Some Real Fed Appeasing

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The jobs report Friday suggested
That everyone who has requested
Employment has found
That jobs still abound
And companies are still invested

The market response was less pleasing
At least for the bulls who seek easing
With equities falling
And yields, higher, crawling
Look, now, for some real Fed appeasing

We are clearly amidst a period of ‘good news is bad’ and ‘bad news is good’ within the market context these days. Friday was the latest evidence of this fact as the much better than expected Nonfarm Payroll report (224K vs. 160K expected) resulted in an immediate sell-off in equity and bond markets, with the dollar rallying sharply. The underlying thesis remains that weakness in the US (and global) economy will be sufficient to ensure easier monetary policy, but that the problems will not get so bad as to cause a recession. That’s a pretty fine line to toe for the central banks, and one where history shows they have a lousy record.

However, whether it is good or bad is irrelevant. What is abundantly clear is that this is the current situation. So, Friday saw all three major US indices fall from record highs; it saw 2-year Treasury yields back up 11bps and 10-year yields back up 8pbs; and it saw the dollar rally roughly 0.75%.

The question is, why were markets in those positions to begin with? On the equity side of the ledger, prices have been exclusively driven by expectations of Fed policy. Until the NFP report, not only was a 25bp rate cut priced into Fed funds for the FOMC meeting at the end of the month, but there was a growing probability of a 50bp rate cut. This situation is fraught with danger for equity investors although to date, the bulls have been rewarded. At least the bond story made more sense from a macroeconomic perspective, as broadly weaker economic data (Friday’s numbers excepted) had indicated that both the US and global economies were slowing with the obvious prescription being easier monetary policy. This had resulted in German bunds inverting relative to the -0.40% deposit rate at the ECB as well as US 10-year yields falling below 2.00% for the first time in several years. Therefore, stronger data would be expected to call that thesis into question, and a sell-off in bonds made sense.

And finally, for the dollar, the rally was also in sync with fundamentals as higher US yields, and more importantly, the prospect of less policy ease in the future, forced the dollar bears to re-evaluate their positions and unwind at least some portion. As I have been writing, under the assumption that the Fed does indeed ease policy, it makes sense that the dollar should decline somewhat. However, it is also very clear that the Fed will not be easing policy in a vacuum, but rather be leading a renewed bout of policy ease worldwide. And as the relative interest rate structure equalizes after all the central banks have finished their easing, the US will still likely be the most attractive investment destination, supporting the dollar, but also, dollar funding will still need to be found by non-US businesses and countries, adding to demand for the buck.

With this as a backdrop, the week ahead does not bring much in the way of data, really just CPI on Thursday, but it does bring us a great deal of Fed speak, including a Powell speech tomorrow and then his House and Senate testimony on Wednesday and Thursday. And don’t forget the ECB meeting on Thursday!

Today Consumer Credit $17.0B
Tuesday NFIB Small Biz 105
  JOLT’s Jobs Report 7.47M
Wednesday FOMC Minutes  
Thursday ECB Meeting -0.4%
  Initial Claims 222K
  CPI 0.0% (1.6% Y/Y)
  -ex food & energy 0.2% (2.0% Y/Y)
Friday PPI 0.1% (1.6% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)

Remember, that on top of the FOMC Minutes to be released Wednesday afternoon, we will hear from seven different Fed speakers a total of thirteen times this week, including Powell’s testimony on Capitol Hill. Amongst this crowd will be the two most dovish members of the FOMC, Bullard and Kashkari, as well as key members Williams and Quarles. It will be extremely interesting to see how these speakers spin the jobs data relative to their seemingly growing bias toward easing. Much has been made of the idea of an ‘insurance’ rate cut, in order to prevent anything from getting out of hand. But Powell will also need to deal with the allegations that he is capitulating to President Trump’s constant demands for lower interest rates and more QE if he comes across as dovish. I don’t envy him the task.

Regarding the ECB meeting, despite continuing weakness in most of the Eurozone data, it feels like it is a bit too soon for them to ease policy quite yet. First off, they have the issue of what type of impact pushing rates even further negative will have on the banking system there. With the weekend news about Deutsche bank retrenching across numerous products, with no end of red ink in sight, the last thing Signor Draghi wants is to have to address a failing major bank. But it is also becoming clearer, based on comments from other ECB members (Coeure and Villeroy being the latest) that a cut is coming soon. And don’t rule out further QE. The ECB is fast becoming desperate, with no good options in sight. Ultimately, this also plays into my belief that despite strong rationales for the dollar to decline, it is the euro that will suffer most.

However, the fun doesn’t really start until tomorrow, when Chairman Powell speaks at 8:45am. So for today, it appears that markets will consolidate Friday’s moves with limited volatility, but depending on just how dovish Powell sounds, we are in for a more active week overall.

Good luck
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More Concern

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Most data of late have been weak
Thus central banks are set to tweak
Their policy rates
As they have mandates
Designed to keep growth at a peak

Now later this morning we’ll learn
If payrolls are starting to turn
Last month’s poor display
And weakness today
Would certainly cause more concern

It’s payroll day in the US and markets have been extremely quiet overnight. In fact, given yesterday’s July 4th holiday here in the US, they have been quiet for two days. However, don’t let the lack of market activity distract you from the fact that there are still a lot of things ongoing in the global economy.

For example, a key question on analysts’ minds has been whether or not a recession is in the offing. Data continues to generally disappoint, with this morning’s sharply lower German Factory Orders (-2.2%) and UK Labor Productivity (-0.5%) as the latest in a long line of crummy results. And given last month’s disappointment on the US payroll front (recall the outcome was 75K vs. the 185K expected) today’s numbers are being closely watched. Here are the current median expectations based on economist surveys:

Nonfarm Payrolls 160K
Private Payrolls 153K
Manufacturing Payrolls 0K
Unemployment Rate 3.6%
Average Hourly Earnings 0.3% (3.2% Y/Y)
Average Weekly Hours 34.4

A couple of things to note are the fact that the NFP number, even if it comes in at the median expectation, still represents a declining rate of job growth compared to what the US experienced in 2018. This is likely based on two factors; first that this historically long expansion is starting to slow down, and second, that there are less available workers to fill jobs as population growth remains restrained. The other thing to remember is that the Unemployment Report has always been a lagging indicator, looking backwards at how things were, rather than giving direction about the future. The point is that worsening of this data implies that things are already slowing. As I wrote Wednesday, don’t be surprised if when the inevitable recession finally gets determined, that it started in June 2019. I failed to mention the ADP report on Wednesday as a data release, but it, too, disappointed, printing at 102K, some 40K below expectations.

With that as our cheerful backdrop, let’s consider what to expect ahead of the release:

Weaker than expected results – If the NFP number prints at 90K or less, look for equity markets to rejoice as they perceive the Fed will become even more aggressive in their attempts to head off a recession, and the idea of a 50bp rate cut at the end of the month takes hold. Bond markets, too, will soar on the same expectations, while the dollar is likely to give up its overnight gains (granted they were only about 0.2%) as a more aggressive Fed will be seen as a signal to sell the buck. The key conundrum in this scenario remains equities, which continue to rally into weaker economic conditions. At some point, if the economy continues to weaken, the negative impact on earnings is going to outweigh the kneejerk reaction of buying when the Fed cuts, but as John Maynard Keynes reminded us all, ‘markets can stay irrational far longer than you can stay solvent.’

Results on or near expectations – If we see a print in the 120K-180K range, I would expect traders to be mildly disappointed as the call for a more aggressive Fed policy would diminish. Thus equities might suffer slightly, especially given they are sitting at record highs, while bonds are likely to see yields head back toward 2.0%. The dollar, meanwhile, is likely to maintain its overnight gains, and could well see a modest uptick as the idea of more aggressive Fed easing starts to ebb, at least for now.

Stronger than expected results – Any print above 180K will almost certainly, perversely, see a stock market selloff. It is abundantly clear that equity buyers are simply counting on Fed largesse to keep the party going. The market has nothing to do with the fundamentals of the economy or individual company situations. With this in mind, strong data means that the Fed will have no call to cut rates. The result is that the futures market will likely reprice the odds of a rate cut in July lower, perhaps to a 50% probability, while equity traders will take the news as a profit-taking opportunity given the lack of reason for a follow through higher in stocks. Bonds will get tossed overboard as well, as concerns about slowing growth will quickly abate, and a sharp move higher in 10-year yields is entirely realistic. As a point of information, the last time the payroll report was released on July 5th, in 2013, 10-year yields rallied 25bps on a surprising payroll outcome. And remember, technical indicators show that the bond market is massively overbought, so there is ample opportunity for a sharp move. And finally, because of the holiday yesterday, trading desks will have skeleton staffs, further reducing liquidity. Oh yeah, and the dollar will probably see significant gains as well.

The point is that there are two possible outcomes that could see some real fireworks (pun intended) today, so stay on your toes. While one number is just that, a single data point, given the recent trend in place, today’s data seem to have a lot of importance. If pressed, my sense is that the trend of weaker data that has been evident worldwide is going to manifest itself with something like a 50K print, and an uptick in the Unemployment Rate to 3.7% or 3.8%.

We will know shortly.

Good luck and good weekend
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Laden With Fears

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When lending, a term of ten years
At one time was laden with fears
But not anymore
As bond prices soar
And bond bulls regale us with cheers

Another day, another record low for German bund yields, this time -0.396%, and there is no indication that this trend is going to stop anytime soon. While this morning’s PMI Composite data was released as expected (Germany 52.6, France 52.7, Eurozone 52.2), it continues at levels that show subdued growth. And given the ongoing weakness in the manufacturing sector, the major fear of both economists and investors is that we are heading into a global recession. Alas, I fear they are right about that, and when the dust settles, and the NBER looks back to determine when the recession began, don’t be surprised if June 2019 is the start date. At any rate, it’s not just bund yields that are falling, it is a universal reaction. Treasuries are now firmly below 2.00% (last at 1.95%), but also UK Gilts (0.69%), French OATs (-0.06%) and JGB’s (-0.15%). Even Italy, where the ongoing fight over their budget situation is getting nastier, has seen its yields fall 13bps today down to 1.71%. In other words, bond markets continue to forecast slowing growth and low inflation for some time to come. And of course, that implies further policy ease by the world’s central bankers.

Speaking of which:

In what was a mini bombshell
Said Mester, it’s too soon to tell
If rates should be lowered
Since, as I look forward
My models say things are just swell

Yesterday, Cleveland Fed president Loretta Mester, perhaps the most hawkish member of the Fed, commented that, “I believe it is too soon to make that determination, and I prefer to gather more information before considering a change in our monetary-policy stance.” In addition, she questioned whether lowering rates would even help address the current situation of too-low inflation. Needless to say, the equity markets did not appreciate her comments, and sold off when they hit the tape. But it was a minor reaction, and, in the end, the prevailing wisdom remains that the Fed is going to cut rates at the end of this month, and at least two more times this year. In truth, we will learn a great deal on Friday, when the payroll report is released, because another miss like last month, where the NFP number was just 75K, is likely to bring calls for an immediate cut, and also likely to see a knee-jerk reaction higher in stocks on the premise that lower rates are always good.

The IMF leader Lagarde
(Whom Greeks would like feathered and tarred)
Come later this year
The euro will steer
As ECB prez (and blowhard)

The other big news this morning concerns the changing of the guard at the ECB and the other EU institutions that have scheduled leadership changes. In a bit of a surprise, IMF Managing Director, Christine Lagarde, is to become the new ECB president, following Mario Draghi. Lagarde is a lawyer, not a central banker, and has no technocratic or central banking experience at all. Granted, she is head of a major supranational organization, and was French FinMin at the beginning of the decade. But all that reinforces is that she is a political hack animal, not that she is qualified to run the second most important policymaking institution in the world. Remember, the IMF, though impressive sounding, makes no policies, it simply hectors others to do what the IMF feels is correct. If you recall, when Chairman Powell was nominated, his lack of economics PhD was seen as a big issue. For some reason, that is not the case with Lagarde. I cannot tell if it’s because Powell has proven to be fine in the role, or if it would be seen as politically incorrect to complain about something like that since she ticks several other boxes deemed important. At any rate, now that politicians are running the two largest central banks (or at least will be as of November 1), perhaps we can dispel the fiction that central banks are independent of politics!

Away from the bond market, which we have seen rally, the market impact of this news has arguably been mixed. Equity markets in Asia were generally weak (Nikkei -0.5%, Shanghai -1.0%), but in Europe, investors are feeling fine, buying equities (DAX +0.6%, FTSE + 0.8%) alongside bonds. Arguably, the European view is that Madame Lagarde is going to follow in the footsteps of Signor Draghi and continue to ease policy aggressively going forward. And despite Mester’s comments, US equity futures are pointing higher as well, with both the DJIA and S&P looking at +0.3% gains right now.

Gold prices, too, are anticipating lower interest rates as after a short-term dip last Friday, with the shiny metal trading as low as $1384, it has rebounded sharply and after touching $1440, the highest print in six years, it is currently around $1420. I have to admit that the combination of fundamentals (lower global interest rates) and market technicals (a breakout above $1400 after three previous failed attempts) it does appear as though gold is heading much higher. Don’t be surprised to see it trade as high as $1700 before this rally is through.

Finally, the dollar continues to be the least interesting of markets with a mixed performance today, and an overall unchanged outcome. The pound continues to suffer as the Brexit situation meanders along and the uncertainty engendered hits economic activity. In fact, this morning’s PMI data was awful (50.2) and IHS/Markit is now calling for negative GDP growth in Q2 for the UK. Aussie data, however, was modestly better than expected helping both AUD and NZD higher, despite soft PMI data from China. EMG currencies are all over the map, with both gainers and losers, but the defining characteristic is that none of the movement has been more than 0.3%, confirming just how quiet things are.

As to the data story, this morning brings Initial Claims (exp 223K), the Trade Balance (-$54.0B), ISM Non-Manufacturing (55.9) and Factory Orders (-0.5%). While the ISM data may have importance, given the holiday tomorrow and the fact that payrolls are due Friday morning, it is hard to get too excited about significant FX movement today. However, that will not preclude the equity markets from continuing their rally on the basis of more central bank largesse.

Good luck
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Still Writing Obits

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The Germans, the Chinese and Brits
Have seen manufacturing hits
But in the US
There’s been more success
Though bears are still writing obits

It is fair to say that the global economic growth rate continues to slow. We have seen weaker data as the norm, whether in manufacturing, housing or agriculture; we have seen a never-ending stream of central bankers expressing concern over this slowing growth and promising to respond appropriately; and we continue to see equity markets trade to new highs. Something seems amiss.

Yesterday was a perfect example of this phenomenon with an ISM print of 51.7, its fourth consecutive decline and the weakest reading since October 2016. In fairness, it was better than consensus estimates of 51.0, and the US was the only major economy to show continued expansion in the sector, but the trend is foreboding. The new orders component was exceptionally weak, and highlights those concerns going forward. And yet, equity prices traded to new highs yesterday afternoon, before ceding some ground into the close.

There has been a pretty complete disconnect between the fundamentals of stock valuation (at least the theories we learned in finance class about discounted future cash flows) and the actual price of stocks. And this is a global phenomenon, not merely a US outlier.

Of course, the missing link in this puzzle is central bank activities. Markets have become entirely dependent on central bank largesse to justify their valuations. Central bankers, after a decade of ZIRP and NIRP led to a huge increase in the financialization of the global economy, are now beholden to markets when they make decisions. This was made plain in January, when the Fed pivoted after equity markets plummeted following their last rate increase. They literally could not stand the pressure for even two weeks before reversing course.

So, the question becomes, will equity markets now dictate every central bank action going forward? While rhetorical, it is not hard to believe that the answer is yes. Despite all the current conversation regarding an uncomfortably low inflation rate as the driver for policy ease, it is abundantly clear that the only data point on which every central bank focuses, is their domestic stock market. I fear this is a situation that will result in extremely negative outcomes at some point in the future. However, there is no way to determine, ex ante, when those negative outcomes will manifest themselves. That is why bulls are happy, they buy every dip and have been rewarded, and why bears are miserable, because despite their certainty they are correct, thus far the central banks have been able to delay the pain.

In the end, though, the story on global growth remains one of a slowdown throughout the world. For all their largesse to date, central banks have not yet been able to reverse that trend.

With that out of the way, let’s see what those central bank activities have wrought in the FX markets. The first thing to note was that the dollar actually had an impressive day yesterday, rallying 0.7% vs. the euro and 0.5% vs. the pound after the ISM data. Given the better than expected print, market participants decided that the Fed may not be as aggressive cutting rates after all, and so the key recent driver of dollar weakness was reevaluated. Of course, one day’s reaction does not a trend make, and this morning, the dollar is backing off yesterday’s rally slightly.

Last night the RBA cut rates another 25bps, to a record low of 1.00%, and left the door open for further rate cuts in the future. Aussie, however, is higher by 0.4% this morning on a classic, sell the rumor, buy the news reaction. In the end, Australia remains entirely dependent on growth in China and as that economy slows, which is clearly happening, it will weigh on the Australian economy. While Australia managed to avoid ZIRP in the wake of the financial crisis, this time around I think it is inevitable, and we will see AUD resume its multiyear weakening trend.

Weighing on the pound further this morning were two data points, the Construction PMI at 43.1, its weakest in more than ten years, as well as the ongoing malaise in housing prices in the UK. Brexit continues to garner headlines locally, although it has not been front page news elsewhere in the world because of all the other concerns like trade, OPEC, North Korea, and in the US, the beginnings of the presidential campaigns.

But there is a very interesting change ongoing in the Brexit discussion. Throughout the process, the EU has appeared to have the upper hand in the negotiations, forcing their views on outgoing PM May. But with all signs pointing to a new PM, Boris Johnson, who has made clear he will leave with or without a deal, suddenly Ireland is finding itself under extreme pressure. A recent report by the central bank there indicated that a hard Brexit could result in a 4.0% decline in Irish GDP! That is HUGE. At the same time, the EU will require Ireland to uphold the border controls that are involved in the new separate relationship. This means they will need to perform any inspections necessary as well as arrange to collect tariffs to be charged. And the UK has made it clear that they will not contribute a penny to that process. Suddenly, Ireland is in a bad situation. In fact, it is entirely realistic that the EU needs to step in to delay the impact and cave to an interim deal that has nothing to do with PM May’s deal. At least that is the case if they want to maintain the integrity of their borders, something which has been given short shrift until now. My point is that there is still plenty of Brexit mischief ahead, and the pound is going to continue to react to all of it. In the end, I continue to believe that a hard Brexit will result in a weaker pound, but I am not so sure it will be as weak as I had previously believed. Maybe 1.20-1.25 is the right price.

In the US today there is no data to be released although we do hear from NY Fed president Williams and Cleveland Fed President Mester this morning. If the Fed is serious about staying on hold at the end of this month, rather than cutting the 25bps that the market has already priced, they better start to speak more aggressively about that fact. Otherwise, they are going to find themselves in a situation where a disappointed equity market sells off sharply, and the pressure ratchets even higher on them to respond. Food for thought as we hear from different Fed speakers during the month.

Good luck
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Cow’ring In Fear

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Tis coming increasingly clear
That growth is at ebb tide this year
The PMI data
When looked at, pro rata
Shows industry cow’ring in fear

Meanwhile in Osaka, the meet
Twixt Trump and Xi lowered the heat
On tariffs and trade
Which most have portrayed
As bullish, though some are downbeat

With all the buildup about the meeting between President’s Trump and Xi, one might have thought that a cure for cancer was to be revealed. In the end, the outcome was what was widely hoped for, and largely expected, that the trade talks would resume between the two nations. Two addenda were part of the discussion, with Huawei no longer being shut out of US technology and the Chinese promising to buy significantly more US agricultural products. Perhaps it was the two addenda that have gotten the market so excited, but despite the results being largely in line with expectations, equity markets around the world have all exploded higher, with both Shanghai and Tokyo rallying more than 2.2%, Europe seeing strong gains, (DAX +1.35%, FTSE + 1.15%) and US futures pointing sharply higher (DJIA +1.1%, NASDAQ +1.75%). In other words, everybody’s happy! Oil prices spiked higher as well, with WTI back over $60 due to a combination of an extension of the OPEC+ production cuts and the boost from anticipated economic growth after the trade truce. Gold, on the other hand, is lower by 1.4% as haven assets have suffered. After all, if the apocalypse has been delayed, there is no need to seek shelter.

But a funny thing happened on the way to market salvation, Manufacturing PMI data was released, and not only was it worse than expected pretty much everywhere around the world, it was also below the 50 level pretty much everywhere around the world. Here are the data for the world’s major nations; China 49.4, Japan 49.3, Korea 47.5, Germany 45.0, and the UK 48.0. We are awaiting this morning’s US ISM report (exp 51.0), but remember, that Friday’s Chicago PMI, often seen as a harbinger of the national scene, printed at a disastrous 49.7, more than 3 points below expectations and down 4.5 points from last month.

Taking all this into account, the most important question becomes, what do you do if you are the Fed? After all, the Fed remains the single most important actor in financial markets, if not in the global economy. Markets are still pricing in a 25bp rate cut at the end of this month, and about 100bps of cuts by the end of the year. In the meantime, the most recent comments from Fed speakers indicate that they may not be that anxious to cut rates so soon. (see Richmond Fed President Thomas Barkin’s Friday WSJ interview.) If you recall, part of the July rate cut story was the collapse of the trade talks and the negative impact that would result accordingly. But they didn’t collapse. Now granted, the PMI data is pointing to widespread economic weakness, which may be enough to convince the Fed to cut rates anyway. But was some of that weakness attributable to the uncertainty over the trade situation? After all, if global trade is shrinking, and it is, then manufacturing plans are probably suffering as well, even without the threat of tariffs. All I’m saying is that now that there is a trade truce, will that be sufficient for the Fed to remain on hold?

Of course, there is plenty of other data for the Fed to study before their next meeting, perhaps most notably this Friday’s payroll report. And there is the fact that with the market still fully priced for a rate cut, it will be extremely difficult for the Fed to stand on the side as the equity market reaction would likely be quite negative. I have a feeling that the markets are going to drive the Fed’s activities, and quite frankly, that is not an enviable position. But we have a long time between now and the next meeting, and so much can, and likely will, change in the interim.

As to the FX market, the dollar has been a huge beneficiary of the trade truce, rallying nicely against most currencies, although the Chinese yuan has also performed well. As an example, we see the euro lower by 0.3%, the pound by 0.45% and the yen by 0.35%. In fact, all G10 currencies are weaker this morning, with the true outliers those most likely to benefit from lessening trade tensions, namely CNY and MXN, both of which have rallied by 0.35% vs. the dollar.

Turning to the data this week, there is plenty, culminating in Friday’s payrolls:

Today ISM Manufacturing 51.0
  ISM Prices Paid 53.0
Wednesday ADP Employment 140K
  Trade Balance -$54.0B
  Initial Claims 223K
  ISM Non-Manufacturing 55.9
  Factory Orders -0.5%
Friday Nonfarm Payrolls 160K
  Private Payrolls 153K
  Manufacturing Payrolls 0K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.3% (3.2% Y/Y)
  Average Weekly Hours 34.4

So, there will be lots to learn about the state of the economy, as well as the latest pearls of wisdom from Fed members Clarida, Williams and Mester in the first part of the week. And remember, with Thursday’s July 4th holiday, trading desks in every product are likely to be thinly staffed, especially Friday when payrolls hit. Also remember, last month’s payroll data was a massive disappointment, coming in at just 75K, well below expectations of 200K. This was one of the key themes underpinning the idea that the Fed was going to cut in July. Under the bad news is good framework, another weak data point will virtually guaranty that the Fed cuts rates, so look for an equity market rally in that event.

In the meantime, though, the evolving sentiment in the FX market is that the Fed is going to cut more aggressively than everywhere else, and that the dollar will suffer accordingly. I have been clear in my view that any dollar weakness will be limited as the rest of the world follows the Fed down the rate cutting path. Back in the beginning of the year, I was a non-consensus view of lower interest rates for 2019, calling for Treasuries at 2.40% and Bunds at 0.0% by December. And while we could still wind up there, certainly the consensus view is for much lower rates as we go forward. Things really have changed dramatically in the past six months. Don’t assume anything for the next six!

Good luck
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A New Plan

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While all eyes are turned toward Japan
Most central banks made a new plan
If there’s no trade truce
They’ll quickly reduce
Their base rates, stock markets, to fan

As the week comes to a close, the G20 Summit, and more importantly, tomorrow’s meeting between President’s Trump and Xi are the primary focus of investors and traders everywhere. While there is still great uncertainty associated with the meeting, at this point I would characterize the broad sentiment as an expectation that the two leaders will agree to resurrect the talks that were abruptly ended last month, with neither side imposing additional tariffs at this time. And quite frankly, that does seem like a pretty reasonable expectation. However, that is not nearly the same thing as assuming that a deal will be forthcoming soon. The negotiations remain fraught based on the simple fact that both nations view the world in very different ways, and what is SOP in one is seen as outside the bounds in the other. But in the meantime, I expect that markets will take the news that the situation did not deteriorate as a massive bullish signal, if only because the market has taken virtually everything that does not guaranty an apocalypse as a massive bullish signal.

At the same time, it has become abundantly clear that the major central banks have prepared for the worst and are all standing by to ease policy further in the event the talks fall apart. Of course, the major central banks have all been pretty clear lately that they are becoming increasingly comfortable with the idea that interest rates can remain much lower than historical levels without stoking inflation. In fact, there are still several central bankers, notably Kuroda-san and Signor Draghi, who feel they are fighting deflation. In fairness, the latest data, released just last night, highlights that runaway inflation is hardly a cause for concern as Japan clocked in at 1.1%, with core at 0.9% and the Eurozone reported inflation at a rip roaring 1.2%, with core at 1.1%. It has been data of this nature that stokes the imagination for further policy ease, despite the fact that both these central banks are already working with negative interest rates.

Now, it must be remembered that there are 18 other national leaders attending the meeting, and many of them have their own concerns over their current relationship with the US. For example, the president has threatened 25% tariffs on imported autos, a move which would have a significantly negative impact on both Germany (and by extension the EU) and Japan. For now, those tariffs are on hold, but it is also clear that because of the intensity of the US-China trade situation, talks about that issue with both the EU and Japan have been relegated to lower level officials. The concern there is that the original six-month delay could simply run out without a serious effort to address the issue. If that were to be the case, the negative consequences on both economies would be significant, however, it is far too soon to make any judgements on the outcome there.

And quite frankly, that is pretty much the entire story for the day. Equity markets remain mixed, with Asia in the red, although the losses were relatively modest at between 0.25% and 0.50%. Europe, meanwhile, has taken a more positive view of the outcome, with markets there rising between 0.2% and 0.5%, which has left US futures pointing to modest, 0.2%, gains at the opening. Bond prices are actually slightly lower this morning (yields higher) but remain within scant basis points of the lows seen recently. For example, Bunds are trading at -0.319%, just 1.5bps from its recent historic low while Treasuries this morning are trading at 2.017%, just 4bps from its recent multi-year lows. Perhaps the most remarkable news from the sovereign bond market was yesterday’s issuance by Austria of 100-year bonds with a coupon of just 1.20%! To my mind, that does not seem like a reasonable return for the period involved, but then, that may be very backwards thinking.

Consider that the acceptance of two policy changes that have been mooted lately, although are still quite controversial, would result in the Austrian issue as being seen as a virtual high-yield bond. Those are the abolition of cash and the acceptance of MMT as the new monetary policy framework. I can assure you that if when cash is abolished, interest rates will turn permanently negative, thus making a yield of 1.20% seem quite attractive, despite the century tenor. As to MMT, it could play out in one of two ways, either government bonds issued as perpetual 0.0% coupons, or the end of issuing debt completely, since the central banks would merely need to print the currency and pay it as directed. In this case too, 1.20% would seem awfully good.

Finally, let’s look at the FX markets this morning, where the dollar is modestly softer against most of its counterparts. But when I say modestly, I am not kidding. Against G10 currencies, the largest movement overnight was NZD’s 0.14% appreciation, with everything else + or – 0.1% or less. In other words, the FX markets are looking at the Trump-Xi meeting and waiting for the outcome before taking a view. Positions remain longer, rather than shorter, USD, but as I have written recently, that view is beginning to change on the back of the idea that the Fed has much further to ease than other central banks. While I agree that is a short-term prospect, I see the losses as limited to the 3%-5% range overall before stability is found.

Turning to the data picture, yesterday saw GDP print as expected at 3.1%. This morning we get Personal Income (exp 0.3%), Personal Spending (0.4%), Core PCE (1.6%). Chicago PMI (53.1) and Michigan Sentiment (98.0). However, barring an outlandish miss in anything, it seems unlikely there will be too much movement ahead of tomorrow’s Trump-Xi meeting. Look for a quiet one.

Good luck and good weekend
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Absent Deceit

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Two presidents are set to meet
From nations that fiercely compete
The issue at hand
Is how to expand
The trade twixt them absent deceit

For markets, this issue is key
And so far, today, what we see
Is traders complacent
A deal is now nascent
So buyers have been on a spree

The upcoming meeting between President’s Trump and Xi, due to be held on Saturday, has drawn the most focus amid financial markets in the past twenty-four hours. Yesterday we heard Treasury Secretary Mnuchin express confidence a deal could be completed and that “we were about 90% of the way there…” prior to the abrupt end of discussions last month. If you recall, the US claimed China reneged on their willingness to enshrine the deal details into their canon of law, which the US demanded to insure the deal was followed. However, shortly thereafter, President Trump, in a Fox News interview, talked about raising tariffs if necessary and seemed quite unconcerned over the talks falling apart. In fact, he turned his ire on India and Vietnam for adding to trade troubles. While Asian markets all rallied as the vibes seemed to be improving, a short time ago China announced they would have a set of conditions to present to Mr Trump in order to reach a deal. These include an end to the ban on Huawei products and purchases as well as an immediate end to all tariffs.

Given the importance of reaching a deal for both sides, my take is these comments and terms are simply being used to establish the baseline for the negotiations between the two men, and that some middle ground will be reached. However, markets (wisely I think) took the Chinese demands as a sign that a deal is far less certain than optimists believe, and European equities, as well as US futures, have sold off since their release. I have maintained throughout this process that a deal was always going to be extremely difficult to achieve given the fundamental problem that the Chinese have yet to admit to IP theft or forced technology transfers while the US sees those as critical issues. In addition, the question of enshrinement of terms into local law describes one of the fundamental differences between the two nations. After all, the US is a nation based on its laws, while China is a nation entirely in thrall to one man. Quite frankly, I think the odds of completing a deal are 50:50 at best, and if the luncheon between the two men does not result in the resumption of talks, be prepared for a pretty significant risk-off event.

In the meantime, the global economic picture continues to fade as data releases point to slowing growth everywhere. Yesterday’s Durable Goods numbers were much worse than expected at -1.3%, although that was largely due to the reduction in aircraft orders on the back of the ongoing travails of Boeing’s 737 Max jet. But even absent transport, the 0.3% increase, while better than expected, is hardly the stuff of a strong expansion. In fact, economists have begun adjusting their GDP forecasts lower due to the absence of manufacturing production. Yesterday I highlighted the sharp decline in all of the regional Fed manufacturing surveys, so the Durables data should be no real surprise. But surprise or not, it bodes ill for GDP growth in Q2 and Q3.

Of course, the US is not alone in seeing weaker data. For example, this morning the Eurozone published its monthly Confidence indices with Business Confidence falling to 0.17, the lowest level in five years, while Economic Sentiment fell to 103.3 (different type of scale), its lowest level in three years and continuing the steep trend lower since a recent peak in the autumn of last year. Economists have been watching the ongoing deterioration in Eurozone data and have adjusted their forecasts for the ECB’s future policy initiatives as follows: 10bp rate cut in September and December as well as a 50% probability of restarting QE. The latter is more difficult as that requires the ECB to change their self-imposed rules regarding ownership of government debt and the appearance of the ECB financing Eurozone governments directly. Naturally, it is the Germans who are most concerned over this issue, with lawsuits ongoing over the last series of QE. However, I think its quaint that politicians try to believe that central banks haven’t been directly funding governments for the past ten years!

So, what has all this done for the FX markets? Frankly, not much. The dollar is little changed across the board this morning, with nary a currency having moved even 0.20% in either direction. The issue in FX is that the competing problems (trade, weakening growth, central bank policy adjustments) are pulling traders in different directions with no clarity as to longer term trends. Lately, a common theme emerging has been that the dollar’s bull run is over, with a number of large speculators (read hedge funds) starting to establish short dollar positions against numerous currencies. This is based on the idea that the Fed will be forced to begin easing policy and that they have far more room to do so than any other central bank. As such, the dollar’s interest rate advantage will quickly disappear, and the dollar will fall accordingly. While I agree that will be a short-term impact, I remain unconvinced that the longer-term trend is turning. After all, there is scant evidence that things are getting better elsewhere in the world. Remember, the ongoing twin deficits in the US are hardly unique. Governments continue to spend far more than they receive in tax revenues and that is unlikely to stop anytime soon. Rather, ultimately, we are going to see more and more discussion on MMT, with the idea that printing money is without risk. And in a world of deflating currencies and halting growth, the US will still be the place where capital is best treated, thus drawing investment and dollar demand.

This morning brings some more data as follows: Initial Claims (exp 220K) and the third look at Q1 GDP (3.1%). Later, we also see our 6th regional Fed manufacturing index, this time from KC and while there is no official consensus view, given the trend we have seen, one has to believe it will fall sharply from last month’s reading of 2.0. There are no Fed speakers on the docket, so FX markets ought to take their cues from the equity and bond markets, which as the morning progressed, are starting to point to a bit of risk aversion.

Good luck
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Not So Fast

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While everyone thought it was nifty
The Fed was about to cut fifty
Said Jay, not so fast
We’ll not be harassed
A quarter’s enough of a gift-y

Once again, Chairman Powell had a significant impact on the markets when he explained that the Fed is fiercely independent, will not be bullied by the White House, and will only cut rates if they deem it necessary because of slowing growth or, more importantly, financial instability. Specifically, he said the Fed is concerned about and carefully watching for signs of “a loss of confidence or financial market reaction.” In this context, “financial market reaction” is a euphemism for falling stock prices. If ever there was a question about the existence of the Fed put, it was laid to rest yesterday. Cutting to the chase, Powell said that the Fed’s primary concern, at least right now, is the stock market. If it falls too far, too fast, we will cut rates as quickly as we can. Later in his speech, he gave a shout out to the fact that low inflation seems not to be a temporary phenomenon, but that was simply thinly veiled cover for the first part, a financial market reaction.

There are two things to note about these comments. First, the Fed, and really every major central bank, continues to believe they are in complete control of both their respective economies and the financial markets therein. And while it is absolutely true this has been the case since the GFC ended, at least with respect to the financial markets, it is also absolutely true that the law of diminishing returns is at work, meaning it takes much more effort and stimulus to get the same result as achieved ten years ago. At some point, probably in the not too distant future, markets are going to begin to decline and regardless of what those central banks say or do, will not be deterred from actually clearing. It will not be pretty. And second, the ongoing myth of central banks being proactive, rather than reactive, is so ingrained in the central bank zeitgeist that there is no possibility they will recognize the fact that all of their actions are, as the axiom has it, a day late and a dollar short.

But for now, they are still in command. Yesterday’s price action was informed by the fact that despite the weakest Consumer Confidence data in two years and weaker than expected New Home Sales, Powell did not affirm a 50bp cut was on its way in July. Since the market has been counting on that outcome, the result was a mild risk off session. Equity prices suffered in the US and continued to do so around the world last night and Treasuries settled below 2.00%. However, gold prices, which have been rocking lately, gave up early gains when Powell nixed the idea of a 50bp cut. And the dollar? Well, it remains mixed at best. It did rally slightly yesterday but continues to be broadly lower than before the FOMC meeting last week.

We also heard from two other Fed speakers yesterday, Bullard and Barkin, with mixed results. Bullard, the lone dissenter from the meeting made clear that he thought a 25bp reduction was all that was needed, a clear reference to Minneapolis Fed President Kashkari’s essay published on Friday calling for a 50bp cut. However, Thomas Barkin, from the Richmond Fed, sounded far less certain that the time was right for a rate cut. He sounds like he is one of the dots looking for no change this year.

And the thing is, that’s really all the market cares about right now, is what the Fed and its brethren central banks are planning. Data is a sidelight, used to embellish an idea if it suits, and ignored if it doesn’t. The trade story, of course, still matters, and given the increasingly hardened rhetoric from both sides, it appears the market is far less certain of a positive outcome. That portends the opportunity for a significant move on Monday after the Trump-Xi meeting. And based on the way things have played out for the past two years, my money is on a resumption of the dialog and some soothing words, as that will help underpin stocks in both NY and Shanghai, something both leaders clearly want. But until then, I expect a general lack of direction as investors make their bets on the outcome.

One little mentioned thing on the data front is that we have seen every regional Fed manufacturing survey thus far released show significantly more weakness than expected. Philly, Empire State, Chicago, Richmond and Dallas have all fallen sharply. That does not bode well for economic growth in either Q2 or Q3, which, in a twisted way, will play right into the President’s hands as the Fed will be forced to cut rates as a response. Strange times indeed.

This morning, two data points are released; Durable Goods (exp -0.1%, +0.1% ex transports) and the Goods Trade Balance (-$71.8B). Look for weakness in these numbers to help perk of the equity market as anticipation will grow that more rate cutting is in the offing. And look for the dollar to suffer for the same reason.

Good luck
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Fear and Greed

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The two things most traders concede
That drive markets are fear and greed
So lately there’s fear
That trouble is near
But too, FOMO, bulls do still heed

Another day of waiting as the market sharpens its focus on the Trump-Xi meeting to take place on Saturday during the G20 meetings in Osaka, Japan. Yesterday saw extremely limited activity in equity markets in the US, albeit with a negative bias, and we have seen similar price action overnight. Data releases remain sparse (French Business Confidence fell to 102, but that was all there was), which means that investors and traders have time to become contemplative.

On that note, it is a truism that fear and greed are the two most powerful human emotions when discussing financial markets, and both have a history of forcing bad decisions. However, in the classic telling of the story, fear is when investors flee for safety (generally Treasuries, yen, the dollar and gold) while greed is apparent when equity markets rally, corporate credit spreads compress, and high yield bonds outperform everything. I guess we need to throw in EMG excitement as well.

But lately fear has become the descriptor of both bulls and bears, with bulls now driven by FOMO while bears have the old-fashioned sense of fear. The thing that has been remarkable about markets lately is that both types of fear are in full bloom! I challenge anyone to highlight another time when there was so much angst over the current situation while simultaneously there was so much willingness to add risk to portfolios. How can it be that both the safest and riskiest assets are in such demand?

While I am very interested in hearing opinions (please respond) I will offer my own view up front. Global monetary policy in the wake of the financial crisis in 2008-9 has completely altered both the macroeconomic framework as well as how financial markets respond to signals from the economy. The biggest change, in my view, has been the financialization of every major economy, especially the US, where corporate debt issuance has been utilized primarily for financial engineering (either share repurchases or M&A) with only a secondary concern over the development of new, productive assets. This has resulted in a much weaker growth impulse (weakening productivity) with the concurrent effect of having changed the coefficients on all the econometric models in use. It is the latter outcome that has led central banks to become completely incapable of enacting policies that achieve their stated goals. Their reaction functions are based on faulty equipment (models) and so will rarely, if ever, give the right answer. But they are so invested in the current process, the idea of changing it is too far outside the box to even be considered.

Anyway, on a quiet day, I would love to hear other views on the subject.

In the meantime, a look at the markets shows that nothing is going on. The dollar is slightly higher this morning, but then it was slightly lower yesterday. Equity markets are drifting aimlessly (Nikkei -0.5%, FTSE -0.1%, DAX flat, S&P futures -0.1%) as everyone holds their collective breath for Saturday’s Trump-Xi meeting, and haven assets continue to perform well (Treasuries -1bp, Bunds -1bp and within 1bp of historic lows). Well, it is not completely true that nothing is going on, there is one market that has been on fire: gold.

That ‘barbarous relic’ called gold
Has seen its demand rise threefold
To some it is clear
That risks are severe
Although stocks have yet to be sold

Gold ($1432, +1.0% and + 10% this year) has broken out to levels last seen in 2013, when it was on its way down from the historic run-up in the wake of the financial crisis. This is simply the latest evidence of the ongoing conundrum I highlighted above. But beyond this, it has been remarkably quiet. Later this morning we see Case-Shiller Home Price data (exp 2.6%) and New Home Sales (680K) and we hear from NY Fed President John Williams. Yesterday, Dallas Fed prez Kaplan explained that he was concerned over the current situation, but not yet ready to pull the trigger. However, my gut tells me he was one of the ‘dots’ in the plot calling for two cuts by the end of the year. We will see what Mr Williams has to say later.

There is no reason to think that we are going to break out of the doldrums today, or this week at all, as catalysts are few and far between. So look for another quiet day in all markets.

Good luck
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Open and Shut

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Kashakari, on Friday, explained
For US growth to be sustained
The case for a cut
Was open and shut
Since then, talk of fifty has gained

As the new week begins, last week’s late trends remain in place, i.e. limited equity market movement as uncertainty over the outcome of the Trump-Xi meeting continues, continued demand for yield as investors’ collective belief grows that more monetary ease is on the way around the world, and a softening dollar vs. other currencies and commodities, as the prevailing assumption is that the US has far more room to ease policy than any other central bank. Certainly, the last statement is true as US rates remain the highest in the developed world, so simply cutting them back to the zero bound will add much more than the stray 20bps that the ECB, which is already mired in negative territory, can possibly add.

It is this concept which has adjusted my shorter-term view on the dollar, along with the view of most dollar bulls. However, as I have discussed repeatedly, at some point, the dollar will have adjusted, especially since the rest of the world will need to get increasingly aggressive if the dollar starts to really decline. As RBA Governor Lowe mentioned in a speech, one of the key methods of policy ease transmission by any country is by having the local currency decline relative to its peers, but if everyone is easing simultaneously, then that transmission channel is not likely to be as effective. In other words, this is yet another central bank head calling for fiscal policy stimulus as he admits the limits that exist in monetary policy at this time. Alas, the herd mentality is strong in the central bank community, and so I anticipate that all of them will continue down the same path with a minimal ultimate impact.

What we do know as of last week is there are at least two FOMC members who believe rates should be lower now, Bullard and Kashkari, and I suspect that there are a number more who don’t have to be pushed that hard to go along, notably Chairman Powell himself. Remember, if markets start to decline sharply, he will want to avoid as much of the blame as possible, so if the Fed is cutting rates, he covers himself. And quite frankly, I expect that almost regardless of how the data prints in the near-term, we are going to see policy ease across the board. Every central bank is too committed at this point to stop.

The upshot of all this is that this week is likely to play out almost exactly like Friday. This means a choppy equity market with no trend, a slowly softening dollar and rising bond markets, as all eyes turn toward Osaka, Japan, where the G20 is to meet on Friday and Saturday. Much to their chagrin, it is not the G20 statement of leaders that is of concern, rather it is the outcome of the Trump-Xi meeting that matters. In fact, that is pretty much the only thing that investors are watching this week, especially since the data releases are so uninteresting.

At this point, we can only speculate on how things will play out, but what is interesting is that we have continued to hear a hard line from the Chinese press. Declaring that they will fight “to the end” regarding the trade situation, as well as warning the US on doing anything regarding the ongoing protests in Hong Kong. Look for more bombast before the two leaders meet, but I think the odds favor a more benign resolution, at least at this point.

Turning to the data situation, the only notable data overnight was German Ifo, which fell to 97.4, its lowest level since November 2014, and continuing the ongoing trend of weak Eurozone data. However, the euro continues to rally on the overwhelming belief that the US is set to ease policy further, and this morning is higher by 0.25%, and back to its highest point in 3 months. As to the rest of the week, here’s what to look forward to:

Tuesday Case-Hiller Home Prices 2.6%
  Consumer Confidence 131.2
  New Home Sales 680K
Wednesday Durable Goods -0.1%
  -ex transport 0.1%
Thursday Initial Claims 220K
  Q1GDP 3.2%
Friday Personal Income 0.3%
  Personal Spending 0.4%
  Core PCE 0.2% (1.6% Y/Y)
  Chicago PMI 53.1
  Michigan Sentiment 98.0

Arguably, the most important point is the PCE data on Friday, but of more importance is the fact that we are going to hear from four more Fed speakers early this week, notably Chairman Powell on Tuesday afternoon. And while the Fed sounded dovish last week, with the subsequent news that Kashkari was aggressively so, all eyes will be looking to see if he is persuading others. We will need to see remarkably strong data to change this narrative going forward. And that just seems so unlikely right now.

In the end, as I said at the beginning, this week is likely to shape up like Friday, with limited movement, and anxiety building as we all await the Trump-Xi meeting. And that means the dollar is likely to continue to slide all week.

Good luck
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