Both Draghi and Carney reflected
Their policies weren’t connected
To Ben’s latest caper
The infamous ‘taper’
Instead low rates should be expected

It seems to me that the market may be moving to a new level of concern about Europe and its ability to address the myriad problems that exist within the Eurozone’s weaker members. Last week, the Greek governing coalition lost its junior member, as they could no longer support the government’s austerity measures. Two days ago it was Portugal that saw turmoil as two ministers, including FinMin Gaspar, resigned from the government calling into question the viability of the governing coalition in Lisbon. Again, the reason was they could no longer support the government’s austerity measures. Notice a pattern here? It took two months for Italy to form a coalition, which ultimately based its electoral legitimacy on its plans to unwind some of the previously implemented austerity measures. Spanish unemployment continues to climb, currently above 27%, and the pressure to find a solution there is intensifying. Through all this, Chancellor Merkel looks on and cares only about her re-election prospects in September, which means she cannot countenance any further German aid for the periphery.

It was back on June 14 when I commented that the euro would trade 1.25 before 1.35 as I felt the underlying structural problems in Europe combined with the idea that the Fed was seeing the light at the end of the free money tunnel would force market participants to reevaluate the euro’s future. Today, I am looking a lot better on that call as the euro is firmly below 1.30, ahead of the Payroll releases this morning, and quite frankly looking like it has nowhere to go but down. As the pressure intensifies on the peripheral nations’ governments to end austerity, the Troika is going to find itself with a real problem. If it condones any changes in policy, it will lose all legitimacy with respect to insisting on conditions for any future bailouts. If it holds the line on its austerity policies, the possibility of Greece or Portugal or Ireland or Cyprus exiting the euro grows dramatically. At some point, these countries are going to start to look more closely at the potential long-term benefits of getting out from under the ECB’s (and Germany’s) thumb.

All of this is the backdrop to yesterday’s unprecedented comments from both the ECB and the BOE. It started with new BOE Governor Carney releasing a statement after the MPC meeting despite not changing policy. The statement was basically, we don’t care what the Fed is doing, we see no reason to raise rates anytime soon. Shortly thereafter, it was Mario Draghi’s turn to step outside the traditional ECB framework and promise that rates would remain low for an extended period of time with a downward bias to boot. It certainly makes sense that the ECB will keep rates low as the recession there continues unabated. So it will be difficult for the euro to find support for a while, especially if US data points to better times ahead. The UK story is a bit tougher as the data there has shown modest growth and the forward looking surveys are actually looking up. My concern for the pound is that inflation starts to increase and the BOE finds itself unable to address the issue effectively.

When the Greek crisis began back in 2010, I had written that the best (only?) solution for the euro was for it to decline dramatically, to parity or below, as only then would the peripheral nations start to have their labor priced competitively in global markets. But that has not happened and that repricing of labor has come via direct cuts in wages and reduction in those nations’ workforces. This has been the recipe for disaster which is currently playing out. The euro has further to fall my friends, of that I am sure.

Today we are awaiting the US payroll story, with the market pretty bulled up on things. Expectations are for NFP at 165K, Private payrolls at 175K and the Unemployment Rate to fall to 7.5%. Equity futures are pointing higher after yesterday’s holiday though equity markets in Europe are generally lower. As I wrote Monday, I expect a good number today, something near 200K, which will simply confirm the differences between the US and the rest of the developed world in terms of economic prospects. This should help the dollar and hurt Treasuries, with the initial move being positive in equities. But the equity conundrum remains; stronger US growth will lead to a quicker taper in QE by the Fed, which means higher interest rates and equity market support will waver. Ultimately, I continue to believe that the US equity market is priced incorrectly and is very expensive. So alongside a strengthening dollar, look for weaker stocks.

Good luck
Adf

In China, Brazil and some others
The market has proved it still smothers
The leaders’ desires
To cause what transpires
No longer do they get their druthers

The dollar is generally stronger this morning as the market continues to react to comments from Central Bankers around the world as well as the ongoing stream of data. The thing is, there is no longer a consensus as to what is going to happen with monetary policy almost anywhere on the globe, Japan excepted. I have discussed the Fed issues at length, and am sure I will continue over time, but suffice it to say that there is a great deal of uncertainty over the timing of any reduction in monetary ease at the moment. The ECB has been somewhat less mysterious, but remains behind the eight ball because the Eurozone economy remains mired in recession and is showing no signs of a quick recovery. So while there is no expectation of tightening any time soon, the real question seems to be will there be further ease?

The BOJ is easy, printing presses are running at full speed with no end in sight. Will it solve their problems? That is far less clear, but after 20 years of economic purgatory, the Japanese seem willing to try anything. The Old Lady of Threadneedle Street is in a quandary similar to the Fed. While they have a new governor, Mark Carney, ready to add to the easy money party, the data from the UK continues to show improvement, like this morning’s Construction PMI print of 51.0, (the highest level in 12 months), and so evidence of a recovery is building. Easing into that situation will be a difficult call for Governor Carney.

We also heard from the RBA last night, which left rates on hold, as expected, and claimed that despite a recent 10% decline in the AUD, it still remains high. It can be no surprise that the new Treasurer, Chris Bowen, came out looking for more rate cuts as every politician is a fan of easy money, but for now, it seems that the RBA will keep further rate cuts in their pocket as the economy continues its adjustment to a less mining intensive one. As long as the AUD continues to soften, and I think it will, the RBA will be reluctant to act further without a sharp decline in output there.

Let’s look at some of the emerging markets though, where the leadership is finding out that one of the downsides of becoming a more open economy is that government control over things is diminished. In China, for example, they have been struggling with how to effectively prevent another housing bubble while simultaneously maintaining sufficient stimulus for the economy to grow elsewhere. There is also a macro program to rebalance the economy to more domestic consumption and less export dependence. Well, that is a tricky set of objectives for any nation, but perhaps even more so for a nation that has a history of intense secrecy in its financial dealings with the market. The results have been a sharp spike in short term financing rates during the past month, rumors of a bank default, weaker economic data and no solution in sight. While the Renmimbi is not likely to collapse any time soon, what has become clear is that its steady appreciation has halted. The current level between 6.12-6.15 seems to be all there is and it would be no surprise to see a gradual move back toward 6.25. This problem for the Chinese is there is no simple solution, and I would look for more market gyrations there, expressed as equity market moves, over the rest of the year and beyond. But remember, no market lives in isolation, so if the Shanghai Composite is tumbling, you can expect a knock-on effect in other markets.

And in Brazil, the problems are manifesting themselves via the massive protests in the streets. Already we have seen the government there back off the bus fare hikes that started things, and now they have offered more direct democracy. But it strikes that what the people want is not direct democracy, they simply want competent and uncorrupted leadership by the elected officials. Of course, that is a rare outcome in any country, let alone one that has as short a history of democracy as Brazil’s. The Central Bank is having a problem because inflation has jumped above the top of its target range at 6.5%, but growth remains weak at 1.9% annually. The term stagflation springs to mind, but in a nation where the government’s legitimacy seems to be being questioned by the people. If you remember, when we first saw the weakness of EMG currencies several weeks ago, I mentioned that I thought there was a chance of a very significant decline in the BRL. I think that probability continues to grow seeking only the next surprise. I fear a move toward 2.50 is a realistic event this summer.

Today’s US data is dull, with only Factory Orders of note. All eyes are on tomorrow’s start to the employment story as that is intimately tied to the FOMC decisions. I sense a modest day today, with limited overall activity in FX, especially as the July 4th holiday approaches.

Good luck
Adf

The FOMC’s running scared
It seems they were quite unprepared
For all the bond selling
And market rebelling
Now can their mistakes be repaired?

Over the weekend, pretty much every story about markets was about the FOMC’s attempts to walk back the Bernanke comments from two weeks ago. It is remarkable how many Fed members were quoted as saying the market is wrong and has overreacted. Now I don’t doubt for a moment that the market overreacted, that is a given with markets, but I am concerned that the illustrious Fed members were completely surprised that markets have responded in this manner. After all, what we are witnessing is the beginnings of a change in the most extraordinary monetary policy stimulus in history. And throughout history, when central banks, notably the Fed, have changed their policy stance from easing to tightening, or vice versa, the market response has been both large and volatile. One would think that the response to this change will be the largest and most volatile in history given the starting point. It could make one think that the FOMC is unaware of the history of its actions. At any rate, while no one denied that at some point QE would end, to a man the entire Fed said that the timing is much later than the market is implying. I think the lesson to learn from this is that the Fed may have finally figured out it cannot directly control, or even impact, unemployment; and that the Fed can only impact inflation with a significant time lag, so it’s only timely feedback is market prices for stocks and bonds. Ipso facto, the Fed is trying to manage the stock and bond markets, which do respond in a timely manner directly to their actions. Just not always the way they want. This story is going to be with us for quite a while yet, so despite the movements we have seen in markets already, don’t expect volatility to decrease any time soon.

Looking at the FX markets this morning, the yen is notable for its ongoing weakness, making another move back toward 100 after the Tankan report was released at 4, up from 3, and indicating continuing recovery in Japan. While there is no doubt that 100 will prove to be a difficult level to once again breech, I am confident it will do so, perhaps sooner than my initial expectations which were following the Upper House election in 3 weeks.

As to the euro, the PMI data showed a modestly better picture, with German PMI slightly softer at 48.6, but EC PMI slightly stronger at 48.8. To me this is all ‘shades of grey’. After all, the readings across the continent remain below 50, and while they have been edging higher, the trend remains one of a very slow return to growth. At the current trend, it will be March 2014 before the PMI prints at 50.0 again. That’s another 3 quarters worth of weakness. All that being said, the euro did manage to rally slightly on the release, although it continues to hover just above 1.30. It appears that there is somebody who is very eager to prevent the euro from falling below 1.30 for now, but I continue to believe that its decline is inevitable.

The pound rallied first thing this morning as the PMI data there was yet another positive surprise for the economy, printing at 52.5 rather than the expected 51.4. As Mark Carney steps into the BOE Governor role today, his job seems to be getting easier. Rather than figuring out how to stop the UK economy’s decline, he merely needs to figure out how to unwind the unprecedented policy prescriptions in place in the UK. While the magnitude of the issue is not as large as the Fed’s, it is still an enormous task for the UK economy. However, you have to like the pound more than the euro here, as at least the UK’s prospects seem much brighter than Europe’s for now.

Looking at the emerging markets, the picture is mixed. The most notable change from last week is INR, which seems to have responded quite positively to the Fed’s efforts to change market views. The Rupee has rallied more than 1% in the last two sessions and is the best performer in the space. It will be interesting to see how BRL opens this morning given its ongoing weakness in the wake of the protests throughout the country. President Roussef’s approval rating has plummeted to 30% from near 60% prior to the outbursts, and it is not yet clear that she will be able to address the concerns of the population. It is always very difficult for a corrupt government to address corruption, no? On the bright side for her, Brazil won the Confederations Cup last night, so I’m sure there will be much celebrating for a little while anyway. My guess is BRL performs well today, but the pressure remains on the government to enact positive changes, and I have a feeling that will be more difficult for them to implement. I look for BRL to weaken further over time.

Finally, this week brings a great deal of data in the US, culminating in the payroll report on Friday:

We will discuss Payrolls tomorrow. Overall, I see no reason to change my views on both bonds and the dollar, lower and higher respectively, but remain amazed at the resilience of the equity markets.

Good luck
Adf

Those leaders in Brussels agreed
That bailing-in banks may proceed
But as many guessed
Dissent was repressed
More problems are still guaranteed

The yen has been the main loser in the overnight session, with many comments about it being a risk on environment. First, let me be clear in that short of a crisis event, I think recent evidence belies the idea that risk-on/risk-off is a viable paradigm any more. And second, I am trying to figure out what would have encouraged investors to take on more risk because of what we saw overnight.

Was it the fact that the Chinese liquidity crunch remains in place, albeit moderating slightly? 7-day repo rates remain at 6.74%, double their average this year and it has become pretty clear that the PBoC is not about to flood the market with liquidity. The Chinese economy is going to need to adjust to the new ideas about monetary policy and that will be a painful and volatile process, hardly a harbinger of buying risky assets.

Perhaps it was the fact that, as I suggested, the EU announced a compromise on the banking situation, which essentially stated that countries need to abide by the rules unless the situation is such that they don’t think they need to abide by the rules for national reasons. This was not the strong and clear rulemaking that is likely necessary for success of the banking safety net. And let’s take a moment to consider the EU meeting that starts this afternoon. Last June, they pledged “immediate action” on growth and jobs. Today, with unemployment having risen since then from 11.4% to 12.2% and GDP having fallen by 1.1% in that time, they are going to pledge “determined and immediate action” on growth and jobs. I know if I were unemployed in Europe I would feel much better now! At any rate, this does not strike as a reason to jump on the risky asset bandwagon.

I know. It was yesterday’s downward revision of US GDP to 1.8% in Q1 from the previously reported 2.4%, with the Personal Consumption piece falling to 2.6% from 3.4%. That type of news would certainly warrant jumping into risky assets, right?

Ultimately, I think all that is going on is market position adjustments ahead of the quarter end. Remember, Friday is the end of Q2 and many investors are massaging their portfolios to appear in the best possible light for reporting purposes. As such, I am not convinced that the recent gyrations are caused by changing views of the global macroeconomic situation, or changes in policy settings. The market remains quite concerned, and rightly so, that as the Fed removes policy accommodation, equity prices and bond prices will decline.

But looking across the FX markets, we have seen some strength and some weakness with no discernible pattern. Today’s US data will reveal Personal Income (exp 0.2%) and Personal Spending (0.3%) as well as Initial Claims (345K). None of these are likely to move markets greatly. Several Fed speakers are slated for today, NY’s Dudley and Atlanta’s Lockhart, and they may have a much bigger impact on things. For now, it seems that virtually all markets revolve around the Fed’s next steps, and indications that the ‘taper’ is closer will result in further selling of both bonds and equities.

Some days it’s just hard to get excited about the markets, and today is one of those. The long term trends remain in place, but the day-to-day is still subject to the next headline.

There will be no commentary tomorrow as I will be traveling and unable to observe the market.

Good luck and good weekend
Adf

In Brussels they’ll once again meet
Those ministers with the clay feet
The question at hand
The German demand
That banks fix their own balance sheet

It has been a mixed day in the FX markets as traders await further US data, but more importantly, await any further news from the Fed as to the possible timing of the next actions. Central banks have been the focus of most traders lately, between the Fed and all the talk of the ‘taper’, the PBoC and its efforts to deflate the real estate bubble without causing an economic crash, the BOE and its pending change in leadership as Mark Carney starts on Monday, and finally, the ECB, where Signor Draghi continues to assure the world that they have plenty of tools at their disposal, but seems unwilling to use very many of them. That’s quite a list and it didn’t even include the BOJ, which we all know is on a mission to double the money supply in Japan over the next two years.

Starting in Europe, more comments from Draghi indicating that the ECB will remain accommodative for now and urging individual nations to address the fiscal problems that bedevil the Eurozone were sufficient to undermine any support for the euro. It is now approaching 1.30 and I continue to believe is heading steadily toward 1.25 over the next several months. The very clear difference in tone between the Fed and the ECB will continue to weigh on the euro going forward. Perhaps just as importantly, the EU FinMins will be back in Brussels trying to iron out the banking resolution process for the future. Remember, late last week they could not agree on the measures to address bank failures and when the new banking regulator should be called in to support a particular bank. I see no reason that positions would have changed in the past 5 days, and so as I wrote Monday, the outcome is likely to be no real resolution, but some announcement that things are solved. Politically, they cannot afford to fail again, but economically, neither side will give in. As I also wrote Monday, this remains an underlying reason the euro will continue its decline.

The pound is also a bit softer this morning, following the euro and seemingly anticipating the onset of the Carney era. Remember, the entire world is expecting great things from Carney, who is on record as calling for ‘flexibility’ in inflation targets (read higher inflation) and has been willing to push the envelope with regard to innovative monetary policy measures aimed at easing policy. Certainly, if the BOE votes for more QE, one of the possibilities at next week’s meeting, the pound will suffer further.

Down Under, the political situation is heating up as PM Gillard lost the Labour Party leadership election and the Labour Party will now be lead by Kevin Rudd in the September elections to come. But the Aussie’s weakness over the past months has not been political, it has been the result of position unwinding. Aussie had been one of the favored destinations for investors seeking a combination of yield and safety with a modicum of liquidity thrown in. It is apparent that much of that positioning has been reduced. Add to that the tepid economic growth and the apparent weakening in China, and Aussie suddenly doesn’t look so attractive. Remember, the 10 year average price of AUDUSD is 0.8575, with recent time spent above 1.00 as the historic outlier. Aussie has further to decline.

And let’s talk about China now, where the PBoC continues to moderate the liquidity problems that have arisen in the banking system. While they are working hard to prevent a melt-down, and certainly do not want to see any bank failures, it has become clear that the Xi Administration is keen to make major adjustments in the Chinese economy. The effort to diversify away from an export led economy to one that is more reliant on domestic consumption has been fraught with periodic problems, like this liquidity situation. This is the conundrum in which the Chinese find themselves. It is easy to add liquidity and reduce the short term lending rates, but in so doing, they would continue to encourage the property speculation they are trying to defeat. So they are trying to find a middle ground, and the short term gyrations are the result. This highlights just how difficult it is for a country to make monetary policy adjustments and have markets behave as desired. And this is in China, where the government has much greater control over everything. Remember that when thinking about the Fed and its ability to control its message, policy and market responses, or rather its inability to do so.

Finally, a quick word on India, where the Rupee traded to a new historic low vs. the USD at 60.765, falling a full 1.75% on the day. The problem has been a steady outflow from the Indian stock markets by international investors combined with the domestic problems of slowing growth and rising inflation. The RBI has not yet focused on either growth or inflation, trying to manage both simultaneously. This has reduced international confidence in the currency, and quite frankly, I expect it will continue to slide. There is nothing that says it cannot reach 65 at some point on this move, regardless of the RBI’s modest intervention efforts.

Good luck
Adf

I have begun the process of archiving my old verse on my blog.  As of now, everything I have from 2009 is on www.fxpoetry.com so if you are interested, click the link and peruse them.  While you are there, you can sign up to follow the blog, which will automatically send you each morning’s report.  I expect to have 2010 and 2011 done over the next several days.

Much to the Fed’s consternation
The market’s most recent translation
Of Chairman Ben’s speech
Was QE would screech
To a halt, causing Ben much frustration

In response we got speeches from two
Presidents of the regional crew
The word ‘exit’s not right
Nor will money get tight
When QE’s days are finally through

Markets are funny things.  Understanding what drives prices and anticipating how they will respond to particular signals is a game fraught with difficulty.  As I wrote last Thursday, historically Central Bankers (and truly government officials on the whole) typically don’t do this very well.  At least based on the remarkably stupid things that they regularly seem to say.  Anyway, it is clear that the Fed was unhappy with the market’s interpretation of Bernanke’s recent press conference and so he sent two of his minions, Fisher and Kocherlakota, out to try to explain further the Fed’s thought processes.  What we learned was that “the word exit is not appropriate” for what the Fed is doing, according to Fisher, and that even if it is, policy would still remain accommodative “for a considerable time” afterwards according to Kocherlakota.  On the surface, these seem somewhat contradictory statements.  It is almost as if they want their eventual reduction in purchases to be ignored as a market signal.  Rather, they would prefer that the economy continue to merrily roll along without the Fed having to do anything special.  Alas for them, that is never going to be the case, and so the process of messaging will remain highly uncertain and extremely difficult.

All that said, the message from the two non-voters seemed to be accepted by the markets as we have seen equity markets bounce modestly, Treasuries rally slightly and the dollar soften a bit.  I don’t think it was the overnight data, which was extremely light, but the other possible catalyst for this bounce could have been comments released from the PBoC, where they indicated that they will keep money market rates at a “reasonable” level going forward.  Those comments were sufficient to reverse a 6% decline in the Shanghai Composite, and perhaps settle market players’ nerves a bit further.

One of the other things I have learned over my extended time in markets is that high volatility tends to come in short bursts.  It is very difficult for traders to continue trading in high volatility environments for extended periods, they literally just get too tired and step away, so given what we have seen over the past several weeks, it would be reasonable to expect a bit more quiet until next week when we get the payroll data.

For the rest of this week, we do have some interesting data being released, notably Durable Goods this morning and the PCE Deflator on Thursday.  The latter is the Fed’s preferred measure of inflation (clearly not one that has anything to do with our everyday lives), but they will respond to that signal rather than CPI.

So for today, I expect that we will continue the consolidation of the bulk of the recent moves without significant volatility.  Of course, this is subject to any comments from other Fed officials, and things remain on edge regardless.  I didn’t mention the yields on peripheral European bonds, with Spain above 5%, Portugal near 7% and asking about the ECB’s willingness to actually use the OMT.  Remember, too, we have the EU meeting in Brussels on Thursday to try to hammer out the details of who is going to be on the hook for any necessary capital infusions into European banks if they should arise under the mooted bank regulator.  In other words, there are plenty of things around which can cause a market dislocation, I just have a feeling that today will be without much drama.  Take advantage of the quiet to establish hedges here.  It is much easier on a quiet day than on one where the s*it hits the fan.

Good luck
Adf

In Europe confusion prevailed
As once again countries there failed
To work out the rules
For bank-closing tools
Which were to have just been unveiled

On the whole, the dollar continues to gain, with only a few minor currencies able to rally as we begin the week.  The notable stories over the weekend were the failure by the EU to come up with a bank resolution mechanism to sever the connection between weak banks and the their national debt problems and the ongoing tightness of Chinese money markets, where the PBoC is trying to rein in ultra loose credit without causing a bank failure or two.

Let’s look at the EU situation to start.  One of the key problems driving the Euro area crisis has been the fact that the peripheral nation’s sovereign debt has largely been held by domestic banks, so Spanish banks own Spain’s debt and Italian banks own Italy’s debt, etc.  That’s all fine and well until the nation’s creditworthiness is called into question.  At that point, the holders of that debt (the banks) are also under the gun.   Given the incestuous relationship between bank and country, problems get multiplied as the viability of the banks is called into question alongside the viability of the nation.  The EU has been trying to address this issue for two years, and last year they ‘agreed’ to a resolution mechanism in one of their meetings with the details to be worked out later.  The idea was that there would be a pan-European entity (under the auspices of the ECB) which would be funded by the members of the Eurozone and would be able to directly recapitalize failing banks.  This would prevent the individual countries from having to take on more debt to save their banks, thus preserving their own creditworthiness.  This all sounded great in principal.  Alas, at the meeting this weekend to hammer out the details, they could not agree on a formula for allocating risk.  In other words, the nations that have to fund this idea (Germany, Austria, Finland and the Netherlands) are not keen to have their taxpayers own bank shares in places like Spain and Italy.  Of course the Spanish and Italians are very keen for others to take that risk.  While it would not be a surprise that, eventually,  European leaders took on this risk despite what could happen to their citizens, it would be a surprise if it were to occur before the German elections in September, as that would open Chancellor Merkel to substantial attacks from her opponents.   And so, despite assurances that they will resolve this issue at yet another meeting this Thursday, I doubt they will reach anything other than a weak compromise with no commitments by the players who matter, although they will describe it as the solution to all their problems.  This is simply another facet of my underlying bearishness on the single currency, the inherent structural flaws in its design.  And while the euro has edged lower overnight, it remains relatively well bid, at least compared to most other European currencies.

I believe the euro’s relative bid is a result of continued unwinding of trades where investors had used the euro as a funding currency to purchase emerging market currencies and assets.  This is exactly analogous to the yen’s behavior in the wake of the financial crisis in 2008.  Back then, the yen was the key funding currency (remember, only they had zero interest rates at the time) and so short-term investors borrowed yen and used the funds to buy other assets.  This was the carry trade, and it was established in very large size.  When things went south after the Lehman bankruptcy, these positions were liquidated very quickly, which resulted in lots of yen buying, and a much stronger yen¹.  I think we are seeing the same thing happen in the euro, although not to the same extent, as the euro had been a popular funding currency for many emerging market trades.  As those trades get unwound, the investor needs to buy euros to repay the funding.  Hence, the euro’s resilience in the face of USD strength elsewhere.  German data was benign, with IFO as expected at 105.9, and I believe all eyes remain on the Fed for now.  I maintain my view that the euro will continue lower over time.

Now, quickly, on to China.  The PBoC is trying to hold the line against the massive real estate speculation that has been occurring in the country, as well as limit the shadow banking system.  However they don’t have the same array of tools to adjust policy that we see in the developed world.  In addition, as there is no semblance of independence, it is widely expected that they will implement whatever policy the government chooses, rather than simply address the monetary concerns in country.  As such, recent gyrations in the short term funding market have been extreme.  A combination of increased demand for funds because of maturing debt and savings withdrawals because of the recent Chinese holidays forced many banks to pay up to fund themselves driving the overnight and 7-day repo rates to records late last week.  While those rates have since fallen, they remain well above recent averages and continue to exhibit a real tightness in markets.  It is becoming clear that the Chinese government is prepared to accept slower growth in order to prevent the inflation of a significant real estate bubble, and that does not bode well for the many exporting nations who rely on China as a key market.  So Chinese monetary foibles are displayed via a much weaker AUD and NZD, both of which count China as their number one export destination.  So too, KRW, MYR and, in fact, the rest of the Asian currency world.  The weakness across all these currencies has further to run.

There is no significant US data today, so we will look at data tomorrow.  Futures are pointing lower and Treasuries are continuing their rout.  (3% in the 10 years anyone?)  I see no reason for those trends to change, nor for the dollar to show any weakness in the near term.  Receivables hedgers, the pressure is continuing and will do so for the rest of the summer at least.

Good luck
adf

1 – This was the genesis of the idea that the yen was a safe haven.  The fact that the yen rallied alongside the dollar as investors fled their carry trades has been confused into a causality.  People weren’t buying yen because they felt it was safe, they were buying yen because they had to repay their debts.  However, the correlation was extremely high, and so many believed the story.  To be clear, yen is NOT a safe haven!

The boys in the Fed are now fighting
Which could make things much more exciting
Bernanke explained
QE could be drained
Then Bullard had words that were biting

The Chairman’s speech was premature
Since right now we just can’t be sure
Of how the US
Will meet with success
Which our buying bonds did ensure

As we walk in to the final day of what has been a pretty dramatic week with respect to market movement, the headline that jumps out to me is the comments from St Louis Fed President Bullard that the Chairman’s remarks were “inappropriately timed”.  This is the Fed’s dirty laundry out in the open and it has been sufficient to roil markets.  One of the things Bernanke has been doing while Fed Chairman has been his effort to bring transparency to the Fed process.  And while I am fully in favor of transparency, I understand that one of its consequences is that there will be more volatility resultant from that transparency.  The question is, does Ben?  After all, think about how markets work.  Traders and investors take the information they have, analyze it and establish their views, then take a position accordingly.  We all know that there are both bulls and bears in any given market, so there are always going to be different views.  But what transparency adds to the situation is that as internal dissent within the Fed becomes clear, it can serve to undermine the perception of the Fed having conviction in its actions.  Any sign of weakness in a central bank, especially the Fed, is an open invitation for markets to test that weakness.  And so now we have dissention in the ranks of the FOMC being played out in the open.  There is more volatility to come.

Yesterday’s FX movements were pretty impressive overall, with multiple currencies falling more than 2% vs. the dollar.  The overnight session has seen a bit of a rebound in the yen, but actually we have seen a continuation in the other major currencies.  The euro has suffered following the news that in Greece (remember them?) the coalition government has been weakened after its decision to close the national radio and television broadcaster, ERT, and fire 2700 government employees.  While this is a condition of the Troika bailout funding, the manner in which this occurred has not gone down well with the smallest member of the coalition.  This has also served to focus attention on questions about Greece’s ability to fund itself for the next year and called into question whether the IMF will continue adding money to the pot.  Euro weakness seems likely the future, although I don’t foresee a collapse, rather a steady decline.  The pound is softer despite better than expected budget numbers, with its deficit much smaller than expected.  However, the impetus from the ending QE story remains the key driver here.

In emerging markets, the PBoC finally injected some cash into the system last night.  This helped ease the growing credit crunch there and overnight rates fell by 442 bps.  It appears that the Chinese are still trying to figure out the best way to manage monetary policy in an economy that is growing at a much slower pace than in the past.  While the CNY is not likely to become extremely volatile any time soon, the impact on other Asian currencies is almost certainly going to be large.  The combination of the Fed changes and the PBoC squeeze has resulted sharp declines in all Asian currencies during the past week, led by INR, but pretty much across the board.  Funds continue to flow out of emerging market economies, both equity and fixed income, and this process is just getting started.  Asian central banks have been actively intervening to prevent a collapse in their currencies, but the weakening trend is going to continue as long as the Fed story remains.  Right now, most of these countries are fine, as they were actively selling their currencies during the past two years to prevent excessive strength, but history shows that defending a weakening currency is a much more difficult process, and if this pressure keeps up, we could start to see other macro policy changes that have real economic impacts, rather than simple FX intervention.  This is simply more of the fallout from Chairman Ben’s transparency initiative.

Finally in Brazil, the protests that I mentioned earlier this week are growing, with more than 1 million people taking to the streets around the country yesterday.  While Sao Paolo has rolled back the bus fare hikes that started it all, it has not been sufficient to end the protests.  Last night resulted in the first casualty in the situation, but I fear there will be more before it is over.  The question is: will President Rousseff be able to address the concerns, which seem to center on corruption in the government?  It is always difficult for a government to look inward and address its own foibles, and I don’t see any reason to believe that this situation will be different.  So to me, these protests are likely to continue for a while, possibly right up until the World Cup, and the BRL probably has further to fall.  I wrote that there was only a 20% chance of a more substantial decline in the Real, to beyond 2.50, but as I read more about what is happening on the ground there, I fear that probability is growing.  I think it is up to a 1/3 probability of a significant decline and those odds are likely to grow.  If you are a receivables hedger in BRL, be very careful.   Things could get ugly in a hurry.

Good luck and good weekend
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Bernanke is getting cold feet
Bond buying he may soon complete
So it’s no surprise
That bond yields did rise
And stocks beat a hasty retreat

In case anyone doubted that the reason equity markets around the world have performed as well as they have over the past two years was directly attributed to the massive liquidity infusion by central banks, those doubts have been erased.  The entire idea behind QE has always been to force investors out of bonds and into riskier assets.  (The underlying premise was that banks would lend the money out to business for expansion, but that’s not really what happened).  Now that Bernanke has intimated conditions may soon lead to the end of QE, it was inevitable that this is how things would play out in the markets.  It doesn’t seem to matter that every time a policy change is made by a central bank, especially the inflection from easing to tightening or vice versa, markets respond with significant volatility.  Central bankers just don’t seem to get it.  The reason for this disconnect between market behavior and central bank desires is that central bankers are traditionally academicians, with little or no market experience, and quite frankly, they simply don’t understand how markets respond to news.  Traders don’t wait around for the eventual changes in the economy to materialize; they adjust their positions at the first hint of a change.  Trading too early is generally a much better error than trading too late.  And this is also why markets tend to trade far beyond any sense of fundamentals.  So if we don’t get some further ‘clarification’ from other Fed members soon, notably Yellen or Dudley, that there is no imminent change in the pace of QE, this market condition can extend quite a bit further.  Higher US yields, lower US stock prices and a rallying US dollar, just like yesterday, will be the norm.  That has been my underlying belief for several months, and I see no reason to change that view.  (Of course if we do get that clarification, look for even more volatility as markets reverse course to some extent.)

Let’s look briefly at just how far things have moved in the past two days:

These are quite substantial movements for a 2-day period, and this increase in volatility is likely to be seen far more frequently as the transition from infinite monetary ease to ‘normal’ monetary policy proceeds.  The market is going to be highly sensitive to comments from all central bankers.  But it is also going to be highly sensitive to US data, because Chairman Ben has made it clear that data is the key.  If growth achieves their forecasts (which have been raised to 3.0-3.5% for 2014), they are going to stop buying bonds and let them start rolling off.

Today’s US data upcoming is as follows:

I think that the first 3 have the opportunity to move markets.  Indications of a better labor market are key, but if the Philly Fed follows the Empire Mfg number, which was much better than expected, and the Housing market continues to show strength, traders are going to be abandoning bonds pretty aggressively.  In fact, in these transitional periods, cash is the best thing to hold, and my guess is that is where we will see investors heading.

Data overseas had limited impact on the FX markets as all eyes remain on Bernanke, but the picture in most places remains bleak.  China’s HSBC PMI data was much weaker than expected at 48.3, and tightening monetary conditions continue to plague the markets there.  Adding this to the Fed change has helped AUD to be the worst performer in the G10 space.  My earlier estimates of 0.90 may be too timid.

In Europe the PMI data for German Mfg was disappointing at 48.7, but its services data was better than expected at 51.3.  In the EU as a whole, the PMI Composite was modestly better than expected at 48.9, still indicating extremely low growth, but edging toward a positive outlook.

The only truly positive story remains the UK, where Retail Sales were up a much better than expected 2.1% in May, continuing the improving economic data there.  It should be no surprise that the pound has been the best performer of all European currencies over the past sessions, as its macro story remains the best of the bunch.

For today the market is likely to continue with its volatile ways.  I believe the trend for dollar strength will underlie most movements, especially in the emerging markets, but I am reluctant to believe that another 2% is in the cards for the rest of the day.  But over the next several weeks, there is ample time for a much stronger dollar.  Do not be looking for other central bankers to stop the USD strength, but do not be surprised if in the emerging market space we see interventions to try to moderate the volatility.  For all you payables hedgers, your time is going to come in the not too distant future, and quite frankly, another layer of hedges after recent moves would not be a bad idea.

Good luck
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