If Things Go Very Wrong

Last year he thought growth would be strong
This year, “if things go very wrong”
It seems Signor Draghi
Just might restart QE
And rate hikes? They’ll ne’er come along!

Markets continue to bide their time ahead of tomorrow’s FOMC statement and the press conference by Chairman Powell. In addition, the Brexit saga continues with a series of votes scheduled today in Parliament that may help determine the next steps in that messy process. And of course, the next round of US-Chinese trade talks are set to begin tomorrow. So, there is plenty of potential news on the near-term horizon. But before I touch on those subjects, I wanted to highlight comments from ECB President Draghi yesterday speaking to EU lawmakers in Brussels. From the Bloomberg article this morning:

        The president of the European Central Bank blamed “softer external demand and some country and sector-specific factors” for the slowdown, but indicated he still has some confidence in the underlying strength of the economy.
       “If things go very wrong, we can still resume other instruments in our toolbox. There is nothing objecting to that possibility,” he told lawmakers in Brussels in response to a question on whether net asset purchases could be restarted. “The only point is under what contingency are we going to do this. And at this point in time, we don’t see such contingency as likely to materialize, certainly this year.”

Basically, he opened the door to reinstate QE, something which just two months ago would never have been considered. And while he tried to downplay the problems, it is clear there is growing concern in Frankfurt about Eurozone growth. Surprisingly, to me, the euro barely budged on the report, as I would have anticipated a sell-off. However, given the Fed is due to make its comments tomorrow, it appears that traders are waiting to see where Powell comes out on the hawkish-dovish spectrum. Because to me, Draghi’s comments were quite dovish. But essentially, the euro has been unchanged since trading opened in Asia yesterday, so clearly the market doesn’t see these comments as newsworthy.

Now, looking at the other three stories, there has been virtually no new information released since last week. Regarding the Fed, yesterday’s WSJ had an article that looked like a Fed plant discussing how unimportant the balance sheet issue was, and how the Fed sees no evidence that shrinking the balance sheet is having any impact on markets. That assessment is quite controversial as many investors and pundits see the balance sheet as a key issue driving recent market volatility. I expect we will hear more on Wednesday from Powell, but I also expect that now that Powell has shown he cannot withstand pressure from a declining stock market, that the pace of balance sheet reduction is going to slow. I wouldn’t be surprised to see it cut in half with a corresponding rally in both stocks and bonds on the news. In this event, the dollar should come under pressure as well.

As to Brexit, there still seems to be this disconnect between the UK and the EU in that the UK continues to believe that if Parliament votes to renegotiate parts of the deal, the EU will do so. Thus far, the EU has been pretty consistent that they like the deal the way it is and that there is not enough time to make changes. But from what I have seen this morning, it seems the most likely outcome is the ‘Malthouse proposal’ which will essentially do just that. Get support from Parliament to go back and change the Irish backstop arrangement. While I know that there is no desire for a hard Brexit, it strikes me that one cannot yet be ruled out.

Finally, on to the trade talks, we continue to get conflicting information from the US side as to where things stand, but ultimately the key issue is much more likely to be enforcement of any deal, rather than the deal itself. There is a great wariness that the Chinese will agree to something, and then ignore the details and go back to business as usual. Or perhaps create new and different non-tariff barriers to maintain their advantages. While the equity market continues to be positive on the process, I don’t see things quite so rosily. I think a deal would be great, but I don’t ascribe more than a 50% chance to getting one. However, I do expect that any tariff increases will be postponed for another round of talks to be enabled.

Beyond those stories, not too much of note is happening, which is evident by the fact that there has been almost no movement in the FX market, or any market for that matter. The G10 currencies are within pips of yesterday’s closing levels, and even EMG currencies are generally little changed. One exception is BRL, which has fallen -0.6% as ongoing news regarding the mining disaster and its impact on CRDV, a huge Brazilian mining conglomerate, seems to be generating a little angst. But otherwise, even this bloc of currencies is little changed. Equity markets are close to flat, as are bond and commodity markets. In other words, investors and traders are looking to the horizon and waiting for the big stories to play out. First in line is the Brexit voting, so perhaps later this afternoon we will see some movement, but I suspect that the FOMC is actually THE story of note for most people right now.

Good luck
Adf

 

If Job Numbers Swoon

For Powell, the data he’s viewing
Shows weakness is palpably brewing
Will he change his tune
If job numbers swoon?
If not, it could prove his undoing!

The admonition that markets will remain volatile in 2019 certainly has held true to form thus far. After a significant sell-off in global equity markets yesterday, two pieces of news have now helped a partial rebound. First was the story that vice-ministerial trade talks are now scheduled to be held between the US and China next Monday and Tuesday. The market has taken this as a sign that the trade conflict is abating and that there will be a deal forthcoming shortly. While that would certainly be great news, it seems a bit premature. Nonetheless, it was clearly seen as a market positive overnight.

The second bit of news comes from China, where the PBOC has announced a 1.0% cut in the RRR for all Chinese banks, half to be implemented next week and half two weeks later. As opposed to the very targeted efforts announced earlier in the week, this is a broad-based easing of monetary policy, the first since 2016, and appears to be a direct response to the fact that the Manufacturing PMI data is alluding to contraction in the Chinese economy. As I have written before, China will be forced to continue to ease monetary policy this year due to slowing growth, and it is for that reason that I expect the renminbi to gradually decline all year.

But the bad news is not restricted to China, we have also seen weaker data from both the US and Europe. Yesterday’s ISM Manufacturing data printed at 54.1, significantly lower than expectations and its weakest print November 2016, and while still in expansionary territory is indicative of slowing growth ahead. Meanwhile, inflation data from the Eurozone showed that price pressures continue to recede there on the back of sharply declining oil prices with the area wide CPI rising only 1.6% and the core reading remaining at 1.0%. It appears that the mooted inflation pressures Signor Draghi has been dreaming about remain only in his dreams.

Bond market reaction to this data was very much as would be expected, with 10-year Treasury yields falling to 2.57%, their lowest level since last January, while Bund yields have fallen back to 0.15%, levels not seen since April 2017. In fact, the futures market in the US is now beginning to bet on a rate cut by the Fed before the end of 2019. If you recall, at the December FOMC meeting, the dot plot indicated a median expectation of two more rate hikes this year.

What we can safely say is that there is a great deal of uncertainty in markets right now, and many disparate opinions as to how the economy will perform going forward, and to how the Fed and its central banking brethren will respond. And that uncertainty is not likely to dissipate any time soon. In fact, my fear is that when it does start to fade, it will be because the data is pointing to a much slower growth trajectory, or a recession on a widespread basis. At that point, uncertainty will diminish, but so will asset values!

And how, you may ask, is all this affecting the dollar? Well, yesterday’s price action was of the risk off variety, where the yen was the leader, but the dollar outperformed most emerging market currencies, as well as Aussie and Kiwi, but was slightly softer vs. the rest of its G10 counterparts. This morning, however, on the strength of the trade talk news and policy ease by China, risk is being tentatively embraced and so the yen has fallen a bit, -0.35%, and the dollar has ceded most of its recent gains vs. the EMG space. For example, ZAR (+1.3%), RUB (+1.0%), TRY (+1.1%), and IDR (+1.0%) have all managed to rally sharply alongside a rebound in commodity prices. As well, the market is still enamored of newly installed President Bolsonaro in Brazil with the real higher by a further 0.9% this morning, taking the YTD gain up to 3.0%.

As for the G10, AUD has benefitted from the Chinese news, rising 0.55%, while CAD and NOK are both higher by 0.5% on the back of the rebound in oil prices. This move was a reaction to OPEC output falling sharply. As to the euro, it is higher by just 0.2% although it has recouped about half its losses from Wednesday now. And finally, the pound has bounced as well after its PMI data was actually a positive surprise. That said, it remains within a few percent of its post Brexit vote lows, and until there is a resolution there, will be hard-pressed to gain much ground. Of course, if there is no deal, the pound is likely to move sharply lower. The UK Parliament is due to vote on the current deal next week, although recent news from PM May’s political allies, the Northern Irish DUP, indicates they are unhappy with the deal and cannot support it yet. With less than three months to go before Brexit is upon us, it is increasingly looking like there will be no deal beforehand, and that the pound has further to fall. For hedgers, I cannot exhort you enough to consider increasing your hedges there. I think the risks are highly asymmetric, with a deal resulting in a modest rally of perhaps 2-3%, while a no-deal outcome could easily see an 8% decline.

For today, the NFP report is on tap with expectations as follows:

Nonfarm Payrolls 177K
Private Payrolls 175K
Manufacturing Payrolls 20K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.5

We also hear from Chairman Powell at 10:15, where the market will be parsing every word to try to get a better understanding of the Fed’s data reaction function, and perhaps to see which data points they deem most important. At this point, strong NFP data ought lead to declining Treasury prices and rising stock prices although I expect the dollar would remain under pressure based on the risk-on feeling. If the data is weak, however, look for stock futures to reverse course (currently they are higher by ~1.0%) and Treasuries to find support. As to the dollar then, broadly stronger, although I expect the yen will be the best performer overall.

Good luck
Adf

New Standard-Bearers

The largest of all Latin nations
This weekend confirmed its frustrations
Electing a man
Whose stated game plan
Is changing the country’s foundations

Meanwhile in a key German state
Frau Merkel and friends felt the weight
Of policy errors
So new standard-bearers
Like AfD now resonate

This weekend brought two key elections internationally, with Brazil voting in Jair Bolsonaro, the right-wing firebrand and nationalist who has promised to clean up the corruption rampant in the country. Not unlike New Jersey and Illinois, Brazil has several former politicians imprisoned for corruption. Bolsonaro represented a change from the status quo of the past fifteen years, and in similar fashion to people throughout the Western world, Brazilians were willing to take a chance to see a change. Markets have been cheering Bolsonaro on, as he has a free-market oriented FinMin in mind, and both Brazilian equities and the real have rallied more than 10% during the past month. The early price action this morning has BRL rising by another 1.65%, continuing its recent rally, and that seems likely to continue until Bolsonaro changes tack to a more populist stance, something I imagine we will see within the first year of his presidency.

Just prior to those results, the German elections in the state of Hesse, one of the wealthiest states in Germany and the home of Frankfurt and the financial industry, showed disdain for the ruling coalition of Chancellor Merkel’s CDU and the Social Democrats, with their combined share of the vote falling to just 39%, from well above 50% at the last election. The big winners were the far left Green Party and the far right AfD, both of whom saw significant gains in the state house there, and both of whom will make it difficult to find a ruling coalition. But more importantly, it is yet another sign that Frau Merkel may be on her last legs. This was confirmed this morning when Merkel announced she was stepping down as leader of her party, the CDU, but claimed she will serve out her term as Chancellor, which runs until 2021.

One other Eurozone story came out Friday afternoon as Standard & Poors released their updated ratings on Italy’s sovereign debt, leaving the rating intact but cutting the outlook to negative. This was slightly better than expected as there were many who worried that S&P would follow Moody’s and cut the rating as well. Italian debt markets rallied on the opening with 10-year yields falling 10bps and the spread with German Bunds narrowing accordingly. So net, there was a euro negative, with Merkel stepping down, and a euro positive, from S&P, and not surprisingly, the euro wound up little changed so far, although that reflects a rebound from the early price action. My concern is that the positive story was really the absence of a more negative story, and one that could well be simply a timing delay, rather than an endorsement of the current situation in Italy. The budget situation remains uncertain there, and if the government chooses to ignore the EU and implement their proposed budget, I expect there will be more pressure on the euro. After all, what good are rules if they are ignored by those required to follow them? None of this bodes well for the euro going forward.

Two other key stories have impacted markets, first from Mexico, the government canceled the construction of a new airport for Mexico City. This was part of the departing administration’s infrastructure program, but, not surprisingly, it has seen its cost explode over time and the incoming president has determined the money is better spent elsewhere. The upshot is that the peso has fallen a bit more than 1% on the news, and I would be wary going forward as we approach AMLO’s inauguration. By cutting the investment spending, not only will the country’s infrastructure remain substandard, but its growth potential will suffer as well. I think this is a very negative sign for the peso.

The other story comes from China, where early Q4 data continues to show the economy slowing further. The government there, ever willing to do anything necessary to achieve their growth target, has proposed a 50% cut in auto sales taxes in order to spur the market. Auto sales are on track for their first annual decline ever this year, as growth slows throughout the country. Interestingly, the market impact was seen by rallies in auto shares throughout Europe and the US, but Chinese equity markets continued to slide, with the Shanghai Index falling another 2.2% overnight. This also has put further pressure on the renminbi with CNY falling another 0.2% early in the session before recently paring some of those losses. USDCNY continues to hover just below 7.00, the level deemed critical by the PBOC as they struggle to prevent an increase in capital outflows. The last time the currency traded at this level, it cost China more than $1 trillion to staunch the outflow, so they are really working to prevent that from happening again.

And those are the big stories from the weekend. Overall, the dollar is actually little changed as you can see that there have been individual issues across specific currencies rather than a broad dollar theme today. Looking ahead to the US session, we get the first of a number of important data points this morning with the full list here:

Today Personal Income 0.4%
  Personal Spending 0.4%
  PCE 0.1% (2.2% Y/Y)
  Core PCE 0.1% (2.0% Y/Y)
Tuesday Case-Shlller Home Prices 5.8%
Wednesday ADP Employment 189K
  Chicago PMI 60.0
Thursday Initial Claims 213K
  Nonfarm Productivity 2.2%
  Unit Labor Costs 1.1%
  ISM Manufacturing 59.0
  ISM Prices Paid 65.0
  Construction Spending 0.1%
Friday Nonfarm Payrolls 190K
  Private Payrolls 184K
  Manufacturing Payrolls 15K
  Unemployment Rate 3.7%
  Average Hourly Earnings 0.2% (3.1% Y/Y)
  Average Weekly Hours 34.5
  Trade Balance -$53.6B
  Factory Orders 0.4%

So there is a ton of data upcoming, with this morning’s PCE and Friday’s Payrolls the key numbers. Last week’s GDP data had a better than expected headline print but the entire weekend press was a discussion as to why the harbingers of weaker future growth were evident. And one other thing we have seen is the equity market dismiss better than expected Q3 earnings data from many companies, selling those stocks after the release, as the benefits from the tax cut at the beginning of the year are starting to get priced out of the future.

The market structure is changing, that much is clear. The combination of central bank actions to reduce accommodation, and an expansion that is exceedingly long in the tooth, as well as increased political uncertainty throughout the world has made investors nervous. It is these investors who will continue to support US Treasuries, the dollar, the yen and perhaps, gold,; the traditional safe havens. At this point, there is nothing evident that will change that theme.

Good luck
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Change Can Come Fast

There once was a market that soared
With tech stocks quite widely adored
The Fed, for eight years
Suppressed any fears
And made sure that rates were kept floored

But nothing, forever, can last
Now ZIRP and QE’s time has passed
Investors are frightened
‘Cause Powell has tightened
Beware because change can come fast!

Many of you will have noticed that equity markets sold off sharply in the past twenty-four hours, and that as of now, it appears there is more room to run in this correction. The question in situations like these is always, what was the catalyst? And while sometimes it is very clear (think Brexit or the Lehman bankruptcy) at other times movements of this nature are simply natural manifestations of a very complex system. In other words, sometimes, and this appears to be one of them, markets simply move because a confluence of seemingly minor events all occur at the same time. Trying to ascribe the movement to yesterday’s PPI reading, or comments from the IMF meetings, or any other specific piece of information is unlikely to be satisfying and so all I will say is that sometimes, markets move further than you expect.

Consider, though, that by many measures equity prices, especially in the US, are extremely richly valued. Things like the Shiller CAPE, or the Buffet idea of total market cap/GDP both show recent equity market levels at or near historic highs. And while the tax cuts passed into law for 2018 have clearly helped profitability this year, 2019 comparisons will simply be that much tougher to meet. There are other situations regarding the market that are also likely having an impact, like the increase in algorithmic trading, the dramatic increase in passive indexing and the advent of risk parity strategies. All of these tended to lead to buying interest in the same group of equities, notably the tech sector, which has been the leading driver of the stock market’s performance. If these strategies are forced to sell due to investor withdrawals, they will do so with abandon (after all, they tend to be managed by computer programs not people, and there is no emotion involved at all) and we could see a substantial further decline. Something to keep in mind.

But how, you may ask, is this impacting the FX markets? Interestingly, the dollar is not showing any of its risk-off tendencies through this move. In fact, it has fallen against almost all counterpart currencies. And while in some cases, there is a valid story that has nothing to do with the dollar per se, in many cases, it appears that this is simply dollar weakness. For example, the euro has rallied 0.5% this morning, after a 0.25% gain yesterday. Part of this has been driven by modestly higher than expected inflation data from several Eurozone countries (Spain and Ireland) while there is likely also a benefit from the story that the Brexit negotiations seem to be moving to a conclusion. However, despite the positive Brexit vibe, the pound has only managed a 0.15% rise this morning. The big winner in the G10 space has been Sweden, where the krone has rallied 1.5% after it also released higher than expected CPI data (2.5%) and the market has priced in further tightening by the Riksbank.

Looking at the EMG space, the dollar has fallen very consistently here, albeit not universally. We haven’t paid much attention to TRY lately, but it has rallied 1.4% today, and 5.5% in the past month. While yesterday they did claim to create some measures to help address the rising inflation there, they appear fairly toothless and I suspect the lira’s recent strength has more to do with the market correcting a massive decline than investor appetite for the currency. But all of the CE4 are rallying today, albeit in line with the euro’s 0.5% move, and there have been no stories of note from the region.

Looking to APAC, the movement has actually been far less pronounced with THB the best performer, rising 0.7% but the rest of the space largely trading within 0.2% of yesterday’s close. In other words, there is no evidence that, despite a significant decline in equity markets throughout the region, that risk-off sentiment has reached dramatic proportions. Now, if equity markets continue their sharp decline today, my best guess is that we will see a bit more activity in the currency markets, likely with the dollar the beneficiary.

Finally, LATAM currencies have had a mixed performance, with MXN rising 0.5% this morning, but BRL having fallen more than 1% on news that the mooted finance minister for Jair Bolsonaro (assuming he wins the second round election) is being investigated for corruption.

Turning to this morning’s session, the key data point of the week is released, with CPI expected to have declined to 2.4% in September (from 2.7%) and the core rate to have risen to 2.3%, up from August’s reading of 2.2%. With every comment from a Fed speaker focused on the idea of continuing to increase Fed Funds until they reach neutral, this data has the opportunity to have a real impact. If the release is firmer than expected, look for bonds to suffer, equities to suffer more and the dollar to find support. However, if this data is weak, then I would expect that the dollar could fall further, maybe back toward the bottom of its recent range, while the equity market finds some support as fears of an overly tight Fed dissipate.

So there is every opportunity for some more market fireworks today. As I believe that inflation remains likely to continue rising, especially based on the anecdotal evidence of rises in wages, I continue to see the dollar finding support. Of course, that doesn’t speak well of how the equity market is likely to perform if I am correct.

Good luck
Adf

The Next Year Or So

Said Williams, “the next year or so”
Should see rates reach neutral, you know
At that point we’ll see
If our GDP
Is humming or soon set to slow

The dollar is under very modest pressure this morning, although in reality it is simply continuing to consolidate its recent gains. While there have been individual currency stories, the big picture continues apace.

As I write, the IMF is holding its annual meeting in Indonesia and so we are hearing much commentary from key financial officials around the world. Yesterday, IMF Managing Director Lagarde told us that the ongoing trade tensions were set to slow global growth. Overnight, we heard from NY Fed President John Williams, who said that the US economy continued to be strong and that while there is no preset course, it seemed likely that the Fed would continue to adjust policy until rates reached ‘neutral’. Of course, as nobody knows exactly where neutral is, there was no way to determine just how high rates might go. However, there was no indication that the Fed was going to pause anytime soon. Dallas Fed President Robert Kaplan, who said that he foresaw three more rate hikes before any pause, corroborated this idea. According to the dot plot, 3.00% seems to be the current thinking of where the neutral rate lies as long as inflation doesn’t push significantly higher than currently expected. All this points to the idea that the Fed remains on course to continued policy tightening, with the risks seemingly that if inflation rises more than expected, they will respond accordingly.

The other truly noteworthy news was from the UK, where it appears that a compromise is in sight for the Brexit negotiations. As expected, there is some fudge involved, with semantic definitions of the difference between customs and regulatory checks, but in the end, this cannot be a great surprise. The impetus for change came from Germany, who has lately become more concerned that a no-deal Brexit would severely impact their export industries, and by extension their economy. The currency impact was just as would be expected with the pound jumping one penny on the report and having continued to drift higher from there. This seems an appropriate response as no deal is yet signed, but at least it appears things are moving in the right direction. In the meantime, UK data showed that Q3 GDP growth is on track for a slightly better than expected outcome of 0.7% for the quarter (not an annualized figure).

As to the other ongoing story, there has been no change in the tone of rhetoric from the Italian government regarding its budget, but there are still five days before they have to actually submit it to their EU masters. It remains to be seen how this plays out. As I type, the euro has edged up 0.15% from yesterday’s close, but taking a step back, it is essentially unchanged for the past week. If you recall, back in August there was a great deal of discussion about how the dollar had peaked and that its decline at that time portended a more significant fall going forward. At this point, after the dollar recouped all those losses, that line of discussion has been moved to the back pages.

Turning to the emerging markets, Brazil remains a hot topic with investors piling into the real in expectations (hopes?) of a Bolsonaro win in the runoff election. That reflected itself in yet another 1.5% rise in the currency, which is now higher by more than 10% over the past month. The China story remains one where the renminbi seems to be on the cusp of a dangerous level, but has not yet fallen below. Equity markets there took a breather from recent sharp declines, ending the session essentially flat, but there is still great concern that further weakness in the CNY could lead to a sharp rise in capital outflows, or correspondingly, more draconian measures by the PBOC to prevent capital movement.

But after those two stories, it is harder to find something that has had a significant impact on markets. While Pakistan just reached out to the IMF for a $12 billion loan, the Pakistani rupee is not a relevant currency unless you live there. However, this issue is emblematic of the problems faced by many emerging economies as the Fed continues to tighten policy. Excessive dollar borrowing when rates were low has come back to haunt many of these countries, and there is no reason to think this process will end soon. Continue to look for the dollar to strengthen vs. the EMG bloc as a whole.

This morning brings our first real data of the week, PPI (exp 2.8%, 2.5% ex food & energy). However, PPI is typically not a market mover. Tomorrow’s CPI data, on the other hand, will be closely watched for signs that inflation is starting to test the Fed’s patience. But for now, other than the Brexit news, which is the first truly positive non-dollar news we have seen in a while, my money is on a quiet session with limited FX movement. The only caveat is if we see significant equity market movement, whereby a dollar reaction would be normal. This is especially so if equities fall and so risk mitigation leads to further dollar buying.

Good luck
Adf

Growth Would Be Marred

The IMF’s Christine Lagarde
Explained global growth would be marred
By tariffs imposed
Which keep borders closed
To products that ought not be barred

The dollar has continued its recent ascent this morning, edging higher still against most of its counterparts as US interest rates continue to climb. In fact, as I type, the 10-year Treasury has breached 3.25% for the first time in more than seven years, and quite frankly, there is no reason to think this trend is going to stop. Rather, given the significant amount of new issuance that will be required by the Treasury Department, and the fact that the Fed is reducing the amount of bonds that it purchases as it shrinks its balance sheet, we should expect to see yields continue higher. Back in January I forecast that the 10-year yield would reach 4.00% by the end of the year. For the longest time that seemed impossible, but while still a difficult conclusion, given the speed with which yields have risen recently, it doesn’t seem quite as far-fetched as it used to.

At any rate, the market stories today are largely the same as those from yesterday. Perhaps the key headline was the IMF announcement that they had reduced their estimates for global growth for 2018 and 2019 by 0.2% to 3.7% for both years. The key change since their last estimate was the increased trade tensions between the US and China and the estimated impact those will have on nations around the globe. However, they did not adjust their estimate of US growth, which is likely to encourage the Trump Administration to continue down the path of further tariffs in their negotiation strategy.

Beyond that story, we are still in the grips of the Italian budget situation, where there has been no indication that the coalition government is going to adjust policy to reduce the projected deficit. Given that every one of these situations in Europe turns into a game of chicken, it is probably too early to assume no solution will be found. However, it is important to remember that DiMaio and Salvini, the heads of the 5-Star and League parties respectively, and the real power in the government, are both anti-establishment, and there appears to be a very real chance that they ignore the European Commission and the EU rules. Certainly the Italian stock and bond markets are concerned over that outcome, as 10-year yields there have risen another 10bps while the FTSE MIB has fallen a further 0.5%. This process will continue to weigh on the euro for now so it should be no surprise that the single currency has fallen by 0.5% this morning. But arguably it is not only the Italian situation impacting the euro, we also saw German trade data, which reported a significant decline in imports, -2.7%. While this did result in an increased trade surplus, sharply falling imports is not a sign of economic strength, and so this was likely not seen as a positive. Net, the combination of ongoing tighter US monetary policy and stalling growth in Europe should help underpin the dollar going forward.

Looking at the rest of the G10 space, the dollar is firmer virtually across the board, with the only exception the Japanese yen, which is flat on the day. Though some may argue that slightly better than expected Economy Wathers Survey data helped, this appears to me to be a consequence of a broader risk-off sentiment that is sweeping the markets. A stronger dollar and a stronger yen are natural consequences of this mentality. What is interesting, however, is that two other natural haven assets, gold and Treasuries, are not performing in the same way. I think the explanation for both is the same: higher US short term rates, now above 2.0% across products, is of sufficient attraction to draw frightened investors into Treasury bills rather than taking the risk of a 10-year note. As well, now that cash earns a return, the opportunity cost of holding gold has increased substantially. Given this situation, it appears there is much further to go for the dollar, as fear will drive investors to short term dollar holdings. With this in mind, I suspect we will hear much less about an inverting yield curve for a time. After all, given the sharp rise in 10-year yields and the increased demand for short term assets, it will be very hard for that to occur.

Flipping to emerging markets, the dollar is broadly stronger here as well, across all three regions. In fact, the only noteworthy exception is BRL, which rallied 1.5% yesterday in the wake of the results of Sunday’s presidential election. It is clear that the market remains highly in favor of a President Bolsonaro there, and I expect that as we approach the run-off vote in three weeks’ time the real will continue to perform well. However, this movement has all the earmarks of a ‘buy the rumor, sell the news’ scenario, which means that a sharp dollar rally could well result in the wake of the run-off vote no matter who wins. Granted, if Fernando Haddad, the left wing candidate wins, I would expect the real’s decline to be much sharper.

Away from that, USDCNY is trading above 6.93 today as the Chinese continue to try to ease policy domestically without causing too much market turmoil. While the Trump Administration is apparently looking at naming China a currency manipulator in the latest report due shortly, given the dollar’s overall strength, it appears to me that the movement is entirely within the confines of the overall market. Quite frankly, it still seems as though the Chinese are quite concerned about a ‘too-weak’ renminbi as a trigger to an increase in capital outflows, and so will prevent excessive weakness for now. That said, I expect CNY will continue to weaken going forward.

And that’s really it for today. The NFIB Small Business Optimism Report was released at 107.9, softer than expected but still tied for the second highest reading of all time. Confidence in the economy remains strong. All we have for the rest of the day are speeches by Chicago Fed President Evans and NY’s John Williams. However, given what we have heard lately and the dearth of new news likely to change opinions, it beggars belief to think that anything new will come from these comments. In other words, there is nothing standing in the way of the dollar continuing to rise on the back of ever tighter US monetary policy.

Good luck
Adf

Both Flexed Their Muscles

In China more policy ease
Did nothing to help to appease
The stock market bears
Who unloaded shares
Along with their spare RMB’s

Then tempers between Rome and Brussels
Got hotter as both flexed their muscles
The latter declared
The budget Rome shared
Was certain to cause further tussles

This morning the dollar has resumed its uptrend. The broad theme remains that tighter US monetary policy continues to diverge from policies elsewhere around the world, and with that divergence, dollar demand has increased further.

China’s weekend action is the latest manifestation of this trend as Sunday they announced a one-percentage point cut in the Required Reserve Ratio (RRR) for all banks. This should release up to RMB 1.2 trillion (~$175billion) of liquidity into the market, helping to foster further economic activity, support the equity markets and keep a lid on interest rates. At least that’s the theory. Alas for the Chinese, whose markets were closed all of last week for national holidays, the Shanghai Composite fell 3.7% on the day, as they caught up with last week’s global equity market decline. It is not clear if the loss would have been greater without the RRR cut, but one other noteworthy feature of the session was the absence of any official attempts to support the market, something we have seen consistently in the past. It ought not be surprising that the renminbi also suffered overnight, as it fell nearly 0.5% and is now trading through the 6.90 level. If you recall, this had been assumed to be the ‘line in the sand’ that the PBOC would defend in an effort to prevent an uptick in capital outflows. As it is just one day, it is probably too early to make a judgment, but this bears close watching. Any acceleration higher in USDCNY will have political repercussions as well as market ones.

Speaking of political repercussions, the other noteworthy story is the ongoing budget saga in Italy. There has been no backing down by the populist government in Rome, with Matteo Salvini going so far as to call Brussels (the EU) the enemy of Italy in its attempts to impose further austerity. The Italians are required to present their budget to the EU by next Monday, and thus far, the two sides are far apart on what is acceptable for both the country and EU rules. At this point, markets are clearly getting somewhat nervous as evidenced by the ongoing decline in Italian stock and bond markets, where 10-year yields have jumped another 15bps (and the spread to German bunds is now >300bps) while the FTSE-MIB Index is down another 2.5% this morning. Given that this is all happening in Europe, it is still a decent bet that they will fudge an outcome to prevent disaster, but that is by no means a certainty. Remember, the Italian government is as antiestablishment as any around, and they likely relish the fight as a way to beef up their domestic support. In addition to the Italian saga, German data was disappointing (IP fell -0.3% vs. expectations of a 0.4% gain), and the combination has been sufficient to weigh on the euro, which is down by 0.4% as I type.

Beyond these stories, the other big news was the Brazilian election yesterday, where Jair Bolsonaro, the right wing candidate, came first with 46% of the vote, and now leads the polls as the nation prepares for a second round vote in three weeks’ time. The Brazilian real has been the exception to EMG currency weakness over the past month, having rallied nearly 9% during the last month. It will be interesting to see if it continues that trend when markets open there this morning, but there is no question that the markets believe a Bolsonaro administration will be better for the economy going forward.

Otherwise, the stories remain largely the same. Ongoing US economic strength leading to tighter Fed policy is putting further pressure on virtually all EMG currencies throughout the world. And it is hard to see this story changing until we see the US economy show signs of definitive slowing.

Turning to the upcoming week, data is sparse with CPI being the key release on Thursday.

Tuesday NFIB Business Optimism 108.9
Wednesday PPI 0.2% (2.8% Y/Y)
  -ex food & energy 0.2% (2.5% Y/Y)
Thursday Initial Claims 206K
  CPI 02% (2.4% (Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Michigan Sentiment 100.5

As to Fed speakers, we have three regional Fed Presidents (Evans, Williams and Bostic) speaking a total of seven times this week. However, it is pretty clear from comments lasts week that there is no indication the Fed is going to relax their view that gradually tighter policy is appropriate for now. The one thing that can derail this move would be much softer than expected CPI data on Thursday, but that just doesn’t seem that likely now. Look for the dollar to continue to trend higher all week.

Good luck
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