Dashing Hopes

Said Trump when he landed in London
Your Brexit deal needs to be undone
Because as it stands
We’ll never shake hands
On trade, dashing hopes ere they’ve begun

On Thursday, PM Theresa May has had yet another trying day. President Trump came to town and wasted no time skewering her recently outlined Brexit framework indicating that if the UK heads down her preferred road (you remember, trade in goods to remain within the EU umbrella, but services to be wide open) that the US would not be able to sign a free trade deal. Trump’s point, albeit indelicately made, is that a comprehensive trade deal with the UK will be impossible because the EU will be involved. And, as you may remember, Trump has several issues with the way the EU approaches trade. This was a terrible blow to May because she has clearly been counting on a deal with the US to help offset the changed status with the EU.

It should be no surprise that the pound did not take the news well and as I type, it is lower by 0.6% today and 1.7% this week. And this is despite the fact that Governor Carney virtually promised to raise rates at next month’s BOE meeting. We are still a long way from any resolution on the Brexit situation, and I continue to believe that uncertainty over the outcome will weigh on Pound Sterling. The pound remains some 12.5% below its levels prior to the Brexit vote two years ago. While it is still well clear of the lows seen at the beginning of last year (1.2000 or so) given my belief that there will be no Brexit deal signed, I expect that the market will return to those lows over time. Higher rates or not, confidence in the UK right now is somewhat lacking.

The other big news overnight was the Chinese data releases that showed that the trade surplus rose sharply to $41.6 billion with the US portion rising to a record $29 billion. This may be a timing issue with many companies anxiously shipping product ahead of the imposition of tariffs. But it also could simply reflect that the Chinese economy is slowing down, thus import growth is ebbing, while the US economy continues to power ahead and lead the global economy. In the end, I am certain that the Trump administration will look at these numbers and feel further justification in their stance on trade.

But on top of the trade data, Chinese Money Supply growth continues to ebb, a sign that economic activity on the mainland is slowing. Other indications of a Chinese slowdown are that the government’s campaign to reduce excess leverage seems to have gone into reverse. There have been several stories about how Beijing is now looking for local governments to insure they spend allocated money rather than worry about cutting back on new allocations. It seems that there is a growing fear that real GDP growth (not necessarily what is reported) is slipping more quickly than President Xi is prepared to accept. With this in mind, it is no surprise that the renminbi is under further pressure this morning, down 0.45%, and is now trading back at levels not seen since last August. And it has further to fall. I expect that we will be testing 7.00 before the year is over.

One last noteworthy item was yesterday’s CPI release, where headline CPI printed at 2.9%, its highest since 2012, and the ex food & energy number printed at 2.3%. What this tells us is that wage gains are barely keeping up with inflation, and so consumers are not really benefitting from the recent modest uptick we have seen there. We heard from both Chairman Powell and Philly President Harker yesterday and both indicated they were comfortable with the Fed’s current trajectory. Both also indicated that while the trade situation has not yet impacted the economy in any meaningful way, they could foresee how that might come about and cause the Fed to rethink their strategy. As of now, I remain in the four hikes this year camp, and will need to see a substantial change to the economic data to change that view.

Turning to the overnight FX performance, the dollar has continued its recent uptrend, rising against almost all its counterparts in both the G10 and the EMG. In fact, the dollar has risen every day this week, completely unwinding last week’s decline. There was a modest amount of data from the Eurozone, all pointing to the ongoing lack of inflation in the region, which continues to undermine the ECB’s case to normalize policy quickly. We also continue to see issues throughout emerging markets with TRY, for example, plummeting 6% this week as the market responds to President Erdogan’s cabinet moves. Remember, he installed his son-in-law as FinMin and ousted all the market friendly ministers in the cabinet. As I have written before, this currency has much further to fall.

Meanwhile, US equity markets continue to power ahead, well at least the big tech names continue to do so and that has been sufficient to drive the averages higher overall. However, market breadth continues to narrow which is always an ominous trend. Treasury yields have been stable in the 10-year space, but the 2-year continues to march higher and that spread is down to 26bps, edging ever closer to inversion. While I believe that the signaling effect this time is not quite the same due to the massive distortions in bond markets brought about by QE, I am in a minority view there.

In the end, the big trends remain intact, which means to me that the dollar is going to continue its march higher. Hedgers keep that in mind as you start to think about your 2019 hedging needs.

Today’s only data is Michigan Sentiment (exp 98.2) and then we hear from Atlanta Fed President Rafael Bostic. But given what we just heard from Harker and Powell (and Brainerd and Williams earlier in the week), there is no indication that the Fed is going to change its tune in the near future. The trend is your friend, and right now that trend is for the dollar to continue to rally.

Good luck and good weekend
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Now In Disarray

The saga of Minister May
Improved not one whit yesterday
When Boris resigned
Pound Sterling declined
And her party’s now in disarray

The news from the UK continues to dominate market headlines as less than twenty-four hours after the resignation of the Brexit Minister David Davis, Boris Johnson, a Brexit hardliner and Foreign Minister also resigned from PM May’s cabinet. While PM May replaced both men quickly, the problem is one of appearances in that she seems to be losing control over her government. The market’s immediate reaction was to sell the pound (it fell 0.7% yesterday after the news and has maintained those losses) as concerns over a leadership challenge and potentially a new election were brought to the fore. However, since then, it seems things have quieted down a bit and there is even talk that this could be a Sterling positive as it may result in a softer Brexit with less economic impact. In the meantime, this morning’s data showed that GDP has been rebounding from Q1’s flat reading, with the monthly May reading rising 0.3% and although IP data was soft (-0.4% in May), Construction was strong (+1.6%) and it appears that Governor Carney will still have enough ammunition to justify a rate increase next month. The risk to that outlook is if a leadership challenge emerges in Parliament and PM May is deposed. In that event, market participants may take a dimmer view of the near future depending on who replaces her.

Away from the British Isles, however, there is less excitement in the G10 economies. The big US news remains political with President Trump naming Brett Kavanaugh to replace retiring Supreme Court Justice Anthony Kennedy. However, on the economic front, there has been precious little news or commentary. In fact, until Thursday’s CPI reading, I expect the US story to be benign unless something surprising happens in the Treasury auctions beginning today, where the US is raising $69 billion via 3yr, 10yr and 30yr auctions.

From Germany we saw the ZEW surveys disappoint with the Sentiment Index falling to -24.7, its lowest print since December 2011 during the European bond crisis. This has encouraged a reversal in the euro, which is down 0.3% this morning after a week of gains. As well, the other, admittedly minor, Eurozone data also pointed to modest Eurozone weakness, thus giving the overall impression that the recent stabilization on the continent may be giving way to another bout of weakness. However, we will need to see more important data weaken to confirm that outcome. Certainly, Signor Draghi is convinced that the worst is behind them, but he has always been an optimist.

In the emerging markets, Turkey has once again stolen the headlines as President Erdogan named his son-in-law as Minister of Finance and Economics, thus following through on his threat promise to take firmer control over monetary policy. In the cabinet reshuffle he also removed the last vestiges of central banking experience so I would look for inflation in Turkey to start to really take off soon, and the currency to fall sharply. And that is despite the fact that it fell 3% yesterday after the announcement. In fact, I would look for more moves of that nature and a print above 5.00 in the not too distant future.

But other than that, while the dollar is stronger this morning, it is not running away. The broad theme today seems to be modest profit taking by traders who had been running short dollar positions, and so a bit of further strength would be no surprise. On the data front, the NFIB Small Business Optimism Index was released earlier at 107.2, stronger than expected and still showing that small businesses remain confident in the economic situation for now. The JOLTs jobs report comes at 10:00 and should simply confirm that the employment situation in the US remains robust. My gut tells me that modest further dollar strength is on tap for today, but really, barring a political bombshell, I expect that things will be very quiet overall. It is the middle of summer after all.

Good luck
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The Winsome Ms. May

The lady who leads the UK
Last night had a terrible day
Dave Davis resigned
And strongly maligned
The PM, the winsome Ms. May

Arguably the biggest news over the weekend was the sudden resignation last night of the UK Brexit Minister, David Davis, who decided he couldn’t countenance the outcome of Friday’s Cabinet meeting. The crux of that agreement was that the UK would continue to abide by EU food and manufacturing regulations after Brexit becomes final in March. Davis, who had campaigned for Brexit and was always seen as more of a hard-liner, thought this was too much of a concession, and heeded PM May’s general call to leave if he couldn’t get on board. While Dominic Raab, another pro-Brexit voice, quickly replaced him, the resignation has simply highlighted the ongoing uncertainties within the UK on the subject.

Markets, however, have remained surprisingly subdued on the news. It appears that traders are far more focused on how the BOE responds to the Brexit story than on the Brexit story’s daily twists and turns. And as of now, there has been no change in the view that the Old Lady is going to raise rates next month come hell or high water. Futures markets continue to price a more than 80% probability of that occurring. So in the end, despite a key political shakeup, the pound has actually rallied 0.45% and is now more than 2.2% clear of the nadir reached at the end of June. Perhaps the mindset is that PM May now has greater control over the cabinet and so is in a stronger position going forward which means that a soft Brexit will be the outcome. At least, that’s the best I can come up with for now.

Otherwise, the weekend has been extremely quiet. With that in mind I think a recap of Friday’s events is in order. The employment report was probably as good as it gets, at least from the Fed’s perspective. NFP increased a better than expected 213K and last month’s number was revised higher to 244K. The Unemployment Rate actually ticked higher to 4.0%, but that was because the Participation Rate rose as well, up to 62.9%, which while better than last month remains well below the longer-term historical trend. But for now, it demonstrates to the Fed that there is still some slack in the labor market, which means there is less concern that wage increases are going to spur much higher inflation. And the AHE data proved that out, rising 2.7% Y/Y, in line with both expectations and recent history. It seems the Fed is going to continue to focus on the shape of the yield curve rather than rising inflation, at least for now. If, however, we start to see some sharply higher inflation data (CPI is released this Thursday), that may begin to change some thinking there.

The other data Friday showed that the Trade deficit shrank to -$43.1B, it’s smallest gap since October 2016. This is somewhat ironic given that Friday was also the day that the US imposed tariffs on $34 billion of Chinese goods. It is too early to determine exactly how the trade situation will play out, although virtually every economist has forecast it will be a disaster for the US, and if it expands potentially for the world. That said, the equity markets have clearly spoken as Chinese stocks have fallen more than 20% in the past months, while US stocks have edged slightly higher. This story, however, has much further to go with there likely being many new twists and turns going forward.

Here in the middle of the summer, it is a light data week, with Thursday’s CPI clearly the highlight.

Today Consumer Credit $12.7B
Tuesday NFIB Small Biz Optimism 105.6
  JOLT’s Job Openings 6.583M
Wednesday PPI 0.2% (3.2% Y/Y)
  -ex food & energy 0.2% (2.6% Y/Y)
Thursday CPI 0.2% (2.9% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Michigan Sentiment 98.2

We also hear from four Fed speakers and we are at the point between meetings where there has been enough data for some views to have changed. However, my sense is there will be more discussion of the yield curve than of the economy as that has once again become a hot topic amongst a number of the regional Presidents.

Broadly the dollar has been under pressure overnight, continuing last week’s corrective price action. There has been some indication that data elsewhere in the world, especially in the Eurozone, has started to pick up again. If that trend continues, then I expect that the dollar will remain on its back foot. After all, its recent strength had been predicated on the idea that the US was continuing to show economic strength, diverging from the rest of the world’s near-term prospects. A change in that narrative will clearly change the FX story. However, it is not a foregone conclusion that is the outcome. I remain convinced that the dollar is likely to be the leader for quite a while yet.

Good luck
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