Past Its Shelf Life

The narrative most of this year
Described central banks full of fear
So rates they would cut
Which might help somewhat
But so far that hasn’t been clear

Instead every meeting’s been rife
With conflict, dissension and strife
For NIRP, the doves pine
While hawks like to whine
That policy’s past its shelf life

At the end of a week filled with numerous central bank meetings, it’s time to consider what we’ve learned. Arguably, the first thing is that groupthink in the central banking community is not quite as widespread as we previously believed. This was made evident by the three dissenting votes at the FOMC on Wednesday as well as last week’s ECB meeting, where at least five members of the council argued vociferously for no further stimulus. The funny thing is that while I understand the European monetary hawks’ zeitgeist, (German hyperinflation of the 1920’s) the fact remains that Europe is slipping into recession and arguably the ECB is correct in trying to address that. With that said, I would argue they would have been far better off extending the TLTRO’s to an even longer maturity and cut rates there, allowing banks to earn from the ECB while they lend to clients at a positive rate. Simply cutting the deposit rate to -0.50% is very unlikely to spur growth further, at least based on the fact that it has not helped yet.

At the same time, the FOMC also has a wide range of opinions on display. Not only were there two hawkish dissents, there was a dovish one as well. And based on the dot plot, after this cut, there are now ten of the seventeen members who see no further rate action in 2019. Meanwhile, the market is still pricing in a 69% probability of a cut by the December meeting. There was a comment by a famous hedge fund trader that Chairman Powell is the weakest chairman in decades, based on these dissents, but it was just three years ago, in the September 2016 meeting when Janet Yellen chaired the Fed, that there were also three dissents at a meeting, with all three seeking a rate hike, while the Fed stood pat. The point is, it is probably a bit unfair to be claiming Powell is weak because some members have different views. And in the big picture, shouldn’t we want a diversity of ideas at the Fed? I think that would make for a healthier debate.

Two other meetings stand out, the BOJ and the PBOC, or at least actions by those banks stand out. While the BOJ left policy on hold officially, they not only promised a re-evaluation of the current monetary policy framework, but last night, they significantly reduced the amount of JGB’s that they purchased in the longer maturities. The absent ¥50 billion surprised market players and helped drive the yields on the back end higher by between 3-4bps. The BOJ have made it clear that they are interested in a steeper yield curve, and that’s just what they got. Their problem is that despite decades of ZIRP and then NIRP, as well as a massive QE program, their inflation target remains as far away as ever. Last night, for example, CPI was released at 0.5% Y/Y ex fresh food, the lowest level since mid-2017. It seems pretty clear that their actions have been a failure for decades and show no sign of changing. Perhaps they could use a little dissent!

Finally, the PBOC cut its 1-year Loan Prime Rate (its new monetary benchmark) by 5bps last night, the second consecutive cut and an indication that they are trying to add stimulus without inflating any financial bubbles. While this move was widely anticipated, they did not change the level of the 5-year Rate, which was also anticipated. The overall difference here, though, is that the PBOC is clearly far less concerned with what happens to investors than most Western central banks. After all, they explicitly take their marching orders from President Xi, so the overall scope of policy is out of their hands.

When looking at the impact of these moves, though, at least in the currency markets, the thrust was against the grain of what was desired by the central banks. If you recall last week, the euro initially declined, but then rallied sharply by the end of the day after the ECB meeting and has largely maintained those gains. Then yesterday we saw JPY strength, with no reprieve overnight after their change of stance, while the renminbi has actually strengthened 0.2% overnight in the wake of the rate cut. As I have been writing, central banks are slowly losing their grip on the markets, a situation which I believe to be healthy, but also one that will see increased volatility over time.

Looking at the market activity overnight, the screen shows that one of the best performers was INR, with the rupee gaining 0.5%. This comes on the back of the government’s announced $20 billion stimulus plan of corporate tax cuts. While equity markets there responded joyfully, Sensex +5.3%, government bonds fell sharply, with 10-year yields rising 15bps as bond investors questioned the ability of the government to run larger deficits. But away from that, the FX market was quite dull. EMG currencies saw both gainers and losers, with INR the biggest mover. G10 currencies were pretty much the same story with NZD the biggest mover, falling 0.4% after S&P explained that New Zealand banks still had funding problems.

The other two big stories have had mixed impact, with positive trade vibes being felt as low-level talks between the US and China have been ongoing this week, while the UK Supreme Court is now done with its hearings and we all simply await the decision. At the same time, EC President Juncker sounded positive that a Brexit deal could be done although Ireland continues to claim that nothing is close. The pound rallied on Juncker’s comments, but fell back below 1.25 after Ireland weighed in. Ask yourself if you think the rest of the EU will tolerate a solo Irish dissent on getting to a deal. It ain’t gonna happen.

As to today’s session, there is no data to be released but we will hear from three Fed speakers, Williams first thing, then Rosengren and Kaplan. It will be interesting to see how they try to spin things as to the Fed’s future activities. With that in mind, the biggest surprise seems like it can come from the UK , if we hear from the Supreme Court later today. While there is no clarity when they will rule, it is not out of the question. As to the dollar, it has no overall momentum and I see no reason for it to develop any without a catalyst.

Good luck and good weekend
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Not the Nadir

The Chairman explained to us all
Preventing the ‘conomy’s stall
Required a cut
Of twenty-five but
Don’t look for, rates, further to fall

However, it’s not the nadir
For all rates, that’s certainly clear
Brazil cut a half
While BOJ staff
Will check if they’re now too austere

As I mentioned on Monday, the Fed was merely the first in a long list of major central banks meeting this week. By now we all know the FOMC cut rates by 25 bps and released a statement that was certainly more hawkish than many had hoped for expected. The vote was largely as expected, with the July dissenters, George and Rosengren, continuing to vote for no change, while this month, St. Louis Fed President James Bullard also dissented, voting for a 50bp cut. Of more interest was the dot plot, which showed five members forecasting no further cuts this year, five looking for one more cut and seven looking for two cuts. That is actually quite a bit more hawkish than expected going into the meeting. In the end, equity markets sold off initially, but rallied late in the day to close essentially unchanged. Treasuries rallied all day leading up to the meeting, but ceded those gains in the wake of the announcement and press conference while the dollar rallied against most currencies, although it has given back those gains overnight.

Powell’s explanation for cutting was that the committee was still concerned over issues like global growth, trade policy and Brexit, and so felt a cut was merited to help insure steady growth. My impression is Powell is not anxious to cut again, but arguably it will depend on how the data evolves between now and the October meeting.

Meanwhile, late yesterday afternoon the Central Bank do Brazil cut their SELIC rate by 50bps to 5.50%, a new record low for the rate, but also a widely expected move by the market. Inflation in Brazil continues to slow, and with growth extremely sluggish, President Roberto Campos Neto made clear that they expect inflation to remain quiescent and will do what they can to help bolster the economy there. Look for another 50bps this year and potentially more next year as well. It should be no surprise that the real weakened yesterday, falling 0.8%, and I expect it has further to fall as Neto was clear that a weaker currency would not deter him.

Then overnight we heard from a number of central banks with Bank Indonesia cutting the expected 25bps top 5.25%, while the HKMA also cut in order to keep step with the US. Both currencies, IDR and HKD, were virtually unchanged overnight as the market had fully priced in the moves. Arguably of more importance was the BOJ meeting, where they left policy unchanged, but where Kuroda-san explained that the BOJ would undertake a full review of policy by the October meeting to insure they were doing everything they could to support the economy. There were a number of analysts who were expecting a rate cut, or at least further QE, and so the disappointment led to a 0.5% rally in the yen.

When Europe walked in, there were three central bank meetings scheduled with the Swiss maintaining policy rates but adjusting the amount of reserves exempt from the deposit rate of -0.75%. While Swiss banks have been complaining about this, given there was already a tiered system it was not anticipated that things would change. The upshot is that the franc is firmer by 0.6% in the wake of the announcement, although traders are a bit on edge given the SNB was clear that intervention remained on the table.

The biggest surprise came from Norway, which hiked rates 25 bps to 1.50%. While several of the Norwegian banks were calling for the hike, the market at large did not believe the Norgesbank would raise rates while the rest of the world was cutting. But there you go, the situation there is that the economy is doing fine, inflation is perking up and because of the government’s ability to tap the oil investment fund, they are actually utilizing fiscal policy as well as monetary policy in their economic management. With all that in mind, however, they were pretty clear this is the last hike for the foreseeable future. NOK rallied 0.5% on the news, but it has given all those gains back and now sits unchanged on the day.

Finally, in what is no surprise at all, the BOE just announced that policy remains unchanged for the time being as all eyes turn toward Brexit and what will happen there. The UK also released Retail Sales data which was bang on expectations and so the pound remains beholden entirely to the Brexit situation.

Speaking of Brexit, today is the third day of hearings at the UK Supreme Court regarding the two lawsuits against the Johnson government’s decision to prorogue parliament for five weeks. If you recall, late Tuesday when word got out that the justices seemed to be very hard on the government, the pound rallied. Interestingly, this morning there are stories all over the press about how the likelihood of a no-deal Brexit seems to be growing quickly. Everybody is tired of the process and thus far, neither side has blinked. I maintain the EU will blink as the economic damage to Germany, the Netherlands and Ireland adding to the entire EU’s economic malaise will be too much to tolerate. But we shall see. As I have been typing, the pound has been edging lower and is now down 0.2% on the day, but in the big picture, that is the same as unchanged.

Turning to this morning’s US data, we start with Philly Fed (exp 10.5) and Initial Claims (213K) and then at 10:00 see Existing Home Sales (5.38M). Yesterday’s housing data, starts and permits, were much better than expected, which given the sharp decline in mortgage rates and still robust employment situation, should not be that surprising. As to Fed speakers, there is no one on tap for today, but three (Williams, Rosengren and Kaplan) due to speak tomorrow. Equity futures are pointing slightly lower right now and if I had to guess, the dollar is more likely to rally slightly than not as the day progresses although large moves are not on the cards.

Good luck
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The Question at Hand

There is an old banker named Jay
Who’ll cut Fed Funds later today
The question at hand
Is, are more cuts planned?
Or is this the last one he’ll weigh?

Well, no one can describe the current market situation as dull, that’s for sure! The front burner is full of stories but let’s start with the biggest, the FOMC announcement and Chairman Powell’s press conference this afternoon. As of now, futures markets are fully pricing in a 25bp cut this afternoon, with a small probability (~18%) of a 50bp cut. They are also pricing in a 50% chance of a cut at the October meeting, so despite the hawkish rhetoric and relatively strong data we have seen lately, the doves are keeping the faith. In fact, it would be shocking if they don’t cut by 25bps, although I also expect the two regional Fed presidents (George and Rosengren) who dissented last time to do so again. What has become clear is that there is no overriding view on the committee. The dot plot can be interesting as well, as given there are only two meetings left this year, it will give a much better view of policy preferences. My guess is it will be split pretty evenly between one more cut and no more cuts.

Then it’s all on Chairman Jay to explain the policy thinking of the FOMC in such a way that the market accepts the outcome as reasonable, which translates into no large moves in equity or bond markets during or after the press conference. While, when he was appointed I had great hopes for his plain spoken comments, I am far less confident he will deliver the goods on this issue. Of course, I have no idea which way he will lean, so cannot even guess how the market will react.

But there’s another issue at the Fed, one that is being described as technical in nature and not policy driven. Yesterday saw a surge in the price of overnight money in the repo market which forced the Fed to execute $53 billion of repurchase agreements to inject cash into the system. It turns out that the combination of corporate tax payments in September (removing excess funds from the banking system and sending them to the Treasury) and the significant net new Treasury issuance last week that settles this week, also in excess of $50 billion, removed all the excess cash reserves from the banking system. As banks sought to continue to manage their ordinary business and transactions, they were forced to pay up significantly (the repo rate touched 10% at one point) for those funds. This forced the Fed to execute those repos, although it did not go off smoothly as their first attempt resulted in a broken system. However, they fixed things and injected the funds, and then promised to inject up to another $75 billion this morning through a second repo transaction.

It seems that the Fed’s attempt at normalizing their balance sheet (you remember the run-off) resulted in a significant drawdown in bank excess reserves, which are estimated to have fallen from $2.8 trillion at their peak, to ‘just’ $1.0 trillion now. There are a number of economists who are now expecting the Fed to begin growing the balance sheet again, as a way to prevent something like this happening again in the future. Of course, the question is, will this be considered a restarting of QE, regardless of how the Fed tries to spin the decision? Certainly I expect the market doves and equity bulls to try to spin it that way!

Ultimately, I think this just shows that the Fed and, truly, all central banks are losing control of a process they once felt they owned. As I have written before, at some point the market is going to start ignoring their actions, or even moving against them. Last week the market showed that the ECB has run out of ammunition. Can the same be said about Powell and friends?

Moving on to other key stories, oil prices tumbled ~6% yesterday as Saudi Arabia announced that 41% of their production was back on line and they expected full recovery by the end of the month. While oil is still higher than before the attacks, I anticipate it will drift lower as traders there turn their collective focus back toward shrinking growth and the potential for a global recession. Chinese data continues to look awful, Eurozone data remains ‘meh’ and last night Tokyo informed us that their trade statistics continued to deteriorate as well, with exports falling 8.2%, extending a nearly year-long trend of shrinking exports. The point is, if the global economy continues to slow, demand for oil will slow as well, reducing price pressures quite handily. In a direct response to the declining oil price we have seen NOK fall 0.5% this morning, although other traditional petrocurrencies (MXN, RUB) have shown much less movement.

On the Brexit story, Boris met with European Commission President, Jean-Claude Juncker on Monday, and while he spun the meeting as positive, Juncker was a little less optimistic. His quote was the risk of a no-deal Brexit was now “palpable” while the EU’s chief Brexit negotiator, Michel Barnier, said, “nobody should underestimate the damage of a no-deal Brexit.” It should be no surprise the pound fell after these comments, but that is a very different tone to yesterday’s NY session. Yesterday, we saw the pound rally more than a penny after word got out that the UK Supreme Court justices were ostensibly very skeptical toward the government’s argument and sympathetic to the plaintiffs. The market perception seems to be that a ruling against the government will essentially take a no-deal Brexit off the table, hence the rally, but that is certainly not this morning’s tale. In the end, the pound remains binary, with a deal of any sort resulting in a sharp rally, and a hard Brexit on Halloween, causing just the opposite. The UK hearings continue through tomorrow, and there is no official timeline as to when an opinion will be released. I expect the market will continue to follow these tidbits until the announcement is made. (And for what it’s worth, my sense is the Supremes will rule against the government as based on their biographies, they all voted remain!)

Finally, a look at the overnight data shows that UK inflation fell to its lowest level, 1.7%, since December 2016. With the BOE on tap for tomorrow, it beggars belief they will do anything, especially with Brexit uncertainty so high. At the same time, Eurozone inflation was confirmed at 1.0% (0.9% core), another blow to Signor Draghi’s attempts to boost that pesky number. As such, the euro, too, is under some pressure this morning, falling 0.25% after yesterday’s broad dollar sell-off. In fact, vs. the G10, the dollar is higher across the board, although vs. its EMG counterparts it is a much more mixed picture.

Ahead of the FOMC at 2:00 we see Housing Starts (exp 1250K) and Building Permits (1300K), but they will not excite with the Fed on tap. Equity markets are modestly higher in Europe though US futures are pointing slightly lower. Overall, barring something from the UK ahead of the Fed, I expect limited activity and then…

Good luck
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Gone To Extremes

In England, the Court of Supremes
Will soon rule on Boris’s dreams
He thought it a breeze
To prorogue MP’s
But they think he’s gone to extremes

Meanwhile oil markets are stressed
With traders, quite rightly, obsessed
‘bout all of the facts
From last week’s attacks
And if a response will be pressed

As New York walks in this morning, markets are still on edge regarding the unprecedented attack on Saudi oil infrastructure over the weekend. Yesterday’s price action saw oil close higher by more than 13%, although this morning WTI has backed off by $1.00/bbl or 1.5%. The short-term issue is how long it will take the Saudis to restore production. Initial estimates seemed a bit optimistic, and the latest seem to be pointing to at least several months before things are back. The long-term issue is more focused on supply disruption risk, something which the market had essentially removed from prices prior to yesterday. It seems that the ongoing problems in Venezuela and Libya, where production gets shuttered regularly, had inured the market to the idea that a short-term disruption would impact prices. After all, oil prices are still well below levels seen a year ago. Now all the talk is how the oil market will need to permanently price in a risk assessment, meaning that prices will default higher. I challenge that view, though, as history shows traders and investors have very short memories, and I would estimate that once the Saudi production is back up and running, it will only be a matter of months before any risk premium is removed. This is especially true if the global growth story continues to deteriorate meaning oil demand will diminish.

The other story of note comes from the UK, where two separate lawsuits against PM Johnson’s act to prorogue (suspend) parliament for five weeks leading up to the Brexit deadline are to be heard by the UK Supreme Court. The government’s argument is that this is not a legal matter, but a political one, and therefore is fine. Of course, Brexit opponents are doing everything they can to prevent Boris from his stated intentions of leaving on October 31 ‘come hell or high water.’ The thing is, unlike the US, where we have a written constitution, there is no such document in the UK. The upshot is twelve unelected officials will be making what may be the most momentous decision in UK history based solely on their personal views of the law, and no doubt, Brexit. And while I am in no way trying to disparage this group, who I am certain are all well-deserved of their roles, the fact that there is neither a guiding document nor precedence results in the opportunity for whichever side loses the argument to scream quite loudly, and I’m sure they will!

A funny thing about this situation is that if the Supremes declare the prorogation illegal, I think the market will see that as a sign that a no-deal Brexit is now off the table completely. And you know what that means for the pound, a significant rally. So for all of you Sterling hedgers out there, the next several days are going to be critical. Hearings are scheduled to take place through Thursday with a decision possible as early as Friday, although more likely next week. So gaming out possible scenarios consider the following choices: 1) Supreme Court (SC) rules against the government and parliament reconvenes => pound rallies sharply, probably back toward 1.30 as markets assume Brexit is dead; 2) SC rules government is within its rights to prorogue parliament for an extended time => pound sells off back to 1.20 as chance of no-deal Brexit grows. Remember, however, that the law in the UK is now that the PM must ask for an extension if there is no deal by the October 18 EU summit. The question, of course, is whether Boris will do so despite the political consequences of not asking, and whether the EU will grant said extension. The latter is not a given either.

With all of that ongoing, the FOMC begins their two-day meeting this morning with the market convinced that they will be cutting rates by 25 bps tomorrow afternoon. Changes to the narrative of late have shown a reduced expectation for a December rate cut, now 53% from more than 90% earlier in the month. Doves will certainly point to the rise in geopolitical risks from the attacks on Saudi oil infrastructure this weekend while hawks will continue to point to solid US data. However, that is a discussion for tomorrow morning.

Turning to market activity overnight, risk is definitely under pressure this morning as most haven type bonds (Treasuries, Bunds, Gilts, etc.) have rallied while Italy, Spain and Portugal have all seen yields rise. Equity markets are somewhat softer, although by no means collapsing, and the dollar is generally, though not universally, stronger. In the G10 space, the Skandies are under the most pressure, with both SEK and NOK falling about 0.4%, as the former is suffering after a terrible employment report which saw the Unemployment Rate rise to 7.4%, rather than decline to 6.8%. NOK, meanwhile, seems to be tracking the price of oil. In the EMG space, KRW was the big loser, still suffering over the much weaker than expected Chinese data and concerns over slowing growth in the economy there.

Data early this morning showed the German ZEW falling more than expected to -19.9, simply highlighting the problems in Germany and increasing the likelihood that the nation enters a technical recession this quarter. Yesterday’s Empire Manufacturing data was a touch weaker than expected, but hardly disastrous. This morning we see IP (exp 0.2%) and Capacity Utilization (77.6%), neither of which is likely to move markets. At this point, it is difficult to make the case for significant movement today as market participants will be waiting for tomorrow’s FOMC decision. Look for a dull one, but with a chance of fireworks on the horizon.

Good luck
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Much Dissension

The market has turned its attention
To Draghi to see if he’ll mention
More buying of bonds
Or if he responds
To those who expect much dissension

While there were fireworks galore yesterday in London, where the UK Parliament had their last meeting before prorogation, this morning sees a much calmer market attitude overall. In brief, Boris did not fare well yesterday as he was unable to achieve his goal of a snap election while Parliament passed a law requiring him to ask for an extension on Brexit if there is no deal at the deadline. (I wonder what will happen if he simply chooses not to do so as that seems entirely feasible given the situation there). The market has absorbed the past several days’ activities with increasing amazement, but ultimately, FX traders have started to price out the probability of a hard Brexit. This is clear from the pound’s nearly 3.0% rally in the past week. While much will certainly take place during the next five weeks of prorogation, notably the party conferences, it would seem the only true surprise can be that a deal has been agreed, at which point the pound will be much higher. I don’t foresee that outcome, but it cannot be ruled out.

With Brexit on the back burner, the market is moving on to the trio of central bank meetings over the next nine days. This Thursday we hear from Signor Draghi while next week brings Chairman Powell on Wednesday and then Governor Carney on Thursday. What makes the ECB meeting so interesting is the amount of pushback that Draghi and his fellow doves have received lately from the northern European hawks. While it is never a surprise that the Germans or Austrians remain monetary hawks, it is much more surprising that Franҫois Villeroy de Galhau, the French ECB member and Governor of the Bank of France, has also been vocal in his rejection of the need for further QE at this time. The issue breaks down to whether the ECB should use its very limited arsenal early in an effort to prevent a broader economic downturn, or whether they should wait until they see the whites of recession’s eyes before acting. The tacit admission from this argument is that there is only a very limited amount of ammunition left for the ECB, despite Draghi’s continuous comments that they have many things they can do if necessary.

Unlike the FOMC or most other central banks, the ECB tries not to actually vote on policy, but rather come to a consensus. However, in this case, it may come to a vote, which would likely be unprecedented in and of itself. It would also highlight just how great the split between views remains, and implies that Madame Lagarde, when she takes the reins on November 1st, will have quite a lot of work ahead if she wants to continue along the dovish path.

In the doves’ favor is this morning’s data releases which showed French IP rebounding less than expected from last month’s disastrous reading (0.3%, -0.2% Y/Y) and Italian IP falling more sharply than expected (-0.7%). Meanwhile, after better than expected GDP data yesterday, the UK employment situation also showed a solid outcome with the Unemployment Rate falling back to 3.8% while earnings rose 4.0%, their highest rate since 2008.

And what did this do for currencies? Well, in that respect neither of these data points had much impact. The euro is lower by a scant 0.1% while the pound is essentially unchanged on the day. In fact, that is a pretty good description of the day overall, with the bulk of the G10 trading +/-0.20% from yesterday’s closing levels although the Skandies have seen more substantial weakness (SEK -0.8%, NOK -0.6%). In both cases, CPI was released at softer than expected levels (SEK 1.4%, 1.6% core; NOK 1.6%, 2.1% core) for August, which puts a crimp in the both central banks’ goal to push interest rates higher by the end of the year.

Turning to emerging markets, the largest movers have been ZAR which gained 0.5% after Factory Output fell a less than expected 1.1% and hope springs eternal for further stimulus driving bond investment. In second place was the renminbi, which has gained 0.25% overnight after the government there, in the guise of SAFE, removed barriers for investment in stocks and bonds. Clearly China has been trying to increase the importance of the renminbi within global financial markets, and allowing freer capital flow is one way to address that concern. However, this process has been ongoing for more than 20 years which begs the question, why now? It is quite reasonable to estimate that the continued pressure being applied by the US via the tariffs and trade war are forcing China to change many things that they would have preferred to keep under their own control. And while it is certainly possible they would have done this anyway, history suggests that the Chinese do not willingly reduce their control over any aspect of the economy. Just a thought. At any rate, initially this freedom is likely to see an inflow of assets as most investors and fund managers are underweight Chinese assets. The newfound ability to move funds in and out is likely to see an inflow to start, with corresponding CNY strength.

Beyond those stories though, it has been pretty dull. Treasury yields are lower by just 1bp, hardly the stuff of a risk assessment, while equity markets are slightly softer after a mixed, but basically flat, day yesterday. At this point, the market is looking toward Signor Draghi, who given futures markets are pricing a 100% chance of a 10bp cut and a 50% chance of a 20bp cut, along with a strong probability of the restarting of QE, has the chance to significantly disappoint. If that is the case, look for the euro to rally quickly, although a move of more than 1.0%-1.5% seems unlikely.

As for today, the NFIB Small Business Optimism Index was released at a bit worse than expected 103.1, perhaps indicating the peak is behind us (certainly my view) and at 10:00 we see the JOLTS Job Opening report (exp 7.331M). But it is really shaping up to be a quiet one with everyone thinking about the ECB until Thursday morning.

Good luck
Adf

Not Making Hay

In China, despite what they say
The ‘conomy’s not making hay
Their exports are lagging
With industry gagging
On stuff manufactured each day

The upshot’s the PBOC
Released billions of renminbi
Reserve rates are shrinking
And everyone’s thinking
They’ll shrink further ere ought twenty

Long before trading started last evening, Chinese trade data set the tone for the markets as exports there shrank by 1.0% in USD terms, a clear indication that the trade war is starting to bite. Imports fell further (5.6%), but overall, the trade surplus was significantly smaller than expected. In the current market environment, it cannot be a surprise that the response was for a rally in Asian equity markets as the weak data presages further policy ease by the Chinese. In fact, there are numerous articles discussing just what options they have. Friday afternoon they cut the reserve ratio by a full percentage point, and analysts all over are expecting at least one more cut before the end of the year. As to direct interest rate cuts, that is far less clear given the still problematic bubble tendencies in the Chinese real estate market. The PBOC is quite concerned over allowing that bubble to blow up further, so any reductions in the benchmark rate are likely to be modest…at least until the renminbi starts to strengthen again.

Speaking of the currency, while it has remained quite stable overall, -0.2% this morning, +0.65% in the past week, it remains one of the easiest tools for the PBOC to utilize. The government there has also sought to stimulate via fiscal policy, with significant tax cuts proposed and some implemented, but thus far, those have not been effective in supporting economic growth. While I am confident that when the next GDP number prints in mid-October it will be above 6.0%, there are an increasing number of independent reports showing that growth there is much slower than that, with some estimates more in line with the US at 3.0%. At any rate, equity markets continue to believe that a trade deal will happen sooner rather than later, and as long as talks continue, look for a more positive risk attitude across markets.

The other big news this morning is from the UK, where British PM Boris Johnson met with his Irish counterpart, Taoiseach Leo Varadkar, to discuss how to overcome the Irish backstop conundrum. It is interesting to see the two attitudes; Boris quite positive, Leo just the opposite, but in the end, nothing was agreed. In this instance, Ireland is at far more risk than the UK as its much smaller economy is far more dependent on free access to the UK than vice versa. But thus far, Varadkar is holding his ground. Another Tory cabinet member, Amber Rudd, quit Saturday night, but Boris is unmoved. There was an interesting article over the weekend describing a possible way for Boris to get his election; he can call for a no-confidence vote in his government, arguably losing, and paving the way for the election before the Brexit deadline. Certainly it seems this would put parliament in an untenable position, support him to prevent the election, but that would imply they support his program, or defeat him and have the election he wants.

Of course, while all this is ongoing, the currency market is looking at the pound and trying to decide the ultimate outcome. For the past two weeks, it is clear that a belief is growing there will be no Brexit at all as the pound continues to rally. This morning it is higher by 0.6% and back to its highest level in over a month. Part of that, no doubt, was the UK GDP data, which surprised one and all by showing a 0.3% gain in July, which virtually insures there will be no technical recession yet. But the pound is a solid 3.5% from its lows seen earlier this month. I continue to believe that the EU will blink and a deal will be cobbled together with the pound rebounding much further.

Elsewhere, the dollar is softer in most cases. The continuation of last week’s risk rally has reduced the desire to hold dollars and we continue to see yields edge higher as well. Beyond the pound’s rally, which is the largest in the G10 space, AUD and NZD have pushed back up by about 0.3% on the China stimulus story, but the rest of G10 is quite dull. In the EMG bloc, ZAR is today’s big winner, +0.8%, as hopes for more global stimulus increase the relative attractiveness of high yielding ZAR denominated bonds. But otherwise, here too, things are uninteresting.

Looking to the data this week, it is an Inflation and Retail Sales week with no Fed speak as they are now in their quiet period ahead of next week’s meeting.

Today Consumer Credit $16.0B
Tuesday NFIB Small Biz Optimism 103.5
  JOLT’s Job Openings 7.311M
Wednesday PPI 0.0% (1.7% Y/Y)
  -ex food & energy 0.2% (2.2% Y/Y)
Thursday Initial claims 215K
  CPI 0.1% (1.8% Y/Y)
  -ex food & energy 0.2% (2.3% Y/Y)
Friday Retail Sales 0.2%
  -ex autos 0.1%
  Michigan Sentiment 90.5

Aside from this, we hear from both the ECB and BOJ this Thursday with expectations for a rate cut and potentially more QE by Signor Draghi, while there are some thoughts that Kuroda-san will be cutting rates in Japan as well. Ultimately, nothing has changed the broad sweep of central bank policy ease. As long as everybody is easing, the relative impact of monetary policy on the currency market will be diminished. And that means that funds will continue to flow to the best performing economies with the best prospects. Despite everything ongoing, the US remains the choice, and the dollar should remain supported overall.

Good luck
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Run Off The Rails

In England and Scotland and Wales
The saga has run off the rails
So Boris is gambling
A vote will keep scrambling
Dissent and extend his coattails

Meanwhile market focus has turned
To data, where much will be learned
When payrolls are shown
And if they have grown
Watch stocks rise as havens are spurned

The Brexit story remains front page news as the latest twists and turns create further uncertainty over the outcome. Boris is pushing for an election to be held on October 15 so that he can demonstrate he has a sufficient majority to exit with no deal when the EU next meets on October 17-18, thus forcing the EU’s hand. However, parliament continues to do what they can to prevent a no-deal Brexit and have passed a bill directing the PM to seek an extension if there is no deal agreed by the current Halloween deadline. With that in hand, they will agree to a vote on October 29, thus not allowing sufficient time for a new government to do anything ahead of the deadline.

But Boris, being Boris, has intimated that despite the extension bill, he may opt not to seek that extension and simply let the UK leave. That would really sow chaos in the UK as it would call into question many constitutional issues; but based on the current agreement with the EU, that action may not be able to be changed. After all, even if the EU offers the extension, the UK must accept it, which seemingly Boris has indicated he won’t. Needless to say, there is no clarity whatsoever on how things will play out at this time, so market participants remain timid. The recent news has encouraged the view that there will be no hard Brexit and has helped the pound recoup 2.0% this week. However, this morning it is slipping back a bit, -0.3%, as traders and investors are just not sure what to believe anymore. Nothing has changed my view that the EU will seek a deal and cave-in on the Irish backstop issue, especially given the continuous stream of terrible European data.

To that point, German IP was released at a much worse than expected -0.6% this morning, with the Y/Y outcome a -4.2% decline. I know that Weidmann and Lautenschlager are ECB hawks, but it is starting to feel like they are willing to sacrifice their own nation’s health on the altar of economic fundamentalism. The ECB meeting next Thursday will be keenly watched and everything Signor Draghi says at the press conference that follows will be parsed. But we have a couple of things coming before that meeting which will divert attention. And that doesn’t even count this morning’s surprise announcement by the PBOC that they were cutting the RRR by 0.5% starting September 16 in an effort to ease policy further without stoking the real estate bubble there.

So let’s look at today’s festivities, where the US payroll report is released at 8:30 and then Chairman Powell will be our last Fed speaker ahead of the quiet period and September 18 FOMC meeting. Here are the current expectations:

Nonfarm Payrolls 160K
Private Payrolls 150K
Manufacturing Payrolls 5K
Unemployment Rate 3.7%
Average Hourly Earnings 0.3% (3.0% Y/Y)
Average Weekly Hours 34.4

Yesterday’s ADP number was much stronger than expected at 195K, but the employment data from the ISM surveys has been much weaker so there is a wide range of estimates this month. In addition, the government has been hiring census workers, and it is not clear how that will impact the headline numbers and the overall data. I think the market might be a little schizophrenic on this number as a good number could serve to reinforce that the economy is performing well enough and so drive earning expectations, and stocks with them, higher. But a good number could detract from the ongoing Fed ease story which, on the surface, would likely be a stock market negative. In a funny way, I think Powell’s 12:30 comments may be more important as market participants will take it as the clear direction the Fed is leaning. Remember, futures are pricing in certainty that the Fed cuts 25bps at the meeting, with an 11% probability they cut 50bps! And the comments we have heard from recent Fed speakers have shown a gamut of viewpoints exist on the FOMC. Interesting times indeed! At this point, I don’t think the Fed has the gumption to stand up to the market and remain on hold, so 25bps remains the most likely outcome.

As to the rest of the world, next week’s ECB meeting will also be highly scrutinized, but lately there has been substantial pushback on market and analyst expectations of a big easing package. Futures are currently pricing in a 10bp cut with a 46% chance of a 20bp cut. Despite comments from a number of hawks regarding the lack of appetite for more QE, the majority of analysts are calling for a reinstitution of the asset purchase program as soon as October. As to the euro, while it has edged higher this week, just 0.35%, it remains in a long-term downtrend and has fallen 1.6% this month. The ECB will need to be quite surprisingly hawkish to do anything to change the trend, and I just don’t see that happening. Signor Draghi is an avowed dove, as is Madame Lagarde who takes over on November 1. Look for the rate cuts and the start of QE, and look for the euro to continue its decline.

Overall, though, today has seen a mixed picture in the FX market with both gainers and losers in G10 and EMG currencies. Some of those movements have been significant, with ZAR, for example, rallying 0.75% as investment continues to flow into the country, while CHF has fallen 0.6% as haven assets are shed in the current environment. Speaking of shedding havens, how about the 10-year Treasury, which has seen yields rebound 15bps in two days, a truly impressive squeeze on overdone buyers. But for now, things remain generally quiet ahead of the data.

Given it is Friday, and traders will want to be lightening up any positions outstanding, I expect that this week’s dollar weakness may well see a modest reversal before we go home. Of course, a surprise in the data means all bets are off. And if Powell sounds remotely hawkish? Well then watch out for a much sharper dollar rally.

Good luck
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