Where Riches Can Be Amassed

According to every newscast
The action in Syria’s past
So traders can focus
On finding the locus
Of where riches can be amassed

The limited military strike on Syrian chemical weapons facilities has quickly receded into the background from a markets perspective. The not surprising outcome has been a more than 1% decline in the price of oil, based on the idea that there will be no escalation of the fighting, and a decline in the Treasury market with yields rising about 4bps. If war is no longer imminent, safe havens are less necessary. In fact, the same is true with gold, which has edged slightly lower and the yen, which is little changed. The point is fear is not today’s market driver.

So what is driving markets? Well the equity space is going to be beholden to the Q1 earnings data that is starting to be released, and where expectations are very high based on the changes in the corporate tax rate. The FX market, however, seems to be looking more closely at the global growth theme. One of the points I have highlighted recently is that while the global economy is still growing, the data from Q1 has universally been softer than that of Q4 2017. The implication is that we may well have seen the peak in economic activity for this cycle and are starting to grow at a slower rate. After all, a quick look at leverage ratios shows that most of the world is already highly indebted and therefore the capacity to increase leverage, as well as its effectiveness at creating further growth, has been severely impinged. So the question becomes whether this situation will lead to a shift in the current narrative regarding central bank activities going forward. Because when push comes to shove, the FX market is still highly dependent on central bank policies for its direction.

One of the interesting features of the FOMC Minutes last week was the little watched description of deflationary concerns. For the first time since before the financial crisis, not a single Fed board member expressed any concern over the possibility of deflation in our future. Remember, this had been the driving force behind Ben Bernanke’s decision to embark on QE and has been part of the underlying mindset ever since. But with inflation clearly trending higher, and growth exceeding most estimates of its long-run potential in the US and Europe, it appears that the deflation boogey man is finally gone. And that implies that there will be much less concern that continuing on the current trajectory of Fed rate hikes will be a significant policy mistake. In other words, there is nothing on the horizon that is going to slow the Fed down, and if anything, I expect that they will tighten at a faster pace than currently forecast. This remains a key pillar underpinning my stronger dollar view.

What about the rest of the world? Well, ECB President Draghi continues to try to dispel the idea that the ECB is anxious to raise rates anytime soon. Measured inflation in the Eurozone continues to lag, and though there is a hawkish contingent in the ECB, led by the Germans and Dutch, they are by no means the majority at this stage. As such, I continue to think that the narrative is far too aggressive in its views of the timing of further ECB policy adjustments. We know that they will be buying €30 billion per month of assets through September but the question is what happens then. While there are some analysts who believe they will stop cold turkey, I disagree and look for them to reduce the purchase amount to either €10 billion or €15 billion per month for the rest of 2018, finally stopping at the end of the year. My confidence in this will increase if we continue to see the inflation data lag as it has been lately. In fact, last night’s German Wholesale Price release was a perfect example, printing at 0.0% rather than the 0.4% expected. There has been a consistency in the lack of measured inflation throughout the Eurozone, which, I believe, will continue to be cause for concern to the ECB.

In fact, the only nations that have actually embarked on tightening policy are Canada and the UK, both of which have raised rates far less than the US. While the market is pricing a 25bp hike by the UK next month, the Canadian story is less clear, especially as the NAFTA negotiations continue to hang over the country like a dark cloud. And, of course, the UK has its own dark cloud, the Brexit negotiations, where there remain several issues that seem intractable at this stage, notably the Irish border question. The point is there is still great uncertainty as to the UK economic situation going forward, and it seems to me that Governor Carney will not be able to become remotely aggressive unless we see inflation there suddenly jump significantly higher. Of course, while my medium term view remains the pound will fall, this morning it has been king of the G10 hill, rising 0.55%. As there has been no UK data released, my sense is that the release of a report by the Institute for Government, a UK think tank, that highlights all the things that the UK could do to moderate the impact of Brexit, including voting to rejoin the EU, may well be the driver.

In the end, the dollar is generally under pressure this morning, especially against its G10 counterparts, but we have also seen a sharp rebound in RUB after the Syrian situation failed to escalate. Of course, the sanctions story remains the key driver there, and I expect that the ruble will remain under pressure until something there changes. And lastly, HKD remains at the lower end of its band, with the HKMA selling another $1.3 billion in an effort to prevent it weakening further. It appears that capital flows out of Hong Kong are larger than initially anticipated. That said, there is no indication that the peg will be abandoned and the HKMA has significant firepower to prevent anything untoward from happening.

As to this week, we get a fair amount of data, led off with Retail Sales this morning.

Today Retail Sales 0.4%
  -ex autos 0.2%
  Empire Manufacturing 18.2
  Business Inventories 0.6%
Tuesday Housing Starts 1.264M
  Building Permits 1.315M
  IP 0.4%
  Capacity Utilization 78.0%
Wednesday Fed’s Beige Book  
Thursday Initial Claims 230K
  Philly Fed 20.1
  Leading Indicators 0.3%

Arguably the Retail Sales data is this week’s most important data point, as it may be seen as a key indicator of the pace of US growth.  At this point, the Fed still seems very committed to raising rates, so the data will have to really begin to pile up on the negative side for that attitude to change.  As it happens, we also hear from six Fed speakers, three of them, Dudley, Williams and Evans, twice.  At this stage, if any member of the FOMC is starting to see something that might give them pause, I expect we will begin to hear about it.  However, despite what is arguably a plateau in the data, there doesn’t appear to be a downturn in the near future, and so I see no reason to hear any dovish rhetoric, especially since none of the avowed doves are speaking.

In the background there are still a number of things that can have a large market impact, notably the trade situation and the politics in Washington, but on the surface, my take is the narrative is going to dominate this week, which means that today’s modest USD losses may extend a bit by Friday.  However, I do not foresee a breakout for any reason.


Good luck




The ECB Minutes explained
That policy must be maintained
Though IP is falling
The euro keeps crawling
Much higher, and must be constrained

While the trade story remains a key driver of market sentiment, and therefore markets, it appears that we are in the middle of a temporary lull in the story. Or at least, the rhetoric has been toned down somewhat. With that said, the two stories of note overnight were that President Trump is pushing for specificity on the mooted $100 billion in tariffs. While this may be merely a negotiating tactic, it also could lead to $100 billion in tariffs being implemented. The word from the White House is that the president strongly believes that playing hardball is working, and he is not about to back off. At the same time, in what could be seen as a distinct positive on the trade front, Mr Trump also indicated that the US might be interested in rejoining the Trans-Pacific Partnership (TPP), a trade pact of 11 nations with Pacific Ocean shorelines excluding China. The idea here is that by rejoining the TPP, the entire group will be able to put even more pressure on China’s trade policies. In the end, I think it is premature to consider that the trade issues have peaked. However, given the law of diminishing returns, I think that the ongoing story is likely to be less and less impactful on markets going forward. In an interesting twist, Chinese trade data last night showed that the nation ran a ~$5 billion trade deficit overall in March, well below expectations. However, that was their total global trade stance. The Chinese surplus with the US grew by 19.4% to $58.25 billion, something that will not serve to mollify the administration. In sum, expect more rhetoric but until there are actual tariffs imposed, this should fade into the background.

There is another sentiment driver in markets as well, and that is the potential for increased conflict in the Middle East on the back of a response to Syria’s alleged chemical weapons usage. The impact here has been on the oil markets, where prices continue to rise to levels not seen since 2014. Of course, there has also been the synchronized global growth story that supports further demand for the stuff. FWIW short of a region-wide conflict, I don’t see this story having the legs to impact global markets. However, if things do escalate, we could see oil shipments from the region fall driving prices higher and that would be a decided negative for the global economy and the equity markets. My gut tells me the dollar would probably edge higher on this outcome, but it would not run away.

Something with a more direct impact on the FX markets were the ECB Minutes released yesterday. If you recall, at the meeting three weeks ago, the ECB surprised many pundits by removing the sentence about increasing QE if necessary, which at the time was seen as hawkish. But despite that change, the Minutes read far more dovish than hawkish, with the council expressing concern on the impact that trade actions might have on the Eurozone economy and counseling “prudence, patience and persistence” in their removal of policy accommodation. The euro fell 0.4% on the release, and remains under modest pressure this morning. Adding to the pressure on the euro yesterday was the Eurozone IP decline of 0.9%, its third consecutive fall. As I have mentioned in the past it certainly seems like Eurozone growth peaked in Q4 of last year as not only are the surveys showing declines, but the hard data is also under pressure. Now this could be a seasonal European thing and the data will start to rebound going forward, but given that this phenomenon is occurring here at home as well as throughout most of the G10, it could also be that we have seen the peak in global growth. If that is the case, it will certainly complicate central bank desires to normalize monetary policy.

Overall, the dollar is under a bit of pressure this morning as the week comes to a close. The pound is actually one of the leaders this morning, rising 0.35%, as market participants continue to look for a 25bp rate hike at next month’s BOE meeting. This is interesting to me as the UK data has been generally disappointing alongside the rest of the G10, with IP falling and GDP estimates being revised lower. But there is increasing confidence that Governor Carney will pull the trigger and move. AUD is also firmer this morning, actually up 0.55%, after the release of the RBA’s Financial Stability Review, where they continue to tout strong global growth helping to underpin domestic economic strength. Interestingly there was no mention of trade tensions, which given that China is their largest export market, was a bit surprising. But in the end, an upbeat forecast about the Australian economy has been enough to underpin the currency.

Beyond those two currencies, and excluding the RUB (+0.4%), which is likely to see ongoing volatility given the sanctions situation, the rest of the market has done very little. The euro is a touch lower and the yen has weakened by 0.3%, but in general, all the currencies remain in their trading ranges with no indication they are about to break out. In fact, despite all the volatility that we have seen in both equity and bond markets of late, the story in FX is much less interesting. It appears we will need to see actual policy changes to get things moving again.

This morning brings two final pieces of data, Michigan Sentiment, which is expected to slip slightly to 101.0, and the JOLTS Jobs report, with the median expectation at 6.143M job openings, again a touch softer than last month’s reading. We also hear from three Fed speakers, Rosengren, Bullard and Kaplan. At this point in the cycle, it is possible there are nuanced differences between Chairman Powell and the other Fed members given that we have seen a bunch of data since the last meeting. However, there has been no indication that the Fed is concerned about any slowing of the growth trajectory in the US, and I expect that we will hear the consensus view of either two or three more rate hikes this year. In other words, there is nothing to indicate that the Fed is going to slow down, and not enough data yet to imply they should speed up. So I look for another lackluster trading day in FX, with movement more likely to unwind the overnight activity than to extend it.

Good luck and good weekend


Hawks’ Dreams

Apparently Powell and friends
Have confidence in recent trends
Four hikes, it now seems
Can fulfill hawks’ dreams
More turmoil this now portends

The other thing causing concern
Is not difficult to discern
The Middle East threat
Has markets upset
And could presage the next downturn

There is no shortage of new information to keep markets on their toes recently as yesterday clearly showed. The CPI data released showed that, as expected, the Y/Y data increased by 2.4% on the headline and 2.1% on a core basis. These in-line prints were seen as generally benign, or at least expected, and the initial market impact was limited. However, as my friend, Mike Ashton, (@inflation_guy on Twitter) has pointed out repeatedly, the inflation data going forward is going to climb based on the arithmetic of the calculation. Core CPI could well be 2.5% by June, and even though it is expected, and was mentioned in the FOMC Minutes, it is still going to be an optical problem for the Fed as it might appear that they are falling behind the curve.

Speaking of the FOMC Minutes, the spin was somewhat hawkish, as they expressed a growing confidence in the economy and the probability that inflation would reach their 2.0% target soon. (As an aside, there is an outside chance Core PCE could print 2.0% at the end of the month, which is even sooner than they expect. But almost certainly it will do so in May.) In fact, apparently there was a great deal of discussion as to whether they should let the economy run ‘hot’ and thus allow inflation to rise beyond their target without acting more aggressively. The idea is that this would draw even more people into the labor market from the sidelines.

However, I would remind you all that inflation is not something that they can steer like a car, rather it is something that responds uncertainly with a significant time lag to their actions. This could be a huge risk as, especially if the Middle East situation starts to get hotter, the potential for a price spike in oil grows commensurately. And while the Fed would likely look through the transitory nature of the initial spike, higher energy costs seep into basic operations and tend to remain there. As an example, my trash collection bill continues to show a fuel surcharge, which was first implemented in 2014 when oil prices were above $100/bbl. My experience is that once companies get to raise prices, they are loathe to reduce them again! The point is that given the inexact science of monetary policy, choosing to run hot could result in bigger problems and market impacts.

Which brings us to the third, and ongoing, market concern, the escalating war of words involving Syria’s alleged use of chemical weapons last week. The US has threatened to respond, being egged on by the Europeans and those in the Middle East who would like to see Syrian President Assad removed. However, Russia and Iran are clearly poised for further response. And this is where things get tricky as both of those nations are key oil producers. This is why oil prices are trading at their highest levels since late 2014, in the midst of the oil price collapse, and it is why equity markets have been having difficulty of late. The early stages of a war tend to be pretty bad for markets.

With all this noise, how should we interpret things for the FX markets? Well the first thing I would highlight is that the trade issue, which had been THE story for the past several weeks, is getting almost no press today. It just goes to show how fickle markets are. But do not forget the issue because I am convinced it will come back in play again soon. Interestingly, China suddenly opened their market for foreign companies to take part in payment processing, something which they alleged they would do more than a year ago, but this is only a small piece of the US’s demands regarding access to the Chinese market. And while this is a good sign, I don’t think it will satisfy the president. In the end, I look for more concessions from both sides, and no actual trade war, but there will be plenty of inflammatory rhetoric on the way, all of which can impact the dollar.

But FX has been the least interesting market around despite the news. Yes, the dollar has edged lower this week, but while technically correct, it seems a bit disingenuous to call a four-day move of about 1% a significant decline. As I have pointed out repeatedly, while the dollar did, in fact, fall about 9% last year, and another 2% in Q1, all that has done is take it back to the center of its long term trading range. The dollar is neither strong nor weak at this time, at least not on a broad basis.

However, there are some currencies that have seen real movement. The biggest mover of late has been RUB, which fell more than 8% at the beginning of the week on the back of the US sanctions against several large Russian companies. However, this morning it has stopped falling, actually rebounding 1% as oil prices continue to climb. The other key EMG story has been HKD, which last night traded to the weak edge of its trading band at 7.8500, for the first time since 2005. This is largely being driven by the fact that the HKMA has not kept local interest rates in line with rising US rates, and so HKD has become a favored funding vehicle. However, there is no indication that the HKMA will allow further weakness nor adjust the band, rather they will intervene as necessary to maintain its integrity. And they have plenty of firepower with which to do it, so while interesting, it is unlikely to have a big impact.

As to the G10, SEK is today’s biggest loser, falling more than 1.1% after Swedish CPI printed at a lower than expected 1.9% in March, forcing investors to reconsider the idea that the Riksbank would be raising rates any time soon. But while that is the largest move, the dollar is generally higher vs. the entire bloc; with the euro giving back 0.25% of its recent gains and the yen 0.3%. But in the end, the FX markets remain generally calm, with only a limited response to all the ongoing stories. I’m not sure what it will take to change this, but until we see the euro trading outside its recent 1.21-1.25 range, it will be tough to get excited.

Data this morning includes Initial Claims (exp 230K) and Import and Export Prices (exp 0.2% and 0.3% respectively). Considering the ongoing inflation theme, it is good to remember that the Y/Y numbers for this series are now 3.5% and 3.3% respectively, so the idea that the US is importing inflation has some validity. In the end, I would argue that inflation remains the key long-term story, one that has the Fed’s focus and one that is going to continue to drive the discussion. All the other stuff will come and go, and while it can have short-term impacts, is not part of the big picture. So higher inflation leading to higher US rates and the dollar’s rebound remain my baseline scenario.

Good luck


Steadfast Belief

The Austrian central bank chief
Said it was his steadfast belief
They ought let expire
Their work as a buyer
Of bonds, pushing rates up, in brief

Remember the trade war? That was so two-days ago! After Chinese President Xi’s conciliatory remarks at the Boao Forum Monday evening, President Trump tweeted a positive reply talking about cooperation and just like that, trade is no longer an issue! Certainly that is how the equity markets understood the discussion as they rallied sharply around the world. Of course, trade is not the only thing that drives markets, in fact generally it doesn’t have much of an impact at all. Arguably, the more important stories from yesterday were the fact that the 3-year Treasury auction was quite poorly received, Austrian Central Bank President, Ewald Nowotny, said it was time to end QE and raise rates, and that US inflation pressures continue to build.

In reverse order, while PPI remains a secondary statistic at best, yesterday’s print indicated that inflationary pressures are continuing to increase in the US. Certainly this morning’s CPI data is far more important to both markets and policymakers, but if you are a Fed member with your antennae tuned to the inflation story, yesterday’s results have to have them twitching in anticipation for this morning. Not only that, but there are some pretty strong relationships between different PPI subcategories and the PCE reading, notably in healthcare and consumer services. And as it happens, both of those are now pointing to increased upward pressure on PCE later this month. The point is that the inflation story is not going away, and that matters a lot for markets, especially if the Fed expresses greater concern as the data evolve.

In contrast, the divergence between US and other major economies on inflation continues apace. Last night we heard from China, which said CPI rose a much less than expected 2.1% Y/Y in March. Now it is possible that residual effects from the Chinese New Year caused this, but for now, what we see is the US clearly leading the way on the inflation front. Next week’s European data will be keenly watched as the inflation story remains topic number one right now.

The second noteworthy story yesterday was a speech by the Austrian central bank president, Nowotny, where he explicitly stated that it was time for the ECB to start normalizing its monetary policy by both ending QE and raising rates. It can be no surprise that the euro rallied on this news, rising 0.4% yesterday and a further 0.2% this morning. In fact, since Friday’s nadir, the single currency has risen 1.4%. But in the grand scheme of things, it remains well within its three-month trading range, and despite the recent fillip, could hardly be described as running away. As I wrote yesterday morning, I believe that the evolving inflation story will continue to favor the dollar in the sense that higher inflation in the US will auger higher rates here, while quiescent inflation in the Eurozone and elsewhere around the world will force the outlook for tighter policy to be delayed.

Finally, the Treasury auction was pretty bad yesterday despite the highest yields on the 3-year note since 2008, as indirect bidders, seen as a proxy for foreign demand, were just 47.6% of the $30 billion on offer, their lowest share since September. If this is indicative of the way financing the budget deficit is going to be in the future it bodes ill for many things in the US. Given the $21 trillion in government debt outstanding, if rates need to climb substantially in order to attract foreign capital, the budget situation will become even worse and will force some very difficult decisions onto Congress and the President, the types that neither party is likely to want to make. While I think there is very little chance that foreign investors aggressively sell Treasuries, it is entirely possible that they reduce their purchases, as evidenced by yesterday’s auction, and that could well spell trouble for the future. Added to the inflation story, this is just another reason to expect that US rates are going to continue to climb.

As to this morning, CPI is obviously the big release with expectations for the headline rate to rise to 2.4% and the core to 2.1%. I maintain that any higher print will be pretty negative for markets as it could imply a faster pace of Fed tightening. We also see the Minutes of the March FOMC meeting this afternoon. While we all know that the consensus is for either two or three rate hikes, it seems pundits are going to be looking for any inklings on how the heightened tensions in trade policy are going to impact the decision process. My sense is that the trade discussion back then was not nearly so evolved and that there will be little of note in the Minutes accordingly. Meanwhile, after yesterday’s big equity rally, concerns over CPI seem to have resulted in some caution as equity futures are pointing lower right now. We also saw both Asian and European markets soften. The one constant is that there is very little certainty as to the future direction of things with numerous conflicting indicators. This is why volatility remains elevated and is likely to continue to be so going forward. In the end, I think that the CPI prints high and that weaker equity prices and higher rates feed into the dollar regaining some of its losses from the last few sessions.

Good luck

Easier Terms

According to President Xi
The next steps from China we’ll see
Are easier terms
Giving foreign firms
The chance not to share their IP

Though no timeline did he announce
Most stock markets really did bounce
The dollar’s been steady
And bonds are already
Declining to larger discounts

Trade remains the primary focus of market participants as the ongoing comments and threats from both sides continue. Last night, however, Chinese President Xi Jinping spoke at the Boao Forum and struck a more diplomatic tone regarding the subject. In fact, he explained that Chinese markets would be opening for more imports of manufactured goods like autos, that foreign investment and activity in financial services and insurance would be allowed to increase and that respect for foreign IP would be reinforced. Of course, those are all terrific outcomes…if they come about. But there was no timeline attached to the discussion, not even a broad one like, ‘by the end of the year’ or ‘within X years’ so at this stage it is simply talk. And we all know the value of talk. That said, equity markets, which have been the ones most impacted by the ongoing trade concerns, have all rallied sharply, with Chinese and HK markets up 1.5%, while the Nikkei rallied a more subdued 0.5%. European markets have also rallied with the German DAX leading the way, up 1.0%, but the rest of the space more in the 0.5% range. Finally, US equity futures are pointing to a 1% rally at the opening.

It remains to be seen just how this plays out, but if pressed I would estimate that there will be some type of agreement reached that both sides will be able to point to domestically as victories. Will the Chinese actually open their markets further? History shows that only in areas where they feel they need something, or where they believe that the domestic industry is at such an advantage there will be limited value for foreign investment. The one thing on which we can count, however, is that this process has not ended, and that we are almost certainly going to hear about it regularly for a while yet. Another risk here is that investors and traders become inured to the discussion and something actually happens which results in real changes in the relationships (e.g. more tariffs or quotas) that has a real impact and requires a reassessment of valuations.

Moving on to the FX markets, we are in the midst of the monthly stretch where inflation data is printed all around the world. Although tomorrow we see both Chinese and US data, and next week brings UK, Eurozone aggregate and Japanese data, this morning we are seeing the first inklings of how things played out in March. For example, Dutch, Danish and Norwegian inflation all fell compared to last month and all were lower than expected. Now I grant that even combined, these nations are not large enough to have an impact on the global situation. However, the trend is clearly not one that Signor Draghi will be happy to see. We also continue to see softening economic growth from various Eurozone nations, with both Italian and Finnish IP falling last month. Once again my point is that the narrative continues to anticipate a more aggressively hawkish ECB going forward, and at this point, the data does not support that thesis.

The flip side of this story is in the US, where virtually every inflation-related piece of data has pointed to higher prices taking hold in the US. While Friday’s AHE data was seen as relatively benign, the underlying wage story continues to improve. Add to that the ongoing increase in oil prices and the cost of filling your tank, and it is well within reason that we see tomorrow’s CPI print higher than expected. Something else working to raise tomorrow’s CPI data is the removal of the cell phone data adjustment as that happened long enough ago to finally exit the data. So even though the reality is that inflation has been steadily rising and likely understated due to the idiosyncrasies of data collection, the optics are likely to look like there has been a sudden increase in the rate of inflation lately, and probably severe enough to cause the Fed to move. At this point, expectations are for headline and core CPI to print at 2.4% and 2.1% respectively, which represent 0.2% and 0.3% rises from last month. Those are already pretty big moves in this series. What if the numbers print at 2.6% and 2.2%? All I’m saying is that Goldilocks has been getting beaten up pretty regularly lately, and a high side surprise could well be enough to kill her.

If inflation is no longer benign and the Fed is forced to tighten even faster, a key part of the global growth story with low inflation is going to crumble, and with it, potentially, many market themes of the recent past. And of course one of those themes is the ever-weakening dollar. A more aggressive Fed combined with a more reluctant ECB is going to support the greenback almost no matter what else is ongoing. This has been part and parcel of my thesis on dollar strength, so it will be tested in stages, first tomorrow and then next Thursday when the ECB releases its CPI data.

A quick look at the dollar’s performance this year shows that while it fell in January as the narrative was strong, since then it has done almost nothing, albeit in a choppy fashion. Coincidentally, since then we have also seen the first inklings that last year’s synchronized global growth story with low inflation was coming undone, and the trade issues have merely reinforced that concern. If/when the market recognizes that inflation rates have started to diverge, I anticipate a lot more pain for those who are still invested in Goldilocks. Just sayin’.

As to today, the NFIB Small Business Index disappointed a short while ago, printing at 104.7, its lowest level since last October and perhaps indicative of a top in this series. We also have PPI at 8:30 (exp 0.1% and 0.2% core which translates into 2.9% and 2.6% Y/Y). This data will have to be shockingly different to move markets as investors focus on tomorrow’s CPI. So for now, despite the weaker NFIB data, equity futures continue to point toward a rebound. However, the equity movement has been insufficient to drive FX markets by itself. So lacking further trade related comments from the administration, I expect a quiet day for the dollar. However, tomorrow has some potential for movement.

Good luck

Quite Consequential

My friends, this is quite consequential
In fact it could be existential
When asked about trade
Mnuchin portrayed
A trade war as having potential

But Sunday when pressed on the subject
His softer tone saying that in effect
He just didn’t think
We were on the brink
Of a trade war with China in retrospect

Trade continues to be the primary focus of markets as Friday’s jitters have abated somewhat over the weekend. In what can only be described as the norm in this administration, there are conflicting views amongst not only different spokespeople, but seemingly, as Mnuchin demonstrated, amongst individuals themselves. If pressed, I would say that it is certainly not the president’s intention to initiate a trade war, but that he is quite focused on adjusting the terms of trade with China, as well as the rest of the world. After all, it was a key campaign promise. The problem for markets is that the volatility that accompanies the various statements and interpretations of those statements is significantly greater than we have seen for a number of years and is likely to continue to be so. Interestingly, comments from Fed Chair Powell on Friday were notable in their complete lack of concern over the current situation regarding trade. It remains clear to me that Mr Powell is unlikely to demonstrate concern if equity markets fall further, barring a complete, October 87 like crash. This may, in fact, be the biggest change in the Powell Fed compared to the previous three iterations, the expiration of the Fed put.

Speaking of Powell’s comments, his message Friday was that a steady pace of rate increases was appropriate policy in order to prevent inflation from building up too large a head of steam. These comments were echoed by both Chicago’s Evans and the NY president-select Williams, which is pretty good evidence that the core of the Fed remains on track to continue raising rates, with the next move to come in June.

The other feature of Friday’s markets was the payroll report, where the headline NFP number was a quite disappointing 103K and the previous two months saw downward revisions totaling 50K. However, that still leaves the 3-month average at ~200K, a very healthy clip. In addition, the AHE number was right on the button at 2.7%, so wages continue to edge higher, although are certainly not running away. The recent economic story in the US, as well as elsewhere in the developed world, is one of moderating economic activity. I have pointed out several times that the ISM/PMI survey data appeared to peak back in December and has been trending lower since. German IP fell a surprising 1.6% on Friday and this morning’s data from the Eurozone showed their trade balance shrinking as well. Economists and policymakers have grown to believe that growth potential in the Eurozone tops out at 2.0%, assuming it can even maintain that pace over time. The fact that last year saw output grow at 2.4%, well above potential has resulted in a greater likelihood of a slowing pace of growth, and with it, the removal of any inflationary impulse, assuming there was one to begin with. This is Signor Draghi’s problem, that despite a year with very positive tidings, that things may be sliding back toward a more lackluster economy, with a reducing in inflation pressure. Under this circumstance, it is awfully difficult to make the case that tightening policy is the appropriate response. And while the hawkish wing of the ECB, led by Germany’s Jens Weidmann, are quite keen to not only end QE but raise rates, there is still a sizable contingent, notably from the peripheral nations, that see no reason for that at all. I continue to believe that the ECB’s actions this year willl be far less hawkish than the narrative.

Of course it is the combination of these views that helps inform my sense that the dollar has further to rebound. That and the policy mix of US loose fiscal and (relatively) tight monetary policy. But there is another side to the dollar, one that I have not addressed, but one that ought to be an important part of the discussion, namely the budget/trade deficits. In the world of capital flows, the fact remains that as the US sees both its budget deficit increase and its trade deficit increase, the money has to come from somewhere to fund it. This is why the US capital account is in such large surplus (all those funds flowing in to buy Treasuries). But the point that dollar bears make is that as both those deficits grow, the US is going to need to offer more attractive terms to get the rest of the world to finance them. That means that not only do rates need to rise, but that the dollar needs to fall.

Here’s a thought experiment. Consider that you are a foreign investor with a euro functional balance sheet. In order to be attracted to Treasuries, you would want not only a higher coupon, which of course you clearly have at this time, but also to have confidence that the dollar would at least not decline, if it doesn’t increase. However, given the recent trend, with the dollar falling for the past fifteen months, it is hard to remain sanguine about its near-term prospects. I would describe this as the transitional phase, where the dollar may not yet have adjusted to a level sufficient to attract that critical inward capital flow. If that is the case, then a further downward adjustment in the dollar may be required before foreign buyers feel confident that the risks are outweighed by the coupon advantage. In other words, as long as the twin deficits continue to climb, the US will effectively have to offer better terms to the buyers of their debt, and that means higher rates and a weaker dollar. In fact, it is a compelling argument and a key part of many forecasts for a weaker dollar. However, when I consider all the evidence, I continue to believe that the dollar is unlikely to fall further, or at least much further, and will begin to rebound when the market understands the change in tone from the ECB. Remember that the entire FX market is a relative one, with important information from both sides of the trade.

A look at this morning’s price action shows that the dollar has edged slightly higher, but in truth, other than against the RUB (which has fallen nearly 3% due to new sanctions on the oligarchs), most of the movement has been relatively muted. In fact, if you consider the past three months, the dollar really has done very little overall.

Looking ahead to this week, the data flow is significantly lighter, with the highlight certainly Wednesday’s CPI print.

Tuesday NFIB Small Biz Optimism 106.5
  PPI 0.1% (2.9% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
Wednesday CPI 0.2% (2.4% Y/Y)
  -ex food & energy 0.2% (2.0% Y/Y)
  FOMC Minutes  
Thursday Initial Claims 230K
Friday Michigan Sentiment 100.8
  JOLTS Jobs Report 6.15M

So Wednesday is clearly the big day, with both CPI and the FOMC Minutes. At this point, it seems pretty clear that inflation indicators continue to slowly grind higher, but the risk to markets will be for a bigger jump. Given the consistent Fed stance that rates are going to only rise gradually, any data that indicates the Fed are falling behind the curve will likely see a reaction. As to the Minutes, given how much we have already heard from Fed speakers, it doesn’t seem like there can be much new information there. And we have four more Fed speakers this week as well, all likely to reinforce the message save Neel Kashkari, the confirmed uber-dove.

In the end, the market is still beholden to the trade rhetoric, and so choppy markets are the most likely outcome for the week. The one thing of which I am sure is that the trade story is nowhere near over.

Good luck

A Great Hullabaloo

Investors collectively squealed
When tariffs, by Trump, were revealed
That opening tactic
Proved anticlimactic
When ongoing talks were revealed

Then last night from out of the blue
Amid a great hullabaloo
The Prez indicated
That he was frustrated
Thus more tariffs now will debut

Meanwhile a few hours from now
The employment report takes its bow
The critical gauge is
The hourly wages
Where strength could give Powell a cow

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

Let’s consider the recent timeline for a moment:

Tuesday night – Trump imposes tariffs on $50 billion of Chinese goods, the Chinese immediately respond and equity prices collapse around the world
Wednesday mid-day – Wilbur Ross and Larry Kudlow explain that senior level negotiations are ongoing between the US and China and that no trade war is imminent. Stock prices immediately turn around, rallying sharply around the world as FOMO grips the investor community
Thursday night – after a two day global equity rally, President Trump surprises one and all by announcing an additional $100 billion in tariffs on Chinese goods with China responding immediately and saying, “The Chinese side will follow suit to the end, not hesitate to pay any price, resolutely counterattack and take new comprehensive measures in response.” I don’t know about you, but when the Chinese invoke the specter of Winston Churchill, it sounds pretty warlike to me!

It should be no surprise that risk has been jettisoned yet again after this latest round of commentary with equity markets in Asia and Europe both falling while US equity futures are pointing lower. Interestingly, the dollar, which has been performing quite well lately, is little changed this morning, as are Treasuries and gold, neither of which seems to be benefitting from a flight to safety. My take is that investors are simply confused at this point and don’t really know which way to turn. And in fairness, how can you know what to expect at this point? The one constant of the Trump administration for market participants is that there is no surety as to what will happen.

So since I have no idea what will occur with the trade situation (does anybody?), I guess its time to focus on the payroll report. Current expectations are as follows:

Nonfarm Payrolls 175K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 4.0%
Participation Rate 62.8%
Average Hourly Earnings (AHE) 0.3% (2.7% Y/Y)
Average Weekly Hours 34.5

The clues that we have seen lately seem to point to another strong report. ADP Employment was a much stronger than expected 241K. The ISM data showed both firmer employment sub-indices as well as firmer price indices, implying that wages remain robust. And of course, Core PCE was firmer than expected last week, adding to the idea that price pressures are increasing. Anecdotally we have seen teachers around the country going on strike for pay raises, and getting them, with the smallest increase I have seen being 5.0%. That certainly smacks of wage inflation and by all accounts, that is the thing the Fed is most focused on. It is hard for me to look at the evidence without getting the feeling that any data surprise will be on the high side.

The question, of course, is how will the market respond to a surprise of any sort. Inflation remains the key driver of policy decisions at this point. In fact, if the Unemployment rate does fall to 4.0%, it will only add further angst to the FOMC as they watch it decline further below NAIRU and given their ongoing belief in the Phillips Curve, prepare for even more inflation. So I continue to believe the AHE number is the most important part of the report. I’m sure you all remember what happened in the February release when AHE jumped to 2.9% and equity markets subsequently fell 10% in a few days. Quite frankly, I don’t rule out a repeat of that type of performance. After all, it is clear that the Fed is geared up to continue raising rates. It has also become clear that Chairman Powell, unlike his three predecessors, is quite comfortable watching equity market volatility rise amid uncertainty and a declining stock market. Finally, it also appears that the FOMC is very keen to ‘normalize’ monetary policy, which I take to mean Fed Funds back at long-term levels of 3% – 4% alongside a much smaller balance sheet. I assure you, another 2.9% print will encourage all of that behavior. In fact, I would argue it will cement four rate hikes for this year. In that event, I like the dollar to continue its recent modest strength, I think equities will suffer, and I expect Treasuries will be caught between concerns over higher inflation driving rates higher and flight to safety driving them lower, so likely not move much at all.

On the other hand, a weak print today will be unambiguous across markets. Equities will recoup their trade war induced losses (unless the rhetoric increases), the dollar will suffer immediately and Treasuries will simply rally, with yields probably falling back to the bottom of the recent trading range. We shall see.

One other thing to note about today, Chairman Powell speaks about the economic outlook at 1:30 this afternoon. Given his penchant for straight talk, I expect that we will have a very good idea about how his thoughts have evolved since the March FOMC meeting. So its not just trade and payrolls today, but Powell as well. I would err on the side of being long dollars here, as the evidence points to both solid payroll gains and higher wages.

Good luck