More Doubt He Is Sowing

In Beijing, the Chinese yuan
Fell sharply as it’s now been drawn
Into the trade fight
Much to the delight
Of bears, who had shorts layered on

For President Xi, though, the risk
Is money there exits the fisc
With growth there still slowing
More doubt he is sowing
So capital flight could be brisk

Things changed overnight as the PBOC fixed the renminbi below 6.90, much weaker than expected and then the currency fell sharply in subsequent trading in both the on-shore and offshore markets. As you will have no doubt seen, USDCNY is trading somewhere in the vicinity of 7.08 this morning, although the price has been quite volatile. While that represents a decline of more than 1.5% compared to Friday’s closing levels, the more important questions revolve around the PBOC’s new strategy going forward.

Recall, one of the reasons that there was a strong market belief in the sanctity of the 7.00 level was that four years ago, when the PBOC surprised markets with a mini-devaluation, locals took their cash and ran for the hills. Capital outflows were so great, in excess of $1 trillion, that the PBOC needed to institute strict new rules preventing further flight. That was a distinct loss of face for an institution that was trying to modernize and prove that it could manage things like G10 countries where capital flows more freely. Ever since, the assumption was that the Chinese population would get nervous if the renminbi weakened beyond that level and correspondingly, the PBOC would not allow that outcome to occur.

But that was then, in the days when trade was simply a talking point rather than the focus of policy. As the trade war intensifies, the Chinese have fewer tools with which to fight given the massive imbalance that exists. The result of this is that increases in US tariffs cannot be matched and so other weapons must be used, with changes in the exchange rate the most obvious. While the PBOC claims they can continue to manage the currency and maintain its stability, the one thing I have learned throughout my career is that markets have a way of abusing claims of that nature, at least for a while. Back in January I forecast USDCNY to reach 7.40 by the end of this year and, as of this morning, that seems quite realistic.

But the impact on markets is far greater than simply the USDCNY exchange rate. This has been the catalyst for a significant amount of risk-off behavior with equity markets throughout Asia (Nikkei -1.75%, Shanghai -1.6%, Hang Seng -2.85%) and Europe (DAX -1.85%, CAC -2.25%, FTSE -2.25%) sharply lower; Treasury (1.76%) and Bund (-0.51%) yields sharply lower, the Japanese yen (+0.6%) and Swiss franc (+0.75%) both sharply higher and most emerging market currencies (e.g. MXN -1.5%, INR -1.4%, ZAR -1.2%, KRW -0.9%) falling alongside the renminbi. It should be no surprise that gold is higher by 1.0%, to a 6-year high, as well this morning and oil prices (-1.1%) are falling amid concerns of waning demand from the slowing global growth story.

So, what’s a hedger to do? The first thing to consider is whether these moves are temporary fluctuations that will quickly be reversed, or the start of longer-term trends. Given the imbalances that have been building within markets for the past decade and given that central banks have a greatly reduced set of monetary tools with which to manage things, despite their comments otherwise, this could well be the tipping point where markets start to unwind significant positions. After all, the one thing that truly underpinned gains in both equity and bond markets, especially corporate and high-yield bond markets, was confidence that regardless of fiscal policy failures, the central banks would be able to maintain a level of stability.

However, this morning that belief seems a little less secure. It will not take much for investors to decide that, ‘it’s been a good run and now might be a good time to take some money off the table’, at least figuratively. Last week saw equity markets suffer their worst week of the year and this week is not starting any better. Yes, the Fed has room to cut rates further, but will 200bps be enough to stop a global recession? Arguably, that’s the question that needs to be answered. From where I sit, that answer is no, but then I am a cynic. Of course, that cynicism is born of a long career in financial markets.

Thus, my take is that there is further to run in most of these currencies, and that assuming a quick reversion would be a mistake. While option prices are clearly higher this morning than last week, they remain low by historic standards and should be considered for their value in uncertain times. Just sayin’.

What else does this week have to offer? Well, the US data set is not that substantial, but we do hear from a number of Fed speakers, which given last week’s confusion will be extremely important and closely watched. There are also a number of foreign central bank meetings that will be interesting regarding their rate maneuvers.

Today ISM Non-Manufacturing 55.5
Tuesday JOLT’s Job Openings 7.317M
Wednesday RBNZ Rate Decision 1.25% (25bp cut)
  RBI Rate Decision 5.50% (25bpcut)
  Consumer Credit $16.0B
Thursday Philippine Rate Decision 4.25% (25bp cut)
  Initial Claims 215K
Friday PPI 0.2% (1.7% Y/Y)
  -ex food & energy 0.2% (2.4% Y/Y)

We also hear from three dovish Fed speakers; Brainerd, Bullard and Evans, who are likely to give more reasons for further rate cuts, especially if markets continue to fall. As to the three central banks with decisions to make, they find themselves in a difficult place. All three are extremely concerned about their currencies’ value and don’t want to exert further downward pressure on them, yet all three are facing slowing economies and need to do something to boost demand. In fact, this is going to be the central bank conundrum for some time to come across both developing and G10 countries as they try to continually manage the impossible trilateral of exchange rates, interest rates and growth.

All of this adds up to yet more reasons for higher volatility across all asset classes in the near future. It appears that these are the first cracks in the old economic order, and there is no way to know how everything will play out going forward. As long as risk is being jettisoned though, Treasuries, the yen, the Swiss franc and the dollar will see demand. Keep that in mind as you manage your risks.

Good luck
Adf

Shocked and Surprised

Delivering just twenty-five
Did not satisfy Donald’s drive
To boost US growth
So he made an oath
That tariffs he’d quickly revive

Investors were shocked and surprised
As trade talks had seemed civilized
Thus stocks quickly fell
And yields did as well
Seems risk assets are now despised

Just when you thought it was safe to go back in the water…

Obviously, the big news yesterday was President Trump’s decision to impose a 10% tariff on the remaining $300 billion of Chinese imports starting September 1st. Arguably, this was driven by two things; first was the fact that he has been increasingly frustrated with the Chinese slow-walking the trade discussions and wants to push that along faster. Second is he realizes that if he escalates the trade threats, the Fed may be forced to cut rates further and more quickly. After all, one of their stated reasons for cutting rates Wednesday was the uncertainty over global growth and trade. That situation just got more uncertain. So in President Trump’s calculation, he addresses two key issues with one action.

Not surprisingly, given the shocking nature of the move, something that not a single analyst had been forecasting, there was a significant market reaction. Risk was quickly jettisoned as US equity markets turned around and fell 1% on the day after having been higher by a similar amount in the morning. Asian equity markets saw falls of between 1.5% and 2.0% and Europe is being hit even harder, with a number of markets (DAX, CAC) down more than 2.5%. But even more impressive was the decline in Treasury yields, which saw a 12bp fall in the 10-year and a 14bp fall in the 2-year. Those are the largest single day declines since May 2018, and the 10-year is now at its lowest level since October 2016. Of course, it wasn’t just Treasuries that rallied. Bund yields fell to a new record low of -0.498%, and we have seen similar declines throughout the developed markets. For example, Swiss 10-year yields are now -0.90%, having fallen 9bps and are the lowest in the world by far! In fact, the entire Swiss government yield curve is negative!

And in the FX market, haven number one, JPY rallied sharply. After weakening early in the session, it rebounded 1.7% yesterday and is stronger by a further 0.5% this morning. This has taken the yen back to its strongest level since April last year. Not surprisingly the Swiss franc saw similar price action and is now more than 1.0% stronger than yesterday. However, those are not the only currencies that saw movement, not by a long shot. For example, CNY has fallen 0.9% since the announcement and is now within spitting distance of the key 7.00 level. Significant concern remains in the market about that level as the last time the renminbi was that weak, it led to significant capital outflows and forced the PBOC to adjust policy and impose restrictions. However, there are many analysts who believe it is seen as less of a concern right now, and of course, a weaker renminbi will help offset the impact of US tariffs.

Commodity prices were also jolted, with oil tumbling 7% and oil related currencies feeling the brunt of that move. For example, RUB is lower by 1.2% this morning after a 0.5% fall yesterday. MXN is lower by a further 0.3% this morning after a 0.6% decline yesterday and even NOK, despite its G10 status, is lower by 1.0% since the tariff story hit the tape. In fact, looking at the broad dollar, it is actually little changed as there has been significant movement in both directions as traders and investors adjust their risk profiles.

With that as a prelude, we get one more key piece of data this morning, the payroll report. Current expectations are as follows:

Nonfarm Payrolls 164K
Private Payrolls 160K
Manufacturing Payrolls 5K
Unemployment Rate 3.6%
Average Hourly Earnings 0.2% (3.1% Y/Y)
Average Weekly Hours 34.4
Trade Balance -$54.6B
Michigan Sentiment 90.3

You can see the bind in which the Fed finds itself. The employment situation remains quite robust, with the Unemployment Rate expected to tick back to 50-year lows and steady growth in employment. This is hardly a classic set of statistics to drive a rate cut. But with the escalation of the trade situation, something they specifically highlighted on Wednesday, they are going to need to address that or lose even more credibility (although it’s not clear how much they have left to lose!) In a funny way, I would wager that Chairman Powell is secretly rooting for a weak number this morning which would allow further justification for rate cuts and correspondingly allow him to save some face.

In the end, the key to remember is that markets are beholden to many different forces with the data merely one of those, and increasingly a less and less important one. While historically, the US has generally allowed most market activity without interference, there has clearly been a change of heart since President Trump’s election. His increased focus on both the stock market and the dollar are something new, and we still don’t know the extent of the impact this will have over time. While volatility overall has been relatively low, it appears that is set to change with this increased focus. Hedgers keep that in mind as programs are implemented. All of this untested monetary policy is almost certainly building up problems for the future, and those problems will not be easily addressed by the central banks. So, my sense is that we could see a lot more volatility ahead.

In the meantime, today has the sense of a ‘bad news is good’ for stocks and vice versa as equity investors will be looking for confirmation that more rate cuts are on the way. As to the dollar, bad news will be bad!

Good luck and good weekend
Adf

Weakness Worldwide

The Fed followed through on their pledge
To cut rates, as they try to hedge
‘Gainst weakness worldwide
But Jay clarified
It’s not a trend as some allege

The market response was quite swift
With equities given short shrift
Commodities fell
While bonds did excel
In FX, the buck got a lift

Something has really begun to bother me lately, and that is the remarkable inconsistency over the benefits/detriments of a currency’s value. For example, the dollar has been relatively strong lately, and as you are all aware, I believe will continue on that path overall. The key rationales for the dollar’s strength lie in two factors; first, despite yesterday’s cut, US interest rates remain much higher than every other G10 country, in most cases by more than 100bps, and so the relative benefit of holding dollars vs. other currencies continues. The second reason is that the US economy is the strongest, by far, of the G10, as recent GDP data demonstrated, and while there are certain sectors of weakness, notably housing and autos, things look reasonably good. This compares quite favorably to Europe, Japan and Oceania, where growth is slowing to the point that recession is a likely outcome. The thing is, article after article by varying analysts points to the dollar’s strength as a major problem. While President Trump rightly points out that a strong dollar can hinder US exports, and as a secondary effect corporate earnings, remember that trade represents a small portion of the US economy, just 12% as of the latest data.

Contrast this widespread and significant concern over a strong currency with the angst over the British pound’s recent performance as it continues to decline. Sterling is falling not only because the dollar is strong, but also because the market is repricing its estimates of the likelihood of a no-deal Brexit. Ever since the Brexit vote the pound has been under pressure. Remember that the evening of the vote, when the first returns pointed to a Remain win, the pound touched 1.50. However, once the final results were in, the pound sold off sharply, losing as much as 20% of its value within four months of the vote. However, since then, during the negotiation phase, the pound actually rallied back as high as 1.4340 when it looked like a deal would get done and agreed. Alas, that never occurred and now that no-deal is not only back on the table, but growing as a probability, the pound is back near its lows. And this is decried as a terrible outcome! So, can someone please explain why a strong currency is bad but a weak currency is also bad? You can’t have it both ways. Arguably, every complaint over the pound’s weakness is a political statement clothed in an economic argument. And the same is true as to the dollar’s strength, with the difference there being that the President makes no bones about the politics.

In the end, the beauty of a floating currency regime is that the market adjusts based on actual and expected flows, not on political whims. If there is concern over a currency’s value, that implies that broader policy adjustments need to be considered. In fact, one of the most frightening things we have heard of late is the idea that the US may intervene directly to weaken the dollar. Intervention has a long and troubled history of failure, especially when undertaken solo rather than as part of a globally integrated plan a la the Plaza Accord in the 1980’s. An unsolicited piece of advice to the President would be as follows: if you want the strongest economy in the world, be prepared for a strong currency to accompany that situation. It is only natural.

With that out of the way, there is no real point in rehashing the FOMC yesterday as there are myriad stories already available. In brief, they cut 25bps, but explained it as an insurance cut because of global uncertainties. Weak sauce if you ask me. The telling thing is that during the press conference, when Powell explained that this was not the beginning of a new cycle and the stock market sold off sharply, he quickly backtracked and said more cuts could come as soon as he heard about the selloff. It gets harder and harder to believe that the Fed sees their mandate as anything other than boosting the stock market.

This morning brings the final central bank meeting of the week with the BOE on the docket at 7:00am. At this point, with rates still near historic lows and Brexit on the horizon, the BOE is firmly in the wait and see camp. Concerns have to be building as more economic indicators point to a slump, with today’s PMI data (48.0) posting its third consecutive month below the 50.0 level. I think it is clear that a hard Brexit will have a short-term negative impact on the UK economy, likely making things worse before they get better, but I also believe that the market has already priced in a great deal of that weakness. And in the end, I continue to believe that the EU will blink as they cannot afford to drive Europe into a recession just to spite the UK. So there will be no policy change here.

One interesting outcome since the Fed action yesterday was how many other central banks quickly cut interest rates as well. Brazil cut the Selic rate by 50bps, to a record low 6.00% as they had room from the Fed move and then highlighted the fact that a key pension reform bill seemed to have overwhelming support and was due to become law. This would greatly alleviate government spending pressures and allow for even more policy ease. As well, the Middle East saw rate cuts by Saudi Arabia, the UAE, Qatar and Bahrain all cut rates by 25bps as well. In fact, the only bank that does not seem likely to respond is the PBOC, where they have been trying to use other tools, rather than interest rate policy, to help bolster the economy there.

This morning sees the dollar broadly higher with both the euro and pound down by ~0.40%, and similar weakness in a number of EMG currencies like MXN and INR. Even the yen has weakened this morning by 0.2%, implying this is not so much a risk-off event as a dollar strength event. Data today brings Initial Claims (exp 212K) and ISM Manufacturing (52.0). Regarding the ISM data, yesterday saw an extremely weak Chicago PMI print of just 44.4, its lowest since December 2015. Given how poor the European and Chinese PMI data were overnight and this morning, I wouldn’t be surprised to see a weak outcome there. However, I don’t think that will be enough to weaken the dollar much as the Fed just gave the market its marching orders. We will need to see a very weak payroll report tomorrow to change any opinions, but for today, the dollar remains in the ascendancy.

Good luck
Adf

 

A Rate Cut’s Assumed

In Washington DC today
We’ll get to hear from Chairman Jay
A rate cut’s assumed
So, equities boomed
While dollar strength seems here to stay

Markets are on tenterhooks as the release of the FOMC statement approaches. That actually may be overstating the case. The market is highly confident that the Fed is going to cut the funds rate by 25 bps this afternoon as there has not been nearly enough change in the trajectory of the economic data over the past ten days to change any views. During this ‘quiet period’ we have seen solid, if unspectacular economic indicators. Certainly nothing indicating a severe slowdown, but also nothing indicating that the economy is overheating. As well, we have heard from several other central banks, notably the ECB and BOJ, that further policy ease is on the way and they are ready to move imminently. Finally, the whipped cream on this particular decision was released yesterday morning when core PCE data printed at 1.6%, a lower than expected outcome, and sufficient proof that inflation remains too quiescent for the Fed’s liking. At this point, it all seems anticlimactic.

Perhaps of more interest will be the press conference to be held at 2:30, when Chairman Powell will be able to explain more fully the rationale behind cutting rates with an economy running at potential, historically low unemployment and the easiest financial conditions seen in a decade. But hey, inflation is a few ticks low, so that is clearly justification. (As an aside, I find it remarkable that any central bank is so wedded, with precision, to a specific target inflation rate, and that not achieving that target is grounds for policy change. Let’s face it, monetary policy tools are blunt instruments and work with a significant lag. In fact, when a target is achieved, that seems to be more luck than skill. There are a number of central banks that aim for inflation to be within a range, and that seems to make far more sense than setting a 2.0% target and complaining when the rate is at 1.6%.)

In the meantime, there are still a few other things that are impacting markets today, notably the US-China trade talks and the ongoing Brexit story. Regarding the trade talks, the delegations met for two days in Shanghai and made approximately zero headway. The word is they are further apart now than when talks broke down three months ago. Suddenly it is dawning on a lot of people that these trade talks may not be concluded on a politically convenient schedule (meaning in time for the US election). The market impact was a decline in Asian equity indices with the Nikkei falling 0.9%, both Shanghai and Korea falling 0.7%, and the Hang Seng in Hong Kong down 1.3%. However, European indices have barely moved on the day and US futures are pointing higher after Apple beat earnings estimates following the close yesterday. The implication here is that US markets have moved on from the trade story while Asian ones are still beholden to every word. Quite frankly, that seems to be a realistic outcome given the fact that trade represents such a small part of the US economy as opposed to every Asian nation, where it is a major driver of economic activity.

Turning to the Brexit story, the pound plumbed new depths yesterday, trading close to 1.21 before a modest bounce this morning (+0.15%) as Boris continues to hold a hard line on talks. He is pushing very hard for the EU to reopen the existing, unratified deal and will not meet face-to-face with any EU counterparts until they do so. Thus far, the EU has been adamant that the deal is done, and they refuse to change it.

But here’s the first clue that things are going to change; the Bank of Ireland said that a hard Brexit will reduce GDP growth in 2020 to 0.7% from the currently expected 4.1% growth. As I mentioned before, Ireland is on the front lines and will feel the brunt of the early impacts. At some point, probably pretty soon, Taoiseach Leo Varadkar is going to prevail on the rest of the EU to reopen talks before Ireland is crushed. And remember, too, that a no-deal Brexit leaves the EU with a £39 billion hole in their budget as that was to be the UK’s parting alimony payment.

While the EU tries to convince one and all that they hold the upper hand, it is not clear to me that is the case. Working in Boris’s favor was today’s Q2 GDP data from the Eurozone showing growth falling to 0.2% in the quarter with Italy at 0.0%, Spain dipping to 0.5% and France having reported 0.2% yesterday. Germany doesn’t actually report until next month, but indications are 0.0% is the best they can expect. The euro remains under pressure, trading at the bottom of its recent 1.11-1.14 trading range and shows no signs of rebounding. And of course, the fact that the ECB is getting set to ease policy further is not helping the single currency at all. I maintain that despite the Fed’s actions today, unless Powell promises three more cuts soon, the dollar will remain bid.

And those are really today’s stories. Overall, the FX market is pretty benign today, with the largest mover being TRY, which rallied 0.45% as optimism is growing that the economy is stabilizing which means that the current high rates are quite attractive to investors. But away from that, movement has been on the order of 0.10%-0.20% in either direction. In other words, nothing is happening.

On the data front, remember this is payroll week as well, and today we see ADP Employment (exp 150K) and then Chicago PMI (50.6) before the FOMC this afternoon. As earnings season is still underway, I expect equities to respond to that data, but the dollar will likely bide its time until the Fed. After that, nothing has changed my broadly bullish view, although an uber-dovish Powell could clearly do so.

Good luck
Adf

Boris is Fumbling

The British pound Sterling is tumbling
As traders think Boris is fumbling
His chance to succeed
By forcing, at speed
Hard Brexit with some Tories grumbling

It’s official, the only story of note in the FX markets today is Brexit. Despite central bank meetings and key data, the number one discussion is about how far the pound will fall in the event of a hard Brexit and how high the likelihood of a hard Brexit has become. Since Friday morning, the pound is down by 2.5% and there doesn’t appear to be a floor in the near term. It seems that traders have finally decided that BoJo was being serious when he said the UK would leave the EU with or without a deal come October 31. As such, today’s favorite analyst pastime is to guess how low the pound can fall with a hard Brexit. So far, there has been one estimate of parity with the dollar, although most estimates talk about 1.10 or so. The thing is, while Brexit will clearly be economically disruptive, it seems to me that the warnings of economic activity halting are vastly overstated for political reasons. After all, if you voted Remain, and you are in the media (which was largely the case) then painting as ugly a picture as possible suits your cause, whether or not it is based on factual analysis or fantasy.

But let’s discuss something else regarding the potential effects of a hard Brexit; the fears of a weaker currency and higher inflation. Are these really problems? Is not every developed country (and plenty of emerging ones) in the world seeking to weaken their currency through easier monetary policy in order to gain a competitive advantage in trade? Is not every developed country in the world complaining that inflation is too low and that lowered inflation expectations will hinder central bank capabilities? Obviously, the answer to both these questions is a resounding ‘YES’. And yet, the prospects of a weaker pound and higher inflation are seen as devastatingly bad for the UK.

Is that just jealousy? Or is that a demonstration of central bank concern when things happen beyond their control. After all, for the past decade, central banks have basically controlled the global economy. Methinks they have gotten a bit too comfortable with all that power. At any rate, apocalyptic scenarios rarely come to pass, and in fact, my sense is that while the pound can certainly fall further in the short run, we are far more likely to see the EU figure out that they don’t want a hard Brexit after all, and come back to the table. While a final agreement will never be finished in time, there will be real movement and Brexit in name only as the final details are hashed out over the ensuing months. And the pound will rebound sharply. But that move is still a few months away.

Away from Brexit, there has been other news. For example, the BOJ met last night and left policy rates on hold, as universally expected, but lowered their inflation forecast for 2019 to 1.0%, which is a stretch given it’s currently running at 0.5%. And their 2.0% target is increasingly distant as even through 2022 they see inflation only at 1.6%. At the same time, they indicated they will move quickly to ease further if necessary. The problem is they really don’t have much left to do. After all, they already own half the JGB market, and have bought both corporate bonds and equities. Certainly, they could cut rates further, but as we have learned over the past ten years, ZIRP and NIRP have not been all that effective. With all that said, the yen’s response was to rise modestly, 0.15%, but basically, the yen has traded between 107-109 for the past two months and shows no signs of breaking out.

We also saw some Eurozone data with French GDP disappointing in Q2, down to 0.2% vs. 0.3% expected, and Eurozone Confidence indicators were all weaker than expected, noticeably Business Confidence which fell to -0.12 from last month’s +0.17 and well below the +0.08 expected. This was the weakest reading in six years and simply highlights the spreading weakness on the continent. Once again I ask, do you really think the EU is willing to accept a hard Brexit with all the disruption that will entail? As to the euro, it is essentially unchanged on the day. Longer term, however, the euro remains in a very clear downtrend and I see nothing that will stop that in the near term. If anything, if Draghi and friends manage to be uber-uber dovish in September, it could accelerate the weakness.

Away from the big three, we are seeing weakness in the Scandies, down about 0.5%, as well as Aussie and Kiwi, both lower by about 0.25%. Interestingly, the EMG bloc has been much less active with almost no significant movement anywhere. It appears that traders are unwilling to do anything ahead of tomorrow’s FOMC statement and Powell’s press conference.

On the data front this morning we see Personal Income (exp 0.4%), Personal Spending (0.3%), Core PCE (0.2%, 1.7% Y/Y), Case-Shiller Home Prices (2.4%) and Consumer Confidence (125.0). Arguably, the PCE data is most important as that is what the Fed watches. Also, given that recent CPI data came in a tick higher than expected, if the same thing happens here, what will that do to the insurance cut narrative? The point is that the data of late has not warranted talk of a rate cut, at least not the US data. But will that stop Powell and company? The controlling narrative has become the Fed must cut to help the rest of the world. But that narrative will not depreciate the dollar very much. As such, I remain generally bullish the dollar for the foreseeable future.

Good luck
Adf

 

More Clear

The contrast could not be more clear
Twixt growth over there and right here
While Europe is slowing
The US is growing
So how come a rate cut is near?

It seems likely that by the time markets close Friday afternoon, investors and traders will have changed some of their opinions on the future given the extraordinary amount of data and the number of policy statements that will be released this week. Three major central banks meet, starting with the BOJ tonight, the Fed tomorrow and Wednesday and then the BOE on Thursday. And then there’s the data download, which includes Eurozone growth and inflation, Chinese PMI and concludes with US payrolls on Friday morning. And those are just the highlights. The point is that this week offers the opportunity for some significant changes of view if things don’t happen as currently forecast.

But before we talk about what is upcoming, perhaps the question at hand is what is driving the Fed to cut rates Wednesday despite a run of better than expected US economic data? The last that we heard from Fed members was a combination of slowing global growth and business uncertainty due to trade friction has been seen as a negative for future US activity. Granted, US GDP grew more slowly in Q2 at 2.1%, than Q1’s 3.1%, but Friday’s data was still better than expected. The reduction was caused by a combination of inventory reduction and a widening trade gap, with consumption maintaining its Q1 pace and even speeding up a bit. The point is that things in the US are hardly collapsing. But there is no doubt that growth elsewhere in the world is slowing down and that prospects for a quick rebound seem limited. And apparently, that is now the driving force. The Fed, which had been described as the world’s central bank in the past, seems to have officially taken on that mantle now.

One fear of this action is that it will essentially synchronize all major economies’ growth cycles, which means that the amplitude of those cycles will increase. In other words, look for higher highs and lower lows over time. Alas, it appears that the first step of that cycle is lower which means that the depths of the next recession will be wider and worse than currently expected. (And likely worse than the last one, which as we all remember was pretty bad.) And it is this prognosis that is driving global rates to zero and below. Phenomenally, more than 25% of all developed market government bonds outstanding now have negative yields, something over $13.4 Trillion worth. And that number is going to continue to grow, especially given the fact that we are about to enter an entirely new rate cutting cycle despite not having finished the last one! It is a strange world indeed!

Looking at markets this morning, ahead of the data onslaught, shows that the dollar continues its winning ways, with the pound the worst performer as more and more traders and investors begin bracing for a no-deal Brexit. As I type, Sterling is lower by 0.55%, taking it near 1.23 and its lowest point since January 2017. As long as PM BoJo continues to approach the EU with a hard-line stance, I expect the pound to remain under pressure. However, I think that at some point the Irish are going to start to scream much louder about just how negative things will be in Ireland if there is no deal, and the EU will buckle. At that point, look for the pound to turn around, but until then, it feels like it can easily breech the 1.20 level before summer’s out.

But the dollar is generally performing well everywhere, albeit not quite to the same extent. Rather we are seeing continued modest strength, on the order of 0.1%-0.2% against most other currencies. This has been the pattern for the past several weeks and it is starting to add up to real movement overall. It is no wonder that the White House has been complaining about currency manipulation elsewhere, but I have to say that doesn’t appear to be the case. Rather, I think despite the international community’s general dislike of President Trump, at least according to the press, investors continue to see the US as the destination with the most profit opportunity and best prospects overall. And that will continue to drive dollar based investment and strengthen the buck.

Away from the FX markets, we have seen pretty inconsequential movement in most equity markets with two exceptions (FTSE +1.50% on the weak pound and KOSPI -1.8% on increasing trade issues and correspondingly weaker growth in South Korea). As to US futures markets, they are pointing to essentially flat openings here this morning, although the earnings data will continue to drive things. And bond markets have seen similarly modest movement with most yields within a basis point or two of Friday’s levels. Consider two bonds in Europe in particular; Italian 10-year BTP’s yield 1.54%, more than 50bps less than Treasuries, and this despite the fact that the government coalition is on the rocks and the country’s fiscal situation continues to deteriorate amid a recession with no ability to cut rates directly; and Greek 10-year yields are 2.05% vs. 2.08% for US Treasuries! Yes, Greek yields are lower than those in the US, despite having defaulted on their debt just 7 years ago! It is a strange world indeed.

A look at the data this week shows a huge amount of information is coming our way as follows:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.3%
  Core PCE 1.7%
  Case-Shiller Home Prices 2.4%
  Consumer Confidence 125.0
Wednesday ADP Employment 150K
  Chicago PMI 50.5
  FOMC Rate Decision 2.25% (-25bps)
Thursday BOE Rate Decision 0.75% (unchanged)
  Initial Claims 214K
  ISM Manufacturing 52.0
  ISM Prices Paid 49.6
  Construction Spending 0.3%
Friday Trade Balance -$54.6B
  Nonfarm Payrolls 165K
  Private Payrolls 160K
  Manufacturing Payrolls 5K
  Unemployment Rate 3.6%
  Average Hourly Earnings 0.2% (3.2% Y/Y)
  Average Weekly Hours 34.4
  Factory Orders 0.8%
  Michigan Sentiment 98.5

And on top of that we see Chinese PMI data Tuesday night, Eurozone GDP and Inflation on Wednesday and a host of other Eurozone and Asian data releases. The point is it is quite possible that the current view of the world changes if the data shows a trend, especially if that trend is faster growth. Right now, the default view is global growth is slowing with the question just how quickly. However, a series of strong prints could well stop that narrative in its tracks. And ironically, that is likely the best opportunity for the dollar to stop what has been an inexorable, if slow, climb higher. However, the prospects of weak data elsewhere are likely to see an acceleration of central bank easing around the world with the dollar benefitting accordingly.

In sum, there is an awful lot happening this week, so be prepared for potentially sharp moves on missed expectations. But unless the data all points to faster growth away from the US while the US is slowing, the dollar’s path of least resistance remains higher.

Good luck
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Rates Will Be Hewn

Inflation remains far too low
In Europe, and so Mario
Has promised that soon
Their rates will be hewn
And, too, will their balance sheet grow

The ECB did not act yesterday, leaving all policy unchanged, but Signor Draghi was quite clear that a rate cut, at the very least, would be coming in September. He hinted at a restart of QE, although he indicated that not everyone was on board with that idea. And he pleaded with Eurozone governments to implement more fiscal stimulus.

That plea, however, is a perfect example of why the Eurozone is dysfunctional. While the ECB, one of the key Eurozone institutions, is virtually begging governments to spend more money, another one of those institutions, the European Commission, is prepared to sanction, and even fine, Italy because they want to spend more money! You can’t make this stuff up. As another example, consider that Germany is running a 1.7% fiscal surplus this year, yet claims it cannot afford to increase its defense spending.

It is this type of contradiction that exemplifies the problem with the Eurozone, and more specifically with the euro. Every nation is keen to accept the benefits of being a member, but none want to assume the responsibilities that come along with those benefits. In other words, they all want the free option. The euro is a political construct and always has been. Initially, countries were willing to cede their monetary sovereignty in order to receive the benefits of a more stable currency. But twenty years later, it is becoming clear that the requirements for stability are greater than initially expected. In a way, the ECB’s policy response of even more NIRP and QE, which should further serve to undermine the value of the single currency, is the only possible outcome. If you were looking for a reason to be long term bearish on the euro, this is the most powerful argument.

Speaking of the euro’s value, in the wake of the ECB statement yesterday morning, it fell 0.3% to 1.1100, its lowest level since mid-May 2017, however, Draghi’s unwillingness to commit to even more QE at the press conference disappointed traders and the euro recouped those early losses. This morning, it is basically right at the same level as before the statement, with traders now turning their focus to Wednesday’s FOMC meeting.

So, let’s consider that story. At this point it seems pretty clear that the Fed is going to cut rates by 25bps. Talk of 50bps has faded as the last several data points have proven much stronger than expected. Yesterday saw a blowout Durable Goods number (+2.0%, +1.2% ex transport) with both being well above expectations. This follows stronger than expected Retail Sales, CPI and payroll data this month, and even a rebound in some of the manufacturing surveys like Philly and Empire State. While the Housing Market remains on its heels, that doesn’t appear to be enough to entice a 50 bp move. In addition, we get our first look at Q2 GDP this morning (exp 1.8%) and the Fed’s favorite inflation data of PCE next week before the FOMC meeting concludes. Strength in any of this will simply cement that any cut will be limited to 25bps. Of course, there are several voting members, George and Rosengren top the list, who may well dissent on cutting rates, at least based on their last comments before the quiet period. Regardless, it seems a tall order for Chairman Powell to come across as excessively dovish given the data, and I would contend that the euro has further to fall as a result. In fact, I expect the dollar has further to climb across the board.

The other big story, of course, is the leadership change in the UK, where PM Boris had his first discussion with EU leaders regarding Brexit. Ostensibly, Boris demanded to discard the Irish backstop and the EU said absolutely not. At this point the EU is counting on a sufficient majority in the UK Parliament to prevent a no-deal Brexit, but there are still three months to go. This game is going to continue for a while yet, but at some point, it is going to be a question of whether Ireland blinks as they have the most to lose. Their economy is the most closely tied to the UK, and given they are small in their own right, don’t have any real power outside the EU. My money is on the EU changing their stance come autumn. In the meantime, the pound is going to remain under pressure as the odds of a no-deal Brexit remain high. This morning it is lower by a further 0.2%, and I see no reason for this trend to end anytime soon.

In other news, Turkey slashed rates 425bps yesterday as the new central bank head, Murat Uysal, wasted no time in the chair responding to President Erdogan’s calls for lower rates. The market’s initial response was a 1.5% decline in the lira, but it was extremely short-lived. In fact, as I type, TRY is firmer by nearly 1.0% from its levels prior to the announcement. Despite the cut, interest rates there remain excessively high, and in a world desperately seeking yield, TRY assets are near the top of the list on both a nominal and real basis.

Beyond that, it is hard to get excited about too much heading into the weekend. While equity markets suffered yesterday after some weak earnings data, futures are pointing to a better opening this morning. Treasuries are virtually unchanged as are gold and oil. So all eyes will be on the GDP data, where strength should reflect in a stronger dollar, but probably weaker equities, as the chance for more than a 25bp cut dissipates.

Good luck
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