Toadies Galore

There once was a time in the past
When jobs like PM were a blast
With toadies galore
And laws you’d ignore
While scheming, all foes, to outlast

But these days when leading a nation
The role has outgrown bloviation
Consider Ms. May
Who just yesterday
Was subject to near ruination

Well, Brexit managed to not be the headline story for the several days between the time the current deal was tentatively agreed with the rest of the EU and the scheduled vote by the House of Commons to approve said deal. During that period, PM May made the rounds to try to sell her deal to the people of the UK. Alas, apparently she’s not a very good saleswoman. Under extreme duress, yesterday she indefinitely delayed the vote that was originally to be held this evening. Amid jeering from the floor of the House of Commons, she tried to make her case, but was singularly unable to do so. As has been the problem all along, the Irish border issue remains intractable with the opposing goals of separating the two nations legally and, more importantly, for customs purposes, while not installing a border between the two. As it currently stands, I will argue there is no compromise solution that is viable. One side is going to have to accept the other side’s demands and frankly, that doesn’t seem very likely. The upshot is that the market has once again begun to assume a no-deal Brexit with all the hyperbolic consequences that entails. And the pound? It was not a happy day if you were long as it fell 2% at its worst point, although only closed down by about 1.5%. This morning, it has regained a further 0.4%, but remains near its weakest levels since April 2017. Unless you believe in miracles (and in fairness there is no better time to do so than this time of year), my strong belief is the UK is going to exit the EU with nothing in place. The pound has further to fall, so hedgers beware.

Let’s pivot to the euro for a moment and discuss all the benefits of the single currency. First, there is the prospect of its third largest trading partner, the UK, leaving the fold and suddenly imposing tariffs on those exports. Next we have France literally on fire, as the gilets jaunes continue to run riot throughout the country while protesting President Macron’s mooted fuel tax increase. In the end, that seems to have been pulled and now he is offering tax cuts! Fiscal probity has been tossed aside in the name of political expediency. Thirdly, we have the ongoing Italian opera over the budget. The antiestablishment coalition government remains adamant that it is going to inject fiscal stimulus to the country, which is slipping into recession as we speak, but the EU powers-that-be are chuffed by the fact that the Italian budget doesn’t meet their criteria. In fact, those same powers continue down the road of seeking to impose fines on Italy for the audacity of trying to manage their own country. (Will someone please explain to me why when the French make outlandish promises that will expand their budget deficit, the EU remains mum, but when the Italians do so, it is an international crisis?)

At the same time as all of this is ongoing, the ECB is bound and determined to end QE this month and keeps talking about starting to normalize interest rates next autumn. Whistling past the graveyard anyone? When three of the four biggest nations in the EU are under significant duress, it seems impossible to consider that owning the euro is the best position. While it is clear that the situation in the US is not nearly as robust as had been believed just a month ago, and the Fed seems to be responding to that by softening their tone; at some point, the ECB is going to recognize that things in the Eurozone are also much worse, and that talk of tightening policy is going to fade from the scene. Rather, the discussion will be how large to make the new TLTRO loan program and what else can the ECB do to help support the economy since cutting rates seems out of the question given the starting point. None of that is priced into the market right now, and so as that unfolds, the euro will fall. However, in today’s session, the euro has recouped about half its losses from yesterday, rebounding by 0.4% after a more than 0.8% decline Monday. As much as there is a building discussion over the impending collapse of the dollar, it continues to seem to me that there are much bigger problems elsewhere in the world, which will help the dollar retain its haven status.

Away from those two stories, I would be remiss if I did not mention that the Reserve Bank of India’s widely respected governor, Urjit Patel, resigned suddenly Monday evening leading to a 1.5% decline in the rupee and a sharp fall in Indian equity markets Tuesday. But then, results from recent local elections seemed to shift toward the ruling BJP, instilling a bit more confidence that PM Modi will be able to be reelected next year. Given the perception of his market/business friendliness, that change precipitated a sharp reversal in markets with the rupee actually rallying 0.9% and Indian equity markets closing higher by 0.6%.

In fact, despite my warnings above, the dollar is under pressure across the board this morning while global equity markets are looking up. It seems there was a call between the US and China restarting the trade negotiation process, which was taken by investors as a sign that all would be well going forward. And while that is certainly encouraging, it seems a leap to believe a solution is at hand. However, there is no question the market is responding to that news as equity markets in Europe are all higher by between 1.0% and 2.0%, US equity futures are pointing to a 1% gain on the open, government bonds are softer across the board and the dollar is down. Even commodities are playing nice today with most rallying between 0.5%-1.0%. So everyone, RISK IS ON!!

Turning to the data story, first let me say that the euro has been helped by a better than expected German ZEW Index (-17.5 vs. exp -25), while the pound has benefitted from a modestly better than expected employment report, with Average earnings rising 3.3% and the Employment Change jumping 79K. At the same time, the NFIB Small Business Optimism Index was just released at a worse than expected 104.8, indicating that the peak may well be behind us in the US economy. At 8:30 we see PPI data (exp 2.5%, 2.6% core) however, that tends not to be a significant market mover. Rather, today is shaping up as a risk-on day and unless there is a change in the tone of the trade talks, there is no reason to believe that will change. Accordingly, for hedgers, take advantage of the pop in currencies as the big picture continues to point toward eventual further dollar strength.

Good luck
Adf

 

A More Dovish Muse

The Chair of the Federal Reserve
For months has displayed steady nerve(s)
He’s gradually lifted
Fed Funds as he’s sifted
The data Fed members observe

But Friday brought more iffy news
And many now look for some clues
That Powell may soon
Abandon his tune
And search for a more dovish muse

Meanwhile o’er in Frankfurt they claim
That QE will end all the same
Though growth there is fading
There is no persuading
The Germans they’ll soon take the blame

The dollar started the Asian session on its back foot as market participants have jumped on the idea that softer employment data on Friday is going to prevent the Fed from maintaining their aggressive stance on monetary policy. And in fairness, we have already heard the first cracks in that story, as a number of Fed speakers were quite willing to admit that if the data slowed, they would not be as aggressive. However, the Fed is now in their blackout period, which means that we will not hear anything from them until they release their statement a week from Wednesday. In this market, that is an eternity with the ability for so much to happen and markets to move extraordinary distances.

As far as selling the dollar is concerned, I certainly understand the impulse given the clearly weaker US data and mildly more dovish tone of the latest comments last week. But the key thing to remember in the FX market is that everything is relative. And while US data is not as robust as it was just a few months ago, the same is true of both Eurozone and Japanese data, as well as Chinese and most EMG data. In fact, while the majority of participants continue to believe that the ECB is going to end QE on December 31st, and confirm that stance this week, there is a very big question mark regarding future European growth, especially in the event of a hard Brexit. Will the ECB have the guts ability to restart QE when inflation data suddenly starts to slide while Q4 GDP disappoints? And so while policy ease may be the proper response, having just ended their program they will be desperate to retain any credibility that they have left. At the end of the day, while the US economy appears to be slowing, it remains significantly brighter than the rest of the world. And that, eventually, is going to underpin the dollar. However, apparently not today.

Arguably, the biggest story this morning is the European Court of Justice’s ruling that the UK can unilaterally withdraw their Section 50 letter (the one where they officially declared they were leaving the EU). The upshot is the Bremainers feel there is new life and they can prevent the disastrous outcome of a hard Brexit. The one thing that seems clear, however, is that the Brexit deal, as currently negotiated, is likely to go down to defeat in the House of Commons in any vote. While that vote had been scheduled to occur tomorrow evening, just moments ago PM May took it off the agenda, with no alternative time scheduled. At the same time, her government reiterated that the UK is going through with Brexit as that was the result requested by the nation during the referendum. The FX market response to the latest histrionics has been to sell the pound. As I type, Sterling is lower by -0.45%, although that is also partially due to the fact that UK data was quite weak as well. For example, Construction Orders fell -30.7% in Q3, its worst performance since the depths of the great recession in 2009. IP fell -0.8% and GDP continues to edge along at a mere 0.1% monthly rate, having grown just 1.5% in the past year. It is becoming ever more clear that Brexit uncertainty is having a negative impact on the UK and by extension on the pound.

Away from the pound’s decline, though, the dollar is generally under pressure in the G10. For example, the euro has rallied 0.3% after modestly positive German trade and Italian IP data, although quite frankly, it seems more of a dollar negative than euro positive story. Bearing out the dollar weakness theme are the commodity currencies, with all three (AUD, CAD and NZD) firmer this morning despite declines across the board in energy, metals and agricultural prices.

Turning to the Emerging markets, the story is a little less anti-dollar as INR has fallen -0.7% after local elections added pressure to PM Modi’s political standing and called into question his ability to be reelected next year. In a more normal reaction to weaker commodity prices, both ZAR (-0.55%) and IDR (-0.5%) are suffering. At the same time, ongoing tensions regarding the US-China trade situation continue to weigh on KRW (-0.7%) and, not surprisingly, CNY (-0.5%). But away from those stories, the broad EMG theme is actually one of modest currency strength. Overall, it has been a mixed picture in the FX space.

Looking ahead to the data this week, with the UK vote now pulled from the calendar and Fed speakers absent, the market will look toward inflation data and Retail Sales for the latest clues on the economy.

Today JOLT’s Jobs Report 6.995M
Tuesday NFIB Small Biz Optimism 107.3
  PPI 0.0% (2.5% Y/Y)
  -ex food & energy 0.1% (2.6% Y/Y)
Wednesday CPI 0.0% (2.2% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial Claims 225K
Friday Retail Sales 0.2%
  -ex autos 0.2%
  IP 0.3%
  Capacity Utilization 78.5%
  Business Inventories 0.5%

While the inflation data is important, the one thing that seems abundantly clear from recent Fed commentary is that they are unconcerned over the potential for inflation to run much higher. Instead, my sense is that they are going to be very focused on the potential first harbingers of a slowdown in the employment situation, where Initial Claims have ended their decade long decline and actually have started to rise. This is often seen as an early sign of potential economic weakness. But in the end, with the Fed quiet this week, I expect that we are going to be subject to much more foreign influence, with the ongoing Brexit situation driving the pound, the potential for a surprise from the ECB (which meets Thursday) and of course, the ongoing trade melee. In addition, we cannot forget the influence of equity markets, which continue to decline this morning after an abysmal week last week. In other words, there is plenty to drive markets this week, even absent the Fed, and for now, the dollar seems to be under pressure.

Good luck
Adf

More Concern

The tide is beginning to turn
As hawks at the Fed slowly learn
Their earlier view
No longer rings true
So they’ve now expressed more concern

These days there are three key drivers of the market narrative as follows:

The Fed – There is no question that the tone of commentary from Fed speakers has softened over the past two weeks, certainly from the way it sounded two months ago. Back then Chairman Powell explained that the Fed Funds rate was “a long way” from neutral, implying numerous further interest rate hikes. Equity markets responded by selling off sharply and talk of a yield curve inversion leading to a recession was nonstop. Meanwhile, the dollar rose nicely vs. most of its counterparties. A funny thing happened, though, on the way to that next rate hike due next week; economic data started to soften.

Softer housing data as well as declines in production numbers and survey data like the ISM have resulted in a more cautionary stance by these same Fed members. While the doves (Kashkari, Bullard and Brainerd) had always shown some concern over the pace of rate hikes given the absence of measured inflation, the rest of the Fed were happy to hew to the Phillips curve model and assume that the exceptionally low unemployment rate would lead to much higher inflation. This latter view encouraged them to gradually raise rates in order to prevent a failure on that part of their mandate.

But whether it is a result of the sharp declines seen in equity prices, the ongoing bashing from President Trump or simply the fact that the growth picture is slowing (I certainly hope it is the last of these!), the tone from this august group is definitely less aggressive. And while yesterday Chairman Powell reiterated that the economy was “very strong” on many measures, he was also clear to indicate that there was much more uncertainty over what the future would bring. This change of tone has been well received by the punditry, and quite frankly, by markets, which saw a sharp late day equity rally sufficient to reduce early session losses to nearly flat.

The Fed’s problem is that they created a monster with Forward Guidance, which was great when it helped them to further their easing bias, but is not well suited to changes in policy. Futures markets are now pricing less than one rate hike in 2019, down from nearly three hikes just a month ago. Transitions are always the hardest times for any market and for all policymakers. It is no surprise that we have seen increased volatility across markets lately, and I expect it will continue.

Trade – The trade situation is extremely difficult to describe. In the course of a week, market sentiment has gone from euphoria over the reopening of talks between the US and China on Monday, to outright fear after the US had the CFO of one of China’s largest companies, Huawei, arrested in Canada regarding the breech of sanctions on Iran. There are two concerns over the trade issue that need to be addressed when considering its impact on markets. First is the impact on prices. Tariffs will unambiguously raise prices to someone as long as they are in place. The question is who will feel the pain. For importers, their choices are pass on the cost by raising prices, eat the cost by reducing margins or have their vendors eat the cost by renegotiating their prices. In the first case, it is a direct impact on inflation data, something that has not yet been evident. In the second case, it is a direct hit to profitability, also something that has not yet been evident, but it has been discussed by a number of CEO’s as they get asked about their business. In the third case, the US makes out well, with neither of the potential problems coming home to roost.

The second, knock-on impact is on growth. Higher prices will reduce demand and lower margins will reduce available cash flow, and correspondingly reduce the ability of companies to invest and grow. In other words, there are no short term positives to be had from the tariffs. However, if negative behavior can be changed because of their imposition, such that IP is protected and an agreement can help reduce all trade barriers, including non-tariff ones, then the ends may justify the means. Alas, I am not confident that will be the case. Looking at the market impact, theory would dictate the dollar should rise on the idea that other currencies will depreciate sufficiently to offset the tariffs and reestablish equilibrium. We have seen that in USDCNY, which has fallen about 8% from its peak in spring, nearly offsetting the 10% tariffs. Looking ahead though, if the tariff rate rises to 25%, it is harder to believe the Chinese will allow the yuan to fall that much further. For the past decade they have been fearful of allowing their currency to fall to quickly as it has led to significant capital flight, so it would be premature to expect a decline anywhere near that magnitude.

Oil – Oil prices have moved back to the top of the market’s play list as a combination of factors has lately driven significant volatility. It wasn’t that long ago that there was talk of oil getting back to $100/bbl, especially with the US sanctions on Iran being reimposed. But then political pressure from the US on Saudi Arabia resulted in a significant increase in production there, which alongside continuing growth in US production, turned fears of a shortage into an absolute oil glut. This resulted in a 33% decline in the price in less than two months’ time, with ensuing impact on petrocurrencies like CAD, RUB and MXN, as well as a significant change in sentiment regarding inflation. With global growth continuing to show signs of slowing further, it is hard to believe that oil prices will rebound anytime soon. As such, one needs to consider that those same currencies will remain under pressure going forward.

All of this leads us to today’s session where the primary focus will be on the employment report. Expectations are as follows:

Nonfarm Payrolls 200K
Private Payrolls 200K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.1% Y/Y)
Average Weekly Hours 34.5
Michigan Sentiment 97.0

It feels like the market is more concerned over a strong number, which might put the Fed on alert for further rate hikes. In fact, it seems like we have moved into a good news is bad situation again, at least for equities. For the dollar, though, strong data is likely to lead to support. My view is that we may start to see a softer tone from the data, which would lead to further softening in the dollar, but a rebound in stocks.

Good luck and good weekend
Adf

Making Its Case

The market is making its case
The Fed should be slowing the pace
Of interest rate hikes
That nobody likes
As growth has begun to retrace

The emerging narrative is that the Fed needs to stop raising rates before it is too late, or else the global economy is going to sink into a recession. Funnily enough, I think this is one area where many of the glitterati agree with President Trump; Chairman Powell is doing the wrong thing. Certainly, recent equity market activity has been pretty bad, with the overnight sessions showing sharp declines again (Shanghai -1.7%, Nikkei -1.9%, DAX -2.4%, FTSE -2.5%) and US futures pointing to a -1.75% fall on the opening. While the proximate cause of today’s move may be the surprising arrest of the CFO of Chinese telecoms manufacturer Huawei, the reality is that there are plenty of issues that are generating concerns these days.

Clearly the primary concern continues to be the trade situation between the US and China. Monday’s relief rally was based on the fact that there seemed to be a truce. Tuesday’s sharp decline was based on the fact that there were disputes to that message. This morning’s declines have been a reflection of growing concern that the above-mentioned arrest will undermine any chance at trade progress between the two nations. But in addition to the trade story, the background narrative has been that the Fed is raising rates despite growing evidence that the US economy is slowing rapidly. Exhibit A in that story is the housing market, which has seen a particularly weak run of construction and sales over the past six months. Then there is the auto sector, where sales have fallen back from the remarkable heights seen last year. These two industries make up a significant portion of the market’s perception of the economy because virtually everybody has a house and a car, and is aware of what prices are doing there. They have always been seen as a harbinger of future economic activity, so if they are slowing, that bodes ill for the economy at large.

And this is where the dissatisfaction with Powell arises, because he continues to raise rates based on the idea that inflation, while remaining subdued, has the potential to rise sharply unless the Fed tightens policy. They continue to look at the Unemployment Rate of 3.7%, a rate well below any estimates of the Natural Rate of Unemployment, and expect that inflation is going to jump soon. And it might, but so far, that has just not been evident. In fact, the past couple of readings have shown a softer inflation bias, which further adds to the pundit’s angst over Powell.

This commentator is not going to opine on whether the Fed is right or wrong at this time, but I will say that my fear is that all the tools that the Fed (and every other economist) are using to forecast future economic activity are likely not up to the task. There have been massive structural changes to both the economy in general (ongoing improvements in automation across industries) but more specifically, to the way monetary policy works. The aftermath of the financial crisis has fundamentally changed the way the Fed and every other central bank oversees their respective economies. No longer do they adjust reserves to achieve a desired interest rate at a clearing price. Now they simply tell us where rates are and use their powers of suasion to keep them there. And ten years on, the market has built up structures that are now reliant on the new process, so reverting to the old one is no longer an option. My strong concern about this is that these changes are not reflected in the way econometric models are built, and therefore those models do not produce results that are coherent with the current reality.

With that as background, it is easier to understand why there is so much confusion and concern in markets in general. If the Fed is using outdated tools to manage the economy, odds are they won’t work very well. Perhaps this is what the equity markets are pointing out, and have been doing pretty much all year outside the US.

Pivoting to FX, the question is, how will this narrative impact the dollar? Generally speaking, what we have seen is an ongoing risk-off scenario throughout markets, and that has historically been quite beneficial for the greenback. Last night was no exception with Asian currencies experiencing significant declines (AUD -0.9%, NZD -0.5%, CNY -0.6%) while the yen, the other chief beneficiary of risk reduction, rallied 0.4%. We have also seen weakness in CAD (-0.6%), MXN (-0.5%) and BRL (-0.8%). Granted, the CAD story has more to do with the BOC walking back their recent hawkish views, and behaving the way the market wants the Fed to behave. But as long as the Fed seems certain to raise rates come December, and the rest of the world is crumbling, the dollar will find support.

Perhaps we will hear a new tone from the Fed today and tomorrow, as Chairman Powell testifies to Congress today and we hear from both Williams and Bostic with Governor Brainerd speaking tomorrow. The risk is that each of them starts to walk back the hawkish views that have predominated, and reconsider future rate hikes. In that case, look for equity markets to rocket higher, while the market prices out a December rate hike and the yield curve steepens. Also in that case, watch for the dollar to decline sharply. But in the event they maintain their current tone, I see no reason for the dollar to backpedal.

We actually have a bunch of data today as yesterday’s data was delayed due to the day of mourning for President Bush. Today includes ADP Employment (exp 195K), Initial Claims (225K), Nonfarm Productivity (2.3%), Unit Labor Costs (1.1%), Trade Balance (-$54.9B), ISM Non-Manufacturing (59.2) and Factory Orders (-2.0%). It will be interesting to see if we start to get softer data from ISM but I really believe that the market will be far more focused on the Fedspeak and tomorrow’s payroll data than today’s data dump.

Good luck
Adf

 

Most Are Afraid

Since pundits have often asserted
A yield curve that’s truly inverted
Will lead to recession
The recent compression
Of rates has investors alerted

Meanwhile the concerns over trade
Have not really started to fade
Twixt trade and those yields
Investors need shields
Explaining why most are afraid

It got ugly in the equity markets yesterday, with significant declines in the US followed by weakness overnight in Asia and continuing into today’s European session. With US markets closed today in observance of a day of mourning for ex-president George Herbert Walker Bush, the news cycle has the potential to increase recent volatility. Driving the market activity were two key stories, ongoing uncertainty over the US-China trade situation and, more importantly, further flattening of the US yield curve toward inversion.

At this point, unless you have been hiding under a rock for the past year (although given market activity, that may not have been a bad idea!) you are aware of the relationship between the shape of the US yield curve and the potential for a recession in the US. Every recession since 1975 has been preceded by an inverted yield curve (one where short-term rates are higher than long-term ones). In each of those cases, the driving force raising short-term rates was the Fed, which is no different than today’s situation. What is different is both the level of yields, on both a nominal and real basis, and the size of the Fed’s balance sheet.

From 1963 up to the Financial Crisis, the average of nominal 10-year Treasury yields had been 7.11%. Since the crisis, that number has fallen to 2.62%! Of course that was driven by the Fed’s policy actions of ZIRP and QE, the second of which was explicitly designed to drive longer-term rates lower. Clearly they were successful on that score. However, ten years on from the crisis, rates remain exceptionally low on a historical basis, despite the fact that the economy has been expanding since the middle of 2009. The reasons for this are twofold; first the Fed had maintained ZIRP for an exceptionally long time, and while they have been raising rates since December 2015, the pace at which they have done so has been extremely slow by historical standards. Secondly, although the Fed has begun to reduce the size of their balance sheet, it remains significantly larger, relative to the size of the economy, than it was prior to the crisis. This means that there is less supply of bonds available for other investors, and so prices continue to be artificially high.

This combination of the Fed’s rate hikes, as slow as they have been, and their ownership of a significant portion of available Treasuries has resulted in a much flatter yield curve. Adding to this mixture is the fact that the economy’s performance is now beginning to show signs of slowing down. This has been evident in the recent weakness in both the housing market and the auto sector. Meanwhile, falling equity prices have encouraged more demand for the safety of Treasuries. Put it all together and you have a recipe for a yield curve inversion, which will simply help fulfill the prophesy of an inverted yield curve leading to recession.

The other pressure point in markets has been the ongoing trade drama between the US and China. The weekend’s G20 news was quickly embraced by investors everywhere in the hope that further tariffs had been avoided and the current ones might be reduced or removed. However, China’s interpretation of the weekend discussions and those of President Trump appear to be somewhat different, and now there is concern that the delay in tariff increases may not result in their eventual removal.

Recapping the two stories, fears over a resumption of the trade war have helped undermine views of future economic growth. This has led investors to seek safety in longer dated Treasury securities helping to flatten the US yield curve. That signal is seen as a harbinger of future recession, which has led investors to sell equities, further increasing demand for Treasuries. It is easy to see how this cycle can get out of hand, and may well lead to much weaker equity prices, lower US yields and slower US growth.

That trifecta would be a cogent reason for the dollar to suffer. But remember, the FX market is a relative one, not an absolute one. And if the US is seeing declining growth, you can be certain that the rest of the world is suffering from the same affliction. In fact, the data from Europe this morning showed that Eurozone Services PMI fell to 52.7, its lowest level since September 2016 and further evidence that the Eurozone economy is quickly slowing. While Italy has garnered the headlines, and appears set to enter yet another recession, the data from Germany has also been soft, which bodes ill for the future. If the slowdown in the Eurozone economy continues its recent trend, it will be that much harder for Signor Draghi to begin tightening policy. So once again, despite the fact that the Fed may be slowing down, signs are pointing to the fact that the ECB will be in the same boat. In that case, the euro is unlikely to be seen as terribly attractive, and the dollar still has potential to rise, despite the recent US softness.

The point is that although the long-term structural issues remain quite concerning in the US, the short-term cyclical factors continue to favor the dollar over its G10 and EMG counterparts. We will need to see wholesale changes within the policy mixes around the world for this to change.

With markets closed today, there is no US data to be released, and I expect a subdued session overall. However, nothing has changed my medium term view of dollar strength.

Good luck
Adf

Progress Was Made

The Presidents, Trump and Xi, met
Attempting, trade talks, to reset
Some progress was made
Though China downplayed
Reductions in tariffs as yet

Risk is back! At least it is for today, with the news that there has been a truce, if not an end, to the trade war between the US and China seen as a huge positive for risky assets. And rightly so, given that the trade contretemps has been one of the key drivers of recent investor anxiety. In addition, the G20 managed to release a statement endorsed by all parties, albeit one that was a shadow of its former self. There remain significant disagreements on the value of the G20 with the Trump administration still convinced that these gatherings seek to institutionalize rules and regulations that are contra to the US best interests.

At any rate, equity markets around the world have rallied sharply with Shanghai jumping 2.5%, the Nikkei up 1.25% and the South Korean KOSPI rising by 1.75%. In Europe, the FTSE is higher by 1.75%, the DAX by 2.2% and the CAC, despite ongoing riots in Paris and throughout France, higher by 1.0%. Ahead of the opening here, futures are pointing to an opening on the order of 2.0% higher as well. It should be no surprise that Treasury bonds have fallen somewhat, although the 2bp rise in 10-year yields is dwarfed relative to the equity movements. And finally, the dollar is lower, not quite across the board, but against many of its counterparts. Today, EMG currencies are leading the way, with CNY rising 0.9%, MXN rising 1.7% and RUB up 0.75% indicative of the type of price movement we have seen.

However, the trade story is not the only market driver today, with news in the oil market impacting currencies as well. The story that OPEC and Russia have agreed to extend production cuts into 2019, as well as the news that Alberta’s Premier has ordered a reduction of production, and finally, the news that Qatar is leaving OPEC all combining to help oil jump by more than 3% this morning. The FX impact from oil, however, was mixed. While the RUB and MXN both rallied sharply, as did CAD (+0.9%) and BRL (+0.9%), those nations that are major energy importers, notably India (INR -1.1%), have seen their currencies suffer. I would be remiss not to mention the fact that the euro, which is a large energy importer, has actually moved very little as the two main stories, trade war truce and oil price rise, have offsetting impacts in FX terms on the Continent.

But through it all, there is one currency that is universally underperforming, the British pound, which has fallen 0.3% vs. the dollar and much further against most others. Brexit continues to cast a long shadow over the pound with today’s story that the DUP, the small Northern Irish party that has been key for PM May’s ability to run a coalition government, is very unhappy with the Brexit deal and prepared to not only vote against it in Parliament next week, but to agree a vote of no confidence against PM May as well. This news was far too much for the pound, overwhelming even much better than expected Manufacturing PMI data from the UK (53.1 vs. exp 51.5). So the poor pound is likely to remain under pressure until that vote has been recorded next Tuesday. As of now, it continues to appear that the Brexit deal will fail in its current form, and that the UK will be leaving the EU with no framework for the future in place. This has been the market’s collective fear since the beginning of this process, and the pound will almost certainly suffer further in the event Parliament votes down the deal.

While all this has been fun, the week ahead brings us much more news and
information, as it is Payrolls week in the US.

Today ISM Manufacturing 57.6
  ISM Prices Paid 70.0
  Construction Spending 0.4%
Wednesday ADP Employment 197K
  Nonfarm Productivity 2.3%
  Unit Labor Costs 1.2%
  ISM Non-Manufacturing 59.2
  Fed’s Beige Book  
Thursday Initial Claims 220K
  Trade Balance -$54.9B
  Factory Orders -2.0%
Friday Nonfarm Payrolls 200K
  Private Payrolls 200K
  Manufacturing Payrolls 19K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.3% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Michigan Sentiment 97.0

So a lot of data, and even more Fed speakers, with a total of 11 speeches, including congressional testimony by Chairman Powell on Wednesday, from six different Fed Governors and Presidents. Now we have heard an awful lot from the Fed lately and it has been interpreted as being somewhat less hawkish than the commentary from September and October. In fact, Minneapolis President Kashkari was out on Friday calling for an end to rate hikes, although he is arguably the most dovish member of the FOMC. Interestingly, the trade truce is likely to lead to one less problem the Fed has highlighted as an economic headwind, and may result in some more hawkish commentary, but my guess is that the current mindset at the Eccles Building is one of moderation. I continue to believe that a December hike is a done deal, but I challenge anyone who claims they have a good idea for what 2019 will bring. The arguments on both sides are viable, and the proponents are fierce in their defense. While the Fed continues to be a key driver of FX activity, my sense is that longer term FX views are much less certain these days, and will continue down to be that way as the Fed strives to remove Forward Guidance from the tool kit. Or at least put it away for a while. I still like the dollar, but I will admit my conviction is a bit less robust than before.

Good luck
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Problem’s Aplenty

Two stories have traders’ attention
The first showed the Fed’s apprehension
That their preferred path
Was earning the wrath
Of markets, thus causing dissention

The other is that the G20
(According to the cognoscenti)
May let Xi explain
A trade war’s insane
Since both men have problems aplenty

Once again the market has narrowed its focus on two things only, in this case the Minutes from the November FOMC meeting and the upcoming dinner between Presidents Trump and Xi at the G20 meeting in Buenos Aires. It seems that traders in virtually every market are taking their cues from these stories.

Starting with the Minutes, it is clear that the Fed finds itself at an inflection point in their policymaking with the easy part now behind them. Up until September, it was evident that policy was extremely accommodative, and the Fed’s goal of gradually reducing that accommodation was easy to achieve, hence the steady pace of a 25bp rate hike every other meeting. However, despite the fact that nobody actually knows where the neutral rate of interest (also known as r*) is, it is apparent that the current Fed funds rate is much closer to that mythical rate than it used to be. Hence the dilemma. How much further should the Fed raise rates, and at what pace? The last thing they want is to raise rates sufficiently to slow the economy into a recession. But they also remain quite wary of policy settings that are too easy, since that could lead to financial instability (read bubbles) and higher inflation. This is why they get paid the big bucks!

Signals from the US economy lately have been mixed, with the housing market slowing along with auto sales, but general consumer confidence and spending remaining at very high levels. Underpinning the latter is the ongoing strength in the labor market, where the Unemployment rate remains near 50 year lows of 3.7%. There is a caveat with the labor market though, and that is the Initial Claims data, which had been trending lower consistently for the past nine years, but has suddenly started to tick higher over the past month. While this could simply be a temporary fluctuation based on changes in seasonal adjustments, it could also be the proverbial canary in the coalmine. We will have a better sense next Friday, when the November NFP report is released, but based on the recent Initial Claims data, a soft employment report is entirely within reason.

The upshot is that the Fed is no longer certain of its near term rate path which means that many of the investing memes of the past ten years, notably buy-the-dip, may no longer make sense. Instead, the volatility that we have seen lately across all markets is likely to be with us going forward. But remember, too, that volatility is a market’s natural habitat. It has been the extreme monetary policies of central banks that have moderated those natural movements. And as central banks back away from excessive monetary ease, we should all expect increased volatility.

The second story is the upcoming meeting between Presidents Trump and Xi tomorrow night. Signals from Trump going into the meeting have been mixed (aren’t all his signals mixed?) but my take is that sentiment is leaning toward at least a pause in any escalation of the trade war, with the true optimists expecting that concrete progress will be made toward ending the tariffs completely. Color me skeptical on the last part, but I wouldn’t be surprised if a temporary truce is called and negotiations restarted as both men are under increasing domestic pressure (China’s PMI just fell to 50.0 last night indicating the economy there is slowing even more rapidly than before) and so a deal here would play well both on a political level, as well as to markets in each country. And when the needs of both parties are aligned, that is when deals are made. I don’t think this will end the tension, but a reduction in the inflammatory rhetoric would be a welcome result in itself.

Recapping the impact of the two stories, the fact that the Fed is no longer inexorably marching interest rates higher has been seen as quite the positive for equities, and not surprisingly a modest negative for the dollar. Meanwhile, optimism that something positive will come from the Trump-Xi dinner tomorrow has equity bulls licking their collective chops to jump back into the market, while FX traders see that as a dollar negative. In other words, both of the key stories are pointing in the same direction. That implies that prices already reflect those views, and that any disappointment will have a more significant impact than confirmation of beliefs.

As it happens, the dollar is actually a bit firmer this morning, rallying vs. most of its G10 counterparts, but only on the order of 0.2%. The pound remains under pressure as traders continue to try to handicap the outcome of the Parliamentary vote on Brexit on December 11, and the signs don’t look great. Meanwhile, the euro has softened after weaker than expected CPI data (headline 2.0%, core 1.0%) and continued weak growth data are making Signor Draghi’s plans to end QE next month seem that much more out of touch.

This morning brings a single data point, Chicago PMI (exp 58.0) as well as a speech from NY Fed President John Williams. However, at this point, given we have heard from both the Chairman and vice-Chairman already this week, it seems unlikely that Williams will surprise us with any new views. Remember, too, that Powell testifies to Congress next week, so we will get to hear an even more detailed discussion on his thinking on Tuesday. Until then, it seems that the dollar will continue its recent range trading. The one caveat is if there truly is a breakthrough tomorrow night in Buenos Aires, we can expect the dollar to respond at the opening in Asia Sunday night. But for today, it doesn’t feel like much is on the cards.

Good luck and good weekend
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