Talks Remain Tough

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In Brussels they’re starting to say
A soft Brexit’s soon on the way
Though talks remain tough
There could be enough
To reach an agreement today!

Nothing has changed with regard to which stories are market drivers, although on the equity front we now get to add Q3 earnings to the mix. But as far as FX is concerned, Brexit and trade still dominate the discussion. Regarding Brexit, the rumblings from Brussels have been far more positive this morning, with the EU’s chief negotiator, Michel Barnier, explaining that a deal was still possible before the EU Summit on Thursday, but difficult. Apparently, the UK has submitted detailed plans of how they would like to address the Irish border situation, and there is serious consideration although negotiations continue. From Parliament, the word is that the votes will be there to pass any deal agreed by PM Johnson, as the Tories and Brexiteers recognize that Boris was a Brexiteer from the get-go. The Summit begins in two days, and I continue to expect that a deal, ‘in principal’ will be agreed beforehand. It should be no surprise that the pound has rallied on the news, after giving up some of Friday’s gains during the European session yesterday. This morning, Sterling is higher by 0.4%, although since we closed Friday, it is actually lower by 0.2%. Nonetheless, I continue to see scope for significant advancement here upon the news that deal has been reached.

As to the trade story, Friday also proved to be something of a false dawn as the Chinese backed away from the idea that a deal has been struck and are seeking continued discussions. This morning, however, there seems to be a bit more upbeat tone, even with the Chinese, as it is clear that talks will continue over the next few weeks at both mid-level and high-level (Mnuchin, Lighthizer and Liu He) conference calls. The Chinese have also figured out that they need to import a LOT if pork and that is something of which the US possesses a great deal. Overnight, Chinese data showed PPI falling 1.2%, meaning factories continue to lose pricing power, but CPI rose 3.0%, above expectations and starting to put pressure on the government. As part of that CPI rise, pork prices rose 69%! African swine fever is clearly taking its toll on the Chinese swine herd. This morning, the Chinese offered to remove tariffs on $50 billion of agricultural products if the US would remove a similar amount. While no decision has been made, I expect that there will be agreement on this subject as for President Trump, the demographics of the beneficiaries of this action would be his biggest supporters. Despite broad dollar strength since Friday, we continue to see the renminbi (+0.2% since Friday) perform well, a testimony to the PBOC’s efforts to prevent the currency from weakening, but also in response, I think, to the idea that there is positive movement on the trade front.

Away from those stories, we continue to see weak Eurozone growth data, with the German ZEW Survey falling to -22.8, slightly better than expected but still miles below its longer term average of +12.8. On top of that, a survey of 53 economists by Bloomberg has forecast that German GDP will shrink 0.1% in Q3, defining a technical recession in the country, and weighing further on the entire Eurozone. As I have repeatedly pointed out, the EU cannot afford a hard Brexit and are highly incented to reach an agreement this week. The euro, which had been holding its own of late has given up 0.2% this morning and a bit more since Friday and is back at the 1.1000 level, although that is in the upper half of performers in the G10 space. The biggest loser is NZD, which is down 1.1% since Friday after the RBNZ bid for bonds, which traders read as a form of QE, and which is tracking Aussie lower after remarks from the RBA indicate that further easing is on the way.

The other big loser this morning is the Norwegian krone, which has fallen 0.8% since Friday following oil prices’ downward trajectory. The latter is due to a combination of concerns over slowing global growth reducing demand for oil, while inventories continue to rise.

In the EMG space, INR is today’s largest mover, sliding 0.75% after CPI data was released at a higher than expected 3.99% in September. The rupee had been a beneficiary of inward investment based on the idea that quiescent inflation would allow further RBI rate cuts and enhanced growth and equity market performance. However, if inflation has bottomed, it seems that investors are likely to be a little more circumspect. Overnight there was clear selling of Indian bonds by international investors leading to the currency’s decline. However, beyond that movement, the EMG bloc had more losers than gainers, but none with a significant move or story.

On the data front this week, we see a bunch of middle tier data with the highlight arguably Retail Sales.

Wednesday Retail Sales 0.3%
  -ex autos 0.2%
  Business Inventories 0.2%
  Fed’s Beige Book  
Thursday Initial Claims 215K
  Housing Starts 1320K
  Building Permits 1350K
  Philly Fed 8.0
  IP -0.2%
  Capacity Utilization 77.7%
Friday Leading Indicators 0.1%

In addition to the data, we hear from a total of ten Fed speakers this week, ranging from the uber-dove James Bullard to the uber-hawk Esther George and every spot along the spectrum in between. Overall, the Fed message has been that they feel the economy is in a ‘good’ place, but they won’t hesitate to ease further if the data turns downward. Of course, their message was also that buying $60 billion / month of T-bills to help ease reserve conditions was in no way more QE. That is a much tougher circle to square.

Looking ahead, the market remains headline driven so care needs to be taken. There is no clear risk view this morning with both equity futures and Treasuries higher, and the dollar is mixed, again clouding any view. My expectation is that the market will likely tread water ahead of the next piece of news. And my money remains on that being a positive Brexit story.

Good luck
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Time’s Crunch

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When Boris and Leo had lunch
No panties were balled in a bunch
The signals showed promise
And no doubting Thomas
Appeared, as both sides felt time’s crunch

Meanwhile, though there’s been no bombshell
The trade talks have gone “very well”
Today Trump meets He
And then we will see
If a deal betwixt sides can now gel

And finally from the Mideast
The story ‘bout risk has increased
A tanker attack
Had market blowback
With crude a buck higher at least

There is no shortage of important stories today so let’s jump right in. Starting with Brexit, yesterday’s lunch meeting between Boris Johnson and Leo Varadkar, the Irish PM, turned into something pretty good. While the comments have been very general, even EU president Donald Tusk as said there were “promising signals.” It is crunch time with the deadline now less than three weeks away. Apparently, the rest of the EU is beginning to believe that Boris will walk with no deal, despite the Benn Act requiring him to ask for an extension if there is no deal in place. At the same time, everybody is tired of this process and the EU has many other problems, notably a declining economy, to address. And so, I remain confident that we will soon hear, probably early next week, about a ‘deal in principle’ which will be ratified by Parliament as well as the EU. Though all the details will not have been completed, there will be enough assurances on both sides to get it through. Remember, Boris has Parliament on his side based on the deal he showed them. I’m pretty sure that his conversation with Leo yesterday used that as the starting point.

When that news hit the tape yesterday morning a little past 10:00, the pound started a significant rally, ultimately gaining 2% yesterday and it is higher by a further 1.0% this morning after more promising comments from both sides of the table. Remember, too, that the market remains extremely short pound Sterling and has been so for quite a while. If I am correct, then we could see the pound well above 1.30 as early as next week. Of course, if it does fall apart, then a quick trip back to 1.20 is on the cards. As I have said, my money is on a deal. One other thing to note here is what happened in the FX options market. For most of the past twelve years, the risk reversal (the price the market pays for 25 delta puts vs. 25 delta calls) has traded with puts at a premium. In fact earlier this year, the 1mo version was trading at a 2.5 vol premium for puts. Well, yesterday, the risk reversal flipped positive (bid for calls) and is now bid more than 1.0 vol for GBP calls. This is a huge move in this segment of the market, and also seen as quite an indicator that expectations for further pound strength abound.

Regarding the trade talks, risk assets have taken a very positive view of the comments that have come from both sides, notably President Trump describing things as going “very well” and agreeing to meet with Chinese Vice-premier Liu He this afternoon before he (He) returns to Beijing. The information that has come out points to the following aspects of a deal; a currency pact to insure the Chinese do not weaken the renminbi for competitive advantage; increased Chinese purchases of grains and pork; a US promise not to increase tariffs going forward as the broader negotiations continue; and the lifting of more sanctions on Chinese companies like Huawei and COSCO, the Chinese shipping behemoth. Clearly, all of that is positive and it is no surprise that equity markets globally have responded with solid gains. It is also no surprise that Treasury and Bund yields are much higher this morning than their respective levels ahead of the talks. In fact, Treasuries, which are just 1bp higher this morning, are up by more than 15bps since Tuesday. For Bunds, today’s price action shows no change in yields, but a 12bp move (less negative rates) since then. The idea is a trade deal helps global economic growth pick back up and quashes talk of deflation.

The last big story of the morning comes from the Persian Gulf, where an Iranian oil tanker, carrying about 1 million barrels of oil, was attacked by missiles near the Saudi port of Jeddah. At first the Iranians blamed the Saudis, but they have since retracted that statement. It should be no surprise that oil prices jumped on the news, with WTI futures quickly rallying more than a dollar and maintaining those gains since then. One of the key depressants of oil prices has been the global economic malaise, which does not yet look like it is over. However, if the trade truce is signed and positive vibes continue to come from that area, I expect that oil prices will benefit greatly as well.

As to the FX market per se, the dollar is overall under pressure. Of course, the pound has been the biggest mover in the G10 space, but AUD has gained 0.55% and the rest of the block is higher by roughly 0.3%. The only exceptions here are the yen (-0.3%) and Swiss franc (-0.1%) as haven assets are unloaded.

Turning to the EMG bloc, ZAR is today’s big winner, rallying more than 1.1% on two features; first the general euphoria on trade discussed above and second on the news that former President Jacob Zuma must face corruption charges. The latter is important because it demonstrates that the rule of law may be coming back into favor there, always a benefit for an emerging market. But most of the space is firmer this morning, with many currencies higher by between 0.5% and 0.6% (RUB, KRW, PLN, HUF, MXN, etc.) In fact, the only loser this morning is TRY (-0.4%), which remains under pressure as President Erdogan presses his military campaign against the Kurds in Syria.

On the data front, the only US news is Michigan Sentiment (exp 92.0) but we also get the Canadian employment picture (exp 7500 new jobs and a 5.7% Unemployment Rate). Three more Fed speakers, Kashkari, Rosengren and Kaplan, are on the slate, but so far, the only clarity of message we have received this week is that everybody is watching the data and will respond as they see fit. Hawks are still hawks and doves are still doves.

I see no reason for the dollar to regain ground today assuming the good news from Trade and Brexit continue. So look for a further decline into the holiday weekend.

Good luck and good weekend
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PS. While typing, the pound jumped another 1.0%.

A Currency Pact

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The market is focused on trade
And hoping that progress is made
There’s news China’s backed
A currency pact
If tariff boosts can be delayed

Activity overnight was considerably more volatile than usual as conflicting stories regarding the US-China trade talks hit the tape. Risk was quickly jettisoned after a story from the South China Morning Post indicated that the talks, starting this morning in Washington, would be cut short. Shortly thereafter, the White House denied that report encouraging traders to buy back their stocks and sell bonds. Then Fox Business reiterated the original report less than a half hour later and the sell-off happened all over again. Finally, two positive reports helped equity markets recoup all of their overnight losses and took the shine off bonds. The first of those was that the currency pact that had been agreed between the US and China back in May (when chances of a big deal seemed realistic) was being dusted off and likely would be part of a mini-deal with the US agreeing to delay the imposition of new tariffs next Tuesday. And finally, President Trump has allowed US firms to sell non-critical technology to Huawei again, which was seen as additional thawing of the trade situation.

Of course, all this means is that we are back where we started, the trade talks are due to begin this morning and the Chinese delegation is scheduled to leave tomorrow evening. Arguably, the story that both sides are willing to agree on a currency pact as part of this round, and the indications that there are low level things that can be agreed, bode well for the rest of the week. But make no mistake, the major issues; IP theft, forced technology transfer and state subsidies are nowhere near being solved, and quite frankly, given they are integral to China’s economic model, seem unlikely ever to be solved. But for equity bulls, at least, hope springs eternal.

The FX impact in the end has been for a much softer dollar pretty much across the board. The idea is that if risk is to be embraced again, the higher yields available in Emerging Markets, as well as developed markets on a swapped basis, are the place to be. While the biggest mover overnight has been SEK, that is actually due to a surprising CPI report, with the annual pace of price increases rising to 1.5%, above the 1.3% expectation and a boon for the Riksbank who has been trying to normalize monetary policy by raising rates back to, and above, zero again. This report has given the market reason to believe that at their next meeting, in two weeks, while they won’t hike, they will continue to give guidance that a hike is coming before the end of the year. As such, SEK has rallied a solid 1.4%, although arguably, the trend is still for a weaker krone.

But the rest of the G10 has performed as well, with AUD, NZD and NOK all higher by 0.6% and the euro, despite disappointing data from both Germany and France, higher by 0.5%. Even the pound is higher this morning, up 0.35%, as the market awaits word on the outcome of a lunch meeting between Boris and Irish PM Leo Varadkar as they try to find a compromise. It seems to make the most sense that Varadkar is representing the EU given Ireland will be the nation most negatively impacted by a hard Brexit. My sense is we should start to hear about the outcome of this lunch around the time that US CPI is released, although I would read a delay as quite positive. The longer it takes; it seems the more likely that they are making headway on a compromise which would be very bullish for the pound. But until we actually see the news, the broad dollar trend is all we have.

In the EMG bloc we have also seen broad based strength paced this morning by HUF’s 0.7% rally. While much of this move is simply on the back of the euro’s rise, Hungary did have a quite successful auction of 5yr-15yr bonds which encouraged additional forint buying. Otherwise, the rest of the CE4 have moved directly in line with the euro and gains throughout Asia were only on the order of 0.2%. Of course, those markets closed before all the trade news had been released, so assuming nothing changes on that front (a difficult assumption) APAC currencies are likely to perform well tonight.

Turning to today’s session, we see our most important data of the week with CPI (exp 1.8%, 2.4% ex food & energy) as well as the usual Initial Claims data (220K). Regarding the former, Tuesday’s PPI report was surprisingly soft, with the headline number printing at -0.3% on the month and dragging the annual number down to just 1.4%. While there have been no forecast shifts amongst economists, there is still some lingering concern (hope?) amongst market participants that we could see a soft number here as well. The issue is a soft number would seem to open the door for the Fed to be far more aggressive in their rate cutting. Remember, Chairman Powell has repeated several times lately that the committee is watching the data closely and will do what they need to do in order to maintain the expansion while achieving their twin goals of stable prices and maximum employment. Obviously, with the Unemployment Rate at 3.5%, there is not much concern there. But falling inflation will ring alarm bells.

One last thing, though, regarding employment. The Initial Claims data is often a very good leading indicator of the overall employment situation, starting to rise well before the nonfarm numbers start to decline. Since the financial crisis, Initial Claims have tumbled from a peak of 665K in March 2009 to the low 200’s that we have seen for the past year. But recently, it appears that the number is beginning to creep higher again, with the 210k-215k readings that we had been seeing regularly now edging toward 220K and beyond. And while I know that seems extremely subtle, I merely caution that Initial Claims is a measure of job cuts, so if they are actually growing, that bodes ill for the economy’s future performance.

As to today, unless and until we hear more from the Trade talks or Boris, don’t look for much movement. But certainly the bias is to add risk for the day meaning the dollar should remain under pressure.

Good luck
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Too Effing High

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Said Powell, we’re going to buy
More assets in order to try
To make sure that rates
Stay where the Fed states
And stop trading too effing high

“This is not QE; in no sense is this QE!” So said Fed Chairman, Jerome Powell, yesterday at a conference in Denver when describing the fact that the Fed would soon resume purchasing assets. You may recall right around the time of the last FOMC meeting, there was sudden turmoil in the Fed Funds and other short-term funding markets as reserves became scarce and interest rates rose above the Fed’s target. That resulted in the Fed executing a series of short-term reverse repos in order to make more reserves available to the banking community at large. Of course, the concern was how the Fed let itself into this situation. It seems that the reduction of the Fed balance sheet as part of the normalization process might have gone a little too far. Yesterday, Powell confirmed that the Fed was going to start buying 3-month Treasury bills to expand the size of the balance sheet and help stabilize money markets. However, he insisted that given the short-term nature of the assets they are purchasing, this should not be construed as a resumption of QE, where the Fed bought maturities from 2-years to 30-years. QE was designed to lower longer term financing rates and boost investment and correspondingly economic growth. This action is meant to increase the availability of bank reserves in the system so that no shortages appear and money markets remain stable and functioning.

As far as it goes, that makes sense given commercial banks’ regulatory needs for a certain amount of available reserves. But Powell also spoke about interest rates more generally and hinted that a rate cut was a very real possibility, although in no way certain. Of course, the market is pricing in an 80% probability of a cut this month and a 50% probability of another one in December. Certainly Powell didn’t dispute those ideas. And yet a funny thing happened in the markets yesterday despite the Fed Chairman discussing further policy ease; risk was reduced. Equity markets suffered in Europe and the US, with all major indices lower by more than 1.0% (S&P -1.5%). Treasury yields fell 3bps and the dollar rallied steadily all day along with the yen, the Swiss franc and gold.

It is the rare day when the Fed Chair talks about easing and stock prices fall. It appears that the market was more concerned with the escalation in trade war rhetoric and the apparent death of any chance for a Brexit deal, both of which have been described as key reasons for business and investor uncertainty which has led to slowing growth, than with Fed policy. And for central banks, that is a bigger problem. What if markets no longer take their cues from the central bankers and instead trade based on macroeconomic events? What will the central banks do then?

On the China front, yesterday’s White House actions to blacklist eight Chinese tech firms over their involvement in Xinjiang and the Uigher repression was a new and surprising blow to US-China relations. In addition, the US imposed visa restrictions on a number of individuals involved in that issue and has generally turned up the temperature just ahead of the next round of trade talks which are due to begin tomorrow in Washington. It has become abundantly clear that the ongoing trade war is beginning to have quite a negative impact on the US economy as well as that of the rest of the world. President Trump continues to believe that the US has the advantage and is pressing it as much as he can. Of course, Chinese President Xi also believes that he holds the best cards and so is unwilling to cave in on key issues. However, this morning there was a report that China would be quite willing to sign a more limited deal where they purchase a significantly greater amount of agricultural products, up to $30 billion worth, as well as remove non-tariff barriers against US pork and beef in exchange for the US promising not to implement the tariffs that are set to go into effect next Tuesday and again on December 15. In addition, the PBOC fixed the renminbi last night at a lower than expected 7.0728, indicating that they want to be very clear that a depreciation in their currency is not on the cards. It is not hard to view these actions and conclude that China is starting to bend a little, especially with the Hong Kong situation continuing to escalate.

It also seems pretty clear that the talks this week have a low ceiling for any developments, but my sense is some minor deal will be agreed. However, the big issues like state subsidies and IP theft are unlikely to ever be resolved as they are fundamental to China’s economic model and there are no signs they are going to change. In the end, if we do get some de-escalation of rhetoric this week, I expect risk assets to respond quite favorably, at least for a little while.

Turning to Brexit, all we have heard since yesterday’s phone call between Boris and Angela is recriminations as to who is causing the talks to fall apart. Blame is not going to get this done, and at this point, the question is, will the UK actually ask for an extension. Ostensibly, Boris is due to speak to Irish PM Varadkar today, but both sides seem pretty dug in right now. The EU demand that Northern Ireland remain in the EU customs union in perpetuity appears to be a deal breaker, and who can blame them. After all, the purpose of Brexit was to get out of that customs union and be free to negotiate terms as they saw fit with other nations. However, as European economic data continues to deteriorate, the pressure on the EU to find a deal will continue to increase. While you cannot rule out a hard Brexit, I continue to believe that some type of fudge will be agreed before this is over. Yesterday the pound suffered greatly, falling below 1.22 for a bit before closing lower by 0.6%. This morning, amid a broadly weaker dollar environment, the pound is a laggard, but still marginally higher vs. the dollar, up 0.1% as I type.

The rest of the FX market was singularly unimpressive overnight, with no currency moving even 0.5% as traders everywhere await the release of the FOMC Minutes this afternoon. Ahead of the Minutes, we only see the JOLTS jobs report (exp 7.25M) which rarely matters to markets. Yesterday’s PPI data was surprisingly soft, falling -0.3% and now has some analysts reconsidering their inflation forecasts for tomorrow. Of course, quiescent inflation plays into the hands of those FOMC members who want to cut rates further. At this point, the softer dollar seems to be more of a reaction to yesterday’s strength than anything else. I expect limited movement ahead of the Minutes, and quite frankly, limited afterwards as well. Tomorrow’s CPI feels like the next big catalyst we will see.

Good luck
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The UK Wants to Shun

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This morning as part of his plan
For Brexit, the PM began
A series of talks,
Before Britain walks,
With Angela as middleman

Alas, when the phone call was done
The odds of a deal approached none
The EU made clear
The (Northern) Irish adhere
To rules the UK wants to shun

The pound is suffering this morning, down 0.5%, after news that a phone call between Boris and Angela resulted in Johnson explaining that a Brexit deal is “essentially impossible” at the current time. If you recall, Boris’s plan was for Northern Ireland to adhere to EU rules on manufactured goods and agricultural products while customs activities would take place a number of miles from the actual border. Finally, Northern Ireland would be allowed to vote every four years to determine if they were happy with that situation. The EU view is that Northern Ireland must remain a part of the customs union in perpetuity, something that would essentially split them from the rest of the UK. It is no surprise that both Boris and Northern Ireland rejected that outcome, and so the Johnson government has increased preparations for a hard Brexit.

There are two interesting tidbits ongoing as well, both of which bode ill for a deal. First is that Irish Taoiseach Leo Varadkar is terrified that he and his nation will be blamed if no deal is reached. And when I say terrified, it means that he is afraid that a no-deal Brexit will result in a significant (~5%) hit to Ireland’s economy and that he will be tossed from office because of that. Remember, every politician’s number one priority during any situation is to be reelected, hence his terror. His response has to increase the rhetoric about how Boris is the problem, further poisoning the well. The second interesting thing is that a survey in the EU by Kantar (a European polling company) showed that between 47% and 66% of citizens in six EU nations (France, Germany, the Netherlands, Ireland, Spain and Poland) believe the EU should not extend the Brexit deadline, with a solid majority in all nations except the Netherlands. Perhaps Boris will get his wish that Europe won’t offer an extension or agree to one if asked. It appears that this saga is reaching its denouement. And despite all of this, I continue to see a strong possibility that the EU blinks as they figure out Boris is serious. My impression is that Merkel and the EU continue to believe that the UK will come begging, hat in hand, for another extension and that a new vote will lead to the end of this process with the UK revoking Article 50. And so they continue to believe they are dealing from a position of strength. We shall see.

Of course, the reason we care so much about this is not just for the impact on the British pound, but actually the impact on the global economy. Consider that the global economy has been slowing steadily for the past eighteen months under pressure from the ongoing trade war between the US and China and the uncertainty that has engendered. If the estimates of the economic impact of a hard Brexit are even halfway correct, we are looking at a sharp decline in economic activity in the UK, Ireland, Germany, France and the Netherlands, ranging between 0.5% and 5.0%. I assure you that will not help the global growth situation. It will also result in immediate additional policy ease by the world’s central banks, notably the Fed. The impact on equity markets will be significant, bond markets will rally sharply as will haven currencies. In other words, it could easily be the catalyst required to bring on that recession on the horizon.

Beyond Brexit, the other big story overnight was on trade as the US put 28 Chinese firms on an export blacklist under the guise of those companies helping in repression of Muslim minorities in northwest China. Not surprisingly, the Chinese were not amused and ‘instructed’ the US to correct its mistake. They also told the world to “stay tuned” for any retaliation that will be forthcoming. Fortunately, this has not changed the plans for the trade talks to be held on Thursday and Friday in Washington with Vice-premier Liu He, at least not yet. But that remains a huge concern, that He will not make the trip and that the trade impasse will harden. At this point it has become pretty clear that a big trade deal is not in the offing. The Chinese appear to be betting that President Trump will lose the election and so are waiting him out. However, this is the one area where the President truly has bipartisan support so it is not clear to me that a President Warren, Biden or Sanders would be any more inclined to come to an agreement that didn’t meet hurdles regarding IP theft and state subsidies.

The combination of these two events has served to undermine equity markets in Europe with virtually every major index having fallen by more than 1% this morning. While Asian equity markets performed well (Nikkei +1.0%, KOSPI +1.2%, Shanghai +0.25%) that was before the Boris-Angela call. US futures have turned lower in the past hour with all three exchanges now pointing to 0.5% declines on the opening. Meanwhile, Treasury yields continue to fall with the 10-year at 1.52%, down 4bps and Bunds are following with yields there down 1.5bps.
As to the dollar, it is no surprise the yen (+0.4%) and Swiss franc (+0.35%) have rallied, but a bit more surprising that aside from the pound, most other G10 currencies are firmer. That said, the movement has not been that large and if we see a true risk-off session in the US, I would expect the dollar to strengthen. In the EMG space, ZAR is the biggest loser today, falling 0.65%, after Renaissance Capital put out a report that the country’s debt would be downgraded to junk status next month. Given their recent track record, correctly calling 8 of the past 9 ratings moves, it is being given some credence. After that, RUB has fallen 0.5% on the back or weaker oil prices, which are down 1.3% this morning and more than 11% from before the attack on the Saudi oil facility in the middle of September.

As to data today, NFIB was already released at a slightly weaker than expected 101.8. While that remains at the high end of its historic readings, it is clear that this series has rolled over and is heading lower. We also get PPI (exp 1.8%, 2.3% ex food & energy) at 8:30 but most folks ignore that and are looking for CPI on Thursday. Chairman Powell speaks again today at 2:30 this afternoon, so all eyes will be focused on Denver to see how he responds to the most recent gyrations in the big stories.

Overall, it feels like a day of uncertainty and risk reduction. Look for further yen and Swiss franc strength as well as for the dollar to regain its footing against the rest of its counterparts.

Good luck
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Digging In Heels

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In Europe they’re digging in heels
Ignoring all UK appeals.
So, Brexit is looming
With Boris assuming
They’ll blink, ratifying his deal

Brexit and the Trade Wars sounds more like a punk rock band than a description of the key features in today’s markets, but once again, it is those two stories that are driving sentiment.

Regarding the former, the news today is less positive that a deal will be agreed. A wide group of EU leaders have said Boris’s latest offering is unacceptable and that they are not willing to budge off their principles (who knew they had principles?). It appears the biggest sticking point is that the proposal allows Northern Ireland to be the final arbiter of approval over the workings of the deal, voting every four years to determine if they want to remain aligned with the EU’s rules on manufactured goods, livestock and agricultural products. This, of course, would take control of the process out of the EU’s hands, something which they are unwilling to countenance.

French President Emmanuel Macron has indicated that if they cannot agree the framework for a deal by this Friday, October 11, there would be no chance to get a vote on a deal at the EU Summit to be held next week on October 17. It appears, at this point, that the EU is betting the Benn Act, the legislation recently passed requiring the PM to ask for an extension, will be enforced and that the UK will hold a general election later this year in an attempt to establish a majority opinion there. The risk, of course, is that the majority is to complete Brexit regardless and then the EU will find itself in a worse position. All of this presupposes that Boris actually does ask for the extension which would be a remarkable climb-down from his rhetoric since being elected.

Given all the weekend machinations, and the much more negative tone about the outcome, it is remarkable that the pound is little changed on the day. While it did open the London session down about 0.35%, it has since recouped those losses. As always, the pound remains a binary situation, with a hard Brexit likely to result in a sharp decline, something on the order of 10%, while a deal will result in a similar rally. However, in the event there is another extension, I expect the market will read that as a prelude to a deal and the pound should trade higher, just not that much, maybe 2%-3%.

Otherwise, the big story is the trade war and how the Chinese are narrowing the scope of the negotiations when vice-premier Liu He arrives on Thursday. They have made it quite clear that there will be no discussion on Chinese industrial policy or subsidies, key US objectives, and that all the talks will be about Chinese purchases of US agricultural and energy products as well as attempts to remove tariffs. It appears the Chinese believe that the impeachment inquiry that President Trump is facing will force him to back down on his demands. While anything is possible, especially in politics, based on all his actions to date, I don’t think that the President will change his tune on trade because of a domestic political tempest that he is bashing on a regular basis. The market seems to agree with that view as well, at least based on today’s price action which can best be described as modestly risk-off. Treasury and Bund yields are lower, albeit only between 1-2bps, the yen (+0.1%) and Swiss franc (+0.2%) have strengthened alongside the dollar and US equity futures are pointing to a decline of 0.2% to start the session. Ultimately, this story will remain a market driver based on headlines, but it would be surprising if we hear very much before the meetings begin on Thursday.

Looking ahead to the rest of the week, the FOMC Minutes will dominate conversation, but we also see CPI data:

Today Consumer Credit $15.0B
Tuesday NFIB Small Biz Optimism 102.0
  PPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Wednesday JOLTS Job Openings 7.25M
  FOMC Minutes  
Thursday Initial Claims 220K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)
Friday Michigan Sentiment 92.0

Source: Bloomberg

Over the weekend we heard from both Esther George and Eric Rosengren, the two FOMC members who dissented against the rate cuts. Both said they see no reason to cut rates again right now, but if the data do deteriorate, they have an open mind about it. Meanwhile, Friday Chairman Powell gave no hints that last week’s much weaker than expected data has changed his views either. This week brings seven more Fed speakers spread over ten different events, including Chairman Powell tomorrow.

At the same time, this morning saw German Factory Orders decline a more than expected 0.6%, which makes the twelfth consecutive Y/Y decline in that series. It is unambiguous that Germany is in a recession and the question is simply how long before the rest of Europe follows, and perhaps more importantly, will any country actually consider fiscal stimulus? As it stands right now, Germany remains steadfast in their belief it is unnecessary. Maybe a hard Brexit will change that tune!

The big picture remains intact, with the dollar being the beneficiary as the currency of the nation whose prospects outshine all others in the short run. As it appears highly unlikely a trade deal will materialize this week, I see no reason for the dollar to turn around. Perhaps the only place that is not true is if there is, in fact, a break though in the UK.

Good luck
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Much Could Be Gained

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Today’s jobs report is the theme
About which most traders will scheme
If strong, bulls will buy
Just like last July
If weak, you can bet they’ll all scream

But yesterday there was some news
About a Fed President’s views
Ms. Mester explained
That much could be gained
If price hikes the Fed could perfuse

Yes folks, it’s payrolls day so let’s get that out of the way quickly. Here are the current consensus estimates as per Bloomberg:

Nonfarm Payrolls 145K (whisper 125K)
Private Payrolls 130K
Manufacturing Payrolls 3K
Unemployment Rate 3.7%
Average Hourly Earnings 0.2% (3.2% Y/Y)
Average Weekly Hours 34.4
Participation Rate 63.2%
Trade Balance -$54.5B

Census hiring explains the relatively wide gap between nonfarm and private payrolls, and it is important to understand that these numbers represent a downtick from the trends we have seen during the past several years. But it is also important to remember that a nonfarm number greater than 100K is deemed sufficient to prevent the Unemployment Rate from rising as population growth in the US slows. Given how poor the data has been this week, while official forecasts at most institutions haven’t fallen much, the trading community is definitely looking for a weaker number.

In the event the data is weak, I expect the dollar to decline as the market starts to price in more than a 25bp cut for the end of this month (currently an 85% probability), but I think the initial reaction to equities could be a rally as the reflex of lower rates leading to higher stock prices kicks in. Alas, for stock bulls, I fear the situation is starting to turn to the data is getting weak enough to indicate an imminent recession which will not be good for equity markets. Of course, a strong print should see both the stock market and the dollar rally, while Treasuries sell off. As an aside, 10-year Treasury yields have fallen 37 basis points since September 13! That is a huge move and a very good indicator of just how quickly sentiment has shifted regarding the Fed’s activity later this month.

But there was something else yesterday that I think was not widely noticed, yet I believe is of significant importance. Cleveland Fed President Loretta Mester, one of the two most hawkish members of the FOMC (KC’s Esther George is the other) spoke yesterday and said she thought, “adopting a band for the Fed’s inflation objective makes sense for communications reasons, as it allows some scope to run inflation a bit higher in the band during good times while allowing the target for price gains to be lower during downturns when interest rates are near zero.” This is hugely significant because if a Fed hawk is now comfortable allowing inflation to run above target, something that hawks specifically fight, it means that the FOMC is much more dovish than previously assumed. And that means that we are likely to head toward ZIRP much sooner than many had thought.

This is clearly an impediment to further dollar strength, as one of the pillars of the strong dollar view has been the idea that the FOMC would maintain relatively tighter monetary policy than other central banks. Of course, as we have already seen, other central banks are not sitting around, waiting for Godot, but acting aggressively already. For example, after the RBA cut rates last week, last night the Reserve Bank of India cut rates by 25bps while lowering GDP forecasts. As inflation remains modest in India, you can bet that there will be further cuts to come. The FX impact was on a day when the dollar lost ground against virtually all EMG counterparts, INR actually weakened by 0.15%.

Away from these stories, Brexit is still Brexit with Boris flitting around Europe trying to close the loop. Though not yet able to get a deal agreed in Brussels, he seemingly is having success at home in getting enough of Parliament to back him to get his deal passed. And that is important for the EU, because given the previous failure of Teresa May to get her deal passed, the EU is wary that anything to which they agree will still be voted down. But if Boris can show his deal will get enacted in the UK, it would be a powerful argument for the EU to blink.

And that’s really it folks. The dollar is generally softer this morning against both G10 and EMG currencies with KRW the biggest gainer (+0.8%) on excitement over prospects for the Fed to cut rates which encouraged profit taking after a two-week 2+% decline. But it’s all about payrolls this morning. We do hear from three more Fed speakers today, with Chairman Jay on the hustings in Washington this afternoon. That will give the market plenty of time to have absorbed the data.

For my money, I fear a much worse NFP number, something on the order of 50K. The data has been too weak to expect something much better in my view.

Good luck and good weekend
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QE We’ll Bestow

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The data continue to show
That growth is unhealthily slow
The pressure’s on Jay
To cut rates and say
No sweat, more QE we’ll bestow

The market narrative right now is about slowing growth everywhere around the world. Tuesday’s ISM data really spooked equity markets and then that was followed with yesterday’s weaker than expected ADP employment data (135K + a revision of -38K to last month) and pretty awful auto sales in the US which added to the equity gloom. This morning, Eurozone PMI data was putrid, with Germany’s Services and Composite data (51.4 and 48.5 respectively) both missing forecasts by a point, while French data was almost as bad and the Eurozone Composite reading falling to stagnation at 50.1. In other words, the data continues to point to a European recession on the immediate horizon.

The interesting thing about this is that the euro is holding up remarkably well. For example, yesterday in the NY session it actually rallied 0.45% as the market began to evaluate the situation and price in more FOMC rate cutting. Certainly it was not a response to positive news! And this morning, despite gloomy data as well as negative comments from ECB Vice-President Luis de Guindos (“level of economic activity in the euro area remains disappointingly low”), the euro has maintained yesterday’s gains and is unchanged on the session. At this point, the only thing supporting the euro is the threat (hope?) that the Fed will cut rates more aggressively going forward than had recently been priced into the market. Speaking of those probabilities, this morning there is a 75% probability of a Fed cut at the end of this month. That is up from 60% on Tuesday and just 40% on Monday, hence the euro’s modest strength.

Looking elsewhere, the pound has also been holding its own after yesterday’s 0.5% rally in the NY session. While I think the bulk of this movement must be attributed to the rate story, the ongoing Brexit situation seems to be coming to a head. In fact, I am surprised the pound is not higher this morning given the EU’s reasonably positive response to Boris’s proposal. Not only did the EU not dismiss the proposal out of hand, but they see it as a viable starting point for further negotiations. One need only look at the EU growth story to recognize that a hard Brexit will cause a significant downward shock to the EU economy and realize that Michel Barnier and Jean-Claude Juncker have painted themselves into a corner. Nothing has changed my view that the EU will blink, that a fudged deal will be announced and that the pound will rebound sharply, up towards 1.35.

Beyond those stories, the penumbra of economic gloom has cast its shadow on everything else as well. Government bond yields continue to decline with Treasury, Bund and JGB yields all having fallen 3bps overnight. In the equity markets, the Nikkei followed the US lead last night and closed lower by 2.0%. But in Europe, after two weak sessions, markets have taken a breather and are actually higher at the margin. It seems that this is a trade story as follows: the WTO ruled in the US favor regarding a long-standing suit that the EU gave $7.5 billion in illegal subsidies to Airbus and that the US could impose that amount of tariffs on EU goods. But the White House, quite surprisingly, opted to impose less than that so a number of European companies that were expected to be hit (luxury goods and spirits exporters) find themselves in a slightly better position this morning. However, with the ISM Non-Manufacturing data on tap this morning, there has to be concern that the overall global growth story could be even weaker than currently expected.

A quick survey of the rest of the FX market shows the only outlier movement coming from the South African rand, which is higher this morning by 0.9%. The story seems to be that after three consecutive weeks of declines, with the rand falling more than 6% in that run, there is a seed of hope that the government may actually implement some positive economic policies to help shore up growth in the economy. That was all that was needed to get short positions to cover, and here we are. But away from that story, nothing else moved more than 0.3%. One thing that has been consistent lately has been weakness in the Swiss franc as the market continues to price in yet more policy ease after their inflation data was so dismal. I think this story may have further legs and it would not surprise me to see the franc continue to decline vs. both the dollar and the euro for a while yet.

On the data front, this morning we see Initial Claims (exp 215K) and then the ISM Non-Manufacturing data (55.0) followed by Factory Orders (-0.2%) at 10:00. The ISM data will get all the press, and rightly so. Given how weak the European and UK data was, all eyes will be straining to see if the US continues to hold up, or if it, too, is starting to roll over.

From the Fed we hear from five more FOMC members (Evans, Quarles, Mester, Kaplan and Clarida), adding to the cacophony from earlier this week. We already know Mester is a hawk, so if she starts to hedge her hawkishness, look for bonds to rally further and the dollar to suffer. As to the rest of the crew, Evans spoke earlier this week and explained he had an open mind regarding whether or not another rate cut made sense. He also said that he saw the US avoiding a recession. And ultimately, that’s the big issue. If the US looks like a recession is imminent, you can be sure the Fed will become much more aggressive, but until then, I imagine few FOMC members will want to tip their hand. (Bullard and Kashkari already have.)

Until the data prints, I expect limited activity, but once it is released, look for a normal reaction, strong data = strong dollar and vice versa.

Good luck
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It’s Now or Never

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Like Elvis said, it’s now or never
For Boris’s Brexit endeavor
The Irish are chuffed
As Coveney huffed
He’s not, but he thinks he’s so clever

Around 7:00 this morning, PM Boris Johnson will be addressing the Tory party at their annual convention and the key focus will be on his plan to ensure a smooth Brexit. The early details call for customs checks several miles away from the border on both sides with a time limit of about four years to allow for technology to do the job more effectively. However, he maintains that the whole of the UK will be out of the EU and that there will be no special deal for Northern Ireland. His supporters in Northern Ireland, the DUP, appear to have his back. In addition, he is reportedly going to demand that an agreement be reached by October 11 so that it can be agreed in Parliament as well as throughout the EU.

Interestingly, the Irish are still playing tough, at least according to Foreign Minister Simon Coveney, who said that the leaked details formed “no basis for an agreement.” Of course, as in everything to do with this process, there are other views in Ireland with Irish PM Varadkar seemingly far more willing to use this as a basis for discussion. His problem is the Fianna Fail party, a key coalition member, is unhappy with the terms. I say this is interesting because in the event of a no-deal Brexit, Ireland’s economy will be the one most severely impacted, with estimates of 4%-5% declines in GDP in 2020.

With respect to the market, it is difficult to untangle the effect of the latest Brexit news from the dreadful economic data that continues to be released. This morning’s UK Construction PMI fell to 43.3, within ticks of the lows seen during the financial crisis in 2009. The pound has suffered, down 0.4% as I type, although it was even softer earlier in the session. The FTSE 100 is also weak, -1.8%, although that is very much in line with the rest of the European equity markets (CAC -1.6%, DAX -1.3%) and is in synch with the sharp declines seen yesterday in the US and overnight in Asia.

Speaking of yesterday’s price action, it was pretty clear what drove activity; the remarkably weak ISM Manufacturing print at 47.8. This was far worse than forecast and the lowest print since June 2009. It seems pretty clear at this point that there is a global manufacturing recession ongoing and the question that remains is, will it be isolated to manufacturing, or will it spill over into the broader economy. Remember, manufacturing in the US represents only about 11.6% of GDP, so if unemployment remains contained and services can hold up, there is no need for the US economy to slip into recession. But it certainly doesn’t help the situation. However, elsewhere in the world, manufacturing represents a much larger piece of the pie (e.g. Germany 21%, China 40%, UK 18%) and so the impact of weak manufacturing is much larger on those economies as a whole.

It is this ongoing uncertainty that keeps weighing on sentiment, if not actually driving investors to sell their holdings. And perhaps of most interest is that despite the sharp equity market declines yesterday, it was not, by any means, a classic risk-off session. I say this because the yen barely budged, the dollar actually fell and Treasuries, while responding to the ISM print at 10:00am by rallying more than half a point (yields -7bps), could find no further support and have not moved overnight. If I had to describe market consensus right now, it would be that everyone is unsure of what is coming next. Will there be positive or negative trade news? Will the impeachment process truly move forward and will it be seen as a threat to the Administration’s plans? Will Brexit be soft, hard or non-existent? As you well know, it is extremely difficult to plan with so many potential pitfalls and so little clarity on how both consumers and markets will react to any of this news. I would contend that in situations like this, owning options make a great deal of sense as a hedge. This is especially so given the relatively low implied volatilities that continue to trade in the market.

Turning to the rest of the session, a big surprise has been the weakness in the Swiss franc, which has fallen 0.6% this morning despite risk concerns. However, the Swiss released CPI data and it was softer than expected at -0.1% (+0.1% Y/Y) which has encouraged traders to look for further policy ease by the SNB, or at least intervention to weaken the currency. But just as the dollar was broadly weaker yesterday, it has largely recouped those losses today vs. its G10 counterparts. Only the yen, which is up a scant 0.15%, has managed to show strength vs. the greenback. In the EMG space, KRW has been the biggest mover, falling 0.55% overnight after North Korea fired another missile into the sea last night, heightening tensions on the peninsula there. Of course, given the negative data (negative CPI and sharply declining exports) there is also a strong case being made for the BOK to ease policy further, thus weakening the won. Beyond that, however, the EMG currency movement has been mixed and modest, with no other currency moving more than 25bps.

This morning after Boris’s speech, all eyes will turn to the ADP employment data (exp 140K) and then we have three more Fed speakers this morning, Barkin, Harker and Williams. Yesterday, we heard from Chicago Fed president Charles Evans, who explained that he felt the economy was still growing nicely and that the two rate cuts so far this year were appropriate. He did not, however, give much of a hint as to whether he thought the Fed needed to do more. Reading what I could of the text, it did not really seem to be the case. My impression is that his ‘dot’ was one of the five looking for one more cut before the September meeting.

And that’s what we have for today. Barring something remarkable from Boris, it appears that if ADP is in line with expectations, the dollar is likely to consolidate this morning’s gains. A strong print will help boost the buck, while a weak print, something on the order of 50K, could well see the dollar cede everything it has gained today and then some.

Good luck
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A Lack of Well-Being

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Down Under the RBA eased
And Aussie bulls have gotten squeezed
In Europe they’re seeing
A lack of well-being
Which has politicians displeased

The RBA cut rates by 25bps last night, as fully expected by the interest rate markets, and they indicated that despite the fact that their base rate was now at a record low of 0.75%, they were considering further easing in the future. The Aussie dollar suffered on the news and is the worst performer in the G10 today, down 0.80%. In fact, Aussie is now at its lowest level since the financial crisis and, in truth, the trend certainly looks like it has further to fall. Australia continues to suffer from the combination of China’s slowing growth as well as the fall-out from the US-China trade war. Alas for the Australians, there is precious little they can do to insulate themselves from those things given they have literally built their economy over the past twenty-five years on the back of Chinese growth. Given the US dollar’s overall trend higher, I see nothing that would change this in the near term. Receivables hedgers beware.

Adding to the global gloom was the release of the Eurozone Manufacturing PMI data which continues to point to a manufacturing recession there. Germany’s was actually slightly better than forecast, but at 41.7 remains far and away the worst of the bunch. The overall Eurozone reading was at 45.7, essentially unchanged from last month and showing no signs of improvement whatsoever. In fact, the sub-indices showed that both new orders and prices paid are falling even faster. Given this news it can be no surprise that Eurozone CPI was released at a weaker than forecast 0.9% this morning as well. It is easy to see why Signor Draghi has been keen to add stimulus to the Eurozone economy, but it will take some time for the most recent activities to work their way into the data, which implies that things are going to get worse before they get better. Interestingly, after an early dip on the data, the euro has clawed back those losses and is now essentially unchanged on the day. Of course, the euro remains in a very clear downtrend and is lower by 1.9% since the ECB’s last policy meeting where they cut rates and restarted QE. Looking back a bit further into the summer, since last June, the single currency has fallen more than 4.6%. This trend, too, has legs.

As a harbinger of the narrative, the WTO released updated forecasts for growth in global trade this morning and the reading was not pretty. The new forecast is for global trade to grow just 1.2% in 2019 and 2.7% in 2020. This compares to growth of 3.0% in 2018, and its last forecasts of 2.6% and 3.0% for this year and next. At this point, the market is sharpening its focus on the upcoming trade negotiations due to begin in Washington on October 10th. Everybody is hoping for a positive outcome, but from everything that has been reported so far, it appears the two sides remain far apart on a number of issues, and though a deal will be beneficial for both, it remains a distant prospect I fear.

Turning our attention to Japan, last night the government auctioned a new tranche of 10-year JGB’s with pretty disastrous results. A day after explaining they will be reducing the amount of purchases in the back end in order to steepen the yield curve, they were true to their word. Yields there climbed 5bps with the bid-to-cover ratio a very weak 3.42, the lowest since 2016. This price action had a knock-on effect everywhere in the world as Treasury prices fell (yields +6bps) with a similar story in Germany (+4.5bps) and the UK (+7bps). For our purposes, the impact was in USDJPY, which is higher by 0.25% this morning, extending its bounce of the last month. Once again, the current market does not appear to be risk sensitive per se, this is simply dollar outperformance.

A quick look at the rest of the FX world shows SEK a key underperformer this morning, falling 0.55% as the market continues to focus on the change in tone from the Riksbank. They had been working hard to ‘normalize’ interest rates over the past year, but the data there continues to undermine their case with this morning’s PMI release of 46.3 dramatically lower than forecasts and the weakest reading since 2012. Instead, they are far more likely going to need to cut rates again, hence the krone’s weakness.

In the EMG sphere, ZAR is the biggest loser today, falling 1.0% on the back of two related stories; first Fitch cut the credit rating of Eskom, the troubled government-owned utility, to CCC-, essentially dead. This situation has been weighing on economic growth there for quite a while, and the bigger concern is that it forces a countrywide credit downgrade. South Africa is currently under review by Moody’s, and another cut would put them in junk territory forcing a significant amount of ZAR bond sales by international investors (with some estimates as high as $15 billion worth), and correspondingly, driving the rand even lower. But if you look across the board, while ZAR is the worst performer, the dollar is higher against virtually the entire space.

Turning to the upcoming session, we are looking forward to ISM Manufacturing data (exp 50.0) after a very weak Chicago PMI number yesterday (47.1). We also get to hear from three Fed speakers, Evans, Clarida and Bowman, although the last of these, Governor Bowman, rarely speaks of monetary policy with her focus on community banking. Beyond this, the bigger trend remains a higher dollar and there is nothing to indicate that trend is changing.

Good luck
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