Weakness Worldwide

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

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

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

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

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

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

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

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

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

Good luck
Adf

 

QE Will Soon Have Returned

The ECB started the trend
Which helped the bond market ascend
Then yesterday Jay
Was happy to say
A rate cut he’d clearly portend

Last night from Japan we all learned
Kuroda-san was not concerned
That yields there keep falling
And if growth is stalling
Then QE will soon have returned

This morning on Threadneedle Street
The Governor and his staff meet
Of late, they’ve implied
That rates have upside
But frankly, that tune’s obsolete

This morning, every story is the same story, interest rates are going lower. Tuesday, Signor Draghi told us so. Yesterday Chairman Jay reiterated the idea, and last night, Kuroda-san jumped on the bandwagon. This morning, Governor Carney left policy unchanged, although he continues to maintain that interest rates in the UK could rise if there is a smooth exit from the EU. Gilt markets, however, clearly don’t believe Carney as yields there fall and futures markets are pricing in a 25bp rate cut by the end of the year.

But it is not just those banks that are looking to ease policy. Remember, several weeks ago the RBA cut rates to a new record low at 1.25%, and last night, Governor Lowe indicated another cut was quite realistic. Bank Indonesia cut the reserve requirement by 0.50% last night and strongly hinted that an interest rate cut was on its way. While Bangko Sentral ng Pilipanas surprised most analysts by leaving rates on hold due to an uptick in inflation, that appears to be a temporary outcome. And adding to the Asian pressure is the growing belief that the RBNZ is also set to cut rates right before Australia does so.

In fact, looking around the world, there is only one place that is bucking this trend, Norway, which actually increased interest rates this morning by 25bp to a rate of 1.25%. In fairness, Norway continues to grow strongly, estimated 2.6% GDP growth this year, and inflation there is running above the 2.0% target and forecast to continue to increase. And it should be no surprise that the Norwegian krone is this morning’s best performing currency, rallying 1.0% vs. the euro and 1.5% vs. the dollar.

But in the end, save Norway, every story is still the same story. Global GDP growth is slowing amid increased trade concerns while inflationary pressures are generally absent almost everywhere. And in that environment, policy rates are going to continue to fall.

The market impacts ought not be too surprising either. Equity investors everywhere are giddy over the thought of still lower interest rates to help boost the economy. Or if not boosting the economy, at least allowing corporations to continue to issue more debt at extremely low levels and resume the stock repurchase schemes that have been underpinning equity market performance. Meanwhile, bond market investors are pushing the central banks even further, with new low yield levels in many countries. For example, in the 10-year space, German bunds are at -0.31%; Japanese JGB’s are at -0.18%; UK Gilts yield 0.81%; and Treasuries, here at home, have fallen to 2.01% right now, after touching 1.97% yesterday. It is abundantly clear that the market believes policy rates are going to continue to fall, and that QE is going to be reinstated soon.

As to the FX markets, yesterday saw the beginning of a sharp decline in the dollar with the euro up nearly 1.0% since the FOMC announcement, the pound +0.5% and the yen +0.6%. This makes sense as given the global rate structure, it remains clear that the Fed has the most room to ease from current settings, and thus the dollar is likely to suffer the most in the short term. However, as those changes take effect, I expect that the dollar’s decline will slow down, and we will find a new short-term equilibrium. I had suggested a 3%-5% decline before settling, and that still seems reasonable. After all, despite the fall yesterday, the dollar is simply back to where it was a week ago, before all the central bank fireworks.

With the BOE out of the way, the rest of the morning brings us two data releases, Initial Claims (exp 220K) and Philly Fed (11.0). For the former, there is still real scrutiny there given the weak NFP number earlier this month, and estimates have been creeping slightly higher. A big miss on the high side will likely see rates fall further and the dollar with them. As to the latter, given the huge miss by the Empire Manufacturing print on Monday, there will be wariness there as well. A big miss here will become the second piece of news that indicates a more acute slowing of the US economy, and that will also likely see rates fall further.

In fact, that is the theme for now, everything will be an excuse for rates to fall until the meeting between President’s Trump and Xi next week, with all eyes looking for signs that the trade situation will improve. And one other thing to remember is that tensions in the Middle East are increasing after Iran claimed to have shot down a US drone. Both oil and gold prices are much higher this morning, and I assure you, Treasuries are a beneficiary of this story as well.

So, for the dollar, things look dim in the short and medium term, however, I see no reason for a prolonged decline. Hedgers should take advantage of the weakness in the buck to add to hedges over the next few weeks.

Good luck
Adf

The Chaff from the Wheat

As markets await the report
On Payrolls they’re having to sort
The chaff from the wheat
From Threadneedle Street
As Carney, does rate hikes exhort

The gloom that had been permeating the analyst community (although certainly not the equity markets) earlier this year, seems to be lifting slightly. Recent data has shown a stabilization, at the very least, if not the beginnings of outright growth, from key regions around the world. The latest news was this morning’s surprising Eurozone inflation numbers, where CPI rose a more than expected 1.7% in April, while the core rate rose 1.2%, matching the highest level it has seen in the past two years. If this is truly a trend, then perhaps that long delayed normalization of monetary policy in the Eurozone may finally start to occur. Personally, I’m not holding my breath. Interestingly, the FX market has responded by selling the euro with the single currency down 0.2% this morning and 1.0% since Wednesday’s close. I guess that market doesn’t see the case for higher Eurozone rates yet.

In the meantime, the market continues to consider BOE Governor Carney’s comments in the wake of yesterday’s meeting, where he tried to convince one and all that the tendency for UK rates will be higher once Brexit is finalized (and assuming a smooth transition). And perhaps, if there truly is a global recovery trend and policy normalization becomes a reality elsewhere, that will be the case. But here, too, the market does not seem to believe him as evidenced by the pound’s ongoing weakness (-0.3% and back below 1.30) and the fact that interest rate futures continue to price in virtually no chance of rate hikes in the UK before 2021.

While we are discussing the pound, there is one other thing that continues to confuse me, the very fact that it is still trading either side of 1.30. If you believe the narrative, the UK cannot leave the EU without a deal, so there is no chance of a hard Brexit. After all, isn’t that what Parliament voted for? In addition, according to the OECD, the pound at 1.30 is undervalued by 12% or so. Combining these two themes, no chance of a hard Brexit and a massively undervalued pound, with the fact that the Fed has seemingly turned dovish would lead one to believe that the pound should be trading closer to 1.40 than 1.30. And yet, here we are. My take is that the market is not yet convinced that a hard Brexit is off the table or else the pound would be much higher. And frankly, in this case, I agree. It is still not clear to me that a hard Brexit is off the table which means that any true resolution to the situation should result in a sharp rally in the pound.

Pivoting to the rest of the FX market, the dollar is stronger pretty much across the board this morning, and this is after a solid performance yesterday. US data yesterday showed a significant jump in Nonfarm Productivity (+3.6%) along with a decline in Unit Labor Costs (-0.9%), thus implying that corporate activity was quite robust and the growth picture in the US enhanced. We also continue to see US earnings data that is generally beating (quite low) expectations and helping to underpin the equity market’s recent gains. Granted the past two days have seen modest declines, but overall, stocks remain much higher on the year. In the end, it continues to appear that despite all the angst over trade, and current US policies regarding energy, climate and everything else, the US remains a very attractive place to invest and dollars continue to be in demand.

Regarding this morning’s data, not only do we see the payroll report, but also the ISM Non-manufacturing number comes at 10:00.

Nonfarm Payrolls 185K
Private Payrolls 180K
Manufacturing Payrolls 10K
Unemployment Rate 3.8%
Participation Rate 62.9%
Average Hourly Earnings 0.3% (3.3% Y/Y)
Average Weekly Hours 34.5
ISM Non-Manufacturing 57.0

One cannot help but be impressed with the labor market in the US, where for the last 102 months, the average NFP number has been 200K. It certainly doesn’t appear that this trend is going to change today. In fact, after Wednesday’s blowout ADP number, the whisper is for something north of 200K. However, Wednesday’s ISM Manufacturing number was disappointingly weak, so there will be a great deal of scrutiny on today’s non-manufacturing view.

Adding to the mix, starting at 10:15 we will hear from a total of five Fed speakers (Evans, Clarida, Williams, Bowman, Bullard) before we go to bed. While Bullard’s speech is after the markets close, the other four will get to recount their personal views on the economy and future policy path with markets still open. However, given that we just heard from Chairman Powell at his press conference, and that the vote to leave rates was unanimous, it seems unlikely we will learn too much new information from these talks.

Summing up, heading into the payroll report the dollar is firm and shows no signs of retreating. My take is a good number will support the buck, while a weak one will get people thinking about that insurance rate cut again, and likely undermine its recent strength. My money is on a better number today, something like 230K, and a continuation of the last two days of dollar strength.

Good luck and good weekend
Adf

Rather Wrong

While Powell said growth may be strong
He still thinks it seems rather wrong
That prices won’t rise
So it’s no surprise
That rates will go lower ‘ere long

After the FOMC left policy largely unchanged yesterday (they did tweak the IOER down by 5bps) and the statement was parsed, it appeared that the Fed’s clear dovish bias continues to drive the overall tone of policy. Growth is solid but inflation remains confusingly soft and it appeared that the Fed was moving closer to the ‘insurance’ rate cut markets have been looking hoping for to prevent weakness from showing up. Stocks rallied and so did bonds with the yield on the 10yr falling to 2.45% just before the press conference while stock markets were higher by 0.5% or so. But then…

According to Powell the story
Is price declines are transitory
So patience remains
The thought in Fed brains
With traders stuck in purgatory

Powell indicated that the majority view at the Fed was that the reason we have seen such weak price data lately is because of transitory issues. These include reduced investment management fees in the wake of the sharp equity market declines in Q4 of last year and the change in the way the Fed gathered price data at retail stores where they now collect significantly greater amounts of data digitally, rather than having ‘shoppers’ go to stores and look at price tags. The upshot is that while he was hardly hawkish in any sense of the word, trying to maintain as neutral a stance as possible, he was far more hawkish than the market had anticipated. Not surprisingly, markets reversed their earlier moves with 10yr yields shooting higher by 6bps, closing higher than the previous day’s close, while equity markets ceded all their early gains and wound up falling about 0.7% on average between the three major indices.

What about the dollar? Well, it followed the same type of trajectory as other assets, softening on the dovish ideas throughout the session before rallying a sharp 0.55% in the wake of Powell’s press conference opening statement. Since then, it has largely maintained the rebound, although this morning it is softer by about 0.1% across the board.

Looking ahead, markets are going to continue to focus on the interplay between the data releases and the central bank comments. Nothing has changed with regard to the overarching dovish bias evident in almost all central banks, but in order for them to act, rather than merely talk, the data will have to be clearly deteriorating. And lately, the best description of the data releases has been mixed. For example, yesterday saw a huge ADP Employment number, 275K, boding well for tomorrow’s NFP report. However, ISM Manufacturing fell sharply to 52.8, well below last month’s 55.3 reading as well as far below the 55.0 market expectation. So, which one is more important? That’s the thing. As long as we see strength in some areas of the economy along with weakness in others, the Fed is almost certainly going to sit on the sidelines. That is, of course, unless the inflation data starts to move more aggressively in either direction. I think it is far better than even money that Fed funds are 2.25%-2.50% on December 31.

But what about other places? Well, the ECB seems stuck between a rock and a hard place as Q1 data has been disappointing overall and they are running out of tools to fight a slowdown. Given the current rate structure, the question being debated in the halls in Frankfurt is just how low can rates go before having a net detrimental impact on the economy. If we see any further weakness from the Eurozone, we are going to find out. That brings us to this morning’s PMI data, where Bloomberg tried hard to put a positive spin on what remains lousy data. Germany (44.4), Italy (49.1) and France (50.0) remain desultory at best. The Eurozone print (47.2) is hardly the stuff of dreams, although in fairness, it was better than analysts had been expecting. So perhaps we are seeing the beginnings of a stabilization in the decline, rather than a continuing acceleration of such. But that hardly gives a rationale for tighter policy. The ECB remains stuck on hold on the rate front and is certainly going to see significant uptake of their new TLTRO’s when they come out. It remains difficult to see a reason for the euro to rebound given the underlying economic weakness in the Eurozone, especially with the ECB committed to negative rates for at least another year.

What about the UK? Well, the BOE met this morning and left rates on hold by a unanimous vote. They also released new economic forecasts that showed reduced expectations for inflation this year, down to 1.6%, with the out years remaining essentially unchanged. They indicated that the delay in Brexit would have a limited impact as they continue to plan on a smooth transition, and their growth forecasts changed with 2019 rising to 1.5% on the back of the inventory led gains in Q1, although the out years remain unchanged. Here, too, there is no urgency to raise rates, although they keep trying to imply that slightly higher rates would be appropriate. However, the market is having none of it, pricing a 30% chance of a 25bp rate cut before the end of next year. The pound chopped on the news, rallying at first, but falling subsequently and is now sitting at 1.3050, essentially unchanged on the day.

Of course, Brexit continues to influence the pound’s movements and recent hints from both PM May and Labour Leader Corbyn indicate that it is possible they are going to agree a deal that includes permanent membership of a customs union with the EU. Certainly, verification of that will help the pound rally back. But boy, if I voted for Brexit and this is what they delivered, it would be quite upsetting. In essence, it destroys one of the main benefits of Brexit, the ability to manage their own trade function. We shall see how it plays out.

This morning brings more data, starting with Initial Claims (exp 215K), Nonfarm Productivity (2.2%) and Unit Labor Costs (1.5%) at 8:30, then Factory Orders (1.5%) at 10:00. The onslaught of Fed speakers doesn’t start until tomorrow, so that’s really it for the day. Equity futures are rallying this morning as the idea that the markets fell yesterday seems more like a mirage than a market response to new information. In the end, you cannot fight city hall, and though Powell tried to sound tough, I didn’t see anything to change the view that the Fed remains biased toward cutting rates as their next move.

Good luck
Adf

Not Yet Inflated

Said Chairman Jay, we are frustrated
That prices have not yet inflated
So, patient we’ll be
With rates ‘til we see
More growth than now’s anticipated

The market response was confusing
With stocks up, ere taking a bruising
While Treasuries jumped
The dollar was dumped
And gold found more buyers, it, choosing

Close your eyes for a moment and think back to those bygone days of… December 2018. The market was still giddy over the recent Brexit deal agreed between the UK and the EU. At the same time, hopes ran high that the US-China trade war was set to be defused following a steak dinner in Argentina with President’s Trump and Xi hashing out a delay of tariff increases. And of course, the Fed had just raised the Fed Funds rate 25bps to its current level of 2.50% with plans for two or three more hikes in 2019 as the US economy continued to outperform the rest of the world. Since that time, those three stories have completely dominated the dialog in market and economic circles.

Now, here we are three months later and there has been painfully little progress on the first two stories, while the third one has been flipped on its head. I can only say I won’t be unhappy if another major issue arises, as at least it will help change the topic of conversation. But for now, this is what we’ve got.

So, turning to the Fed, yesterday afternoon, to no one’s surprise, the Fed left policy rates on hold. What was surprising, however, was just how dovish Chairman Powell sounded at the press conference, essentially declaring that there will be no more rate hikes in 2019. He harped on the fact that the Fed has been unable to push inflation to their view of stable, at 2.0%, and are concerned that it has been so long since prices were rising at that pace that they may be losing credibility. (I can assure them they are losing credibility, but not because inflation has remained low. Rather, they should consider the fact that they have ceded monetary policy to the stock market’s gyrations and how that has impacted their credibility. And this has been the case ever since the ‘Maestro’ reacted in October 1987!)

So, after reiterating their current patient stance, markets moved as follows: stocks rallied, bonds rallied, and the dollar fell. Dissecting these moves leads to the following thoughts. First stocks: what were they thinking? The Fed’s patience is based on the fact that the US economy is slowing and that the global economy is slowing even more rapidly. Earnings growth has been diminished and leverage is already through the roof (Corporate debt as %age of GDP is at record levels, above 75%, with more than half of the Investment Grade portion rated BBB, one notch from junk!) Valuations remain extremely high and history has shown that long-term returns from periods of high valuations are de minimus. Granted, by the end of the session, they did give back most of those gains, but it is difficult to see the bull case for equities from current levels given the economic and monetary backdrop. I would argue that all the best news is already in the price.

Next bonds, which rallied to the point where 10-year Treasury yields, at 2.51%, are now at their lowest level since January 2018, and back then, Fed Funds were 100bps lower. So now we have a situation where 3mo T-bills are yielding 2.45% and 10-year T-bonds are yielding 6bps more. This is not a market that is anticipating significant economic growth, rather it is beginning to look like one that is anticipating a recession in the next twelve months. (My own view is less optimistic and that we will see one before 2019 ends.) Finally, the dollar got hammered. This makes sense as, at the margin, with the Fed clearly more dovish than the market had expected, perception of policy differentials narrowed with the dollar on the losing side. So, the 0.6% slide in the broad dollar index should be no surprise. However, until I see strong growth percolating elsewhere, I cannot abandon my view the dollar will remain well supported.

Turning to Brexit, the situation seems to be deteriorating in the final days ahead of the required decision. PM May’s latest gambit to get Parliament to back her bill appears to be failing. She has indicated she will request a 3-month delay, until June 30, but the EU has said they want a shorter one, until May 23 when European parliament elections are to be held (they want the UK out so there will be no voting by UK citizens) or a much longer one so that, get this, the UK can have another referendum to reverse the process and end Brexit. It is remarkable to me that there is so much anxiety over foreign interference in local elections on some issues, but that the EU feels it is totally appropriate to tell the UK they should vote again to overturn their first vote. Hypocrisy is the only constant in politics! With all this, May is in Brussels today to ask for the delay, but it already seems like the EU is going to need to meet again next week as the UK Parliament has not formally agreed to anything except leaving next Friday. Suddenly, the prospect of that happening has added some anxiety to the heretofore smug EU leaders.

Meanwhile, the Old Lady meets today, and there is no chance they do anything. In fact, unless the UK calls off Brexit completely, they will not be tightening policy for years. Slowing growth and low inflation are hardly the recipe for tighter monetary policy. The pound has fallen 0.5% this morning as concerns over the Brexit outcome are growing and its value remains entirely dependent on the final verdict.

As to the trade story, mixed signals continue to emanate from the talks, but the good news is the talks are continuing. I remain more skeptical that there will be a satisfactory resolution but thus far, equity markets, at least, seem to believe that a deal will be signed, and all will be right with the world.

Turning away from these three stories, we have heard from several other central banks, with Brazil leaving the Selic rate on hold at 6.50%, a still historic low, with a statement indicating they are comfortable with this rate given the economic situation there. Currently there is an attempt to get a new pension bill through Congress their which if it succeeds should help reduce long-term debt implications and may open the way for further rate cuts, especially since inflation is below their target band of 4.25%-5.25%, and growth is slowing to 2.0% this year. Failure of this bill, though, could well lead to more turmoil and a much weaker BRL.

Norway raised rates 25bps, as widely expected, as they remain one of the few nations where inflation is actually above target following strong growth throughout the economy. Higher oil prices are helping, but the industrial sector is also growing, and unemployment remains quite low, below 4.0%. The Norgesbank indicated there will be more rate hikes to come this year. It should be no surprise that the krone rallied sharply on the news, rising 0.9% vs. the dollar with the prospect for further gains.

Finally, the Swiss National Bank left rates unchanged at -0.75%, but cut its inflation forecast for 2019 to 0.3% and for 2020 to 0.6%. The downgraded view has reinforced that they will be sidelined on the rates front for a very long time (and they already have the lowest policy rates in the world!) and may well see them increase market intervention going forward. This is especially true in the event of a hard Brexit, where their haven status in Europe is likely to draw significant interest, even with a -0.75% deposit rate.

On the data front today, Philly Fed (exp 4.5) and Initial Claims (225K) are all we’ve got. To my mind, the market will continue to focus on central bank policies, which given central banks’ collective inability to drive the type of economic rebound they seek, will likely lead to government bond support and equity market weakness. And the dollar? Maybe a little lower, but not for long.

Good luck
Adf

Incessant Whining

Can someone help me understand
Why euros remain in demand?
Theira growth rate’s declining
While incessant whining
Is constant from Rome to Rhineland

Another day, another failure in Eurozone data. This morning’s culprits were German and Spanish IP, both of which fell sharply. The German outcome was a fourth consecutive monthly decline, with a surprise fall of 0.4%, as compared to expectations for a 0.7% rise. Not only that, November’s release was revised lower to -1.3%. It seems pretty clear that positive growth momentum in Germany has faded. At the same time, Spain, which had been the best growth story in the entire Eurozone, also released surprisingly weak IP data, -6.2%, its largest decline in seven years, and significantly lower than the -2.3% expected. This marks two consecutive months of decline, and three of the past four. It appears that the Spanish growth story is also ebbing.

It should be no surprise that the euro has fallen further, down another 0.3% this morning and back to its lowest levels in two weeks. As I have consistently maintained, FX movements rely on two stories, with the relative strength of one currency’s economy and monetary policy stance compared to the other’s. And while the Fed’s U-turn at the end of January, marked an important point in the market’s collective eyes, thus helping to undermine the dollar strength story, the fact that the European growth story seems to be diminishing so rapidly is now having that same impact on the euro. The EU has reduced, yet again, its growth forecasts for the EU and virtually every one of its member nations. Italy’s forecast was cut to just 0.2% GDP growth in 2019. Germany’s has been cut to 1.1% from a previous forecast of 1.9% in 2019. As I have written repeatedly, the idea that the ECB can tighten policy any further given the economic outlook is fantasy. Look for a reversal by June and either a reinstatement of QE, or forward guidance eliminating any chance of a rate hike before 2021! Rolling over TLTRO’s is a given.

But the euro is not the only currency under pressure this morning, in fact, the dollar, once again, is on the move. The pound, for example, is also down by 0.3% as the market awaits the BOE’s rate decision. There is no expectation for a rate move, but there is a great deal of interest in Governor Carney’s comments regarding the future. Given the ongoing uncertainty with Brexit (which shows no signs of becoming clearer anytime soon), it remains difficult to believe that the BOE can raise rates. This is especially true because the economic indicators of late have all shown signs of a substantial slowdown of UK growth. The PMI data was awful, and growth forecasts by both private and government bodies continue to be reduced. However, despite the fact that the measured inflation rate has been falling back to the 2.0% target more quickly than expected, there is a great deal of discussion amongst BOE members that wages are growing quite quickly and thus are set to push up overall inflation. This continues to be the default mindset of central bankers around the world, as it is built into their models, despite the fact that there is scant evidence in the past ten years that rising wages has fed into measured price inflation. And while it is entirely possible that inflation is coming soon to a store near you, the recent evidence has pointed in the opposite direction. Inflation data around the world continues to decline. Despite Carney’s claims that Brexit may force the BOE to raise rates after a sudden spike higher in inflation, I think that is an extremely low probability event.

In the meantime, the Brexit saga continues with no obvious answers, increasing frustration on both sides, and just fifty days until the UK is slated to exit the EU. Parliament is due to vote on PM May’s Plan B next week, although it now appears that might be delayed until the end of the month. But in the end, Plan B is just Plan A, which was already soundly rejected. At this point, it is delay or crash, and as the pound’s recent decline implies, there are more and more folks thinking it is crash.

Other currency news saw the RBI cut rates 25bps last night in what was a mild surprise. If you recall I mentioned the possibility yesterday, although the majority of analysts were looking for no movement. Interestingly, the rupee actually rallied on the news (+0.2%), apparently on the belief that the new RBI Governor, Shaktikanta Das, has a more dovish outlook which is going to support both growth and the current market friendly government of PM Modi. However, beyond that, the dollar is broadly higher this morning. This is of a piece with the fact that equity markets are generally under pressure after a lackluster decline yesterday in the US; commodity prices have continued their recent slide, and government bonds are firming up with yields in the havens, like Treasuries and Bunds, declining. In addition, the one other currency performing well this morning is the yen. In other words, it appears we are seeing a mild risk-off session

Turning to the data, yesterday’s Trade deficit was significantly smaller than expected at ‘just’ -$49.7B with lower imports the driving force there. Arguably, we would rather see that number shrink on higher exports, but I guess tariffs are having their intended effect. This morning, the only scheduled data is Initial Claims (exp 221K), which jumped sharply last week, but have been averaging about 225K for the past several months. However, given what might be a turn in the Unemployment Rate trend, it is entirely possible that this number starts trending slightly higher. We will need to keep watch.

At this point, the dollar has continued to perform well for the past several sessions and there is no reason to believe that will change. The initial dollar weakness in the wake of the Fed’s more dovish commentary is now being offset by what appears to be ongoing weakness elsewhere in the world. I admit I expected to see the dollar remain under pressure for a longer period than a week, but so far, that’s been the case, one week of softening followed by a rebound with no obvious reason to see it stop. If equity markets continue to underperform, then it seems likely the dollar will remain bid.

Good luck
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Yikes!

Said Powell, we’re now “just below”
The neutral rate, thus we’ll forego
Too many more hikes
The market said yikes!
And saw all key price metrics grow

If you wonder why I focus on the Fed as much as I do, it is because the Fed continues to be the single most important player in global financial markets. This was reinforced yesterday when Chairman Powell indicated that the current Fed Funds rate, rather than being “…a long way from neutral at this point,” as he described things on October 3rd, are in fact, “…just below” the neutral rate of interest. The implication is that the Fed is much closer to the end of their rate hiking cycle than had previously been anticipated by most market participants. And the market response was immediate and significant. US equity markets exploded higher, with all three major indices rising more than 2.3%; Treasury yields continued their recent decline, with the 10-year yield falling 4.5bps to levels not seen since mid-September; and the dollar fell sharply across the board, with the euro jumping 1% at one point, although it has since given back about 0.3% of that move. But it wasn’t just the euro that rallied, overnight we saw IDR and INR, two of the worst performing EMG currencies, each rally more than 1.0% as a more dovish Fed will clearly bring relief to what has ailed economies throughout the emerging markets.

It is abundantly clear that a more dovish Fed will have significant consequences for markets around the world. In this event we can expect the recent equity market correction to come to an end, we can expect the dollar to give back some portion of its recent gains, and we can expect Treasury yields to level off, especially in the front end, with fears over a yield curve inversion dissipating rapidly. However, is the Fed really changing its tune? Or is yesterday’s market reaction significantly overdone? Unfortunately, it is far too soon to judge. In fact, this will add further significance to the FOMC Minutes from the October meeting, which will be released at 2:00pm today. Remember, that meeting was held nearly four weeks after Powell’s ‘long way from neutral’ comments, so would reflect much more updated thinking.

Something else to keep in mind regarding the potential future path of interest rates is that we continue to see evidence that key sectors of the US economy are slowing down. Yesterday’s New Home Sales data reinforced the idea that higher mortgage rates, a direct consequence of Fed actions during the past two years, continue to take a toll on the housing sector as the print was just 544K, well below expectations and indicative of a market that is flatlining, not growing. We have also seen the trade data deteriorate further despite the president’s strenuous efforts at reversing that trend. In other words, for a data dependent Fed, there is a growing segment of data showing that rates need not go higher. While Powell was clear that there is no preset path of interest rates, the market is now pricing in just two more hikes, one in December and one in March, and then nothing. If that turns out to be the case, the dollar may well come under pressure.

Of course, FX is really about interest rate differentials, not merely interest rates. And while changes in Fed expectations are crucial, so are changes in other central bank actions. For example, early this morning we saw that Eurozone Consumer Confidence fell for the 11th straight month; we saw that Swiss GDP shrank -0.2% unexpectedly in Q3; and we saw that Swedish GDP shrank -0.2% unexpectedly in Q3. The point is that the slowing growth scenario is not simply afflicting the US, but is actually widespread. If Eurozone growth has peaked and is slipping, it will be increasingly difficult for Signor Draghi and the ECB to begin to tighten policy, even if they do end QE next month. The Swedes, who are tipped to raise rates next month are likely to give that view another thought, and the Swiss are certain to maintain their ultra-easy policy. In other words, the interest rate differentials are not going to suddenly change in favor of other currencies, although they don’t seem likely to continue growing in the dollar’s favor. Perhaps we are soon to reach an equilibrium state. (LOL).

On Threadneedle Street there’s a bank
That raised interest rates to outflank
Rising inflation
But now fears stagnation
If they walk the Brexit gangplank

The only currency that has not benefitted from the Powell dovish tone has been the British pound, which has fallen 0.5% this morning back toward the bottom of its recent trading range. The Brexit debate continues apace there and despite analyses by both the government and the BOE regarding the potential negative consequences of a no-deal Brexit (worst case is GDP could be 10% smaller than it otherwise would be with the currently negotiated deal) it seems that PM May is having limited success in convincing a majority of MP’s that her deal is acceptable. Interestingly, the BOE forecast that in their worst-case scenario the pound could fall below parity with the dollar, although every other pundit (myself included) thinks that number is quite excessive. However, as I have maintained consistently for the past two years, a move toward 1.10-1.15 seems quite viable, and given the current political machinations ongoing, potentially quite realistic. All told, the pound remains completely beholden to the Brexit debate, and until the Parliamentary vote on December 11, will be subject to every comment, both positive and negative, that is released. However, the trend remains lower, and unless there is a sudden reversal of sentiment amongst the politicians there, it is feeling more and more like a hard Brexit is in our future. Hedgers beware!

Quickly, this morning’s data brings Initial Claims (exp 221K), Personal Income (0.4%), Personal Spending (0.4%), and the PCE data (Headline 2.0%, Core 1.9%) as well as the FOMC Minutes at 2:00. Unless the PCE data surprises sharply, I expect that markets will remain quiet until the Minutes. But if we see softer PCE prints, look for equities to rally and the dollar to suffer.

Good luck
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