December Rate Hike Probabilities:

USD   87.1% + (Increasingly likely)

EUR     2.7% – (Think December 2019)

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

CAD   43.6% = (NAFTA uncertainty impact)

Fed Rhetoric               25bps

In London on Threadneedle Street

The BOE, monthly, does meet

The data today

Could certainly sway

Next week, a rate hike, to complete

The pound is the big winner this morning, rallying more than a penny after Q3 GDP data was released showing better than expected growth of 0.4%. While that still equates to an annual growth rate of just 1.6%, the market was looking for worse, hence the pound’s sharp reaction. Interest rate traders have taken the news as a reaffirmation that the BOE will raise rates at their meeting next week. Alas, the BOE remains caught in a tough situation. GDP growth at 1.6% is just not that impressive on a historical basis, and ordinarily would not result in a central bank considering rate hikes. But the ongoing impact of the pound’s sharp deterioration since the Brexit vote in June of last year has led to inflation running well ahead of the bank’s mandate of 2.0% (last printed at 3.0%). Thus Governor Carney and his colleagues find themselves between the proverbial rock and hard place. They need to address inflation but they don’t want to undermine a soft growth pattern. Thus my view remains that while the BOE will act next week and raise the base rate by 25bps, it will be the last rate hike for a number of years. As long as there is uncertainty due to the Brexit outcome, which should last until the UK leaves the EU in March, 2019, the BOE will not be able to consider raising rates again. All told, I see today’s rally as a gift to receivables hedgers.

On the other side of the spectrum, today’s biggest loser has been the Aussie dollar, falling nearly 1.0% after weaker than expected CPI data (1.8%, exp 2.0%) undermined any thoughts that the RBA would consider raising rates in the near future. While the base rate in Australia remains at historically low levels of 1.50%, the ongoing lack of inflationary pressures has allowed the central bank to watch from the sidelines as growth Down Under picks up. But traders continue to be more focused on interest rate policy than growth, per se, and so with policy tightening the order of the day elsewhere in the world (notably the US and Eurozone), the lack of tightening here will continue to weigh on the currency.

But away from those two currencies, there is truly not much of a story to tell in FX today. The yen continues its weakening pace, but last night’s movement was meaningless. Meanwhile, the euro has edged higher again this morning, just 10 pips though, ahead of tomorrow’s ECB announcement. The debate on exactly what the ECB is going to do with regards to tapering QE continues, but with no further clarity until tomorrow, there is no reason to consider establishing a position here. It is uniformly expected that the amount of bonds purchased each month will decline, but by how much remains unknown. Of more importance, at this stage, seems to be the wording around when interest rates might start to rise. The current guidance explains that, “We expect them [interest rates] to remain at their present levels for an extended period of time, and well past the horizon of our net asset purchases.” So any changes to that line will be closely watched by the market. Personally, I don’t believe Draghi will adjust that wording while he is explaining the changes in QE. It will be easy for him to wait until the December meeting to start adjusting those expectations, especially given just how persistently low inflation remains in the Eurozone. But until we hear from Signor Draghi, I can’t imagine the euro will show much movement.

As to the Emerging markets, it has been a rather dull session with an equal number of gainers and losers and no currency making any significant headway in either direction. The end of the Chinese Communist Party Congress resulted in President Xi consolidating his power without naming a likely successor. Arguably, this means that we will see further state control of the economy there which means that in the short run, currency activity will be closely managed. Therefore, it may well be time to reconsider my belief that the renminbi would weaken more substantially going forward. Rather, my take is that Xi will want a stable currency as part of his legacy, and given both the ability and willingness of the PBOC to essentially fix the currency, I’m guessing that is the most likely outcome going forward. For hedgers, payables ought to be hedged to earn those points while receivables are probably best left alone.

This morning brings the first real data of the week with Durable Goods (exp 1.0%, 0.5% ex-transport) and New Home Sales (554K). The thing about Durable Goods is that the series is so volatile it is difficult to draw any conclusions about the economy from any one data point. Meanwhile, the housing market continues to exhibit the behavior of a market that has peaked with all of the indicators somewhat lower than they were earlier this year. Perhaps the Fed’s actions to date have had a bigger impact than generally believed. But at the end of the day, I don’t believe either of these numbers will be sufficient to change views by Fed policymakers, or by the traders and investors who are watching them. So two surprising numbers brought two opposite reactions in the markets overnight, but for the rest of the day I don’t expect much additional movement. We will need to wait until tomorrow’s ECB statement for the next really big piece of news.

Good luck

Adf

December Rate Hike Probabilities:

USD   83.6% = (Still in the cards)

EUR     4.4% + (Think December 2019)

GBP   84.6% + (Done deal, probably in November)

CAD   43.8% + (NAFTA uncertainty impact)

Fed Rhetoric               25bps

The focus in markets is turning

To central bank meetings concerning

How fast they may tighten

And still fail to frighten

Investors who are quite discerning

The ECB will be debating

The pace for their recalibrating

Of purchasing bonds

As Draghi responds

To markets he feels need placating

FX markets have done little overnight, though if pressed I would say the dollar continues to perform well overall. While the euro has edged higher after mixed PMI data, both the yen and pound are weaker as I type. The thing is, given the lack of significant movement I would contend we are simply seeing positions adjusted ahead of Thursday’s ECB meeting and then the BOE’s meeting next week.

At this point, the market is certain that Draghi will announce a reduction in QE although there is debate as to exactly what form it will take. Numerous economists have estimated that there are only about €300 billion of eligible bonds left for the ECB to buy which means that the program will need to end some time next year. Either that or they will need to change their self-imposed guidelines on purchases. Draghi’s problem is that core CPI continues to run far below their target of ‘just below 2.0%’ with the most recent print at just 1.1%. So despite a clearly recovering economy, the actual ECB mandate is in no danger of being met in the near term. In fact, even the ECB’s own estimates claim the target won’t be reached until 2020! And yet reducing QE is clearly the direction in which they are heading, or in the vernacular, they will be ‘recalibrating’ QE as the last thing they want is to ‘taper’ purchases. A rough and ready way to determine the impact on the euro is to calculate the total amount of purchases they promise and compare that outcome to €200 billion. The larger their number, the more euro negative the outcome. For example, if the promise is €30 billion/month for at least six months, that would be seen as mildly hawkish and I would expect the euro to rally, while if they extend that to nine months or one year, it should be somewhat dovish. My view remains that they will be more dovish than expected and, when combined with the Fed staying the course, I still like the euro lower.

Meanwhile, the pound continues to suffer from a lack of clarity on the Brexit story with growing concerns that the mooted transition period may not materialize. British industry is clamoring for some idea of what to expect as well as a two-year period in which to make the necessary changes. But if the latest news is accurate, it seems there will be no clarity on how things will evolve for quite some time. This ought continue to be a negative for the UK economy and will prevent the BOE from doing more than the single rate hike they are seemingly determined to implement next week. If anything, I expect this hike will need to be rolled back sometime next year and the BOE’s credibility will be dented further. All in, the pound still looks too rich to me.

Finally, in Japan the BOJ has not been active in the equity market for most of this month. Remember, their ETF purchase target was ~¥500 billion per month, but they would only by when the Nikkei was lower in the morning session in order to support the market. However, the market there has risen for 16 consecutive sessions, thus eliminating the BOJ’s raison d’etre in this space. In the wake of PM Abe’s landslide reelection, foreign investors have been actively buying Japanese equities while the yen has remained under pressure. For now, there is nothing to suggest this will change, although one has to expect that the Japanese equity market will correct somewhat in the near term.

The emerging market space has been far more mixed, with both winners and losers, but in truth, only the Czech koruna has moved more than 0.25%. It seems that expectations are growing that the central bank there is increasingly likely to raise rates next week as inflation pressures build in the country on the back of a stronger economy. But away from that, there is really nothing in the space to discuss.

There is no first tier data today, with only the Richmond Fed Mfg. Index (exp 17) to be released. As the Fed is also in its quiet period ahead of next Wednesday’s meeting, the FX market will need to look elsewhere for catalysts. I would keep an eye on the ongoing strife in Spain as both the Spanish government and the Catalans prepare for a more contentious period later this week when the Spanish federal government will allegedly attempt to strip the region of its autonomy completely. Meanwhile the tax reform debate in the US could see some headlines with the ability to move markets, or perhaps President Trump will surprise us with an early Fed chair selection. However, my gut tells me that we are likely to remain in tight ranges ahead of the ECB’s press conference on Thursday morning.

Good luck

Adf

December Rate Hike Probabilities:

USD   83.6% + (Still in the cards)

EUR     2.2% – (Think December 2019)

GBP   83.6% + (Done deal, probably in November)

CAD   38.8% – (NAFTA uncertainty impact)

Fed Rhetoric               25bps

Japan reelects

Abe-san in a landslide

Prepare for more yen

The dollar is firmer this morning, rising against all its G10 counterparts as well as most of the EMG bloc. The weekend brought us the Japanese general election where PM Abe cemented his grip on power with his LDP party winning more than 60% of the votes in yesterday’s election and his coalition claiming more than two-thirds of the seats. This result may open the way for the first amendments to the Japanese constitution since US General Douglas MacArthur imposed it some seventy years ago. At the top of the list for Abe-san is to allow Japan’s Self-Defense Force to be upgraded to armed forces with the ability to project power and participate in peacekeeping missions outside of Japan. This is clearly an area where Japan’s neighbors are somewhat concerned given the history from the first half of the twentieth century. But it is also in keeping with what we have seen all over the world during the past two years, wherein homogenous groups of people want to have more authority over their lives and nations. It is this urge that drove the Brexit vote, that seems to be fueling the Spanish crisis in Catalonia, and underpinned the less well-known votes in Lombardy and Veneto that occurred this weekend where both Italian provinces voted, in non-binding referenda, for more independence.

So why does this matter, you may ask. Generically, I would say that the currencies of nations feeling these internal pressures are likely to weaken over time as the very nation’s existence may be called into question. But for today, specifically, it is all about the increased probability that Abe will reappoint Haruhiko Kuroda as BOJ Governor and that means that QQE is alive and well in Japan. Kuroda-san is a one trick pony who’s strong belief is that if he prints enough yen and buys enough assets the Japanese economy will power ahead and create inflation. In fairness, Japan has seen six consecutive quarters of GDP growth, its best performance since the late 1990’s. His problem is that the BOJ’s mandate is to generate 2.0% inflation, something that has not been achieved since the early 1990’s. But a long track record of failure is no reason for a government to change its approach, and I fully expect that the BOJ will continue to expand its balance sheet until at least the end of Abe-san’s time as PM. After all, if purchasing $2.5 trillion of assets hasn’t had an impact, the reason must be they simply haven’t done enough yet!

In the end, we have seen the yen trade back above 114 this morning, back to its weakest (strongest dollar) point since July and I would contend that there is more room to run. The high for USDJPY this year has been 118.60 and I expect that we are heading back to that direction, and potentially beyond. If you consider the simple fact that the BOJ are going to continue to run an easy money policy while the Fed remains on track to tighten further this year and next, a higher dollar should be the result.

As to the rest of the G10 this morning, the Swedish krona is the worst performer, falling 0.65%, although the euro (-0.4%) and Swiss franc (-0.3%) are all leaning in the same direction. In fact, the pound is holding its own (-0.2%) after PM May seems to have garnered some support after last week’s EU summit in Brussels. While infighting by the Tories remains rampant, at least there seems some possibility that the UK will move forward in Brexit negotiations.

In the emerging markets, TRY is the laggard, falling 0.8%, after a story in a local newspaper there raised the possibility that the US would impose sanctions against Turkish banks because of Iranian sanction violations. While the Turkish government denied the story, it has clearly impacted the lira. But the dollar is generally firmer, with the all of the CE4 falling between 0.2% and 0.4%, ZAR down 0.4% and even CNY falling 0.3%. This has been all about broad-based USD strength this morning, although there are a number of stories with modest individual impacts around.

Shifting to the data front, while the volume this week is limited, we do get the first look at Q3 GDP here in the US, which will certainly have the market’s interest piqued.

Wednesday                        Durable Goods                                     1.0%

-ex transport                                          0.5%

New Home Sales                                    554K

Bank of Canada Rate Decision            1.00% (unchanged)

Thursday                        ECB Rate Decision                                    -0.40% (unchanged)

Initial Claims                                               235K

Wholesale Inventories                             0.4%

Friday                             Q3 GDP                                                          2.5%

Q3 Price Index                                             1.8%

Michigan Sentiment                                   100.8

Aside from the US GDP data, the most widely anticipated feature of the week is the ECB meeting, where while no changes are expected for actual policy, Signor Draghi promised to outline the next steps beyond the current QE program. Expectations are for the current €60 billion/month of purchases to be reduced to between €30 billion and €40 billion and promised for another six to nine months (or longer if necessary). The smaller the promised total amount (monthly x minimum number of months promised) the better the euro should perform. After all, that will be seen as confirmation by the narrative that the ECB is tightening policy more rapidly.   But I continue to take issue with the entire narrative and expect that Fed actions will continue to dominate expectations, meaning tighter policy here will lead to a higher dollar. That’s just the way it works.

Good luck

Adf

December Rate Hike Probabilities:

USD   80.2% = (Still in the cards)

EUR     2.5% – (Think December 2019)

GBP   81.9% – (Done deal, probably in November)

CAD   44.7% – (NAFTA uncertainty impact)

Fed Rhetoric               25bps

Excitement is sweeping the Street

As Congress seems set to complete

Reform that’s elusive

Which might be conducive

To helping the US compete

So how will this impact the buck?

I tell you it clearly won’t suck

It should free the Fed

To tighten ahead

For dollar shorts this is bad luck

Arguably the biggest news overnight has been that the US Senate has passed a budget resolution that may pave the way for the President’s mooted tax reform. While the procedures to get from here to enacting a law are still complex and there is no certainty they will be completed, this is certainly the best fiscal news we have heard in a while. Under the circumstances, it is not surprising that the dollar, as well as US equity futures, are higher this morning, nor that Treasuries yields have risen almost 5bps. If Congress is able to agree a deal and put it on the President’s desk, it is increasingly likely that the Fed will feel far more comfortable in following through with their current policy path. Remember, the Fed has penciled in not just a rate hike in December, but also three more next year. The market, while it has finally come around to believing in the December move, remains skeptical of further action in 2018, with barely half that amount priced for next year. As I have written consistently, at some point, there will be a convergence between market pricing and Fed rhetoric. I continue to believe the Fed is going to stay the course, which means the market is going to need to reprice their expectations. Higher US interest rates will continue to underpin the dollar going forward. Add to this the imminent announcement of a new Fed chair, who will almost certainly be more hawkish than Janet Yellen and it simply reinforces that view.

So looking at G10 currencies, the euro has fallen a quick 50 pips this morning, essentially unwinding yesterday’s gains completely. The news from Europe was not data driven but rather focused on the outcome of the EU summit meeting where UK PM May continues to try to move the Brexit talks forward while the rest of Europe wants her to commit to a payment before anything else gets done. Chancellor Merkel did sound upbeat on the prospects for movement by December, but I remain skeptical that anything of note will happen even then. Interestingly, the pound is not following the script this morning, trading slightly higher (+0.1%) after its Public Sector Accounts data showed surprising strength. Comments from BOE member Cunliffe seemed to cloud the issue, but net the market is taking it all in stride. Whether the BOE does hike rates in November or not, the one thing that is clear is it will be a single, isolated rate hike and not the beginning of a tightening cycle. The pound has further to fall.

The yen has actually underperformed significantly this morning, falling 0.7%, after new polls from Japan showed the most likely outcome of Sunday’s general election is that PM Abe will lose his two-thirds majority in the Diet. While he should still cruise to victory, it means that constitutional change will be exceedingly difficult and that even the ordinary act of governance will be somewhat impaired. Finally, in the commodity bloc, both AUD and NZD are under pressure, with the former feeling the weight of commodity price declines across both energy and metals, while the latter continues to suffer from the ongoing fallout of the elections bringing the Labour Party to power. In fact, Kiwi has fallen below 0.70 cents for the first time since late May. Adding it all up and I feel like the dollar is set to gain momentum as we head into the weekend.

In the Emerging markets, it can be no surprise that ZAR is the biggest decliner; falling 1.45% this morning after further political ructions roiled the market. Today’s slide stemmed from rumors that Deputy president Cyril Ramaphosa, a strong candidate to succeed President Zuma, and someone widely respected, is tipped to be fired. The ongoing internal strife within the ruling ANC party has been a millstone around the currencies neck and does not seem likely to end soon. It is hard to be bullish the rand. Away from ZAR, the CE4 currencies have all followed the euro lower this morning, and we have seen similar magnitude declines from both the MXN and BRL as the markets there wake up. While neither of the key LATAM currencies has made a new low here, both are trading near the bottom of their recent trading ranges and seem poised to break lower (dollar higher). Stay tuned.

Yesterday’s US data showed a remarkable plummet in Initial Claims, falling to 222K, its lowest level since 1969, and also saw Philly Fed print at a better than expected level of 27.9. So we continue to see a seemingly strong US labor market and strong manufacturing sector as well. In many ways it is remarkable that GDP growth in the US remains so desultory. Of course, counter to that good news was the Leading Indicators printing at -0.1%, potentially a harbinger of a future slowdown. This morning brings Existing Home Sales (exp 5.30M), which seem likely to disappoint slightly, as they have for five of the past six months. Despite what appears to be a fairly strong manufacturing sector, the housing market in the US has not been along for the ride.

Nonetheless, barring an outright collapse in the US data over the next six weeks, it seems to me the Fed remains on track to raise rates and that the short term correction in the dollar is ending.

Good luck and good weekend

Adf

December Rate Hike Probabilities:

USD   80.2% – (Still in the cards)

EUR     3.9% + (Think December 2019)

GBP   85.6% + (Done deal, probably in November)

CAD   46.1% + (NAFTA uncertainty impact)

Fed Rhetoric               25bps

The UK continues to suffer

As May seeks an interim buffer

‘Gainst Brexit’s effects

While Europe rejects

Her pleas thus its sure to get rougher

The dollar is mixed this morning, gaining against a handful of currencies while falling against a similar amount. In fact, I would say that the dollar is the least interesting currency today with markets focused on other individual currency stories. For example, the largest movement has been seen in NZD, which has fallen by 1.65% after a government coalition was finally formed. The reaction was due to the fact that the Labour Party was the one that led the coalition, despite winning only ~37% of the vote, as they brokered a deal with the New Zealand First party, an upstart nationalist leaning group that entered Parliament there for the first time. The party platform included planks on reforming the central bank and addressing social issues, neither of which have been seen by the market as a harbinger of future economic or monetary strength. So a far less certain future has resulted in a sharp decline in the Kiwi. While New Zealand is generally too small to have any substantive global impact, this reaction does highlight the ongoing market belief set that a strong economy and independent central bank are two keys for currency stability.

The other notable loser in the G10 space was the pound, falling 0.35%, after it released much weaker than expected Retail Sales figures (-0.8%, exp -0.1%). So some of the first hard data that will be part of Q3’s GDP reading is extremely disappointing. It is interesting to me that while the pound suffered (and has more to come) the market probability of a rate hike next month actually rose slightly. If anything I believe this signals the market sees the BOE move as a ‘one and done’ concept and not the beginnings of a policy tightening program. In fact, I would estimate that the BOE, if they move in November, will not adjust policy for at least another two years following. And if they do, it will be to ease it again as the UK exits the EU rather than to take another tightening step. All of this continues to play to my view that the pound has much further to decline.

On the other side of the ledger, both the Swiss franc and Japanese yen are the best performers in the G10, rising 0.6% and 0.4% respectively. As both of these currencies are seen as haven assets, and given that US equity futures are actually quite a bit lower this morning alongside equities throughout Europe and Asia, we may well be looking at a bit of a risk-off reaction. There has been precious little other news to drive these two currencies, and it is certainly reasonable to expect at least some correction in the equity markets. I’m not saying this is the beginning of a major move, simply that as investors shed some of their risk, these currencies are prone to benefit. Otherwise, the G10 space has been rather dull with the ongoing Spanish drama having little impact on the euro and no substantive news from the US.

In the EMG world, we have also seen a mixed picture although if forced to choose I would say there are probably a few more gainers than losers. What makes this confusing is that in a risk off scenario, I would have expected things to be the other way round. It is this conundrum that prevents me from calling, at this time, that the market is ready to moderate its risk appetite, even temporarily. Of course, if equity market declines continue or accelerate that would certainly change my view.

Arguably the most noteworthy thing happening in this space is the Chinese Communist Party Conference, where President Xi has outlined his plans to stay in office until he dies and all the while strengthen state control over the economy. Interestingly, PBOC governor Zhou claimed that they are going to continue to focus on making the renminbi a more freely convertible currency, but there is no plan to either widen the trading band or reduce intervention. It seems to me that, like the Cheshire Cat, words mean exactly what Zhou wants them to mean, regardless of a more conventional definition elsewhere. At any rate, CNY has given up all of its gains since the week-long national holiday at the beginning of October, and seems simply to be continuing its slow decline vs. the dollar that began back in early September. Ultimately, I believe that a weaker CNY is in our future, but I don’t expect anything to happen quickly.

Yesterday’s US housing data was not very inspiring with both Housing Starts and Building Permits falling well short of expectations. As I wrote yesterday, it certainly appears to me that this part of the economy has plateaued and may be rolling over. This morning we see Initial Claims (exp 240K), Philly Fed (22.0), and Leading Indicators (+0.1%). Given the robust reading from the Empire Manufacturing data earlier this week, I wouldn’t be surprised to see Philly surprise on the high side. Yesterday afternoon’s Beige Book told us that the economy continues to grow at a moderate pace, and that the Hurricane trio of August/September is unlikely to have very long lasting effects. Despite the Housing plateau, I believe the Fed remains on track to raise rates in December and that my underlying thesis remains intact. This points to the dollar ultimately gaining further ground going forward.

Good luck

Adf

December Rate Hike Probabilities:

USD   83.6% + (Still in the cards)

EUR     3.1% + (Think December 2019)

GBP   84.9% – (Done deal, probably in November)

CAD   44.2% – (NAFTA uncertainty impact)

Fed Rhetoric               25bps

As government’s try to conclude

The series of talks they’ve pursued

Enhancing relations

On trade betwixt nations

They’re finding they lack fortitude

Thus most trade agreements in place

Have lately been labeled disgrace

While market reactions

Have caused more distractions

And made outcomes hard to embrace

It couldn’t have been ten minutes after I finished writing yesterday about how the pound was outperforming its peers on the back of the high inflation readings in the UK that BOE Governor Mark Carney disappointed markets in his testimony to Parliament by saying policy adjustments would likely be made in the coming months rather than pinpointing November. This was seen as far less hawkish than anticipated and the pound suffered immediately, falling 50 pips in minutes and ultimately nearly a big figure. It simply goes to show that there are myriad potential catalysts for movement and many come out of the blue. This morning’s UK Labor market data was largely in line with expectations as the Unemployment Rate remained at cycle lows of 4.3% while wages grew slightly faster than expected at 2.1%. The problem is that Inflation is still running near 3.0%, so real wages continue to shrink. Adding to this is the ongoing impasse in Brexit negotiations, where the EU’s chief negotiator, Michel Barnier, claimed that no progress would be made at this week’s summit thus making December the earliest point for a substantive breakthrough. As I type, the pound is little changed on the day, although it did trade lower by as much as 50 pips earlier this morning. And as I have consistently written, the pound is going to suffer further during the Brexit process and I continue to look for it to fall well below 1.30 and test even the 1.20 level over time. Receivables hedgers need to take note.

But Brexit is not the only trade pact in the news these days, NAFTA is still front and center as well. The renegotiation of that pact is going through its own ups and downs, which has been evidenced by the peso’s underperformance during the past month, having fallen 5.5%. And that decline has been flattered by yesterday’s 1.4% rally on the news that despite tough going, the original December deadline that had been mooted by the US has been extended into next year. NAFTA is also having a direct impact on the Canadian dollar, which has seen its own gyrations based on headlines on the subject. There is a secondary impact as well, on the BOC’s reaction function. Recent comments from BOC Governor Poloz have cast doubt on how rapidly he will tighten policy because of the uncertainty of any potential outcome in those trade talks. Thus, as the rate probabilities at the top of the note point out, what had seemed a sure thing for one more rate hike this year has now fallen to less than a 50/50 chance. Let me say that if the BOC is going to react to NAFTA, I am not going to try to opine on the likelihood of any action there. However, given the fact that the Fed still seems slated to raise rates in December, I believe USDCAD probably has some short term upside potential.

Away from these specific stories, the dollar continues to perform relatively well, rising against all its G10 counterparts and most EMG counterparts today, as the Fed has shown no signs of backing off their December move. Adding to that is the belief that President Trump may appoint a more hawkish Fed Chair, with three of the five on the short list (Warsh, Taylor and Powell) seen as hawks. The other two are arguably just one, reappointing Chair Yellen, as I believe that Gary Cohen has virtually no chance. So if I am correct about Cohen, and you consider that Yellen is the one currently advocating further rate hikes, despite her history of dovishness, it seems to me that US policy is going to continue to tighten, narrative be damned. And that is going to support the dollar against all comers going forward. We will need to see other central banks start to become far more hawkish to change that dynamic, and I continue to believe we are just not close to that situation. No matter what the narrative says about the ECB on the cusp of tightening, the reduction in QE is likely more a technical problem than a statement of intent (they are running out of bonds to buy) and they are not going to actually raise rates for at least another 18 months, if not longer. Look for the dollar to continue to gain.

This morning brings Housing Starts (exp 1175K) and Building Permits (1245K), with both those expectations modestly lower than last month’s outcomes. After a long slow rebound in housing, it seems that this sector may be leveling off. We also get the Beige Book this afternoon, which ought to provide some insights into the ongoing economic situation. Of late, it has pointed to continued moderate growth with only small signs of wage price pressures. We shall see.

As I wrote earlier this week, my sense is the dollar is gathering itself for the next leg higher as the Fed remains resolute while other central banks falter.

Good luck

Adf

December Rate Hike Probabilities:

USD   80.2% + (Still in the cards)

EUR     2.0% – (Think December 2019)

GBP   86.6% + (Done deal, probably in November)

CAD   45.8% – (Actually falling pretty sharply)

Fed Rhetoric               25bps

Inflation in England’s attained

A level that must be restrained

Another tick higher

And feet to the fire

For Carney, by law its ordained

It’s always difficult to figure out exactly what drives the dollar (or any market) during a particular session. Ultimately, I always revert to the economic fundamentals, as they ought to exhibit the most influence over time. But in any given session, there are any number of things that can do the job. The dollar is generally stronger this morning as pundits point to a meeting President Trump had with Stanford economist John Taylor regarding chairmanship of the Fed. Ostensibly, Trump was quite impressed. Taylor is best known for his eponymous Taylor Rule, which derives the proper rate for Fed Funds based on specific economic and financial criteria. And that rule, right now, signals that Fed Funds should be near 3.75%, not 1.25%. So the idea that the next Fed chair will be more hawkish gained a great deal of credence overnight and the dollar benefitted directly.

One minor exception, however, is the pound, which had rallied a bit after September’s CPI data printed at 3.0% as expected (It has actually started to give back some of this gain but continues to outperform other G10 currencies). UK legislation requires the BOE Governor to write an open letter of explanation if the headline inflation rate moves more than 1% in either direction from the statutory target of 2.0%. So despite the fact that market participants were anticipating this outcome, the reality was still enough to move the market. Essentially, this has made it clear that the UK will be raising rates at their November meeting, removing the emergency 25bp rate cut they implemented immediately in the wake of the Brexit vote in June of last year. What makes this surprising is that given the otherwise desultory UK data, it seems hard to believe that they would go down this path, but it does seem to be highly probable at this time. What is truly interesting, though, is the fact that the market isn’t looking for another move by the BOE for more than a year after this. The point is that a hike in three weeks’ time is not the beginning of a tightening cycle as much as it is a knee-jerk response to recent inflation readings. And of course, the weak pound has dramatically impacted those inflation readings, which despite its recent performance is still lower by 10% since the Brexit referendum.

Speaking of Brexit, I have not seen any news that indicates the current stalemate between sides has changed and so the odds of ‘no deal’ seem to be climbing every day. As I read about the ongoing talks, it almost seems to me that neither side really wants a deal. The EU is terrified that if they give anything away in a deal, other members are going to raise their hands for the same benefits. At the same time, the UK has made it clear that while a financial settlement is possible, they are not going to pay a lot of money without getting something in return. I have suspected for a while that a transitional deal would be highly problematic, and nothing I have heard or read lately has changed that view. We will know for sure when the UK Treasury starts allocating funds for contingency issues in the event of a ‘no deal’ outcome. I think that will be a very negative signal for the pound as the rest of the market will come around to the idea that the UK is about to exit the EU with no contingency plans. I maintain that receivables hedgers need to be taking advantage of this short-term rally.

Away from the UK, the euro has been one of the worst performers overnight as the ongoing Spain/Catalonia saga continues to sap good will from the currency. Spain reduced its own growth outlook for 2018 (2.3% down from 2.6%) due to the repercussions from the secessionist impulse in Catalonia. Since Spain has been an important bright spot for the Eurozone, especially from the southern portion, as long as this crisis remains unresolved I expect further pressure on the euro. At the same time, this morning’s data reconfirmed that inflation is nowhere near the ECB’s target of ‘just below 2.0%’ with core CPI printing at 1.1%. We even saw some softness in the German ZEW figures (17.6 vs. exp 20.0). None of this bodes well for the narrative of an early end to QE or tighter policy and it has resulted in a 0.4% decline in the euro this morning.

In the Emerging markets, we have seen some more significant movement this morning, led by ZAR (-0.65%), whose political machinations rarely seem to be a positive for either the economy or the currency. Today’s story has revolved around Cabinet changes made by President Zuma there as he tries to consolidate whatever power he has remaining. We have also seen a sharp decline in KRW (-0.4%) after North Korea rejected diplomatic talks and said a nuclear war “…may break out any moment.” Finally, CNY has fallen by 0.45% overnight as the Communist Party congress opens in Beijing. Surveying the situation there over the past months shows that President Xi, far from being embracing markets to help the economy, has decided that centralized control is the best way forward. It is an open question, in my mind, whether they will be able to control both the currency and economy in the manner they like, and when push comes to shove, I expect them to let the currency correct, not the economy. So while I am pretty bearish the renminbi in the long term, for now I suspect it will not be allowed to move very far. In fact, last night’s decline is quite surprising to me.

This morning’s data brings IP (exp 0.3%) and Capacity Utilization (76.2%). These generally don’t move the market. Yesterday morning we saw a much stronger than expected Empire Manufacturing print (30.2 vs. exp 20.4) indicating that US industrial growth remains on track. My sense is it is time for the dollar’s uptrend from early September to begin to reassert itself as the combination of ongoing strong data, a potentially hawkish new Fed chair and problems elsewhere in the world all point to strength. Hedgers beware!

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% = (Still in the cards)

EUR     3.1% = (Think December 2019)

GBP   84.8% + (Done deal, probably in November)

CAD   49.7% – (Actually falling pretty sharply)

Fed Rhetoric               25bps

This weekend we heard from a bunch

Of policymakers whose hunch

Is prices will rise

As each of them tries

To stop short the next global crunch

Last week saw the dollar retreat overall as the bullish case was negatively impacted by continued disappointment in the actual inflation data despite the ongoing Fed rhetoric that another rate hike is coming by Christmas. Of course, there were other stories to help the cause including stronger commodity prices underpinning that bloc and comments from several European officials that an interim deal with the UK might be possible. This morning, however, the dollar has regained its footing and has edged higher on balance.

It seems that the mood from the G30 conference in Washington this weekend was somewhat schizophrenic. While the US contingent remained upbeat about economic prospects in the near term, looking at improving growth and the strong employment picture as leading to their desired, if elusive, rise in inflation, both European and Japanese leaders were far less positive in their outlook.

Kuroda-san made clear that the BOJ was not even contemplating the ending of QQE in Japan, nor the targeting of 10-year JGB yields at 0.0%. With inflation in Japan running at 0.7%, well short of the 2.0% goal, Kuroda said, “The Bank of Japan will consistently pursue aggressive monetary easing with a view to achieving the price-stability target at the earliest possible time.  Achieving the 2% target is still a long way off.” 

Meanwhile, Draghi and friends were at pains to point out that inflation in Europe also remains far from its goals but that their current policy settings were doing the job. “Therefore, we’ve got to be persistent with our monetary policy,” Draghi said. “We also have to be prudent” and will maintain “an extraordinary degree of monetary accommodation.” I don’t know about you, but that certainly sounds to me like any changes that are coming will be minimal, at best.

Of course, the ECB hawks couldn’t let Draghi have the last word and commented on the fact that based on the ECB’s current, self-imposed restrictions, they can only purchase another €200 billion or so to add to the €2.3 trillion already purchased. The implication here being that QE doesn’t have much more time in it after all. However, despite this unwelcome hawkish tilt from Jens Weidmann, President of the Bundesbank, the market appears to be more in step this morning with Draghi and the doves, hence the euro’s 0.25% decline.

If I were to sum up the G30, then, I would say that financial officials are not adhering to the prevailing FX market narrative. The G30 sees stronger growth leading to higher inflation and higher rates in the US while the rest of the world continues to see inflation as elusive and will continue to pursue extraordinary monetary policy ease. That is not a prescription for the dollar to fall!

Away from the G3, the biggest surprise to me is the consistent decline in the market perception of Canada’s rate hike prospects. Just a month ago, the market was pricing in a 75% probability that the BOC would raise rates by December. That has fallen to less than 50% today. What’s interesting is that during that time, Canadian data has maintained a solid performance, with growth and employment doing well, and inflation edging ever higher. During that period the Loonie has also weakened nearly 4%, although in fairness, it has done little over the past two weeks. What I would say is that if we continue to see that probability slide lower, USDCAD has room to move higher. It seems that, for now, CAD has disconnected from commodity prices.

In the EMG bloc, the most noteworthy action has been the decline of the Mexican peso, falling 0.75% on renewed concerns that the ongoing NAFTA negotiations are starting to turn negative for the country. This has the added impact of helping the electoral prospects of AMLO, the hard-left Presidential candidate, and that combination will not be a positive for the Mexican economy. With the peso through 19.00 this morning, for the first time in 5 months, I fear there is further room for decline there. Otherwise, this broad bloc of currencies has shown unimpressive activity overnight and has maintained the bulk of last week’s gains vs. the dollar.

On the data front this week, we see the following:

Today                           Empire Manufacturing                        20.5

Tuesday                       IP                                                              0.2%

Capacity Utilization                              76.2%

Wednesday                 Housing Starts                                        1175K

Building Permits                                    1240K

Fed Beige Book

Thursday                    Initial Claims                                            240K

Philly Fed                                                   22.0

Leading Indictors                                     0.1%

Friday                         Existing Home Sales                                5.30M

It strikes me that this list of data is not that likely to drive the FX markets although if everything leans in one direction we could certainly see a cumulative effect. We also hear from six more Fed speakers, including Chair Yellen on Friday evening, but given the timing of her speech, any impact there won’t be felt until Sunday in Asia.

Lately, however, the FX market seems to be all-in on the narrative of slowing Fed activity and imminent policy tightening elsewhere. Certainly equity markets continue to believe that story as there is no evidence the inflating bubble is of any concern to most investors. As such, it is hard to make a case that the dollar will rally in the short term, although if we see strong data across the board this week, it may be enough for a little benefit. That said, nothing has changed my view that the narrative is wrong here, and as it adjusts over time the dollar will strengthen. However, I am hard pressed to make a case that the dollar weakens much from these levels either.

Good luck

Adf

December Rate Hike Probabilities:

USD   76.7% = (Will CPI drive this higher?)

EUR     3.2% = (Think December 2019)

GBP   81.2% = (Done deal, probably in November)

CAD   59.1% = (Not as confident as before)

Fed Rhetoric               25bps

The word out of Brussels was that

The EU just might arrive at

An interim deal

With modest appeal

For each Eurozone bureaucrat

The pound, on that news jumped to highs

But then, in what’s no real surprise

The Germans said ‘nein!,

We have a timeline’

It’s money first, then compromise

As we walk in on this Friday the 13^th, FX markets are little changed on a broad basis. If pushed, I would say the dollar is a bit softer, but we continue to lack a strong short-term theme for now. The one place we have seen movement is in the British pound, where an article yesterday afternoon indicated that EU Brexit negotiator, Michel Barnier, may be willing to offer a two year transitional deal to help smooth the break-up. Not surprisingly, the pound rallied sharply on the news, jumping more than a penny in minutes. Alas, earlier this morning, after a bit more euphoria that had driven the pound back above 1.33, European Commission President Jean-Claude Juncker dismissed that idea out of hand, repeating his mantra of no trade discussions until they agree the money owed. The pound quickly gave back most of this morning’s gains and is now just slightly higher on the day. I guess the idea that the EU is now allegedly discussing a transition deal is seen as a positive for the pound, although it appears to me that it will be difficult to agree anything here. Remember too, that Germany, the most critical EU country, is not really focused on these issues for now as Chancellor Merkel is too busy trying to create her governing coalition after last month’s inconclusive elections. The point is I believe it would be a mistake to assume a more significant boost in the pound on the basis of the EU giving ground at this stage. And there has certainly been nothing out of the UK that indicates they are on track to make concrete proposals. All told, I remain a committed seller of pounds at these levels as the odds of a hard Brexit seem to grow every day.

Elsewhere, the annual IMF and World Bank meetings brought nothing but platitudes from the likes of Mme LaGarde, although the IMF did raise its global GDP forecast by 0.1% for 2018. However, despite a plethora of central bank speakers at the event, nobody really said anything noteworthy, and so markets have largely moved on.

The one constant this morning is that commodity currencies are modestly firmer on the back of stronger commodity prices in general. WTI is back above $51/bbl and both the base metals complex and agricultural prices are firmer. A key driver here seems to have been the Chinese Trade Data from overnight that showed a continued surge in import growth (+18.7%) and, surprisingly, a sharp narrowing in the Trade Surplus to $28.5B down from $41.9B last month. The skeptic in me would point out that the Party Conference is next week and, while I have no knowledge or proof of this, the idea that the Chinese government might manipulate this data for what they perceive is a beneficial political effect cannot be ruled out. After all, a shrinking Chinese Trade surplus will certainly play well in the White House, and growing imports would indicate that the Chinese transition away from its mercantilist past is proceeding apace. Interestingly, there was essentially no impact on the renminbi, although the firmer commodity prices have helped both AUD and NZD to rise by about 0.3%.

For volatility traders, the gift that keeps on giving is South Africa, where the rand has rallied a further 0.65% this morning (3.6% this week) after a court ruled that President Zuma would be able to face corruption charges after all. My take is that the market would like to see him deposed and someone less venal in his place. Or at least someone more market friendly. But away from the rand, the EMG bloc has been quite dull as well.

Yesterday’s PPI data was exactly on expectations, and the Initial Claims number actually fell further than anticipated. Given this week is the Survey week for the monthly NFP report, that bodes well for what we will see in early November. This morning we get CPI (exp 0.6%, 0.2% ex food & energy); Retail Sales (1.7%, 0.9% ex autos); Michigan Sentiment (85.3) and Business Inventories (0.7%). Clearly it will be the two 8:30 numbers that matter, and given the robust expectations, one would expect the chance to fall short is great. What does seem clear is that the market will respond in a logical manner to the outcome so strong data will result in higher interest rates and a stronger dollar and vice versa. While the Fed’s official focus is PCE, which isn’t released for another two weeks, a strong print in today’s CPI would not be ignored and I think we could easily see the market probability for the December rate hike pick up further alongside the dollar. Plus a strong reading this morning would give ammunition to Chair Yellen that the transitory factors are beginning to fade away. And that would strengthen her hand against the remaining doves on the board.

Net net, I still like the dollar story better than others and remain convinced that hedgers need to take advantage of current levels in the dollar for better long-term performance.

Good luck and good weekend

Adf

December Rate Hike Probabilities:

USD   76.7% = (The Minutes should help confirm)

EUR     3.6% − (Think December 2019)

GBP   81.0% − (Done deal, probably in November)

CAD   59.2% − (Not as confident as before)

Fed Rhetoric               25bps

Like any religious consistory

The FOMC looks at history

Though it can’t explain

Why prices remain

So stable, it’s truly a mystery!

In the wake of the FOMC minutes released yesterday afternoon, and ahead of Friday’s CPI release, the dollar has taken a breather overnight, showing very little net movement. While that broad stability masks some individual movement, the big picture remains of a dollar that appears to have halted its year-long slide, but is not ready yet to accelerate higher.

A quick look at the Minutes showed that the Fed’s models are still not doing a very good job in forecasting inflation. The hawks continue to discuss one-off idiosyncrasies, like the decline in cell-phone data charges as a possible hindrance to higher inflation. The doves are coming round to the idea that the inability of wages to rise is a result of the increasing global supply of labor.   In other words, they have no idea why prices are behaving as they are, and are throwing every idea they can against the wall to see which one sticks. The one thing that seems clear, however, is that they will not be deterred from raising rates again in December unless the interim data takes a significant turn for the worse. And given the uncertain impact of the hurricanes on that data, it seems that they will be able to look through any weakness as merely another transitory factor. However, having said all this, it appears that the market’s interpretation of the Minutes was far more dovish than mine, hence the dollar’s late afternoon sell-off.

It is fair, however, to ask if the three rate hikes for next year that the FOMC have, themselves, penciled in are going to see the light of day. I continue to believe that one of the key reasons they are so anxious to raise rates is to have room to cut them when the next downturn arrives, although they cannot actually admit that. My point is that we will need to see extremely weak data in order to derail that plan, and as of now, there is no indication that will be the case. One other thing to keep in mind is that we are fast approaching the announcement of the next Fed Chair, and I keep reading that Kevin Warsh is the front-runner. He is decidedly more hawkish than Ms. Yellen, and would almost certainly seek to push rates higher still. Of course, all of this matters to us in FX because of the current dollar narrative, which despite all evidence to the contrary, continues to assume that the Fed will be less hawkish than their rhetoric and the ECB and BOE more hawkish. Nothing in these Minutes has changed my view that the narrative is wrong and will change with the dollar benefitting over time.

The other story of note this morning is the ongoing angst in the UK over the progress, or lack thereof, in the Brexit negotiations. The latest round of talks, which are due to end this week, have produced nothing of note and it appears that both sides are waiting for the other to crack on something. If forced to handicap this outcome, I am leaning toward a hard Brexit with no transitional deal. Ultimately, the biggest sticking point is going to be money, and the EU is going to continue to insist that the UK owes an astronomical number, which I bet will grow to be €100 billion before the talks are done. At the same time, the UK is going to insist that without a transitional agreement, there will be no payment, and even with one, the number is in the €20 billion range. That’s a pretty big gulf to overcome, and based on the ongoing dysfunction within PM May’s government, I just don’t see a resolution. No matter the long-term potential benefit for the UK to regain its sovereignty, the near term is going to be messy, and the pound is going to suffer. Folks, above 1.30 the pound remains a screaming sale in my view. Ironically, as I was typing this, the pound just fell 50 pips on this BBG headline “*GBP/USD FALLS TO 1.3170; BARNIER SAYS DEADLOCK IN BREXIT TALKS”

Looking elsewhere, the yen continues to edge ever so slightly higher on the back of a series of polls showing that PM Abe is set to win a resounding victory in the upcoming Japanese elections with a chance to capture a two-thirds majority of the lower house, enough to make constitutional changes. The Nikkei has been performing well while the yen has arrested its month-long decline and found a new stability. In the commodity bloc, both AUD and NZD are firmer by about 0.5% this morning as a result of renewed Japanese investor buying of both currencies.

Meanwhile, in the EMG bloc, amid a session with an equal number of gainers and losers, no currency has moved more than 0.3%, and there are no stories of note to reflect.

This morning brings the first real hard data of the week, PPI (exp 0.4%, 0.2% ex food & energy) as well as Initial Claims (250K). The thing is the FX market doesn’t typically pay close attention to PPI, especially with CPI to be released tomorrow morning, and the Initial Claims data continues to be roiled by the aftermath of the hurricanes last month. As such, I don’t see either one having a substantive impact on the FX markets today. That leaves us with Central bank speakers as the most likely catalyst for movement today. It seems the bulk of them are in Washington for the annual IMF and World Bank meetings with Powell and Brainard from the Fed on the schedule as well as Draghi, and we will also hear from Germany’s outgoing FinMin, Wolfgang Schaeuble. While I don’t anticipate too much new news, one can never be sure in these circumstances.

Net, I don’t anticipate much movement overall today, but if I had to guess, the dollar’s corrective fall is likely close to an end.

Good luck

Adf