Both Driver and Bane

Though Brexit and China remain
For markets, both driver and bane
The rest of the globe
Is worth a quick probe
Since some things are clearly germane

The markets are beginning to demonstrate Brexit fatigue as each day’s anxieties are no longer reflected in price movements. Broadly, a hard Brexit is still going to be bad and result in a significant decline in the pound, and a signed deal should see the pound rally somewhat, but the political machinations are just getting annoying at this point. Yesterday’s news was the House of Commons voted to seek a delay, although there has been no definition of how long that delay should be. It seems PM May is going to bring her deal to the floor one more time to see if she can get it passed this time:

Although her rep’s suffered much harm
The PM has rung the alarm
It’s time to get real
And vote for her deal
Perhaps the third time is the charm

The threat to the Brexiteers is a long delay opens the way for a reversal of the process, so this deal is better than that outcome. Of course, as I have written before, a delay requires unanimity from the rest of the EU and given the uncertainty of what can be gained by a delay at this time, it still appears there is a real risk of a hard Brexit, despite Parliament’s vote yesterday.

The latest news is a delay
In Brexit is what’s on the way
But will that resolve
The issues involved
Don’t count on it in any way

As to the pound, yesterday it fell, today it is rallying, but in general, it is still stuck. For the past three plus weeks it has traded between 1.30 and 1.33, albeit visiting both sides several times. Let’s move on.

The China trade story continues in slow motion as hopes of a late March meeting between President’s Xi and Trump have now faded to late April. Of note overnight was a new law passed by the Chinese government that alleges to address IP theft and international investment. While that certainly appears to be in response to US concerns, the lack of an enforcement mechanism remains a significant obstacle to concluding the process. However, it does appear to be a tacit admission that IP theft has been a part of the program in the past, despite vehement protestations on the part of the Chinese. But for now, this issue is headed to the back burner and will only matter to markets again when a deal seems imminent, or the talks collapse.

So what else is happening in the world? Well, global growth remains under pressure with data around the world indicating a slowdown is essentially universal. German production, US housing, Japanese inflation, you name it and the data is weaker than expected, and weaker than targeted. What this means is that pretty much every central bank around the world, at least in the developed world, has stopped thinking about policy normalization and is back on the easy money bus.

While Chairman Powell takes the brunt of the criticism for his quick volte-face last December, we have seen it everywhere. ECB President Draghi will have spent eight years at the helm and only cut rates and added monetary stimulus, all to achieve average growth of a whopping 1.5% or so with inflation remaining well below the target of 2.0% throughout his tenure. And, as he vacates the seat, he will leave his successor with further ease ongoing (TLTRO’s) and no prospect of a rate hike for years to come. But hey, perpetual debt-fueled slow growth and negative interest rates should be great for the stock market! What could possibly go wrong?

Meanwhile, the BOJ finds itself in exactly the same place as the ECB, lackluster growth, virtually no inflation and monetary policy set at extreme ease. Last night, Kuroda-san and his friends left policy unchanged (although two BOJ members voted for further ease) and said that the 2.0% inflation target remained appropriate and they were on track to achieve it…eventually. Alas, unless anti-aging medicines are available soon, I don’t think any of us will ever see that outcome. The yen’s response was to sink slightly further, falling 0.2%, and it is trading near its weakest levels of the year. However, in the big scheme of things, it remains right in the middle of its long-term trading range. My point is that we will need a stronger catalyst than more of the same from Kuroda to change things.

Other noteworthy currency stories are the weakness in HKD, as a glut of cash pouring into the island territory has driven interest rates there down significantly and opened up a carry trade opportunity. The HKMA has already spent close to $1 billion supporting the currency at the floor of its band over the past two weeks and seems likely to spend another $5-$7 billion before markets are balanced again.

Sweden has watched its krone depreciate steadily as slowing growth has caused a change in the Riksbank’s tune. In December, it was assumed they would be raising rates and exiting NIRP given the growth trajectory, which led to some modest currency strength. However, the reality has been the growth has never appeared and now the market has priced out any rate hikes. At the same time, FX traders have all unwound those long krone positions and pushed down the SEK by more than 4% this year. While it has rallied 0.4% overnight, it remains the key underperformer in the G10 this year. in fact, there is talk that the Riksbank may need to intervene directly in FX markets if things get much worse, although given the lack of inflation, it seems to me that is excessive.

So you see, there is a world beyond Brexit! As to today’s session, we see a bit more data from the US including: Empire Manufacturing (exp 10.0); IP (0.4%); Capacity Utilization (7.4%); JOLT’s Job Openings (7.31M); and Michigan Sentiment (95.3). This is a nice array of data which can help give an overall assessment as to whether the economy is continuing to sag, or if there are some possible bright spots. But unless everything is extraordinarily strong, I imagine that it will have limited direct impact and the dollar, which has been broadly under pressure today (after a rally yesterday) will continue to slide a little. Right now, there is no strong directional view as traders await the next central bank pronouncements. With the Fed, that comes next week. Until then, look for range trading.

Good luck and good weekend
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Bred On Champagne

In Davos, the global elite
Are gathering midst their conceit
That they know what’s best
For all of the rest
Though this year they’re feeling some heat

As growth ‘round the world starts to wane
This group, which was bred on champagne
Is starting to find
Their sway has declined
And people treat them with disdain

This is Davos week, when the World Economic Forum meets in Switzerland to discuss global issues regarding trade, finance, economics and social trends. Historically, this had been a critical stopping point for those trying to get their message across, notably politicians from around the world, as well as corporate leaders and celebrities. But this year, it has lost some of its luster. Not only are key politicians missing (the entire US entourage, PM May, President Xi, President Macron, AMLO from Mexico and others), but the broad-based rejection of globalist policies that have led to a significant increase in populism around the world has reduced the impact and influence of the attendees. Of course, this hasn’t prevented those who are attending from declaring their certitude of the future, it just puts a more jaundiced eye on the matter. As to the market impact of this soiree, the lack of keynote addresses by policymakers of note has resulted in quite a reduction of influence. But that doesn’t mean we won’t see more headlines, it just doesn’t seem like it will matter that much.

Inflation forecasts
In Japan have been reduced
Again. Is this news?

The BOJ met last night and left policy settings unchanged, as universally expected. This means that the BOJ is still purchasing assets at a rate of ¥80 trillion per year (ostensibly) and interest rates remain at -0.10%. Their problem is that despite the fact that they have been doing this for more than 6 years, as well as purchasing corporate bonds and equity ETF’s, they are actually getting worse results. Last night they downgraded their growth and inflation forecasts to 0.9% for both GDP and CPI as they continuously fail in their attempts to stoke price increases.

While the Fed has already begun normalizing policy and the ECB is trying to move in that direction (although I think they missed the boat on that), the BOJ is making no pretenses about the fact that QE is a fact of life for the foreseeable future. Policy failure at the central bank level has become the norm, not the exception, and the BOJ is Exhibit A. As such, the yen is very likely to see its value remain beholden to the market’s overall risk appetite. If we continue to see sessions like yesterday, where equities and commodities suffer while Treasuries are bid, you can be pretty sure the yen will strengthen. While this morning the currency is actually weaker by 0.3%, that seems more like a position adjustment rather than a commentary on risk. In fact, if equities continue to suffer, look for the yen to regain its lost ground and then some.

As to Brexit, the pound is trading back above 1.30 this morning for the first time since the first week of November, which was arguably more about the US elections than the UK. But the market is becoming increasingly convinced that a hard Brexit is off the table, and that some type of deal will get done, maybe not by March, but then after a several month delay. If this is your belief, then the pound clearly has further to rally, as the market remains net short, but my only advice is to be very careful as policy mistakes are well within the remit of all government organizations, not just central banks.

Beyond those stories, there has been no movement on the trade talks, although Larry Kudlow did highlight that some type of verification would be needed before anything is agreed. US data yesterday showed a much weaker than expected housing market with Existing Home Sales falling 10.0% since last year to just 4.99M in December. The Fed is silent as they prepare for next week’s meeting and the ECB is silent as they prepare for tomorrow’s meeting. In other words, it is not that exciting. Equity futures are pointing modestly higher, about 0.25%, although that is after a >1% decline in all markets yesterday. Treasury yields are higher by 2bps and oil prices are modestly higher (0.7%) after a sharper decline yesterday. Overall, the market remains unexciting and I expect that until we see a resolution of one of the key issues, notably trade or Brexit, things are likely to remain quiet. That said, it does appear that there are ample underlying concerns to warrant a fully hedged position for risk managers.

Good luck
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Is That Despair?

Forward guidance is
Kuroda-san’s newest hope
Or is that despair?

The BOJ has committed to keep the current extremely low levels for short- and long-term interest rates for an “extended period of time.” Many of you will recognize this phrase as Ben Bernanke’s iteration of forward guidance. This is the effort by central banks to explain to the market that even though rates cannot seemingly go any lower, they promise to prevent them from going higher for the foreseeable future. Alas, forward guidance is akin to Hotel California, from which, as The Eagles famously sang back in 1976, “you can check out but you can never leave.” As the Fed found out, and the ECB will learn once they finally end QE (assuming they actually do so), changing tack once you have promised zero rates forever can have market ramifications. The first indication that forward guidance might be a problem came with the ‘taper tantrum’ in 2013, but I’m confident it won’t be the last.

However, for the BOJ, now trumps the future, and they needed to do something now. But forward guidance was not the only thing they added last night. It was the cover for their attempts to adjust policy without actually tightening. So, yield curve control now has a +/- 20bp range around 0.0% for the 10-year JGB, double the previous level, and thus somewhat more flexible. And they reduced the amount of reserves subject to the -0.10% deposit rate in order to alleviate some of the local banks’ profit issues. In the end, their commitment to maintaining zero interest rates for that extended period of time was sufficient for FX traders to sell the yen (it fell -0.40%), and JGB yields actually fell a few bps, closing at 0.065%, which is down from 0.11% ahead of the meeting. All in all, I guess the BOJ did a good job last night.

There is, however, one other thing to mention, and that is they reduced their own inflation forecasts (to 1.1% in 2019, 1.5% in 2020 and 1.6% in 2021) for the next three years, indicating that even they don’t expect to achieve that elusive 2.0% target before 2022 at the earliest. In the end, the BOJ will continue to buy JGB’s and equity ETF’s and unless there is a substantial acceleration in global growth, (something which seems increasingly unlikely) they will continue to miss their inflation target for a very long time. As to the yen, I expect that while it fell a bit last night, it is still likely to drift higher over time.

In Europe the story is still
That growth there is starting to chill
The data last night
Did naught to delight
Poor Mario, testing his will

Beyond the BOJ, and ahead of the FOMC announcement tomorrow, the major news was from the Eurozone where GDP and Inflation data was released. What we learned was that, on the whole, growth continued to slow while inflation edged higher than expected. Eurozone GDP rose 0.3% in Q2, its slowest pace in a year, while headline inflation rose 2.1%, its fastest rate since early 2013. Of course the latter was predicated on higher energy prices with core CPI rising only 1.1%, still a long way from the ECB’s target. The point is that given the slowing growth trajectory in the Eurozone, it seems that Draghi’s confidence in faster growth causing inflation to pick up on the continent may be unwarranted. But that remains the official line, and it appears that the FX market has accepted it as gospel as the euro has traded higher for a third consecutive day (+0.3%) and is now back in the top half of its trading range. If Q3 growth continues the trajectory that Q2 has extended, it will call into question whether the ECB can stop buying bonds, or at the very least, just how long rates will remain at -0.4%, with those looking for a September 2019 rate hike sure to be disappointed.

There is one country in Europe, however, that is performing well, Sweden. GDP growth there surprised the market yesterday, rising 1.0% in Q2 and 3.3% Y/Y. This has encouraged speculation that the Riksbank will be raising rates fairly soon and supported the krone, which has rallied 1.0% since the announcement.

The final piece of news to discuss from last night was from China, where the PMI readings all fell below expectations. The official Manufacturing data was released at 51.2, down from last month’s 51.5 and the third consecutive monthly decline. The non-manufacturing number fell to 54.0, its weakest print since October 2016. These are the first data from China that include the impact of the US tariffs, and so are an indication that the Chinese economy is feeling some effects. I expect that the government there will add more stimulus to offset any more severe impact, but that will simply further complicate their efforts at reducing excess leverage in the economy. Meanwhile, the renminbi slid 0.25% overnight.

This morning’s data releases bring us Personal Income (exp 0.4%), Personal Spending (0.4%) and PCE (2.3% headline, 2.0% core), as well as the Case-Shiller Home price index (6.4%), Chicago PMI (62.0) and Consumer Confidence (126.0). In other words, there is much for us to learn about the economy. While I believe the PCE data could be market moving, especially if it is stronger than expected, I continue to believe that traders and investors remain far more focused on Friday’s payroll report than this data. Recent weakness in equity markets has some folks on edge, although futures this morning look benign. But if we do see that weakness continue, the chances of a full-blown risk off scenario materializing will grow substantially. And that means, the dollar has the potential to rally quite sharply. Keep that in mind as a tail risk, one where the tail grows fatter each day that equity markets disappoint.

Good luck
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Still At Its Peak

Three central bank meetings this week
Seem unlikely, havoc to wreak
When they all adjourn
Attention will turn
To joblessness, still at its peak

In the current central bank calendric cycle, the ECB meeting was the first to be completed, and last Thursday we learned virtually nothing new about Mario Draghi’s plans. The ECB is going to reduce QE further starting in October and is due to end it completely by year end. As to interest rates, ‘through summer’ remains the watchword, with markets forecasting a 10bp rate rise in either September or October of next year.

This week brings us the other three big central bank meetings, starting with the BOJ’s announcement tomorrow evening, then the FOMC on Wednesday and finally the BOE on Thursday. Going in reverse order, the market remains convinced that Governor Carney will raise rates 25bps, with a more than 80% probability priced in by futures traders. While I think it is a mistake, it does seem increasingly likely it will be the outcome. As to the Fed, there are no expectations of any policy adjustments at this meeting, and as there is no press conference following, I expect that the statement, when released Wednesday afternoon, will have little market impact.

This takes us to tomorrow evening’s BOJ meeting, which is the only one where there seems to be any real uncertainty. Last week I discussed the questions at hand which boil down to whether or not Kuroda and company have come to believe that QQE is not only ineffective, but actually beginning to have a detrimental impact on the Japanese economy. After all, they have been at it for the better part of five years and have still had zero success in achieving their 2.0% inflation goal. The three biggest problems are that Japanese banks have seen their business models decimated by increasingly narrow lending spreads; the ETF purchase program has had an increasingly large distortive impact on the Japanese stock markets as the BOJ now owns roughly 4% of all Japanese equities; and finally, the yield curve control plan has essentially broken the JGB market as evidenced by the fact that they continue to see sessions where there are actually no trades in the 10-year JGB. (Consider what would happen if there were no trades in 10-year Treasuries one day!)

With all of this as baggage, there has been increasing discussion that the BOJ may seek to tweak the program to try to make it more effective. However, they have painted themselves into a corner because if they reduce their activity in the JGB market, the market is likely to see it as a reduced commitment to QE and it is likely to result in higher yields there, which can easily lead to two separate but related outcomes. First, USDJPY is likely to fall further, as higher JGB yields lead to more interest for Japanese investors to bring their funds home. Given the disinflationary impact of a stronger currency, this would be a disaster. And second, if there is less support for JGB’s, given the fungibility of money and the open capital markets that exist, we are likely to see yields rise in US, UK, European and other developed markets. While Chairman Powell may welcome this as it will reduce concern over the Fed inverting the yield curve, the rest of the world, which retains far easier monetary policy, is likely to be somewhat less welcoming of that outcome. And this is all based on anonymous reports that the BOJ is going to make some technical adjustments to their program, not change the nature of what they are doing. So if you are looking for some fireworks this week, the BOJ is your best bet.

However, beyond the central banks, the market will turn its attention to Friday’s employment report here in the US. Last Friday saw a robust GDP report, as widely expected, and further proof of the divergence between the US and the rest of the global economy. This Friday could simply add to that impression. Here is the full listing of this week’s data, which is quite robust:

Tuesday BOJ Rate Decision -0.10% (unchanged)
  Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.3% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
  Case-Shiller Home Prices 6.4%
  Chicago PMI 62.0
Wednesday ADP Employment 185K
  ISM Manufacturing 59.5
  ISM Prices Paid 75.8
  FOMC Rate Decision 2.00% (unchanged)
Thursday BOE Rate Decision 0.75% (+0.25%)
  Initial Claims 221K
  Factory Orders 0.7%
Friday Nonfarm Payrolls 190K
  Private Payrolls 185K
  Manufacturing Payrolls 22K
  Unemployment Rate 3.9%
  Average Hourly Earnings 0.3% (2.7% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$46.2B
  ISM Non-Manufacturing 58.7

So, as you can see there is much to be learned this week. With the focus on the central banks and Friday’s payroll data, don’t lose sight of tomorrow’s PCE report, because remember, that is the Fed’s go-to number on inflation. Overall, looking at forecasts, things remain remarkably strong in the US economy this long into an expansion, which is something that has many folks concerned. We also continue to see important corporate earnings releases this week for Q2, which given the high profile misses we had last week, could well impact markets beyond individual equity names.

As to the dollar through all this, it is a touch softer this morning, but remains on the strong side of its recent trading range. While I still like it higher, there is so much potential new information coming this week, it is probably wisest to remain as neutral as possible for now. For hedgers, that means the 50% rule is in effect.

Good luck
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Twixt Juncker and Trump

The meeting today in DC
Twixt Juncker and Trump will be key
In helping determine
If cars that are German
Are hit with a new import fee

Markets overnight have been relatively muted as today’s big story revolves around EU President Jean-Claude Juncker’s meeting with President Tump in Washington. The agenda is focused on tariffs and trade as Juncker seeks to de-escalate the current trade policy differences. At this point, while most market participants would love to see signs that the US is backing off its recent threats, and that progress is made in adjusting the terms of trade, I don’t sense that there is a lot of optimism that will be the case. Remarkably, the US equity market has been able to virtually ignore the trade story, with only a few individual companies suffering due to direct impacts from the situation (or poor quarterly numbers), but that has not been true elsewhere in the world. Other equity markets have fared far worse in the wake of the trade battle, and I see no reason for those prospects to improve until there is a resolution. At the same time, while the dollar has fallen from its highs seen early last week, it remains significantly stronger than it was three months ago. In fact, during the recent escalation in Presidential rhetoric, while we saw a reaction last Friday, the reality is that there has been little overall movement.

While the value of the dollar clearly has an impact on trade, historically the reverse has been far less clear. In other words, although there have been knee-jerk reactions to a particular trade number that missed expectations, or similar to Friday’s movement, knee-jerk reactions to political statements about trade policy, generally speaking, trade’s impact on the dollar has been very hard to discern. Several months ago I highlighted the tension between short-term and long-term drivers of the dollar. On the short-term side, which is what I believe has been dominant this year, is monetary policy and interest rate differentials. These have clearly been moving aggressively in the dollar’s favor. On the long-term side is the US’ fiscal account, namely its current account deficit and trade deficit. Economic theory tells us that a country that runs significant deficits in these accounts will see its currency decline over time in order to help balance things. In fact, this has been the crux of the view that the dollar will fall in the long run. However, given the US’ unique situation as the global reserve currency, and the fact that so much global trade is priced in dollars as opposed to other currencies, there remains an underlying demand for dollars that is not likely to disappear anytime soon.

The point here is that if the current trade situation deteriorates further, with additional tariffs imposed on all sides, and growth slows correspondingly, it is still not clear to me that the dollar will suffer. In fact, most other countries will seek to weaken their own currencies in order to offset the tariffs, which means the dollar will likely continue to outperform. In other words, in addition to the US monetary policy benefit, it seems likely that the dollar will be the beneficiary of policy adjustments elsewhere designed to weaken other currencies. And ironically, in the current political situation, that is only likely to generate even more Presidential rhetoric on the subject. Quite frankly, I feel the dollar has potentially much further to climb as long as trade is the topic du jour.

Of course, that doesn’t mean it will rally ever day. In fact, today the dollar is very modestly softer vs. most of its counterparts. The biggest gainer has been CNY, which is firmer by 0.55% overnight, as China appears very interested in calming things down. But away from that move, most currency gains have been on the order of 0.1% or so. The most notable data overnight was the German IFO report, which declined for the eighth consecutive month and is now back to levels last seen in March 2017. While the ECB continues to look ahead to the ending of their extraordinary monetary policy, the economy does not seem to be cooperating with their views of a sustainable recovery. While I think there is very little chance that the ECB changes its stance on bond buying, meaning come December, they will be done, it remains an open question as to when they might start to raise rates. This is especially true given the potential for an escalating trade conflict between the US and the EU resulting in slower growth on both sides of the Atlantic. If that is the case, the ECB will have a much harder time normalizing policy. At this time, however, it is still way too early to make any determinations, and I suspect that tomorrow’s ECB meeting will give us very little new information.

Meanwhile, the market is still extremely focused on the BOJ meeting early next week, with varying views as to the potential for any policy shifts there. What does seem clear is there has at least been discussion of the timing of ending QE, but no decisions have been made. The problem for the BOJ is that after more than five years of aggressive bond buying, not only have they broken the JGB market, but they have not been able to achieve anywhere near the results they had sought. Given that the BOJ balance sheet is now essentially the same size as the Japanese economy (for comparison, in the US despite its remarkable growth during QE, it remains ~20% of the US economy), there are growing concerns that current policy may be doing more harm than good. Apparently there are limits to just how much a central bank can do to address inflation. As to the yen, if the market perception turns to the BOJ stepping back from constant injections of funds, it is very likely that the yen will find itself in great demand and USDJPY will fall steadily. I maintain my view that 100.00 is a viable target for the end of the year.

Today brings just New Home Sales data (exp 670K, a 2.8% decline from last month) but this is generally not a key figure for markets. Rather, today’s price action will be dependent on the outcome of the Trump-Juncker meeting and whatever comments follow at the press conference. A conciliatory tone by President Trump would almost certainly result in a stock market rally and modest dollar strength. Continued combativeness is likely to see stocks under pressure and the dollar, at least initially, falling as well.

Good luck
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Tired

Speculation’s rife
Kuroda is tired of
JGB support

For the fifth consecutive session, the Japanese yen is rising amid growing speculation that the BOJ, when it meets next Monday and Tuesday, is going to adjust monetary policy tighter. During that run, which also included President Trump’s harangues on currency manipulation around the world, the yen has strengthened nearly 2%. My point is that the dollar has suffered somewhat overall during that period, so this movement is not entirely due to the BOJ story. But, as the meeting approaches, that is becoming the hottest topic in the market.

A quick look at the Japanese economy shows that inflation remains quiescent, with the latest core reading just 0.2%, a far cry from the 2.0% target the BOJ has been aiming for during the past five years. In addition, last night’s PMI data, (printing at 51.6, well below expectations of 53.2) has to give Kuroda and company pause as well. In other words, while Japan is not cratering, it doesn’t seem like there is any danger of overheating there either. However, with the Fed actively tightening, the BOE widely expected to raise rates in early August and the ECB highlighting its plans to end QE this year with interest rate increases to follow next year, the BOJ is clearly feeling somewhat left out of the mix. Apparently groupthink is a strong emotion for central bankers.

At any rate, whether justified or not, the story that is getting play is that they are going to tweak their operations, perhaps allowing (encouraging?) the long end of the JGB yield curve to see higher yields, although they will likely keep control of the 10-year space and below. But all the market needed to hear was that QE was going to be reduced and the reaction was immediate. JGB yields in the 10-year space jumped from 0.03% to 0.09%, at which point the BOJ stopped the movement by stepping in with an unlimited bid for bonds. Remember, they already own 42% of all outstanding JGB’s, and liquidity in that market is so thin that there have already been six days this year where there were absolutely zero trades in the 10-year JGB. The FX market was not going to be left out and seeing the prospect for less QE immediately added to the yen’s recent gains. It remains to be seen whether Kuroda-san will be able to actually implement any policy changes given the combination of slackening growth and still low inflation, especially with the prospects of a trade war having an even more deleterious impact on the economy. However, the market loves this story and is going to continue to run with it, at least until the BOJ announcement next Tuesday. So I would look for the yen to continue to trade slowly higher during that period.

The other big story overnight was the PBOC injection of CNY502 billion of liquidity into the market as part of their ongoing policy adjustments. It is becoming increasingly clear that the Chinese economy is having trouble dealing with the simultaneous deleveraging demanded by President Xi for the past two years and the increased trade issues that have arisen quite rapidly of late. Of course, the PBOC is no wallflower when it comes to taking action, and so having already cut reserve requirements three times this year; they decided that direct injection of funds into the market was a better method of achieving their goals. In addition the government created tax incentives for R&D, encouraged more state infrastructure spending and told banks to offer more credit to small firms. The market impact of these measures was immediate with the Shanghai Stock Exchange rallying 1.6% while the renminbi fell as much as 0.6% early, before retracing somewhat and now standing just 0.2% lower on the day.

When considering the CNY, the opposing forces are that a weaker yuan will certainly help support short-term growth due to the still significant reliance on exports by the Chinese economy. However, there is a feared tipping point at which a weak yuan may encourage significant capital outflows, thus destabilizing the Chinese economy and Chinese markets. We saw this play out three years ago, shortly after the PBOC surprised markets with its mini (2%) devaluation of the yuan. The ensuing global market sell-off was significant enough to prevent then Fed Chair Yellen to hold off on raising rates, despite having signaled that the Fed was ready to do so. However, it is not clear to me that Chairman Powell sees the world the same way as Yellen, and my take is that he would not be dissuaded from continuing the Fed’s current trajectory despite some increased global volatility. Of course, the Chinese instituted strict capital controls in the wake of the 2015 situation, so it is also not clear that the contagion can even occur this time. In the end, though, this is simply further evidence of the diverging monetary policies between the US and China, and continues to underpin my views of USDCNY moving to 7.00 and beyond before the year ends.

Away from those two stories, the dollar is modestly softer this morning despite mixed to weaker Eurozone PMI data (Germany strong, France weak, Eurozone weak), and US Treasury yields that gained nearly 10bps yesterday after the BOJ story broke. Yesterday saw weaker than expected Existing Home Sales (5.38M), which is the third consecutive monthly decline. While there is no important data today, we do see the critical first look at Q2 GDP on Friday, and of course, the ECB meets Thursday, so there is ample opportunity for more opinion changing information to come to market. But right now, the dollar remains largely trapped between the positive monetary policy story and the negative political story, and so I don’t anticipate it will be breaking out in either direction in the short run. However, as long as US monetary policy continues on its current trajectory, I believe the dollar has further to run. We have not yet evolved to a point where other issues are more important, although that time may well come in the future.

Good luck
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