will tell, but it may well be the first encouraging act.

But as I look at the FX markets, and truly equities and bond markets as well, there is just nothing to discuss today. The dollar is modestly softer this morning against nine of its G10 brethren with only the British pound failing to rally. The story behind the pound seems to be yet more political troubles for PM May as she may be forced to fire her International Development Secretary, Priti Patel, after Ms Patel engaged in some unauthorized diplomacy. The problem is this has the appearance of PM May losing control of her cabinet and may well lead to a shake-up of the Tory leadership. Of course, with the next Brexit talks due to start tomorrow, the last thing May can afford is any sign of weakness. All told, it is no surprise the pound suffered, falling 0.4% after the news hit the tape, and I expect the pressure to remain on the currency. But away from the pound, small gains have not yet offset yesterday’s losses. With a lack of data due and no scheduled commentary from central bank speakers, I expect we will continue to see lackluster trading in the space.

The EMG picture is a bit more mixed with both gainers and losers on the screen, but none showing significant movement. The biggest gainer today is BRL, +0.55%, as news that President Temer is back supporting pension reforms has been taken as a positive. Pension reform is something that is desperately needed throughout the world, so any country that addresses the issue may well see its currency benefit as investors applaud the actions. It is certainly something desperately needed in the US at both the Federal and State levels. And I am quite confident that if Congress were to address it in a meaningful way, we would see the dollar benefit immediately. (More dreaming on my part!) But away from BRL, no other currency in this bloc has moved more than 30bps and despite President Trump’s trip to Asia, there has been nothing of substance on any particular nation to drive trading. In other words, look for limited activity here as well today.

There is no US data on the slate today, nor are there any Fed speakers scheduled. Equity futures are little changed this morning and Treasuries have moved less than 1bp. Adding it all up leads me to believe that there will be very limited action in the FX market today. Arguably, the lack of volatility will provide a good opportunity for hedgers to enter the mix.

Good luck

Adf

There once was a group of nineteen

Who met with six weeks in between

But lately we’ve learned

That many have spurned

The chance to meet when they convene

Some days there is less to discuss than others, and this is one of those days. Let me start by explaining that I will no longer produce the interest rate probability table, as it no longer seems likely to add much value. Consider that the BOE just acted last week and is unlikely to do anything until well after Brexit has occurred. Also, the ECB is clearly on the sidelines for a minimum of fifteen months as per their own rhetoric, and likely longer in my view, as inflation will not be making a comeback there soon. The Fed is all but certain to act in December, and the interest there will be about just how many times they hike in 2018 and, finally, Canada has pushed to the sidelines until they have a clearer idea of the US economy and Fed activity. So it seems to me that day-to-day movement in these probabilities are not going to be market drivers for a while.

In the meantime, I would contend the most interesting (puzzling?) thing ongoing is the fact that membership of the FOMC (group of 19) is no longer seen as the perk it once was. Yesterday’s announcement that NY Fed President Dudley will be leaving earlier than anticipated follows the exits of Vice-Chair Stanley Fischer and Governor Daniel Tarullo earlier this year. Obviously, Chair Yellen is being forced to step down, but in my estimation is likely to leave her board seat as well. Other governor’s who reigned during the financial crisis, Kevin Warsh, Sarah Bloom Raskin and Jeremy Stein have since left and their seats have not yet been filled. And on the Regional President side, Richmond President Lacker has resigned and his seat has yet to be filled.

And so, I ask myself, why would so many leave a job with such power and so many perks? The skeptic in me would answer that this group of people, who essentially ruled the financial world for the last decade through their monetary policy decisions, may have figured out that when things turn south, they will be in the crosshairs for all the blame. And they have recognized that the ongoing Goldilocks scenario of improving growth and low inflation is coming to an end. While nobody knows when things will turn, it certainly feels to me like we are much closer than not. This concept would also explain why the Fed Governor seats have been so hard to fill. Who wants to take a job that is going to be blamed by one and all for the next downturn? Of course, the problem is that the Fed is finding itself with a diminished leadership capacity at exactly the time it will need significant and strong leadership. Nothing good can come of this.

Will this impact the dollar? Absolutely! If the Fed loses its luster as the premier central bank in the world, it will not only negatively impact the dollar, but also it will have a significant (and I believe negative) impact on both bond and equity markets. One of the things that has underpinned US economic leadership since the end of WWII has been a strong Federal Reserve. History shows that when politics was driving Fed actions (1971-1979), the dollar was under enormous pressure and the global economy floundered amid stagflation. While today’s macroeconomic situation is clearly different than back then, a lack of Fed leadership in a crisis will be felt around the world. My point is that many of the things about FX that we currently take for granted may be called into question in the future, most notably the dollar as the world’s reserve currency. Again, I am not forecasting that this will happen soon, just that it should now be a risk on the radar. After all, risk management is what every hedger is tasked with.

As to today’s markets, the dollar is generally putting in a good performance, rallying vs. all its G10 counterparts, with the average currency loss about 0.45%. We did see some softer than expected secondary data from the Eurozone but that doesn’t seem to have been the driver. The RBA left rates on hold, as expected, and the statement indicated that they were unlikely to start to tighten policy anytime soon. That certainly has helped undermine AUD this morning. But away from that information, there was precious little else to discuss.

On the emerging market side, the dollar has shown a much stronger general performance with TRY falling 1.0%; and both BRL and ZAR down 0.8%. In fact, the only gainer of note was KRW, +0.3%, which was a reaction to President Trump’s visit and positive comments on the US-Korean relationship. As to the decliners, it seems that the scheduled meeting between Vice-President Mike Pence and Turkish Premier Yildirim was postponed, as visa issues remain unresolved between the two nations. Meanwhile, the rand story seems to be more about its ordinary volatility as there has been neither data nor news of note released. Finally, yesterday saw a substantial BRL rally on the back of the strength of oil and commodity prices in general, and this morning, the lack of follow through there seems to be weighing on the real.

Looking ahead, there is little in the way of data today, just the JOLTS report (exp 6.075M) which has had very limited impact over time. We also hear from new Fed Governor Quarles, but his topic of discussion doesn’t seem to be related to monetary policy. In other words, it is another day with no clear drivers to follow. Equity futures are little changed this morning, offering no clues to direction there, and Treasuries have given up a bit of their recent gains, but remain beneath the key 2.40% level. If pressed, I would say we are likely to see the dollar soften a touch in the NY session, as I can find no real driver for its overnight strength. But don’t look for too much movement overall.

Good luck

Adf

December Rate Hike Probabilities:

USD   92.3% + (NFP leaves Fed on track)

EUR     2.9% + (Think December 2019)

GBP    0.2% – (Thursday’s move will be last til 2019)

CAD   23.6% = (Middle of next year)

Fed Rhetoric               25bps

Last week we heard two things of note

First that Powell, the Prez would promote

Then the payroll report,

Though the headline fell short,

Showed the Fed, higher rates, will soon vote

FX markets this morning have shown little movement from Friday’s closing levels after a more tumultuous session last week. While the market reaction to the news that Jerome Powell would be the next Fed Chair was limited, the payroll report on Friday morning had the expected impact of boosting the dollar further. Nonfarm payrolls were not quite at the level expected, although there was a significant revision higher to previous months’ data, which offset the headline print. Of more importance, it seems was the fact that the Unemployment Rate fell to 4.1%, its lowest level since December 2000, and significantly below the Fed’s own estimate of full employment, which currently sits at 4.6%. As such, it should be no surprise that the market continues to ramp up their expectations for higher US interest rates at an increasing clip. And that will continue to support the dollar going forward. So since the close of business on Thursday, ahead of the report, only two currencies have shown any gains vs. the USD: CAD and GBP.

The CAD story can be attributed to the ongoing rally in oil prices I believe, as WTI has now rallied nearly 14% in the past month and is at its highest level since February. If we continue to see oil rise, I expect that we will continue to see support for the Loonie. Rig counts in the US have been falling of late and OPEC appears set to extend its own production cuts now that oil prices are moving up. From a technical perspective, we have also seen the Brent market extend its backwardation (when spot prices are higher than future prices), which has historically been a signal of further price rises. This indication of spot shortages is relatively new and I expect will underpin oil prices as well as the petrocurrencies for a while. While we have not seen that price action in MXN or RUB yet, NOK is firmer this morning as well.

The other rally has been in the pound, and that is one that is much harder for me to rationalize. While the BOE did raise rates, as widely expected, last week, as can be seen from the table above, the market remains convinced that they will not act again anytime soon. Adding to that is the ongoing political scandal in the British government, where senior figures are being accused of rampant sexual harassment, distracting PM May from her already difficult task of dealing with Brexit. While the UK data has held its own, given the prevailing view that the BOE is now sidelined, it is hard to make a case for a higher pound. While we have seen Sterling fall sharply since the BOE announcement, my sense is that the price action today simply represents a modest rebound on the unwinding of short positions from that move. Given the combination of the ongoing growth story in the US with the concomitant expectations of further Fed rate hikes, and the belief that the BOE will be sidelined indefinitely, or at least until after the UK exits the EU, it is increasingly hard for me to make a case for the pound to do anything but fall. Selling rallies here remains the best opportunity for hedgers in my view.

But otherwise, the G10 currencies have done little of note overnight. On the EMG side, there are two major gainers, BRL and TRY, both of which have rallied more than 0.8%. The story in Brazil is of higher commodity prices helping to underpin Brazil’s export industries and by extension its currencies. Updated inflation forecasts remain under control (3.08% for 2017, 4.02% for 2018), which has reduced expectations for policy adjustments amid a period of stability. My take is that stability is a positive here. Meanwhile, the TRY story is one of central bank support in the market as a means to slow down its recent, sharp decline. After all, in the past two months, the lira has fallen nearly 14%, and that includes today 0.85% rally. The central bank is becoming concerned and is likely to become more active in the FX market there going forward. But away from those two currencies, stories in this space are sparse.

While the first week of the months tends to bring a great deal of economic data, the second week is just the opposite, with a limited slate. Here’s what to expect:

Tuesday                        JOLTS Job Openings                                    6.053M

Consumer Credit                                         $17.5B

Thursday                      Initial Claims                                                 232K

Wholesale Inventories                                 0.3%

Friday                            Michigan Sentiment                                    100.6

And that’s it! None of these are likely to drive market sentiment, quite frankly. And looking to the Fed shows a limited calendar there as well, with just Dudley and Quarles on the slate for today and tomorrow. One thing I didn’t mention was the news that NY Fed Prez Dudley is set to announce an early retirement today, apparently leaving ahead of schedule, which means that there will be yet another new face at the FOMC meetings going forward. My observation is that given the markets’ generic reliance on central bank activities to support asset prices and constrain volatility, it seems that having this many changes at the Fed in such a short period of time offers the opportunity for some investors to reconsider their current market stance. If money is no longer free, does it make sense to earn just 2.3% for 10-year Treasuries? How about less than 2.0% for European High Yield securities. Perhaps normalization is coming sooner to a screen near you than expected. Benign markets have been with us for almost a decade, since the financial crisis in 2008-09. They will not last forever.

Good luck

Adf

December Rate Hike Probabilities:

USD   92.3% + (No surprises yesterday, high confidence now)

EUR     1.9% – (Think December 2019)

GBP   91.6% + (Done deal this morning)

CAD   21.7% = (Ain’t gonna happen now, maybe July 2018)

Fed Rhetoric               25bps

This morning as I go to press

The Old Lady’s likely to stress

Inflation is rising

And so She’s revising

The base rate to limit excess

While yesterday Janet and friends

Implied that she fully intends

To hike in December

Though not every member

Is likely, this move, to defend

The FOMC meeting went off without a hitch yesterday, with the statement actually upgrading the view on economic growth to “…a solid rate despite hurricane related disruptions.” There is certainly nothing dovish about that comment. The committee’s view on inflation remains less upbeat, and it is clearly still a mystery to them why measured inflation remains below their 2.0% target given consistent GDP growth and the ongoing strength of the labor market. However, there was nothing about the statement that could be construed as dovish in any sense, and while Neel Kashkari may well dissent in the December meeting, it remains abundantly clear that the Fed is going to raise rates by 25bps at the next meeting. If you recall, yesterday’s probabilities showed a substantial decline as some traders bet on a dovish outcome. However, with the market now pricing north of a 90% probability for a December move, it will require a significant downturn in economic data to halt that momentum. In addition, we learned that Jerome Powell is now set to be the new Fed Chair. He is a current governor (who has never dissented on policy votes) and is seen as a moderate. Happily, he is not a PhD in Economics, although unhappily he is a lawyer. However, it appears that the trajectory of monetary policy is not likely to change much, at least initially, and his focus may well be on regulatory issues. I would be quite surprised if the market reacted in any significant way to the formal announcement due later today.

Which brings us to this morning’s key activity, the Bank of England’s monthly meeting. Though there are many pundits who believe it is a mistake, it does seem likely that the BOE will raise rates by 25bps this morning. They have essentially talked themselves into the move as their key concern remains, despite substandard growth (averaging just 1.5ish% since Brexit), inflation caused by the pound’s sharp, post-Brexit decline. I continue to believe that this will be ‘one and done’ with almost no probability that Carney will raise rates again until after the UK leaves the EU. Uncertainties over the potential framework by which this occurs will continue to weigh on business decisions and by extension economic growth. Although the data this morning (Construction PMI at 50.8) was modestly better than expected, there is no indication that growth is picking up significantly. At the same time, nominal wage growth remains desultory and with the elevated inflation readings real wage growth is actually negative. It is just hard for me to see how the BOE will be able to raise rates more aggressively with that economic background. Of course it is not only interest rates that drive currencies, and yesterday saw the pound reverse all of its early morning gains, and then some, after the news that UK Defense Secretary, Michael Fallon, resigned. While I am confident that few FX traders know who he was or what his policy agenda was, it was yet another sign that PM May’s grip on power remains tenuous. Right now, the pound appears to be caught between concerns over a more hawkish than warranted BOE and concerns over further weakness in the government. The one thing of which I am confident is that if PM May were to lose control, and the market believed that Jeremy Corbyn was likely to become PM, the pound would fall further. Socialism is not seen as a benefit for either markets or currencies these days! But for today, it will be all eyes on the BOE, with the statement due at 8:00 this morning.

Beyond the Fed and BOE, there has been much less of interest overnight. Eurozone PMI Manufacturing data was released largely as expected and saw little reaction in the markets. Growth in the Eurozone remains solid, if unspectacular. Meanwhile, the euro continues to trade at the lower end of its three-month trading range, although today it is higher by 0.2%. And beyond that, it is exceptionally hard to find interesting news.

EMG currencies have also been pretty dull although ZAR has rebounded about 0.7% from its recent depths. It doesn’t appear there have been any changes to the political situation on the ground, simply that traders are reducing short ZAR positions.

As to the US this morning, we get more data to add to the mix: Initial Claims (exp 235K); Nonfarm Productivity (2.6%); and Unit Labor Costs (0.4%). Now there are many pundits, myself included, who believe that one of the key problems we have in the US economy is the lack of productivity growth. I think this stems from the fact that since the beginning of the ZIRP era corporate policies have been far more focused on financial engineering (issuing debt to repurchase shares) rather than investment in production facilities. As such, if today’s report meets expectations, it would be good news. But in the end, tomorrow’s payroll report is of far more consequence than today’s data so I wouldn’t expect any FX movement regardless of the release.

One more thing, I will not be writing tomorrow, as I will be out of town. But I strongly believe that the FX market will respond somewhat symmetrically to the jobs release. If pressed, my sense is the post-hurricane rebound will be even larger than currently expected, maybe 350K-375K, and it will simply cement the idea that the Fed is going to be raising rates come December. Look for the dollar to benefit on that type of news.

Good luck and good weekend

Adf

December Rate Hike Probabilities:

USD   66.8% – (Worries about a dovish surprise today)

EUR     2.7% = (Think December 2019)

GBP   89.9% + (Done deal, probably tomorrow)

CAD   21.4% – (Ain’t gonna happen now, maybe May 2018)

Fed Rhetoric               25bps

At two o’clock this afternoon

The Fed will explain, none too soon,

That rates are on hold

But on the threshold

Of moving ere the next blue moon

In what has to be one of the least anticipated Fed meetings in the past several years, the FOMC will release its latest statement at 2:00 today. As there is no press conference scheduled to follow the meeting, expectations for any rate movement are essentially nil. Interestingly, the Fed Funds futures market rallied pretty sharply yesterday as can be seen by the 20% decline in the probability of a rate hike by December. However, I would dismiss that idea completely.

One of today’s minor narratives is that the Fed statement is far more likely to be seen as relatively dovish given the growing expectations of a December hike and the still notable absence of inflationary pressures. With the most recent core PCE release at 1.3%, the doves want to believe that the Fed could walk back talk of a December move. But I think that hope is misplaced. Given the ongoing strength of the economy as evidenced by recent GDP and PMI data, the Fed is going to cling to its Phillips Curve model and offer no indication that December is in question. While they won’t promise a rate hike then, they will not dispel the idea either. All told, I would fade any moves representative of the Fed changing their ideas.

But this morning, there are precious few of those ideas, quite frankly. The dollar has had a mixed session, with both winners and losers in both the G10 and EMG blocs. The biggest gainer overnight was NZD, which rallied nearly 1.0% after better than expected employment data was released. Remember, kiwi had suffered on the political changes that had occurred after the election several weeks ago, so it was likely a bit oversold as well. While it remains some 3.5% lower than before the election, last night’s move was impressive nonetheless. Away from that, though, the G10 has shown modest movement overall with the yen’s 0.3% decline (risk-on anyone?) the next largest move. We did see one interesting piece of news, UK Manufacturing PMI was released at a better than expected 56.3. This number continues to show that the pound’s post-Brexit depreciation has been beneficial for the sector, especially exports. The data also showed that price pressures continue to rise thus underpinning the BOE’s desire to raise rates tomorrow. While the pound is slightly higher, the 20-pip move is hardly enough to generate excitement.

Pivoting to the emerging markets, the biggest mover was TRY, falling 0.75% after the central bank governor warned of higher inflation in both October and November. This comment hurt Turkish equities and bonds as well as the lira. But away from that news, the other currencies in the group that fell all did so in minimal fashion. On the other side of the spectrum, KRW rallied 0.55% overnight, as relations between China and South Korea seem to be warming somewhat. If you recall, the Chinese were quite upset when the US sold South Korea the THAAD missile defense system in an effort to help protect against North Korean actions. The Chinese claimed it was a threat to them. But after a year, and arguably given just how erratically North Korea has behaved, the Chinese seem to be a bit more forgiving of the action and so economic ties are beginning to warm again. With China as Korea’s largest export destination, those relations are critical to South Korea’s economy. If these problems are now past, I would expect KRW to outperform most of its APAC brethren for a while. But away from that news, the rest of the gainers are unimpressive with no real storylines to follow.

Ahead of the FOMC this morning we will see the ADP Employment number (exp 200K); ISM Manufacturing (59.5) and Prices Paid (67.8); as well as Construction Spending (-0.2%). With yesterday’s blowout Chicago PMI number (66.2, exp 60.0), I would expect that traders are looking for even better data this morning. And it is this data that will continue to underpin the Fed’s drive to raise rates in December. Finally, at 2:00 the Fed statement will be released. I remain firmly in the camp that they will acknowledge the continued improvement in the economy and do nothing to dissuade from the idea that rates are set to move higher soon.

Good luck

Adf

December Rate Hike Probabilities:

USD   82.8% – (Increasingly likely)

EUR     2.4% – (Think December 2019)

GBP   88.5% + (Done deal, probably this week)

CAD   24.3% – (Ain’t gonna happen now, maybe June 2018)

Fed Rhetoric               25bps

The one thing that’s truly ‘persistent’

Is price rises are nonexistent

Thus Draghi will keep

The cash rate quite cheap

With any rate hike still quite distant!

Inflation – Inflation is defined as a sustained increase in the general level of prices for goods and services in a county, and is measured as an annual percentage change. Under conditions of inflation, the prices of things rise over time. Put differently, as inflation rises, every dollar you own buys a smaller percentage of a good or service. When prices rise, and alternatively when the value of money falls you have inflation. (from Investopedia)
Once again I will ask, why are central bankers so keen for the rest of us to pay more for the goods and services that we buy on a regular basis? I don’t know about you, but I know that I am perfectly happy when the price of things remains stable over time. And for those things like electronics, where the price falls, I think that is even better. I guess this attitude precludes me from ever being a central banker, but I would be interested to hear from anyone who appreciates rising prices in their daily life. I bring this up because once again inflation, or the lack thereof, is a key topic of discussion. This morning the Eurozone CPI data showed that headline inflation fell to 1.4% (exp 1.5%) while core fell even further to 0.9% (exp 1.1%). This brings to mind the ECB’s recent meeting where they laid out plans to cut the rate of QE purchases in half starting in January 2018, and retain the current interest rate structure (Deposit rate of -0.4%) for an extended period of time beyond the end of QE. Remember, Signor Draghi said that the ECB will remain “…patient and persistent” in their easy money stance. Well, certainly today’s CPI data will not have changed that view.

Interestingly, Eurozone GDP data continues to improve, with Q3 printing, preliminarily, at 0.6% and Q2 revised higher to 0.7%. So the economy in the Eurozone seems to be performing pretty well. In fact, it is the best performance since 2011 on that measure. At the same time, the Unemployment Rate there fell to a lower than expected 8.9%, its lowest measure since 2009. And yet, to listen to the ECB, you would think the Eurozone economy was in a depression. Falling unemployment, quickening growth and modest inflation sounds like a winning combination. But I guess not. At any rate, the market response was to sell the euro on the CPI data as that merely cemented the idea that the ECB will not be adjusting policy rates for several years to come. I have been suggesting December 2019, but if CPI remains this low, it could be longer still.

Last night we also heard from the BOJ which left policy unchanged as universally expected. Negative rates and control of the yield curve have certainly helped the economy, which has shown positive GDP growth for the past seven quarters, its longest streak in 16 years, and it has helped power the Nikkei to its highest level since 1996. But there is no happiness there either. In fact the one dissenting vote on the BOJ council wanted to control the yield curve out to 20-years, not just 10. I guess some people are never happy. At any rate, it should be no surprise that the yen is a bit softer this morning as well, down 0.15%.

In fact the only G10 currency that is higher this morning vs. the dollar is the pound, which is up just marginally, as the market prepares for the BOE to raise rates on Thursday. CPI is running at 3.0% in the UK, well above their 2.0% target, and though GDP growth remains desultory and uncertainty over the Brexit outcome is significant, Governor Carney seems set to raise rates. This will, however, be one and done. The BOE will not raise rates from the new level, expected to be 0.50%, for at least a few years.

In the end, all of this is why I continue to harp on the policy divergence story. It is truly only the Fed that is willing to acknowledge that the economy no longer needs the continuous boost of extraordinary monetary policy stimulus and will continue its rate hike path. And in the end, higher US interest rates combined with stagnant, record low interest rates elsewhere in the world will draw dollar buyers out of the woodwork. The dollar has further to run higher!

Helping to underpin the Fed’s case was yesterday’s Personal Income and Spending data, as well as yet another Fed survey (Dallas) showing manufacturing growth performing well. In fact, since the hurricane impacted payrolls data at the beginning of October, we have seen a steady run of positive, better than expected US data. I continue to expect the Fed to raise rates at least three times next year and believe that four hikes are quite viable. The Fed funds futures market continues to price in just 40bps over that time frame. The dollar has further to run. And that doesn’t even assume that tax reform is passed and with it some sort of repatriation act, which will simply supercharge the dollar’s rally. (Remember the HIA in 2005?). Hedgers beware.

As to today’s data, we see the Employment Cost Index (exp 0.7%); Case Shiller House Prides (5.93%); Chicago PMI (60.0); and Consumer Confidence (121.5). I would argue that all eyes will be on the Chicago number as a harbinger for tomorrow’s ISM data. But in the end, Friday’s payrolls report remains the big kahuna and so positioning is likely to remain light. Of course, the BOE meets Thursday, so there is always the possibility that Governor Carney fails to deliver the widely expected rate hike, something he has done before both at the BOE and previously at the Bank of Canada. I don’t expect that, but it cannot be ruled out. However, my assumption is the BOE will act according to plan and that the US data picture will be the critical feature. Oh yeah, the FOMC meets tomorrow, but there is essentially no expectation that they will do anything, a prospect with which I agree heartily.

To sum it up, all signs still point to tighter US policy alongside unchanged, ultra-easy policy elsewhere in the world. The dollar has further to run.

Good luck

Adf

December Rate Hike Probabilities:

USD   84.3% – (Increasingly likely)

EUR     3.1% + (Think December 2019)

GBP   88.0% – (Done deal, probably this week)

CAD   26.9% – (Ain’t gonna happen now)

Fed Rhetoric               25bps

The signs point to growth on the rise

With GDP’s Friday surprise

So look for the Fed

To power ahead

With rate hikes bond bulls will despise

Although the Fed does meet this week, there is virtually no expectation that there will be any policy adjustments at the meeting as there is no press conference scheduled to follow. It seems that Chair Yellen, as did Chair Bernanke before her, are afraid to allow the market to simply respond to their actions without an explanation. One might think that market participants are incapable of understanding what the Fed is doing if the Fed doesn’t tell them explicitly (certainly Yellen believes that). I actually consider this to be one of the worst features of the current Fed, this effort at transparency, which has resulted in the entire market building the same position. And while I understand that it was an effective method of driving policy ease during the crisis, its shortcomings are far more evident now as the Fed attempts to adjust its policy. Forcing Encouraging investors to buy risky assets during a crisis is an understandable, if potentially misguided, central bank response. However, the palpable fear that those same central banks now exhibit over any market correction has delayed policy normalization for a number of years and allowed significant excesses to build in markets. It is why virtually every equity (and fixed income) valuation measure is at historically high levels, and why I remain concerned that when this market cycle turns (and it will turn at some point) the results will be at least as dire as the financial crisis in 2008/09 if not worse. There is no perpetual motion machine, the laws of physics see to that. Similarly there is no perpetual moneymaking machine, the laws of economics prevent that as well. With that in mind, I think it is fair to say that Wednesday’s Fed meeting will have virtually no impact on the market. I would look for the statement to be essentially unchanged from the September meeting and all focus will remain on December’s outcome.

It is with this backdrop that we turn to this morning’s FX market where the dollar is modestly softer. The thing is, given the dollar’s performance during the past two weeks, where it has rallied vs. essentially all its counterparts, a modest correction is only to be expected. In fact, Friday’s US GDP data showed that the economy is not only maintaining a fairly strong pace of growth, printing at a better than expected 3.0%, but that price pressures continue to build. The GDP Price Index printed at 2.2%, its highest level in five quarters, and potentially indicative that the Fed’s goal of generating price inflation, as opposed to asset inflation, is working. After all, they have generated asset inflation in spades for the past nine years! Nonetheless, the data are simply the latest in a long line that will help cement the Fed’s more hawkish rhetoric and insure that they raise rates, not only in December, but numerous times next year. Once again I will reiterate that the narrative that has been driving markets, that of policy convergence, is no longer valid. The Fed remains in tightening mode, despite the market’s reluctance to accept that, while the ECB remains in easing mode, despite the market’s reluctance to accept that either. The dollar has further to climb, although it won’t be in a straight line. Hence, today’s price action of a modest correction is perfectly normal.

A quick tour of the overnight activity shows that both Japanese and German Retail Sales data continue to grow as expected, if not even a little better. Meanwhile, German inflation data are drifting out from the states with the national number due at 9:00 this morning (exp 0.1%, 1.7% Y/Y). But Signor Draghi has made it clear that he is less concerned about Germany than about the Eurozone as a whole, and that easy money is the order of the next nine months, at least, on the continent. The other piece of news from Europe was a stronger than expected Economic Confidence number, printing at multi-year highs. However, the continued absence of measured price inflation will keep the ECB at bay for a long time to come.

Otherwise there has been remarkably little news of note released. And that includes the emerging market bloc as well. While the dollar is generally softer there, the movement is so modest and broad based, it can only be a position squaring exercise.

As this is the first week of the new month, we do see a great deal of US data as follows:

Today                         Personal Income                                    0.4%

Personal Spending                                 0.9%

PCE Core                                                   0.1% (1.3% Y/Y)

Dallas Fed Mfg                                         21.0

Tuesday                     Employment Cost Index                        0.7%

CaseShiller Home Prices                        5.90%

Chicago PMI                                              60.0

Consumer Confidence                             121.0

Wednesday               ADP Employment                                    200K

ISM Mfg                                                     59.4

ISM Prices Paid                                        67.3

Construction Spending                           -0.2%

FOMC Rate Decision                                1.00%-1.25% (unchanged)

Thursday                   BOE Rate Decision                                    0.50% (+0.25%)

Initial Claims                                             235K

Nonfarm Productivity                              2.5%

Unit Labor Costs                                        0.4%

Friday                        Nonfarm Payrolls                                    310K

Private Payrolls                                        300K

Mfg Payrolls                                                18K

Unemployment Rate                                 4.2%

Average Hourly Earnings                        0.2%

Average Weekly Hours                            34.4

Participation Rate                                     63.1%

Trade Balance                                           -$43.3B

ISM Non-Mfg                                              58.5

Factory Orders                                          1.2%

So as you can see there is a ton of stuff coming out this week. And expectations are running high for the data to demonstrate continued strength in the US economy. Clearly the NFP number is expected to make up for last month’s hurricane impacted number, so I would look for the average as a better idea of the run rate. In this case, that would be about 138K, not dissimilar to what we were seeing before the hurricanes. But looking at the ISM data, the Personal Spending data and the confidence data, it is very easy to understand why the Fed is going to stay the course. And this is true regardless of who is the next Fed Chair. This week should remind everyone why the dollar is likely to recoup a significant portion of its lost value from earlier this year. As I have been discussing for a while, hedgers, take advantage before the move starts in earnest.

Good luck

Adf

December Rate Hike Probabilities:

USD   87.1% + (Increasingly likely)

EUR     2.6% – (Think December 2019)

GBP   90.0% – (Done deal, probably in November)

CAD   30.2% – (Ain’t gonna happen now)

Fed Rhetoric               25bps

The ECB, yesterday, stressed

Inflation continues depressed

So bonds they’ll keep buying

As Draghi keeps trying

To show how much Europe’s progressed

The dollar has been the main beneficiary of yesterday’s ECB meeting, with a sharp rally against every currency in both the G10 and EMG blocs since then. The euro is lower by more than 1.6% in the interim, with the Skandies even worse off, down more than 2% each, as their central banks are now seen as more likely to delay any policy tightening until the ECB gets started. As I suggested, while the ECB reduced the QE purchase program to €30 billion/month for at least the first nine months of 2018 with the option to continue beyond that, Signor Draghi was emphatic in his description of the interest rate trajectory, which will remain at current levels well beyond the end of QE. I have been adamant that the ECB will not touch the interest rate structure for another two years, and it appears that Signor Draghi is in the same camp. Given this outcome, it can be no surprise that the euro fell sharply, nor that the dollar rose overall. After all, as I have also been discussing, the narrative took a hit on the news. Policy divergence remains the order of the day (Fed tightening, ECB still adding stimulus) rather than policy convergence. And the euro’s vaunted 12% rally since the beginning of the year, which has largely been predicated on the policy convergence story, is now likely to reverse somewhat further. As of now, the euro is at its lowest level since late July. Look for further declines. 1.12 anyone?

Looking to the pound, it too continues to suffer as the market becomes increasingly certain that the 25bp rate hike, that seems almost assured next week, is the only one for a long time. UK data has had a bad run lately everywhere except on the inflation front, with prices the only thing showing upward momentum. There is no way that Governor Carney can raise rates next year, or any time ahead of the Brexit resolution in Q1 2019 for that matter, as the UK economy will be gripped with uncertainty during that period. With the Fed still in tightening mode, the pound will find itself under increasing pressure going forward. As I have said repeatedly, receivables hedgers need to take advantage of prices above 1.30 because we are going to spend a long period of time below that level in the near future.

The last noteworthy story in G10 space has been in Australia where the High Court there ruled that five of the ruling party’s lawmakers were ineligible to serve because of their hitherto unknown dual citizenship status. While the issue seems technical, what happened is that PM Turnbull has lost his majority in Parliament and his ability to govern effectively has now called into question. As such, policy prescriptions that the market had seen as favorable and leading to more economic growth have been called into question, reducing the chances that the RBA will raise rates any time soon and undermining the currency further. Aussie has had a bad run of it lately, falling more than 2.25% in the past week. Given the evolving narrative, I think it has further to fall as well.

Pivoting to the emerging markets, it should be no surprise that the worst performers since the ECB meeting have been the CE4, all of which are down at least 1.7%. Given the tight relationship between these currencies and the euro, it is only natural they have followed the single currency lower. Away from this space, BRL has been the biggest loser in the EMG bloc, falling 1.7% since then, and 3.5% this week, on a combination of factors. Arguably, the big picture policy divergence story is giving an underlying bearish tone to all EMG currencies. But we also had the BCB cut its benchmark Selic rate to 7.5% yesterday, taking it below the rates of both Turkey and South Africa, two competitors for carry trade flows. Meanwhile, the Brazilians are trying to address their own pension crisis, with policy outcomes there likely to have an important impact on the economy and the currency by extension. The recent break above the 3.20 level has traders scrambling to cover exposures, further pressuring dollar short positions, and on top of it all, there is the hawkish Fed backdrop. It is not hard to envision a move back toward 3.50 in USDBRL as these issues play out.

This morning brings the most important US data of the week, with our first look at Q3 GDP (exp 2.6%) and its concurrent subcomponents, as well as Michigan Sentiment (100.7). Yesterday’s data was largely in line with expectations, although interestingly, the Pending Home Sales number I had highlighted came in much worse than expected at 0.0%, which is more in line with the trend we had been seeing prior to the hurricanes’ collective impact. Nonetheless, I continue to look for the US data to be sufficient to allow the Fed to maintain its hawkish tone and stay on track for a December rate hike and more next year. If pressed, my sense is that President Trump will name John Taylor as the next Fed chair, which will be perceived, at least initially, as hawkish as well. US Treasury yields continue to rise, helping to underpin the dollar as spreads to other government debt widen in the US’ favor. All signs still point to a higher dollar in my view. Hedgers, keep that in mind.

Good luck and good weekend

Adf

December Rate Hike Probabilities:

USD   83.6% – (Increasingly likely)

EUR     3.3% + (Think December 2019)

GBP   91.5% + (Done deal, probably in November)

CAD   32.5% – (Ain’t gonna happen now)

Fed Rhetoric               25bps

This morning Signor Draghi tries

To find a path forward that’s wise

How much and ‘til when

Will Draghi’s wise men

Buy bonds ere the program’s demise?

Markets in general have been fairly quiet as traders across all asset classes await the ECB decision this morning. Expectations are for the ECB to reduce the amount of bonds it buys each month, to between €30 billion and €40 billion, with a promise to continue buying those bonds for at least six more months and potentially longer if deemed necessary. There is no expectation for a change in either interest rates, or even in the forward guidance regarding the potential timing of interest rate changes. In fact, expectations are that Draghi will seek to lean toward the dovish side of the spectrum to prevent the euro from rallying further. Remember, that although the euro is higher by some 12% this year, it hasn’t actually moved at all in the past three months. Draghi’s fear of a higher euro stems from the concern that it will negatively impact both Eurozone inflation and corporate earnings and the export sector of the Eurozone economy going forward. All told, I agree with the consensus here, as the ongoing lack of any true inflationary impulse in Europe will force the ECB to continue QE for longer than they may want to do so. In fact, the area in which I disagree with consensus is that of interest rate expectations, with my view that the ECB, even after they have stopped adding to their balance sheet, will not raise rates for far longer than currently expected. Net, it should be no surprise that the euro has barely moved overnight amid an extremely tight trading range.

I failed to mention the Bank of Canada meeting yesterday, but it actually resulted in a somewhat surprising outcome as Governor Poloz backed away from the more hawkish rhetoric of late and not only passed on a third consecutive rate hike, but indicated that going forward policy was likely to be somewhat less hawkish than previously assumed. The market reaction was swift with the Loonie falling 1% on the news and essentially maintaining those losses overnight. As you can see at the top of the note, the probability for a December rate hike continues to fall, and even if (when) the Fed moves in December, the BOC is likely to stay put.

The most notable G10 mover overnight was GBP, falling 0.3%, after a much weaker than expected retail sales report. In the UK, there is an organization, the Confederation of British Industry (CBI), which surveys its membership with regard to different economic variables. Their October report on Retail Sales fell to its lowest level since the financial crisis in 2009, and the pound declined immediately. Clearly, the combination of Brexit uncertainty and lack of real wage growth in the UK is having an impact. Once again I will reiterate my strong belief that the pound has much further to fall as the Brexit saga plays out. Hedgers take note.

Away from the G10, the biggest mover was, once again, ZAR, which has declined 1.7% this morning after the new FinMin, Malusi Gigaba, described a bleak outlook for the country’s fiscal picture during the next three years. Concerns of yet another credit ratings cut for the nation’s growing debt load are weighing on the currency. But away from the rand, there is precious little happening in the EMG bloc as well.

Aside from the ECB meeting, we see some more US data including Initial Claims (exp 235K); Wholesale Inventories (0.4%); and Pending Home Sales (0.5%, -4.2% Y/Y). I bring up the last because of the blowout number in New Home Sales yesterday, rising by 667K, well above the expected 554K. It seems this is a direct impact of the hurricanes, as almost 20% of these sales have not even broken ground. Generally that percentage is much lower. Yesterday also saw Durable Goods print at a higher level than anticipated, 2.2% vs. 1.0% expected, as hurricane related growth there was also evident. While I am certain the Fed will recognize that this data has been distorted by the hurricanes, it also serves a great purpose in helping them argue for their continued tightening cycle despite the lack of measured price inflation.

At this point, markets remain dependent on both central bank activities as well as the US fiscal/political story. I have not mentioned Treasuries of late but during the past two months, yields on the 10-year have climbed almost 40bps. At the same time, yields on the 2-year have climbed 30bps. Historically, as US yields climb, the dollar gathers support and I see no reason for this time to be different than any of the past situations where this has occurred. Again, I continue to disagree with the narrative and believe that the Fed will remain more hawkish than the market currently expects while the ECB remains more dovish. I still like the dollar higher over time.

Good luck

Adf