Flummoxed

Kuroda flummoxed
As inflation fails to rise
How low can rates go?

You know things are tough in Japan, at least for the BOJ, when a sales tax hike, that in the last go-round increased inflation by nearly two percentage points, had exactly zero impact on the latest CPI readings. Last night’s Tokyo CPI data was released at 0.4%, unchanged from the September data and well below the 0.7% expected. And that’s an annual number folks, not the monthly kind. It seems that the government’s efforts to help young families by reducing tuition for pre-school and kindergarten to zero was enough to offset the impact of the rise in the Goods and Services Tax, essentially the Japanese VAT. However, the upshot is that CPI inflation, at least in Tokyo which is seen as a harbinger for the nation as a whole, remains nonexistent. Now for the average Japanese family, one would think that is a good thing. After all, who wants the prices of the stuff they need to buy rising all the time. But for the BOJ, who doggedly continues to believe that unless inflation rises to 2.0% the economy will implode, it is merely the latest sign that central banks are out of ammunition.

The yen’s response to this ongoing futility was to rise ever so marginally, not quite 0.1%, but that has not changed its more recent trend. In the past two months, the yen has weakened a solid 4.4%. But the picture changes if you step a bit further back for more perspective. Over the past six months, since late April, the yen has actually strengthened nearly 3.0%. So, which is it; is the yen getting stronger or weaker? In fact, I would argue that it is doing neither, but rather the yen is in a major long-term consolidation pattern (a triangle formation for the technicians out there) and that barring a major exogenous shock like a GFC2, the yen is likely to continue trading in an even narrower range going forward, perhaps for as long as the next year. The thing is, these triangle patterns tend to resolve themselves with a very significant break-out move when they end. At this stage, there is no way to discern which direction that will follow, and , as I said, it is probably a year away, but it is quite realistic to expect that the doldrums we have experienced in the yen for the past many years is likely to end. Perhaps the US presidential election will be the catalyst to cause a change, at least the timing will be right.

For hedgers, the best advice I can offer is to extend the tenor of your hedges as much as you can. This is especially true for receivables hedgers, where the carry is in your favor. But the reality is that even a payables hedger needs to consider the benefits of hedging in an extremely low volatility environment as opposed to waiting until a breakout, which may result in the yen jumping higher by as much as 5%-10%, completely outweighing the current cost of carry.

Three Latin American nations
Have populist administrations
Brazil, on the right
Of late’s shining bright
But fear’s grown ‘round Argie’s relations

For the past two weeks, the story in Brazil has been one of unadulterated joy, at least for investors. The real has rallied more than 5.0% in that time as President Jair Bolsonaro, the right-wing firebrand, has been able to push pension reform through congress there. That has been warmly received by markets as it implies that Brazil’s long-term finances are likely to remain under control. The pension system had been massively underfunded and was far too generous relative to the government’s ability to pay. Correcting these problems is seen as crucial to allowing Brazil to move forward with other investments to help the nation’s economy and productivity. Again, a glance at the charts shows that USDBRL has formed a triple top formation and is already accelerating lower. Quite frankly, it would not surprise to see BRL strengthen to 3.70 before this movement is over.

Turning to Mexico, it too has performed extremely well over the past two months, rallying more than 5% during that time. It is interesting that the markets have been extremely patient with AMLO as, since his initial action to cancel the Mexico City Airport construction, which was seen in an extremely negative light, his policies have been far less disruptive than most investors feared. Clearly, Mexico has been a beneficiary of the ongoing US-China trade war as companies seek low cost manufacturing sites near the US and given the (still pending) USMCA trade agreement, there is more confidence that companies will be able to set up shop there with fewer repercussions.

However, as with the yen, I might argue that what we have seen over the past five years is an increasingly narrowing consolidation in the peso’s exchange rate, albeit with a tad more volatility attached. And the thing about this pattern is its culmination is likely to occur much sooner than that in the yen. A quick look at MXN’s PPP shows that the peso remains significantly undervalued vs. the dollar, and in truth vs. most currencies. All this points to the idea that barring any surprisingly anti-business actions from AMLO, the peso may be setting up for a much larger rally, especially with the carry benefits that continue to exist.

Argentina, on the other hand, with newly elected left-wing President Fernandez, has its work cut out for itself. If you recall, the preliminary vote back in August, saw the peso decline more than 35%, and while it was choppy for a bit, the price action of late has been for steady depreciation. It is too early to know what Fernandez will do, but given the dire straits in the Argentine economy, with inflation running north of 50% while growth is shrinking rapidly and the debt situation is untenable, it seems the path of least resistance is for ARS to continue to weaken.

A quick look at the majors sees the dollar generally firmer this morning as there is a mild risk-off sentiment in markets. However, the news moments ago that the Labour party agreed to an early election has helped bolster the pound specifically, and risk in general. I expect that the pound will now be reacting to the polls as it becomes clearer if Boris can win with a majority, or if he will go down to defeat and perhaps an even more beneficial outcome for the pound will arise, the withdrawal of Article 50. My money remains on a Johnson victory and a Brexit with the recently negotiated deal.

This morning we get two minor pieces of data, Case Shiller Home Prices (exp 2.10%) and Consumer Confidence (128.0). Yesterday we did see a weak Dallas Fed manufacturing index print, but equity markets made new highs. I can see little reason, beyond the ongoing Brexit story, for traders to alter their positions ahead of tomorrow’s FOMC meeting, and so anticipate another quiet day in the market.

Good luck
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So Despised

Is anyone truly surprised
That Parliament, once authorized
To find a solution
Found no substitution
For May’s deal that they so despised?

One of the more confusing aspects of recent market activity was the rally in the pound when Parliament wrested control of the Brexit process from PM May. The idea that a group of 650 fractious politicians could possibly agree on a single idea, especially one so fraught with risks and complexities, was always absurd. And so, predictably, yesterday Parliament voted on seven different proposals, each designed to be a path forward, and none of them even came close to achieving a majority of votes. This included a vote to prevent a no-deal Brexit. In the meantime, PM May has now indicated she will resign regardless of the outcome, which, arguably, will only lead to more chaos as a leadership fight will now consume the Tories. In the meantime, there is still only one deal on the table, and it doesn’t appear to have the votes to become law. As such, while I understand that the idea of a hard Brexit is anathema to so many, it cannot be dismissed as a potential outcome. It should not be very surprising that the FX market is taking the idea a bit more seriously this morning, although only a bit, as the pound has fallen a further 0.4%, which makes the move a total of 1.0% lower in the past twenty-four hours.

One way to look at the pound’s value is as a probability weighted price of three potential outcomes; no deal, passing May’s deal and a long delay. Based on my views that spot would trade to 1.20, 1.38 or 1.40 depending on those outcomes, and assigning probabilities of 40%, 20% and 40% to those outcomes, spot is actually right where it belongs near 1.3160. But that leaves room for a lot of movement!

Meanwhile, elsewhere in the FX market, volatility is making a comeback. Between Turkey (-5.0%), Brazil (-3.0%) and Argentina (-3.0%), it seems that traders are beginning to awaken from their month’s long hiatus. Apparently, the monetary policy anesthesia that had been administered by central banks globally is wearing off. As it happens, each of these currencies is dealing with local specifics. For instance, upcoming elections in Turkey have President Erdogan on the defensive as his iron grip on power seems to be rusting and he tries to crack down on speculators in the lira. Meanwhile, recently elected Brazilian president Bolsonaro has seen his honeymoon end quite abruptly with his approval ratings collapsing and concerns over his ability to implement key policies seen as desirable by the markets, notably pension reform. Finally, Argentine president Macri remains under pressure as the slowing global growth picture severely restricts local economic activity although inflation continues to run away to unsustainable levels (4% per month!) and the peso, not surprisingly is suffering.

As to the G10, activity there has been less impressive although the dollar’s tone this morning is one of strength, not weakness. In fact, risk continues to be jettisoned by investors as can be seen by the continuing rally in government bonds (Treasury yields falling to 2.35%, Bund yields to -0.07%, JGB’s to -0.09%) while equity markets were weak in Asia and have gained no traction in Europe. Adding to the impression of risk-off has been the yen’s rally (0.2% overnight, 1.0% in the past week), a reliable indicator of market sentiment.

Turning to the data, yesterday saw the Trade Balance shrink dramatically, to -$51.1B, a much lower deficit than expected, and sufficient to positively impact Q1 GDP measurement by a few tenths of a percent. This morning we see the last reading on Q4 GDP (exp 1.8%) as well as Initial Claims (225K). Given the backward-looking nature of Q4 data, it seems unlikely today’s print will impact markets. One exception to this thought would be a much weaker than expected print, which may convince some investors the global slowdown is more advanced than previously thought with equities selling off accordingly. But a better number is likely to be ignored. We also hear from (count ‘em) six more Fed speakers today (Quarles, Clarida, Bowman, Williams, Bostic and Bullard), but given the consistency of recent comments by others it seems doubtful we will learn anything new. To recap, every FOMC member believes that waiting is the right thing to do now and that they should only respond when the data indicates there is a change, either rising inflation or a significant slowing in the economy. Although the market continues to price rate cuts before the end of the year, as yet, there is no indication that Fed members are close to believing that is necessary.

Ultimately, the same key stories are at the fore in markets. Brexit, as discussed above, slowing global growth and the monetary policy actions being taken to ameliorate that, and the US-China trade talks, which are resuming but have made no new progress. One of the remarkable features of markets lately has been the resilience of equity prices despite a constant drumbeat of bad economic news. Investors have truly placed an enormous amount of faith in central banks (specifically the Fed and ECB) to be able to come to the rescue again and again and again. Thus far, that faith has been rewarded, but keep in mind that the toolkit continues to dwindle, so that level of support is likely to diminish. In the end, I continue to see the dollar as a key beneficiary of the current policy mix, as well as the most likely ones for the near future.

Good luck
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Too Arcane

The Fed took the time to explain
Why ‘Neutral’ they’ll never attain
Though theories suppose
O’er that rate, growth slows
Its measurement is too arcane

If one needed proof that Fed watching was an arcane pastime, there is no need to look beyond yesterday’s activities. As universally expected, the FOMC raised the Fed funds rate by 25bps to a range of 2.00% – 2.25%. But in the accompanying statement, they left out the sentence that described their policy as ‘accommodative’. Initially this was seen as both surprising and dovish as it implied the Fed thought that rates were now neutral and therefore wouldn’t need to be raised much further. However, that was not at all their intention, as Chairman Powell made clear at the press conference. Instead, because there is an ongoing debate about where the neutral rate actually lies, he wanted to remove the concept from the Fed’s communications.

The neutral rate, or r-star (r*) is the theoretical interest rate that neither supports nor impedes growth in an economy. And while it makes a great theory, and has been a linchpin of Fed models for the past decade at least, Chairman Powell takes a more pragmatic view of things. Namely, he recognizes that since r* cannot be observed or measured in anything like real-time, it is pretty useless as a policy tool. His point in removing the accommodative language was to say that they don’t really know if current policy is accommodative or not, at least with any precision. However, given that their published forecasts, the dot plot, showed an increase in the number of FOMC members that are looking for another rate hike this year and at least three rate hikes next year, it certainly doesn’t seem the Fed believes they have reached neutral.

The market response was pretty much as you would expect it to be. When the statement was released, and initially seen as dovish, the dollar suffered, stocks rallied and Treasury prices fell in a classic risk-on move. However, once Powell started speaking and explained the rationale for the change, the market reversed those moves and the dollar actually edged higher on the day, equity markets closed lower and Treasury yields fell as bids flooded the market.

In the end, there is no indication that the Fed is slowing down its current trajectory of policy tightening. While they have explicitly recognized the potential risks due to growing trade friction, they made clear that they have not seen any evidence in the data that it was yet having an impact. And given that things remain fluid in that arena, it would be a mistake to base policy on something that may not occur. All told, if anything, I would characterize the Fed message as leaning more hawkish than dovish.

So looking beyond the Fed, we need to look at everything else that is ongoing. Remember, the trade situation remains fraught, with the US and China still at loggerheads over how to proceed, Canada unwilling to accede to US demands, and the ongoing threat of US tariffs on European auto manufacturers still in the air. As well, oil prices have been rallying lately amid the belief that increased sanctions on Iran are going to reduce global supply. There is the ongoing Brexit situation, which appears no closer to resolution, although we did have French President Macron’s refreshingly honest comments that he believes the UK should suffer greatly in the process to insure that nobody else in the EU will even consider the same rash act as leaving the bloc. And the Italian budget spectacle remains an ongoing risk within the Eurozone as failure to present an acceptable budget could well trigger another bout of fear in Italian government bonds and put pressure on the ECB to back off their plans to remove accommodation. In other words, there is still plenty to watch, although none of it has been meaningful to markets for more than a brief period yet.

Keeping all that in mind, let’s take a look at the market. As I type (which by the way is much earlier than usual as I am currently in London) the dollar is showing some modest strength with the Dollar Index up about 0.25% at this point. The thing is, there has been no additional news of note since yesterday to drive things, which implies that either a large order is going through the market, or that short dollar positions are being covered. Quite frankly, I would expect the latter reason is more compelling. But stepping back, the euro has traded within a one big figure range since last Thursday, meaning that nothing is really going on. The same is true for most of the G10, as despite both data and the Fed, it is clear very few opinions have really changed. My take is that we are going to need to see material changes in the data stream in order to alter views, and that will take time.

In the emerging markets, we have two key interest rate decisions shortly, Indonesia is forecasts to raise their base rate by 25bps to 5.75% and the Philippines are expected to raise their base rate by 50bps to 4.50%. Both nations have seen their currencies remain under pressure due to the dollar’s overall strength and their own current account deficits. They have been two of the worst three performing APAC currencies this year, with India the other member of that ignominious group. Meanwhile, rising oil prices have lately helped the Russian ruble rebound with today’s 0.2% rally adding to the nearly 7% gains seen in the past two plus weeks. And look for the Argentine peso to have a solid day today after the IMF increased its assistance to $57 billion with faster disbursement times. Otherwise, it is tough to get very excited about this bloc either.

On the data front, this morning brings the weekly Initial Claims data (exp 210K), Durable Goods (2.0%, 0.5% ex transport) and our last look at Q2 GDP (4.2%). I think tomorrow’s PCE data will be of far more interest to the markets, although a big revision in GDP could have an impact. But overall, things remain on the same general trajectory, solid US growth, slightly softer growth elsewhere, and a Federal Reserve that is continually tightening monetary policy. I still believe they will go tighter than the market has priced, and that the dollar will benefit accordingly. But for now, we remain stuck with the opposing cyclical and structural issues offsetting. It will be a little while before the outcome of that battle is determined, and in the meantime, a drifting currency market is the most likely outcome.

Good luck
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Doves Will Despise

Come two o’clock later today
The Fed will attempt to convey
How high rates may rise
Though doves will despise
The idea that more’s on the way

Ahead of the conclusion of the FOMC meeting today, very little has happened in the FX markets, and in fact, in most markets. At this point, given the fact that the Fed remains one of the key drivers to global monetary policy, and the still significant concern that the ongoing divergence in Fed policy with that of the rest of the world can have negative consequences, pretty much every investor is awaiting the Fed statement and Chairman Powell’s press conference. It is a foregone conclusion that they will raise the Fed Funds rate by 25bps to 2.00% – 2.25%.

So the big question is just what the dot plot will look like, especially since today is the first time we will see their 2021 forecasts. Economists and analysts have slowly accepted that the Chairman is on a mission here, and that rates are going to continue to rise by 25bps every quarter at least through June 2019. That would put Fed Funds at 2.75% – 3.00%, a level that is currently seen as ‘neutral’. But what is still uncertain is how the Fed itself expects the economy to evolve beyond the end of the previous forecast period. Any indication that their models point to faster growth would be quite surprising and have a market impact. In fact, the most recent Fed forecasts have been for the economy to peak soon and begin to slow back to a 2.0% GDP growth rate by 2020. It is changes in this trajectory that will be of the most interest. That and Chairman Powell’s comments and answers at the press conference. But at this point, all we can do is wait.

Looking around the rest of the world, we see that central banks everywhere continue to have their policy dictated by the Fed. Two examples are Indonesia and the Philippines, both of whom are expected to raise rates this week (Indonesia by 25bps, Philippines by 50bps) as both of these nations continue to run current account deficits and have seen their currencies erode in value faster than any of their Asian peers other than India. The nature of these two countries, which is quite common in the emerging market sphere, is that currency weakness passes through quickly to higher inflation, and so the dollar strength that we have seen since the beginning of Q2 has already had a significant impact. It is this issue that has prompted a number of emerging market central bankers to caution Chairman Powell of the negative consequences of the current Fed policy trajectory. However, Powell has dismissed these out of hand and the Fed continues on its course.

The other notable movement in the EMG bloc was in Argentina, where the central bank president resigned after just three months on the job. Luis Caputo was both liked and respected by markets and the FX market responded by pushing the peso lower by 2.5% on the news. Of course, in the broad scheme of things, this is not very much compared to the currency’s 50% decline this year.

Pivoting to the G10, FX movement has been modest overall, with the biggest movers AUD and NZD, both of which seem to be benefitting from the recent revival in commodity prices. There has been no new Brexit news and so the pound remains relatively unscathed. Meanwhile, after Monday’s excitement in the euro following Signor Draghi’s “relatively vigorous” comments, it seems that ECB member Peter Prâet was trotted out to explain that there was no change in the committee’s view and that rates would not be rising until much later next year. Ultimately, however, the euro is essentially unchanged on the day, with the market having drawn that conclusion shortly after the comments were made.

Yesterday’s US data showed that Consumer Confidence was approaching all time highs but House prices seemed to display some weakness. This is the perfect mix for the Fed, lessening price pressures along with optimism on economic growth. I assure you this will not deter the Fed from continuing on its path. Before the FOMC meeting ends this afternoon, New Home Sales data will print, expected to be 630K, which looks right about in line with the longer term trend, albeit showing some softness from the situation earlier this year.

I see no reason to expect that the market will move significantly before the FOMC, and of course, can only watch with the rest of the market to see what actually comes from the meeting as well as what the Chairman says. Until then, look for a quiet session.

Good luck
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Realistic

As far as the market’s concerned
The mood out of Brussels has turned
They’re quite optimistic
A deal is “realistic”
By early November, we’ve learned

Michel Barnier, the EU negotiator for Brexit has lately changed his tune. Last month, ostensibly at the direction of his political masters, he was playing hardball, shooting down every UK proposal as inadequate and saying there was no negotiating room on the EU’s positions. Not surprisingly, the pound came under pressure during this period, trading to its lowest level in more than a year and approaching the post-vote lows. But a funny thing happened during the past week, Europe suddenly figured out they didn’t really want a no-deal Brexit. The first inkling came from comments by German officials who indicated that compromises were available. That changed the tone of the negotiations and suddenly, as I mentioned last week, it seemed that a deal was more likely. Those comments last week helped the pound rally more than 1%. Then yesterday morning Barnier explained that a deal is both “realistic” and “possible” within 6-8 weeks. It should be no surprise that the pound rallied yet again on the news, jumping another 1% during the US session and maintaining those gains ever since.

Regular readers will know that I have been quite bearish on the pound for two reasons; first is the fact that I continue to see the dollar strengthening over the medium term as the Fed’s tighter monetary policy leads all developed nations and will continue to do so. But the other reason was that I have been quite skeptical that a Brexit deal would be agreed and that the initial concern over damage to the UK economy would undermine the currency. However, this change in tone by the EU over Brexit is almost certainly going to have a significant positive impact on the pound’s value vs. both the euro and the dollar. And even though any deal is likely to be short on details, I expect that we will see the pound outperform the euro for the next several months at least. So any dollar strength will be less reflected vs. the pound than the euro, while any dollar weakness should see the pound as the top performer. The thing is, the details of the deal still matter a great deal, and at some point in the future, the UK and the EU are going to need to figure out how they are going to deal with the Irish border situation, even if they have kicked that particular can further down the road for now.

While on the topic of the UK, I would be remiss if I didn’t mention that the employment situation there remains robust. Unemployment data was released this morning showing the Unemployment Rate remained at 4.0%, the lowest level since 1975, while wage growth accelerated to 2.9%. The latter potentially presages further inflation, as measured productivity in the UK remains quite soft at 1.5% per annum. If this continues, higher wages amid low productivity, the BOE may find itself forced to raise rates regardless of the Brexit situation. Yet another positive for the beleaguered pound. Perhaps the bottom is in after all.

However, away from yesterday’s news on the pound, the FX markets have been quite uninteresting in the past twenty-four hours. Arguably, the dollar is a touch stronger, but the movement has been minute. Even the emerging market bloc has been less active with perhaps the most notable feature the fact that INR continues to trade to new historic lows (dollar highs) every day. As to the group of currencies that has led the turmoil, TRY, ARS and ZAR, all of them are slightly firmer this morning as they continue to consolidate their losses over the past month. In addition, we hear from the central banks of both Argentina (today) and Turkey (tomorrow), with more attention focused on the latter than the former. Recall that Argentine interest rates are already the world’s highest at 60% and no move is anticipated. However, Turkey’s meeting is anxiously awaited as the market is looking for a 300bp rate hike to help stem rising inflation and the currency’s weakness. The problem is that Turkish President Erdogan has been quite adamant that he is strongly against higher interest rates and given his apparent control over the central bank, it is by no means assured that they will act according to the market’s expectations. Be prepared for another leg lower in the lira if the Bank of Turkey disappoints.

As to today’s session, the NFIB Small Business Index was released at 108.8, stronger than expected and a new record high for the release. Despite the trade concerns and the political circus in Washington, small businesses have never been more confident in their future. I will admit that this almost seems like whistling past the graveyard, but for now everything is great. Later this morning we see the JOLTs Job report (exp 6.68M), which should simply reconfirm that the employment situation in the US remains robust.

And that’s really it for today. Equity futures are flat although the 10-year Treasury is continuing its recent trend lower (higher yields), albeit at a slow rate. There is certainly no evidence that the Fed is going to change its path, but for today, it seems unlikely that we will see much movement in either direction beyond what has already occurred. Barring, of course, any surprising new comments.

Good luck
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Mostly At Peace

Ahead of the payroll release
The market is mostly at peace
But there is no sign
The recent decline
In values is set to decrease

While I apologize for the double negative, this morning’s price action is a story of consolidation of recent losses across emerging market currencies and their respective equity markets. In fact, the biggest gainers in the FX markets today are some of the currencies that have been suffering the most recently. For example, the South African rand is higher by 1.4% on the day, but still down nearly 3.0% this week. Meanwhile in Brazil, in the wake of the assassination attempt on Brazilian presidential candidate Jair Bolsonaro, the real has rebounded 1.75%, essentially recouping the week’s losses, although is still down almost 8.0% this month. The story here is that Bolsonaro, who was leading in the polls and is favored by markets due to his free-market leanings, is expected to receive a sympathy vote along with more press coverage, and has increased his odds of winning the election next month. And of course, everyone’s favorite pair of losers, TRY and ARS, are both firmer this morning as well, by 3.5% and 2.75% respectively, but both remain down substantially in the past month. And there is no sign that policy is going to change sufficiently to have any positive impact in the short term. In other words, while many EMG currencies have performed well overnight, there is little reason to believe that the unfolding crisis in the space has ended.

Turning to the biggest news of the day, the payroll report is due with the following expectations:

Nonfarm Payrolls 191K
Private Payrolls 190K
Manufacturing Payrolls 24K
Unemployment Rate 3.8%
Average Hourly Earnings 0.2% (2.7% Y/Y)
Average Weekly Hours 34.5

If forecasts are on the mark, it will simply represent a continuation of the current US expansion and cement the case for two more rate hikes by the Fed this year. In fact, we would need to see substantially weaker numbers to derail that process on a domestic basis. And given yesterday’s Initial Claims data of 203K, the lowest print since 1969, it seems highly unlikely that this data will be weak.

A second factor reinforcing the view that the Fed will remain on their current rate-raising path was a comment by NY Fed President John Williams. Yesterday, after a speech in Buffalo, he said that he would not be deterred from raising rates simply because it might drive the yield curve into an inversion. This is quite a turn of events for Williams who had historically leaned more dovish when he was at the San Francisco Fed. In addition, it is exactly the opposite from what we have recently heard from two separate Fed presidents, Atlanta’s Bostic and St Louis’ Bullard, both of who were explicit in saying they would not vote for a rate hike if that would cause an inversion. Of course, neither of them is a voter right now while Williams is, so his voice is even more important.

While it is not clear whether Chairman Powell is of a like mind on this subject, there is certainly no evidence that Powell is going to be deterred from his current belief set that further gradual rate hikes are necessary and appropriate. The one thing that is very clear is that the current Fed is focused almost entirely on the US economy, to the exclusion of much of the rest of the world. And this focus reduces the chance that Powell will respond to further emerging market instability unless it reaches a point where the US economy is likely to be impacted. As far as I can tell, the Fed’s focus remains on the impact of the recent increase in fiscal stimulus and how that might impact the inflation situation.

There is one other thing to keep in mind today, and going forward, and that is that yesterday was the last day of comment period on President Trump’s mooted tariff increase on a further $200 Billion of Chinese imports. If he does follow through by implementing these tariffs, look for significant market impact with the dollar resuming its climb and a much bigger negative impact on equity markets as investors try to determine the impact on company results. Also look for commodity prices to decline on the news.

But that is really it for the day. Ahead of the data there is little reason for much of a move. However, even after the data, assuming the forecasts are reasonably accurate, I would expect the dollar’s consolidation to continue. In the end, though, all signs still point to a stronger dollar over time.

Good luck
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Their Canard

At last both the Germans and Brits
Realized, nations both, would take hits
If Brexit was hard
So now their canard
Is claiming, details, they’ll omit

The tone of the market changed early yesterday afternoon when a story hit the tape about Brexit indicating that both sides had moved closer to finding an agreement. While some might say this is simply a muddle-through effort (and I would be one of those) the facts seem to be that both sides are willing to move forward with far less specificity than had previously been demanded. In a nutshell, the prior stance had called for a Brexit agreement that was explicit as to the solutions for things like the Irish border issue when the UK leaves the EU. In essence, while both sides agree a transition period is necessary, the EU especially, was demanding to know the details of how things would eventually fall out. Of course, the UK couldn’t discuss those given the amount of internal dissention amongst the May government on the issue. But now, the Germans have said that those details could wait until after the March 2019 exit, and that the future trade agreement can be negotiated in more detail then. This opens the door for a more wishy-washy Brexit agreement, which is likely the only type that can be approved by both the UK Parliament and the EU’s 28 other members.

The market impact was immediate with the pound gapping higher by 1% when the story was released, and although it has given back a portion of those gains, it remains higher overall today. The euro, too, jumped at the same time, albeit not quite as far, with an immediate bump of 0.5%, most of which it has retained. The real question, though, seems to be; is this a temporary situation, or has there been a fundamental change in the FX market?

Certainly there is a valid argument that a positive turn in the Brexit negotiations should lead to further pound strength. After all, while the dollar has appreciated a solid 6% against a basket of currencies since April, the pound has fallen more than 10% over that time. It is not unreasonable to assume that the difference is attributable to the steadily deteriorating views on a positive Brexit outcome. If the Brexit situation becomes less fraught, then a rebound in the pound would be a natural outcome. While one day does not make a trend, we will watch this closely going forward.

But aside from the news on Brexit, the main theme in the markets continues to be the ongoing meltdown in EMG currency and equity markets. Yesterday saw some of the worst behavior we have witnessed in this move, and the term contagion was bandied about in many analyses. This morning, things have settled down a bit, and actually we are seeing several of the worst hit currencies claw back a small portion of recent losses. For example, ZAR, which had fallen nearly 6.0% yesterday, is higher by 0.75% this morning. MXN, which lost 2.5% yesterday at its worst, has since regained about half of that with 0.5% coming this morning. Meanwhile, both TRY and ARS, the leaders of the pack when it comes to collapsing currencies, are both higher by a bit over 1% this morning. Of course, relative to their 20+% declines in the past month, this is small beer. However, the point is that the market feels far more stable this morning than yesterday’s situation.

Despite this morning’s stability, though, the broader issues remain. I assure you that neither Turkey nor Argentina have solved their macroeconomic problems. Inflation remains rampant in both nations and will continue to do so for a while. India, Brazil and Indonesia still have large C/A deficits and the Fed has not yet changed its tune. They will raise rates by 25bps later this month, and the odds are still quite high they will do so again in December. This tells me that today’s price action is a breather as traders and investors prepare themselves for tomorrow’s payroll report. Remember, one of the things we learned from Powell’s Jackson Hole speech was that the Fed is closely watching the data and has concerns about an overheating economy. If tomorrow’s data shows higher than expected hourly earnings, or a dip to 3.7% Unemployment, those could well be the signals that add urgency to their tightening process.

Meanwhile, looking ahead to the rest of the US session, we get quite a bit of data as follows:

ADP Employment 190K
Initial Claims 214K
Nonfarm Productivity 3.0%
Unit Labor Costs -0.9%
Factory Orders -0.6%
ISM Non-Manufacturing 56.8

This week’s ISM data was very strong, and the Trade Deficit has blown out as US growth outpaces that of pretty much every other developed nation. So as far as the data story goes, there is no reason to believe that the Fed is going to pause in the near term, despite concerns over the shape of the yield curve. And given that stance, I remain a firm believer in the dollar’s potential. Until the Fed changes its tune, I see no reason to change mine.

Good luck
Adf