There once was a fellow named Cohn
Who markets thought stood all alone
‘Gainst forces quite set
To keep up the threat
Of tariffs. Now this bird has flown!

Apparently trade friction and tariffs ARE a problem in the market’s eyes. Who’d a thunk it? The announced resignation of President Trump’s chief economic advisor, Gary Cohn, was not well received by markets anywhere as he was seen as the last free trade voice in the White House. S&P futures fell 1% within minutes of the announcement and we have seen that follow through in equity markets around the world. The dollar has been a different story though. While the yen has rallied about 0.35% on its haven status, the euro is little changed, and the dollar has actually shown strength against many key US trade partners amid the escalating rhetoric on trade. For example, CAD has declined 0.45%, MXN is down 0.6% and KRW is lower by 0.5%. Of course, it should be no surprise the renminbi has suffered as well, down 0.15%. Net, the dollar is little changed on the day, at least as measured by the many indices that track it, but there has been some movement.

So what are we to make of all this? Quite frankly I would argue there is no way to know at this time. On the one hand, President Trump campaigned on this specific issue; countless times declaring he would get better deals for the US. Does this mean that he will follow through on these threats and actually impose the tariffs? I am not prepared to answer that question other than to say the probability is clearly non-zero. Will this lead to escalation and retaliation by other nations? Certainly they have made clear they are willing to do that, but a funny thing is given the size of the US trade deficit with the rest of the world, it just might be they have more to lose than the US. Now I’m not advocating for a trade war as history shows those can be quite destructive to all involved, but based on my observations of the President to date, I would not rule out that outcome. There is, however, a more likely thought process to these tariffs; they are the latest salvo in a trade negotiation. In fact, Administration members have been essentially saying that already, for example, pointing to NAFTA and saying if a new agreement is reached that is more to the US liking, tariffs won’t apply to either Mexico or Canada. And when looking at the largest exporters of steel and aluminum to the US, both Canada and Mexico are top of the list, well ahead of China in both cases.

So here’s my broad observation about what is happening in the US right now, at least from the perspective of markets and their investors. There is a significant transition in the tone and language that is emanating from the key power centers in the US: the White House, the Treasury and the Fed. For the past umpteen years, every comment has been carefully considered before being made public, as there was a great fear that speaking forthrightly would unleash market turmoil. Arguably this has been the case since at least the Clinton Administration when the term ‘bond vigilantes’ was invented.

But the current administration is quite different than all we have seen in the past, perhaps since Andrew Jackson in the 1860’s. Forthrightness has become a hallmark of the communication policy, as evidenced by Fed Chair Powell’s testimony, by Treasury Secretary Mnuchin’s comments at Davos, and by the daily commentary from the White House. And markets are having a tantrum because they seem to be losing the control they feel that they had. And in reality, they did have control. Thus the taper tantrum in 2013 was met with the Fed bending over backwards to deny that they would ever stop QE, and the entire concept of the Fed put is based on the idea that if policy changes aren’t met with market approval, a sell-off will result in a change in those policies. But as I have said before, the stock market is not the economy, and despite the fact that President Trump has been bragging about the stock market’s rally, he will drop that discussion in a heartbeat if he has something else to say. I assure you that if this is a negotiating tactic and Canada and Mexico cave on current outstanding issues in NAFTA, that will be the entire discussion, regardless of where equity prices go. I think the rest of the world is having trouble digesting this change as well, as circumspection in announcements has been the norm. It will become ever harder for Draghi or Carney or Merkel or any foreign leader to remain subtle in the face of straightforward comments from the US. Maybe that’s not such a bad thing!

Anyway, we are getting to watch a remarkable turn of events in communication, and I would look for market volatility to continue to rise accordingly. So what is in store for today? As another Nor’Easter bears down on NY, we get our first hint at the payroll data with ADP Payroll (exp 205K) and then Trade Data (-$55.1B). A little later comes Nonfarm Productivity (-0.1%) and Unit Labor Costs (+2.2%) and finally the Fed’s Beige book is released at 2:00. We also hear from Bill Dudley again, as well as Atlanta’s Raphael Bostic. One of the interesting things from yesterday was Governor Lael Brainerd, seen as one of the most dovish Fed members, turned quite bullish on the economy and seemingly hawkish in comments she made. She used the term headwinds turning into tailwinds just like we heard from Chair Powell at his testimony. I remain convinced that the Fed hikes four times this year. I remain convinced that the ECB remains far more dovish than currently anticipated, and I remain convinced that the dollar will end the year higher. For today, I like a modestly firmer dollar by the close.

Good luck
Adf

Apparently tariffs are not
The problem that people had thought
With nary a worry
Investors still scurry
To buy all the stocks that are hot

The dollar, however, ignored
The rally and looked rather bored
But later this week
We’ll hear Draghi speak
Then Friday’s employment’s explored

One has to be impressed with the speed with which tariffs went from ‘the worst thing ever’ to ‘no big deal’. If market activity at the end of last week was indeed due to the President’s announcement of tariffs on imported steel and aluminum, and that certainly seemed to be the case, then yesterday was all about the blowback that followed that announcement, not only from the nations directly impacted, but from the GOP congressional delegation as well as numerous major US companies. At this point, there is no way to know whether these tariffs are going to ultimately be emplaced or not, but the market has clearly decided that the answer is not. What that does is set us up for further volatility if they actually do come about.

But away from the tariff discussion, there was not much else of note to drive markets. Yesterday’s ISM Non-Manufacturing data showed continued strength in the US economy, printing at 59.5, slightly below the previous month but above expectations. However, in the current market, at least in the current FX market, data of that sort has limited impact. Rather, traders went back to their continuing bias for a weak dollar, and while yesterday saw little movement in the buck, since Europe opened this morning, we have seen it pressured lower. In fact, the euro has rallied in the past hour by 0.5%, although the only data released was third tier in nature. We have seen a similar rally in GBP, and there was no data on which to base the move. Even more impressively, AUD is higher by 0.7% in that time span. Now last night, the RBA left rates on hold at 1.5%, which was universally expected, and when looking at interest rate differentials, US 10-year yields are actually higher than those in Australia. The last time this was the case was in 2001, and AUD was trading below $0.50, as opposed to today’s levels around $0.78. Obviously, there were many other different things ongoing then, but it is an interesting point to be made. However, the market movement has been just in the past hour, long past the time of the RBA decision.

Interestingly, the yen has been lagging this move, but that is more likely because Kuroda-san was testifying for a second time at his confirmation hearings, and he walked back the discussion about ending QQE in 2019 when he expects inflation to achieve their 2.0% target. Now it was always silly to me that they could have such a precise forecast for something like inflation, especially given that over the past decade, the BOJ has proven it has no idea what drives the statistic. So the idea that they would change policy instantaneously at a time twelve months from now because of their inflation forecast was always unlikely. After all, they have been saying for the past five years that they would achieve their target within the next twelve to twenty-four months, and yet here we are with CPI there below 1.0% five years on! At any rate, the yen lost some of its impetus from those comments and has lagged other currencies, strengthening only 0.1% today.

Away from the G10, we have seen a more mixed picture, although the dollar is predominantly weaker here as well. For example, ZAR has rallied 0.75% after a better than expected GDP outcome as investors continue to favor the new Ramaphosa administration. Similarly, KRW is higher by 0.6% after news that North Korea would be willing to explore talks with the US leading toward denuclearization hit the tapes. But in general, it seems there doesn’t need to be a specific catalyst today, we are seeing risk being embraced, as evidenced by equity market rallies around the world, and the dollar is suffering as well.

As to the session here today, the only data point is Factory Orders (exp -1.2%), which is not typically a market mover. In addition, we hear from three Fed speakers, Dudley, Brainerd and Kaplan, which means things are likely to sound slightly more dovish than not. But really, that’s all we’ve got today. The background picture remains one where US growth continues apace, and the biggest question is just how aggressive the FOMC is going to be this year. Starting tomorrow, we get much more market information with both an ECB and BOJ meeting on Thursday and payroll data on Friday. If we continue to see AHE push higher, like last month, you can be sure that the equity markets will have a shaky time as expectations of four Fed hikes this year grow further. But that is still a few days away. For today, the dollar is under pressure and likely to remain so.

Good luck
Adf

In Europe, Italian elections
Had voters express their objections
Incumbents were tossed
And centrists all lost
Look out for more market corrections

The big weekend news was, of course, the European electoral situation. In what can be no surprise, the German SPD caved and joined the ‘grand coalition’ again, despite the fact that the party is drifting into irrelevance largely because of these coalitions. As I wrote Friday, the aphrodisiac of power was far more compelling than any alleged principals they claimed to hold. While this outcome was foreseen, it simply highlights that the center of German politics is losing its grip. Unless they make some big changes in policy, and they are not discussing anything of the sort, my take is that at the next election, putting together a governing coalition will be far more difficult than this time, and remember, it took an unprecedentedly long six months this time!

Meanwhile, Italy went to the polls and elected…nobody. Well, that’s not really fair, what they did was split the vote pretty significantly, with the anti-establishment 5 Star Movement winning the largest number of votes, capturing 32%. However, that remains far below the estimated 40% required to manage an effective government there. The right-wing grouping of Forza Italia and Lega Norda, won 37%, although that too, seems unlikely to be able to rule. Finally, the incumbent Democratic Party saw its support fall to just 19%. So there is no obvious solution as to how a government will be formed there, and it is entirely possible that a new vote will be held after a few months of futility. But none of this seemed to matter to markets, at least FX markets. In truth, Italian share prices are down 1% this morning, although the rest of Europe is marginally firmer.

In fact, the subject that still gathers the most attention is the tariff announcements made last week by President Trump.

Trump said that the problem with trade
Is everyone’s been so afraid
To call out the cheating
Which is why he’s tweeting
America won’t be betrayed!

Let me start by saying that any escalation in this adventure will be a distinct negative for every economy and global markets as well. The foundation of global growth over the past fifty years has arguably been the ongoing globalization of manufacturing where comparative advantage has demonstrated that prosperity could be widespread. However, the reason insurgent political parties and candidates, (e.g. Trump, Brexit, AfD, 5 Star Movement, etc.) have had so much success is because it turns out that the benefits of this growth have been very unevenly distributed. And those who have been missing the gains have found their collective political voice. Ultimately, this is a very difficult problem, and one that is unlikely to simply disappear. Rather, I expect that we will see an ongoing increase in insurgent support. And that is not likely to bode well for growth anywhere in the world. But that is a long-term process, so will be background noise more often than not, except when we have elections that explicitly show how the previous system and assumptions continue to slowly unravel. And while that is a somewhat dark view, I fear it is the most likely outcome.

With that as background, let’s pivot to the markets this morning. The dollar is little changed, slightly stronger vs. the euro, slightly weaker vs. the pound and yen, and mixed around the world. In addition to the elections in Europe, we saw PMI data released at softer than expected outcomes. While the growth trajectory there remains quite positive, it is very possible that we have seen the peak already, and that the Euozone is going to head back to its long-run sustainable rate of growth which is estimated at somewhere between 1.5%-2.0%, well below the most recent readings of 2.5% or so. At the same time, UK Services PMI data surprised on the high side, printing at 54.5, well above the expected 53.3 level, and indicating that despite the uncertainty of Brexit, the economy there is continuing to muddle through. Also helping the pound, which is higher by just 0.1%, is the fact that the market seems to believe that PM May is about to cave on the Brexit negotiations thus insuring a soft Brexit and less economic impact. If that is the case, I have a feeling PM May just may lose her office with PM Corbyn entirely feasible. Quite frankly, that would be similar to a President Sanders here, and a situation where the pound, in my estimation, would suffer greatly.

In the emerging markets, the situation is one of general dollar strength. For example, MXN is weaker by 0.6%, with RUB not far behind it. KRW is under pressure, as is the CE4, although interestingly, ZAR is actually a bit firmer. The latter, however, is likely due to the solid performance of gold (+0.9% overnight). One other notable mover is CNY, which is weaker by 0.2% after Caixin PMI data released overnight showed a further slowdown in growth there. This is of a piece with the Chinese National Party Congress, where last night Premier Li Kiquang laid out plans for GDP growth this year of 6.5%, down from 6.9% in 2017, while they continue to try to force further deleveraging of sectors like real estate and local government. The point is the picture today is mixed, with no broad theme.

On the data front, this week brings a great deal of new and important information, culminating in Friday’s payroll report:

So plenty of new information to help us determine the next steps in the ongoing saga of markets. Signor Draghi may have been helped by the recent softening trend in PMI data in the Eurozone as he continues to want to leave policy alone despite many calls by the hawks to finally end QE. It will also be interesting to hear what Kuroda-san has to say given his comments last week about an exit to QQE there. My gut tells me that neither will be aggressively hawkish and will do everything they can to keep things on an even keel.

As for today, it depends on if there is further information regarding the tariff situation, which in its purest form is clearly inflationary. However, barring that, I think the market is likely to have a nondescript session, with the dollar waffling along with equity and bond markets.

Good luck
Adf

Next Fiscal Year end
Kuroda will bless us with
Thought’s on QE’s end

Is easy money
No longer panacea?
Can markets survive?

Much has served to roil markets in the past twenty-four hours, notably the announcement by President Trump of the imposition of tariffs on imported steel and aluminum. But that wasn’t all. Chairman Powell was back in front of the cameras, once again affecting his plainspoken message that the economy seems pretty good right now and that he expects that situation to continue driving inflationary pressures higher, hence the need for tighter monetary policy.

But that’s not all! Overnight we heard from the BOJ’s Kuroda-san. If you recall, Kuroda was just reappointed to a second term in the seat, unlike the change at the Fed and the impending one at the ECB. His surprise was to offer a timeline as to when the BOJ would consider changes to its own QQE program. Apparently, the BOJ’s crystal ball points to March 2019 as the time when inflation will be at or finally approaching their 2.0% target. My one comment about this is that every central bank has been a notoriously bad forecaster when it comes to specific levels of particular data points. I see no reason why the BOJ suddenly has better insight than its history of failure in this situation. But in fairness, last night we also saw Japanese data released that was encouraging, with Tokyo core CPI rising a more than expected 0.9% in February while the Unemployment Rate fell to 2.4%, its lowest level since 1993. Adding up all the activity resulted in a much stronger yen. From early yesterday afternoon, in the wake of the tariff announcement, the yen has appreciated nearly 2% and is now trading at its strongest level since October 2016. And my take is it has further to run. The yen continues to be seen as a haven asset and in the new market paradigm, where volatility is no longer banished, many investors will find that comforting. This is also why we have seen US Treasuries perform so well recently, their haven status is extremely attractive in uncertain times.

True to form for havens, the Swiss franc, too, has performed extremely well, rallying 0.75% since yesterday’s close and 1.5% since its nadir ahead of the tariff announcements. In fact, the dollar has been under consistent pressure since the tariffs.
However, the weakness has not been universal. For example, CAD has fallen by 0.25% overnight as the market recognizes that Canada is actually the largest exporter of steel and aluminum to the US, and would be quite significantly impacted by the tariffs. But we have also seen USD strength against MXN, +0.75%, and BRL, +0.4%, both of which seem to be suffering on the combination of reduced risk appetite and declines in the commodity space. Ironically, despite all the Administration rhetoric regarding China, the renminbi is essentially unchanged on the day.

In an environment where policy adjustments are coming fast and furious on both the fiscal and monetary sides of the equation, there is no way to forecast the day-to-day outcomes and likely movements in markets. (If there ever were!) But as I mentioned yesterday, the one thing of which we can be sure is that trade tensions will lead to higher inflation, which means that we are likely to see monetary policy tighten even further going forward. I continue to believe the US will be in the vanguard of this movement and the dollar will benefit accordingly.

I would be remiss if I did not touch on one other thing, the elections in Europe this weekend. Italy heads to the polls to select a new government on Sunday and at this point, there is no clear favorite amongst the parties to take a majority. The anti-establishment Five Star Movement is the leader, but is not seen likely to win an absolute majority by itself and the other parties have refused to work with them. Ultimately, the outcome seems likely to be a broad coalition that will not be able to effect much needed policy changes in the labor, regulatory and pension spheres, thus leave Italy lagging the rest of Europe in growth. But we cannot forget Germany, where the SPD ballots, to determine if they want to join with Chancellor Merkel once again in a grand coalition, are also to be counted. Given the SPDs dreadful election performance back in September, there is a large bloc that wants nothing to do with a repeat of the past four years. However, the aphrodisiac of power is strong, and I expect them to approve the deal in a close vote. After all, these are politicians, and the only thing worse than not being elected, would be passing up the chance at power if you were elected. In the end, I don’t expect that the euro will be significantly impacted by the weekend news. Its future will continue to be determined by monetary policy and economic outcomes.

This morning’s only data point is Michigan Confidence (exp 99.5), and it wouldn’t surprise me greatly if a big surprise impacted markets. Looking at other catalysts, equity futures continue to point lower, European equity markets are falling and there seems to be a general pall cast over the markets right now. I expect that after several days of strength, today’s mixed picture will resolve itself in the dollar falling a bit further into the weekend. Remember, next week brings both the ECB meeting and US payroll data, so there is plenty on the horizon to keep us interested.

Good luck and good weekend
Adf

The data from Europe today
Implied that, from Spain to Norway,
The outlook for growth
May make Draghi loath
To soon take the ‘punch bowl’ away

The dollar continued to perform well overnight, edging higher again vs. most of its counterpart currencies and actually trading to its highest level in more than six weeks. While I wouldn’t necessarily characterize it as strong, it certainly has started to regain some momentum with a 3% rally over the past two weeks. The proximate cause today was the release of PMI data from around the world, which hinted at the idea that the recent pace of growth seen throughout the G20 may, in fact, have peaked. The direct result of this is that all those who expected the ECB would be sounding more hawkish next week have had to re-evaluate their strategies. In fact, one of the tell-tale signs that I saw was commentary by Bundesbank President Jens Weidmann, an arch-hawk, that QE is likely to remain in place through the end of 2018 and interest rates unlikely to rise before late 2019. To me that is groundbreaking stuff, and I am shocked it has not gotten more play. (I read it in an article about German wage settlements; it was not a headline!) At any rate, by combining this modest adjustment in the outlook for growth with Chairman Powell’s comments on Tuesday, it is easy to understand the recent change in sentiment.

So will this change have staying power? While it is anybody’s guess, my vote is with yes. As I have been discussing, inflation remains the key driver in central bank eyes these days. Certainly for the G10 that is the case. And it is also clear that due to the way it is calculated, on a year over year basis, we are very likely to see inflation in the US run higher than we have seen for the past twelve months. This will be the elimination of Yellen’s ‘idiosyncrasies’ from the data, such as the hedonic adjustment for unlimited data use in cell phones, to name one. The point is that inflation in the US is set to rise, and the Fed will be very attuned to that process. In fact, this morning we get the latest reading of PCE (exp 1.7%, core 1.5%), which is the number they plug into their models. My gut tells me that we could see those come in a tick higher which would almost certainly be enough to cement more hawkish attitudes amongst the majority of the FOMC.

At the same time, the inflation story in both Europe and Japan remains one of absence. Neither of these economies has shown any hint of rising inflation and so it remains increasingly difficult to maintain the idea that either central bank is going to tighten policy any time soon. My point is that all of the hype over a tighter ECB or BOJ while the Fed lags its own estimates must surely have been dispelled at this point. If anything, I would argue things would be the other way round, with a tighter Fed and an easier ECB (especially if Weidmann has changed his stripes.) And that will lead to dollar strength. Remember, too, that there are very significant short USD positions built up in the markets, so at some point, if the dollar continues its recent rise, these positions will be unwound and the dollar will find an even more substantial bid. Hedgers, you are forewarned.

What can change this view? Essentially, we will need to see US data start to crack, especially the inflation data. If that continues to lag estimates, then I suspect that the Fed will change its tune. But until that is the case, I would look for the Fed to remain in the lead regarding policy tightening amongst central banks.

Is there anything else? Well, there is one thing that is gathering more press lately but doesn’t feel to me like it is priced into markets and that is trade tensions. Headlines this morning indicate that President Trump may be imposing tariffs or quotas on imported steel and aluminum, this after his tariffs on solar panels and washing machines. Not surprisingly, other nations are looking at retaliation and a full-fledged trade war cannot be ruled out. While it is not my base case, what is certain is that a more protectionist stance by the US (and in truth by any nation) is going to result in higher inflation. Whether it is price rises due directly to tariffs, or price rises due to higher costs of local production, prices will rise. Since the US is in the lead on this front, (a dubious distinction at best) it is quite likely that the Fed will find itself behind the curve before any other nation. And this, too, is a reason for the Fed to move faster than currently priced. In fairness, we have seen markets adjust somewhat over the past sessions with Fed Funds futures now pricing in about a 40% probability of a fourth rate hike this year. But on a relative basis, I continue to believe the market is under pricing the eventual interest rate differential between the US and other major economies. Hence my still bullish dollar view.

This morning, in addition to the PCE data, we will see Initial Claims (exp 230K); Personal Income (0.3%); Personal Spending (0.2%); ISM Manufacturing (58.6) and Construction Spending (0.3%). Of course, we also hear round two from Chairman Powell, and we hear from NY Fed President Dudley as well. It will be interesting to see if Powell tries to walk back any of his comments from Tuesday, but the very fact that there has been no attempt in the interim means to me that he is comfortable with the market’s interpretation. Equity markets have been behaving poorly of late, with early rallies giving way to late day sell-offs. That is a very interesting change in tone, and one that I feel bodes ill for future gains. Treasury prices have been behaving well, almost as though we are back to a risk-off scenario, which with declining stocks and stronger Treasuries and a stronger dollar could be the case. I see no reason for these recent trends to change and expect that the dollar will continue to edge higher for the rest of the session.

Good luck
Adf

The world is a funny old place
Where confidence in growth’s fast pace
Is what undermines
The positive signs
In stocks and bonds, causing retrace (ment)

“My personal outlook for the economy has strengthened since December. We’ve seen continuing strength in the labor market. We’ve seen some data that will, in my case, add some confidence to my view that inflation is moving up to target. We’ve also seen continued strength around the globe, and we’ve seen fiscal policy become more stimulative.” So said Jerome Powell to the House Financial Services Committee yesterday morning when answering a question specifically about the number of rate hikes the Fed may implement this year. And the market response was immediate, with both stock and bond prices falling sharply while the dollar rose on this ‘hawkish’ reply.

One cannot be surprised at this market reaction. We have spent the past several years in the ‘Goldilocks’ economy, where growth has been solid but inflation absent thus allowing the Fed, and truly most central banks around the world, to leave excessive monetary accommodation in the system. The result has been remarkably low interest rates for an economy growing reasonably well, and a boon to both equity and fixed income markets. But all good things must come to an end, and with the uber-dove Janet Yellen no longer occupying the Chairmanship, it was inevitable that this would occur.

My take on Chairman Powell’s testimony is that he is not likely to attempt to obfuscate his views in the manner of the more recent Fed Chairs. I believe he knowingly personalized his testimony, discussing his own views rather than the committees, and that his more forthright manner is likely to be welcomed by investors over time. But my view is likely a minority one. The evolution of policy under both Bernanke and Yellen had been such that they appeared overly sensitive to market movements. In other words, if either of them said something that upset the market’s ‘demand’ for continuing Fed largesse and resulted in a sharp decline in the stock market especially, Fed speakers were on the tape within hours to walk back the comments. I foresee much less of this behavior going forward. Instead, my sense is that markets will simply have to evaluate the data and adjust accordingly. Personally I see this as a healthy and long overdue change to policymaking. It is likely to increase the volatility in markets somewhat, especially since Powell is alone in this attitude. After all, the other main central banks continue under their previous leadership, so it is unlikely that either Signor Draghi or Kuroda-san are about to change their style. In the end, this is merely one more reason that I like the dollar to rebound as the year progresses.

But let’s look at the things impacting the dollar today. The buck is broadly stronger (EUR -0.1%, GBP -0.7%, JPY +0.3%) after not only the perceived hawkishness from Mr. Powell, but also from a swath of weaker than expected economic data from around the world. Chinese PMI data printed at its weakest level in nearly two years at 50.3. While there was no doubt that the Lunar New Year celebration had some impact, the underlying indices showed very consistent weakness. We also saw weakness in Japanese Construction Orders and Housing Starts to close out the Asia session.

European data then followed this trend with weaker than expected Finnish GDP (0.7%); German GfK Confidence (10.8); French inflation (1.4%); and Italian Inflation (0.7%); and that was after a weaker than expected German Inflation print yesterday (1.2%). The continuing lackluster inflation data remains Draghi’s driving impetus in his efforts to prevent the market from assuming the end of QE. So when the ECB meets at the end of next week, the latest set of data will show still limited progress on inflation, especially in the big three economies of Germany, France and Italy, and will allow the doves to continue to control the message. As I have consistently maintained, the market continues to underestimate coming Fed aggressiveness (although that is changing after Powell yesterday) and overestimate the probability that the ECB is going to tighten policy soon. Eurozone data from yesterday and today simply highlight my case and this is the crux of my argument that the dollar will rebound.

This morning brings a reprieve on the Powell front, with the Chair waiting until tomorrow to address the Senate. However, we get the second reading of Q4 GDP, originally showing growth of 2.6%, but forecast to decline to 2.5%. That adjustment appears to reflect expectations that Real Consumer Spending in Q4 was actually a touch lower at 3.7% (originally released at 3.8%). We also see Chicago PMI (exp 65.0), which would be a modest decline from last month, but still at nearly the highest levels since the late 80’s. In other words, it seems unlikely that the Chairman’s bullish view on the US economy is going to be called into question today. Ultimately, I continue to see the trajectory of US interest rates higher at a faster pace than elsewhere in the world, and I continue to see the dollar benefitting. Hedgers, keep that in mind.

Good luck
Adf

There is an old banker named Jay
Who’ll speak before Congress today
Most analysts doubt
New views he will spout
But all want to hear what he’ll say

Some days, there is just not much to discuss, and today is one of those days. Ahead of Chairman Powell’s testimony this morning, markets have been extremely quiet around the world. The one consistency has been that equity markets have seen a minor bout of profit-taking after their recent recovery rally, but trading volumes appear to be light across the board. As to the dollar, it is virtually unchanged this morning from yesterday’s closing levels, and in truth, has not shown much movement for the past week.

As such, a look at Powell’s testimony and how it may impact the FX and other markets seems to be in order. The biggest unknown is likely to be the style with which he addresses the House Financial Services Committee. Markets have grown accustomed to the combination of obfuscation and circumspection that has defined Fed testimony for the past thirty years (since Alan Greenspan was first appointed). In fact, the only time that a Fed Chair actually broke new ground in one of these events was in 2013, when Ben Bernanke hinted that QE would not last in perpetuity and that the Fed was considering when to stop buying more bonds. Of course the result of that was the Taper Tantrum, a virtual collapse in the price of bonds, and a sharp correction in the price of stocks. And that was the last time a serious discussion of policy was held. But Mr. Powell is not a PhD economist; rather he is a former investment banker and businessman who in his few public appearances thus far, including his confirmation hearings seems to speak a bit more plainly. While I applaud that in any person, there is no question that it opens the door for a bit more volatility in markets. Remember, too, that despite her best efforts, Chair Yellen made a few inadvertent comments in her first two appearances that had market impacts and were subsequently walked back by other Fed members.

So what can he say? It seems likely that in his prepared remarks he will need to discuss the improvement in the economy since the Fed last met in January. It is also likely that he will touch on the increased market volatility we have experienced since then, but I would be surprised if he says anything other than this is normal and of no concern to the FOMC. In other words, my sense is he will try to remove the Fed put from the dialog. He will almost certainly mention the new budget and its added fiscal stimulus in an effort to highlight the potential risks of inflation rising faster than currently anticipated. And I’m sure he will conclude by saying the economy is in great shape and that the Fed is doing a wonderful job meeting its mandates of full employment and stable prices.

Will he touch on the timing of specific policies? Almost certainly not. What about the number of rate hikes the Fed is likely to impose this year? That is a possibility in the context of the discussion about the improvement in the overall economy. I doubt he will even mention the reduction of the balance sheet as that is something the Fed is very keen to keep in the background.

Remember, too, that he will be asked a series of questions by the committee members, almost none of which will be of substance, but a few of which could be tricky. It is in this section of the event that there is the greatest chance for a market surprise. As we saw with both Yellen and Bernanke, sometimes they are ‘too’ honest in their answers and get away from the broad storyline they are trying to maintain.

The thing is, it seems that there are very few things likely to come from the testimony that lean dovish. Given the constant improvements in the economy, there is a growing sense from many members (Bullard and Kashkari excepted) that the Fed may be falling behind the curve in their efforts to moderate building inflationary pressures. If that attitude is displayed, then we could well see a more clearly hawkish result. In that event, look for the dollar to benefit, and both bonds and stocks to fall. But my sense is that Powell will do whatever he can to sound as neutral as possible. In the end, one can be certain that he will discuss data dependence regarding Fed actions. And so as we look ahead to the data tomorrow and Thursday, any further indication that inflation is rising faster than previously forecast ought to result in further pressure on equities and bonds and further strength in the dollar. But we will need to see that data to respond.

As to today’s data, Durable Goods (exp -2.0%, +0.4% ex transport) and Case Shiller Housing Prices (6.3%) are on the docket, but will likely not see much response given the Powell testimony. The market response today will be entirely dependent on what he says, and until then, there is likely to be little price action at all.

Good luck
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This week there’ll be much more to see
It starts with Jay’s testimony
Then data galore
Will tell us much more
From ISM to PCE

Today I’m going to start with a brief history of what has been the most important monthly data release during the past thirty-nine years. These are not hard and fast dates, merely approximations.

1979 – 1984: M2 Money supply was the key data point (it is actually released weekly) based on the fact that Fed Chair Paul Volcker was a pretty strict monetarist. This was before press conferences and the Fed never announced rates, they simply acted in the money markets to drive the Fed funds rate to their desired level. Remember, too, that this period was one where inflation was significantly higher and the Fed’s goal was to bring it down to a more reasonable level. However, there was no specific target like today.

1984 – 1988: The Trade Balance became the key data as the deficit grew significantly while the dollar approached record highs during this period. Volcker’s willingness to run tight monetary policy while the US was in the midst of expansive fiscal policy underpinned the dollar, and made US goods quite expensive globally. Remember, too that despite the equity market crash in 1987, the economy did not enter a recession.

1988 – 2017: For the past twenty years, the payroll report has clearly become the critical monthly release, starting with Alan Greenspan and running on through to Chair Yellen. This was during the ‘Great Moderation’ when central bankers thought that they had figured out how to defeat the business cycle. The employment data was seen as the key marker of economic activity, especially as the bulk of this time was before the Fed set a specific inflation target in 2012. For the period here before the financial crisis, the Fed was still far more concerned about inflation running too hot rather that too low, although the financial crisis certainly changed viewpoints there.

2017 – ?: At this point, I would argue that Core PCE has become the critical data point. While the argument over whether CPI or PCE is the better measure of inflation has been ongoing for a long time, the market reality is that PCE is what the Fed plugs into its models, so that is the one that should drive their decision-making function. Combined with the fact that the nation’s employment situation is now considered extremely robust, inflation is the variable that has the Fed’s attention. It is unclear how long this will remain the case, but I imagine it will be so for at least another year or two. After all, it’s not as though the Fed can change inflation’s course at the drop of a hat. So get used to the inflation story being the driver for now. And while PCE is the Fed’s preferred number, we get at least a half dozen different readings each month, any of which are likely to impact markets if they surprise, especially to the high side.

With that in mind, let’s look at what is happening in markets right now. If I had to characterize the dollar broadly I would say it is under pressure but there is very little consistency to the movement. Amid the G10 set, the pound has been the best performer after a speech from Labour leader Jeremy Corbyn highlighted his view that the UK should remain in a customs union with the EU upon Brexit. This view, which aligns with the portion of the Tory contingent that wanted to remain in the EU, may well moderate the outcome of the Brexit negotiations, and at least prevent the worst case of a ‘hard’ outcome. Combining this news with comments from BOE member Dave Ramsden who was previously considered a dove, that rates would be rising sooner than many expect, It should not be surprising that the pound has benefitted, rallying 0.5% this morning.

However, away from that news, there has been scant other commentary or data to drive things. For instance, while EUR and JPY are a bit firmer, CAD and MXN are both weaker. Commodity prices show strength in metals but not energy. Bond yields are little changed, although they have fallen from last week’s highs, and equity prices continue to march higher. In other words, there is certainly no broad theme to which markets are responding. I continue to look for tomorrow’s testimony by Chairman Powell as the first key for the week, but we do get a lot more data to ponder:

Powell testifies to the Senate on Thursday as well, and we also hear from Bullard, Quarles and Dudley this week, but it beggars belief that the market will care about them with Powell so prominent. The data, however, should be critical, because we get the latest reading on Core PCE on Thursday. Given the recent inflation readings, where every one of them has been surprising to the high side, it doesn’t seem hard to believe that we see something higher here as well. My take is that the inflation story is evolving far more rapidly this time than it has in the past, and that econometric models are not coping well with the change. Don’t forget there will be a Prices Paid component to the ISM data as well, so there is plenty of opportunity for the recent price pressures to be made more evident this week. My gut tells me that we will continue to see inflation readings move higher and surprises will be in that direction.

In the end, I have a feeling that the question of whether the Fed is behind the curve is going to be asked more frequently as we go forward, maybe even at this week’s Humphrey-Hawkins testimony, and that the answer is a resounding yes. Powell’s style in this forum is a complete unknown, but he has been more forthright in his commentary style than any of the past three Fed chairs, so it is quite possible that the market gets a little shock tomorrow in the Q&A. But for today, I expect that market participants will remain quiet as they await tomorrow’s testimony.

Good luck
Adf

Inflation continues to be
The issue that most people see
As driving the bus
When they all discuss
What’s next for the economy

When you think about it, it is remarkable that inflation is now the hottest topic in economics and markets. For the past nine years, central banks collectively have been trying to raise prices around the world and while they have certainly succeeded when it comes to the prices of assets, when looking at the measured prices of goods and services, their efforts have been wanting. Not only that, but investors had seemingly dismissed the idea that inflation would ever return (except for a few outlying voices) and were basing their portfolios on that fact. But suddenly, rising inflation is the topic du jour with investors and traders trying to judge just how quickly those same central banks are going to adjust their policies. And given that virtually all market movements in the past nine years have been driven by central bank policies, this is important stuff for those with hedging requirements. In fact, right now I would contend that the dollar’s near-term future is directly based on just how those policies change.

Since the beginning of February we have learned that wage pressures in the US are increasing, CPI, PPI and Import Prices are all rising faster than expected, and that the Fed has clearly recognized the improved economic situation in the US and the rest of the world. We have also learned that the ECB is contemplating further changes in policy, but remains on the slow track. We learned that the BOE has expressed real concern over the rising inflation levels in the UK (which they attribute to the pound’s sharp decline in the wake of the Brexit vote in June 2016), and apparently are poised to tighten policy further. We have learned that the PBOC is continuing its crackdown on excess leverage in the Chinese economy, tightening policy there. And we have even begun to suspect that the BOJ, despite virtually no signs that inflation is beginning to actually rise in Japan, is getting ready to adjust policy there. In sum, these first hints of rising inflation have been sufficient to get global central banks to finally change their tune.

Of course, nine years of extraordinary monetary policy around the globe has had other consequences, notably the eye watering valuations of both equity and bond prices in many markets. And so, as policies change, it is reasonable to expect these valuations are going to change as well. So for investors, at this point in time, caveat emptor are the most important two words to remember.

But how does this impact the dollar? In a nutshell, the dollar (and in fairness every currency) will be subject to movement based on market expectations of policy changes vs. the actual changes that are made and, most importantly, the sequence of those changes around the world. And this has been my thesis for the past year or more. The market continues to under price the probability that the FOMC is going to be more aggressive, while it is over pricing the probability that the ECB is going to be more aggressive. This has been the proximate cause for the dollar’s sustained weakness even in the face of the Fed having proven it is the far more aggressive actor when it comes to tightening policy. Remember, not only are they raising rates, but they are also allowing QE to slowly diminish. Meanwhile the ECB is working overtime to explain that they are going to be moving at a glacial pace, with the idea that QE in the Eurozone would end abruptly in September getting short shrift. And I believe them.

Remember one thing about Europe, Signor Draghi is Italian, and the Italian economy is arguably the weakest in the Eurozone. With his term coming to an end next year, he almost certainly has designs to go into politics back home, and he will not want to be remembered as the central banker who prevented the Italian economy from recovering by tightening policy too quickly! I continue to believe that the ECB is going to lag in their policy tightening for at least the rest of his tenor, which is a bit more than a year. In the meantime, Chairman Powell is just getting started, and the one thing that we have consistently heard from every Fed speaker is that they are unconcerned with recent gyrations in the markets. As inflation in the US rises rapidly during the next six months (almost guaranteed to happen based simply on the math), attitudes will be forced to change, expectations of a faster pace of Fed tightening will become the norm, and the dollar will rebound. That’s my story and I’m sticking to it!

As to the overnight session, the dollar is modestly stronger, but that simply is unwinding yesterday’s net modest weakness. Yesterday’s US data was quite strong, with the Initial Claims number demonstrating a still robust labor market, and the Leading Indicators figure pointing to faster growth ahead. But we continue to see market players doubt the Fed’s stomach for tighter policy.

We have seen one outlier this morning, the British pound jumped about 0.5% after a story hit the tape a short time ago that there seemed to be a growing chance that a vote to reverse Brexit could be forthcoming. Now I don’t know if that is even possible given the arcana of the EU construction and the fact that the UK did officially invoke Article 50 to begin the withdrawal process. However, based on the fact that the pound has clearly been undermined by Brexit, the market reaction does make sense. But away from that it is hard to get too excited about any other currency movement.

There is no US data today, although we have three Fed speakers, Dudley, Mester and Williams. It would be surprising if any of them altered the current Fed message, especially with Chairman Powell set to speak to Congress next week. I would expect that he would be the one to change any views. As such, it is hard to get excited about prospects for significant movement today. Next week brings far more new information, including the latest GDP and PCE readings that will get all the attention. Today, though, look for a lackluster session.

Good luck and good weekend
Adf

So what did we learn from the Fed?
They still think three hikes lie ahead
Investors, though, traded
Like they were persuaded
That four were more likely instead

The first thing to know about the FOMC Minutes is that it is a long, boring document. After all, they are the official record of a government institution’s two-day meeting. And while it may seem that not much gets done, I assure you much get’s said! Looking at yesterday’s release, after an initial modest uptick in both equity and Treasury prices, it seems that investors and traders finally read through to the point (on page 16!) where the FOMC hinted that policy tightening could quicken. The result was a sharp reversal in stock prices, with the major indices falling nearly 2% from their intraday highs, and Treasury yields pushing up to new highs for the move. (Arguably the latter was helped along by the massive amount of paper the Treasury has been auctioning this week, yesterday in the 5-year sector with yields there reaching their highest level since 2009 at 2.658%.

I believe the key paragraph was this one:
“Almost all participants continued to anticipate that inflation would move up to the Committee’s 2 percent objective over the medium term as economic growth remained above trend and the labor market stayed strong; several commented that recent developments had increased their confidence in the outlook for further progress toward the Committee’s 2 percent inflation objective. A couple noted that a step-up in the pace of economic growth could tighten labor market conditions even more than they currently anticipated, posing risks to inflation and financial stability associated with substantially overshooting full employment. [My emphasis] However, some participants saw an appreciable risk that inflation would continue to fall short of the Committee’s objective. These participants saw little solid evidence that the strength of economic activity and the labor market was showing through to significant wage or inflation pressures. They judged that the Committee could afford to be patient in deciding whether to increase the target range for the federal funds rate in order to support further strengthening of the labor market and allow participants to assess whether incoming information on inflation showed that it was solidly on a track toward the Committee’s objective.” FOMC Minutes released 21Feb2018
It is also key to remember that it has been three weeks since they last met and that we have seen a great deal of new information in the interim, notably a payroll report showing AHE rising at 2.9%, and every price gauge printing higher than forecast. It is not hard to understand why the market turned around yesterday afternoon. In short, the idea that the Fed was already leaning toward concern over stronger economic growth leading to inflation moving back to their target and the fact that the recent data was clearly even stronger than expected has investors on alert for a somewhat more aggressive Fed for the rest of this year. Quite frankly, much has been made about the term ‘gradual’ with regard to the pace of rate hikes this year, but if the Fed raises rates once each quarter, that doesn’t seem more than a gradual pace to me.

While there are a number of other Fed speakers on the schedule for the rest of the week, I think all eyes will be turning to next Tuesday morning, when Chairman Powell makes his first appearance before Congress in semi-annual testimony. At this point, it would be surprising if his message was substantially different than what Ms Yellen had been saying, but do not discount a change in style as having an impact. Also, as this is his first meeting, it would not be surprising for the market to react to some throwaway comment he makes in response to a question. If you recall, both Yellen and Bernanke in their first meetings made seemingly innocuous comments that had larger than expected market impacts. In the end, the story remains that the US economy continues to show growth and that price pressures are increasing. I continue to look for interest rates in the US to rise across the curve, and for the dollar to benefit accordingly.

Speaking of the dollar, a look at the overnight session tells us virtually nothing. It was a mixed performance with some currencies showing strength (JPY +0.4%) while others displayed weakness (GBP -0.25%). The most obvious catalyst for movement was in the UK, where GDP growth for Q4 was revised lower to 0.4% and Business Investment in January was actually flat rather than growing the expected 0.5%. Interestingly, Governor Carney was on the tape explaining that the BOE is increasingly concerned over inflation and despite lackluster growth seems more likely to increase rates. In fact, after his comments, the market bid up the probability of a BOE move in May to 85%. And yet the pound could find no solace. As to the yen’s strength, this seems more of a chicken and egg question, given the 1% decline seen in the Nikkei overnight. So did stocks drive the yen or the other way round? Perhaps we saw a bit of a safe haven bid after equity market weakness, but that is not a widespread situation.

However, looking at the dollar over the past week, it has exhibited a solid performance, gaining 1.5% against a broad index and looks like it may have bottomed for now. While the overwhelming majority of pundits continue to look for the dollar to resume its decline, it appears to me as though they are relying on the idea that the market will respond to tighter ECB policy or BOJ policy, but ignore tighter FOMC policy. And of course, that is entirely possible. However, I find it unlikely to be the case, and rather continue to see the dollar as an undervalued asset here. Consider this, with 10-year Treasury yields at 2.95%, which is 2.9% higher than JGB’s and 2.25% higher than Bunds, it is not hard to see the attraction of owning a higher yielding asset in a currency whose central bank is continuing to provide support.

On the data front today we see Initial Claims (exp 230K) and Leading Indicators (0.6%), neither of which is likely to have an impact. We also hear from NY Fed Prez Dudley this morning and Dallas’ Kaplan this afternoon. To me, those will be far more critical to see if there are any clues to how the Fed’s thinking is evolving. Hawkishness has to be creeping into their minds given the recent data releases. Next week’s PCE data will be quite interesting, and after the Powell testimony is likely to be the most important thing we see. But for today, I have a feeling that the dollar will continue to edge higher and both equities and Treasuries will remain under pressure.

Good luck
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